California Air Board Approves Controversial Greenhouse Gas Cap-and-Trade Rules

The California Air Resources Board (CARB) has adopted rules establishing a controversial economy-wide cap-and-trade program for greenhouse gas (GHG) emissions that will be the first of its kind in the nation. The rules adopted by CARB on October 20, 2011 will become final in December 2011, and will impose limits upon GHG emissions commencing January 1, 2013. The new regulations will almost certainly be challenged. This article explains the program and identifies arguments likely to be brought in challenges to the new rules.

CARB’s sweeping rules were adopted to implement AB32, legislation enacted in 2006 that requires reductions of GHG emissions in California to 1990 levels by 2020. See California Sets Mandatory Limit on Greenhouse Gas Emissions, Marten Law Environmental News (Sept. 20, 2006). Under the cap-and-trade program, CARB will establish a cap on aggregate GHG emissions by various economic sectors in California, and will allocate tradable allowances to certain utilities and industries. The first phase of the program, commencing January 1, 2013, will apply to approximately 350 electric utilities, importers of electricity and specified energy-intensive industries, representing approximately 600 facilities, such as electric generating stations, refineries, cement kilns and other manufacturing facilities. Each entity subject to the program will be required to use an “allowance” for each metric ton of GHGs it emits. Allowances will be allocated for free to some entities, but must be purchased by others.  The program will expand in 2015 to include importers and distributors of natural gas, transportation fuels, and other fossil fuels used in California.

The primary means of allocating allowances will be by auctions, in which CARB has set minimum prices of $10 per metric ton. CARB will award the allowances to the highest bidders. The increased costs represented by the purchase prices for allowances obtained at auction will be passed on to California consumers through higher prices for electricity, fuel and goods. Economic competition from out-of-state suppliers of energy and goods (known as “leakage”) is partly offset by allowance requirements imposed on electricity imports and by free allowances allocated to the most vulnerable industries. Revenues from the auctions will be used by CARB for various purposes, including alternative energy investment and rebates to the customers of certain utilities.

The program is likely to be challenged in court by many affected parties under a range of legal theories.  There are arguments that the regulation illegally discriminates against out-of-state suppliers of fuel and electricity or unduly burdens interstate commerce by imposing state-mandated fees upon imports. There are arguments that the program illegally interferes with and is not consistent with the federal regulation of GHG emissions under the Clean Air Act. There are arguments that the cap-and-trade requirements were not imposed consistently with the California Environmental Quality Act or with Proposition 26, an amendment to California’s Constitution prohibiting new taxes and fees without a two-thirds vote of the Legislature. There are also numerous arguments that the requirements of AB32 – including requirements that the program be designed to be cost-effective and to impose costs and burdens in an equitable manner – have not been implemented properly or fairly.

This article will review the background, summarize the new regulations in detail, and analyze major elements of the program.

I. Background

A. Cap and Trade

Cap-and-trade, in concept, is a form of regulation in which aggregate emissions are capped and allocated through the distribution of allowances representing a right to emit. The allowances are tradable, and may be bought or sold among regulated entities and third-party market makers. The environmental theory is that market “demand” for emissions allowances will increase as the number of available allowances decreases, resulting in higher prices for the regulated emissions. This market-based regulatory system sends a price signal that increases the cost of the GHG-emitting activities and, presumably, reduces the demand for such activities. Higher prices will drive regulated parties to employ more energy efficient production methods and additional pollution control technologies that otherwise might not be cost-competitive. Trading of allowances among regulated entities allows the market to find the most economically efficient means of compliance.

Cap-and-trade regulations have been used in at least two highly-focused air pollution programs: a federal program governing sulfur dioxide emissions from power plants, and a regional program adopted by ten Northeastern and Mid-Atlantic states (the Regional Greenhouse Gas Initiative, or RGGI) governing carbon dioxide emissions from power plants. These programs were successful because they focused on selected pollutants from selected industries and were designed to allow gradual adaptation to the constraints imposed by the cap. As discussed below, CARB’s sweeping program differs radically from those models in almost every element of program design.

B. Lead Up to CARB’s Rules

In 2006, California enacted AB32, the Global Warming Solutions Act, which requires California to reduce statewide state-wide GHG emissions to 1990 levels by 2020. The law grants CARB broad discretion to develop regulations, including market-based programs, to achieve the required reductions. AB32 imposes general limitations on CARB’s discretion, requiring that it consider only feasible alternatives, that the regulations be cost-effective, and that they be equitable.

In 2009, CARB published its “Climate Change Scoping Plan,” which identifies cap-and-trade regulations as a centerpiece of achieving AB32’s emission reductions. CARB subsequently adopted near-final cap-and-trade regulations in December 2010. See California Unveils Nation’s First Economy-Wide Cap-and-Trade Program, Marten Law Environmental News (November 12, 2010) (describing draft regulations). At the time CARB announced these “final” regulations, it acknowledged that it had received hundreds of public comments that it had not had time to review, and identified numerous issues that had not yet been addressed. CARB accordingly promised to continue its rulemaking activities into 2011 to address the comments and the then-identified issues.

In July 2011, CARB announced that the 2010 regulations would not be fully implemented on January 1, 2012, as originally planned, and that GHG compliance obligations and emissions trading would not commence until January 1, 2013. CARB then issued two rounds of so-called “15-day amendments,” which are supposed to be minor amendments of regulations for which only a 15-day comment period is provided. But even as CARB approved the final regulations on October 20, 2011, it also took note of significant issues that would require further study and perhaps further amendments.

II. Summary of Program

CARB’s rules will be implemented in three compliance periods:

• First Compliance Period: January 1, 2013 – December 31, 2014;
• Second Compliance Period: January 1, 2015 – December 31, 2017; and
• Third Compliance Period: January 1, 2018 – December 31, 2020.

The program is complex, and consists of the following major elements.

A. Regulated GHGs: The program addresses carbon dioxide, methane, nitrous oxide, sulfur hexafluoride, hydrofluorocarbons, perfluorocarbons and other fluorinated gases specifically identified in the regulations. These GHGs are regulated based on their equivalent carbon dioxide global warming potential, measured in metric tons of carbon dioxide equivalent, or MtCO2e. For comparison, other successful cap-and-trade programs are limited to single pollutants (e.g. sulfur dioxide, or in the case of RGGI, carbon dioxide), while CARB’s rules apply to multiple GHGs.

B. Regulated Sectors: The regulations impose allowance obligations upon the electricity distribution entities in California (both for in-state generation and out-of-state generation that is imported into the state) as well as certain large industrial facilities in specified industries whose GHG emissions exceed 25,000 MtCO2e. In the second compliance period, starting January 1, 2015, producers and importers of natural gas and other fossil fuels will become subject to the regulations at a threshold of zero GHG emissions. The threshold for inclusion of imported electricity would also drop from 25,000 MtCO2e to zero beginning in 2015. This means that virtually all importers of electricity, natural gas, and motor fuels will be snared by the program.

C. The Cap: The goal of the cap-and-trade system is to reduce the aggregate GHG emissions from regulated entities to 1990 levels by 2020. In order to achieve this objective, CARB has established an initial aggregate cap of 162.8 million MtCO2e for all regulated sectors as of 2013, which will decline to 159.7 million MtCO2e in 2014. During the second compliance period (2015-2017), the aggregate cap is raised due to the inclusion of new sectors (e.g., natural gas importers and fuel distributors), to 394.5 million MtCO2e. The cap then declines to 334.2 million MtCO2e by 2020. The declines represent a reduction of 2-3 percent per year in emissions from fossil fuel use by Californians.

D. Sector Allocations: One of the controversial aspects is how regulated facilities will receive their emission allowances. Some sectors will receive allowances through free allocations issued by CARB, while other sectors will be required to purchase allowances via auctions or market-based trades. Allowances are allocated by industry sector and then distributed within sectors to specific regulated entities.

The aggregate cap includes a cap for the electricity distribution industry of 97.7 million MtCO2e, which is further reduced by an “adjustment factor” to 98.1%, for a total cap of 95.8 million MtCO2e in 2013. The cap and adjustment factors for the electricity distribution industry are set forth below in Table 1.

Table 1: Annual Cap on GHG Emissions, Electric Sector (million MtCO2e)

Industrial sectors and other regulated sectors are treated differently from the electric sector. These sectors do not have a numerical total allocation number, but instead receive the allowances remaining after the electric distribution sector receives allowances and other allowances are reserved by CARB for other purposes. The initial non-electrical sector allowances are approximately 63-64 million MtCO2e in 2013-2014, but with the inclusion of other sectors in 2015, rise to 285.5 million MtCO2e. Table 2 below sets forth the total cap, reserves, and amounts of allowances left over for non-electrical sectors in 2013-2020.

Table 2: Allowance allocations by Sector (million MtCO2e)

As shown in Table 3 below, the cap on non-electrical emissions declines more rapidly than the cap on electrical sector allocations. Electrical sector allocations decline a total of 13.3% from 2013 to 2020, while industrial and other sector allocations decline 20.5% from 2015 to 2020.

Table 3: Percentage Reduction in Cap, by Sector (million MtCO2e)

E. Allocations within Sectors: Allocations of allowances are made within sectors based upon historical and projected emissions of GHGs. The allocations to the regulated electricity generating utilities in California are made pursuant to a simple table that was developed based upon baseline generation. Allocations are made to publicly-owned utilities (POUs) for free and may be immediately used for compliance. Allocations are made to investor-owned utilities (IOUs) initially for free, but are required to be “monetized,” which means consigned to CARB for auction into the regulated market.

Allocations to regulated industrial sectors are made for free to those industries exceeding the inclusion thresholds in 2013. But the number of freely-allocated allowances is made on the basis of documented historical use, as adjusted by an industry-specific benchmark. The benchmarks reflect CARB’s assessment of the average emissions of GHGs per unit of output relevant to that industry based on an assessment of operations both in California and elsewhere. In other words, the allowances allocated to California industries are roughly those required to operate at a level that is better than average (in terms of GHG emissions per unit of output), as determined by CARB. CARB has announced that approximately 90% of historical emissions will be covered by free allocations of allowances in the first compliance period. Industries covered by the regulations will be reqired to purchase the remainder at auction.

Over time, the free allowances are allocated to industry on the basis of two additional factors that decline over time. One is the “adjustment factor,” set out for most industries in Table 1 above, which is designed to gradually reduce the free allocation of allowances in order to incentivize reductions in the average energy used to produce the output within a particular industrial category. The second is a factor related to the potential for “leakage,” which is defined as the likelihood that an industrial facility or industry would transfer its operations outside of California. Industries with a high risk for “leakage” continue to receive 100% of their allocations for free, while other industries and facilities receive only 75% for free in the second compliance period and no more than 50% for free in the third compliance period. In the second and third compliance periods, industrial facilities will be required to obtain additional allowances through CARB’s auctions or third-party trades.

Allowances will not be allocated to out-of-state entities, and they will not be allocated to importers of electricity, natural gas or covered fossil fuels. In addition, they will not be allocated to independent power generators (electricity generating facilities not owned by electric utilities). Each of these is a regulated entity under the cap-and-trade program that will be required to purchase allowances in order to continue operating.

F. Allowance Auction: The predominant method of allocating allowances will be through auctions, which will award allowances to the highest bidder. The allowances to be auctioned include all IOU allowances, the allowances reserved by CARB for specific purposes, and the allowances not allocated for free to industrial entities in the second and third compliance periods.

The auctions are intended to be conducted on a blind, one-bid basis, in which the highest bidder is awarded allowances. A reserve (minimum) price of $10 per MtCO2e is established in 2012 and 2013, and that reserve price increases by five percent (above inflation) in ensuing compliance periods.[1] The “price reserve” allowances maintained by CARB to prevent price spikes will be sold, if needed, at reserve prices of at least $40 per allowance, escalated annually by 5% over inflation.

CARB has implemented a number of prohibitions in order to maintain an orderly market. One prohibition prevents regulated parties from using agents to hold allowances or participate in auctions (except for utilities or brokers in certain circumstances). A second prohibition requires disclosure of corporate affiliations and prohibits holding more than a specified percentage of the available allowances among affiliated companies. A third prohibition is an absolute limit on allowances that may be held by any regulated party or affiliated group of parties equal to 2.5 million allowances, plus 2.5% of the available allowances above 25 million, or 5.9 million total allowances in 2013.

G. Offsets: CARB allows up to 8% of a regulated entity’s allowance obligation (sometimes called the “surrender” obligation) to be supplied by “offsets,” which are units of reduction in GHG emissions effected by certified third-party actions. A prime example is forest preservation or growth, and other examples have been approved by CARB. The main limitation upon offset use is that parties using offsets for compliance are liable if the supplier of the offset defaults or fails to perform post-sale covenants. This facet of the offset program imposes considerable due diligence and enforcement obligations upon buyers of offsets that will likely dampen demand for offset credits.

H. Enforcement: Under the allowance allocations rules (and not the reporting rules), CARB will allow regulated entities to mis-report GHG emissions and not make up the difference so long as the misreporting is not more than 5% of GHG emissions. Above 5%, the enforcement penalty for underreporting is limited to the replacement of the allowances that would otherwise have been required. A failure to submit allowances for actual emissions, however, entails a severe penalty. A violator who submits allowances late is required to supply four times the original requirement of allowances and is subject to other penalties.

III. Analysis and Discussion

The cap-and-trade program development generated hundreds, if not thousands, of comments from affected utilities and industries, environmental groups, union representatives and individuals, as well as governmental bodies involved in the purchase, sale or consumption of electricity in the state. The issues raised in these comments ranged far and wide, covering many details affecting specific industrial segments or sectors. The following major themes emerge.

A. Cap: CARB has established the cap at GHG emissions levels that are significantly below emissions in California in 2008, according to emissions inventory data posted by CARB on its website. In addition, the total cap, and cap on the electrical sector and industrial sector, are below “business as usual” levels for 2013. Table 4, below, presents the comparisons of 2008 inventory data, 2013 business-as-usual levels, and the caps set forth in the new regulations.

Table 4: Comparison of Cap to Inventory and Projected GHG Emissions (million MtCO2e)

In other words, CARB’s cap will enforce limits on aggregate GHG emissions and industrial GHG emissions that do not permit California’s economy to recover to pre-recession levels. Furthermore, CARB has established the cap at a level that is likely to induce some level of scarcity in the early years of the program. By reducing supply, regulators hope to ensure that the cost of allowances sends an appropriate price signal. It is believed by some constituencies that the imposition of high allowance values represents success by successfully supporting competing energy and energy-conserving technologies.

Prior programs, such as the federal sulfur dioxide allowance program and the cap-and-trade program under RGGI, demonstrate that imposing immediate shortages of allowances is not necessary for program success. These programs established caps at levels well above business as usual, and in additional included long phase-in periods for lower caps. The federal SO2 program, for example, originated in 1990, and established an emission cap on a small group of regulated sources effective in 1995. It expanded the regulatory cap to additional categories of users in 2000. The long lead time resulted in achievement of the program goals immediately upon the program’s effectiveness, in 1995. The RGGI program was similarly successful by establishing a high cap and allowing a long period for regulated sources to adjust.

California’s cap-and-trade program, in contrast, imposes binding limits that are likely to constrain California’s energy use immediately, without adequate notice or phase-in periods that would enable regulated parties to change their operations or invest in energy-conserving technologies. CARB’s establishment of a relatively low cap assumes that artificial scarcity is important to maintaining higher values for allowances than would otherwise prevail in a market without scarcity induced by regulation. A convincing case could be made, however, that the short lead time for CARB’s program leaves few alternatives for investing in alternative technologies. The choices appear limited to reducing or curtailing operations, or moving operations out of California.

B. Auction of Allowances: The theory of auctioning allowances is that an auction “recovers the value of emissions rights” for purposes selected by CARB. Free allocations are thought to convey a “windfall.”

A major issue for commenters is the auction of allowances and the establishment of a minimum (or reserve) price. The auction of allowances raises revenues for the person conducting the auction (a CARB-directed affiliate). In a program of induced scarcity, the auction has the potential to generate unexpectedly high prices, as businesses compete for the right to continue operating. The use of an auction overlooks the economic reality that an auction requires some regulated entities to pay for cap-and-trade twice – once when they buy allowances to keep operating, and again by investing in operational alternatives for reducing their GHG emissions. The main problem with an auction is that it deprives the regulated parties of resources they could use to make their own investments in alternative technologies.

The minimum price ensures that there will be a payment by regulated entities of hundreds of millions of dollars per year to the auction authority, potentially exceeding the real economic incentives required to force reduced energy use. These costs are then passed on to ratepayers of electric companies and to the purchasers of goods within California. The auction process as implemented by CARB has the potential to double the costs of reducing GHG emissions over a free allocation program. Auctions make cap-and-trade more damaging to the regulated economy than it needs to be to achieve the environmental objective.

The most significant problem of the auction program, however, arises from inter-sector competition. In its simplest terms, if utilities are competing with industry for available allowances, utilities will win. Utilities can pass through the increased costs in their regulated rates, while industrial customers cannot. Industrial customers do not operate in a regulated market, and must compete for their customers. An increase in price in an industrial sector may reduce demand more than in the electricity sector. So, the artificial market that creates such competition unintentionally creates a preference for certain sectors. On a more complicated level, the same dynamics occur among industries, and even among different participants within a single industry sector, as some regulated parties must cease operations as a result of artificially-induced regulatory costs while others can afford to purchase allowances.

The inter-sectoral competition is exacerbated by the distribution of allowances for free to some participants, while other participants must purchase some or all of their allowances at auctions. As a result, only some of the regulated entities must pay for allowances (and increase their operating costs), while other regulated entities do not. The result is that some entities are entirely dependent upon success in the auction for their continuing operation, and either must bid higher prices than their competitors (some of whom receive free allowances) or must make alternative plans, such as reducing operations or leaving California. An auction minimizes the ability to plan ahead, and in some cases, CARB has already picked the winners and losers.

The ultimate effects of the program upon industrial sector users and fuel suppliers are difficult to predict. But one thing is certain. The costs of operating in California will rise materially as a result of the combination of a cap that constricts growth and an allocation system that imposes a minimum fee on GHG emissions. Facilities that are likely to be hardest hit are those whose competitors already exist, internationally or across state boundaries, or those that are part of a corporate family that can shift production out of state.

C. Rebate of Auction Proceeds: CARB is required to use the proceeds of auctions for the benefit of electricity ratepayers, subject to mandates to administer the program equitably and not to unduly burden lower-income communities. In its simplest form, the program raises money from electric utility ratepayers to pay for higher electricity costs, and then rebates a portion of the proceeds (after administrative costs and public-sector “investment” in emissions reduction technologies) back to the same ratepayers. More troubling, the net revenues raised by auctioning allowances to industrial entities and other non-utility sectors, and the proceeds of these sales will also be used to make rebates to utility ratepayers. If the program operates as planned, significant subsidies can arise under which some consumer groups will be subsidizing utility ratepayers.  For example, some users of water are not customers of the investor-owned utilities, and will pay for allowances (through their water bills), but receive no rate relief in the rebate program.

A real question arises concerning the use of hundreds of millions of dollars of allowance auction proceeds. In earlier drafts of the regulations, CARB indicated that it would distribute the proceeds in part on a per capita ratepayer basis, effectively subsidizing smaller users of electricity at the expense of larger consumers. In the final version of the regulations, CARB has simply said that the revenues will be paid back to utility ratepayers, without indicating how the revenues would be allocated. The method of allocation remains undetermined, but continues to be reviewed by CARB to assess the potential for significant subsidization of some segments of the California economy by other segments.

D. Coordination with Other Programs: CARB’s cap-and-trade program shares the same goals as other programs established in California, notably the Renewable Portfolio Standards (RPS), under which certain utilities are required to obtain 33% of their electricity from renewable sources by 2020. Additionally, GHG reduction requirements are incorporated into various other programs and regulatory mandates. For example, GHG emissions are regulated under the Federal Clean Air Act. In addition, GHG mitigation is required under the California Environmental Quality Act. The final version of the regulations does not address or mitigate any of these overlapping requirements. Moreover, the cap-and-trade regulations are inconsistent with some of these other programs. For example, the cap-and-trade program treats biomass conversion and biofuel in a manner that differs from and potential conflicts with the treatment of biomass under the RPS program. Likewise, the cap-and-trade program exempts geothermal emissions of GHGs while other California programs regulate such emissions. The lack of coordination and consistency among programs creates duplicative and sometimes inconsistent compliance programs.

E. Impact upon Markets: There are other ways in which the CARB cap-and-trade program adversely affects markets. Two examples discussed below were raised in the final hearing on the cap-and-trade regulations on October 20, 2011. Despite two years of testimony and five years of rulemaking on these issues, CARB expressed confusion and agreed to continue reviewing the program for possible solutions in 2012.

The first example is the case of an independent power producer, which is not utility-affiliated, that sells electricity to a load-serving entity or distributor. That generator must purchase allowances at auction to cover its GHG emissions, because CARB does not allocate allowances to such entities. The allowances attributable to their generation are distributed, in fact, to utilities who purchase electricity from the independent producers. In some cases, the agreements under which the electricity is sold by independent generators to utility customers do not permit the passthrough of GHG allowance costs to the utility. So, the situation created by CARB is one in which the utility purchaser of electricity from an independent generator receives the allowances from CARB for the generator’s electricity and sells those allowances to the generator at auction. At the same time, the independent generator is not allowed to recover the costs (from the utility) of purchasing allowances from that utility, making such independent generation a money-losing proposition.

CARB’s answer to this inequity is that the parties to such contracts should try to work out the problem, and that if necessary CARB will take action to make sure the contracts are modified to allow such passthroughs. But this proposed solution does not appreciate how difficult the negotiations to modify contracts could be when there is no incentive for one party to compromise, or how limited CARB’s ability to modify pre-existing private contracts might be. CARB is likely to have to change the allocation system to solve this problem.

The second example in which CARB has failed to understand the market relates to imports of electricity. Some importing authorities import on behalf of other entities under agreements that cover that relationship like a power purchase agreement in the above example. If the importer/supplier imports the electricity, it must buy allowances to cover those imports (importers do not receive allocations). Yet the utility customers who are buying the power may have received allocations of allowances that the importer must purchase in order to sell electricity to their customers. Again, the costs of the imports are sometimes not passed through to customers, and the only solutions are to breach the agreement, change the manner of doing business or change the CARB program to impose regulatory requirements only on those who can somehow recover their costs in the market. In contrast, other cap-and-trade programs have allocated allowances on an equal basis to all regulated persons.

F. Administrative Efficiency: CARB’s cap-and-trade program is also unique in its approach to the regulated community as it pertains to compliance monitoring and enforcement. Under the federal SO2 program, for example, regulated entities must report their regulated emissions in certifications to a central regulatory authority, subject to inspections and audits. Such certifications are at the heart of all regulatory programs. The assumption is that the person making a certification will not risk a prison sentence to ensure that the regulated entity pays a slightly lower cost of operating. This mode of monitoring is nearly universal in conventional command-and-control programs as well as in cap-and-trade programs and has proven very effective in practice.

CARB’s program, in contrast, requires that virtually all emissions reports be validated by third-party private inspectors. Not only does this impose upon the program huge administrative costs in comparison to other programs, but it requires regulation of the inspector entities as well (to avoid conflicts of interest). The conflicting mandates of the regulated entities and their inspectors creates an industry revolving around highly technical arguments concerning the accuracy of reported emissions. The overall effect is to magnify the costs of the program significantly beyond what is necessary. This regulatory micromanagement is evident in all parts of the program.

In a similar vein, the enforcement penalties for non-compliance with CARB’s program are unique. Under existing cap-and-trade programs, predictable and effective enforcement penalties are important, because the programs are complex and allow for many types of potential cheating. The solution in many regulatory programs and in cap-and-trade in particular is to set a penalty price to be paid for any missing allowances, and set the price high enough to prevent cheating, but low enough to allow for continuing operations if a party that has erred. The penalty price is generally set at an amount sufficiently above the price of ordinary compliance to make it economically disadvantageous to cheat.

CARB’s program imposes a penalty requiring the violator to purchase four times the number of allowances that were originally required, apparently in an effort to create a penalty so large that it will discourage non-compliance. By imposing the penalty in terms of purchasing allowances, it establishes a penalty that may be impossible to comply with, or may result in a penalty that is many multiples of the original compliance cost. The “price containment reserve” allowances are sold at a minimum price of $40 per Mt, meaning that the purchase of an amount of replacement allowances sufficient to pay the penalty could cost sixteen times the original compliance price. This penalty is significantly higher than what would be required to ensure enforcement, and may result in the failure of a business as a result of unintentional violations.

V. Conclusion

In its regulatory order approving the cap-and-trade program, CARB identified a host of major issues that require modifications to the just-approved program. One example is the possibility of offsetting the compliance obligations of the University of California by its investment in research or alternative energy facilities. Another example was an agreement to study the problems of state water authorities, which consume large amounts of electricity and so would be required to pass large GHG allowances costs back to water utility ratepayers (to subsidize IOU ratepayers). CARB also agreed that its resolution of issues relating to waste-derived fuels may need additional work.

All of this adds up to a cap-and-trade program that is very much a “work in progress” subject to ongoing modifications and considerable additional thought and discussion. CARB has allowed a year to work out more details, but no amount of “fine tuning” in that time period will be sufficient to address the structural flaws now built into the program. If the rules survive the anticipated legal challenges, some companies will find it difficult to operate or do business in California. Others are unlikely to make new investments, given the uncertainty that remains. The cap-and-trade concept will not work well under such circumstances. Investors and businesses need a simpler, more predictable and more equitable program.