California Moves Ahead With Cap-and-Trade Rules

by Tom Mounteer and Elizabeth Deane, Paul Hastings

While conventional wisdom suggests the U.S. Senate will find it hard to join the House of Representatives in passing comprehensive federal climate change legislation, California is moving ahead with its own efforts to limit greenhouse gas emissions (GHG) to combat climate change.

California joins other states, including its neighboring western states, in adopting a GHG emissions cap-and-trade program. Cap-and-trade programs set limits on aggregate GHG emissions from a baseline level and then reduce aggregate allowable emissions over time to reach desired reduction goals.

In Copenhagen in December, President Barack Obama pledged the U.S. would attain 17 percent reductions in national GHG emissions in 2020 from a 2005 baseline. To reach a goal like that, a cap-and-trade program is essential, and such programs have been the centerpieces of leading federal legislative proposals for years.

Congress has struggled to reach agreement on federal cap-and-trade legislation. The House passed a bill in June 2009, but in the Senate, comparable legislation has met an impasse.

In 2006 California enacted its Global Warming Solutions Act in which a cap-and-trade program is also the centerpiece. In the case of the Global Warming Solutions Act, the baseline is 1990 emission levels, which must be met by 2020.

In fall 2009, the California Air Resources Board (ARB) proposed draft preliminary rules to implement the cap-and-trade program called for by the act. To facilitate soliciting comments early in the process, the preliminary regulations identify several key issues that ARB staff have yet to resolve. ARB expects to release its final draft proposed rules regulations this summer and to finalize them during its October meeting.

Even with its own cap-and-trade rules, California will continue to participate in the Western Climate Initiative’s (WCI’s) regional cap-and-trade program in which a dozen western states participate. ARB’s proposed rules generally are consistent with the WCI’s framework regarding when they become effective, the emissions sources covered, the goals for emissions reductions, and the timetable for meeting those goals. California might impose rules more stringent than the WCI’s.

California’s GHG cap would apply to sources of about 85 percent of the state’s emissions. Electricity generators, large industrial sources that emit at least 25,000 metric tons of carbon dioxide or its equivalent of other GHGs and fuel suppliers would be subject to the cap.

ARB’s draft rules propose two initial compliance periods, each of which is three years. The first would start Jan. 1, 2012. Beginning then, ARB proposes to cover 600 of California’s largest GHG emitters.

These include in-state electricity generators (including operators of stationary combustion and cogeneration sources) that emit at least 25,000 tons of CO2 or equivalent; out-of-state generators that deliver electricity to California; and large industrial emitters at the 25,000-ton or greater level in specified industrial sectors, including cement, aluminum, glass, iron and steel production, petroleum refining, natural gas transmission and distribution, petroleum extraction, and other sectors.

Under the preliminary proposal, ARB would bring fuel suppliers under the emissions cap beginning Jan. 1, 2015. Suppliers of all industrial, commercial and residential fuel would be subject to the cap based on the amount of emissions associated with the fuel supplied.

Natural gas suppliers particularly would be affected, as would suppliers of transportation fuels, including gasoline, diesel and ethanol. Whether the compliance date for fuel suppliers will remain on a separate track from other sources, however, is still being evaluated. In the proposed regulations, ARB has indicated that it also is considering bringing fuel suppliers under the emissions cap beginning Jan. 1, 2012.

The proposed rules would create two compliance instruments to allow covered sources to satisfy their obligations under the cap: emissions allowances and offsets. Each allowance or offset would equal one metric ton of CO2 or its equivalent. At the end of each three-year compliance period, covered sources would be required to turn in enough compliance instruments to match their emissions during that period.

ARB would create emission allowances in a number equal to the aggregate cap for emissions from all covered sectors. ARB first must determine the maximum allowable level of emissions under the cap. ARB has indicated that it would establish the initial baseline cap based upon 2012 emissions. The cap would decline each year beginning in 2013, and fewer allowances would be issued on an annual basis.

ARB has yet to decide how it will distribute the allowances but is considering distribution through auction, by freely providing them to covered sources, or through a combination of both methods. An initial auction of allowances is expected to occur in fall 2011 with the overall cap-and-trade program going into effect Jan. 1, 2012.

In addition to allowances, covered sources could meet part of their compliance obligations through the purchase and use of emission offset credits, or simply offsets. Offsets would permit sources in capped sectors to exceed the amount of allowances issued, but only to a point. Under the current proposal, each covered entity could use offsets for up to 4 percent of the total amount of allowances that it would be required to turn in at the end of a compliance period.

ARB’s preliminary draft rules would require eligible offsets to meet “rigorous criteria” to demonstrate that they are real, additional, quantifiable, permanent, verifiable and enforceable.

“Additionality” is particularly important because projects and actions would not be credited as offsets unless they were in addition to any reduction, avoidance or sequestration of GHGs that a law or regulation otherwise would have required.

ARB proposes letting covered emitters bank allowances and offsets in holding accounts for use during future compliance periods. Banked allowances would become increasingly valuable as the number of available allowances would decline annually under a diminishing emissions cap. Likewise, the increased expense of obtaining additional allowances in subsequent years is expected to create an incentive for covered emitters to reduce their emissions in earlier years.

ARB will develop an enforcement system that monitors the market (e.g., by identifying suspect transactions), and ARB expects to develop enforcement provisions that will correspond to each requirement of the final rules (e.g., not holding sufficient allowances or offsets for a covered source’s emissions). These enforcement provisions include methods for calculating the number of violations and consequences for noncompliance. Penalties would follow the pattern set out in existing rules for air-emission violation penalties.

If the U.S. Senate defies conventional wisdom and fulfills Obama’s Copenhagen pledge by enacting cap-and-trade legislation, then what becomes of ARB’s proposed rules? If the Senate follows the House’s lead, it will preempt state and regional programs while accommodating the redemption of allowances issued by California or the WCI. Should a federal program emerge, ARB anticipates linking or transitioning to the federal program.


Tom Mounteer is a partner in the Washington office of international law firm Paul Hastings, an adjunct professor in the masters in environmental law program at George Washington University Law School, and author of the “Climate Change Deskbook.”

Elizabeth Deane is of counsel in the firm’s San Francisco office.

Matt Raeburn, an associate in the Washington office, contributed to this article.


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