Up One Day, Down the Next—California Air Resources Board Receives Mixed Reviews in its Implementation of its Cap-and-Trade Program and Low Carbon Fuel Standard

by Downey Brand LLP

Petroleum Pollution

In recent weeks, California appellate courts issued two decisions regarding California Air Resources Board (CARB) programs implemented under AB32, the Global Warming Solutions Act, with mixed results.  The first decision upheld the legality of a key element of CARB’s cap-and-trade program, the auction of emission credits.  In that case, the Third Appellate District rejected an industry challenge and found that the auctions are within the authority granted to CARB by AB32 and are not an illegal tax. In the second case, the Fifth Appellate District delivered a setback—the second in that court—for CARB’s Low Carbon Fuel Standard (LCFS), finding the agency failed under the California Environmental Quality Act (CEQA) to adequately analyze the potential effects of NOx emissions resulting from the increased use of biofuels mandated by the LCFS.  CARB was first ordered by the court to correct this CEQA violation in a 2013 writ of mandate, but the agency failed to do so in its 2015 re-adoption of the LCFS.  The court, noting the environmental benefits of this program, however, did not invalidate the LCFS and only froze the required standards at 2017 levels until CARB corrects the CEQA deficiencies.  These decisions do little to clarify the muddy waters around how agencies should analyze greenhouse gas emissions under CEQA, as that analysis is inextricably intertwined with the effectiveness of the State’s greenhouse gas regulatory programs.

Cap-and-Trade Ruling

On April 6, 2017, in California Chamber of Commerce v. California Air Resources Board, the Third Appellate District found that CARB’s emission credit auctions are within the agency’s authority under AB32 to implement the cap-and-trade program and that these auctions are not a tax.  CARB’s cap-and-trade program regulates many of the largest sources of greenhouse gases in the state, including power plants, industrial facilities, and fuel suppliers.  Under the program, each regulated entity must surrender emission credits to cover its emissions of greenhouse gases.  Entities may accumulate the credits through free allocations, emission offsets, trading, and auctions.  Auctions held by CARB have served as a significant source of revenue for the state, providing funding for many projects, including high-speed rail. Although the case did not involve any CEQ A claims, the cap-and-trade program has served as mitigation or offsets in CEQA analysis for greenhouse gas emissions arising from regulated industries, or as part of the assumptions built into the State’s ability to achieve long-term targets.

In California Chamber of Commerce, the court unanimously ruled that the cap-and-trade program and the auctions fall within the very broad authority granted to CARB to regulate greenhouse gases by the legislature under AB32.  Next, in a 2-1 decision, the court ruled that the auction of emission credits under the cap-and-trade program was not an illegal tax under Proposition 13.  The majority reasoned that these auctions were not a tax because 1) purchase of the credits was voluntary, in that a participant can choose to either reduce emissions or purchase credits; and 2) the purchasers acquire a “valuable asset – the privileged to pollute the air,” a type of property right that may be traded.  Conversely, taxes are mandatory and a taxpayer receives nothing of particular value in exchange for payment.

Several initiatives to repeal, modify, or replace cap-and-trade are being actively considered by the legislature, so this ruling may become moot.  In addition, at least one of the industry plaintiff groups, represented by the Pacific Legal Foundation, has indicated it will seek review in of the tax decision in the California Supreme Court.  Among the issues of concern noted by the plaintiffs and outlined in the dissenting opinion is that the majority failed to consider how the state has used the revenue generated by the auctions, a key test in determining whether a payment to the government is a tax or a fee as outlined by the California Supreme Court in Sinclair Paint Co. v. State Bd. Of Equalization (1997) Cal.4th 866.

Low Carbon Fuel Standard Ruling

On April 10, 2017, in POET, LLC., v. California Air Resources Board, the Fifth Appellate District found that CARB continues to violate CEQA by failing to consider all of the environmental effects of the LCFS.  This program reduces greenhouse gas emissions by requiring fuel suppliers to reduce the “carbon intensity” of gasoline and diesel used in the state.  The reduction of carbon intensity is accomplished through the substitution of biofuels for petroleum-based fuels.  The current LCFS regulations increase the percent reduction required each year, culminating in a reduction of 10 percent by 2020.

In a 2013 ruling, this same court found that CARB violated CEQA when it first adopted the LCFS in 2009 and issued a writ of mandate ordering CARB to correct six deficiencies.  Among the deficiencies noted was a failure by CARB to consider the potential impacts of increased NOx emissions that could be caused by an increase of biodiesel use.  In its environmental analysis of the 2009 rules, CARB side-stepped the question of whether biodiesel use could increase NOx emissions and instead stated it would adopt fuel specifications to ensure no overall NOx emission increases.  CARB readopted the LCFS regulations in 2015, intending to correct the CEQA deficiencies, but did not include the promised fuel specifications.  The same group of plaintiffs challenged the 2015 rulemaking, arguing CARB failed to cure the CEQA deficiency regarding NOx emissions.

In reviewing the challenge to the 2015 rulemaking, the Poet court agreed with the plaintiffs, finding that the 2015 LCFS re-adoption failed to adequately address the NOx emissions issue because CARB used an improper baseline to calculate the effects of the project.  Instead of analyzing whether there could be a potential increase based on 2009 emissions, CARB found no potential increase of emissions from the project based on 2014 emissions.  The court ruled this analysis was incorrect finding that “project” under CEQA includes the enactment, implementation, and enforcement of a regulation.  Stating there was no doubt that the 2009 adoption and 2015 re-adoption of the LCFS were one project, the court found that CARB’s baseline analysis must be based on conditions present at the time it first reviewed the project.

While ruling against CARB, the court, found that on balance the effects of the rule provide environmental benefits that outweigh the potential adverse impacts, so it did not invalidate or suspend the LCFS requirements.  Instead, it froze the standards for diesel that are in effect for 2017 until CARB remedies the CEQA violation.  In addition, the ruling is limited to diesel and does not affect the LCFS standards for gasoline or alternative diesel fuels.  By declining to invalidate the regulation and instead of freezing the standard at current levels, the court has likely reduced potential impacts of this ruling.  However, because the current standard only requires a 3.5% reduction in carbon intensity, it seems a stretch for CARB to complete the analysis required to support a reduction in intensity of 10% by 2020, its ultimate mandate.

Post Publication Note: On May 30, 2017, the court vacated the April 6 opinion in POET, LLC v. State Air Resources Board and re-issued the decision certified for publication, with no material changes.

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Written by:

Downey Brand LLP

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