Effect of Lower Cap-and-Trade Revenues on the High-Speed Rail Project

The final quarterly cap-and-trade auction in 2019‑20—which was held in May 2020—generated very little revenue compared to recent auctions. In this post, we discuss how the reduction in cap-and-trade revenues might affect the state’s high-speed rail project.

Cap-and-Trade Is Key Fund Source for High-Speed Rail Project

May Cap-and-Trade Auction Generated Little Revenue. Based on the preliminary results of the quarterly cap-and-trade auction held on May 20, 2020, the state will receive an estimated $25 million in revenue from the auction. As we discuss, in our May 2020 Cap-and-Trade Auction Update post, this represents a significant decline in revenues from recent quarterly auctions, which each have generated over $600 million. The lower revenues in the May auction are likely related to various factors, including the economic effects of the coronavirus disease 2019 (COVID-19). At this time, there is significant uncertainty regarding the amount of revenues that will be generated in future auctions, and there is a reasonable possibility that revenues from future auctions could also be depressed. For more detail on potential cap-and-trade auction revenue scenarios and implications for programmatic spending, see our post: Addressing Revenue Uncertainty in the 2020‑21 Cap-and-Trade Expenditure Plan.

Lower Cap-and-Trade Revenues Reduce Funding Available for High-Speed Rail Project. The high-speed rail project receives about 25 percent of the state’s revenues from the quarterly cap-and-trade auctions. Accordingly, the lower the state’s cap-and-trade revenues, the less funding is available for the project. Notably, cap-and-trade revenues represent a major source of funding for the high-speed rail project, making up more than 40 percent of the funds the High-Speed Rail Authority (HSRA) plans to use to construct its proposed Merced-to-Bakersfield segment and meet commitments to local and federal partners (such as to fund certain local bookend projects and complete additional environmental work).

Potential for Lower Revenues Exacerbates Project Funding Risks

Project Already Facing Uncertain Funding Picture. Even prior to the recent economic downturn, it was unclear whether HSRA would have sufficient funding to complete the Merced-to-Bakersfield segment and meet other related commitments. Specifically, we noted in a March publication, Review of the Draft 2020 High-Speed Rail Business Plan, that under certain circumstances the state would need to identify other fund sources—such as the General Fund—to fully fund the Merced-to-Bakersfield segment and other related spending commitments. For example, this could occur if the state has to return some or all of its federal grant awards (which the federal government has threatened to rescind), the amount of cap-and-trade auction revenue assumed in the project’s business plan does not materialize, and/or the project’s costs are significantly higher than estimated.

Lower Revenues Would Increase Risk of Insufficient Funds for Merced to Bakersfield. HSRA’s Draft 2020 Business Plan assumes the project receives between $500 million and $750 million annually in cap-and-trade revenues through 2030. The May 2020 auction generated just over $6 million for the high-speed rail project, bringing the amount of cap-and-trade revenue generated for the project in 2019‑20 to $493 million. The project’s annual auction revenues have averaged $534 million since 2015‑16, with a low of $221 million and a high of $787 million. For reference, if the project is able to keep its federal grant funds and experiences no further cost increases, it would need to average almost $500 million per year in future auction revenues through 2030 to have sufficient funding to complete the Merced-to-Bakersfield segment and meet related commitments. However, if the project ends up having to return all of its federal funds (but experiences no further cost increases), it would need to average over $800 million per year in future auction revenues. The longer the state’s cap-and-trade revenues remain depressed, the higher revenues will need to be in future auctions to make up for the lower revenues received in the near term to continue to meet the project’s funding needs.

Lower Revenues Could Exacerbate Possible Timing Issues for Funding. It is possible that revenues from future quarterly auctions will rebound sufficiently to generate enough total funding to cover the costs for the Merced-to-Bakersfield segment and related commitments. However, even a short-term reduction in revenues could increase the chances that the project’s funding will not align with the project’s cash needs. This is because the vast majority of the project’s costs for the Merced-to-Bakersfield segment—nearly 90 percent—are anticipated to be needed by 2023‑24. However, HSRA’s funding plan relies in part on revenues from cap-and-trade auctions, which are not available up front, and, moreover, could be particularly low in the near term given the recent economic downturn and other factors.

Budget Situation Makes it Difficult for General Fund to Backfill Losses or Provide Loans. The economic effects of COVID-19 are creating very large budgetary problems for the state. Specifically, the Governor’s May Revision estimated the state faces a General Fund budget problem of $54.3 billion. Both our office and the administration expect budget deficits to persist until at least 2023‑24. Given these challenges, the state will have to make very difficult budget choices for the upcoming fiscal year and likely beyond. This will mean that the General Fund is unlikely to have additional funds to support the project, and any General Fund support in the near term—whether as a backfill or loan—likely would come at the expense of other state funding priorities. In addition to the General Fund, there are only a few state funding sources—such as a greater share of cap-and-trade funds—that could be used to support the project. However, these other funding sources are also facing fiscal strain due to the recent economic downturn.

Legislative Options to Reduce Near-Term Project Costs. As we discussed in our March review of the draft funding plan, there are other options the Legislature could consider besides the current scope of the Merced-to-Bakersfield segment, and some of these options could cost less. It will be important for the Legislature to provide direction on which option it would like to pursue soon, since HSRA is poised to take actions—such as entering into contracts—that will make it difficult for the state to change course to select a less costly option should shortfalls materialize in the future.