Are California Carbon Allowances an Attractive Investment?

Yes, California Carbon Allowances (CCAs) are an attractive investment opportunity, though they come with political tail risk. California’s Cap-and-Trade Program requires companies in regulated industries to purchase CCAs to offset a portion of their carbon emissions. The CCA supply is mandated to decline over time to support higher carbon prices and discourage emissions. After peaking at $40, CCAs fell nearly 40% from February 2024 to April 2025, driven by delayed supply cuts from the California Air Resources Board (CARB) and President Trump’s April 8 Executive Order (EO), “Protecting American Energy from State Overreach.” With CCAs now priced near the program’s floor, they offer highly asymmetric return potential. The program has enjoyed bi-partisan support in California, survived previous legal challenges posed by the first Trump administration, and provides significant revenue for the state budget. Legislative extension of the program from 2030 to 2045 and implementation of planned supply cuts are key catalysts for unlocking value.

The core investment thesis is that CCAs will transition from an annual supply surplus to persistent deficits within the next one to two years, even without further supply tightening. In more mature carbon markets, such a shift has historically led to sharp price increases. Total program cumulative supply, including inventories, is expected to go into deficit between 2030 and 2035, with 2030 depletion estimates dependent on timely implementation of CARB’s supply reduction plan.

CCAs now trade near the 2025 price floor set by CARB, limiting downside risk. The floor price increases annually by 5% plus inflation, providing a steadily rising base. With the CCA price roughly 3% above the floor, the minimum return from the current purchase price is 2% plus inflation over the next year, and inflation plus 5% over subsequent years. Should anticipated catalysts materialize, prices could retrace its losses to around $40, a gain of nearly 50%.

While timing is uncertain, annual deficits will eventually drive prices to the first price containment tier, designed to slow carbon price increases. If covered entities need to buy CCAs beyond what remains in inventory and the allowance price containment reserve, CARB executes a price ceiling sale. The potential upside from such an eventuality is eyepopping. There are multiple price ceilings with set allowances in reserve, with the first at $60.47, increased by 5% plus inflation annually. As of May 2, prices are 143% below the first containment tier value for 2026. Accounting for the mandated price increases, if it takes three years to reach the containment tier, CCAs could deliver a 41% annualized return, and if five years, a 26% annualized return.

While the price floor limits downside, program elimination would render CCAs worthless. President Trump’s EO elevated concerns, even though the risk to the program is likely minimal. The order directs the US Attorney General to review state and local climate regulations, including California’s Cap-and-Trade Program, to determine if they are unconstitutional and obstruct US energy use or production by June 7. Legal counsel for managers participating in this market has consistently concluded the EO has no legal basis. The program has also survived court scrutiny, including by the current Supreme Court.

Following the EO, Governor Newsom and bipartisan state legislators have reaffirmed strong support for the CCA program and expressed intent to pass legislation extending it through 2045 this year. CARB has announced plans to implement program tightening soon after. These actions, if realized, would be significant catalysts for CCA prices, providing greater certainty and potentially accelerating the shift to a market deficit.

The upside potential for CCAs relative to the downside risk justifies an allocation, particularly when funded from global equities. For example, if global equity valuations revert to their historical median over three years, the annualized price return would be -8.3%. With CCA prices near the floor, the probability of program termination would need to be at least 20% for the probability-weighted downside to match that of equities reverting to their median valuation. In contrast, if CCAs recover to their prior highs of around $40, the annualized returns would be 14.4% over three years—a scenario requiring global equities to reach record-high valuations. Political risk is inherent in the CCA market and may not suit all investors. Overall, for investors comfortable with the unique risks, CCAs offer a compelling risk-reward profile that can enhance portfolio diversification and return potential.

Celia Dallas, Chief Investment Strategist