California regulators last week claimed a landmark achievement in the implementation of the state's ambitious but controversial AB32 climate legislation with the release of the results from its first carbon auction.

The California Air Resources Board has been developing regulations for the world's second largest cap and trade program to help the state reduce CO2 emissions to 1990 levels by 2020. In the first phase, electric utilities, refiners and heavy industries emitting more than 25,000 tons of CO2 per year will be capped. From 2015, suppliers of liquid fuels and natural gas will be included in the cap of 394.5 million tons of CO2.

CARB's cap-and-trade program has so far withstood repeated challenges by the oil industry, environmentalists and intervention from the Federal Energy Regulatory Commission over concerns about electricity imports.

Mary Nichols, CARB chairwoman, insisted that she was "delighted" with the results of the auction. "The goal was to have a competitive bidding process and get the allowances to the people who needed them, and we were extremely successful in doing that."

Market participants, 97 percent of them among the 300 capped entities, snapped up allowances for 2013 with a 3:1 bid ratio.

A Real-World Test

Celebrations at CARB will be muted as auction bids were settled at $10.09, a mere nine cents above the reserve price. Last week, the Legislative Analysts Office revised down the estimated revenues from the auction of 2015 allowances from $600 million to $100 million. Based on $10 a ton, the real figure ended up being $5 million.

But Nichols insisted that low prices of allowances indicate that compliance can be achieved at a lower cost than some participants feared. 

And although all of the 23,126,110 allowances for 2013 were sold, 2015 allowances settled at the $10 reserve price, with only 5,576,000 allowances purchased from a total of 39,450,000 that were offered.

Ashley Lawson, senior analyst at Point Carbon Thomson Reuters in Washington, D.C., said that expectations for the settlement price had been in the range of $12, the price of allowances trading on the secondary market.

"The volumes went mostly as we had forecast in that buyers bought all of the 2013 vintages and very few of the 2015. The price on the 2013 vintage allowances did come as a bit of a surprise and well below what market prices have been for some time now." 

Lawson said that strong market participation in the auction was an indicator of success.

"It's a good sign to the market that the government is taking this very seriously, holding up their end of the bargain and going to provide that stability that you need to create the foundation for a robust carbon market. We've had the first successful auction and now we'll see what the market does with this information."

She said that one possible explanation for the low auction settlement price could have been the launch of the latest in a series of legal challenges. The day before the November 14 auction, the California Chamber of Commerce submitted a petition to prohibit CARB from raising revenues through auction, claiming that the state agency does not have the authority to raise taxes from business.

Legal experts claim that CalChamber's legal argument is weak. But it could have been a deliberate tactic to spook the market, said Lawson.

"All of the lawsuits have increased perceived risk and weighed down prices, and this is just the latest," she said.

The response from the secondary carbon market was bullish, said Samantha Unger Katz, managing director at BGC Environmental Brokerage Services. Within an hour of the results release, 2013 vintage allowances futures traded up from $10.75 to a high of $11.75 per ton, she said.

"The auction clearing price below the current December 2013 vintage 2013 futures contract pricing echoes the sentiments expressed by some market participants regarding the uncertainties and the sheer volume of allowances being auctioned in this round. We do anticipate continued new market entry, trading and price volatility over the next few months. It will be interesting to see what happens between now and February, when the second auction is scheduled to take place." 

Perverse Incentives, Long-Term Success?

The relatively low price of carbon allowances may mean that it will be cheaper to pollute than to invest in energy efficiency and clean energy technologies. But investors welcomed the results of the auction.

Nancy Pfund, managing partner of DBL Investors in San Francisco, said: "A strong carbon market sends clear indicators to investors that California's cleantech economy is open for business. We already see California as an enormously attractive investment, but AB 32 is driving tremendous innovation in exactly the types of companies that venture capitalists like me love to fund."

Rob Day, partner at Black Coral Capital in Boston, said: "Certainty is [more] important, not necessarily price. I'm not relying on a certain price on carbon before I make my investments." 

Black Coral invests exclusively in cleantech through early-stage startups, project finance and funds of funds. Its nine-strong portfolio includes Seattle-based Powerit Solutions, which designs energy management systems in major industrial facilities, and San Diego-based One Roof Energy, a financing firm for residential rooftop solar. 

"Anything that's on the right side of natural resource trends, we consider inbounds for us," he said.

The firm is aiming to put "several hundred million dollars" to work over the next few years, said Day.

"Today's result makes me want to invest more in California. It's an important signal. In this policy environment, being able to point to a working policy is really valuable to an investor like myself. And to see California pull this off -- and especially getting this level of bidder interest -- is a really positive development."

"I'm hopeful that it will be a positive demonstration for the national policy debate, too," he added.

Hurricane Sandy, closely followed by the re-election of President Obama, has revived national discussion about climate change and the potential of a price on carbon to help curb it.

Nathaniel Keohane, vice president at Environmental Defense Fund and a former economic adviser to the Obama administration, said: "California will be a model for the nation. I don't know that it will spur action in the next few months, but as it proceeds with its cap-and-trade program, and as people around the country see it as a concrete thing, a success and something that works," more states may adopt a similar model.

As another round of United Nations climate talks start this week in Doha, even those working in climate policy realize that the process of a global and binding agreement hoped for at Copenhagen in 2008 looks all but defunct. But what has emerged in its place is a patchwork of 33 countries and 18 sub-national jurisdictions with carbon programmes that may one day link together to form a quasi-global market.

Europe's Emissions Trading System has already worked out a memorandum of understanding to link with Australia. California's program will link with Quebec next year, and may link in with Europe in the near future.

"It's an alternative approach," said Keohane. "It's not the global deal that people envisioned in Copenhagen, but it's something that can get us to the same place.

"All the actions other countries are taking is a good first step, but it's a first step on a long road."


Editor's note: This article is reposted in its original form from AOL Energy. Author credit goes to Felicity Carus.