It's Getting Cheaper to Pollute in California

California just had its fourth auction of greenhouse gas emission allowances under its cap-and-trade law, and the price to emit a ton of greenhouse gases in the state has dropped significantly since the last auction in May. But some climate activists are relentless in saying that drop isn't necessarily bad news.

The August auction, held by the California Air Resources Board (CARB) on August 16, was part of California's greenhouse gas cap and trade program established by AB 32, the Global Warming Solutions Act of 2006. The auction included both emissions allowances for this year and advance sales of some allowances for 2016's "vintage."

The intent of the law, under which California's largest emitters of greenhouse gases must buy permits for the privilege, is to provide an incentive for those companies to reduce their emissions. Each "allowance" corresponds to a ton of carbon dioxide or its greenhouse gas equivalent. If a firm can reduce its greenhouse gas emissions to the point where it has extra allowances, it can sell those to a company that hasn't reduced its emissions quite so well. That secondary market in allowances creates an additional impetus to cut down on belching greenhouse gases into the atmosphere.

According to CARB, last week's auction covered 13,865,422 emissions allowances for 2013. The results showed a bit less demand for those allowances than in May. The prices offered cover a fairly wide range, as is usual when you're auctioning off 13,865,422 of anything, but bids for those 13 million allowances where lower last week than they were for the 14.5 million allowances auctioned off in May, and by a considerable margin.

The median price paid for emissions allowances in last week's auction was $13.01, down $1.24 from May's. The median bid price, which is related to but not identical to the median allowance price, was $12.62 last week, down from $13.49 in May.

If your eyes glazed over at the difference between those two prices, don't worry, so did ReWire's. They're just different ways of figuring out the average price.

Quick math class:

Ask most people for an average price on a bunch of items being sold (as in emissions allowances) and they'll divide the total proceeds by the number of items. Sell a dozen eggs for $18.00 and they'll divide 18 bucks by 12 eggs to establish that the average price per egg was $1.50.

That sort of average is called a "mean," and it's useful for many daily tasks like splitting cab fare or a dinner tab at a family-style restaurant.

But sometimes a mean doesn't tell you all that much. Let's say that dozen eggs wasn't sold whole, but was bought a few eggs at a time for different prices. One guy bought six eggs and paid 99 cents each. A woman offered $1.01 each for two more, then her friend buys another two for $1.02 each. A guy needs just one egg but he has only a two-dollar bill, and he shrugs and says "keep the change." Finally a woman engaged in a scavenger hunt is about to lose unless she can find one egg in a hurry. She pays six bucks for the remaining egg.

That's a dozen eggs sold for $18, but not a single buyer paid the mean price of $1.50 per egg. To learn more about who paid what for the eggs, your consulting egg accountant would instead turn to another kind of average, the median. A median is that number in a range of figures that's midway in the range. Half of the figures will be above the median, and half will be below it.

In this example, half the eggs sold for $1.01 or more, and the other half, which all went to that six-egg guy with the 99-cent sweetheart deal, sold for less than $1.00. That makes the median egg price $1.00. Substitute greenhouse gas allowances for eggs and that's the thinking behind the median allowance price.

But what about the median bid price? Our egg-monger had five "bids" for those dozen eggs: 99 cents, $1.01, $1.02, $2 and $6. That makes the median bid price for those eggs $1.02. So we're just talking about different ways of finding the "average" of a set of purchase prices, all useful to explain different things.

Thus endeth the math.

Anyway, the general thinking behind the cap-and-trade incentive is that a higher price for those emissions means a more robust financial incentive to reduce them. You might reasonably expect that a price drop of more than a dollar on a price of $13 to be cause for concern among environmentalists tracking California's greenhouse gas cap and trade auction.

As it turns out, though, those enviros were quick to point out that this drop in prices was not only expected, but could be spun as good news for climate activists. A bit of an adjustment in free allowances extended to natural gas companies and a few other emitter classes had been expected to create a drop in prices, and besides, as Environmental Defense Fund's Emily Reyna points out, the minimum bids received for those allowances went up from CARB's absolute legal minimum of $10.71 to $11.10. Reyna suggests that this raised floor means that auction participants are feeling more secure that the emissions trading market is here to stay, and are thus willing to participate beyond the minimum levels legally required. Reyna also suggests that a recent increase in efficiency projects by California oil refineries and other large polluters may be reducing future projected emissions, and thus demand for allowances.

Reyna points out that doomsday predictions of cap-and-trade's effect on California's economy have mostly so far been proven wrong, as the state's economy has recovered somewhat during the course of the auction from the smoking crater it landed in in 2008. That's a bit of conjecture, of course, and supporters of greenhouse gas emissions, if you were to find any, could as easily argue that the recovery would have been stronger without charging polluters for the privilege to pollute.

Which is to some degree beside the point. The intent of the cap-and-trade law is to help forestall a climate change disaster whose misery could dwarf that of any historic economic crisis on record. It's an important project regardless of its economic cost, and as the saying goes, you can't make an omelet without, well, you know.