Vermont Law Top 10 Environmental Watch List 2013

First Compliance Period Begins for California’s Landmark Climate Change Law

California is set to enter the first compliance period for its landmark climate change law on January 1, 2013, after successfully holding an inaugural auction. It was the first step to reducing the Golden State’s greenhouse gas emissions over the next decade, but legal challenges to the law continue to accumulate.

California’s cap-and-trade program—the centerpiece of the climate change law—requires greenhouse gas emitters to hold emission allowances and surrender them at designated intervals over the next decade. The program was designed to reduce greenhouse gases, such as carbon dioxide and other pollutants that contribute to global warming. The legal foundation stems from Assembly Bill 32—California Global Warming Solutions Act (AB 32), enacted in 2006. AB 32, one of the first such regulations in the nation, gave California the authority to enact a carbon pricing scheme and is currently the country’s most extensive market-based program for reducing carbon emissions.

The law is being implemented in the face of public uncertainty about a national emission reduction plan. Notably, the 111th Congress and the Obama administration failed to enact a national cap-and-trade program. California’s legislation on climate change highlights the idea that the states can act as laboratories for testing environmental regulations before implementing similar national or regional regulatory schemes. It is clear that California’s successes, or failures, will play a major role in not only the environmental legislation other states pursue, but in prospects for federal legislation.

However, the courts have some deciding to do first.

California takes on greenhouse gas reduction

The signing of AB 32 into law set a 2020 greenhouse gas (GHG) emission reduction goal. It directed the California Air Resources Board to begin developing early actions for reduction and identify how best to reach the 2020 limit—427 million metric tons of greenhouse gases based their emissions’ equivalence to carbon dioxide. The limit was chosen based on the state’s level of greenhouse gas emissions in 1990. Business as usual would put California at 507 million metric tons by 2020.

AB 32 required the Air Resources Board to adopt a regulation that would establish a market-based system that would annually reduce the aggregate emissions of greenhouse gas emissions. In 2011, the Air Resources Board adopted the cap-and-trade regulation covering major sources of GHG emissions in the state and included an enforceable emissions cap that will decline over time. There also is hope in the future to link to other market-based programs reducing emissions.

Cap-and-trade game rules

Under California’s new regulation, the state will distribute allowances—tradable permits—equal to the emissions allowed under the cap to major GHG source emitters in phases. Phase one will cover electricity generation, including importers and industrial sources. Phase two—beginning in 2015 and onward—will add distributors of transportation fuel, natural gas, and other fuel.

Sources will have to surrender allowances and offsets equal to their emissions at the end of each compliance period—of which there are three; the last period ends December 2020. The compliance period begins in January 2013 and ends in December 2014. There is also an annual obligation to surrender allowances covering 30 percent of the previous year’s emissions. In other words, companies will need to give the state one allowance for each metric ton of GHG emissions they are held accountable for. Those companies missing a deadline or experiencing a shortfall are found in noncompliance and must surrender four allowances for every ton.

A key question is how the regulated companies get their allowances—and whether they have to pay for them. Initially, the state will distribute most of the allowances at no cost, with the amount distributed for free declining over time. Free emission allowances for industries with high potential to relocate their business out-of-state will decline less drastically overtime.

For example, at the outset, electric utilities will receive allowances for free and industrial sources will receive free allowances covering about 90 percent of the sources’ average emissions. Any allowances not distributed for free will be available for purchase at auction four times a year. Once the allowances are distributed into the marketplace, their owners can hold them or trade them. Hence, cap and trade.

No tax without…a supermajority

The inaugural carbon allowance auction proceeded despite an 11th-hour lawsuit from the California Chamber of Commerce. The suit, filed in Sacramento County Superior Court, alleged the Air Resources Board does not have the statutory authority to distribute allowances through an auction. The chamber argued that even the 10 percent of carbon allowances available for auction should be allocated free of charge. It also claimed, as expected, that even if AB 32 authorizes the use of auction to distribute allowances, that the auction is unconstitutional under California’s constitution. Forcing entities to pay for allowances, through the auction, imposes a “tax.”

When AB 32 was approved, any legislation that would raise taxes required approval by a supermajority—two-thirds—of the California Assembly. Legislation involving fees did not. This was later changed in 2010 when voters approved Proposition 26 requiring that both fees and taxes be passed with a supermajority. AB 32 was approved but not by a supermajority when legislators voted back in 2006. So, if cap-and-trade is found to be tax, it may be infirm constitutionally, attorneys say.

Brenda Coleman, a policy analyst for the California Chamber of Commerce, said to the Los Angeles Times, “As it stands today, this program is far from flexible and far from cost effective as it seeks to impose a multibillion-dollar energy tax.” According to California’s Department of Finance, cap-and-trade auctions are expected to raise about $1 billion a year in new state revenues next year. This lawsuit focuses specifically on the sale of allowances and whether an auction format is the best mechanism for distribution. It is not challenging the entire cap-and-trade program. Future auctions will continue until the court has rendered a decision, as the chamber did not ask for an injunction halting the auctions.

Bidders avant-garde

Still, businesses spent $289 million on permits over a mere three-hour period on the November 14 auction. All 23.1 million allowances offered in the 2013 vintage sold. Three times as many bids were received for the amount of allowances available, according to the auction results released November 19. The auction was conducted using an electronic, internet-based auction platform. Bidders submitted their bids—bids included a price and a quantity of allowances to be purchased at that price—in multiples of 1,000 allowances. There was only a single round and the sealed-bid auction format did not allow bidders to see what others had already bid.

Companies bought 97 percent of allowances. Speculators, such as investors and traders, bought the remaining three percent of the 2013 allowances. “I think we have evidence here that we were able to run a successful auction and that people were able to get the allowances that they wanted and that the whole thing went off without a hitch,” Mary Nichols, Air Resources Board chairwoman, told ClimateWire on November 20. “I think the fact that the full volume cleared is a strong signal to the market,” Samantha Katz, managing director of BGC Brokerage, said. “It will be interesting to see what happens between now and February,” said Katz.

Some notable businesses registered for the auction included BP PLC, Exxon Mobil Corp., Tesoro Corp., Chevron Corp. and Royal Dutch Shell PLC.

AB 32 meets the Commerce Clause

AB 32 is also facing continued legal challenges on other fronts, most notably Rocky Mountain Farmers Union v. Goldstene, which was one of the first and most important challenges to law thus far.

Rocky Mountain Farmers Union challenges the legality of AB 32’s establishment of low-carbon fuel standard for transportation fuels in California. The low-carbon fuel standard requires that regulated entities must achieve an average of a 10 percent reduction in the “carbon intensity” of covered motor fuels by 2020. Carbon intensity is a calculated number for specific categories of motor fuels and motor fuel substitutes (such as biofuels) that takes into account the life-cycle GHG emissions, including indirect emissions associated with production and transportation. Under the low carbon fuel standard, out-of-state fuel producers, such as corn ethanol producers in the Midwest, are assigned a higher CI score due to the greater distances they must be shipped.

California argues that the low carbon fuel standard is a valid exercise of its authority under Section 211(c)(4)(B) of the Clean Air Act, which allows it to regulate fuel or fuel components for the purpose of controlling motor vehicle emissions. But the out-of sate producers argue that the low-carbon fuel standard unfairly discriminates against them in violation of the Commerce Clause of the U.S. Constitution.

In December 2011 the District Court of the Eastern District of California agreed with the out-of-state producers and enjoined California from enforcing the low-carbon fuel standard. But the Ninth Circuit issued a stay of the injunction and on October 16 a three-judge panel heard arguments in the case. On October 22, one of the members of the panel, Senior Judge Betty Binns Fletcher, died. Judge Ronald Gould was named to replace her, but it is not known at this time whether reargument will be required or when a decision can be expected. Ultimately, as with the Affordable Health Care Act, the U.S. Supreme Court may be called upon to decide what limits the Constitution places on state authority to advance climate change mitigation measures.

Other challengers have been environmentalists who argue in different lawsuits that AB 32 has a negative impact on minority communities or does not do enough to reduce emissions. A California state appeals court already upheld AB 32 when faced with the first argument. State court decisions upholding AB 32 when faced with the second argument may still be appealed.

In conclusion, the courts’ upcoming decisions about the soundness of AB 32 will have a large effect on states’ abilities to enact regulatory efforts to combat climate change. While an auction and purchasable GHG allowances is not the route many had hoped California would go, the point is that California is taking action on climate change. If we can’t get this type of legislation passed on the national stage, why not let the states experiment with some of these options? If states’ efforts are substantially restricted, let’s hope the rest of the country sees fit to take action on climate change in the near future.