California’s Air Resources Board Provides First Preliminary Draft of Cap and Trade Regulation for Greenhouse Gases
December 4, 2009
Elizabeth Lake - San Francisco
On November 24, 2009, the California Air Resources Board (ARB) released for public comment a preliminary draft regulation (PDR) for a California cap and trade program for greenhouse gases (GHG) under California’s Global Warming Solutions Act, Cal Health & Safety Code §38500 et seq. The PDR sets forth the essential elements of the cap and trade program as envisioned by ARB staff. ARB is planning a public workshop for December 14 to discuss this draft and is soliciting public comments “on all portions” of the PDR until January 11, 2009. ARB staff expects to revise this draft in spring 2010 and issue the proposed draft regulation in September 2010.1
Release of the PDR presents an important opportunity for all entities that will be subject to the cap and trade program to provide input before the design of the program is finalized.
Relevant design features of the draft cap and trade system are summarized below.
Industrial facilities and those with large boiler or furnace systems, electricity producers or importers, and fuels suppliers who may potentially be covered by cap and trade should carefully review the PDR for potential compliance obligations under the system and consider commenting on:
- the feasibility and costs of compliance
- the appropriate mechanisms for allocation of GHG allowances
- the process for determining the total number of allowances that will be available
Companies whose cap and trade compliance strategy includes possible offset projects also should read closely the requirements and limitations in the PDR on the use of offsets.
Who Will Be Subject to Cap and Trade? §§95210 95820, 95830, 95940, 95950
Stationary sources in listed process categories2 with GHG3 process and combustion emissions totaling 25,000 metric tons of carbon dioxide equivalent (MTCO2e) will be covered by cap and trade beginning January 1, 2012. Electricity suppliers also will be covered for emissions associated with “first delivery” of electricity to the California grid, unless the electricity is imported from a state with which California has entered into a regional cap and trade implementation agreement. Once an entity meets the inclusion threshold, each metric ton of reported GHG process and stationary combustion emissions will generate a “surrender obligation” that must be satisfied either by obtaining emission allowances or, to the extent authorized, offset credits.
Fuel suppliers4 also will be covered by cap and trade; however, how to compute the threshold and surrender obligation is still undecided. For “transportation fuels” (gasoline, diesel and liquid biofuels), computation options identified in the PDR include: net carbon content (with or without some portion of each fuel’s lifecycle emissions), direct combustion emissions and lifecycle carbon intensity factor. Under the ARB’s December 2008 Scoping Plan, these entities were to be included in cap and trade beginning in 2015; however, ARB is also considering bringing these sources into the system as early as 2012.
How Many Allowances Will There Be? §95890, 95910
The PDR sets out an “Allowances Base Budget” for 2012 to 2020; however, these numbers are described as “preliminary and for illustrative purposes only,” to be revised as part of the continued stakeholder participation process on cap setting.”5 However, it is clear from the illustration that the total number of allowances will decrease annually during each compliance period from 2012 to 2020.6 ARB staff contemplates developing a process for administrative adjustments to the base allowance to account for severe over or under allowances while still assuring the integrity of the declining total cap. An adjustment process is also being considered to account for voluntary investment in renewable sources of electricity.
How Will Allowances Be Allocated? Subarticles 8 and 10
Significantly, the mechanism for allocating allowances available under the cap and trade system has not yet been specified. How many allowances will be freely distributed and under what formula? How many allowances will be auctioned? These issues await the January 2010 report of the Economic and Allocation Advisory Committee (EAAC), a panel of financial and economic experts appointed to advise ARB on these issues, and should be specified in the next version of the PDR due in spring 2010.
The PDR does provide certain hints, however. It indicates that the percentage of allowances allocated for auction likely will be “significantly more” than the 10 percent minimum recommended under the Western Climate Initiative (WCI). It also raises the prospect that, “in principle,” some portion of allowances (or the proceeds from their sale or auction) could be allocated to parties other than the business entities subject to cap and trade.7
Will Offset Credits Be Available? §95970; §§96220 - 96430
An extensively debated issue has been the availability and requirements for offset credits. ARB staff’s analysis has resulted in a numerical limit for offset currently set at just under 4 percent for each covered entity. Thus, any business subject to cap and trade can satisfy no more than 4 percent of its total surrender obligation using offset credits. The remaining 96 percent will have to be satisfied with allowances, either those allocated freely or those purchased through auction or trades.
Discussion of the requirements for creating and recognizing offset credits is the lengthiest subject addressed, comprising 24 pages. Staff concedes that the topic “involves complex legal, enforcement and administrative issues that require public comment and staff consideration.” PDR at p. 60. The governing principle is that offset credits must represent a reduction, avoidance or sequestration of GHG that is “real, additional, quantifiable, permanent, verifiable and enforceable.” Id. Specific requirements for offsets to be registered include ARB approval of the quantification methodology used, including requirements to address activity shifting and market shifting leakage; annual accredited verification statements; monitoring, reporting and record retention for offset projects; and reversal of credits later found to be invalid.
One important issue on which ARB staff explicitly requests comment is the geographic area for which ARB itself would review and issue offset credits. Significantly, the PDR confirms that ARB will not limit the geographic area of potential offset projects. However, unless ARB itself reviews and issues credits for projects located outside California, businesses would be limited to credits issued by other GHG compliance systems specifically approved by ARB under the “linkage” provisions discussed below.
Availability of Allowances and Offsets from External GHG Systems §§96150 -96200
Allowances and offset credits from external GHG emissions trading systems (e.g., WCI or the EU’s ETS) are potentially available under the concept of “linkage.” ARB would implement any linkage through a formal “linkage” Memorandum of Agreement. Each proposed linkage also would be subject to public notice and comment.
To approve an external cap and trade system for linkage, ARB would first have to find that the system met specified criteria, including a commitment to a binding and annually declining GHG emissions cap, mechanisms to limit issuance of allowances to the cap, and monitoring, reporting, verification, compliance and enforcement provisions of GHG emissions and reductions comparable to those of California. For offsets, ARB likewise would need to find that the external system provided assurances of integrity for offset credits equal to or greater than California’s, as a quantitative limit on the use of offsets similar to those of California.
Under a “unilateral” linkage to another cap and trade system, both allowances and offsets from that system would be subject to the 4 percent quantity limitation discussed above for offset credits discussed above. Under a “bilateral linkage,” in essence integrating California’s cap and trade system into a regional or other external system, allowances would be freely available to meet California surrender obligations; however, offset credits would still be subject to California’s 4 percent per covered entity quantity limitation.
Conclusion
The goal of the cap and trade program is to capture approximately 85 percent of California’s emissions of GHG under an aggregate declining cap to support the state’s goal of reducing GHG emissions to 1990 levels by 2020. While the PDR allows for eventual integration with regional or federal cap and trade systems, California faces a statutory implementation deadline for its program of January 1, 2012. The release of the PDR puts California on schedule to meet this deadline – and to be the first state to implement a cap and trade program for GHG.
Holland & Knight looks forward to assisting our clients to evaluate the PDR in light of their existing and likely future business plans for California, and submitting comments to help inform ARB’s final proposed rule.
1 The full text of the PDR is available at www.arb.ca.gov//cc/capandtrade/meetings/121409/pdr.pdf. Page 2 of the PDR provides URLs for further information about the workshop and for submittal of comments.
2 These categories include heavy industrial processes, petroleum refining, electricity generation and stationary combustion. §95820 Thus institutional facilities with stationary combustion sources whose emissions exceed the inclusion threshold also will be subject to cap and trade.
3 The PDR specifies seven GHG, as follows: carbon dioxide, nitrous oxide, methane, sulfur hexafluoride, hydrofluorocarbons, perfluorocarbons and nitrogen tri-fluoride. §95810
4 As currently envisioned, covered fuels would include: California diesel, California reformulated gasoline, liquid biofuels, natural gas and natural gas liquids.
5 See §95890 Further information on the derivation of these preliminary numbers is available at http://www.arb.ca.gov/cc/capandtrade/meetings/121409/capcalc.xls
6 The illustration appears to show an increase in total allowances at the beginning of the second compliance period due to an assumed phase-in of cap and trade obligations for certain categories of covered entities until 2015.
7 This results from ongoing discussion of policy claims on “allowance value” (i.e., allowances themselves or proceeds derived from their auction or sale). These claims include (i) compensation for “those disproportionately impacted by the imposition of the cap and trade program and/or historically impacted by air pollution”; (ii) dividends or tax reductions to the general public on the theory of allowances as a public resource; and (iii) financing for investments to achieve the goals of AB 32 and related public spending programs.
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