California launches cap and trade – will other WCI jurisdictions follow? 


December 2011

energy and emissions trading bulletin

On October 20, 2011, the California Air Resources Board ("CARB") adopted regulations to implement a state-wide cap and trade program to regulate greenhouse gas ("GHG") emissions commencing January 1, 2013. California and five other U.S. states are members of the Western Climate Initiative ("WCI"), together with the provinces of Ontario, Quebec, British Columbia and Manitoba. On July 7, 2011, Quebec published for comment draft regulations to implement its own provincial cap and trade program, also expected to commence on January 1, 2013. British Columbia and Ontario continue to support the WCI, but have not made a decision on their respective start dates. The California program is designed to link in the future with similar programs in other WCI jurisdictions, so the features of the California program should be of interest to GHG emitters in Canada.

The California program will be phased in between 2013 and 2017, and will cap emissions from approximately 350 large emitters, representing about 600 facilities, in the utility, industrial and transportation fuel sectors. Large emitters are those which emit at least 25,000 metric tonnes of carbon dioxide equivalent of GHG emissions annually. The program will not apply to small businesses. Large emitters account for approximately 85% of the state's GHG emissions. In 2013 the "cap" will be set at 2% below the level of GHG emissions forecasted for 2012 and the "cap" will decline thereafter by a further 2% in 2014 and 3% annually from 2015 to 2020. California, like other jurisdictions, has for some time had mandatory emission reporting rules which allow annual GHG emissions to be tracked by source for purposes of setting appropriate cap levels.

Businesses in California which are subject to the regulation will acquire "allowances" which may be surrendered for each metric tonne of carbon dioxide equivalent of GHG emissions. Initially CARB will issue allowances at no cost to emitters equivalent to 90% of their average emissions. The number of "free" allowances issued each year will decline, and an increasing number of allowances will be auctioned. Once issued, allowances may be traded and may be "banked" for use in future years. The program is set up with three-year compliance periods. An emitter may submit a smaller quantity of allowances during the first two years of a given compliance period, with the balance of its three-year total obligation due at the end of year three.

Emitters may also use "offset credits" to meet up to 8% of their compliance obligations. The program anticipates two types of offset credits: those issued by CARB and those issued by entities recognized by and registered with CARB. Although the regulation anticipates that in future offset credits may be generated from projects located elsewhere in North America, initially only U.S. based projects are eligible. The regulation currently has four approved protocols for offset credits generated from (a) livestock projects, (b) urban forest projects, (c) U.S. forest projects and (d) ozone depleting substances projects. More protocols are expected to be announced. Offset credits must be independently verified and CARB will retain rights to invalidate credits retroactively which may have been issued in error. All projects will be subject to detailed monitoring and reporting obligations.

Every market participant will be required to register with CARB, and allowances and offsets will be tracked. The regulation sets a reserve price for allowances to be auctioned at US$10 per metric tonne of carbon dioxide equivalent of GHG emissions. To deal with the risk of unexpected high prices, 4% of total allowances will be set aside in a strategic reserve to be released if prices for allowances rise above thresholds (starting at US$40 per metric tonne in 2013). There will be a limit imposed by CARB on the total amount of allowances and offsets which may be held by any person, company or group.

In Quebec, the draft regulation published for discussion is similar to the California regulation. However, emitters in Quebec may apply for "early reduction credits" for activities undertaken between January 1, 2008 and December 31, 2011 which made permanent decreases in emissions. Compliance obligations under the Quebec regulation may be satisfied with (a) emission units (i.e. allowances) issued without charge or auctioned, (b) offset credits (up to 8%) or (c) early reduction credits. The Quebec government has not yet issued draft regulations which define eligible offset credits or the protocols under which they may be created. It is possible that the Quebec government may be considering modifications to the California protocols to make them suitable for the Quebec context.

By comparison, Alberta has approximately 30 protocols for recognizing carbon offsets which may be acquired by GHG emitters to meet emission reduction targets imposed by the Alberta government. The Alberta program is an intensity-based system without a hard cap and has been operating since 2007. Eligible carbon offsets must originate from Alberta-based projects. In November 2011, the Auditor General of Alberta criticized the program stating that some of the carbon offsets were not real, measurable or provable. The government is taking steps to improve the program.

In British Columbia, there is already a carbon tax which in 2013 is expected to increase to C$30 per metric tonne. It is not clear how the carbon tax will co-exist with a cap and trade system if B.C. goes ahead and follows the lead of its WCI partners to implement a cap and trade program.

In a separate development, in August 2011, the Chicago Climate Futures Exchange announced that it will close in the first quarter of 2012 due to low trading volumes. Regional Greenhouse Gas Initiative ("RGGI") futures will continue to trade over the counter. RGGI is an existing cap and trade program regulating GHG emissions in the power sector in New York and nine other participating states in the northeastern U.S. RGGI is currently studying whether to tighten its GHG emissions caps which will apply from 2012 to 2014.

On November 8, 2011, the Australian government passed legislation to impose a carbon tax on Australia's large emitters commencing July 1, 2012. The tax requires large emitters to purchase carbon units from a government agency at a cost of AUS $23/per metric tonne of GHG emissions. The businesses affected are in the mining, utilities and industrial sectors. The carbon tax will be in place for 3 years, increasing to AUS $25.40 in the third and final year. After 3 years, Australia will transition into a cap and trade system to be known as the Emissions Trading System ("ETS"). Under the ETS, large emitters may purchase carbon units by auction or on the open market, thereby setting a market price. Carbon units may also be generated by renewable energy projects, such as wind, geothermal and solar. The government has set a floor price for carbon units under the ETS of AUS $15 commencing July 1, 2015.

The California cap and trade program was originally scheduled to commence January 1, 2012, but in June 2011 CARB announced a delay to January 1, 2013. Climate change policies at the federal level have lagged in both the US and Canada. In the US, attempts by the Obama administration to introduce a federal cap and trade program failed to receive approval in Congress. In Canada, the Conservative government has not endorsed cap and trade. However the California state government has persevered. California is the world's eighth largest emitter of GHGs. It is appropriate that California is showing leadership by introducing North America's first cap and trade program as an integral part of the state's plan to reduce carbon emissions causing climate change.

by David E. Thring

a cautionary note

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2011