Mistake in First California Carbon Auction Raises Questions About Secrecy

California’s cap-and-trade program to cut greenhouse gases resumed this week with its second auction of carbon allowances to industrial polluters. The market is being closely watched around the world, and billions of dollars are at stake. But some nagging questions are lingering from the first auction.

The state’s first-ever carbon auction last November was a very exclusive online event, open only to bidders and regulators at the California Air Resources Board (CARB). Four days later, Mary Nichols, who heads the board, declared it a resounding success, saying the auction came off "without a hitch."

"Hundreds of participants were trained at every stage of the process, including how to register and how to bid," Nichols told reporters in a victory-lap news conference. "And it all worked just as we had hoped it would. "Well, not quite “all.” One of the biggest players in the auction encountered a rather sizable hitch that Nichols never mentioned. More than a than a month later, Bloomberg reported that one of California’s largest utilities, Southern California Edison, had inadvertently bought about 40 percent more permits than it intended. Bloomberg said it obtained internal documents revealing that Edison bidders had used “the wrong format” to submit its bid.

Some market players have expressed concern that the $16 million mistake overstated the real demand for carbon permits and set the price for carbon artificially high ("settlement" price of the first auction was about nine cents higher than the $10 floor price). It was a gaffe that ensured the auction would sell out, and a “hitch” that was never made public by regulators.

"There’s a security aspect to it," CARB spokesman Dave Clegern explained in an interview a few days before the first auction. He said there’s a reason for the tight lid on bidders. About a week after the Bloomberg story appeared, and KQED made its inquiries, the Air Board put out a stern “reminder” of the rules prohibiting bidders from talking about the auctions.

Clegern went on to say that, "We are simply trying to let the market take its course without being flooded with misinterpretation or rumors or anything like that, that might cause spikes that are unrealistic and unnecessary."

Neither Edison nor the Air Board would talk with us about this particular incident. The current rules prohibit it. And at a recent workshop on “information sharing” from the cap-and-trade program, it was clear that the Air Board is taking it seriously.

"Even statements such as, ‘We were unable to purchase as many allowances as we would’ve liked,’ are related to strategy and bid quantity, so those are also prohibited," intoned CARB official Rajinder Sahota, who manages monitoring of the cap & trade program. The state releases general information about each auction -- like the total permits offered and purchased -- but there’s a strict gag order on all market participants when it comes to what individual companies are bidding and buying.

"If it comes to our attention that those kinds of discussions are occurring and that information is being shared," Sahota warned attendees, "ARB will investigate, because at face value they are a violation of the regulation."

Some large corporate cap-and-trade players are still arguing for less disclosure. But other observers say, generally, more is better.

"By increasing the transparency, increasing access to data, then people can start to realize that it’s not a shell game," said Tim O’Connor, who's been closely watching California’s carbon market for the Environmental Defense Fund. "It’s a legitimate tool for reducing emissions."

This concept of “transparency” is crucial to public confidence, especially in California, where memories are still raw from the late ‘90s, when manipulation of the electricity market sent utility bills soaring, put PG&E into bankruptcy, and helped unseat Governor Gray Davis.

UC Berkeley energy economist Severin Borenstein says that this time around, "If we had had more transparency, it would’ve become much more quickly clear what had happened." Borenstein is on an independent market assessment committee that has argued for more “transparency” in the carbon markets. But he says it’s still a bit unclear where to draw the line.

"I think that they are still in the process of developing policy on this," he said. "Certainly in the long run I would want to see them be more transparent and certainly allow more public discussion among stakeholders."

Most of the experts we spoke with agree with Borenstein that overall, the market seems to be working. Since its launch in November, the price of California carbon has gone up, which is the right direction for emissions to eventually come down. The minimum bid for today’s auction has been raised, from $10 to closer to $11 per ton of carbon. Futures have been trading in the mid-teens.

And Borenstein says it’s not unusual for new markets to start with a hiccup or two. "The market is not gonna launch smoothly on Day 1. Markets never do," he explained. "It’s gonna require adjustments. And so the screw-up in the first auction, for instance, is one that I don’t anticipate will happen again."

The question remains: if it does happen again, and it does affect the market price of carbon credits in California--who will know?