Cap and giveaway

Environmental groups were ecstatic that voters last week emphatically rejected an oil-company-backed ballot measure to suspend California’s breakthrough global-warming law, Assembly Bill 32.

“It feels very much like a referendum to go full steam ahead,” said Kristin Eberhard, with the Natural Resources Defense Council.

But days before the polls opened, the California Air Resources Board announced it was ready to make some major concessions to oil companies, electric utilities and other polluters—and proposed to give away hundreds of millions of dollars worth of carbon allowances to businesses as part of a “cap and trade” rule to be formally adopted in December.

The proposal is a departure from what a panel of economists recommended to the agency earlier this year. But CARB chairwoman Mary Nichols blamed the recession for the different approach. “Because of the state of the economy, to go to a large auction quickly just isn’t realistic,” she told state legislators in October, shortly before the 3,000-page rule was formally released.

Sierra Club California executive director Bill Magavern says this is not the path he anticipated when A.B. 32 passed in 2006, adding that “it’s become increasingly obvious over the last year” that CARB was trying to make the regulations more business friendly.

“I do think it was a political choice to lessen opposition,” Magavern explained.

The cap-and-trade program is just one part of the broader effort to fight climate change under A.B. 32. CARB’s “scoping plan” includes dozens of measures affecting everything from new cars and trucks to power plants, refrigerators and fire extinguishers. But cap and trade has proven to be one of the trickiest parts of the plan for regulators.

Cap-and-trade systems are often described as being like a game of musical chairs. When the California game begins in 2012, every regulated business—about 600 facilities statewide, including oil refineries, electricity generators and big industrial operations such as cement and glass manufacturers—are given a certain number of carbon allowances.

Any facility that pollutes more than its cap permits has to buy additional allowances. And every year the regulators will lower the cap. Sticking with the musical-chair analogy, every year the state will take away so many chairs.

CARB has yet to determine what the carbon cap will be for each factory and power generator, but it’s assumed that factories and manufacturers that are more efficient and better at cutting their carbon footprint will be able to sell carbon allowances to dirtier facilities that can’t meet the cap. That’s the “trade” part of cap and trade.

Both business groups and environmental groups are worried about how the state is going to issue those allowances, especially in the beginning.

Under the newly proposed cap-and-trade rule, CARB wants to give pollution allowances away—potentially worth hundreds of millions of dollars—instead of selling them to the regulated businesses.

Some, such as Magavern, say that goes against the basic principle that polluters ought to pay for their pollution. If carbon doesn’t have a price, the argument goes, there’s little incentive to make improvements or invest in cleaner technology.

A CARB-assembled panel of economists and other experts earlier this year said exactly that: The system would work best if the state auctioned carbon allowances instead of giving them away.

In fact, the committee even suggested a sort of “cap and dividend” system by which taxpayers would get money from the fees collected, as part of their tax refunds. At the time, the state estimated it could collect more than $2 billion a year in revenue from the fees.

Under the proposed rule, the giveaway won’t last forever. Auctions would be phased in beginning in 2015.

But even that’s too soon, says Dorothy Rothrock, vice president of government relations for the California Manufacturers & Technology Association, which fought passage of A.B. 32 and endorsed Proposition 23. “Even though in the early years it’s 100 percent free, five years down the road there are auctions coming. And that sends a signal to businesses. It’s a bad signal.”

Cap and trade has always been meant as a sort of concession to business groups, a “market based” mechanism included in the early planning for implementation of A.B. 32 at the insistence of Gov. Arnold Schwarzenegger and grudgingly accepted by the big environmental groups.

And Rothrock acknowledges that business has been generally supportive of cap and trade, rather than a more direct “command and control” type of regulation. “It does create flexibility, and it encourages the lowest-cost emissions reductions to occur,” she explained. But Rothrock says auctions are still likely to drive businesses out of state.

“Even at the lower price, it’s money we don’t have,” she said.

Meanwhile, environmental groups are also worried about another part of the new rule that would allow businesses to purchase “carbon offsets” rather than clean up their operations. Offsets are carbon credits that capped businesses can purchase from outside their industry, and from outside the state, to apply toward their own pollution balance. Timber farms and facilities that capture methane from farms and use it to make power are examples of projects that could sell carbon credits to California’s big polluters.

Environmentalists are particularly concerned about forestry offsets, in part because they could end up rewarding big timber companies that plant trees on land that they previously clear-cut.

“And it can be really tricky to quantify how much carbon is really being sequestered by these kinds of forestry projects,” explained Erin Rogers, with the Union of Concerned Scientists, adding that “it’s like adding chairs to a game of musical chairs.”

Supporters of cap and trade say the system would work much better, would provide more flexibility and have a greater impact if California’s cap-and-trade system were part of much larger cap-and-trade system. The European Union has been developing such a system—with mixed results—for several years. Today, that system is the largest commodity market in the world, worth more than $150 billion.

But with the Republican takeover of the House of Representatives last week, it’s not very likely that Congress will take any action on climate change, let alone anything as aggressive as cap and trade.

There is the Western Climate Initiative, a regional cap-and-trade agreement that’s been under development for several years. But it’s gotten off to a slow start. So far, just California, New Mexico and four Canadian provinces have committed to being a part of that system.

Still, Eberhard says that the WCI is a promising start, especially when considered in conjunction with a similar regional cap-and-trade system being developed by 10 states in the northeastern region of the United States.

“That’s a lot of movement in North America,” said Eberhard. “It would be better to have a single federal bill. But there’s a lot that states can do by working together.”

Meanwhile, another ballot measure that voters approved last week could open another avenue for attack on the state’s global-warming law.

Proposition 26, approved by voters, requires a two-thirds vote for any new fee imposed by the state or local governments—the same requirement already in place for new taxes.

And that could make Prop. 26 the basis for industry lawsuits targeting carbon auctions as a form of illegal tax.

“To the extent an auction can really be considered a tax, I think there are some questions about its legitimacy,” Rothrock told SN&R.