January 01, 2014

An update on California’s cap-and-trade climate change policy: Continuing forward, perhaps beyond California

Nicholas W. van Aelstyn

On October 25, 2013, the California Air Resources Board (CARB) listened patiently to testimony from all sectors about proposed amendments to what’s known as CARB’s Cap-and-Trade Regulation, promulgated pursuant to the state’s landmark Global Warming Solutions Act of 2006 (better known by its bill number, AB 32). With the exception of two issues discussed below and regardless of the sector being represented, nearly all the testimony favored the amendments. Chairwoman Mary Nichols shortened the comment period, stipulating that the Board understood that most wished to thank CARB staff for their hard work and engagement with stakeholders. This meeting encapsulated much of what is going on with AB 32—and its potential impacts beyond California.

Context: AB 32 and the progress to date

When it comes to AB 32, CARB is where the action is. AB 32 established mandatory goals and deadlines—primarily, to reduce the state’s greenhouse gas (GHG) emissions to 1990 levels by 2020—and delegated broad authority to CARB to achieve those goals. CARB has been engaged in nearly non-stop rulemaking since January 2007 to implement AB 32.

In 2008, as required by AB 32, CARB adopted the initial Scoping Plan, which is the blueprint for how it intends to achieve the required GHG emission reductions by 2020. CARB is now updating the plan and looking beyond 2020, even though AB 32 itself did not look beyond that date. However, Arnold Schwarzenegger, who was governor at the time, issued Executive Order S-3-05 establishing a goal of reducing emissions to 80 percent below 1990 levels by 2050, while current Governor Jerry Brown expanded this goal to the transportation sector (EO B-16-2012).

On October 1, 2013, CARB released a draft Updated Scoping Plan. It proposes that CARB continue its policies toward achieving Schwarzenegger’s 2050 goal and develop interim emission reduction goals for 2030. Most importantly, it proposes to continue the cap-and-trade program beyond 2020. Cap-and-trade is at the center of the CARB’s AB 32 efforts, though it’s intended to achieve only a portion of the emission reductions. The rest are to be achieved through a host of complementary measures, including the Low Carbon Fuel Standard (LCFS) (for transportation fuels), the Renewable Portfolio Standard (for electricity production), improved energy efficiency requirements, and many others. The Updated Scoping Plan modifies the balance of reductions to be achieved by the different policies (e.g., cap-and-trade now represents close to 30 percent of the reductions needed to reach 1990 levels by 2020, up from 20 percent), but it essentially calls for more of the same.

The state’s GHG emission reduction goals are ambitious. CARB’s recently released GHG emission reporting data indicates that total emissions actually increased from 429 million metric tons (MMT) in 2011 to 437 MMT in 2012. The 2020 target is 427 MMT. The goal is in sight—and certainly it’s closer than the business-as-usual (BAU) estimate for 2020 of 509 MMT, but much more progress is needed to meet AB 32’s mandate.

One point in an elaborate rulemaking process

The October 25 Board meeting exemplified much of what is taking place in the development of California’s climate change policies. First, the praise for CARB staff reflects the large degree of stakeholder participation in CARB’s rulemaking. CARB has worked closely and extensively with stakeholders throughout the process and by doing so has achieved a remarkable level of buy-in for such a large and complex program. The market also effectively endorsed CARB’s work: since CARB proposed the 2013 amendments, the price for allowances has remained flat and close to the floor CARB established.

What the Board actually did at the meeting also is important—and so too what it did not do. The Board did not actually adopt the proposed amendments to the Cap-and-Trade Regulation. Instead, it adopted a resolution that obligates CARB staff to revise the regulation still further. CARB expects to do so this spring with an expedited process that provides for a 15-day public comment period instead of the standard 45 days. Under the state’s Administrative Procedure Act, this abbreviated process is intended for minor cleanups, although CARB’s use of this approach has become common for the Cap-and-Trade Regulation.

At each major rulemaking concerning the Cap-and-Trade Regulation, CARB has adopted a companion resolution in which it lists the issues that CARB will address in future processes. This approach of continuing to work on the regulation with stakeholders has helped CARB to (largely) avoid litigation. Why challenge the regulation in court when CARB promises to tweak it? Stakeholders can hope that they will get the changes they want using the less-costly, less-controversial, and more manageable route of negotiation.

One example of this is the GHG emission benchmarks for different industrial sectors, which is how CARB applies the cap to particular facilities. In general, CARB has aimed to set the compliance benchmark at 90 percent of current BAU emissions for each sector, which it then will ratchet down in the years ahead. This is a complicated process. There are dozens of sectors, and different facilities within the same sector may utilize different technologies. Further, in many sectors there are now so few facilities remaining that it is difficult to develop benchmarks that are true industry-wide averages. Trade secret issues arise, as do issues of favoritism if a benchmark is based more on one facility’s technology than another. The proposed amendments included numerous changes to different benchmarks—and CARB will be addressing many others in the upcoming 15-day rulemaking.

Included amongst the latter are the many benchmarks for the oil and gas sector, which also was a focus of many of the proposed amendments before the Board. This is because, in 2015, CARB will expand cap-and-trade to include transportation fuels, which contribute 38 percent of the state’s total GHG emissions. Adding transportation fuels will bring approximately 85 percent of the state’s emissions under the cap, almost doubling the amount of capped emissions and making it the world’s most comprehensive cap-and-trade program.

Controversial issues: Resource shuffling and coal mine methane offsets

Two of the proposed amendments generated controversy. CARB proposed to codify previously issued guidance with respect to resource shuffling, which the Cap-and-Trade Regulation prohibits to prevent leakage. Leakage occurs when total GHG emissions are not reduced but are simply moved out-of-state. CARB defines “resource shuffling” as “any plan, scheme, or artifice” by a “First Deliverer of Electricity” into the state to substitute low carbon intensity electricity for higher intensity imports (e.g., substituting wind power for coal) for the purpose of “reduc[ing] its compliance obligation.” Resource shuffling has been a complex and contentious issue since CARB first issued a discussion draft of the Regulation in 2009. The 2013 amendments propose to create certain “safe harbor” practices that would not constitute resource shuffling. Some testified that they would swallow-up the rule, allowing for leakage equal to the in-state emission reductions. At the meeting, however, the Board indicated that it would reject these arguments and adopt the amendments codifying the safe harbors.

CARB’s proposed new offset protocol for coal mine methane capture also generated controversy. Critics view it as a boon to the coal industry that would encourage new coal production, while others defended it as applying only to methane that now is neither profitable to capture nor required to be captured. In its resolution, the Board specifically directed staff to, in effect, scrub the protocol one more time to ensure that it prevents any invalid crediting.

Litigation challenges

CARB has not managed to ward-off all litigation challenging its AB 32 efforts, though thus far it has fared well in court. There have been five challenges to date, one of which has been resolved (CARB won), three of which are on appeal (with CARB currently ahead in two of the three), and one that CARB had just won in the trial court at the time of this writing.

Rocky Mountain Farmers Union v. Corey, 730 F.3d 1070 (9th Cir. 2013). Midwestern ethanol producers contended that the LCFS program violates the dormant Commerce Clause because it places a higher compliance cost on Midwestern ethanol than in-state ethanol. CARB argues that the program does not discriminate because the lifecycle analysis used to determine the carbon intensity of each fuel must include the GHG emissions associated with transporting out-of-state fuel into California. On September 18, the U.S. Court of Appeals for the Ninth Circuit ruled in favor of CARB, reversing the district court. As of this writing, the petitioners are seeking en banc review.

Association of Irritated Residents v. CARB, 206 Cal. App. 4th 1487 (1st Dist., Div. 3 2012) (AIR v. ARB). Environmental justice groups contended that the 2008 Scoping Plan violated the California Environmental Quality Act (CEQA, the state’s more stringent version of the National Environmental Policy Act) by not giving due consideration to the option of a carbon tax; they also argued that CARB’s cap-and-trade program violated AB 32. The trial court upheld the CEQA challenge and ordered CARB to stop work on cap-and-trade until it had conducted a full CEQA review. CARB complied with this order and later re-approved the Scoping Plan. The trial court rejected the petitioners’ challenge to the Cap-and-Trade Program as violating AB 32, however, and the appellate court upheld this ruling, holding that AB 32 granted CARB “exceptionally broad and open-ended” directives. Id. at 1495.

POET, LLC v. CARB, 217 Cal. App. 4th 1214 (5th Dist. 2013). This case presents a CEQA challenge to the LCFS program, and in July the appellate court ruled in the petitioners’ favor. CARB subsequently delayed the 2013 LCFS compliance mandates for a year while it works to complete its CEQA review of the LCFS program (much as it did previously with the Scoping Plan pursuant to the order in the AIR v. ARB case).

Our Children’s Earth Foundation v. CARB, No. A138830 (Cal. Ct. App. 1st Dist., Div. 4. This case challenges the offset program, contending that it violates AB 32 by utilizing standards-based protocols rather than determining the additionality of each and every offset project. In January 2013, the trial court—ironically, the same judge that had held that the Scoping Plan violated CEQA in the AIR v. ARB case—rejected the challenge. The case is now pending before the Court of Appeal. [Full disclosure: The author represents three of the Intervenor-Appellees in this case.]

California Chamber of Commerce v. CARB, Nos. 34-2012-80001313 & 34-2013-80001464 (Sacramento Super. Ct. Nov. 12, 2013). The petitioners contend that CARB’s auctioning of emission allowances exceeds its authority under AB 32 and that the auctions constitute an illegal tax because they don’t qualify as an administrative fee and were not approved by a two-thirds vote of the legislature. On November 12, the trial court rejected both arguments, following the rationale of AIR v. ARB with respect to the first. With respect to the second, the court held that the auction “charges are more like traditional regulatory fees than taxes, but it is a close question.” Id., slip op. at 16. The petitioners in the two consolidated cases immediately announced that they would appeal. Assuming they do, the court of appeal will review the trial court’s decision on this “close question” de novo. That said, the longer it takes for the case to be finally resolved, the more auction revenues will have been raised and spent, making it more difficult from a practical standpoint for the auctions to be enjoined.

Whither California’s cap-and-trade?

The tone of confidence that characterized the October 25 Board meeting also was indicative of what’s going on in California. CARB is committed to moving forward with cap-and-trade—and not only in California. On November 1, it sent its Linking Readiness Report to Governor Brown, proposing that the already approved linkage with Québec’s cap-and-trade program begin on January 1, 2014, with joint auctions to take place later in the year. Just days before, the governments of California, Oregon, Washington, and British Columbia signed a joint Pacific Coast Action Plan on Climate and Energy in which they pledged to coordinate their climate policies. And less than a month before that, Governor Brown signed a memorandum of understanding (MOU) with China’s central economic planning agency, pledging to assist China with its development of GHG emission trading programs. That MOU grew out of a prior MOU between CARB and the government of Shenzen, China. At that time Chairwoman Nichols rang the bell to open Shenzen’s emissions trading system, China’s first.

Will the other Pacific Coast governments and some Chinese regional governments follow Québec and link with California’s cap-and-trade program? Perhaps. Will the U.S. Environmental Protection Agency’s evolving regulation of GHG emissions under the Clean Air Act come to include endorsement of State Implementation Plans that include cap-and-trade programs like California’s? Perhaps. The future of global climate change policies may not lie in a new Kyoto Accord so much as a connected patchwork of subnational cap-and-trade programs.

Nicholas W. van Aelstyn

Nicholas W. van Aelstyn is a principal with Beveridge & Diamond, PC in San Francisco whose practice focuses on environmental law. He chairs the firm’s climate change practice.