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Western Regional Cap-and-Trade System Takes Shape

June 25, 2008

While members of Congress and the two presumptive Presidential candidates continue to spar over climate policy, the states are continuing to move forward with their own plans. Most recently, the Western Climate Initiative (WCI) issued plans for a regional greenhouse gas (GHG) cap-and-trade system to be rolled out in August of this year. The announcement of the design recommendations fulfills a commitment made on August 22, 2007, when members of the WCI announced plans to reduce GHG emissions, in the aggregate, by 15 percent below 2005 levels by 2020,[1] an action that was previously reported in this newsletter.[2]

Draft recommendations from a number of WCI subcommittees were released in April 2008, and a stakeholder meeting to discuss those recommendations was held in Salt Lake City on May 21, 2008. The final recommendations are now available for review at this link and comments may be submitted using this link. The current set of public comments on those recommendations may be reviewed here. Additional public comments on the final design of the proposed cap-and-trade program will be accepted in anticipation of another stakeholder meeting which is scheduled for July 29, 2008 in San Diego, California. Interested parties can obtain more information here.

When it becomes operational in August, the WCI program will be the second active regional GHG trading program in North America. The first such program was developed by the Regional Greenhouse Gas Initiative (RGGI), a multi-state cooperative effort created in 2005 aimed at reducing GHG emissions in the Northeast from coal-fired power plants. In April of this year, RGGI announced that it will hold its first regional auction of carbon dioxide emissions allowances on September 10, 2008, with a second auction scheduled for December 17, 2008.[3]

Background on WCI

The WCI is a collaboration among 13 western states, five Canadian provinces, and six Mexican states to develop a regional strategy to reduce GHG emissions.[4] In August 2007, six U.S. states and two Canadian provinces announced plans to reduce GHG emissions, in the aggregate, by 15 percent below 2005 levels by 2020.[5] In announcing its regional GHG reduction goal, the WCI committed its formal Partners to develop a regional market-based mechanism, such as an emissions cap-and-trade program, by August 2008. Since August 2007, an additional 16 U.S. and Mexican states and Canadian provinces have joined the Initiative, and a total of 10 Partners are formally bound to participate in the regional cap-and-trade emission reduction program. The WCI Partners are the U.S. states of Arizona, California, Montana, New Mexico, Oregon, Utah and Washington and the Canadian provinces of British Columbia, Manitoba and Quebec.

Following announcement of the regional goal in 2007, five subcommittees were formed to address allocation, electricity, offsets, reporting options, and the scope of the program. In October 2007 the five subcommittees each issued a paper describing the options under consideration as part of the design of a regional, multi-sector, cap-and-trade program. These options were presented and discussed at the January 10 stakeholder workshop in Portland, Oregon. Each of the subcommittees’ papers can be viewed at this link.

Elements of WCI’s Proposed Cap-and-Trade System

• Scope of Coverage

The “scope” of a cap-and-trade system refers to the number and the type of sources covered by the program, the GHGs that the program regulates, and the geographic area where the cap would be enforced. The scope of the WCI’s program is addressed in the report of the Scope Subcommittee, which can be viewed at this link.

The RGGI program has a very narrow scope, i.e., coal-fired power plants. By contrast, the WCI has stated a policy preference that its program be much broader. The Scope Subcommittee evaluated seven different design options,[6] ultimately recommending that the program begin with a scope consisting of the electricity sector, other large fossil fuel stationary combustion sources, industrial process and waste management emissions, as well as emissions from the production and processing of fossil fuels.[7],[8] Large stationary sources and industrial process emissions would be regulated at the point of combustion under the current recommendations, and the subcommittee recommends that the threshold for inclusion in the program be set between 10,000 and 25,000 metric tons of carbon dioxide of equivalent GHGs per facility.[9] Fossil fuel production and processing emissions would be regulated at the facility level, such as the oil and gas field, gas processing plant, or coal mine.[10] In addition, the WCI recommends that transportation fuels and dispersed residential and commercial fuel combustion be targeted for abatement, either in later phases of the cap-and-trade program or through alternative fiscal or regulatory measures policies. The appropriate point of regulation for the electricity sector was analyzed in a separate report from the WCI Electricity Subcommittee.[11]

The limited scope suggested for Phase I of the cap-and-trade program means that the initial program would cover less than 50% of the GHG emissions in the region,[12] which will likely be insufficient to meet the regional emission reduction target. If transportation fuels and residential and commercial fuel combustion are included in the program, these sectors would increase overall coverage to more than 80% of the region’s emissions.[13]

• Emissions Reporting

Emissions reporting and verification are at the core of any regulatory cap-and-trade program, and are therefore included in WCI’s draft recommendations. The Reporting Subcommittee suggests that WCI Partners rely on a North American collaboration called The Climate Registry (TCR), which provides guidelines for entity-wide GHG reporting across sectors.[14] The Subcommittee suggests that TCR be the ultimate repository for all WCI emissions data, with regulated sources reporting directly to TCR or to the Partner jurisdictions, which will then upload data to the central TCR database. Each Partner jurisdiction, however, is to establish procedures for verification of reported emissions data.[15]

• Allocation of Allowances

An emissions allowance is an authorization to emit a set amount of pollution. Some of the most difficult components in any cap-and-trade system are the development of the number of allowances to issue and the methods for allocation and distribution of allowances across sectors. If too many allowances are issued, sources will be able to obtain and sell credits without being forced to reduce emissions or increase efficiency. However, an overly restrictive allocation of allowances could drive the cost of compliance too high and have excessive economic impacts.

In addition to recommending the amount of allowances, the Allocations Subcommittee was asked to make recommendations on the method for distributing allowances.[16] The Subcommittee recommended: (1) each Partner (state or province) be given an allowance budget, with the overall regional cap being the sum of all allowance budgets.[17] Allowance budgets were to be set at the outset of the program for every year through 2020, with changes to the budgets occurring only when errors are discovered, or new sectors are added to the cap.[18] (2) WCI Partners would distribute allowances, not the regional organization,[19] and distribution is to occur through a coordinated regional auction, with between 25% and 75% of overall allowances being auctioned.[20] Draft recommendations show a preference for allowing unused allowances to be banked and awarding credit for early action in reducing GHG emissions, but also recommend against allowing entities to borrow allowances from future time periods for compliance.[21]

In order to prevent a situation where a particular member chooses to auction all of its allowances to favor industries within its jurisdiction, the Subcommittee acknowledged that it may be necessary to undertake case-by-case sector analysis to determine whether standard allocation approaches are necessary to prevent economic disparities.[22] The Subcommittee recommended that the total quantity of regional allowances be increased as new states or provinces enter the cap-and-trade system.[23]

• Compliance Period

The WCI recommends a compliance period of three years. This is consistent with the compliance period used by RGGI.[24]

• Offsets

An offset is a credit for emission reductions created by some entity which is not covered by the regulatory scope of the emissions cap. The Offsets Subcommittee recommended that offsets be included,[25] using both a standardized and an ad-hoc approach to approving offset projects.

The standardized approach would create a set of pre-approved project types and develop a set of protocols for determining whether a particular project would receive offset credit.[26] By contrast, the ad-hoc approach would allow for the review of innovative projects that were not pre-approved, but which could become eligible for offset credit. The Subcommittee recommended that limits be placed on the quantity of offsets usable for compliance by regulated entities, to ensure that significant direct GHG emission reductions take place, but did not make any specific recommendations as to what that limit should be.[27]

Under the recommendations, projects located anywhere in the United States, Canada or Mexico could be approved by the WCI, so long as the meet appropriate standards for validation, verification and enforcement.[28] Offsets and allowances from other “government-regulated” GHG trading systems, such as RGGI, would be eligible for consideration, but the Subcommittee suggested that offsets generated within the WCI region be given priority for inclusion.[29]

Conclusion

With the issuance of its final recommendations, the WCI has taken a significant step towards the finalization of its regional cap-and-trade program. Because the WCI program will be economy-wide and multi-sector, and because it covers much of the western United States and Canada, the adoption of these recommendations and implementation of the cap-and-trade system could have significant economic impacts. With the failure of the federal Lieberman-Warner bill to survive a cloture vote, the WCI and RGGI systems remain the only GHG trading programs sponsored by governmental entities within the United States that are at or near the final stages of a fully vetted design process.

For more information, contact any member of our Climate Change and Sustainability Practice Group.

[1] The WCI’s Statement of Regional Goal can be viewed at this link.

[2] For more information see States Move Forward With Implementation of Greenhouse Gas Reduction Initiatives, Marten Law Group Environmental News (August 22, 2007).

[3] See RGGI Sets First Auction of CO2 Emissions Allowances for September 2008, Marten Law Group Environmental News (April 2, 2008).

[4] Current WCI Partners include: Arizona, British Columbia, California, Manitoba, Montana, New Mexico, Oregon, Quebec, Utah, and Washington. Alaska, Colorado, Idaho, Kansas, Nevada, Wyoming, the Canadian providences of Ontario and Saskatchewan, and the Mexican states of Baja California, Chihuahua, Coahuila, Nuevo Leon, Sonora, and Tamaulipas are participating in the WCI as observers.

[5] WCI, Statement of Regional Goals (Aug. 22, 2007), available at http://www.westernclimateinitiative.org/ewebeditpro/items/O104F13006.pdf.

[6] See Western Climate Initiative Draft Program Scope Recommendations (WCI Scope Report), dated March 3, 2008, at 16-18.

[7] WCI Draft Design Recommendations on Elements of the Cap-and-Trade Program. May 16, 2008. p. 9.

[8] The WCI noted that prior to including emissions from the production and processing of fossil fuels in the program emissions protocols would need to be developed to assist in the quantification and measuring of emissions from these sources. See WCI Scope Report at 17.

[9] WCI Draft Design Recommendations on Elements of the Cap-and-Trade Program. May 16, 2008. p. 10.

[10] WCI Scope Report at 5-8.

[11] WCI Electricity Draft Design Recommendations, dated March 3, 2008, available at http://www.westernclimateinitiative.org/ewebeditpro/items/O104F15951.PDF.

[12] WCI Scope Report at 18.

[13] See WCI Scope Report at 17-18.

[14] WCI Draft Design Recommendations on Elements of the Cap-and-Trade Program. May 16, 2008. p. 5.

[15] Ibid.

[16] See Western Climate Initiative, Draft Allocations Design Recommendations (WCI Allocation Report), dated April 2, 2008, available at http://www.westernclimateinitiative.org/WCI_Documents.cfm.

[17] WCI Allocation Report at 3.

[18] WCI Allocation Report at 3.

[19] WCI Allocation Report at 3.

[20] WCI Allocation Report at 5.

[21] WCI Draft Design Recommendations on Elements of the Cap-and-Trade Program. May 16, 2008. p. 16.

[22] See WCI Allocation Report at 4-5.

[23] WCI Draft Design Recommendations on Elements of the Cap-and-Trade Program. May 16, 2008. p. 16.

[24] WCI Allocation Report at 6.

[25] WCI Draft Offsets Design Recommendations (WCI Offset Report), April 3, 2008, available at http://www.westernclimateinitiative.org/WCI_Documents.cfm.

[26] WCI Offset Report at 2.

[27] WCI Draft Design Recommendations on Elements of the Cap-and-Trade Program. May 16, 2008. p. 19.

[28] WCI Offset Report at 2-3.

[29] WCI Draft Design Recommendations on Elements of the Cap-and-Trade Program. May 16, 2008. p. 19.

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