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CARB Issues Preliminary Draft Regulation for a California Cap-and-Trade Program

Dec. 3, 2009

On November 24, 2009, the California Air Resources Board (CARB) issued its “Preliminary Draft Regulation for a California Cap-and-Trade Program” (Draft Regulation) for public review and comment. The comment deadline is January 11, 2010. CARB will hold a workshop for the Draft Regulation on December 14, 2009.

Basic Concept of the Draft Regulation

The Draft Regulation provides:

  • Preliminary regulatory language “on the cap-and-trade process and structure;” and
  • “Narrative text” that describes more than 25 “concept” discussions; these discussions focus on key issues (such as the “quantitative usage limit on offsets”) for which CARB will be issuing proposed regulatory language in Spring 2010.

The Draft Regulation is the beginning of the next phase of formal AB 32 cap-and-trade rulemaking. It is based on a year-long rule development process involving 21 public workshops. The Draft Regulation provides the basic structure of the expected final rule and initial determinations for a few issues. Specific proposals for most of the key issues are not offered, although approaches or specific options are presented.

The Draft Regulation also provides a “preview of upcoming regulatory revisions” to the CARB Mandatory Reporting Regulation (MRR). The MRR will be revised to include a broader range of covered facilities to make the MRR consistent with the cap-and-trade program. In addition, CARB “will propose” to lower the reporting threshold to 10,000 metric tons of CO2 equivalent (mtCO2e) from the current threshold of 25,000 metric tons of CO2.

Key Elements of the Draft Regulation

Key elements of the Draft Regulation are:

1. Cap-and-Trade System with Aggregate Declining Cap. Establishes fixed caps on GHG emissions from covered entities (specific cap amounts not proposed); these caps will decline from 2012 to 2020 to achieve a reduction in GHG emissions to 1990 levels by 2020. A total number of GHG credits or “allowances” equal to the cap will be auctioned and/or given freely to covered entities and other groups. After initial distribution, the allowances can be freely traded. At the end of each compliance period, covered entities then would be required to surrender to the state enough GHG allowances to match their emissions during that period. CARB is considering whether to make the compliance period three years (with an obligation for sources to surrender some portion of their allowances yearly) or one year. 

2. Covered Entities; Program Scope. Proposed phase-in of the obligation to surrender GHG allowances, implementing first a “narrow scope” and then a “broad scope” program.

  • The “narrow scope” would begin in 2012 and cover “electricity deliverers” and industrial facilities within 19 industrial categories (e.g., stationary combustion, petroleum refining, pulp and paper production) whose emissions exceed 25,000 mtCO2e (estimated to be about 600 facilities).
  • The “broad scope” program would begin in 2015 and would expand the universe of covered sources to include not only those identified above, but also industrial fuel combustion at facilities with emissions below 25,000 mtCO2e, and “fuel deliverers” for fuels combusted in transportation, commercial and residential uses (i.e., deliverers of transportation fuel, natural gas and natural gas liquids).
  • CARB is considering whether to implement both the “narrow scope” and “broad scope” phases of the program simultaneously in 2012, and is soliciting comments on the question.
  • The final program would cover 85 percent of California’s GHG emissions.
  • Combustion of most biomass fuels would not be subject to the obligation to surrender GHG allowances; biomass CO2e emissions would, however, count toward the threshold for mandatory GHG emissions reporting.

3. Allowance Allocation and Auction. The allowance allocation scheme will not be proposed until Spring 2010, following consideration of the January 2010 final report of the Economic and Allocation Advisory Committee (EAAC). The proposal will provide the percentage of allowances that will be auctioned, based on three key EAAC Draft Report concepts: (i) compensation for harm; (ii) dividends or tax reductions to the general public; and (iii) financing investments to achieve AB 32 goals and related public spending programs. At the start of the cap-and-trade program in 2012, a minimum (but currently unspecified) number of allowances will be auctioned. The Draft Regulation notes that the Scoping Plan stated that transition to a 100 percent auction “was a worthwhile goal.”

4. Offsets. Offsets must be real, additional, quantifiable, permanent, verifiable and enforceable. Only 4 percent of a covered entity’s end-of-compliance-period obligation to surrender allowances may be met by offsets (i.e., “tradable credits that represent GHG emissions reductions made in areas or sectors not covered by the cap-and-trade program”).

5. Banking; Trading. Establishes banking and trading schemes to provide flexibility and market mechanisms to enhance the efficiency of achieving cap-and-trade emissions reductions requirements. Very strict trading requirements (e.g., general prohibitions, holding limits, restrictions on market participants) are proposed so that CARB can adequately monitor the market.

6. Enforcement. The goal is to remove “any economic benefits of non-compliance.” Penalties will be assessed per California Health and Safety Code (H&S Code) Sections 38580 and 42400 et seq. (which generally provide civil and criminal penalties ranging between $500 and $75,000 per day, per violation). Injunctive relief will be available per H&S Code Section 41513. In addition, the CARB Executive Officer is given authority to place restrictions on the allowance Holding Account of a covered entity participant who is in violation of cap-and-trade regulatory requirements.

7. Linkage to Other GHG Emissions Trading and Offset Crediting Systems. Establishes criteria for approving linkages to other trading and offset crediting systems. The external systems must comply with certain CARB cap-and-trade regulatory requirements (e.g., have published standards, quantification methodologies and protocols that require credited GHG emissions reductions to be real, additional, quantifiable, permanent, verifiable and enforceable).

8. Western Climate Initiative (WCI) Consistency. CARB states that the design of the Draft Regulation is consistent with the design of the WCI program (released in 2008).

9. Modification of CA Mandatory GHG Reporting Requirements (MRR). The MRR will be amended to make it consistent with final cap-and-trade program requirements. Among the proposed changes are:

  • Lowering the reporting threshold to 10,000 mtCO2e from 25,000 mtCO2e.
  • Revising electricity sector reporting requirements in consultation with CPUC and CEC.
  • Adding reporting requirements for industrial process and fugitive emissions and for upstream suppliers of fuels and industrial gases.
  • Revising MRR reporting requirements to make them consistent with the final EPA GHG mandatory reporting requirements.

Other Key Concepts

Among the key Draft Regulation concept discussions, CARB addresses the following:

1. Regulation of Co-Pollutants. Regulation of co-pollutants (e.g., NOx, air toxics, particulates) is not addressed in the Draft Regulation. In the Draft Regulation Overview, CARB specifically requests public comment “on whether and how best to incorporate co-pollutant considerations into the cap-and-trade program.”

2. Adjustment for Voluntary Investment in Renewable Sources of Electricity Generation. CARB plans to consider the option of “tightening the cap. . .to account for voluntary investment in renewable sources of electricity generation that indirectly reduces the need for emissions from the covered entities.”

3. Cost Containment: Mitigating High/Low Market Prices. To mitigate high/low prices, CARB is considering “soft collars” (adjustment of market supply of compliance instruments or allowances when price triggers are reached). CARB states that the mitigation mechanism “must respect the integrity of the cap by not including a ‘safety valve.’”

4. Reversals of Offset Credits: Penalty Policy. If an offset is found to be invalid after having been accepted by CARB, CARB prefers requiring the entity using this offset to replace the lost tons and make the system whole.

5. Enforcement and Penalty Provisions. CARB is considering penalizing an entity that misses its compliance deadline because it failed to surrender its allowances on time by requiring the entity to surrender more allowances than it was originally required to surrender.

6. International Offset Credits. CARB prefers to utilize a sector-based offset crediting mechanism for international offsets instead of the Kyoto Protocol project-based Clean Development Mechanism. CARB provides an extensive discussion of “requirements that must be met” in order to establish a sector-based system.

Timeline

The timeline CARB has established for adopting the cap-and-trade program is:

  • December 14, 2009             Public Workshop of Draft Regulation
  • January 11, 2010                 Draft Regulation Public Comment Deadline
  • February CARB Meeting     EAAC Allowance Recommendations Presented
  • Spring 2010                         Proposed Cap-and-Trade Regulation Released
                                                Proposed Mandatory GHG Reporting Regulation (MRR) Amendments
                                                Released
  • Spring-September 2010       Workshops on Proposed Regulations
  • September 2010                  Proposed Cap-and-Trade Regulation Released
                                                Proposed MRR Amendments Released
  • October 2010                      CARB considers Final Cap-and-Trade and MRR Regulations

For more information on this alert, please contact the lawyers listed below:

Edward Strohbehn, Partner
edward.strohbehn@bingham.com, 415.393.2059

Rick Rothman, Partner
rick.rothman@bingham.com, 213.680.6590

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