We expected the story to change, however, if California\u2019s program was extended past 2030.\u00a0 That was because the aggregate surplus of allowances looked like it would become a deficit somewhere around the mid 2030s (see chart above). This was the case even though we assumed less ambitious carbon reduction goals than what was eventually adopted.\u00a0 After 2033 or so, sharp declines in the carbon cap would require ever more rapid reductions of emissions, or else the price would settle in at the allowance price ceiling.\u00a0 I fully expected that, if the program were extended past 2030, the market would start to price in the prospect of a looming, if somewhat distant, shortage of allowances and start driving up near-term demand for allowances, which, with some restrictions, can be banked indefinitely and cashed in at a later date.\u00a0 In other words, I expected firms would start buying up allowances at today\u2019s low prices and banking them for the future, thereby increasing prices in the near term.<\/p>\n Over the last year, the market has simply not cooperated with my cogent analysis.\u00a0 California\u2019s legislature, at the urging of Governor Newsom, and perhaps in response to President Trump\u2019s vague threats against the program, passed legislation extending the program to 2045<\/a>.\u00a0 The legislation codified an extremely aggressive schedule of emissions reductions over the next 20 years.\u00a0 More recently, the California Air Resources Board (CARB) released a proposal<\/a> that would remove a further 118 million tons from the market between 2027 and 2030.\u00a0\u00a0<\/p>\n In response to all this news the allowance market did, well, nothing.\u00a0 The price for vintage 2026 allowances started the year around $33\/ton, dropped below $30 at midyear, climbed up to $34 around the time of the program\u2019s extension in August 2025, but finished the year back down at $30\/ton.<\/p>\n \u00a0Data for DEC26 vintage 2026 California Carbon Allowance from Intercontinental Exchange: http:\/\/www.ice.com<\/a><\/p>\n So, in summary, our model said carbon prices are likely to be near the price ceiling of over $150\/ton (in 2024 dollars) by the mid 2030\u2019s, and that current day prices would be bid up to just a little below that in near-term.\u00a0 Instead, you can buy allowances for around $30\/ton today.\u00a0\u00a0<\/p>\n I just hate it when the world doesn\u2019t behave like my model.\u00a0\u00a0\u00a0<\/p>\n So what\u2019s going on?\u00a0 First let me say that I have ABSOLUTELY NO inside knowledge of what\u2019s going on with this market. I also have no financial stake in this market. The following is just speculation on my part as I am trying to understand this market\u2019s dynamics. Suggestions from readers would be welcome.\u00a0 I can think of several possibilities.<\/p>\n Explanation 1: It\u2019s the Model<\/p>\n Maybe our model is wrong. Now, it goes without saying that this is the least credible explanation \u2026.\u00a0\u00a0<\/p>\n More seriously, while our model has a lot of technical bells and whistles to it, this really comes down to how fast you think California can reduce its carbon emissions, and at what cost.\u00a0 \u00a0 While the carbon cap was less binding, and some believe too lax, during the 2010s, the trajectory of the cap sharply declines from 2020 onward.\u00a0 Further, the declines in emissions during the 2010s were dominated by the electricity sector, particularly imported electricity.\u00a0 This was the low-hanging fruit.\u00a0 Large reductions in industrial and residential emissions are likely to be slower and more costly.<\/p>\n The key aspect of California\u2019s carbon market is that there is a price floor and a price ceiling.\u00a0 Our model estimates that the amount of carbon abatement induced by higher carbon prices, even at the price ceiling, is not sufficient to keep up with the reduction goals of the program.\u00a0 One way the market could produce carbon prices lower than our model is if there is a lot more abatement possible at prices in the $50 \u2013 $150\/ton range than we thought.<\/p>\n How plausible is that?\u00a0 Another way to look at this question is to ask, why were prices for vintage 2026 allowances close to $48\/ton in early 2024 and barely more than half of that today?\u00a0 Has there been new information that makes it clear California will more easily stay under its cap?\u00a0 Let\u2019s recount some of the pertinent events since 2024.<\/p>\n a)\u00a0 \u00a0 \u00a0 \u00a0 The Trump administration eviscerates regulations supporting EVs and improved vehicle fuel economy<\/a>. California and other states are still disputing these moves.<\/p>\n b)\u00a0 \u00a0 \u00a0 \u00a0 Almost all of the clean energy provisions in the IRA, including subsidies for EVs, home electrification, and renewable electricity get repealed<\/a>.<\/p>\n c)\u00a0 \u00a0 \u00a0 \u00a0 Under pressure from tariffs and the changing regulatory landscape, the EV market stagnates even in California<\/a>.<\/p>\n d)\u00a0 \u00a0 \u00a0 \u00a0 California commits to either cutting its current emissions from 267 mmTons\/year in 2025 to only 30 mmTons\/year in 2045 or, if it can\u2019t reach these levels, letting its carbon price follow a trajectory that starts at over $100\/ton in 2026 and rises to almost $200\/ton by 2040.\u00a0\u00a0<\/p>\n If this market were behaving rationally, the price movements over the last year imply that compliance with our future cap now looks less costly than it did two years ago. Yet almost all the news since 2024 points toward an environment where complying with the carbon cap will be more difficult, not less.\u00a0<\/p>\n Explanation 2.\u00a0 Its the Risk<\/p>\n Firms and speculators may believe it\u2019s too risky to buy permits and plan on holding them to sell in the future.\u00a0 Trump could kill the program.\u00a0 California could back off its goals.\u00a0 A meteor could hit the earth.\u00a0 Cold fusion could be commercialized.\u00a0 You get the point.\u00a0<\/p>\n In a way, if you believe our model, this explanation is almost definitionally true.\u00a0 Firms are not willing to risk holding permits even for what look like potentially enormous returns.\u00a0 But the implied risk aversion is pretty staggering.\u00a0 The price ceiling in 2035 will be close to $150\/ton plus inflation. \u00a0 For an investor buying permits at $30\/ton today, that would constitute more than a 20% annual real return. \u00a0 I was curious about what kinds of investments require that amount of return to draw capital.\u00a0 Some of the riskier sovereign debt out there runs up to 20%.\u00a0 California carbon allowances are somewhere between Ghana and Egypt on the expected return, except that carbon allowances have no currency and less inflation risk because the floor and ceiling prices are pegged to inflation.<\/p>\n For most of these international bonds, the downside risk is default.\u00a0 For a cap-and-trade market, I would think the downside risk is less extreme.\u00a0 Even if you think the Federal government could somehow kill a state program like California\u2019s cap and trade, if it were completely eliminated I would imagine that outstanding permits would be repurchased.\u00a0 When Ontario left the WCI market (of which California is the largest member) participants holding unused allowances were compensated<\/a>,\u00a0 at something like the average auction price over previous auctions.\u00a0\u00a0<\/p>\n For California\u2019s carbon market a more realistic scenario might be a relaxation of the regulation, either by increasing emissions caps or allowing more controversial compliance instruments like offsets or dairy gas<\/a>.\u00a0 Another possibility is that the price ceiling may be set at a lower level, or more plausibly, frozen. However, the price ceiling is over $100 this year, so upside price potential is still large even if the current level is held fixed. Further, the market still has a floor price that is also increasing at 5% real per year.\u00a0 This means the lowest the price would be in 2035 would be about $41 plus inflation.\u00a0 In other words, the downside risk (as long as the program continues to exist) would be getting \u201conly\u201d a 4% real return.\u00a0 Inflation protected treasury bonds are yielding a little under 2% right now.<\/p>\n Risk is clearly a factor, but I have trouble believing this risk is being arbitraged in any kind of sophisticated and rational way.\u00a0\u00a0\u00a0<\/p>\n Explanation 3:\u00a0 It\u2019s the Refineries\u00a0<\/p>\n This is pure, uninformed, speculation on my part.\u00a0 Consider two related facts.\u00a0 First, the combustion of gasoline and diesel constitutes more than half of California\u2019s capped emissions, about 126 mmTons in 2023.\u00a0 Most of the other half of emissions are covered through allocated, rather than auctioned, allowances.\u00a0\u00a0<\/p>\n In other words, the firms with the largest requirements to purchase allowances, by far, are the ones that sell gasoline. \u00a0 According to my calculations, about 197 mmTons of California allowances were sold in the 4 auctions in 2025 (Electricity allocations \u2013 the purple sliced -are consigned into the auction).\u00a0 If emissions from transportation fuels remained steady from 2023, then about 60% of the allowances sold in 2025 would be needed by sellers of transportation fuels to comply with their obligation to cover the tailpipe emissions associated with the fuels they sell.\u00a0<\/p>\n However, two of those firms, Valero and Phillips 66, are closing their refineries and leaving the state in 2026.\u00a0 These firms will no longer need to buy allowances anymore if they won\u2019t be selling gasoline in California (Phillips says they will be).<\/p>\n Now, like most people I believe that most of the gasoline from the closing refineries will need to be replaced from somewhere<\/a>, probably from imported fuel. \u00a0 But I\u2019m not sure if anyone knows exactly how that fuel will be imported, and by whom.\u00a0 Probably the importing firms themselves don\u2019t know for sure.\u00a0 They probably aren\u2019t going out and buying carbon allowances yet on the off chance they might be selling gasoline in California.\u00a0 In any event, the current compliance window runs through December 2027, so firms have almost two years to buy the allowances they need even for gasoline they sell today.\u00a0\u00a0<\/p>\n This scenario is one of a market disequilibrium, where previous buyers of permits have stopped buying, and the new buyers haven\u2019t yet shown up at the auction.\u00a0 For whatever reason, firms in environmental compliance markets behave very myopically. Anecdotally, compliance entities prefer to \u201cpay as they go\u201d and buy allowances only when they need to surrender them for compliance.\u00a0 If this is what\u2019s going on, we may see a big run up as we get closer to the compliance deadline in 2027.<\/p>\n What data are available don\u2019t really scream that this is what is going on.\u00a0 In the following figure I plotted a couple statistics that are reported from the CARB auctions.\u00a0 The top line is the percentage of purchased allowances bought by compliance entities (as opposed to financial firms with no emissions).\u00a0 There is no real movement in this number since 2021.\u00a0 The blue line plots the number of allowances sought (e.g. the quantity of allowance purchases bid) divided by the number being sold.\u00a0 A number greater than one means that there was more \u201cdemand\u201d than supply.\u00a0 Demand was in fact a little lower in 2025, even after accounting for the fact that the number of allowances on offer was also declining each year.<\/p>\n Even if this is part of the story, it still doesn\u2019t explain why other firms aren\u2019t jumping on allowances today at what seem like discounted prices.\u00a0 There is clearly risk, but how high is it really?\u00a0 Is it really, more than Ghana level risk? Or Six Flags Corp. bond level risk?\u00a0 \u00a0 Sometimes markets just aren\u2019t as efficient as economists think they should be.<\/p>\n The Energy Institute blog will be on vacation next week for the President\u2019s day holiday. It will return on Monday, February 23.<\/p>\n Follow us on\u00a0Bluesky<\/a>,\u00a0LinkedIn<\/a>, and our new Instagram<\/a>. Also subscribe\u00a0to our\u00a0email list<\/a>\u00a0to keep up with future content and announcements.\u00a0<\/p>\n Suggested citation: Bushnell, James.\u00a0\u201cWhy Are California Carbon Prices So Low?\u201d\u00a0Energy Institute Blog, February, 9, 2026, https:\/\/energyathaas.wordpress.com\/2026\/02\/09\/why-are-california-carbon-prices-so-low\/<\/a><\/p>\n![\"\"](\"https:\/\/www.newsbeep.com\/il\/wp-content\/uploads\/2026\/02\/cumulative_floor.png\")
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