California’s Cap-and-Trade Program for greenhouse gases (GHG) became effective on Jan. 1, 2012. The program – a central element of the state’s landmark “Global Warming Solutions Act” (AB32) – is currently applicable only to facilities that emit 25,000 metric tons of CO2-equivalent compounds per year (comparable to burning approximately 40 million BTU/hour of fuel continuously for a year).

Covered Entities
The California Air Resources Board’s (ARB) draft list of “covered entities” contains approximately 400 qualifying GHG generators. It is populated primarily by companies in the food (canning, drying, brewing, dairy, baked goods), pulp/paper, petroleum extraction and refining, industrial gas, chemical, pharmaceutical, glass, cement, nonferrous metal and power generation industries … plus a catch-all category called “Electricity Importer.”

There are only three ways an included entity can escape from the program: (1) improve fuel efficiency, (2) reduce production or (3) shut down operations. Only option 3 takes effect immediately. The other two options take effect the year after the entity has emitted less than the 25,000 MT/year threshold for an entire three-year compliance period.

Compliance Instruments
Regulated entities can only emit GHG if they are in possession of a “compliance instrument,” of which there are two types – allowances and offsets.

An allowance is a tradable authorization to emit 1 metric ton of CO2 equivalent. Initially, allowances are issued by ARB to generators at no cost, according to the baseline GHG emission levels they reported in previous years. Later, ARB will auction off the available allowances to the highest bidder. The minimum bid is currently set at $10 per MT.

An offset credit is a tradable instrument that represents a reduction or removal of 1 metric ton of GHG. Offset credits may be sold by one generator to another. According to the regulation, such reductions must be “real, additional, quantifiable, permanent, verifiable and enforceable.”     In the context of offsets, the term “real” means resulting from a demonstrable action called an “offset project” (e.g., changing from a high-carbon to a lower-carbon fuel); “additional” means beyond compliance; “quantifiable” means accurately and reproducibly measurable; “permanent” means irreversible (i.e. not simply due to a temporary reduction in production); “verifiable” means the offset project is documented sufficiently so that it can be reviewed objectively by a third-party verifier; “enforceable” means subject to action by the ARB if any provision of the law is violated.  

California State GHG Budget
Each year, ARB determines how many allowances are available to be auctioned. The sum total of allowances is equal to the state’s GHG “budget,” or “cap.” The cap is initially equal to the sum of baseline GHG emissions from the covered entities. The inventory subject to the cap will be approximately 395 million MT in 2015.

Over time, ARB will gradually reduce the cap and auction off fewer allowances; thereby, the state’s total emission of GHG will be reduced. The program’s goal is to reduce California’s GHG emissions to 1990 levels by 2020. Ostensibly, the goal can be met by annual cap reductions of 3%.

Auction, Trading, Banking, Retiring
ARB will establish auctions to disburse allowances. Any entity that purchases, holds, transfers or surrenders compliance instruments must be registered with ARB. Covered entities must report their GHG emissions annually and surrender allowances to match their emissions. There will be two auctions held in 2012: Aug. 15 and Nov. 14. Beginning in 2013, auctions will be held quarterly. Entities that must procure allowances will pass costs on to their customers. ARB’s auction proceeds will be invested in alternative-energy projects and given out as rebates to electricity rate payers.

A covered entity that wishes to trade allowances to another entity may do so at any time, but the trade is not recognized by ARB until the parties submit appropriate paperwork. Allowances not used in the year issued can be “banked” for use in a future year. Allowances can also be purchased by entities not covered under the program (e.g., “green” organizations) for purposes of “voluntary retirement.” Emissions from combustion of biomass fuels are not subject to compliance when reported as “Biomass CO2.”

Although entities responsible for generating less than 25,000 MT/year are not currently required to procure allowances, the mandatory reporting threshold was recently reduced to 10,000 MT/year, which makes it appear that significantly more entities will be covered by the program in the future. There is also speculation that offsets will be less expensive than allowances, but the price of each will ultimately be determined by market forces. IH