Frequently Asked Questions
What are environmental markets?
Environmental markets are based on regulatory structures that utilize market mechanisms to address environmental issues. A market-based approach is designed for companies to have flexibility in achieving obligation targets. The market provides a price for planning purposes and to achieve the lowest cost to society. This includes various markets for renewable energy portfolios, energy efficiency certificates, and greenhouse gas (GHG) emissions.
What is emissions trading?
Emissions trading or cap-and-trade is a market-based approach for controlling pollution by providing economic incentives for achieving reductions in the emissions of pollutants. This applies to companies subject to a limit or cap on the amount of pollutants that may be emitted usually determined by a central authority such as a government body. Companies are required to hold a number of allowances equivalent to their emissions and cannot exceed the cap. Allowances can be acquired through allocations, auctions and/or from transfers from other companies. The buying and selling resulting in the transfer of allowances is referred to as a trade.
The European Union Emissions Trading System (EU ETS) was the first large GHG emissions trading scheme in the world, and remains the most significant as of 2013. The EU ETS includes all 28 current EU member states plus Iceland, Norway, and Liechtenstein.
The Regional Greenhouse Gas Initiative (RGGI) was implemented a GHG cap-and-trade program on January 1, 2009, to reduce GHG emissions from the power sector, making it the first market-based regulatory program in the United States to reduce GHG emissions. The program applies to any electricity generator with a nameplate capacity equal to or greater than 25 MW. RGGI is a cooperative effort among the states of Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island, and Vermont.
California Assembly Bill 32 was signed into law in 2006 and requires California to return to 1990 levels of GHG emissions by the year 2020, achieving a 15 percent reduction in GHG emissions beginning in 2013. The law establishes a statewide limit on sources that are responsible for an estimated 85 percent of California’s GHG emissions, and establishes a price signal needed to drive long-term investment in cleaner fuels and promote more efficient use of energy. More information can be found at the California Air Resources Board.
Quebec's Environmental Quality Act required GHG emission reductions and the Climate Change Action Plan put in place a cap-and-trade program beginning in 2013 to reduce GHG emissions by 20 percent below 1990 levels by 2020. More information can be found at the Ministere de l'Environnement. On January 1, 2014, the California and Quebec cap-and-trade programs linked and the first joint auction was held on November 25, 2014. Carbon allowances between the two programs are now fungible and can be used to satisfy compliance requirements in both jurisdictions.
On June 25, 2013, President Obama announced executive actions for a Climate Action Plan resulting in the United States Environmental Protection Agency's (EPA) Clean Power Plan to to reduce carbon pollution by 30 percent from 2005 in 2030 with progress by 2020. The Clean Power Plan sets individual state goals and allows states the flexibility on meeting these goals. The plan offers 4 pillars, but not limited to or required, toward achieving the goals: 1) increasing power plant efficiency; 2) dispatch of lower-emitting power plants; 3) use of renewable energy; and/or 4) use of demand-side energy efficiency. States are also given the option to use a rate-based or mass-based and the option to implement a state-only or multi-state collaboration. A mass-based program could lead to new cap-and-trade programs on a state-only or multi-state basis.
Other GHG cap-and-trade markets continue to be implemented in countries throughout the world. You can find more information on the status of these programs here.
How can I buy and/or sell carbon instruments for compliance in California?
California Carbon Allowances (CCA) can be acquired directly from the primary market in one of three ways. Many Covered Entities receive at least some free allocations of CCAs. Also, CCAs are also sold at quarterly Auctions and can be purchased by both Covered Entities and General Market Participants. In order to participate in the quarterly auctions, entities must have an approved Compliance Instrument Tracking Service System (CITSS) account and active Auction Platform Account. The price is determined by the auction clearing price mechanism and purchases are transferred into an entity’s General Holding Account from which the entity can trade with other parties or transfer into their Compliance Account. CCAs are also sold at quarterly Reserve Sales, which have the same requirements as auctions; however, only Covered Entities may participate in Reserve Sales. CCAs are purchased at a fixed price and transferred directly into an entity’s Compliance Account.
Entities may also purchase California Carbon Offsets (CCO) for different types of projects under approved protocols, but these instruments can only be used up to 8% of a Covered Entity’s compliance obligation. There are 3 types of California Carbon Offsets: 1) CCO8, 2) CCO3 and 3) GCCO, representing different invalidation risks to the buyers. There is also insurance against invalidation of offsets offered by third-parties.
Both CCAs and CCOs can be bought and sold in the secondary market. This includes trading on an organized exchange which requires an account with a Futures Commission Merchant. Also, these instruments can be transacted through brokers. Exchange and broker transactions will requirement the payment of service fees. Additionally, transactions might only be available in minimum quantities or standard lot sizes. You can also transact through an over-the-counter bilateral trade with a counterparty that can be a Covered Entity or General Market Participant. However, not all Covered Entities and/or General Market Participants may be interested in trading. An entity that buys and/or sells these instruments is commonly known as a marketer or trader.
Trades can be implemented in several forms. This includes spot, futures, forwards, options, and swaps. Also, trades can be in the form of a negotiated fixed price or a cost-based indexed to auction or exchange prices. Strategies for managing portfolios including an average price and target price orders. Instruments can also be used to generate short-term capital through a repurchase agreement or an income stream through a lending agreement. These agreements provides ways to optimize the value of assets between the period of acquisition and surrender deadline for compliance (e.g., free allocation of allowances).
How do I determine which counterparties I can I transact with to buy or sell carbon instruments for compliance in California?
Only those entities with CITSS accounts can hold, buy and/or sell CCAs and CCOs for physical delivery. ARB lists entities with accounts in its CITSS Registrant Report. The report lists both Covered Entities with a reporting and compliance obligation, as well as General Market Participants that include marketers and other entities. Since CCAs and CCOs are tracked in CITSS, instruments transferred within CITSS can be used for compliance. With respect to CCOs, the California Air Resources Board publishes the list of issued CCOs that can be used for compliance.
Also, you can request your counterparty to pre-deliver instruments to your CITSS account for purchases made by you and/or to prepay for transfers from your CITSS account for sales made by you. In most instances, this would require a Know-Your-Customer (KYC) check that would require information for your organization such as the Business Name and Business Address shown on your entity’s income tax return and Tax Identification Number and/or a W9 to determine creditworthiness. Depending on your federal tax classification, there might be other documents required by various counterparties for onboarding to trade. The KYC process is very similar to opening a bank account, CITSS account, and/or Auction Platform account. Conversely, if you are the counterparty that will be pre-delivering or prepaying, you can opt to perform a KYC check on your counterparty.
What contract terms can I expect in an agreement to trade instruments?
Agreements for trading can be in the form of a Master Trade Agreement, which allows for frequent and continuous trading of instruments, or a Single Trade Agreement. These agreements not only document the trade (e.g., instrument type, quantity, price, delivery date, settlement date, etc.), but also the general contract terms, including how different events might be handled between the parties (e.g., force majeure, registry unavailability, program changes, etc.). The following organizations offer industry standard Master Trade Agreements:
- International Emissions Trading Association
- International Swaps and Derivatives Association
- Edison Electric Institute
How can I assess the supply, demand, and prices in the California carbon market?
The California Air Resources Board publishes a Compliance Instrument Report that lists the total amount of CCAs and CCOs held in entity accounts and jurisdiction accounts by vintage in their Publicly Available Market Information section, which identifies the total supply.
The demand for compliance instruments is driven by both Covered Entities and General Market Participants. Only the demand for Covered Entities can be approximated based on historic GHG emissions data by the California Air Resources Board.
The California Air Resources Board also publishes information and results of quarterly Auctions and Reserve Sales. However, current secondary market prices can differ from auction prices and change in the period between auctions. There are several news and information services that report on market prices. Also, The InterContinental Exchange publishes settlement prices for End of Day Report – IFED Futures and IFED that are publicly available. You can also shop with marketers and/or brokers for a price quote.
What are some other uses of environmental commodities?
Many cap-and-trade systems offer a way to voluntarily retire compliance instruments to reduce the number of instruments in the market to place greater pressure on GHG emission reductions. In addition to voluntarily retiring compliance instruments, there are environmental credits/certificates that are widely used in voluntary market to achieve environmental objectives as part of the "triple bottom line."
In traditional accounting, a company’s bottom line is measured by profit. However, the concept of the "triple bottom line" adds social and environmental concerns. Often paraphrased as "profit, people, and planet," it is based on a commitment to corporate social responsibility (CSR). Through CSR efforts, companies are able to show that they are part of the solution in addressing global climate change and caring for their stakeholders and local communities. By taking action, many companies have benefited from the good publicity that comes about when manifesting their image as a company who includes social and environmental goals with profit. This voluntary act is becoming a symbol of good will and is being used by more and more companies. The positive marketing effects not only help to attract more customers and gain visibility, but can also reduce borrowing costs as investors are keen to invest in “green” portfolios. There is also an acknowledgement that investments into communities where the company operates will lead to cost savings in the future.
Voluntary environmental credits/certificates can be acquired from a marketer or through a broker. Removal of these certificates/credits from the market to avoid double counting are recorded in a registry.