California regulators have released the country's first comprehensive, mandatory emissions trading system for greenhouse gases.

The California Air Resources Board issued a preliminary design last week detailing how approximately 2.7 billion allowances will be distributed to emitters in their effort to reduce greenhouse gas emissions to 1990 levels by 2020 -- an amount anywhere between 18 million and 27 million metric tons of CO2 equivalent.

The system will cover 85 percent of the state's industrial emissions by the time it ends in 2020. At the outset of trading, in 2012, industrial sources and electricity generators and suppliers responsible for more than 25,000 tons of CO2 per year will be covered; in 2015, it will expand to cover transportation fuels and fuels combusted at industrial, residential and commercial buildings that are not otherwise covered directly.

The cap is being set at business-as-usual levels for 2012 and will decline linearly after that, except to include transportation fuels in 2015 at their anticipated business-as-usual level. Regulators have estimated emissions in 2012 will be 165.8 million metric tons of CO2 equivalent; after reaching a peak in 2015 of 394.5 million tons, the cap will decline to 334 million tons by 2020.

The plan contains several provisions aimed at limiting the cost to emitters: offsets, three-year compliance periods, the ability to hold allowances for future use, and an allowance reserve, which can be released into the market when prices are high. The most important cost-containment provision is the allocation of free allowances to industries that could most easily move their operations to a region without a carbon cap.

Oil and gas extraction and paper, glass, cement, lime, iron and steel manufacturing are among the industries that California has decided to protect the most by giving them 100 percent of their allowances through 2020. Food producers, sawmills, breweries and pesticide and clothing manufacturers are among those in the second tier, receiving 100 percent at the outset but ratcheting down to 50 percent by 2018. Medicine and aircraft makers are in the bottom category, with 30 percent of their emissions burden covered by the end (E&ENews PM, Oct. 29).

"For as long as ARB assesses that the risk of leakage persists, allowances will be allocated for free to those at risk," ARB staff said in its statement of reasons justifying the program.

To calculate how many allowances each emitter should receive, the state will use historical emissions levels for each industry to establish a "benchmark," or standard level of emissions associated with each type of industrial process. When individual industries are too heterogeneous to use one benchmark, ARB will take a step back and evaluate them based on their fuel sources.

Regulators are still figuring out how to deal with electric utilities and generators and their wildly disparate emissions profiles. Utilities in Southern California typically rely more heavily on coal-fired generation and have longer-term purchasing contracts than in the north, which has more hydropower and natural gas.

However they decide to distribute them, investor-owned utilities will receive their allowances for free, but they will have to offer them up for sale at the quarterly auctions that ARB will hold to distribute permits to other sectors. The proceeds from the utilities' allowances will go toward rate relief and other customer benefits.

Four types of offsets allowed

For offsets, the plan recognizes four types that have been evaluated by the Climate Action Reserve, California's state-founded, nonprofit offset verifier. They will allow reductions outside the cap from livestock manure digesters, forests and technology that reduces ozone-depleting organic compounds chlorofluorocarbons and hydrochlorofluorocarbons. California is also looking at allowing some offsets from international programs like the United Nations' Reduced Emissions from Deforestation and Forest Degradation plan.

Offsets will be limited to no more than 8 percent of an individual emitter's reduction obligation through 2020, or 232 million offsets overall.

California's plan contains several references to linking either to other states and provinces or to other trading regimes altogether but steers clear of specific language for now. The plan requires the ARB to approve linkages with other WCI members on a case-by-case basis, likely starting with New Mexico, British Columbia, Quebec and Ontario in 2011.

"These partners represent approximately two-thirds of the total emissions in the WCI jurisdictions -- a critical mass and a robust market for achieving significant GHG emissions reductions," ARB staff wrote.

Trying to improve on earlier market designs

The strength of the plan lies in its acceptance by a broad swath of society, from environmental justice advocates to oil refiners, its supporters said.

"To me, the most important feature is the cap; it's really the defining characteristic of cap-and-trade," said Kristin Eberhard, legal director of western energy and climate initiatives for the Natural Resources Defense Council. California's cap is much more robustly researched than past cap-and-trade programs like the European Union's Emission Trading Scheme and the Northeast's Regional Greenhouse Gas Initiative, she said.

"A lot of other cap-and-trade programs in the past have stumbled," she said. "The E.U., it just didn't have the data when it started, and RGGI made an assumption that the boom times were going to continue forever," resulting in a too-high cap, she said. CARB updated its plan last year to reflect the reduced emissions resulting from the economic downturn (ClimateWire, Nov. 17, 2009).

Former ARB staffer Jon Costantino, now at Sacramento law firm Manatt, Phelps and Phillips, agreed. "The key to this whole program is actually having a program, so if they were to come out and say, 'Full auction and no price collars and no offsets,' you've created something that people can't live with and then you don't have a program."

It remains unclear whether the plan's release will affect tomorrow's popular vote on a ballot initiative that would overturn California's parent climate law, A.B. 32. Proposition 23 would suspend the law and all its attendant emissions-reduction programs until unemployment falls to 5.5 percent for four consecutive quarters. In the most recent Field Poll, released yesterday, it was losing 48 to 33 percent.

Eberhard said she didn't think it would sway public opinion in favor of Prop 23. "I doubt anyone's looking into the details of this, but if they were, they should be really reassuring. CARB's been really careful here, possibly overly cautious about making sure they're not affecting the state economically."

The A.B. 32 Implementation Group, a coalition of 200 companies and chambers of commerce that has been actively lobbying for free allowances, has tentatively praised the design.

"Obviously the devil is in the details, but I think we're encouraged that it tracks with the governor's letter from March regarding allowance allocations," said spokeswoman Shelly Sullivan. In March, Gov. Arnold Schwarzenegger (R) advised ARB to start out with very limited auctioning to jibe with the House bill sponsored by Reps. Henry Waxman (D-Calif.) and Ed Markey (D-Mass.) ClimateWire, March 26).

Correction: A previous version of this story incorrectly listed methyl bromide and nitrous oxide as ozone-depleting chemicals included in the offsets program. The only ozone-depleting chemicals allowed as offsets are CFCs and HCFCs.

Reprinted from Climatewire with permission from Environment & Energy Publishing, LLC., 202-628-6500