The California cap-and-trade program is a prominent component of the California Air Resources Board’s Climate Change Scoping Plan.
Cap-and-trade refers to a system in which production of pollutants is capped, producers receive allowances, giving them the right to pollute up to their respective caps, and a market is created for trading allowances among producers, The ability to trade allowances gives producers the opportunity to choose between reducing production or buying allowances from producers that don’t need them – by reducing their own production below their caps. Cap-and-trade systems have been adopted in Europe for greenhouse gas emissions under the European Union Emission Trading Scheme and in the US for the reduction of acid rain. A federal cap-and-trade program for greenhouse gas emissions has been proposed, but is not yet as developed as the program mandated by California AB32. In theory, the cap-and-trade market rewards more efficient constituents and offers flexibility to more deliberate constituents, allowing the benefits of reduced emissions to be achieved at the least overall cost. In practice, a number of challenges, including market resistance and the cost of administration, face cap-and-trade systems as they are implemented.
To implement the cap-and-trade program under the Scoping Plan, the state plans to:
- impose a cap on total greenhouse gas emissions which will decline over time to achieve 1990 levels by 2020;
- issue and distribute “allowances,” units of allowed emissions under the cap, to greenhouse gas producers;
- award “offsets” for verifiable reductions in emissions not otherwise covered by a cap or other regulation that may be applied toward compliance in addition to allowances; and
- create a market in which allowances and offsets may be traded.
The declining cap specifies the ceiling on greenhouse gas emissions for a specified producer at a given time. By 2012, caps will be imposed on electricity generation and large industrial facilities emitting more than 25,000 metric tons of CO2E per year, and by 2015 the caps will extend to other industrial facilities as well as commercial, residential and transportation fuel combustion. Each of the capped producers will require allowances or offsets to be able to emit greenhouse gasses after the applicable cap effective dates.
Creating a market for allowances and offsets offers flexibility and encourages innovation and investment while striving to achieve an overall reduction in greenhouse gas emissions. Opportunistic producers may sell their excess allowances or offsets to more deliberate producers, giving prospective sellers an incentive to innovate and invest in reduction programs and offering buyers additional flexibility in achieving compliance. Allowances may also be banked for future use, encouraging early emission reductions and reducing market volatility. In addition, allowances may be set aside for dedicated purposes, including early compliance and use by local governments for targeted projects.
The California cap-and-trade system will be linked with the regional cap-and-trade system being developed by the Western Climate Initiative, which was formed in 2007, and includes the states of California, Arizona, New Mexico, Oregon, Washington, Utah, and Montana, and the Canadian provinces of British Columbia, Manitoba, Ontario, and Quebec. Regional cap-and-trade offers even greater flexibility and market stability and helps reduce “leakage,” the movement of greenhouse gas production from California to other areas.
A number of significant challenges will need to be addressed in the rule-making process. These include:
- Determining and setting caps for individual producers;
- The method for distributing allowances, whether by grant, sale or auction;
- Measuring compliance with allowances and verifying milestones for offsets; and
- The nature of incentives offered for early compliance.
Businesses and business operations in California should plan for the impact of the impending caps and consider providing input into the rule-making process. Allowances and offsets will represent substantial economic value, and many interests are expected to weigh in on development of the final regulations for the program.
Implementation of the cap-and-trade system in California and the Western Climate Initiative offers a number of opportunities for entrepreneurs and opportunistic enterprises. In addition to producers who can derive value from early reduction of greenhouse gas emissions, these include developers of alternative energy sources, biofuels, energy storage and management systems, green manufacturing processes, chemicals and building materials, and water purification and distribution technologies, valuation experts and financial engineers who can assist producers in evaluating alternatives and generating and trading allowances and offsets, market makers and brokers, and investors in the enterprises addressing each of these areas.
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