California Approves Cap and Trade, But Toughest Decisions Lie Ahead

What was left to do later is almost as revealing – and important – as what was done.

California’s environmental bureaucracy took a series of huge, grinding steps forward last week, approving several measures that make the state an unquestioned world leader on climate policy. Exactly where that path is leading, however, remains unclear.

The state Air Resources Board and the Public Utilities Commission voted last Thursday and Friday to adopt a cap-and-trade system, approve a subsidy program for energy efficiency by major utilities and finalize regulations against diesel soot from trucks. In all these steps, what was left to do later is almost as revealing – and important – as what was done.

The task of curbing emissions from California’s $1.9 trillion per year economy is dauntingly complex, and political pressure is fierce. At the meetings in San Francisco and Sacramento, conservative protesters held signs that read, “Global Warming: Science by Homer Simpson.” Corporate lobbyists warned that the new cap-and-trade system could be overthrown in court for allegedly violating Proposition 26, an anti-tax measure approved by the state’s voters in November.

Yet most powerful is the simple inertia of business as usual. After approving an extra $63 million in energy-efficiency subsidies to utilities, the Public Utilities Commission returned to old form. With little debate, its commissioners approved an application from Pacific Gas & Electric Corp. for construction of a $1.5 billion, 586 MW gas-fired power plant in Oakley, about 40 miles east of San Francisco.

The application had been opposed by the PUC’s own staff, who wrote a blistering report calling it “unnecessary” and “irresponsible” and saying the extra power was not needed.

PUC President Michael Peevey spoke skeptically about what he saw as some environmentalists’ anti-business attitude.

“I can understand those who … prefer command and control,” he said with more than a dose of sarcasm. “One of [their] arguments is that we don’t really need an incentive mechanism and we can just go and smack these utilities upside the head and they will go ahead and do this.”

At the Air Resources Board meeting Friday, the diesel soot rules, under which the state’s heaviest trucks must install filters, were delayed from a 2013 start date to 2014 because of concerns that the $3.8 billion cost could be excessive for some firms during tough economic times.

The most intricate compromise of all was the cap-and-trade system, approved by the Air Resources Board on Thursday. This program will cover 360 businesses representing 600 facilities and will be divided into two broad phases: an initial phase beginning in 2012 that includes the electricity industry and large companies that manufacture glass, paper, concrete and other industrial products, and a second phase starting in 2015.

In the first phase, businesses will be granted free permits for emissions corresponding to their existing production levels, and will have to pay only for additional permits beyond those baselines.

In the second phase, refiners and distributors of transportation fuels, natural gas and other fuels will be required to purchase emissions credits at regular auctions conducted by the Board or to buy the credits from other firms. Over time, as the cap gets lower and fewer allowances are available, costs will rise and businesses will be pressed to make long-term investments in emissions-reducing strategies.

Key Decisions Lie Ahead

The regulations implemented last week included thousands of pages of documents. But the fine print to come will amount to many thousands more, released in a steady regulatory blizzard in the months to come. The most important decisions ahead include these:

Allowances – Business groups and environmentalists alike complain that the board did not give hard details about what each company’s allowances will be. Many analysts warn that California must not repeat the mistakes of its parent, the European Union Emissions Trading System, in which companies received too many free allowances. The excess drove the market price of carbon credits too low and eliminated the incentive to invest in energy-saving technologies. Environmentalists urge the Board to move toward 100 percent auctioning – a step it has not yet indicated it will take.

Leakage – Industries that can prove the regulations are putting them at a competitive advantage to companies in other states – creating the risk of emissions “leakage,” in cap-and-trade jargon – can petition for additional free allowances. Environmentalists have reluctantly accepted the concept because they have long justified California’s climate laws as having huge potential for “green jobs,” and they are loathe to admit the possibility of job loss. But they warn that the extra allowances could become a wasteful form of corporate welfare.

Offsets – Companies will be allowed to satisfy a maximum of 8 percent of their annual emission obligations by purchasing offsets, which are credits for reduced emissions in domestic projects in forestry management, urban forestry, dairy methane digesters, and the destruction of ozone-depleting refrigerants. Some of the regulatory details have already been decided, such as adhesion to the Climate Action Reserve Forest Protocol as the yardstick for domestic offset credits. Yet environmental groups have complained bitterly that these rules could stimulate clear-cut logging because some measurements show second-growth tree plantations absorbing more carbon than old-growth forests.

International – The Air Resources Board also suggested it will develop international offset programs that could include the preservation of tropical rain forests. California officials have signed a Memorandum of Understanding with the state governments of Chiapas, Mexico, and Acre, Brazil. Many environmentalists insist that these programs should conform to the fine print emerging out of the U.N. climate negotiations. In particular, they say, California should explicitly recognize the rights of indigenous peoples in forest projects, and should expressly adopt the so-called REDD+ system of improved forest management practices.

Markets – Carbon trading in California is likely to start small because most emission allowances are being given away for free. What’s more, companies do not have to trade through exchanges. However, offset prices have doubled from about $4 a ton of carbon dioxide to $8 a ton amid higher volumes of trade in recent weeks. Experts estimate California’s emissions market volume could be worth anywhere from $3 billion to $58 billion by 2020.

Linkage — The regulation is designed so that California may link up with programs in other states or provinces within the Western Climate Initiative, including New Mexico, British Columbia, Ontario and Quebec. Yet New Mexico’s Republican governor-elect, Susana Martinez, has said she will pull the state out of the cap-and-trade system once she takes office from the Democrat Bill Richardson in January.

Biofuels – The cap-and-trade regulations currently exempt emissions from all biodiesel and fuel ethanol and do not address any other type of biofuels. This could create conflicts with California’s pioneering Low Carbon Fuel Standard, adopted in 2007, under which state regulators have determined that ethanol made from corn starch and biodiesel derived from soybeans can have higher greenhouse gas emissions than some petroleum-based fuels. Environmental groups are warning of a dangerous loophole and are urging the Air Resources Board to require low-carbon fuel standard analyses of all transportation biofuels.

Biomass – Another loophole to be filled is the exemption of biomass power generation facilities from compliance obligations. Some of these facilities, using fuel derived from landfills, wastewater treatment facilities or waste-to-energy facilities, have higher greenhouse gas outputs than conventional natural gas power plants.

Revenues – The cap and trade program did not specify how the billions of dollars in future auction revenues would be spent, saying only that it be used for the benefit of ratepayers “consistent with the goals of AB 32.” On Thursday, the Board authorized a Community Benefits Fund to spend revenues in poorer communities, but left the details for further analysis by staff and a separate decision next year.

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