California Carbon Allowances (CCA): Price Appreciation and Outlook for Market Growth in 2023

California Carbon Allowances (CCA) experienced a notable appreciation of 2.4% over the first quarter of this year, reaching a closing price of $30.07. Throughout the quarter, the price remained within the range of $29 to $31, demonstrating stability and investor confidence. An impressive bid coverage ratio of 1.84 was observed during the February auction, indicating a consistent and strong demand for CCAs.

One noteworthy development in the auction was the introduction of a new reserve price, also known as the floor price, set at $22.21. This figure represented a 12.74% increase from the previous year and was calculated based on a 5% increment plus the inflation rate observed in 2022. The floor price's annual adjustment in line with inflation provides an attractive feature for investors, as it offers inherent inflation protection while potentially mitigating downside risks for long-positioned participants.

On the regulatory front, the market continued to adapt to the impact of California's ambitious 2022 Scoping Plan, aimed at achieving carbon neutrality by 2045 and reducing emissions by 48% by 2030 compared to 1990 levels. To meet its 2030 scoping plan goals, California must bridge an emissions gap of approximately 80Mt per year, which constitutes about 30% of the average annual emissions cap projected for the period from 2023 to 2030. Such a significant reduction can only be achieved with a substantial contribution from the cap-and-trade system.

The California Air Resource Board (CARB) has consistently relied on tightening annual emissions caps and utilizing cap-and-trade to realize approximately 40% of the planned emissions reductions. In early March, CARB confirmed the necessity of further tightening the cap-and-trade system to achieve the Scoping Plan's goals. Measures to reduce the surplus of allowances held in reserve were discussed, and there is even a possibility that the emissions reduction target will be strengthened to 55%, surpassing the initial goal of 48%. These signals indicate a trajectory of tighter emissions caps, providing favorable market conditions as the legislature progresses through deliberations in 2023, final voting in 2024, and anticipated implementation in 2025.

The performance of CCAs in the first quarter was influenced by macroeconomic sentiment. California's real GDP experienced a modest growth rate of 0.38% in 2022 and is projected to reach 1.5% in 2023, lower than its historical average of 3%. Consequently, industrial demand for emissions allowances has decreased. However, based on projections by the International Monetary Fund (IMF), the US economy is expected to return to its long-term average GDP growth from 2025 onwards, as it absorbs the aggressive rate hikes implemented by the Federal Reserve since March of the previous year. This rebound may generate increased forward hedging demand from industrial sectors, thus boosting CCA prices.

The extension of the CCA market beyond 2030 has been a subject of much discussion. Although the cap-and-trade program officially runs until 2050, CARB's authority to actively operate and revise the program after 2030 will likely require new legislation. The lack of clarity regarding this matter has impacted the CCA market; however, more recently, market experts have expressed strong confidence in the program's extension. The North American Carbon World conference highlighted the crucial role of the CCA market in achieving the state's climate goals, reinforcing the sentiment that the program will continue.

Analysts and legal teams have emphasized various factors that support the longevity of the program. CARB's regulatory guidelines, published in 2019, outline specific annual market caps until 2031, along with a predetermined formula for setting caps from 2032 to 2050. Additionally, the Scoping Plan's target of carbon neutrality by 2045 necessitates the ongoing existence of the cap-and-trade structure. Despite the new emissions reduction target, which aims to bring emissions down to approximately 200Mt by 2030, there is still ample room for the CCA program to contribute significantly toward achieving the state's climate goals by 2045.

Looking ahead, the CCA market can expect positive tailwinds as the legislature proceeds with deliberations throughout 2023, culminating in final voting in 2024 and subsequent implementation in 2025. The tightening emissions caps and reinforced commitment to emission reductions in California create a favorable environment for the CCA market to thrive.

Furthermore, the market can anticipate increased demand and price appreciation as California's economy rebounds and grows closer to its long-term average GDP growth rate, projected to occur from 2025 onward. This anticipated economic resurgence will likely drive industrial sectors to hedge their emissions through CCAs, further boosting their value.

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