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Climate Change

State Net Climate Change News: Hard Part Just Beginning For California Cap-And-Trade Program

By most measures, California's nascent cap-and-trade program had a solid first year of operation, producing hundreds of millions of dollars in revenue for state coffers and, perhaps more important, not dragging the state's still-recovering economy back into the abyss it had been wallowing in for years. But while the fast start calmed some of cap-and-trade's fiercest critics, significant hurdles remain as the program moves forward.

California's cap-and-trade program is a direct byproduct of AB 32, the 2006 bill championed by former Gov. Arnold Schwarzenegger (R) that requires the state to reduce its production of greenhouse gas (GHG) emissions — which are linked to global climate change — to 1990 levels by 2020. The law itself is fairly brief and ambiguous, leaving virtually all of the details for how to achieve that goal to the California Air Resources Board (CARB). The agency has implemented a number of regulations to do so, but none compare in scope to the cap-and-trade program, which essentially sets a limit on how much GHG emissions certain industries can produce. Businesses receive or buy "credits," equal to one ton of GHG each, and then may sell or trade unused credits to other businesses that exceed their own limits. Each year the overall cap is reduced, requiring polluters to either generate less GHG or pay major fines to the state.

The state has held five carbon allowance auctions since November 2012. Summaries of those auctions supplied by CARB show that buyers have scooped up all 81 million available 2013 compliance allowances-for-purchase, as well as another 36 million future credits for years 2015 and 2016. Approximately 207 more credits were given for free to regulated businesses, something written into AB 32 to help those businesses adapt more quickly to the new system. The 324 million total credits were valued at over $1.1 billion. While slightly more than $600 million of that was eaten up by the free credits given to businesses like cement manufacturers and food processors, the rest — $533 million — went into state coffers. This year's auctions are expected to produce even more revenue — up to $1.5 billion in total, with around $850 million of that going to the state.

A strong secondary market has also developed for companies looking to buy and sell allowances, with almost 2 million credits being exchanged each week over the last year. Allowance prices hovered at around $11 throughout 2013, far less than many regulated businesses feared they would end up paying. California also completed its first linkage with another jurisdiction, inking a deal that has now connected its cap-and-trade program with that of the Canadian province of Quebec. The state also fended off multiple lawsuits seeking to stop the program in its tracks, one that challenged CARB's authority to hold carbon allowance auctions and another claiming that revenue from those auctions constitutes an illegal tax. As LexisNexis Law 360 reports, the court rejected both on Nov. 12. The plaintiffs have about another month to decide whether to appeal.

It was a start that has the program's supporters understandably pleased.

"There were a host of theories of what would happen when the program began, from the camp that lauded California for having really progressive environmental policies to those who said it was going to kill jobs and businesses," says Joaquin McPeek, the California Media Director for the Environmental Defense Fund (EDF), which detailed the program's initial success in a report released last week. "But the fact that we've created a statewide carbon market that is a model for other states and countries is nothing short of a major achievement for California. We're proving that good environmental policy is also good economic policy."

That may ultimately prove to be true, but even the program's most ardent fans acknowledge the path forward only gets harder — arguably much harder — from here.

For one thing, as of Jan. 1, 2015 the cap-and-trade program will include producers of transportation fuels and natural gas, more than doubling the program's size. That could conceivably produce sudden and dramatic spikes in both gasoline and electricity prices, hitting consumers who have so far been relatively unscathed in the cap-and-trade rollout square in the pocket book. While nobody knows for sure how big of a hit gas prices could take, some fear the worst.

"We've seen estimates of spikes of up to 40 cents a gallon," says Gino DiCaro, Vice President of Communications for the California Manufacturers and Technology Association. "Who knows what it's actually going to be, but raising gas prices by 25 cents a gallon or more is not going to be cost effective at all."

There are other hurdles as well, such as the fact that Golden State lawmakers never envisioned California being a lone wolf in this effort. In 2007, there was reason to believe Arizona, New Mexico, Oregon and Washington would soon follow California's lead. That year, those states and California formed the Western States Climate Initiative (WCI), a coalition aimed at developing market-based programs to reduce their production of greenhouse gas emissions. In 2008 they were joined by Utah and Montana as well as Canadian provinces Quebec, British Columbia, Ontario and Manitoba. The plan was for the states and provinces to create a giant web of linked cap-and-trade programs that would encompass 20 percent of the U.S. economy and about 70 percent of Canada's. But years of economic and political upheaval sent that plan up in smoke. Today, California and the Canadian provinces are the WCI's only remaining members.

California Gov. Jerry Brown (D), however, has continued trying to gain partners. Last fall, he signed an agreement with Democratic Govs. John Kitzhaber of Oregon and Jay Inslee of Washington and British Columbia Premier Christy Clark in which all four agreed to work to implement a carbon tax in their respective jurisdictions. Dubbed the Pacific Coast Action Plan on Climate and Energy, it would also promote more use of alternative fuels and high mileage electric vehicles. None of which, however, remotely constitutes the equivalent of a cap-and-trade program. While Inslee last December voiced support for one in the Evergreen State, lawmakers there have so far been lukewarm to the idea. Legislatures in both Washington and Oregon have in recent years rejected bills that would have created cap-and-trade systems in those states.

Questions have also persisted in California about the money generated by its cap-and-trade program. Citing budget needs, Brown last year took $500 million of the program's revenue for the state's General Fund, promising to pay it back this year. The 2014-15 budget proposal he released last Thursday, however, would repay only $100 million of that this year, with the rest to follow over the next few years.

Brown also has come under criticism for proposing to spend $250 million from this year's cap-and-trade revenues to pay for the state's ongoing effort to build a high-speed rail system, with another $50 million for the state Department of Transportation to help integrate current rail systems with the high-speed system. That has angered both environmental groups, which contend the money by law is supposed to be spent only on reducing the state's GHG emissions, and high-speed rail opponents, who say the governor is wasting money on an already-troubled project that has little chance of gaining the billions of dollars in federal funding it needs to be completed.

Bill McGavern of the Coalition for Clean Air voiced the concern of many, lauding Brown's plans to spend the bulk of the cap-and-trade funds on emission reduction efforts but also questioning the governor's insistence on siphoning off money for the troubled rail project.

"High-speed rail has some merit, but it should not be the biggest spending category in this proposal," he said.

But Brown defended taking the money, telling reporters at his budget release press conference that it was "very appropriate," insisting that high-speed rail will be "a reducer of greenhouse gases." That claim, however, has already been refuted by the nonpartisan Legislative Analyst's Office, which said GHG reduction attributable to high-speed rail will come decades in the future, if at all. In the short term, the LAO says, the system will likely even raise those emissions.

There is also the strong likelihood that the court's decision to allow CARB to accumulate revenue will be appealed, leaving the long-term legality of the system at least somewhat in doubt. There is also the daunting prospect of lawmakers and CARB needing to codify plans for how the state will continue to meet even more stringent GHG reduction goals set by former Gov. Schwarzenegger via executive order in 2005. Under that directive, California must cut its GHG emissions by 80 percent by 2050. Experts say hitting the 2020 goals will be no problem; but with the state's 2050 population expected to top 50 million, significantly increasing the demand for electricity and transportation fuels, hitting the 80 percent reduction goal will be almost impossible.

Cap-and-trade supporters acknowledge the daunting nature of these issues, but that has not dampened the enthusiasm of folks like EDF's McPeek.

"We recognize there are some major challenges ahead," he says. "But we have taken a really strategic approach by enacting policies that will benefit not just the few, but the many. We're cautiously optimistic that this next year will see policies that help to successfully implement the law."

Jon Costantino, a senior adviser with Mannatt, Phelps and Philips LLC in Sacramento and a former key manager on the CARB team that developed the cap-and-trade plan, is a bit more reserved.

"Last year went off without too many hiccups," he says. "Let's just say it wasn't the Obamacare rollout."

But he also warns that the big consumer costs haven't hit yet, and the legal issues are not fully resolved.

"Things look okay, the program is converging on stability," he adds. "But let's just wait and see how we progress. There's still a long way to go."

— Compiled by RICH EHISEN

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