MAC curve steepening

What California's mix of carbon policies means for price discovery

The Californian carbon market has the broadest scope of any emissions trading scheme anywhere in the world. Covering around 80-85% of the state’s emissions it includes emissions from power generation, industrial production, and transportation fuels.

Economic theory suggests that the high coverage should result in a carbon price that reflects California’s marginal supplier of abatement. However, this is not how things have turned out. Since the outset of the scheme, carbon prices have typically settled at or near the floor price.

The problem is that the Californian carbon market is characterised by emission abatement supply that is highly price inelastic. Three factors are especially important in influencing this lack of responsiveness: the electricity generation capacity mix, the role of complementary policies and the use of free allocations to protect industry.