Key Takeaways

1. Washington’s targets are more stringent than California’s, prices could escalate faster in Washington
2. Washington keeps most of the mechanisms uniform with California, except the offsets program and legs of the compliance periods.
3. Offset used will result in the same number of allowances being retired from future allowance supply.
4. Compliance periods are 4 years against the 3-year periods in California-Quebec.

Washington is the latest North American state with a proposed Cap and trade program that is scheduled to start operations in January 2023. The program will run under the WCI framework, the same framework used by California and Quebec. It is expected that in time the state will integrate into the California-Quebec linked Cap-and-trade program, enabling cross-trading of allowances among the three jurisdictions. To give some context to its emissions, Washington’s economy emitted 98 million tons of CO2e in 2018, which is about a fourth of California, and slightly larger than Quebec.

The Washington Department of Ecology published its updated program regulations on May 16th, 2022. We find that most of the program is consistent with the California-Quebec framework, though it initiates an entirely new approach to the usage of offset credits.

Cap Reductions

The major downside with the Offsets program under California-Quebec is that it enables emitting ‘over the cap’. This has been a major point of discontent among stakeholders. Currently, in the California-Quebec cap-and-trade, offsets are counted in addition to the established allowance budget or Cap.  For example, in 2020, the Cap was 330 million allowances, over this offset added another 6.96% to the Cap in CP3, bringing the overall emissions all entities can emit per year to 352 million allowances. SB-1391, currently passed by the California Senate, hopes to reform California’s offset mechanism, to discount additional Washington credits used in the California system.

In the case of Washington, a major new addition that Washington’s program includes is that it decreases future allowance supply proportionately, to account for the offsets used.

The Washington offset program aims to bring emissions under the CAP, hence whenever an offset is used for compliance purposes, the same number of allowances are retired from the allowance supply in the following year.

E.g. In the year 2023: if 4% of allowances are used in 2023, in 2024 the allowance supply will be reduced by the same number of offsets used in 2023.

This step ensures  that offsets do not enable emitters to emit more than the state’s Allowance budget, and puts a full stop to the practice of offsets as an instrument to emit more.

Offsets usage limits remain comparable. The limit is 5% for the compliance period (2023-2026), in Washington against the 4% in California in its fourth compliance period. In the next compliance period, California offsets usage increases to 6% while Washington’s falls to 4%.

The aim of the program

Washington’s program is more ambitious than California’s, aiming  for more GHG reductions in 2030 and 2050. The more stringent targets and offsets programs imply that Washington’s allowance price will likely be higher than California’s.

The program seeks to reduce the Cap, to meet the state’s targets listed below:

(* California does not have a 2040 interim target)

Cap Reductions

The Cap reduces by 7% per year in the first compliance period, which is significantly quicker than the 5% in the California program. There is a defined CAP reduction until  2050 in Washington, while California only has CAP reduction defined until 2030. The relatively quicker Cap decline is an impact of the more ambitious targets. The program carbon budget has not yet been finalized by Ecology, though the temporary program baseline (GHG budget) in the last regulation update is 68 million MTCO2e, which is down from the earlier placeholder of 71 million Mt CO2e.

The Cap is expected to decline, as shown below:

Compliance events and Surrender events

Washington has 4-year compliance periods, with the surrender of 30% of the prior year’s emissions and the remaining retirements after the completion of the last year of the compliance period. However, California has 3 year compliance periods. The abrupt choice of a 4-year compliance period is an attempt to sync with the California program, as the California fourth  compliance period runs from (2021-to 2023), and the fifth in (2024-to 2026),  aligning the end of California’s 5th compliance period with the end of Washington 1 st compliance period.

No cost allowances

The no cost allowance a.k.a free allowance is an integral part of any Cap-and-trade program. In the Washington program, the following sector have regulations for no cost allowances:

(i)                  Electricity Sector:

• All allowances at no cost, according to the electricity mix of the utility.
• The electricity sector emits 16.2 MT CO2e (23% of covered emissions)

(ii)                 Natural Gas Supplier 

Allowances to cover 93% of supplier’s allocation baseline for 2023-2030. From 2031 to 2042, the no-cost allowance decreases by 1.8 percent annually. And from 2043-to 2049, the no-cost allowances will decline an additional 2.6% annually.

• Natural gas emits 12 MT CO2e (18% of covered emissions)

(iii)         Trade Exposed and Emissions intensive Industry: 

• Allowances to cover 100% of the facility’s allocation baseline for each year during the first compliance period, allowances to cover 97% of the facility’s allocation baseline for each year during the second compliance period, and allowances to cover 94% of the facility’s allocation baseline for each year during the third compliance period.
• EITA industries emit 6.3 MT CO2e (9% of covered emissions)

APCR, ECR, and Other Mechanisms

All other price stability mechanisms, the Emission Containment Reserve (ECR), Allowance price containment Reserve (APCR), and ceiling prices are consistent with the California Program.

The “Allowance price containment reserve” means an account maintained by ecology with allowances available for sale through separate reserve auctions at predefined prices to assist in containing compliance costs for covered and opt-in entities in the event of unanticipated high costs for compliance instruments. 

The “Emissions containment reserve allowance” means a conditional allowance that is withheld from sale at an auction by ecology to secure additional emissions reductions in the event prices fall below the emissions containment reserve trigger price. California doesn’t have an emission containment reserve, it has a price floor instead. The latest draft regulation indicates that the ECR has been suspended in Washington, indicating Washington is likely to do away with the ECR.

“Price ceiling unit” means a unit issued at a fixed price by ecology for the purpose of limiting price increases and funding further investments in GHG reductions.

All the mechanism prices grow annually at a rate of 5% + CPI (urban consumers). 

Washington Price tiers for 2023 reflect California’s 2022 tiers adjusted for 5% + CPI

APCR reserve receives  5% of the annual allowance budget for each year of the compliance period. In California, the APCR Currently receives allowances in the range of 3.5%. California has in prior years accumulated a significant amount of allowances in the APCR reserve.

ECR in Washington will receive 2% of the annual allowance budget annually.

Final thoughts

The Washington program has so far illustrated a far more effective offsets program and steeper reductions in allowance budgets. Also, the Department of Ecology has published allowance budgets till 2050 which creates a definitive future for the program and its participants. And the long-term visibility allows for far better planning from entities.

In an aim to align with Washington’s offset program, California in its latest SB1391 (in the pipeline) proposes that the offsets generated only from to-be-linked jurisdictions be brought under the CA cap, by removal of additional allowances. The bill text suggests that all historical and future non-debs supply from Washington offset projects be adjusted against California’s future allowance supply, should Washington link with the California-Quebec program.

Overall, we find that the Washington program is setting itself up for linkage while California is matching its steps. The timeline for linkage remains uncertain. The most comfortable year from an accounting standpoint is 2028, after the end of WA’s and CA’s full surrender obligation (2027).

Analyst Contact:

Craig Rocha (cmrocha@ckinetics.com)