What Will It Cost for California to Save the World? California Conducts its First Greenhouse Gas Cap-and-Trade Auction

by Sheppard Mullin Richter & Hampton LLP
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[authors: Whitney Hodges, Randy Visser & Olivier Theard]

The landmark Global Warming Solutions Act of 2006 (“AB 32”) tasked the California Air Resources Board (“ARB”) with reducing greenhouse gas (“GHG”) emissions to 1990 levels by 2020. In adopting a scoping plan assembling a number of differing, but complementary, GHG reduction strategies, the ARB included a “cap-and-trade” program as one such strategy to help satisfy AB 32’s goals while allowing industry flexibility in choosing emissions reduction options (i.e., facilities could choose to buy pollution credits, or could choose to reduce emissions and sell credits on the market). The “cap-and-trade” program was deemed preferable to other potential options such as a carbon tax.

On November 14, 2012, ARB conducted the first of these auctions, distributing 23.1 million vintage 2013 carbon allowances and 39.5 million vintage 2015 allowances. The vintage 2013 allowances can be used in the first compliance phase of the program starting January 1, 2013 or be saved for use in subsequent years. The vintage 2015 allowances can be used for the second phase of the program starting in 2015 or later.

Regulated sectors are subject to declining emissions caps during each of the compliance periods and must submit GHG allowances to ARB at the end of each period to cover the total volume of GHG emitted. The first regulated sectors include power plants and large industrial facilities emitting more than 25,000 tons of GHG pollution annually, such as oil refineries and cement manufacturers. Transportation fuel and natural gas distributors will be regulated beginning in 2015.

If an entity does not have enough GHG allowances to meet its obligation, it must purchase additional allowances to remain in compliance. During the first compliance period, 90% of the allowances will be free in order to avoid economic harm to the industries. However, the free allowances are scheduled to decline over time to between 50% and 75%, depending on the industry sector. Because free allowances will decrease and the market price of credits is expected to rise, companies will have the incentive to curb GHG emissions by installing new control technologies (selling any allowance “room” below the companies’ cap to help finance the new controls) rather than to buy allowances.

The results of the November 14, 2012 auction, released on November 19, 2012, indicated that ARB sold 100% of the vintage 2013 allowances at $10.09 and approximately 14% of the vintage 2015 allowances at $10.00. $10.00 was the reserve price “hard floor.” Purchasers were primarily compliance entities subject to the program. The gross revenue is estimated as follows:

  • 23.1 million vintage 2013 allowances at $10.09 equals $233 million. These funds are primarily consigned utility allowances, and the revenue will be used to benefit ratepayers, as regulated by the Public Utilities Commission.
  • 5.5 million vintage 2015 allowances at $10.00 equals $55 million.

All unsold advances will be held by ARB and offered for sale in late 2014 or early 2015, when vintage 2015 allowances become “current.” The maximum bid for a vintage 2013 allowance was $91.13, with a median price of $12.96. Early market reaction to the future sale of the vintage 2013 trading indicated the trade prices to be between $10.75 and $11.75; meaning, the market anticipates the vintage 2013 allowance prices will rise to approximately $11.25 by December.

Despite selling out of vintage 2013 allowances, the auction fell short of expectations for vintage 2015 allowances. California's Legislative Analyst's Office earlier this year estimated that this auction would generate between $650 million and $1 billion in allowance sales, assuming that all vintage 2015 allowances were sold in addition to all vintage 2013 allowances. For its part, the Legislature expected that auction revenue would be $500 million, which was already set aside to “backfill” the General Fund for the current fiscal year budget. The actual revenue was much lower, however, raising questions about how to make up the shortfall.

Legal Challenges

The day prior to the auction, the California Chamber of Commerce (“CalChamber”) attempted to halt the sale of the allowances by filing a lawsuit in Sacramento Superior Court. CalChamber alleged that the cap-and-trade legislation had never authorized the State to be an active participant in the program. Specifically, CalChamber asserted that AB 32 does not authorize ARB to impose any fees other than those needed to cover the administrative costs of the regulatory program. Consequently, the suit states that if ARB was permitted to auction such allowances, then ARB is essentially imposing a tax. For this to be legally permissible, the Legislature would be required to approve such a measure with a two-thirds vote. According to the suit, the Legislature approved AB 32 by a simple majority, and the fee amounts to an unauthorized, unconstitutional tax. The complaint sought to stop the auction and have the auction-authorizing regulations declared invalid. This legal challenge did not derail the auction, but uncertainty about its outcome may have depressed auction revenue. Interestingly, because Democrats now have a two-thirds super majority in both houses of the Legislature and can pass any tax they choose, CalChamber’s legal challenge may end up being mooted by legislative action.

In addition, the Pacific Law Foundation (“PLF”), a group that advocates property rights and limited government, is expected to file one or more lawsuits challenging AB 32. Among PLF’s claims is the allegation that AB 32 violates the Constitution’s interstate commerce clause because, in some instances, imported electricity would be more expensive.

Lastly, some experts assert that cap-and-trade regulations’ treatment of imported power intrudes upon the Federal Energy Regulatory Commission’s exclusive jurisdiction over pricing of wholesale power in interstate commerce under the Federal Power Act.

Conclusion

Though cap-and-trade is now in effect, both legal and economic challenges remain. In addition, only time will tell whether the cap-and-trade program will have any impact on reducing greenhouse gas emissions, a global issue, or otherwise spurring sub-global climate action by other states and regions.

 

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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