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Understanding the Reach of California’s Cap-and-Trade Program

By John J. Lormon and Matthew L. Abbot

Greenhouse gas (GHG) emissions regulation continues to intensify across California, impacting companies operating in the state or seeking to do so. Ensuring full regulatory compliance can be quite confusing, often requiring legal counseling. A critical regulatory tool that is economy-wide in its impact is the state’s Climate Change Scoping Plan.

The Scoping Plan was initially created in response to Assembly Bill (AB) 32, which required the California Air Resources Board (ARB) to outline California’s strategy to lower GHG emissions to 1990 levels by the year 2020. The Scoping Plan addresses approximately 85% of the State’s GHG emissions. The Cap-and-Trade program is one element of the Scoping Plan.

The Cap-and-Trade program does the following: (1) sets an annual declining emissions limit on the sources responsible for the majority of the State’s GHG emissions; (2) provides free allowances to cover a portion of that limit; and (3) provides trading and banking of those allowances to minimize the cost and volatility of pollution controls.

So how does the Cap-and-Trade program fit into California’s efforts, and what does it mean for your business? Let’s answer a few common questions:

  1. Who is Covered? The Cap-and-Trade program covers about 450 entities responsible for 85% of State GHG emissions, including electricity generators, fuel distributors, and large industrial facilities emitting greater than or equal to 25,000 metric tons of carbon dioxide equivalent emissions annually.
  2. What is the Cap? The Cap is the total number of California GHG allowances issued over a given period of time. It was set in 2013 at about 2% below the emissions level forecast for 2012, and it declines approximately 3% annually.
  3. What are Allowances? An allowance is a tradable authorization to emit up to one metric ton of carbon dioxide equivalent emissions. Allowances are set at about 90% of average annual state-wide emissions, and allowance distribution is updated annually to decline over time in proportion to the annual decline in the overall cap. Allowances are acquired through free allocation, auction, and by trading through the Compliance Instrument Tracking System Service (CITSS). A certain number of allowances are held in reserve each year as a price-containment measure (the Allowance Price Containment Reserve or APCR).
  4. What do Allowances Cost? The first auction reserve price in 2012 was $10, and auction reserve prices have increased every year by 5% plus the cost of inflation. In February of 2021, auction allowances were offered and sold at $17.80.
  5. What are Offsets? Offset credits are another cost-containment element in the Cap-and-Trade program. Offsets are issued by the ARB to qualifying projects that reduce or sequester GHG in the areas of forestry, mine methane capture, biogas control, rice cultivation, and ozone-depleting substance destruction. In 2021, covered entities may use offsets to satisfy up to 4% of their overall compliance obligation (the Quantitative Usage Limit). No more than half of the Quantitative Usage Limit may be sourced from projects that do not provide a reduction or avoidance of air or water pollution in California (Direct Environmental Benefits in the State (DEBS)). In 2017, AB 398 required the ARB to establish the Compliance Offsets Protocol Task Force to assist in establishing new offset protocols with DEBS while prioritizing disadvantaged communities, Native American or tribal lands, and rural and agricultural regions.

As is always the case with the state of California, the state legislature continues to modify state regulations through new bills signed into law. AB 398 extended the Cap-and-Trade program through 2030, created a “hard” price ceiling in addition to the APCR ceiling, and reduced the offset credit limit from 8% to 4%. Additionally, it prioritized the use of program revenue and prohibited local air districts from regulating emissions from stationary sources already subject to the program.

The future of the Cap-and-Trade program remains uncertain, however. Some groups, including those who argue for a carbon tax or for more direct regulatory control, feel the program is not moving with sufficient urgency. Additionally, a precipitous drop in quarterly auction revenue due to the COVID-19 pandemic prompted the California Secretary for Environmental Protection to direct a reevaluation of the program in 2020. Future program changes may also occur as the Biden-Harris Administration takes executive action to address the climate crisis at home and abroad.

If you are concerned about the impact of California’s Cap-and-Trade program on your business, John Lormon, Matt Abbot, and Procopio’s Energy and Environmental Law attorneys can help. Please feel free to reach out for a complimentary conversation.

 

John L. Lormon leads Procopio's Energy and Environmental Law practice groups. He provides counsel for projects requiring environmental permits to meet the Clean Water Act, California Water Code, endangered species, climate, and CEQA/NEPA obligations. John has been lead counsel for large-scale biofuels, food product and food processing facilities, desalination plants, waste water treatment plants, hotels, and a variety of other industrial, commercial, and residential developments. He also provides compliance counseling on hazardous and universal waste, Prop 65, asbestos abatement, and stormwater. In addition, John represents clients in defending against agency, citizen, local, state, and federal environmental enforcement claims. John has provided permitting, power purchase agreements, analysis and written submittals related to CPUC integrated resource and long term procurement plan proceedings; provided advice related to decarbonization of projects, as well as counsel to energy project entity formation and financing.

Matthew L. Abbot is an attorney in Procopio's Energy and Environmental Law practice groups. Matt received multiple awards and scholarships in law school, including the Owen Stark Heriot Award, the Veterans Legal Clinic Award, and CALI awards for obtaining the highest grades in his Climate Change Law and Policy, Law of American Democracy, and Law and Politics of Education classes. Prior to joining Procopio, Matt served as a pilot in the U.S. Navy.