Greenhouse Gas Emissions Cap-and-Trade Program Enacted by Washington Legislature

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The Washington Legislature passed Senate Bill 5126, the Climate Commitment Act, on April 24, 2021, which establishes a greenhouse gas emissions cap-and-invest program for utilities, industrial facilities, and other operations with greater than 25,000 metric tons of emissions. Covered entities will be subject to a statewide emissions cap that decreases over time to match the state’s goal of net-zero emissions by 2050. Under the Climate Commitment Act, the Washington State Department of Ecology (Ecology) will seek to link the cap-and-invest program’s market for emissions allowances and offsets with California’s cap-and-trade program. Revenue from Washington’s program is intended to fund emissions reduction projects, emphasizing projects in communities overburdened by the impacts of climate change and air pollution.

Past Efforts to Limit Greenhouse Gas Emissions in Washington

Since 2008, the Washington legislature has twice declined to pass bills that would have capped greenhouse gas emissions. Voters also twice rejected ballot initiatives that would have established a carbon tax or fee. In 2015, Governor Jay Inslee directed Ecology to assess its authority under the state’s Clean Air Act (Chapter 70A.15 RCW) to regulate greenhouse gas emissions. In response, Ecology promulgated the Clean Air Rule in 2016 that set greenhouse gas emission standards and required covered businesses to reduce emissions by 1.7% every year. The Washington State Supreme Court ruled in January 2020 that Ecology lacked authority under Washington’s Clean Air Act to cap greenhouse gas emissions from indirect emitters like natural gas and petroleum product distributors, weakening the impact of the rule and prompting Governor Inslee and legislators to seek another path toward mandating statewide emissions reductions. In 2020, the legislature enacted statewide greenhouse gas emissions limits, requiring Washington to reduce emissions to 45% below 1990 levels by 2030, 70% below 1990 levels by 2040, and 95% below 1990 levels by 2050. The 2020 legislation did not authorize any new regulations to achieve the limits.

The Climate Commitment Act Establishes a Cap-and-Invest Program

The Climate Commitment Act directs Ecology to establish a cap on greenhouse gas emissions by determining the proportionate share of the state’s total greenhouse gas emissions emitted by covered entities—utilities, industrial facilities, and other businesses with at least 25,000 metric tons of annual greenhouse gas emissions. Other entities with lower emissions may opt into the program.

Based on the statewide cap, Ecology will then distribute allowances or instruments that allow an entity to emit up to one metric ton of greenhouse gases. A facility that emits more than its budgeted allowances must purchase allowances from other entities or purchase offsets. A facility that emits less than its budgeted allowances could keep the extra allowances for future use or sell them to other entities. The annual budget of allowances will decrease over time to match the state’s emissions limits for 2030, 2040, and 2050.

Compliance Obligations

Covered and opt-in entities must meet their compliance obligations over a four-year compliance period. The first compliance period begins on January 1, 2023. Covered and opt-in entities must transfer compliance instruments equal to their covered emissions by November 1 for each calendar year with a compliance obligation. Ecology must develop rules that require covered and opt-in entities to transfer a minimum of 25% of their compliance instruments each year to smooth out their compliance obligations within the compliance period.

Allowances are submitted by the transfer of compliance instruments from an entity’s holding account to its compliance account. A covered or opt-in entity that submits insufficient compliance instruments to meet its compliance obligation will be subject to penalties. A covered or opt-in entity must transfer allowances in the order in which they were purchased and may not borrow from a future allowance year to meet a current or past compliance obligation. Ecology will retire all transferred allowances or offset credits used to meet compliance obligations.

Auctions

Ecology must distribute allowances through a maximum of four auctions annually. An auction may include allowances from the current year’s annual allowance budgets and allowances yet to be distributed from prior allowance budget years. A registered entity must submit an application to participate and will only be eligible to participate in an auction after receiving approval by Ecology. Ecology may require a bid guarantee in an amount greater than or equal to the sum of the maximum value of bids that will be submitted by the registered entity.

Registered entities will be subject to auction purchase limits:

  • A covered or opt-in entity may not buy more than 10% of allowances offered during a single auction;
  • General market participants may not buy more than 4% of allowances offered during a single auction and may not in aggregate own more than 10% of total allowances to be issued in a calendar year; and
  • No registered entity may buy more than its bid guarantee or allowances that would exceed its holding limit at the time of the auction.

Additionally, Ecology must adopt rules to guard against bidder collusion and minimize the potential for market manipulation. The legislation prohibits a registered entity from disclosing bidding information, such as an intent to participate in an auction, auction approval status, bidding strategy, bid price or quantity, or bid guarantee. Ecology may cancel or restrict auction participation if the registered entity has provided false or misleading facts, withheld material information, or violated auction rules or registration requirements. Finally, Ecology will have the authority, in addition to any other penalties and fines, to cancel or restrict participation permanently or for a specified number of auctions.

Price Containment

The Climate Commitment Act requires a price ceiling and price containment reserve to provide cost protection for facilities obligated to comply with the program. Ecology must establish this price ceiling at a level sufficient to facilitate investments to achieve emission reductions beyond those enabled by the price ceiling. Ecology must issue price ceiling units for sale at a fixed price if no allowances remain in the allowance price containment reserve. Funds raised in connection with sales of price ceiling units must be expended to achieve emissions reductions.

Offset Credits

The Climate Commitment Act permits compliance through offset credits from projects that result in greenhouse gas emissions reductions that are real, permanent, quantifiable, verifiable, and enforceable. These projects must be in addition to greenhouse gas reductions otherwise required by law and must be certified by a recognized registry within two years prior to the effective date of the section of the Act creating offset credits. At least half of the offset credits must be from projects that provide direct environmental benefits in Washington state during the first compliance period, and the remaining offset projects must be in a linked jurisdiction with Washington. For the second compliance period, at least 75% of offset credits must be from projects that provide direct environmental benefits in Washington. However, Ecology may reduce the requirement if it determines there is not sufficient offset supply in the state to meet offset demand.

A covered or opt-in entity may use offset credits to meet no more than 5% of compliance obligations for the period January 1, 2023, through December 31, 2026. A covered or opt-in entity may use offset credits to meet no more than 4% of compliance obligations for the period January 1, 2027, through December 31, 2030.

Offset projects on federally recognized tribal land do not count against the offset credit limits for covered or opt-in entities and may be no more than 3% of compliance obligation for the period January 1, 2023, through December 31, 2026, and 2% for the second compliance period January 1, 2027, through December 31, 2030.

Emissions-Intensive and Trade-Exposed Facilities

The Climate Commitment Act notes the legislature’s intent to avoid leakage of emissions outside of Washington that may occur when facilities lose market share to less energy-efficient businesses not subject to the program’s restrictions. In an attempt to avoid leakage, the Act establishes a separate compliance pathway for emissions-intensive and trade-exposed facilities (EITEs) and grants allowances through 2035 based on each such facility’s efficiency improvements or other considerations. The Climate Commitment Act identifies these facilities by industrial sector and allows manufacturing businesses in other sectors to apply for treatment as an EITE. The legislature will need to act again to develop the compliance pathway for these facilities through the end of the program in 2050.

Electric Utilities

In consultation with the Washington State Department of Commerce and the Washington Utilities and Transportation Commission, Ecology must adopt rules to provide allowances at no cost to electric utilities subject to compliance with the Clean Energy Transformation Act. These allocations must be consistent with a forecast of each utility’s supply and demand and the cost burden resulting from the inclusion of the covered entities in each compliance period. Allowances allocated at no cost to electric utilities must be consigned to auction for the benefit of utility customers, deposited for compliance by the electric utilities, or a combination of the two. Utilities may not receive any free allowances after 2045, when all electric utilities must provide carbon-free electricity under the Clean Energy Transformation Act.

Natural Gas Utilities

Ecology must, in consultation with the Washington Utilities and Transportation Commission, adopt rules to provide allowances at no cost equal to emissions for the natural gas sector and declining consistently with the cap. Again, allowances must be provided at no cost for the benefit of utility customers, deposited for compliance by the natural gas companies, or a combination of the two. However, 65% of the no-cost allowances, increasing at 5% annually, must be consigned to auction for the benefit of utility customers, prioritizing low-income customers. Revenues from allowances sold at auction must be returned by providing nonvolumetric credits on utility bills, prioritizing low-income customers, or may be used to minimize cost impact on low-income, residential, and small business customers for actions such as weatherization, decarbonization, conservation and efficiency services, and bill assistance.

Other Aspects of the Climate Commitment Act

Revenue from the Climate Commitment Act’s cap-and-invest program will go to a number of new accounts intended to fund emissions-reduction projects and climate resiliency in Washington. Environmental justice assessments by Ecology and recommendations by an Environmental Justice Council will help identify projects to receive funding. The legislation requires a goal of 40%, with no less than 35%, of total investments to provide direct and meaningful benefits to vulnerable populations within overburdened communities.

The Climate Commitment Act also requires an air monitoring network in overburdened communities to identify high priority emitters and potentially prompt stricter air quality standards.

The Climate Commitment Act preempts the Clean Air Rule promulgated by Ecology in 2016. The Climate Commitment Act does not, however, preempt ongoing rulemaking by Ecology to promulgate the Greenhouse Gas Assessments for Projects rule that will potentially require life-cycle emissions analysis and mitigation for greenhouse gas emissions of new or modified industrial and fossil fuel projects going through state permit review.

Next Steps to Implementation

To implement the cap-and-invest program by January 1, 2023, Ecology will promulgate rules for the baseline allowance budget, the allowance auction, and offset credits or projects. Ecology must also consider ways to develop Washington’s cap-and-invest program so that it can be linked with greenhouse gas emissions trading programs in other jurisdictions.

Importantly, the Climate Commitment Act ties the cap-and-invest program to future enactment of a transportation revenue package. Before the program may go into effect, the legislature will need to pass transportation legislation that includes a gas tax increase of at least five cents per gallon. California is currently the only other state with a multi-sector emissions cap-and-trade program.

In addition to the Climate Commitment Act, the Washington legislature passed House Bill 1091, a low-carbon fuel standard that requires progressively low-carbon transportation fuels. To implement both the cap-and-invest program and the low-carbon fuel standard program before January 1, 2023, Ecology will be engaged in significant rulemaking activity.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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