Cap-And-Trade Auction Update and Ggrf Projections

analysis full gutter Cap-And-Trade Auction Update and GGRF Projections DECEMBER 2021 Revenue from quarterly cap-and-trade Summary of November 2021 auctions is deposited in the Greenhouse Gas Auction Results Reduction Fund (GGRF), and the funds are November 2021 Auction Generates allocated to various climate-related programs. In $1.3 Billion in GGRF Revenue. The California Air this post, we (1) summarize the results from the Resources Board (CARB) released a summary recent November 2021 cap-and-trade auction, of the results from the most recent quarterly (2)estimate future GGRF revenue and the amount cap-and-trade auction held on November 17, 2021. available for discretionary spending under three Based on the preliminary results, the state will different scenarios, and (3) identify issues for receive an estimated $1.3 billion in revenue from legislative consideration as it begins its 2022-23 the auction—the highest amount for any quarterly budget deliberations. auction in the program’s history. As shown in Figure 1, this amount is somewhat more than what the state received from the August 2021 auction ($1.1 billion). The change is due primarily to an increase in allowance prices. Allowances sold Figure 1 Quarterly Auction Revenue Has Increased Substantially (In Millions) $1,200 1,000 800 600 400 200 Feb May Aug Nov Feb May Aug Nov Feb May Aug Nov Feb May Aug Nov 2018 2019 2020 2021 Legislative Analyst’s Office 1 analysis full gutter for $28.26 at the current auction and $34.01 at allowance prices were consistently near the floor the advance auction, or about $5 and $10 higher, price, changes in quarterly cap-and-trade auction respectively, than the prices at the August auction. revenue were largely driven by differences in the The November prices were significantly higher than number of allowances that would sell at each the auction floor price established by CARB ($17.71 auction. In contrast, if allowance prices remain well for both vintages). above the floor price then all allowances will likely The increased revenue from higher allowance be sold at auctions in the next couple of years. prices was partially offset by a 4 million decrease Instead, the primary driver of revenue uncertainty in the number of state-owned allowances that is now related to future allowance prices. Based were offered (and sold). This change was driven on our understanding of market trends, the recent by the fact that the November auction sold about increase in allowance prices has at least partly 8 million allowances that previously went unsold in been driven by more “non-compliance” entities 2020 auctions, compared to 12 million allowances buying and selling allowances. For example, in the August 2021 auction. (The November auction investment firms are purchasing allowances with sold the last remaining batch of allowances that the expectation that prices will increase in the future went unsold in 2020.) and the allowances can be sold for a profit. As a result, future market prices will be determined, in Auction Generates $732 Million More Than part, by the behavior of these investment firms. This the 2021-22 Budget Assumes. The 2021-22 market dynamic makes it difficult to predict future budget for GGRF—approved in September 2021— allowance prices and GGRF revenue. assumes $2.8 billion in total auction proceeds, including $557 million from the November Stable Prices Would Generate Over $4 Billion 2021 auction. Based on the November auction in Total Annual Revenue. We estimate 2021-22 results, the state will generate about $732 million and 2022-23 auction revenue under three different more than the budget assumes. Under current allowance price scenarios, as shown in Figure 2: law, about 65 percent of this additional revenue • Stable Prices (Base Forecast). Under this ($439 million) will be continuously appropriated to scenario, allowance prices remain relatively high-speed rail (25 percent), affordable housing stable—growing at the rate of inflation—over and sustainable communities (20 percent), the remainder of the current and next fiscal transit capital (10 percent) and operations (5 percent), and safe Figure 2 drinking water (5 percent). (The continuous appropriation for Annual Auction Revenue Under safe drinking water is capped Different Allowance Price Scenarios at $130 million annually.) The (In Billions) remaining $293 million will be available for future discretionary $6 spending. As we discuss below, $5.7 future cap-and-trade auctions 5 $5.1 could also exceed 2021-22 4 $4.5 $4.2 budget assumptions and $3.7 generate additional revenue for 3 discretionary programs. 2021-22 Budget Act $2.7 2 GGRF Revenue Forecasts 1 and Funding for Discretionary Programs 2021-22 2022-23 Market Prices Have Become Drop to Price Floor Stable Prices Continued Price Growth the Primary Driver of Revenue Uncertainty. Historically, when Legislative Analyst’s Office 2 analysis full gutter years, resulting in more than $4 billion in total will be a key consideration in the Legislature’s GGRF revenue in each year. We consider upcoming budget deliberations.) this our base forecast because we think it As shown in Figure 3, under stable allowance is a more likely scenario than the other two prices, $2.1 billion would be available for scenarios that reflect dramatic changes in discretionary spending in 2022-23 and a reserve in allowance prices. the fund. (This includes $754 million carryover from • Drop to Price Floor. In this scenario, we current year.) Under alternative revenue scenarios, assume prices drop to the floor beginning the amount available for discretionary expenditures in February 2022 and remain there through and a reserve would range from $1.2 billion 2022-23. These prices would result in GGRF to $3 billion. By comparison, the approved revenues totaling $3.7 billion in 2021-22 and discretionary cap-and-trade expenditure plan is $2.7 billion in 2022-23. $1.5 billion in 2021-22. • Continued Price Growth. Under this Issues for Legislative Consideration scenario, prices increase to $40 in 2022 We will provide the Legislature with updated and $43 in 2023. Under this scenario, prices revenue forecasts in the coming months as more would be slightly below the first “containment information becomes available, including the results reserve” price, which is a design element of the cap-and-trade program that is intended to slow a rapid Figure 3 price increase. Revenues would exceed $5 billion in Summary of 2022-23 Funding Available both 2021-22 and 2022-23. Under Different Revenue Scenarios About $2 Billion Available (In Billions) for Discretionary Spending and/or Reserve in 2022-23. $8 Under current law, about Available for Discretionary Spending and Reserve 65 percent of auction revenue 7 Continuous Appropriations is continuously appropriated to Other Existing Commitments certain projects and programs. In addition, beginning in 2022-23, 6 the Legislature continuously appropriated $200 million annually $3.0 5 for forest health and wildfire prevention. This $200 million is taken “off the top” before 4 $2.1 calculating the other continuous appropriation percentages. The 3 remaining revenue is available for $1.2 appropriation by the Legislature through the annual budget for other 2 $3.5 ongoing funding commitments $2.6 (such as state administrative costs 1 $1.7 and statutory transfers), as well as discretionary spending programs. $0.3 $0.3 $0.3 (These funds do not count Drop to Price Floor Stable Prices Continued Price Growth toward the State Appropriations (Base Forecast) Limit which, as we discuss in our recent Fiscal Outlook, likely Legislative Analyst’s Office 3 analysis full gutter of future quarterly auctions. However, based on Depending on its spending priorities, the recent increases in allowance prices, we think Legislature could consider a variety of modifications the Legislature should begin to think about how to the continuous appropriations. For example, it might allocate a substantial increase in GGRF if the Legislature considers certain discretionary revenue. Below, we identify a few key issues for programs higher priority, it could give those the Legislature to consider as it begins its 2022-23 discretionary programs first call on future auction budget deliberations. revenue. This could be similar to the Legislature’s What Level of GGRF Reserve Is Needed to action to allocate $200 million “off the top” to Address Revenue Uncertainty? If the Legislature forest health and wildfire prevention as part of the assumes stable allowance prices, it might want to 2021-22 budget agreement. The Legislature could maintain a substantial reserve in the GGRF (also also consider allocating a specific annual amount known as a fund balance) in case revenue is lower to each continuously appropriated program, rather than expected. For example, in previous reports, than a set percentage of auction revenue. This we suggested a reserve of about 10 percent approach would provide a more consistent funding of estimated annual revenue is a reasonable amount for these programs. Plus, if annual revenue starting point. Under our base revenue forecast, continues to grow, this structure would allow the a 10 percent reserve would be slightly more than Legislature to use the annual budget process to $400 million—which would leave about $1.7 billion determine how to allocate the additional funding in available for discretionary programs. Alternatively, a way that best reflects its changing priorities. the Legislature could take a more conservative How Should the Legislature Allocate budgeting approach by allocating $1.2 billion Discretionary Funding? The Legislature will have to discretionary programs—a spending level to weigh many different spending priorities when that could be met even under a scenario where considering how to allocate discretionary funding. allowance prices drop to the floor price. If actual One important factor to consider is that the 2021-22 revenue available exceeds the budgeted level, the budget agreement included multi-year funding additional revenue would be deposited in the fund commitments, including for some programs that and allocated in future years. have received GGRF funding in prior years. For Do Continuous Appropriations Continue to example, as previously mentioned, the Legislature Reflect Legislative Priorities? When developing approved a $200 million GGRF continuous its cap-and-trade expenditure plan, the Legislature appropriation for forest health and wildfire resilience should consider the degree to which both for the next several years. In addition, the budget continuous appropriations and past discretionary agreement included multi-year zero-emission spending programs continue to be consistent vehicle funding package that includes General with its current priorities. Most of the continuous Fund allocations for low carbon transportation in appropriations were established as part of the 2022-23 and 2023-24. Many of these low carbon 2014-15 budget, and it is possible that legislative transportation programs previously received priorities have changed over the last several years. GGRF. (For more detail on these multi-year funding In addition, as revenues increase, continuous packages, see our post The 2021-22 Spending appropriations going to these programs would be Plan: Natural Resources and Environmental much higher than in prior years. Under our base Protection.) The Legislature will want to consider forecast, about $2.4 billion would be continuously the degree to which its 2022-23 cap-and-trade appropriated to these programs in 2022-23 (not expenditure plan should supplement these efforts including the $200 million continuous appropriation versus targeting other areas not already addressed for forest health and wildfire prevention). This in the packages. For example, other areas of focus is roughly twice the average annual continuous could include reducing local air pollution and appropriation provided in past years. The supporting climate adaptation activities. Legislature might want to consider whether these As we have emphasized in previous reports, appropriation levels continue to reflect its priorities. the Legislature is not limited to focusing its Legislative Analyst’s Office 4 analysis full gutter cap-and-trade expenditure plan on spending cap-and-trade’s incentive for households and options. We recommend the Legislature consider businesses to reduce greenhouse gases, while using a portion of GGRF revenue to provide direct also partially or fully offsetting the financial impact financial support to households and/or businesses. of cap-and-trade prices on businesses and For example, the Legislature could use GGRF to consumers—particularly low- and moderate-income provide lump sum rebates to households, reduce households. In our view, these revenue recycling other state taxes (such as sales tax rates), or options become even more attractive if allowance use the funds to reduce retail electricity rates. prices—and associated impacts on energy prices— Importantly, each of these “revenue recycling” continue to increase. options could be structured in a way that maintains LLeeggiissllaattiivvee AAnnaallyysstt’’ss OOffffiiccee 5 analysis full gutter Legislative Analyst’s Office 6 analysis full gutter Legislative Analyst’s Office 7 analysis full gutter LAO PUBLICATIONS This report was prepared by Ross Brown, and reviewed by Brian Brown and Anthony Simbol. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. Legislative Analyst’s Office 8