California AB32 Cap and Trade Rules ‘Lift Off’

By a 9-1 vote the California Air Resources Board (CARB) adopted rules putting the cap and trade requirements of AB32, the California Global Warming Solutions Act of 2006 into effect at its meeting December 16, 2010.  The AB32 cap-and-trade rules will make California the largest U.S. emissions allowance trading market once this “soft start” regime gets implemented.

California is launching into a historic adventure. We’re inventing this.  There is going to be quite a bit of action needed before it becomes operational.” —-CARB Chair Mary Nichols

The action represents both hubris and hullabaloo given the recent election results on the national stage.  But California dodged the 2010 election bullet and now it’s just where it wants to be—leading the nation into the future—a clean, green, responsible energy future with our new, old Governor Jerry Brown taking office in January.

The CARB action was taken following testimony from more than 170 people who showed up for the meeting.  Not all the witnesses inside the room or protesting outside supported the CARB action.  Some skeptics outside carried signs with “Global Warming: Science by Homer Simpson” but the action inside the meeting room was preordained with voter rejection of Proposition 23 to suspend the law on the November ballot.

But CARB still has “issues” to address before its cap and trade program is fully operational as the Chair noted:

  • Soft Start ‘Get Out of Jail Free’ Permits. The soft start is the result of compromises that mean most of the initial allowances will be issued without a fee but over time CARB will charge fees for emissions allowances to change behaviors sufficient to meet the 2020 emissions reduction goal to limiting greenhouse gas emissions to the 1990 levels.
  • Carbon Offsets: Indulgences or Scam? Once the cap and trade program is going emitters will have to buy permits to cover their emissions beyond their allowances.  The program allows up to 8% of those emissions to be covered by carbon offsets or credits for reforestation or other projects that reduce greenhouse gases. Both proponents of cap and trade and its fiercest critics hate carbon offsets for very different reasons.  Environmental groups see offsets as ‘indulgences’ that allow the company to keep emitting while buying cheap credits elsewhere.  Critics see it as a scam where money is paid for some remote environmental project without ever knowing if the program actually works as planned.
  • California may be Big but the Carbon Market is Small.  Given the lack of national legislation and international resolve the carbon markets are small and fragmented lacking the scale necessary to make a material difference or create pricing transparency. In short, California may not large enough to create an attractive market without raising emission permit fees so high that they have adverse impacts.
  • What about Emissions Allowance Permit Fees? Under the California program, CARB sets annual fee levels theoretically at levels sufficient to achieve the goals.  The fees are set administratively and California law requires voter approval of new taxes and fees. So expect issues to be raised about whether the fees charged by CARB comport with the new legal requirements in Prop 26 on fees and taxes in California.

CARB faces a very difficult balancing act in setting future emissions permit fees given California’s precarious economic condition.  Set the fee too high and it becomes a cause célèbre for business to pull up stakes and abandon the Golden State.  Set the fee too low and it fails to provide the price incentive to achieve the emissions reductions to achieve the 2020 goal and the law fails.

The experience to date with emissions trading is mixed at best.  The northeastern states formed a regional greenhouse gas emission trading scheme called RGGI with great fanfare but the failure of Congress to exact cap and trade legislation combined with the failure of nations to reach agreement in Copenhagen in 2009 and again in Cancun this year on a new treaty to replace the Kyoto Protocol has cooled interest in assertive emissions trading efforts.  Allowance prices in RGGI’s latest auction hovered around $2 per tonne—hardly enough to induce any business to change its behavior and reduce emissions.  The Chicago Climate Exchange recently announced in was shutting down for lack of business interest.  The Western Climate Initiative announced with great fanfare by Western Governors has largely fallen apart over political differences.

The new rules CARB adopted will go into effect in January, 2012, California will start distributing emissions allowances to large emitters like electric power plants, oil refineries and manufacturers that release large amounts of greenhouse gas emissions. In stage two beginning in 2015 the rule will apply to distributors of transportation fuels.  So anxiety will grow as the pain sets in for most business in later year especially if the emissions fees scale significantly.

The question is whether California can resuscitate the cap and trade movement with this lift off of the AB32 program?  If California stumbles or the program causes substantial disruption to economic recovery or business exit or other alleged unintended consequences then AB32 might just be the death rattle to cap and trade in the US.

NOTE: Original post revised Dec 17 2010 to reflect the CARB actual vote to approve the rules.