Background

On the 9th of June, Ecology released its methodology on the supply of APCR allowances at the upcoming APCR auction on August 9^th, and the subsequent APCR auctions.

In relation to this, we are hosting a webinar on 3rd August 2023 where we will delve into the dynamic phases of the Washington and California Cap-and-Invest programs, where pivotal policy shifts and fundamental changes are currently underway.

In our earlier articles, we had pointed to a supply of around 18.6 million allowances which accounted for Ecology front-loading the APCR allowances for the first two compliance periods. In addition, the allowances were evenly distributed between APCR 1 and APCR 2 Tiers. While the two points are accurate, Ecology has used a methodology that staggers the APCR allowances, somewhat throttling the supply of allowances.

Ecology defined the goal of the APCR as to ensure that covered businesses have access to the allowances they need for compliance and that the supply of allowances available to them is not restricted by speculative market participation. Hence the base methodology is to replace the investor-bought allowances at the preceding auction with APCR allowances, within a given range.

It’s an interesting approach, and we hope to give a primary understanding and will shortly follow with more detailed scenario analysis in a later article. In this article, we’d cover

• Total Annual Supply
• What’s the methodology?
• The ramifications of the changes on the Washington market.

The Total Annual Supply 

The allowance is now staggered into the number of allowances available each year. In the event that the allowance is not utilized in the year, it will get rolled into the next year.

The methodology to calculate the supply of APCR allowances at the Auction

The methodology uses a unique supply formula, where the base supply formula depends on investor participation, but is range bound between a minimum and maximum supply:

Supply = Total auctioned allowances at the prior regular auction * Investor won allowances

Total Auctioned current allowances at Auction#2 = 8,585,000
Percentage of allowances won by investors = 10.12% 

Supply = 8,585,000* 10.12% = 868,802 allowances

The supply calculated needs to be within the maximum and minimum supply range calculated below. If the supply is lower than the minimum supply then the minimum allowances enter the APCR auction, if it is above the maximum supply then the maximum supply available is available at the APCR auction.

Maximum Supply = 2023 APCR Supply / Remaining APCR auction opportunities
8 million / 3 = 2,666,667 APCR allowances

• Initially, for 2023, 2 million is temporarily placed for each of the four APCR auction.
• If an APCR auction is not triggered, the number of allowances for the year is now divided between the remaining auction possible in that year.
• In case 2023 years allowances are under-utilized, in 2024 it will be rolled over to the APCR supply in 2024.

Minimum Supply = 2023 regular allowance budget * 5% / Remaining APCR auction opportunities

63,288,565 * 5% / 3 = 1,054,809 APCR allowances

• A minimum of 5% of the annual budget is the minimum supply that should enter if at least one APCR auction is triggered.
• Initially, the minimum triggered supply is:
  – 2023 regular allowance budget* 5%/ 4
  – If not triggered in the first auction it increases the next auctions minimum supply to  2023 regular allowance budget* 5%/ (Remaining auctions in 2023)

What does this mean for the market?

Control entry of APCR allowances – to cool current panic in the market

The market right now has a huge appetite for allowances, from both compliance entities and investors. The new methodology will provide a small batch of extra allowances to compliance entities – in view of the allowances bought by investors. If all the APCR allowances were available at one auction, that could have seen some entities secure a bank of allowances at APCR 1 prices. This would have resulted in sky-high prices for compliance entities that did not participate in the auction.

Prices are likely to move higher than previously anticipated – towards the end of the first compliance period

In most scenarios, the supply is likely to be restricted to the minimum APCR supply, as investor participation is unlikely to go much higher than the current 10%. In each year the minimum number of allowances at APCR is 5% of the year’s budget. It is likely that at each auction, the minimum number of allowances will be released at the auction.

The implication is that only around 10 million of the 16 million APCR allowance (first two compliance periods) is likely to be available in the first compliance period. Further reducing the allowances available in the first compliance period, to those previously modeled.

Conclusion

The quick pace of getting the Washington program online has resulted in multiple aspects of the program that are left to be figured out, once those play out. The APCR auction is one of them. The Washington’s APCR is comparably much smaller than California, and hence it had to get creative to see that APCR allowance remain at later stages of the program. The state has decided to stagger the APCR allownaces. We see a short term cooling of prices, but a further tightening of the program at the end of the first compliance period.