Market Launch: Cap and Trade Goes Live California’s Unique Design Features IEPA 31 st Annual Meeting September 20 Jan Mazurek, PhD ICF International Sacramento, CA icfi.com © 2006 ICF International. All rights reserved.

icfi.com 2 CA’s Unique Design Features Design featureCAEU ETS GEOGRAPHY Caps imported electricityYesNo Bans resource shufflingYesNo Industry benchmarksYes MARKET SIZE Holding limitsYesNo Allowance reserveYesNo Offsets central to cost containment YesNot as much CDMNoYes Offset buyer liabilityYesNo

icfi.com 3 Geography “California never intended to go it alone” ARB Chair Nichols “Leakage” –Electricity: “Shuffling” low GHG-intensity electricity to CA; high to other states First deliverers and attestation meant to address US Constitution Commerce Clause Suspending attestation requirements 18 months –Some worry about legal risk? –Low auction demand if there is shuffling –“Trade exposed” industry—refineries, cement, food processors, paper, glass, steel Uncapped outside of California, in neighboring states and other countries. Industry benchmarks based on output –Are ARB formulas satisfactory to those sectors (10 percent haircut, heterogeneity)? –Some worry about over allocation based on EU ETS experience.

icfi.com 4 Market Size Holding Limits –Restricts the number of allowances that may be held at any one by a covered entity. Designed to address threat of market manipulation due to relatively small market Limit set below compliance obligation of some large entities (though ARB provides a limited exemption), and takes allowances out of circulation to comply with the holding limit (concerns about liquidity, market power). Compliance Offsets –Essential to cost containment (CA sits high on MACC) ARB model shows cutting supply in half causes allowance prices to double –First four protocols (forestry, urban forestry, livestock, ODS) based less on supply Next two, CMM, Rice –CMM could produce 1.9 MMTCO2e but delay in announcement may cause contracts to lapse ICF estimates supply short in CP2, CP3; ACR estimates 29% short CP1; 67% short CP3 Buyer liability may be an additional constraint on protocols subject to reversal (ag, forest)

icfi.com 5 Other potential issues Whither linkage? November “surprise” (new litigation)? Ongoing competition for allowance use value Experiments to test market design (with attention to market manipulation): –Allowance reserve –Holding limits –Low hydro Preliminary results available by October 25, Environmental Markets Association, Santa Monica –University of Virginia and Power & Energy Analytic Resources.* *Pacific Gas & Electric, Sacramento Municipal Utility District, Southern California Edison, Chevron, NRG Energy, Northern California Power Authority, Southern California Public Power Authority, Los Angeles Department of Water and Power

icfi.com 6 Further information Jan Mazurek, PhD Senior Fellow ICF International