About California's Proposed Cap & Trade Regulation

11/17/2010 03:56 pm ET | Updated May 25, 2011
  • Mike Sandler Political economist, climate change professional and sustainability advocate

The midterm elections have sent a new class of climate deniers to Congress, making it unlikely that Congress will take up climate legislation for the foreseeable future. This leaves national climate leadership where it has been for almost 10 years now: Sacramento.

California's election results were mostly hopeful for the climate. Californians elected a pro-climate governor, Jerry Brown, and rejected an anti-climate proposition, Prop 23, a failed attempt to suspend AB32, the state's Global Warming Solutions Act of 2006. Voters did not believe the jobs versus the environment arguments, and Prop 23 was defeated by an overwhelming 62 to 38 percent margin. AB32, which started as an executive order, then became law, now has an effective mandate through a vote of the people.

Meanwhile, the week before the election, the California Air Resources Board released a proposed Cap & Trade regulation, which will guide the flexible market mechanism portion of their AB32 implementation. The public comment period is now open through December 16th, when the Air Board will meet to decide whether to approve or make changes to the proposal.

The proposal is thousands of pages long, but here is a rough sketch of what the CARB staff has proposed. There will be different rules for each of the following three categories of regulated entities:

  1. Industrial emitters (for example, a cement factory). The industrial emitters would get almost 100 percent of the permit allowances they need for free in order to shield them from costs. This is worth billions of dollars as an enticement for them not to flee the State.
  2. Transportation fuels (Chevron, Exxon, etc.). Unlike the industrial sector, companies that sell transportation fuels in California would not receive free allowances, but they do receive an exemption for the first 3 years of the program. Then, starting in 2015, they would be required to purchase the allowances at quarterly auctions. The money would go into an Air Pollution Control Fund, and be appropriated by the Legislature and the Governor. Possible uses of this revenue include government programs and investments, a Community Benefits Fund, or dividend checks to every California household to help with the costs that will be passed down to consumers (i.e. Cap & Dividend).
  3. Utilities that deliver electricity (PG&E, SoCal Edison, LADWP, SMUD, etc.). For this sector, CARB staff have proposed a combination of free allowance giveaways and (secondary) auctions. The allowances are given for free to utilities that deliver electricity. Investor-owned utilities would sell the allowances to the generators when they buy electricity from them. Publicly-owned utilities that produce their own generation would need the allowances themselves. After the allowances are "monetized," the utilities are to use the billions of dollars in allowance value "to reduce the costs of AB 32 policies on their ratepayers," for "ratepayer benefit" and "for protection of electricity customers and for other AB 32 purposes." As with the industrial emitters, the subsidy to utilities is in the billions of dollars. CARB wants the utilities to pass along the subsidy to consumers in a way that encourages conservation. One approach to this is a so-called "lump-sum transfer," which could be implemented through a dividend check.

It is a complicated regulation, and many important aspects are not described here, but one item is especially noteworthy: a floor on the price of allowances, which starts at $10/ton, and increases by inflation plus 5 percent annually. The price floor is insurance against price drops due to overallocation and giveaways, and is perhaps the best aspect of whole program.

In summary, the regulation includes several good design elements, including:

  • The price floor,
  • The full auction of transportation fuel allowances,
  • The requirement to spend the collected revenues from the auction of transportation sector allowances for public purposes. The regulation leaves open the possibility to use the funds as the State's Economic and Allocations Advisory Committee recommended: 75% for dividends and 25% for other uses such as a Community Benefits Fund. Such an approach would mirror the federal legislation introduced by Senators Cantwell and Collins, the CLEAR Act.

But the regulation still has much room for improvement, including:

  • Reduce the billions of dollars in allowance value giveaways to industry. In Europe, the giveaways to industry resulted in windfall profits for companies and limited reductions in emissions. California can avoid that outcome by monitoring how allowance costs are passed through to consumers in the early years of the program, and modify the giveaways to reduce the likelihood of excess free allowances. Another option would be to tax the resulting windfall profits, so that a portion of that allowance value is recaptured and used for public purposes. Regulators can improve industry-specific benchmarks. Otherwise they may encourage manufacturers using current technologies to add some moderate efficiencies to their processes, but disadvantage out-of-the-box innovators such as Calera, Inc.
  • Provide a more specific definition of "ratepayer benefit" to utilities.

An alternative strategy for climate protection advocates would be to ask for a delay. It probably sounds silly to ask for a delay given the urgency of climate action, but political observers note that the current proposed regulations were written in the context of Prop 23's shadow. The down economy may have been enough reason for Governor Arnold Schwarzenegger to encourage a more "pro-business" allocation to industry, or he could have been making concessions to Republican candidate Meg Whitman. In any case, CARB could delay making a decision on the regulation until Governor-elect Jerry Brown's incoming pro-climate staffers look it over. On the other hand, CARB's Chair Mary Nichols was a Brown staffer herself back in the 1970's. So, instead of a delay, maybe all we need to do is send her "back to the future" like in a Michael J. Fox movie. Anyone know where we can find a Delorean?