The latest auction in California's cap-and-trade market for greenhouse gases fell sharply below expectations, as buyers purchased just 2% of the carbon credits whose sale funds a variety of state programs -- notably, the proposed high-speed rail project.
The quarterly auction, conducted May 18 and announced Wednesday, will provide just $10 million for state programs, including $2.5 million for the bullet train. The rail authority had been expecting about $150 million.
The reason is unclear, but state officials and outside experts pointed to several possible causes: less need for the credits, pending litigation that may overturn the entire system and volatility spawned by speculators in a secondary trading market.
Whatever prompted the lack of buyers, the auction is a stark example of the uncertainty and risk of relying on actively-traded carbon credits to build the bullet train, a problem highlighted in recent legislative testimony by the Legislative Analyst's Office and a peer-review panel for the $64-billion high-speed rail.
The state rail authority is counting on the greenhouse gas fees to fulfill its legal obligation of matching about $3.5 billion in federal grants. The Federal Railroad Administration just last week modified one of its two grants to allow the state to spend all the federal money by next year but not match it with state funds until 2022.
The grant modification also allows the federal agency to extend a cash advance, needed by the rail authority to cover a cash-flow problem it has experienced. It is unclear whether the auction shortfall will exacerbate that cash-flow problem or worse, undermine the state's already-stretched financial plan.
The rail authority's recently released 2016 business plan had counted on getting about $10.6 billion from the greenhouse gas fees through 2050, about half of it by borrowing on the future income stream in about 2025. The plan drew warnings even before the auction that there are no assurances the market will generate the expected revenue or that private lenders would make loans vital to the project without demanding high-risk premiums on the interest rate.
H.D. Palmer, a spokesman for the California Department of Finance, said the current budget anticipated that the four quarterly auctions would raise $2.4 billion, with $600 million going to the rail project. Earlier auctions in this fiscal year met expectations, but the poor performance of the May 18 auction leaves the annual total at $1.8 billion, with $450 million going to rail.
But Palmer noted that there is a $500-million reserve set up in anticipation of volatility that could help close the gap. The use of that reserve will have to be agreed upon by Gov. Jerry Brown and the Legislature, he said.
In addition to the rail project, the fees provide funding for transit projects, affordable housing and other transportation programs.
The auction market is designed under the state's Global Warming Solutions Act to curtail the emission of carbon dioxide and other greenhouse gases. Companies or organizations that emit those gases have to buy credits issued by the Air Resources Board.
Buyers at the auction took just 785,000 of the 43 million allowances offered, each of which allow the emission of one metric ton of carbon dioxide. All the permits were bought at the floor price of $12.73.
But there is a secondary market, where the private parties who own the credits trade them daily. Those credits were recently priced at $12.34, well below the state floor in the auctions. It means that any company needing a credit could buy it more cheaply on the secondary market than in the auction.
"I don't think we know for sure what happened," said Ross Brown, an expert in the program at the Legislative Analyst's Office. "A lot of theories have been put forward."
One possible cause is that potential buyers believe a pending lawsuit could overturn the entire system. The California Chamber of Commerce is the lead plaintiff in a suit that contends the fees are a tax that was never authorized by the required two-thirds of the Legislature and that the law never specifically authorized the auctions. The state contends the fees are not taxes, but a consequence of regulations.
The lawsuit was filed years ago, however, well before the first auction. A judge recently asked a series of questions that perhaps fueled speculation that he might rule in favor of the suit.
Another serious possibility is that emitters of carbon dioxide are making better-than-expected progress at cutting their gas output. That would mean the program is more successful than expected, but the success would be a blow to the bullet train.
A third potential cause is that markets sometimes behave irrationally when buyers and sellers make wild swings in their behavior. David Clegern, a spokesman for the state Air Resources Board, said he believed the auction results reflected simple volatility.
If the auction results reflect a long-term shift in greenhouse gas revenue, it would raise new concerns about the viability of building the bullet train.
"This is an example of the kinds of uncertainty that we have identified," said Jessica Peters, a Legislative Analyst's Office expert on the bullet train who has testified before the Legislature.