The design of the California cap-and-trade program allows linkage with programs established by partner jurisdictions in the Western Climate Initiative (WCI) to create a regional market system.

Under the cap-and-trade program, ARB will place a cap on GHG emissions by issuing a limited number of tradable permits (allowances) equal to the cap. Over time, the cap will steadily decline. The cap is enforced by requiring each source that operates under the cap to turn in one allowance or offset credit for every metric ton of carbon dioxide equivalent (MTCO₂e) that it emits. Because the allowances are tradable, individual emitters do not have specific emission limits. The cap-and-trade program gives sources flexibility to make the most cost-effective choices about when and how to reduce emissions.

The basic components of the California cap-and-trade program include:

• Scope. The program will cover the major sources of GHG emissions in the State, including refineries and power plants, industrial facilities, and transportation fuels. Starting in 2012, the program will cover electricity generation, including imports, and large industrial sources and processes with annual GHG emissions at or above 25,000 MTCO₂e.

  The program will expand in 2015 to include fuel distributors to address emissions from combustion of transportation fuels and combustion of natural gas and propane at sources not covered in the first phase of the program.

  The proposed regulation addresses emissions of carbon dioxide (CO₂), methane (CH₄), nitrous oxide (N₂O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), sulfur hexafluoride (SF₆), and nitrogen trifluoride (NF₃).

• Cap. ARB Staff has designed the program to be sufficiently stringent to spur GHG emissions reductions to achieve AB 32 goals. The program cap determines the number of total allowances issued by ARB. At the start of the program, ARB will issue allowances for each year consistent with the declining level of the cap.

  The initial cap level in 2012 will be set at the level of emissions expected in 2012 from sources covered at the start of the program. In 2015, the program scope expands to include the distributed use of fuels, and the cap increases to include emissions from those fuels based on the level of emissions expected in 2015 from the newly covered fuels. The cap will decline to a level in 2020 designed to ensure that emissions decline over time and California achieves the AB 32 GHG emissions target in 2020.

• Allowance Distribution and Trading. ARB plans to distribute allowances through a mix of direct allocation and auction. At the beginning of the program, most allowances will be distributed for free to help provide a soft start for the program. The allocation system is designed to reward those who have taken early action and have invested in energy efficiency and GHG emissions reductions and will encourage continued investment in efficiency and clean energy in the future. Because the allowances can be traded, the program provides incentives for those with the most cost-effective reduction opportunities to reduce emissions quickly.

  Entities other than covered entities may be eligible to participate voluntarily in the program, including financial institutions, brokers, offset developers, and those who may want to voluntarily retire allowances. An entity that holds an allowance may surrender it to comply with its obligation under the regulation, bank it for future use, sell it to another entity, or ask ARB to retire it.

  The program includes creation of an auction system that will allow for broad participation and minimize opportunities for manipulation, according to ARB. Over time, the program will transition toward a greater reliance on auctioning, which will help maximize incentives for continued investment in clean and efficient technologies and provide revenue that can be reinvested for public benefit.

• Cost Containment Mechanisms. Key elements of the program have been designed to optimize cost-effectiveness, including: (1) three-year compliance periods, which smooth year-to-year variations in emissions levels; (2) allowance banking, which allows participants to hold allowances and use them for compliance in a later period; (3) offsets, which offer additional low-cost emissions-reduction opportunities; and (4) the establishment of an allowance reserve account, which allows covered entities access to allowances at set prices as a hedge against higher costs.

• Reporting. The cap-and-trade program will rely on the Mandatory Reporting Regulation (MRR) as the primary mechanism for emissions reporting. Revisions to the MRR are being proposed by ARB staff concurrently with the proposed cap-and-trade regulation. These revisions are intended to align California’s reporting requirements with the federal reporting rules recently enacted by the US Environmental Protection Agency (EPA), and to ensure that the information collected by those covered by the cap-and-trade program is of sufficient quality to support the program.

  Additional registration and reporting requirements are established in the cap-and-trade regulation for those who hold allowances or offset credits, and for other participants in the program, including offset registries and offset project developers.

• Offsets. Under the cap-and-trade program, covered entities may use a limited amount of offset credits to satisfy a portion of their compliance obligation. Offsets are tradable credits that represent verified GHG emissions reductions made in areas or sectors not covered by the cap-and-trade program. One offset credit is equal to one metric ton of GHG emissions.

  Offsets must meet criteria that demonstrate that the emissions reductions are real, permanent, verifiable, enforceable, and quantifiable. To be credited as an offset, the action or project must also be in addition to what is required by law or regulation or would otherwise have occurred. ARB will adopt specific compliance protocols for different project types, and will issue or recognize offset credits based on those adopted protocols that can be used for compliance purposes.

• Offset Protocols. ARB staff reviewed four offset protocols and recommends that they be approved as part of this regulatory package: (1) the Urban Forest Projects Protocol; (2) the US Ozone Depleting Substances Projects Protocol; (3) the Livestock Manure (Digester) Projects Protocol; and (4) the US Forest Projects Protocol. These protocols are based on those initially developed by the Climate Action Reserve (CAR) and its predecessor, the California Climate Action Registry (CCAR).

• Sector-Based Offset Credits. Sector-based crediting can increase participation in international efforts to control GHG emissions and address concerns about competitiveness and emissions leakage, according to ARB staff. California has been working with strategic partners in the forest and cement sectors to explore sectoral crediting approaches to international action. The proposed regulation anticipates future inclusion of sectoral credits based on continuing work with international partners.

• Compliance and Enforcement. For each compliance period, each covered entity is required to surrender a sufficient number of compliance instruments (allowances and offset credits) to cover its total GHG emissions during that compliance period. A portion of the allowances must be provided annually, with the remaining allowances due following the end of the compliance period. Once allowances and offsets are surrendered they are permanently retired by ARB.

  Enforcement will play a vital role in the success of the cap-and-trade program by discouraging noncompliance and by deterring and punishing fraudulent activities. It also will play a vital role in the success of the cap-and-trade program by discouraging gaming of the system and by deterring and punishing fraudulent activities. Staff designed the proposed regulation to remove any financial incentive for noncompliance by requiring that additional allowances be surrendered for excess emissions not covered by the compliance deadline. Staff will also ensure that the requirements are enforced fairly, and that the enforcement process is transparent.

• Linkage to Other Greenhouse Gas Emissions Trading Systems. Linkage involves the reciprocal acceptance of compliance instruments issued by another system. The proposed regulation includes a framework for California to link its cap-and-trade program to other emissions trading systems of similar scope and rigor. Linkage can expand the coverage of the cap-and-trade program to include emissions-reduction opportunities for sources covered in another program.

The cap-and-trade program is expected to result in increased investment in efficient buildings and technologies and in advanced fuels. At expected allowance prices ($15 and $30 per metric ton in 2020), these investments would reduce fuel use by 2 to 4 percent in 2020, while economic growth between 2007 and 2020 continues at a rate of 2.3 percent, virtually on par with the projected rate of 2.4 percent. Implementation of the program will, however, shift investment and growth within the overall economy toward those sectors driven by the production of cleaner and more efficient technologies.

—ARB Staff Initial Statement of Reasons

Transportation fuels. ARB staff proposes to regulate fuel suppliers based on the quantities of fuel consumed by their customers. Fuel suppliers will be required to report emissions as specified in the MRR. While many of these suppliers will have a cap-and-trade compliance obligation, some who utilize eligible biomass-derived fuel sources may be reporting for informational purposes only.

For natural gas combustion emissions, the covered entity is the supplier, meaning the owner when the fuel is distributed—i.e., public utility gas corporations, publicly-owned natural gas utilities operating in California, and owners and operators of intrastate pipelines that distribute natural gas directly to end users and are not part of utility pipeline systems.

For transportation fuel combustion emissions, the covered entity is the supplier of the fuel. Transportation fuel suppliers are limited to position holders (those who own fuel) at terminal racks that dispense Reformulated Gasoline Blendstock for Oxygenate Blending (RBOB) and/or diesel fuel, and enterers (those who bring in fuel from outside the State) that deliver fuel outside of the terminal system.

For liquefied petroleum gas (LPG), the covered entity is the LPG supplier—producers, including fractioners and refiners, and importers of LPG.

Staff proposes to include residential and commercial fuels, as well as transportation fuels, in the program starting in 2015 because together they are the largest source of GHG emissions in California. Including transportation fuels and fuel suppliers will help achieve the objective of reducing emissions not only by 2020, but also help to drive the long-term transition to cleaner fuels well into the future. Additionally, including these fuels in the program provides a consistent price on GHG pollution throughout the economy and ensures a level playing field across all fuels and consumers. Consequently, staff concluded that there are important benefits from including transportation fuels and fuels for residential, commercial, and small industrial users.

—ARB Staff Initial Statement of Reasons

AB 32, signed by Governor Schwarzenegger in 2006, is California’s Global Warming Solutions Act that set in law greenhouse gas reduction targets that will reduce emissions to 1990 levels by 2020. In 2008 ARB approved the AB 32 Scoping Plan that uses a mix of approaches to meet climate change goals, including a cap-and-trade program and other complementary measures.

Resources

• ARB Emissions Trading Program Overview

• Proposed Regulation to Implement the California Cap-and-Trade Program. Staff Report: Initial Statement of Reasons

• Cap and Trade 2010