California Air Resources Board Adopts Emissions Trading Program

by Danielle Sugarman

On December 16, 2010 the California Air Resources Board (CARB) voted 9 to 1 to approve regulations that will establish a cap-and-trade program for greenhouse gases (GHGs) in California. This move marks a significant step in achieving obligations set under CA’s 2006 Global Warming Solutions Act (AB 32) which requires the state to reduce GHG emissions to 1990 levels by the year 2020.

The cap-and-trade program regulates sources that emit carbon dioxide, methane, nitrous oxide, sulfur hexafluoride, hydrofluorocarbons, perfluorocarbons, nitrogen trifluoride and other fluorinated GHG’s.  Proposed Regulation (PR) §95810.  Certain specified sources and industrial sources that emit more than 25,000 metric tons of carbon dioxide equivalents (mt Co2e) per year are deemed “covered entities,” thus generating compliance obligations under the program.  PR §95812.

Beginning in 2012, regulated companies will be required to supply a sufficient number of emission allowances or offset credits (each covering one ton of Co2e) to cover their annual emissions over a three year “compliance period.”  PR §§95820, 95853.  The regulations will cover upwards of 600 facilities over the course of three phases.  The first compliance period will run from 2012-2014, and will apply the cap to operators of large processing facilities, electricity-generating facilities in CA, electricity importers, and suppliers of Co2.  PR §95851.  The second phase, beginning in 2015 and running through 2017, will expand the cap to suppliers of natural gas, suppliers of RBOB and Distillate Fuel Oil, and suppliers of liquefied petroleum gas.  PR §95851.  The third compliance period will cover all entities through 2020.  PR §§95840, 95851.

Each year, the total number of allowances issued by the CARB will be reduced, requiring companies to find the most efficient method of lowering their emissions.   Initially, the cap will be set at projected 2012 emission levels but will decline by 2 percent annually through 2014, and 3 percent annually between 2015 and 2020, to achieve a 15% pollution reduction by the year 2020.  PR §§95812, 95841.

In addition to setting a cap on how much facilities can ultimately emit, the regulations set penalties for facilities that exceed their number of allowances.  The CARB requires submission of four compliance instruments for every one credit exceeded and views each day for which the compliance instrument is not furnished as a separate violation.  PR §§95857, 96014.  Clear penalties provide incentives for industry to stay within or below emissions allowance limits.

In order to ease the financial burden of the regulated entities in shifting to lower carbon manufacturing, the CARB plans to issue a significant number of free allowances to industrial sources (including electrical distribution utilities PR §95892) during an initial transition period.  PR §§95850, 95870.  During the first compliance period, each industrial sector with compliance obligations will receive free allocations covering the majority of that sector’s total emissions.  See Industry Assistance chart PR §95870.  In subsequent compliance periods the total allocation will decrease.  Free allowances will also be available to sources deemed to be at risk for “leakage.”  Leakage occurs where industry is moved out of state due to an inability or lack of desire to achieve the cost of compliance.  PR §95870.  Those industries determined to be at greater risk for leakage will receive free allocations beyond the initial compliance periods.

In general, companies requiring additional emissions credits to cover their allowances can purchase them on the market or at regular quarterly auctions conducted by the CARB.  PR §95910.  This allows companies that pollute less than their limit to sell their unused allowances to companies that pollute heavily.  Proceeds from auctions are set to be placed into CA’s Air pollution Control Fund and will be available for appropriation for green initiatives.  PR §95870.  The CARB set the auction reserve price at a floor of $10 per mt Co2e for vintage 2012 with the reserve price to increase annually by 5 percent until 2020.  PR §95911.

Under the regulations, eight percent of an entity’s total compliance obligation can also be achieved through external offsets.  PR §95970.  An offset represents a reduction or removal of GHG emissions from activities outside of the cap-and-trade program but which none the less result in GHG emissions reduction or GHG removal enhancements.  The regulation includes four protocols covering carbon accounting rules for offset credits in the following areas; ozone depleting substance projects, livestock methane digester projects, urban forest projects and U.S. forest projects. PR §95970.

While the CARB provided a general approval of the cap-and-trade regulations, further modifications will be made in light of comments generated during the 45-day comment period.  A revised version will be released in 2011 and the Board hopes to finalize the regulations by late summer of 2011.  Ultimately, the cap-and-trade program sets a statewide limit on emissions from sources responsible for 80 percent of CA’s GHG emissions.  It sets a clear price signal and penalty provisions while allowing covered entities flexibility to find the most marketable options for reducing emissions.

Yet, several aspects of the provision have generated controversy.  Opponents object to the provision of free allowances during the initial compliance phase of 2012-2014.  While businesses will be required to pay for emissions beyond their baseline level, initially, past emitters will be the entities receiving permits for free.  This speaks to the fundamental question of whether industry has a right to emit GHGs or whether they should have to pay for that right.  Additionally, the worst emitters will receive a number of allowances that will likely exceed an optimum emissions level thus bringing into question whether the government should set a more optimal cap that all emitters are required to meet.

Another source of controversy surrounds the issue of whether to issue GHG credits for clear-cutting forests on land that might be eligible for tree-planting credits.  Opponents argue that the result would be a reduction in old-growth forests replaced by stands of trees the same age.  They argue that this would in essence amount to the issuance of credits for activities that do not represent actual emissions reductions.  In a comment period after the adoption of the cap-and-trade program, the CARB considered modification of the U.S. forest projects protocol but ultimately the protocol was approved as presented.

Ultimately, while several portions of the regulations have been controversial, compliance with the program will require utilities and industries to make broad changes to reduce their GHG outputs.  Additionally, the impact of the regulations will be felt on both the national and international stages.  By maintaining its position at the forefront of state climate policy, CA will continue to be a player in the international market for renewable energy-related goods and will provide a model for action on climate change in the absence of congressional legislation.

A copy of California’s Proposed Regulation can be found at:

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