The solution
California's cap-and-trade law set a falling cap on greenhouse gases, but a cap only moves behaviour if the resulting allowance price is credible. Europe's first trading phase had collapsed to near zero partly because permits were handed out free and there was no floor.
California's answer was to auction permits and clothe the auction in a price collar. Its first sale, in November 2012, cleared at $10.09 per tonne against a $10 reserve floor, and the program held a reserve of allowance prices in escrow to dampen future spikes.
More than half of allowances go to auction; a share is handed to utilities which must sell them and credit ratepayers, and a reserve fund sits ready to steady prices. The design gives the market a predictable carbon price rather than a gimmicky one.
What it achieved
Auction with built-in price collars
Why it worked
Free allocation gave the EU ETS a price that collapsed to near zero
A reserve price floor stops a bust before prices lose all meaning
A containment reserve releases allowances to stop a price spike
Auctioned revenue returns value to ratepayers and to clean-energy programmes
What can be applied
A quantity instrument fails if the price is unstable; putting a floor and a release valve into the same auction gives a cap-and-trade the price certainty that makes it actually reduce emissions.
Aftermath
California's cap-and-trade became the anchor of a North American carbon market, linking with Quebec and later Ontario. It survived legal challenges and continued through 2030 emissions targets, valued as a workable model for giving a quantity cap a stable price, in contrast to the first EU ETS collapse.
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