Creating an Emissions Trading System for Greenhouse Gases: Recommendations to the California Air Resources Board
By Justin Kirk
INTRODUCTION
On September 27, 2006, California Governor Arnold Schwarzenegger signed into law Assembly Bill 32 (AB 32), the California Global Warming Solutions Act of 2006.1 To date, this is the most significant piece of legislation addressing the challenge of global climate change in the nation, with major economic and environmental implications that reach far beyond California's borders. The Act aims to reduce the state's total greenhouse gas (GHG) emissions to 1990 levels by 2020. The Act itself does not establish a method by which the state will reach this goal; instead, it directs the California Air Resources Board (CARB) to adopt regulations to achieve this goal pursuant to certain considerations and processes prescribed by the Act. If CARB succeeds in designing a system that is enforceable, politically achievable, and realizes a low overall cost of compliance, California will have set the groundwork for a future in which governments around the world make real progress in addressing this global crisis. If it fails, a major opportunity will be lost.
While the Act contemplates and fully authorizes CARB to adopt a cap-and-trade system to reduce GHG emissions, this Note suggests that an executive order signed by Governor Schwarzenegger on October 17, 2006 (Order) requires such a system. Cap-and-trade is a method of reducing pollution under which a government agency: (1) sets a system-wide level of allowable pollution, called the “cap”; (2) divides the total cap into small units of pollution, called “credits”; (3) distributes these credits to polluters, allowing each to pollute up to the amount of credits they possess; and (4) allows credit holders to sell any unused credits to entities that wish to pollute in excess of the credits they possess. The success of any cap-and-trade system depends upon a sequence of design choices, and this Note makes a series of recommendations for the design of CARB's cap-and-trade system based on an analysis of the successes and failures of other cap-and-trade systems.
The first section of this Note discusses the Act and Governor Schwarzenegger's Order in detail, and it concludes that a cap-and-trade-style emissions trading system will necessarily be part of CARB's regulatory scheme. The second section examines other emissions trading systems and GHG reduction programs to glean relevant lessons for California's program. The third section outlines a set of specific recommendations to CARB regarding the design and implementation of its GHG emissions trading system. The Note concludes that:
1. The system should initially cover the industrial and electrical sectors of the economy.
2. The state should seek reductions in GHG emissions from the transportation industry through more tailored regulations rather than through CARB's cap-and-trade system.
3. Non-covered sectors should be allowed to opt-in using a baseline-and-credit approach.
4. Credits should be initially distributed through a combination of free allocation and auction. Those allocated freely should be distributed using a benchmarking approach.
5. CARB should resist requiring pre-approval of credit trades or other pre-trade mandates, such as anti-backsliding requirements.
6. Each credit should be clearly defined and uniform so that credits can be traded as commodities on existing trading markets.
7. Banking should be allowed and encouraged.
8. Borrowing should not be allowed. Instead, CARB should allow and promote a healthy futures trading market for emissions credits.
9. CARB should, over time, reduce the amount of emissions each credit represents in order to reduce the state's overall GHG emissions.
10. Strict and serious penalties should be enforced quickly against violators.
On September 27, 2006, California Governor Arnold Schwarzenegger signed into law Assembly Bill 32 (AB 32), the California Global Warming Solutions Act of 2006.1 To date, this is the most significant piece of legislation addressing the challenge of global climate change in the nation, with major economic and environmental implications that reach far beyond California's borders. The Act aims to reduce the state's total greenhouse gas (GHG) emissions to 1990 levels by 2020. The Act itself does not establish a method by which the state will reach this goal; instead, it directs the California Air Resources Board (CARB) to adopt regulations to achieve this goal pursuant to certain considerations and processes prescribed by the Act. If CARB succeeds in designing a system that is enforceable, politically achievable, and realizes a low overall cost of compliance, California will have set the groundwork for a future in which governments around the world make real progress in addressing this global crisis. If it fails, a major opportunity will be lost.
While the Act contemplates and fully authorizes CARB to adopt a cap-and-trade system to reduce GHG emissions, this Note suggests that an executive order signed by Governor Schwarzenegger on October 17, 2006 (Order) requires such a system. Cap-and-trade is a method of reducing pollution under which a government agency: (1) sets a system-wide level of allowable pollution, called the “cap”; (2) divides the total cap into small units of pollution, called “credits”; (3) distributes these credits to polluters, allowing each to pollute up to the amount of credits they possess; and (4) allows credit holders to sell any unused credits to entities that wish to pollute in excess of the credits they possess. The success of any cap-and-trade system depends upon a sequence of design choices, and this Note makes a series of recommendations for the design of CARB's cap-and-trade system based on an analysis of the successes and failures of other cap-and-trade systems.
The first section of this Note discusses the Act and Governor Schwarzenegger's Order in detail, and it concludes that a cap-and-trade-style emissions trading system will necessarily be part of CARB's regulatory scheme. The second section examines other emissions trading systems and GHG reduction programs to glean relevant lessons for California's program. The third section outlines a set of specific recommendations to CARB regarding the design and implementation of its GHG emissions trading system. The Note concludes that:
1. The system should initially cover the industrial and electrical sectors of the economy.
2. The state should seek reductions in GHG emissions from the transportation industry through more tailored regulations rather than through CARB's cap-and-trade system.
3. Non-covered sectors should be allowed to opt-in using a baseline-and-credit approach.
4. Credits should be initially distributed through a combination of free allocation and auction. Those allocated freely should be distributed using a benchmarking approach.
5. CARB should resist requiring pre-approval of credit trades or other pre-trade mandates, such as anti-backsliding requirements.
6. Each credit should be clearly defined and uniform so that credits can be traded as commodities on existing trading markets.
7. Banking should be allowed and encouraged.
8. Borrowing should not be allowed. Instead, CARB should allow and promote a healthy futures trading market for emissions credits.
9. CARB should, over time, reduce the amount of emissions each credit represents in order to reduce the state's overall GHG emissions.
10. Strict and serious penalties should be enforced quickly against violators.
