California Climate Bills Should Support Carbon Prices

PIMCO

Contributor:
PIMCO
Visit: PIMCO

By: Greg E Sharenow, Lewis Hagedorn, Andrew Dewitt

The California legislature recently passed a series of bills, signed into law by Governor Gavin Newsom on 16 September, that should have meaningful effects on environmental policies and the green energy transition. The highlight of the bills is a goal of carbon neutrality by 2045.

While this legislative package is meaningful for many industries, we focus this note on the impact to the state’s carbon cap-and-trade program. Although the bills have positives and negatives for the value of California carbon allowances (CCAs), we view the likely alignment of the cap-and-trade program with the 2045 goal to be positive for carbon prices.

The bills follow on the heels of the Inflation Reduction Act (IRA), passed by the U.S. Congress and signed into law by President Biden, which included many components supportive of renewable energy, carbon sequestration, and other climate-friendly policies. Much like the IRA, the California bills together aim to reduce emissions and encourage growth in non-hydrocarbon energy sources, while encouraging carbon capture usage and sequestration (CCUS) to facilitate the ultimate goal of carbon neutrality.

In his August letter to the California legislature, Governor Newsom outlined five priorities:

  1. A legally binding goal to achieve statewide carbon neutrality by no later than 2045
  2. An acceleration of the pace of greenhouse gas cuts
  3. Interim targets for alternative sources of energy
  4. Setbacks for new oil and gas production wells
  5. A regulatory framework for carbon removal technologies

In addition, the governor’s office prioritized legislation to extend the operation of the Diablo Canyon nuclear plant to 2030 from the current scheduled closure by 2025. This closely followed on rulemaking that will prohibit the sale of new vehicles powered by internal combustion engines in the state by 2035.

The irony of the timing of passage of this rule – while at the same time California was asking consumers to conserve energy and not charge their electric cars – was not lost on many and, if anything, demonstrates the long-term challenges the state faces in meeting its varied goals.

State steps support cap-and-trade valuations

By the end of California’s 2022 legislative session on 31 August, all of the governor’s proposals passed but one – California Assembly Bill 2133, which fell short by four votes in the state assembly after passing through the senate. The bill would have strengthened California’s 2030 target to reduce emissions from 40% to 55% below 1990 levels, much like the European Union is intending to do with its own carbon emissions from power and large stationary industrial sources.

While the 55% reduction target could have been an immediate catalyst for higher carbon prices, the California Air Resources Board (CARB) is likely to align policies in the state’s cap-and-trade program to reflect the newly legislated goal of carbon neutrality by 2045 (California Assembly Bill 1279). Modifications to align the program – which is currently slated to expire in 2030 – with broader, more ambitious climate goals and an extension to 2045 would provide welcome clarity and could support higher valuations for CCAs, in our view.

CARB sells CCAs at auction, generating revenue that’s invested in projects such as renewable energy, public transportation, recycling, and affordable housing. By buying CCAs, investors can help fund efforts to decarbonize California’s economy while also providing companies incentives to reduce their emissions. CCAs may have a natural fit in environmental, social, and governance (ESG) portfolio allocations.

By extending the cap-and-trade program alone, the present value of the future price floor for auctions of CCAs (see Figure 1), which rises at a rate equal to the consumer price index (CPI) plus five percentage points, could increase by at least 50%. 

Extending cap and trade through 2045 could raise valuations and send a stronger signal to emitters to reduce emissions

In addition, other jurisdictions in the U.S. and globally continue to move to reduce carbon emissions as well, which may enable CARB to continue to tighten the cap-and-trade program due to reduced potential leakage of economic activity to other more carbon-friendly areas.

Less than a year ago, the U.S. reentered the Paris Agreement but brought very little in the way of proposals to the U.N. Climate Change Conference (COP26) in Glasgow, Scotland. The White House’s attempts at climate change legislation appeared to be floundering, and few initiatives were progressing on the state level. Fast-forward one year and much has changed.

Yet recent events in Europe demonstrate that it’s necessary to consider expanding energy supplies while also ensuring the security of those supplies. At the same time, growing clean energy supplies and reducing carbon emissions to limit global warming and its adverse effects should be imperatives. To that end, we believe the steps taken by the U.S. and California – while not perfect or beyond criticism – are pointed in the right direction and are strongly supportive of carbon prices.

Originally Posted September 21, 2022 – California Climate Bills Should Support Carbon Prices

All investments contain risk and may lose value.

ESG investing is qualitative and subjective by nature, and there is no guarantee that the factors utilized by PIMCO or any judgment exercised by PIMCO will reflect the opinions of any particular investor, and the factors utilized by PIMCO may differ from the factors that any particular investor considers relevant in evaluating an issuer’s ESG practices. In evaluating an issuer, PIMCO is dependent upon information and data obtained through voluntary or third-party reporting that may be incomplete, inaccurate or unavailable, or present conflicting information and data with respect to an issuer, which in each case could cause PIMCO to incorrectly assess an issuer’s business practices with respect to its ESG practices. Socially responsible norms differ by region, and an issuer’s ESG practices or PIMCO’s assessment of an issuer’s ESG practices may change over time. There is no standardized industry definition or certification for certain ESG categories, for example “green bonds”; as such, the inclusion of securities in these statistics involves PIMCO’s subjectivity and discretion. There is no assurance that the ESG investing strategy or techniques employed will be successful. Past performance is not a guarantee or reliable indicator of future results.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.

PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2022, PIMCO.

Disclosure: PIMCO

All investments contain risk and may lose value. This material is intended for informational purposes only. Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. THE NEW NEUTRAL is a trademark of Pacific Investment Management Company LLC in the United States and throughout the world. ©2022, PIMCO

Disclosure: Interactive Brokers

Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.

This material is from PIMCO and is being posted with permission from PIMCO. The views expressed in this material are solely those of the author and/or PIMCO and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

In accordance with EU regulation: The statements in this document shall not be considered as an objective or independent explanation of the matters. Please note that this document (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and (b) is not subject to any prohibition on dealing ahead of the dissemination or publication of investment research.

Any trading symbols displayed are for illustrative purposes only and are not intended to portray recommendations.