Harnessing Carbon Value to Lower Costs in California

This issue brief examines how a small reform to the California carbon market could improve affordability by delivering billions of dollars to harden infrastructure, advance climate goals, and improve affordability in California. This reform kicks in only when allowance prices are low, harvesting emissions reductions when they are low cost.The state’s most impactful efforts to reduce greenhouse gas emissions have been sector-specific policies such as building standards, vehicle efficiency standards, the renewable portfolio standard, and other measures. In this context, the cap-and-trade program contributes a numerical carbon budget for covered sectors and generates revenues to the Greenhouse Gas Reduction Fund to fund investments.The cap-and-trade program also improves affordability by lowering cost.Although sector-specific policies have been effective in driving emissions reductions, the average cost per ton reduced by these policies has typically been greater than the cost of emissions reductions under the cap-and-trade program, as identified by the price of an emissions allowance. For instance, the 2022 Scoping Plan estimated average annual cost (2022-2035) per ton of emissions reductions under most regulatory measures would be multiple times greater than the price of an emissions allowance, which represents the marginal cost of emissions reductions motivated by the carbon market. An exception is the zero-emissions vehicle standard, another market-based mechanism, and measures to reduce vehicle miles traveled, which have negative costs.In other words, every emissions reduction motivated by the carbon market represents a cost savings for California.A reform that would further improve the cost effectiveness of California’s climate policy portfolio is the introduction of an Emissions Containment Reserve (ECR), which we describe below, and which exists in other robust carbon markets. We find that in 2023-24, improved market design through the introduction of an Emissions Containment Reserve would have collected nearly $1.5 billion in benefits for ratepayers and the state’s Greenhouse Gas Reduction Fund.An ECR would improve the contribution of emissions reductions from the cap-and-trade program in accelerating decarbonization of the state’s economy and boost ratepayer climate dividend and to the state’s Greenhouse Gas Reduction Fund. Moreover, this feature would be triggered only when allowance prices are low and when emissions reductions driven by the carbon market are less expensive than sector specific regulation, contributing in multiple ways to affordability in California. We identify several other benefits of an Emissions Containment Reserve including better alignment of the carbon market with the state’s overall climate policy portfolio, and reduced market uncertainty.