By Tom Roderick, portfolio manager of the Trium Epynt Macro Fund.
California’s carbon market just got political. After President Trump deployed the National Guard to Los Angeles in response to ICE raid protests, tensions with Democratic Governor Gavin Newsom hit a new high. The two have clashed repeatedly, and with Newsom eyeing a 2028 White House bid, the environmental clash is getting dirtier.
Trump’s latest move is directing the DOJ to try and shut down California’s cap-and-trade program. This is the emissions trading scheme at the heart of the state’s 2045 plan for carbon neutrality – which Trump has labelled a “radical” drag on American energy. Newsom, sensing political upside, has jumped to defend it. The clash has gone beyond a question of environmental policy, becoming a fight for narrative control ahead of the next election cycle, while having implications for California’s tax revenues.
Nowhere is the climate fight more vivid than in California. Wildfires continue to devastate parts of the state, with climate change blamed by many (though Trump blames water mismanagement). California’s carbon market is a prime example of how decarbonisation is creating tradeable distortions.
Dislocation is opportunity
Carbon prices were already soft on uncertainty around the California cap-and-trade scheme’s post-2030 future, but Trump’s shutdown threat triggered a further sell-off. Now, carbon allowances are on the floor – May’s quarterly auction failed to clear at the price floor, meaning that 16% of new issuance was withheld from the market until at least next year. That puts a cap on downside from here.
If Trump’s effort fails, a return to pre-election levels would deliver a 50%+ return. You don’t need options when the asset price itself carries that kind of asymmetry. Even better, the floor is not flat but is a staircase with a riser of 8% per year (inflation +5%). The system ensures a base of rising prices by design.
History rhymes
We have been here before, with Trump trying to kill the program during his first term. The courts shut him down then, and we expect a similar outcome this time, as we don’t sense this is a real priority for the administration. There is the possibility that continued legal challenges sour investors towards the market and prices dip temporarily below the floor. That leads to more failed auctions and a lack of supply for emitters, who still must meet their obligations. This is what the floor is for – the system is self-correcting. Fewer credits issued would cause a squeeze and push prices back up.
Yes, carbon markets come with regulatory risk, without regulation the price would be zero. Trump’s executive order throws up a smokescreen aiming at real disruption. A Trump win here would raise broader rule-of-law questions and likely damage confidence across U.S. markets, and there are better hedges for that scenario.
Clean trade
Positioning now looks clean, after a couple of early attempts by speculators to buy the dip prior to hitting the floor. Speculative positioning as a proportion of open interest is at four-year lows.
A more likely outcome is that this episode galvanises support to extend and strengthen the scheme. That would mean tighter supply, higher prices, and tailwinds for long positions. Next year, we may have stopped talking about the floor and started worrying about the ceiling.
The trade is to be long California Carbon Allowances. With limited downside thanks to the floor, regulatory overhang already priced in and a real catalyst path to upside, this is a rare moment where policy risk has created a clean macro trade at distressed valuations with a defined downside.
