Environmental Law ReSource : Environmental Lawyer & Attorney : Reed Smith Law Firm : Climate Change, Sustainability

California’s Global Warming Solutions Act of 2006, also known as AB 32, mandates that California reduce GHG emissions to 1990 levels by 2020. In December 2008, CARB issued a Scoping Plan that outlines California’s strategies for meeting this mandate. Establishing a California cap-and-trade program is a prominent component of the Scoping Plan. Cap-and-trade refers to a system in which production of pollutants is capped, producers receive allowances that give them the right to pollute up to specified amounts, and a market is created for trading allowances among producers. For more background on AB 32, the Scoping Plan, and cap-and-trade programs, please review our earlier postings.

California’s cap-and-trade program will include a stringent declining emissions cap, meaning the amount of emissions allowed will be reduced for each subsequent compliance period. The proposed regulations outline three three-year compliance periods (2012 to 2014, 2015 to 2017, and 2018 and 2020). But CARB is considering shortening the compliance period to one year. 

Sectors subject to the cap-and-trade program include large stationary sources of GHG emissions, electricity deliverers, and fuel deliverers that emit at or above a 25,000 metric ton of carbon dioxide equivalent (MTCO₂e) threshold. In the Scoping Plan, CARB outlined a staggered approach for phasing regulated sectors into the program. Under the staggered approach, certain sectors would be covered by the program starting in the first compliance period (e.g. 2012 to 2014) with additional sectors becoming covered in subsequent periods. The proposed regulations retain the staggered approach, with 600 of California’s largest GHG-emitting stationary sources subject to the program starting January 1, 2012. But CARB has indicated that it is considering abandoning this approach and making all regulated sectors subject to the program starting January 1, 2012.

Once covered by the cap-and-trade program, an entity will hold emission allowances that it can (1) surrender to cover its emissions, (2) bank for future use, (3) trade to another entity, or (4) retire. The preliminary draft outlines the process for each of the options. But the biggest issue left open is how emission allowances will be allocated in the first instance. Options include free allocation, auction, or a mix of the two. CARB has formed a 17-member Economic and Allocation Advisory Committee (EAAC) to advise CARB on allocation and implementation issues. EAAC is expected to issue a report regarding allocation strategies in January 2010 and the recommendations in this report will be addressed in the revised draft regulations to be issued in Spring 2010.

Additional issues addressed by the preliminary draft include offsets and linkage to other trading programs. Offsets are tradable credits that represent GHG emission reductions in areas or sectors outside the scope of the cap-and-trade program. The preliminary draft proposes that covered entities be allowed to use offsets to cover up to four percent of their emissions. Thus, instead of surrendering emission credits to cover those emissions, the entity would use offsets. Emission reductions achieved by offsets must be real, permanent, verifiable, enforceable, and quantifiable. Further, the reduction must be additional to what is required by law or regulation or would otherwise have occurred.

The preliminary draft also outlines how California’s program could be linked with regional or national cap-and-trade programs. Outside of California and the Northeast, however, little is happening with regards to cap-and-trade programs. National cap-and-trade regulations are currently stalled in Congress. Thus, rather than linkage, the issue is really one of preemption. There is concern that a later-enacted national program could conflict with California’s program or that express preemption of California’s program could hamper California’s ability to meet its AB 32 mandate. Aside from a standard severability provision, preemption is not discussed in the preliminary draft but it will remain an issue in the national debate.

The full text of the preliminary draft regulations can be found here. For additional information, including specific applicability questions, please contact the Reed Smith lawyer with whom you regularly work.

Currently, the electricity sector accounts for 25 percent of California's GHG emissions. The CARB's Climate Change Draft Scoping Plan expects that the electricity industry will contribute at least 40 percent of the total GHG reductions from direct mandatory approaches and measures. With the addition of a potential cap-and-trade program, the electricity sector may be called upon to reduce its emissions even more. The Proposed Final Opinion describes specific mechanisms for requiring the electricity industry to meet the goals set out in the draft Scoping Plan. To achieve these ambitious cuts in GHG emissions, the Proposed Final Opinion offers recommendations and options in energy efficiency and renewable resources and combined heat and power ("CHP"), and describes a complementary cap-and-trade program. In more detail, the Proposed Final Opinion:

• Reaffirms the commitment to pursue all of the state's cost-effective energy efficiency options and urges the expansion of renewable energy to 33 percent of energy usage for all retail providers.
• Considers electric sector costs and rate impacts of reaching the 2020 GHG levels through more energy efficiency, greater use of renewable energy, and increased CHP, and concludes that the impacts will vary depending on service territory and on the design of the ultimate program developed by the CARB. (Staff and consultants of the Commissions developed a variety of illustrative scenarios that indicate that, unrelated to AB 32 compliance, utility rates are likely to rise above the rate of inflation because of increased capital and operating costs and load growth. Under some scenarios related to AB 32 policies, however, utility costs may be reduced compared with business as usual, after accounting for the adoption of significant energy efficiency measures by consumers.
• Recognizes the value of higher energy efficiency provided by CHP projects, and recommends that for larger installations (over the size-threshold adopted by CARB), the GHG emissions for electricity consumed onsite and/or delivered to the grid be included in the cap-and-trade program, and receive allowance allocations comparable to other electricity providers and consumers.
• Identifies auctioning as the preferred method to distribute emission allowances. Starting in 2012, 80 percent of the emission permits or allowances would be distributed for free to electricity deliverers and 20 percent would be auctioned, with 100 percent auctioned by 2016.
• Recommends that free allowances be allocated to deliverers based on energy output and electricity fuel source. (Allowances would be granted to the electricity retail providers on behalf of their customers, with the allowances offered for sale in an independent, centralized auction. These allowance allocations will change over time based on historical portfolio emissions to a sales basis by 2020, to allow transition time for retail providers with emission intensive portfolios.)
• Proposes that auction revenues be used for AB 32-related purposes, and all revenues auctioned by the retail providers be used to support investments in renewables, efficiency, new energy technology, infrastructure, and customer bill relief.
• Urges, in considering market structure, that the key market design feature is maintaining environmental integrity. (Market structure should encourage open and transparent allowance trading with many participants, unlimited banking of allowances and offsets, and offsets that must meet AB 32 requirements to be real and permanent. Offsets should not be limited geographically. If a multi-sector regional cap-and-trade is developed, a three-year compliance period should be established to allow time to implement emission reduction measures and to account for hydrologic conditions that can significantly impact the electricity sector.)

The development of this Proposed Final Opinion has been an open public process beginning with a joint Commission symposium in April 2007 that addressed GHG emissions and various types of possible cap-and-trade markets. A number of workshops have helped craft the recommendations. The Proposed Final Opinion on Greenhouse Strategies, A Summary of the Proposed Opinion, and Frequently Asked Questions are available from the Energy Commission, and are also available from the California Public Utilities Commission.