CARB Adopts First U.S. GHG Emissions Cap-and-Trade Program

December 23, 2010

On December 16, 2010, the California Air Resources Board (CARB) adopted Resolution 10-42 to approve the “California Cap-and-Trade Program” with specified modifications that will be completed through a series of 15-day rulemakings, some of which will include workshops. The final Cap-and-Trade Program, which will include any adopted modifications, must be submitted to the Office of Administrative Law prior to October 28, 2011.

CARB’s action is the first step in putting in place the first GHG cap-and-trade regulatory program in the United States. The program is designed as a key element in implementing the landmark legislation California Global Warming Solutions Act of 2006, known as “AB 32.” AB 32 mandates reducing California’s GHG emissions to 1990 levels by 2020 — CARB estimates that this amounts to a 15 percent reduction from current GHG emission levels.

Key elements of the approved Cap-and-Trade Program are:

  • The program takes effect January 1, 2012.
  • Covered entities are:
    • Beginning in 2012 (First Phase): (i) electricity generation, including electricity imported from outside California; and (ii) large industrial facilities that emit 25,000 metric tons or more carbon dioxide equivalent (MTCO2e) of GHGs per year, such as petroleum refineries, cement production plants, oil and gas production facilities, glass manufacturing facilities, and food processing plants.
    • Beginning in 2015 (Second Phase): fuel distributors, addressing emissions associated with: (i) fuels used for transportation; and (ii) combustion of gasoline, diesel, natural gas and propane from sources with emissions below 25,000 metric tons of GHGs, including all commercial, residential and small sources.
    • The program covers 360 businesses representing 600 facilities.
  • Regulated GHGs consist of those subject to the California mandatory GHG reporting regulation: i.e., CO2, methane (CH4), nitrous oxide (N2O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), sulfur hexafluoride (SF6) and nitrogen trifluoride (NF3).
  • CARB will “cap” statewide GHG emissions by issuing annually allowances corresponding to the capped amount of GHG emissions (in MTCO2e) that can be emitted for that year. The initial cap for 2012 will equal the total emissions expected in 2012 from sources covered in the First Phase. In 2015, the cap will include the level of emissions expected in 2015 from the fuel distributors. Each year, from 2012 to 2020, the number of allowances will decline, except for the 2015 step-up, when the Second Phase cap is established.
  • Allowances will be distributed by CARB via a combination of freely allocated allowances and allowances purchased through auctions. The determination of allocation amounts will be set by one of the forthcoming 15-day rulemakings. Initially, CARB plans to distribute most allowances through free allocations, though CARB also will conduct quarterly auctions at which sources may bid on and win allowances both from the current and future budget years. CARB has set a minimum reserve price of $10/MTCO2e for auctioned allowances, but ultimately expects market prices for allowances to increase to $15-$30 by 2020. Allocated allowances to investor-owned electrical distribution utilities must be consigned to the quarterly auctions for sale and will be sold if the winning bid exceeds the minimum auction reserve price, with proceeds used to mitigate bill impacts of AB 32 to customers. Publicly owned utilities have an option to use the allocated allowances to meet direct compliance obligations, though they too are expected to consign a large number of allowances for auction.
  • CARB will establish an Allowance Price Containment Reserve from which covered entities may make quarterly allowance purchases at fixed prices, if allowance prices are high or are expected to be high.  Initially, the reserve will be filled with some allowances from each budget year, and each year CARB may add allowances unsold at the quarterly auctions, and allowances surrendered to comply with excess emissions provisions. CARB has set pricing tiers of $40, $45 and $50/MTCO2e for allowances from the reserve.
  • A facility can meet up to 8 percent of its annual GHG compliance obligation through offsets. An offset is a reduction or removal of GHG emissions by an activity (or facility) not covered by the Cap-and-Trade Program that can be measured, quantified, verified and approved by CARB.
  • Compliance periods are three years in length, which is the time period within which a covered entity must submit to CARB compliance instruments (i.e., allowances or offsets) equal to their verified GHG emissions.

Among the notable 15-day rulemaking modifications that CARB will implement are:

  • Establish an allowance allocation for the electricity sector.
  • Ensure proper treatment under the regulation of electricity generators and combined heat and power facilities with pre-AB 32 long-term contracts that do not allow for the pass-through of costs associated with GHG emissions.
  • Establish a thermal-based allocation calculation methodology to ensure that the regulatory requirements for new entrants appropriately address facility expansions.
  • For the petroleum refining sector, develop a final Energy Intensity Index approach that may be a simple barrel allocation approach. CARB staff is directed to develop a regulatory process that transitions to a more complex carbon-weighted barrel approach “as soon as possible.”
  • Establish four offset protocols for U.S. ozone-depleting substances projects, livestock manure (digester) projects, urban forest projects and U.S. forest projects.

In sum, key rulemaking actions remain to be taken before the Cap-and-Trade Program is complete. In addition to the modifications noted above, CARB staff will be reevaluating the regulation of cement and fuels importers under the program, offset provisions, and use of auction and allowance sale revenues.

Once the final California Cap-and-Trade program is approved by the Office of Administrative Law in 2011, the program will produce a price for GHG emissions and a market for trading GHG emissions allowances. The program is designed to enable the development of lower-cost options for meeting the GHG emissions reduction requirements of AB 32.

For more information, please contact:

Edward L. Strohbehn Jr., Partner, 415.393.2059

Rick R. Rothman, Partner, 213.680.6590

This article was originally published by Bingham McCutchen LLP.