Using the Value of Allowances from California's GHG Cap-and-Trade System

The GHG cap-and-trade system is a key element of the policies designed to achieve California's ambitious goal of reducing GHG emissions to 1990 levels by the year 2020. The cap-and-trade program creates allowances necessary for regulatory compliance that become valuable because of their limited supply. Decisions about how to initially allocate these allowances have important consequences for the cap-and-trade program's environmental effectiveness, economic performance, and distributional impact.Regulators have three basic options for allocating allowances initially: allocating pre-determined fixed quantities for free (“fixed allocations”), allocating each year's allowances in proportion to recent actual production output (“updating output-based allocations”), and auctions. The choice among these alternatives does not directly affect environmental performance. Regardless of the choice of allocation method, aggregate emissions are limited by the emissions cap. However, allocation choices may indirectly affect emissions through emissions leakage if economic activity shifts to unregulated sources due to cap-and-trade costs. In the context of California's GHG cap-and-trade program, leakage is most likely to occur if all allowances are distributed through some combination of auctions and fixed allocations. Appropriately designed output-based allocations can reduce leakage and thus increase emission reductions achieved by AB 32 policies