California's Ambitious Cap-and-Trade Program

California’s cap-and-trade program, launched in 2013, has been described as one of the most ambitious and aggressive in the world. It is one of a suite of major policies the state is using to lower its greenhouse gas, or GHG, emissions to 1990 levels by 2020 and 40 percent below 1990 levels by 2030. California’s program is the fourth largest in the world, after the cap-and-trade programs of the European Union, the Republic of Korea and the Chinese province of Guangdong.

How does California cap-and-trade work?

The Global Warming Act of 2006 (AB 32) authorized the California Air Resources Board, or CARB, to adopt a market-based mechanism to reduce GHG emissions in the state to 1990 levels by 2020. CARB designed and implemented a multi-sector cap-and-trade program, a market-based mechanism to discourage industrial companies from emitting greenhouse gases while providing them with flexibility in how they comply with the state’s climate change regulations. Approximately 450 businesses, including large electric power plants, industrial plants and fuel distributors that emit 25,000 tons of carbon dioxide equivalent per year or more have to comply with the program. These businesses produce about 80 percent of the state’s output of carbon dioxide and other GHG. 

The “cap” creates a limit on carbon dioxide equivalent emissions, while a corresponding number of allowances or permits within the cap can be “traded.” CARB has established a statewide limit on emissions (or cap) from businesses covered by the law. By law, the cap must be reduced annually. In 2018, the cap for allowances is 358.3 million metric tons of carbon dioxide. It falls to 346.3 million in 2019 and 334 million in 2020.

Businesses can meet their emission target by investing in anti-pollution measures, or buying emission allowances at the quarterly state auctions held every year (CARB also gives some allowances away for free), or trading existing allowances with each other. The number of emission allowances offered for purchase every year is progressively lowered and the minimum price rises at 5 percent per year plus inflation. The price of a permit was $14.76 per reduced ton in November 2017 auction. Theoretically, if a business estimates its cost for pollution control equipment to be lower than $14.76 per reduce ton, it would buy and install the equipment. If the cost is higher, it would buy the needed allowances. Businesses that cut their pollution faster can sell allowances to businesses that pollute more, or bank them for future use.

Offsets, projects that reduce carbon emissions elsewhere such as planting trees or preserving forests, can account for up to 8 percent of a polluter’s allowance obligation.

California has linked its cap-and-trade program with similar programs in the Canadian provinces of Ontario and Quebec. Businesses in one jurisdiction can use emission allowances issued by one of the others for compliance. California has also entered into partnerships with Mexico and China to share best practices for climate policies, which could lead to closer cooperation on cap-and-trade practices in the future.

California extended its cap-and-trade program in 2017

California’s program was set to expire in 2020 and needed to be extended. The cap-and-trade program also needed to align with a 2016 legislation setting a new target of reducing GHG emissions by 40 percent below 1990 levels by 2030, one of the world’s most aggressive climate change goals.

California last year approved a 10-year extension of its cap-and-trade program, keeping the five-year old program operating until 2030. The legislation to extend the program, Assembly Bill 398, was passed with bipartisan support. National advocacy organizations, such as the Environmental Defense Fund and the Natural Resources Defense Council, and business groups, including the California Chamber of Commerce and associations representing manufacturers and agricultural interests, backed the legislation.

For some other groups, however, the legislation fell short of what California should be doing. Environmental justice advocates had concerns about a specific provision that prohibits CARB and local air districts from directly regulating carbon emissions by sources that are also subject to the state’s cap-and-trade program. According to them, the provisions of AB 398 are too weak to fully combat local emissions and air quality issues, especially in neighborhoods that are home to big emitters and whose residents disproportionately bear the burden of pollution. Under only the cap-and-trade program, a big polluter could buy its way to compliance by purchasing allowances and/or offsets from elsewhere.

The companion bill to AB 398, AB 617, addresses some of the local air pollution concerns. The new law establishes a statewide program to measure and combat air pollution at the neighborhood level. AB 617 requires CARB to develop a program to reduce exposure to ozone, particulate matter (PM 2.5), and criteria pollutants like oxides of nitrogen and sulfur in communities most impacted by air pollution.

Another concern is the continuation of free allowances, which is seen as a giveaway to industry. Proponents of free allowances argue that they are meant to keep California companies competitive with those in states without such regulations and that over 40 percent of free allowances would be phased down by 2030.

AB 398 includes tax breaks for a number of industries including manufacturing and agricultural businesses. It also repealed the fire prevention fee, which has been opposed on the grounds that it disproportionately hurts rural residents.

Despite some of the drawbacks, the extension of the cap-and-trade program represents a bipartisan commitment to reducing emissions in California. State Senator Tom Berryhill (R-Modesto) said in a statement, “This bill is not perfect, but it is more reasonable after a bipartisan negotiation. I am very pleased to have given farmers, small-business owners and rural Californians a voice.”

Cap-and-trade auction revenues are benefitting communities throughout California

Beyond providing a mechanism to discourage GHG emissions, California’s cap-and-trade program also provides a substantial amount of money for investment in carbon emission reduction programs and projects. Many of these programs and projects are located in disadvantaged communities and bring benefits to low-income communities and households.

Communities where investments occur are realizing a wide range of benefits, including more transit options; increased affordable housing opportunities near jobs and services; improved mobility options through transit, walking and biking; cleaner air through zero-emission vehicles; energy and water savings; and expanded job opportunities. These funds also support California’s ability to drive innovation, advance emerging technologies, and enhance natural and working lands.

The auction proceeds are deposited in the Greenhouse Gas Reduction Fund. According to the latest annual CARB report, nearly $6.1 billion has been appropriated by the Legislature and given to various state agencies administering GHG emission reduction programs and projects. Funded programs and projects are collectively referred to as California Climate Investments.   

Is cap-and-trade the climate solution?

California’s cap-and-trade program hasn’t been around for that long. Hence it is difficult to demonstrate with absolute certainty to what extent it has directly contributed to carbon emissions reduction in the state. The Environmental Defense Fund, or EDF, has calculated that the various industries covered under the program saw their emissions reduce by 4 percent between 2013 and 2015.

However, it is hard to say if cap-and-trade was largely responsible for that drop. California has a myriad of environmental regulations, including the state’s 50 percent renewables by 2030 mandate, zero emission vehicle regulations and the low carbon fuel standard, to help lower its carbon footprint. The cap-and-trade program coexists with these other regulations.

To its supporters, cap-and-trade is doing exactly what it is supposed to do, achieving its goals without holding back economic growth.

“In the twelve years since California’s first cap and trade law was signed, the state has gone from the eight largest economy in the world to the fifth and our economic growth has been faster than the rest of the United States,” said California state Assemblymember Cristina Garcia. “In the past seven years, California has created more than 2.5 million new jobs, cut its unemployment rate in half, eliminated a $27 billion budget deficit and boosted its credit rating to the highest level in more than a decade. We’ve reduced our reliance on fossil fuels, gone after the ‘bad-actors’ and put long-term policies in place to incentivize those investments, built up a thriving green economy and reinvest the monies the program earns back into communities most impacted, which will reduce the health costs.  I’d say the overall economic benefits are priceless.”

Currently California is on track to reduce emissions to meet its 2020 target. According to EDF’s Katelyn Sutter, “California’s suite of climate policies together is meeting the state’s climate goals. The final 2016 greenhouse gas emission inventory that has recently come out show that California is actually ahead of schedule to meet its 2020 emission reduction target. Assuming the state stays on that trajectory, California will actually beat the 2020 goal. California would reduce even more than what it has set out to do.”

The rate of emission reductions will need to increase significantly in order to meet the 2030 target. This will require massive changes to electricity generation, transportation-sector emissions, and emissions from industrial, commercial, and residential sectors. In many ways, California has already plucked most of the low-hanging fruit—it has the third lowest per capita emissions in the nation, it hardly uses any coal and has installed as many solar panels as the rest of the country combined. Moving forward, each additional increment of carbon reduction will be harder than the previous one.

CARB expects that the revised cap-and-trade program will contribute at least 25 percent of total emission reductions by 2030, with other regulations making up the remainder.

As CARB’s Rajinder Sahota notes, “We have a whole suite of policies. All these programs will work together. We have the renewable portfolio standard, we have low-carbon fuel standard, the cap-and-trade program and advanced clean cars. We are not relying on one single program to achieve our mandated target.”

Ultimately, the success of the program will depend on maintaining a delicate balance between limiting the total cost and achieving the emissions goal. The revised program maintains a price floor below which permits are not sold, but also sets a ceiling on permits prices. If the price of permits spikes and hits the ceiling, CARB will sell an unlimited amount of permits at the ceiling price. While it is not clear how much California’s cap-and-trade program will ultimately cost, this ceiling puts a limit on that price tag.

While this has the downside of weakening the cap part of the cap-and-trade, it provides a balance between high cost of emission reduction, which would be politically unviable, and the need to meet emission reduction targets.

“The cap-and-trade program isn’t perfect; no system of managing fluctuating supply and demand could be,” said Garcia. “But it has worked as a crucial element of California’s portfolio of climate change policies and it’s one tool that we need to continue to hone as the environment and usage change.”

California’s program is being studied closely by other states and countries who wish to set up their own emission trading systems. In both its success and failure, California’s cap-and-trade program can provide valuable lessons. 

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