Generally, from the perspective of entities covered be the California scheme (voluntarily associated entities excluding), knowing that the Reserve is available quarterly at an established price provides an alternative to purchasing allowances in the market at prices above the price level set.
The internal structure of the Allowance Price Containment Reserve, the size of its resources, the mechanisms for supplying the Reserve and for its use play consequently a key role in every strategic analysis of possible market trends as regards prices of California emission allowances (CCAs).
What is an Allowance Price Containment Reserve and what are its main parameters
Broadly speaking, an Allowance Price Containment Reserve (the Reserve or APCR) is an account that is filled with a specified number of allowances removed from the overall cap at the beginning of the California cap-and-trade program. The idea for APCR consists in that covered entities may purchase reserve allowances at specified prices during direct quarterly sales. The main purpose for that is covered entities gain flexibility through access to the Reserve if prices are high or entities expect prices to be high in the future.
Price-Containment Reserve California Sales 2013–2020:
- First sale: was scheduled for March 8, 2013 but no covered entities or opt-in entities had indicated an intent to bid at the March 2013 reserve sale and provided a bid guarantee, the next reserve sale is scheduled for June 27, 2013
- Subsequent sales occur on the first business day six weeks after each quarterly auction
- Three fixed-price tiers (in 2013: $40, $45, and $50),
- Prices adjust annually for inflation and 5% real appreciation,
- 12 days prior: Bid guarantees due (bond, cash, or letter of credit),
California’s Cap-and-Trade Program: Program Basics and Requirements for Electrical Distribution Utilities, May 2012 (http://www.arb.ca.gov/cc/capandtrade/
At each Reserve sale all of the allowances available in the Reserve will be offered. These allowances have no vintage year.
The two facts that may occur important for certain carbon market participants are:
1) only entities registered into the California GHG cap-and-trade system as covered entities or opt-in covered entities are eligible to purchase allowances from the Reserve thus the reserve allowances will not be available to voluntarily associated entities,
2) purchases from the Reserve are subject to the Holding Limit.
It is useful to observe, the Allowance Price Containment Reserve is specifically linked to the separate mechanism of the California scheme i.e. auction price floor.
To ensure that allowance prices do not get too low to stimulate emissions reductions, the scheme regulations establish a price floor at the auction. Allowances that are unsold at auction will, however, be added to the Reserve. This may happen if not all allowances are sold at the price floor. It follows that the Reserve will be continuously supplied with additional allowances if prices in the California carbon market trends are running at low levels (below auction floor price). This, in turn, will reduce the risk of the resources of the Reserve being prematurely exhausted.
Interesting feature is segmenting the Reserve into tiers.
As can be inferred from Appendix G to the documents containing the legislative reasons for implementing the California cap-and-trade program Appendix G, the three-tiers structure of the APCR isn’t the necessary feature of the mechanism, and as well it can, theoretically, contain only one or two tiers. However, the definitive text of the Final Regulation Order introducing the emission trading program in the California evidences that three-tier structure is the approach that has been ultimately applied.
The said Appendix G clarifies that three fixed-price tiers (in 2013: $40, $45, and $50) adjusted annually for inflation and 5% real appreciation, ‘provide a mechanism for observing the degree of imbalance in the supply and demand for allowances. If only the first tier is accessed, then the maximum size of the imbalance is known more precisely. If the first tier is exhausted quickly and purchases are made from the higher tiers, then a more significant imbalance is occurring, and more substantial adjustments to the program may be required, or may be required more quickly.’
To simplify, it seems from the above citation that the tiers were intended, from the regulators point of view, first of all as a peculiar meter for continuously measuring the imbalance of the California carbon market. The segmenting the Reserve into tiers have however also important implications for market participants the covered ones (eligible to purchase allowances from the Reserve) as well as voluntarily associated (not eligible) – see below under heading ‘Risk factors of the APCR’.
The Allowance Price Containment Reserve functioning needs to be separately considered in the context of undergoing process of linking of the California and Quebec emission trading programs.
The recently proposed amendments to the California cap-and-trade regulations (State of California Air Resources Board Proposed Amendments to the California Cap on Greenhouse Gas Emissions and Market-Based Compliance Mechanisms to Allow for the Use of Compliance Instruments Issued by Linked Jurisdictions, Staff Report: Initial Statement of Reasons of May 9, 2012) underline that the tier prices need not to be harmonised in both schemes as the sales are separate.
Nevertheless, the California and Québec Reserve sales have the same structure, escalation rates, and starting prices (in each currency).
While both Québec and California intend to schedule Reserve sales for the same day, the recent proposed amendments to the California cap-and-trade regulations are proposing that covered entities may only purchase from the jurisdiction with which they register.
The conclusion is that only California‘s covered entities could purchase allowances from the California Reserve sales and only Québec‘s covered entities could purchase allowances from the Québec Reserve sales.
The absence of political will to share the Reserve resources between linked jurisdictions is clearly visible from the above. Given the strategic role of the APCR in the managing carbon market these precautions may, however, prove justified.
The above recently proposed amendments to the California cap-and-trade regulations introduce the obligation to cover bids put
An entity intending to participate in a Reserve sale will be under obligation to submit to the financial services administrator a bid guarantee, payable to the financial services administrator, in an amount greater than or equal to the sum of the maximum value of the bids submitted by the entity.
Allowed forms of the bid guarantee are:
- bond issued by a financial institution with a United States banking license;
- cash in the form of a wire transfer or certified funds, such as a bank check or cashier’s check; or
- an irrevocable letter of credit issued by a financial institution with a United States banking license.
Considering the guarantee needs to be submitted at least twelve days before the scheduled Reserve sale, and, concurrently mustn’t expire no sooner than twenty-one days after such sale it follows that the potential participants in the Reserve sale will face thirty-three days period of funds’ freezing.
APCR risk factors
The above-mentioned Appendix G contains several significant considerations regarding the general effects of the mechanisms introduced by the Reserve.
Generally, from the perspective of entities covered be the California scheme (voluntarily associated entities excluding), knowing that the Reserve is available quarterly at an established price provides an alternative to purchasing allowances in the market at prices above the established price. Only when market conditions warrant, will compliance entities purchase the allowances in the Reserve.
Thus, by offering to sell allowances in the Reserve at an established price or prices, the Reserve provides protection against prices being higher than the established price or prices.
If the demand for allowances is higher than expected so that allowance prices are also higher than expected, the ability to purchase allowances from the Reserve will moderate the upward pressure on the market price as it approaches the established reserve sales price. The actual purchase of allowances from the Reserve will increase the supply in the market, thereby moderating the price.
This influence of the Reserve on CCAs prices is present at all times (so long as allowances remain in the Reserve). Consequently, the Reserve provides cost containment even under rapidly changing market conditions.
This protection against high prices is limited, however, because the number of allowances in the Reserve is limited. Once the allowances in the Reserve are all purchased, there is no additional buffer against higher than expected prices.
And here we have the first of main dilemmas California carbon market participants face as regards the APCR, i.e. whether the Reserve is likely to be run out.
If the market analysis prove this evolution is probable, the another issue not easy to determine is when this fact may occur - such an assessment being carried out separately with respect to each of the three tiers.
It is evident from the above, the lack of the Reserve additional market buffer consequent upon the Reserve resources has run out will expose the market to increased price volatility.
This would interact with another cost containment mechanisms in the California carbon market.
It may however also occur that allowance prices remain within the range no allowances will be purchased from the Reserve because the established sales price or prices would be higher than the market price of allowances.
In the analysis of price interactions in the California cap-and-trade scheme the APCR plays, nevertheless, such significant role that it mustn’t, in any case, be neglected.