Tracking banking in the Western Climate Initiative cap-and-trade program
We present a method for tracking the private bank of compliance instruments in the Western Climate Initiative cap-and-trade program, drawing on official market data. Banking metrics allow policymakers and the public to track the extent to which independent analysts’ concerns about allowance overallocation are manifesting in practice. Accordingly, we recommend that the California Air Resources Board include a banking metric in its official cap-and-trade reporting, as the Board currently does for its Low Carbon Fuel Standard program.
Our metric indicates that the private bank is already quite large. Approximately 108 million compliance instruments were held in private accounts at the end of 2017, beyond what market participants need for the 2015-2017 compliance period. So long as annual program caps remain above actual covered emissions and quarterly auctions continue to sell out—conditions that have held true so far in 2018—the private bank will continue to grow.
Our metric accounts for the fact that regulated emitters naturally seek to increase the number of compliance instruments they hold as a compliance deadline approaches. We measure only those instruments held in excess of outstanding compliance obligations, such that our banking metric is strictly independent from this natural market behavior.
In addition to tracking market health, banking metrics offer a basis for implementing program reforms that are conditional on market participants’ observed behavior. In reaction to excess allowance supply conditions, the RGGI and EU ETS carbon markets recently enacted dynamic program adjustments that reduce allowance supplies on the basis of observed banking outcomes. One advantage of dynamic program adjustments, such as those implemented in RGGI and the EU ETS, is that they tighten markets only if undesirable conditions manifest in practice: if the balance of market supply and demand stays within a desired range, no action is taken.
Dynamic cap adjustments enable regulators to avoid significant delays associated with waiting for lagged data to be released before beginning a lengthy rulemaking process to address any problems revealed by those data. As a result, a cap-and-trade program with dynamic cap adjustments has a higher likelihood of delivering desired emission reductions compared to one with a multi-year gap between detection of any problems and the completion of a responsive rulemaking process.