California’s “self-correcting” cap-and-trade auction mechanism does not eliminate market overallocation

Executive summary

In recent public statements, ARB staff have suggested that California’s “self-correcting” cap-and-trade auction mechanism will address overallocation—referring to a unique provision of the state’s market rules that removes unsold allowances from the auction supply after 24 months. In the auction collapse of 2016 and 2017, nearly 120 million allowances went unsold and are now being reintroduced for sale at current auctions. To the extent some hit the 24-month threshold and are removed from future auction supplies, this would tend to reduce risks related to overallocation.

Our calculations show this “self-correction” mechanism will help reduce the extent of overallocation in the cap-and-trade market, but will address only a fraction of the overallocation expected by 2020 (Figure 1).

Figure 1: Market overallocation in 2020 with auction “self-correction” mechanism (million allowances)

While the magnitude of the effect is small, the exact size of the “self-correcting” mechanism depends on whether or not auctions are fully subscribed in 2018 and 2019. A prominent estimate of overallocation from Energy Innovation’s Chris Busch included this mechanism and assumed that all auctions would sell out, resulting in an oversupply in 2020 of around 270 million allowances. Even if the remaining auctions are undersubscribed, we show here that, in a range of likely scenarios, at most 25 million additional allowances could be removed from the auction supply. While any assessment of overallocation should consider these potential effects, they are minor and do not eliminate the problem.