AB 32 And Cap And Trade Design Basics

California, the world's fifth-largest economy and 18th in total carbon emissions if it were a separate country1, is rapidly moving forward with the development of its cap and trade program scheduled to be implemented in 2013. This has drawn a lot of attention from businesses generating high quantities of carbon emissions or who consume large amounts of energy or fuel. Carbon futures linked to Californian's cap and trade program slipped recently2, but after a test auction in late August 2012, news articles reported that major banks are weighing whether to wade into the California carbon market, which experts believe could grow into a $40 billion-a-year market by 2020. The California state legislature passed Assembly Bill 32 (AB 32) in September 2006 requiring the state to reduce greenhouse gases emissions to 1990 levels by 2020, a 17 percent reduction—and eventually to an 80 percent reduction by 2050. There are complications to the California cap and trade system that do not exist in other cap and trade programs to date. For example, California's program covers all six "Kyoto" GHGs—a multi-gas-wrinkle that the EU-ETS will only be tackling in this, its third compliance period. Further, the California Air Resources Board (CARB) retains the ability to reverse trades of carbon offsets or credits in order to enforce holding limits under the CARB regulations. These will present unique challenges to compliance entities, as well as to the brokers, traders, suppliers, and others trying to create a new carbon market. To understand the basic underpinnings of the California cap and trade system, this Alert sets forth design elements of the system: the "what, who, when, and hows" of cap and trade under AB 32.

WHAT is cap and trade?

A key element of AB 32's GHG emissions reduction requirements is the Cap and Trade Program that was adopted in December 2011. The Cap and Trade Program creates a carbon market in which major emitters of GHGs may buy, sell, and trade GHG compliance instruments. At the end of the compliance period, covered entities must relinquish these compliance instruments to CARB via a registry account in an amount equal to their GHG emissions. The cap starts at expected business-as-usual emissions levels in 2012, and declines 2 percent to 3 percent per year through 2020.4 Fewer and fewer allowances are available each year, requiring polluters to reduce their emissions or pay increasingly high allowance prices. WHAT is an allowance? An...