Key Takeaways:

1. Washington State Ballot Initiative 2117 is having a significant impact on WCA pricing and will continue to impact the market through November 2024.
2. In other instances, legal challenges to a cap-and-trade program have led to allowance prices trading at the floor and depressed auction participation; here the fundamentals and nature of vote means some price-floor premium is retained.
3. Compliance entities in WA will still need allowances to cover the first compliance deadline in November 2024 – where entities submit allowances for 30% of their 2023’s emissions.
4. While WA is strongly democratic and its legislation has a history of supporting environmental initiatives, the state’s voting history shows Initiative 2117 may not run strictly along partisan lines.
5. Even if 2117 passes in November, WA legislators have several pathways to continue a decarbonization program.
6. cCarbon expects WA Auction #5 to clear at $32 – $34, slightly below current WCA secondary market prices.

Washington Cap and Invest will hold its first auction of 2024 next Wednesday, March 6^th. As the WA market has seen significant decline in recent months, we will provide below a review of some of the dynamics at play as well as our outlook for WCA Auction #5.

Ballot Initiative 2117

The main driver for the decline of WCA prices over the past three months (from $55 at the end of November 2023 to $34.25 as of Feb 28^th) has been the emergence of Ballot Initiative 2117, which would repeal the legislation behind the cap and invest program, as well as prohibit future carbon tax credit trading programs in the state. The initiative was certified in January and will appear on the WA state ballot on Nov 5^th, 2024.[1] It is one of six separate initiatives introduced by republican state representative Jim Walsh, all funded by citizen Brian Haywood via the group ‘Let’s Go Washington’.[2]

Although it is difficult to predict whether 2117 will be successful, there are some important dynamics to consider. First, although Washington is one of the more progressive US states, it is also historically cautious about taxation (the state does not have an income tax and only recently introduced a capital gains tax, which is also being challenged). In the past eight years, Washington state has seen two separate initiates which sought to implement some sort of carbon tax or fee on GHG emissions. Both of these initiatives failed in a statewide vote. Notably, Initiative 732 failed in 2016[3] by a margin of 18.6% in the same election that saw Hillary Clinton beat Donald Trump in WA by more than 15%. [4] As such it would be an over-simplification to view this initiative strictly along partisan lines, moreover, citizens voting an active ‘yes’ to adopt a direct taxation measure will always be harder to popularise. That being said, the fact that 2117 is part of a group of initiatives all sponsored by   make a ‘blanket no’ vote easier to communicate for opposition groups. The WA legislature is reportedly considering adopting three of the less impactful of these initiatives to further simplify voter issues on the ballot.

Opposition to 2117

Initiative 2117 could technically be challenged if a parallel bill modifying the CCA were introduced in the current WA legislative session ending March 7^th. However, such an ‘alternative’ would then also go to a popular ballot vote in November. Democratic legislators have indicated they will not take this route as it would add complexity and risk, rather than simply campaigning for a no vote against 2117 (they will likely take the same tact against an additional Initiative 2109, which would repeal WA’s capital gains tax). What legislators have done, however, is to propose a rebate of cap and invest dollars to offset utility costs for middle and low income WA residents, a move intended to ease sentiments against the program.[5] In addition to the utility rebate program, the state budget also includes resources for farmers with the intent of addressing the issue of exemption which has been a contention with the CCA.

In terms of identifying sectors in support or opposition to Initiative 2117, transportation infrastructure has the most to lose should the cap and invest program cease to exist.[6] Emissions intensive trade exposed (EITE) entities receiving free allocations are another example of entities that have an interest in the program’s continuance. There does not seem to be formal institutional support for 2117, with backing coming generally from the Republican party and some grass roots groups.  Meanwhile, campaigns to oppose 2117 have already emerged, and the most prominent “No on 2117” has so far raised over a million dollars.[7] Other business organizations, including the Seattle Chamber of Commerce and Washington Roundtable (a non-profit coalition of private sector leaders) are expected to support No on 2117.

2024 compliance and other considerations

Regardless of the November election results, compliance entities will still be required to submit their 2024 compliance obligations equivalent to 30% of 2023 emissions on November 1^st, representing roughly 20 million allowances.

It is also important to note that as the WA legislature is almost certain to retain its strong Democratic majority, it is very possible that, if the CCA were repealed, an alternative decarbonization requirement would take its place. This could take several forms, perhaps through the re-instatement of WA’s clean air rule [8], but without a market mechanism to ease costs, this would likely be even less popular with industry. As the implications of such an alternative are carefully weighed, this could ultimately galvanize support for the CCA.

There is also the possibility that, if it passes, Initiative 2117 could face legal challenges from supporters of the CCA. This is because WA Initiative’s are required to address only a single subject, and some have noted that 2117 includes two: repealing the CCA and banning future carbon tax credit trading. Ballot initiatives in the state have been ruled unconstitutional in the past on such grounds.[9]

On a parallel note, there is wide consensus that no matter the fate of the cap and invest program, Initiative 2117 would not threaten the continuance of the state’s clean fuel standard.

Precedent for challenges against a carbon tax

When trying to understand a possible trajectory for WCAs over the rest of the year, it is useful to look at historic precedent. To draw from experience in California, the closest parallel we have is the 2017 legal challenge to California’s cap and trade program, which precipitated several weak auctions with poor participation and a clearing price just slightly above the program’s floor. For a time, CCAs traded below the program’s floor price on the secondary market. To look even further back, 2010’s Proposition 32 sought to delay implementation of California’s cap and trade program but was defeated by a margin of 23% during a statewide election.

This year the floor price in Washington is set at $24.02. So far WCAs have not dropped to this level, but this auction will be an important indicator on where prices are headed. The last two weeks have seen WCAs slightly more stable, ranging between $34-35, on the weight of linkage legislation passing through the WA state Senate on Feb 16th. This linkage bill, SB6058, is currently passing through committee in WA’s house of representatives, and a passing vote could provide additional support for WCAs.

cCarbon’s expectation for Washington Auction #5

The market is now pricing in the possibility of a program end date, resulting in a market price well below the fundamental valuation of the WCA – which we assess at around the APCR Tier 1 of $51.90 (given the release of a large pool of APCR Tier 1 allowances last fall). The allowances have found a risk-adjusted price range of $34-$35. We expect the auction to clear between $32-$34 due to lower participation and a greater supply of available allowances. Investors and smaller compliance entities are likely to avoid the auction due to the high risks and likely have already acquired sufficient allowances for their 2023 interim compliance period. Apart from the very speculative, we don’t anticipate much participation from investors. It’s important to note that this is the largest WCA auction yet, with 7.44 million allowances, including an additional supply of 667,022 V23 allowances. This puts supply significantly above the average 6.8 M in 2023. The combination of uncertain demand and higher supply does not bode well for those optimistic about a high clearing price.