Dissecting California’s Cap-and-Trade Plan: What’s your Free Piece of the Carbon Pie?

by | Dec 13, 2010

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It sounds like an old regulatory joke:

Professional #1: “If the 8th largest economy in the world put a price on carbon and started a Cap and Trade Program, how many free allowances would you get?”

Professional #2: “I don’t know. How many free allowances would I get?”

But California is serious about putting price on carbon. Four years after the passage of AB 32, The Global Warming Solutions Act of 2006, the California Air Resources Board (CARB or Board) released their 3,900-plus page proposed Cap and Trade regulatory package.  The Cap and Trade regulation is the final policy component of the broader GHG mitigation package outlined in 2008’s Scoping Plan to be brought to the Board for adoption. AB 32 required that all regulations necessary to achieve reductions to 1990 levels by 2020 be adopted by December 31, 2010. The Board will hear the Cap and Trade regulation and the necessary amendments to the Mandatory Reporting Regulation on December 16th.

This Cap and Trade program will be the first binding program to control greenhouse gas emissions (GHGs) on an economy-wide scale though the use of market mechanism (trading) in the nation. Once fully implemented, it will directly or indirectly touch every manufacturer, fuel provider, business, and individual in California.

Though the Board had released a Preliminary Draft Regulation (PDR) in November 2009, there were still many questions left to be answered about the program. The biggest one was: Who, if anybody, will be allocated free greenhouse gases allowance and who has to pay for the right to emit greenhouse gases? And when? The amount of greenhouse gas allowances freely distributed to entities in the program is truly a billion-dollar policy question. A single allowance is equal to one metric ton of CO2e emissions.

So who gets what for free?

The easy answer is that California industrial facilities will receive free allocations in the early years of the program, also known as the First Compliance period (2012-2015). The number of fee allocations will decline annually until 2020. But, as with anything this complicated, it really depends on a variety of factors. And it is still not yet finalized. The Board’s staff is currently accepting comments until the Board acts on December 16, 2010. The proposed regulation also has ten sections reserved for future language, including some directly affecting allowance distribution. It is expected that some of these questions will be answered by the Board on the 16th, and that others will be included in future modifications to the regulation after the Board meeting.

So how does it work?

The proposed regulation has two formulas for free distribution for industrial entities — one based on production and the other on thermal use (steam and fuel), with applicability dependent on the type of industrial facility. For electrical utilities, CARB has yet to decide the specifics for allocation distribution. These formulas are hard-wired into the regulation and will dictate how many allowances each industrial facility will be provided for free in any given year and include the following adjustment factors:

–Benchmark Efficiency Factor: This factor is sector-specific and is intended to reward those facilities that are more energy efficient than others in their own industry.

–Assistance Factor: This factor is intended to help specific industries compete with entities outside of California and prevent emissions leakage.

–Cap Adjustment Factor: This factor starts at 1.0 in 2012 and declines annually to reduce the amount of free allowances available each year.

Inputs to these formulas come from either tables in the regulation, or from verified GHG Mandatory Reporting data.

So what does this all mean?

The program is set up to provide greater free allowances in the early years, with a year-by-year reduction toward 2020. Any allowances a subject entity doesn’t receive for free must be purchased at the State auction, through offsets credits, or from another market participant. In reality, the amount of free allowances for each facility will vary in a declining trend from year to year.

Additionally, the Cap and Trade program contains many other complexities. These additional complications come from the other aspects of the Cap and Trade program: offset limitations, enforcement penalties, market trading rules, offset protocols, environmental/economic analysis, and more. All of these program facets have an interplay and will be discussed by staff and the Board before a final program emerges.

In the end, CARB has proposed a complex long-term program to reduce GHG emissions that starts with short term goal of having as little impact on California industry as possible. As the free allowances are reduced, the established formulas for who receives what will become all the more important. Decision day is on the 16th, tune in to the webcast to watch how it all unfolds.

Jon Costantino is a Senior Advisor at Manatt, Phelps & Phillips, LLP, in the Sacramento Government practice group. He manages complex political and regulatory issues for clients in the area of  climate change, clean energy and environmental issues and previously served as Climate Change Planning Manager within the Office of Climate Change at the California Air Resources Board. Mr. Costantino can be reached at (916) 552-2365 or [email protected].

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