Will California and Washington marry their carbon markets?

By Anne C. Mulkern | 10/23/2023 06:43 AM EDT

Evergreen State officials face a choice: Should they link their system with a market run jointly by Quebec and California?

The sun sets over Southern California during a blistering heat wave in September 2022.

The sun sets over Southern California during a blistering heat wave in September 2022. Patrick T. Fallon/AFP via Getty Images

Washington state made history in January when it became only the second U.S. state to launch an economywide program for buying and selling permits to emit carbon.

Now Evergreen State officials face a new choice — whether to link their system with a carbon market run jointly by Quebec, the Canadian province, and California, the first U.S. state to establish a broad cap-and-trade system.

The stakes are significant.


For Washington, joining with Quebec and California could help lower the cost that Washington businesses pay to emit carbon dioxide, one of the main drivers of global warming. When Washington held an auction for emission allowances in August, its prices were nearly twice those of California and Quebec: about $63 per allowance versus $34 per allowance.

The high prices are good for the climate, environmentalists say, as they show Washington is aggressively pursuing its goal of lowering carbon emissions. But the cost can be tough on both businesses and consumers. One complaint is that Washington’s carbon market has pushed up gas prices.

State officials in California have almost the opposite problem. A flush supply of allowances for sale and their relatively lower cost has enticed some business to stockpile the permits. Analysts say that practice — and the market’s low prices in general — threaten efforts by the state to meet new, more ambitious climate goals.

The tension between price points and climate aims is common for carbon markets, experts say. And it’s one reason other U.S. states are expected to watch with interest whether California and Quebec ultimately decide to join forces with Washington state.

“You can have a program with high prices, which will do a lot of work to cut emissions,” said Danny Cullenward, a California-based climate economist and lawyer. Or “you can design a program with lower prices, which will lead to lower revenues and fewer reductions.”

But if you choose the second option, he added, state officials will need other policies to cut emissions or “you’re going to miss your climate targets.”

How carbon markets work

Broadly speaking, a cap-and-trade market seeks to cut greenhouse gas emissions but allows regulated businesses to decide how to achieve mandated reductions.

The first such program in the United States came in 2009 with the Regional Greenhouse Gas Initiative (RGGI), an alliance of East Coast states that seek to cut carbon dioxide emissions from power plants. But it’s limited to just that sector.

California piloted the first economywide cap-and-trade system, which regulates roughly 450 businesses responsible for about 85 percent of the state’s greenhouse gas pollution.

Washington’s program followed about a decade later. It regulates about 100 businesses responsible for about 75 percent of the state’s carbon emissions.

The agencies that run the state programs set a yearly cap on greenhouse gas emissions allowed by regulated businesses. The agency then auctions off a number of environmental permits — or “allowances” — tied to that cap.

Businesses get a yearly greenhouse gas emissions limit and must either cut their emissions to get to that mandated number or buy and submit enough allowances to compensate. Each allowance is equal to one metric ton of carbon emissions.

The more greenhouse reductions a state needs, the fewer allowances it will sell. That means prices of the allowances rise. Businesses must then decide whether to pay the cost of cutting their emissions or pay for the allowances.

Washington, for example, by state law needs to cut emissions about 7 percent annually through the end of the decade. That has fueled demand for the limited allowances available. The August auction sold out of the nearly 8.6 million allowances offered, at a $63.03 per allowance price.

In a theoretical joint market containing Washington, California and Quebec, allowances from all three places would be priced jointly and sold in one auction. They could be traded among all regulated businesses.

Washington has not made a decision on whether to link with California and Quebec, it said in a recent analysis. But it is poised to do so shortly. The Washington Department of Ecology expects to issue a recommendation as soon as this month.

But even if Washington announces an intent to link, uniting the programs wouldn’t happen quickly.

California and Quebec each would need to approve linking. California officials have said they won’t consider the issue until Washington makes a decision.

If Washington wants to link, California would then do its own evaluation process. That “would take us about two years to finalize the linkage process,” Lys Mendez, California Air Resources Board (CARB) communications director, said in an email.

The programs likely would need legal wording changes to sync up, officials said.

Washington voices concerns about political backlash

If Washington linked with California and Quebec, it likely would bring costs for businesses in Washington, the state analysis said.

Prices in the Washington market already have risen so high, they’ve triggered a release of allowances from the state’s price containment reserve. When the allowance price hit $51.90 this year, it prompted a separate auction to make sure businesses “can obtain enough allowances at a reasonable price,” the state’s explanation on it said.

The California and Quebec market is six times the size of the one in Washington and is already the fourth largest worldwide behind China, the European Union and South Korea, in terms of emissions controlled.

A three-jurisdiction market likely would ease costs for Washington businesses, the state’ analysis said, by both pushing down allowance prices and by “expanding market demand for cleaner technologies and energy sources.”

Lower allowance prices might be a political positive for Washington lawmakers who face criticism about higher gas prices because of the carbon market. Washington in its analysis acknowledged that public outcry could threaten the program.

“High allowance prices can negatively impact consumers if businesses elect to pass along their compliance costs in the form of higher prices for goods like gas, home heating, or food products,“ the analysis said. “Moreover, high allowance prices and the associated economic impacts can breed public mistrust of the program and leave it vulnerable to curtailment or repeal.”

If that happened, it said, there would be, “no other alternative economy-wide program in place to ensure Washington is able to meet GHG reduction limits.”

But linking to a market with lower allowance prices also might mean Washington misses hitting its goals for greenhouse gas reduction because lower allowance prices lessens the incentive for businesses to cut emissions at their locations.

Questions for California

All the talk about linking with Washington takes place as California considers making its program tougher, in order to meet the state’s more ambitious climate targets. California wants to reduce its emissions 48 percent below 1990’s level by 2030.

Multiple analyses say the California cap-and-trade program isn’t aggressive enough to play a major role in helping achieve that reduction.

Low auction prices in the early years of California’s program allowed businesses to stockpile allowances, multiple critics have noted. Their bank is about 300 million allowances, about equal to the 294 million allowances California plans to auction off this year. That means many businesses likely don’t need to buy many allowances between now and 2030, analysts have said.

CARB, the state agency that runs its market program, plans next year to look at the allowance issue as part of potential market reforms. It would not take away any allowances businesses hold but would look at cutting the number of allowances for sale and future years. That likely would drive up the price of those permits

But staff at CARB has warned that it must consider whether the changes are feasible or whether they would damage the state’s economy.

Different approaches in the states created varying carbon markets.

Washington and California markets produce disparate prices in part because the states took different approaches when developing their programs and balancing cost and desired greenhouse gas cuts.

The Evergreen State needed to take an ambitious approach because California had a more than 10-year head start, said Reuven Carlyle, a previous Washington Democratic representative, who wrote the legislation that became Washington’s climate law.

The California market launched in late 2012 and became mandatory for businesses in 2013. California and Quebec linked their markets in 2014.

In Washington, “the central guiding principle of this policy … was the desire to embrace the letter and the spirit of the Paris Agreement,” to limit worldwide temperature rise to 1.5 degrees Celsius, he said.

To ease compliance, he said businesses in the program only need to submit a third of their required allowances in November 2024, and then the remaining two-thirds is in four years.

But Carlyle also acknowledged “a natural tension between meaningful climate action and ensuring that the impact is well designed and thoughtful and equitable.” At the same time, “everyone is deeply sensitive to cost,” Carlyle added.

In California, there was a concern about cost from the start, said Cullenward, the climate economist. And the state knew it had other policies that would help cut greenhouse gas emissions. The state’s first analysis on how it would reach its 2020 climate target said it would happen about 80 percent through regulation and about 20 percent through markets, he said.

“So California designed an intentionally regulation first strategy, and then took several steps to make sure that the allowance supply-demand situation was fairly generous,” Cullenward said. “Washington, although they also have strong regulatory policy, has leaned a little bit more into the cap-and-trade program than did California initially.”

In a joint market, California businesses would be able to sell allowances from their large stockpile to Washington businesses. The result likely would be no corresponding cut in greenhouse gas emissions, said Derik Broekhoff, senior scientist at the Stockholm Environment Institute.

The Washington business would submit the allowance instead of an on-site reduction, and the California businesses wouldn’t need to reduce, he said, “because these are just unused allowances sitting around that no one is using for compliance.”

Broekhoff said Washington should consider holding off linking with California until CARB makes those reforms.

The Washington Policy Center, which favors market-based solutions, said it probably would be a good thing for businesses in the state if Washington married its program with California and Quebec.

“If we join them, what happens is that our prices will go down, which will make us happy,” said Todd Myers, political director at the Washington Policy Center. But he predicted prices for California businesses in their program “will go up, which I’m guessing won’t make them happy.”