A four-year old lawsuit brought by manufacturers against California’s carbon market, and specifically its auctioning system, has become the top concern among the scheme’s participants, who fear that it could deter other states from joining the WCI programme while stifling investment.

“Everyone should be nervous about it,” said Sean Penrith, executive director of NGO The Climate Trust, at last week’s Navigating the American Carbon World conference in San Diego.

If the courts rule in favour of the big-emitting businesses, experts said California carbon prices could collapse to their fundamental value as it would mean the abolition of the market’s floor price, which is implemented through the auctions and stands at $12.73 currently.

The suit, initially filed by the National Association of Manufacturers via the California Chamber of Commerce in late 2012 on the eve of the state’s inaugural allowance auction, argues that the auctions represent an unconstitutional tax.

The lawsuit was merged with another brought by the Morning Star Packing Company, but a California lower court judge in 2013 ruled that the auctions were within the state regulator Air Resource Board (ARB)’s mandate and that it did not need support from a two-thirds majority of California’s legislature, a requirement for any new taxes as set out in the state’s constitution.

The manufacturers appealed and last month an appellate court sent all parties seven questions seeking clarity on issues including whether the proceeds are being used to replace general budgetary spending.

The responses are scheduled to be published on May 23, with oral arguments expected to be made this autumn and a verdict anticipated before the end of the year.

However, several legal experts have in recent weeks warned that the nature of the questions may imply a ruling against the state is impending.

“The court is just doing their homework, and asking for more info … [but] there’s probably years more litigation on this,” said Erica Morehouse, senior attorney at green group Environmental Defense Fund, which is acting as a respondent with the ARB in the case.

Regardless of the verdict, the matter will likely be appealed by either side, which could mean it’s then heard by California’s Supreme Court, with a ruling expected next year at the earliest.

“It’s not a question of whether this lawsuit prevails or not, it’s what impact it has while they’re trying to figure it out … I hope that the next year is not a lost year or prevents other states from joining WCI because of the uncertainty,” said Sean Carney, president of offset developers Finite Carbon.

“It could cause some delays and further uncertainty … but California is very committed to its climate policies, and I’m confident they’d find a way to move forward whatever the decision,” Morehouse added.

PRICES

A couple experts predicted that if the lawsuit is successful, California Carbon Allowances could drop from around $13.00 towards prices seen in the north-eastern US’s RGGI market, which at around $5 may be considered a benchmark.

Others said CCA prices could theoretically fall even further considering the size of the oversupply in the California programme, which was estimated at around 30 million tonnes at the end of 2014.

“Prices are likely to see more volatility, but I’m not sure they will fall to zero,” Judith Schroeter, lead analyst on US carbon markets for ICIS-Tschach Solutions, told Carbon Pulse.

“That said, if the ARB lost, they would have to get the allowances into the market somehow, and if they don’t figure it out quickly, then it becomes a short market … No auctions doesn’t mean companies don’t have to comply anymore.”

She suggested that while many participants in California’s carbon market are tired of the uncertainty bred by the lawsuit, some may be hoping for a victory for the plaintiffs because it would mean lower compliance costs.

But several observers noted that with so many possible outcomes in this case, it makes it very difficult to predict any effects on the market and on prices.

“Nobody gave a shit about this until February, but now it’s all anyone talks about,” said one trader who asked not to be named.

Another added that while the market continued to follow the case very closely, traders’ options for hedging against the uncertainty were limited due to poor liquidity in both futures and options contracts for post-2016 expiry.

“You don’t want to be buying the Dec-17s for over $13 at the moment in light of all this.”

ICIS’ Schroeter said to expect a short-term impact on CCA prices from the appellate court decision, regardless of which way it rules.

LONGER-TERM IMPACT

“[The case] is not going to have too much of an effect on our commercial activities, but there will be a market effect because investment is going to lag,” said Ray Williams, director of long-term energy policy at utility PG&E.

“We saw the calamity of the Clean Power Plan stay, which sent a nervous shock through the market, so anything’s possible at this point,” said The Climate Trust’s Penrith, referring to the US Supreme Court’s February decision to suspend enforcement of the EPA’s programme, which forms the centrepiece of the country’s strategy to rein in its GHG emissions.

“But California will go to great lengths to figure out a creative way of maintaining the programme,” he added.

California’s carbon auctions have raised more than $4 billion for the state to date.

By Mike Szabo – mike@carbon-pulse.com

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