On April 18, 2017, California Assembly Members Garcia, Holden, and Garcia proposed amendments to Assembly Bill No. 378 (AB 378) that are intended to extend but significantly reshape California’s Cap-and-Trade Program. This post briefly summarizes the backdrop against which AB 378 has been proposed and discusses the key provisions of AB 378.
The Members initially introduced AB 378 on February 9, 2017 to “make sure social justice [and] environmental justice [are] addressed” as the California Legislature contemplates how to meet Governor Brown’s 2030 greenhouse gas (GHG) emission reduction goals, as codified in Senate Bill 32 (SB 32). As discussed below, it would appear that the amendments to AB 378 would support the extension of the Cap-and-Trade Program through 2030. The amendments to AB 378, however, propose a number of fundamental changes to the Program. For example, the amendments would create individual facility GHG emissions caps and empower the California Air Resources Board (ARB) to establish “no-trade zones” and facility declining caps. These changes, taken together, would gut the flexibility that is otherwise inherent to a cap-and-trade program, convert the Program into an unwieldy command-and-control mechanism, and ultimately undermine the ability of the state to meet the SB 32 GHG emission targets in a cost-effective way. Finally, the amendments also would require ARB to adopt new criteria pollutants and air toxics emissions standards in response to ongoing concerns expressed by the Environmental Justice (EJ) Community.
This post uses “February Version” to refer to AB 378 as introduced on February 9, 2017 and “April Amendments” to refer specifically to the proposed amendments published on April 18, 2017.
Until an April 19, 2016 Opinion by the Legislative Counsel Bureau (the Opinion), the future of California’s Cap-and-Trade Program post-2020 had not garnered much public attention. However, the dissemination of that Opinion, which found that the Governor and ARB lacked the authority to establish a statewide GHG emissions limit below the state’s 1990 level of emissions or to extend the Cap-and-Trade Program beyond 2020, spotlighted the issue for the California Legislature, environmental NGOs, the EJ Community, and carbon market participants.
Carbon market participants seemed particularly rattled by the Opinion, as well as the judicial challenge to the Program’s allowance auctions as an unconstitutional tax, such that the May 2016 and August 2016 allowance auctions were drastically undersubscribed. Those two auctions could have raised approximately $1.12 billion for the state (assuming all state-owned allowances sold at the floor price), but instead raised only $18.4 million. The failure of the auctions to raise the expected and budgeted revenues gave rise to a general sense in the Legislature that the Cap-and-Trade Program is not “working,” even if in reality the Cap-and-Trade Program has successfully put the state on track to meet the GHG reductions targets adopted in the seminal Assembly Bill 32 (AB 32). Furthermore, as state law requires that at least 25 percent of monies in the GHG Reduction Fund go to projects within and benefitting disadvantaged communities, these auctions represented a significant loss of investment in these communities (i.e., approximately $275 million).
To add to the complexity of the current situation in Sacramento, when it adopted SB 32 the Legislature also adopted AB 197 that implemented a number of changes advocated for by the EJ Community.  Chief among those changes, AB 197 requires ARB to “consider the social costs of the emissions of greenhouse gases” and “prioritize . . . Emission reduction rules and regulations that result in direct emission reductions . . . .”
Finally, as flagged in our earlier post, the Court of Appeals for California’s Third Appellate District recently issued its decision in California Chamber of Commerce, et al., v. State Air Resources Board, et al., ruling that the state’s auctions of Cap-and-Trade Program allowances were not an unconstitutional tax. Accordingly, subject to possible review of the ruling by the California Supreme Court, the allowance auctions are permitted to continue. However, given the uncertainty that remains concerning the future of the Cap-and-Trade Program, the Governor continues to push and the carbon market participants continue to ask for an express extension of the Program via a supermajority vote, which would serve to insulate the Program from future, tax-based challenges.
Extension of Cap-and-Trade Program
AB 378 would amend Section 38562.5 of the California Health and Safety Code, which was added by AB 197. The February Version of AB 378 specified that ARB was authorized to adopt “new” regulations to establish a market-based compliance mechanism to regulate the state emissions between 2021 and 2030. Although the February Version did not explicitly require ARB to replace the Cap-and-Trade Program, the reference to “new” regulations can be interpreted as such. Further, the February Version used the umbrella term “market-based compliance mechanism” rather than specify a cap-and-trade program, suggesting that ARB could adopt a variety of market-based mechanisms, such as a carbon tax or a cap-and-“dividend” program.
Conversely, the April Amendments refer to a “system of market-based declining annual aggregate emissions limits for sources or categories of sources that emit greenhouse gases, applicable from January 1, 2021, to December 31, 2030 . . . .” This language comes directly from AB 32 (holding “the state board may adopt a regulation that establishes a system of market-based declining annual aggregate emission limits for sources or categories of sources that emit greenhouse gas emissions, applicable from January 1, 2012, to December 31, 2020”). As ARB adopted the Cap-and-Trade Program pursuant to AB 32, one could interpret this as a signal that the authors of AB 378 now support the extension of the Cap-and-Trade Program through 2030.
Even if the April Amendments can be interpreted as extending Cap-and-Trade through 2030, however, AB 378 continues to describe the Cap-and-Trade Program not as the backbone of the state’s GHG reduction efforts, but rather as a backstop. Indeed, the April Amendments provide that market-based mechanisms are intended “[t]o complement direct emissions reduction measures in ensuring the reductions in greenhouse gas emissions required pursuant to Section 38566 . . . .”
Individual Facility GHG Caps
The April Amendments provide that “[w]hen adopting rules and regulations pursuant to this division to achieve emissions reductions beyond the statewide greenhouse gas emissions limit and to protect the state’s most impacted and disadvantaged communities,” ARB shall prioritize “[e]mission reduction rules and regulations that result in direct emission reductions” and, in doing so, “shall not permit a facility to increase its annual emissions of greenhouse gases compared to the annual average of emissions of greenhouse gases reported from 2014 to 2016, inclusive.” In other words, the April Amendments would establish a GHG emissions cap on each entity currently subject to the Cap-and-Trade Program (each, a covered entity), and such individual facility cap would be the average of the covered entity’s GHG emissions in 2014-2016.
Needless to say, this provision raises a number of significant issues. First, it is fundamentally inconsistent with the basic operation and structure of cap-and-trade programs, as such programs are understood to operate in California and around the world based on years of experience. Indeed, one of the key benefits of a cap-and-trade program is to allow covered entities to increase or lower their GHG emissions over time based on each facility’s GHG emissions abatement costs. By placing individual caps on each facility, the April Amendments would greatly diminish the program’s ability to allocate the burden of meeting the statewide emission targets at the least cost possible and it would turn the Program into a cumbersome command-and-control mechanism.
Second, the provision would have a number of unintended adverse impacts on the economic activity in the state. For example, the April Amendments would prevent new covered entities that did not operate in 2014-2016 from starting operations after 2017 because they would not have any historical baseline. Similarly, the April Amendments would restrict any covered entity from increasing its production output if such increased production resulted in higher emissions, even if other covered entities have reduced their GHG emissions or if the state is meeting the AB 32 and SB 32 targets. Finally, the April Amendments would penalize covered entities that did not operate for a period of time during 2014-2016. For example, a covered entity may have gone offline in 2015 to upgrade its criteria or hazardous pollutant control technologies and would then be penalized because its GHG cap would be lower than it requires to operate going forward.
No-Trade Zone or Facility-Specific Declining GHG Limits
The April Amendments also provide that ARB shall prioritize “[e]mission reduction rules and regulations that result in direct emission reductions” and in doing so, “may adopt no-trade zones or facility-specific declining greenhouse gas emissions limits where facilities’ emissions contribute to a cumulative pollution burden that creates a significant health impact.”
The facility declining GHG emissions caps raise the same issues as the facility caps discussed above. The concept of a “no-trade zone” is not defined and, to our knowledge, there is no equivalent concept in other climate regulation and legislation in the nation and, potentially, globally. Presumably, this concept would prohibit a covered entity located in a specific geographic area from engaging in the sale or purchase of allowances and offset credits. But it is unclear, for example, if an entity in a “no-trade zone” would be permitted to purchase allowances at auctions. If they are not, the April Amendments would prevent companies from operating at all, resulting in facility closures and loss of employment. Similarly, it is unclear if a facility in a no-trade zone could implement GHG efficiency projects and sell any excess allowances. If the April Amendments would prohibit such sales, they could materially dampen the incentive for covered entities to make voluntary investments to reduce GHG emissions.
Similarly, it remains unclear precisely what “contribute to a cumulative pollution burden that creates a significant health impact” means, but the authors of AB 378 seem to be borrowing language from the California Environmental Quality Act (CEQA). In particular, “cumulative” and “significant” are terms of art under CEQA, which have been the subject of extensive regulatory and case law interpretations. Indeed, California’s local air districts often have adopted CEQA guidance specific to their air basins and, as such, do not assess air quality impacts uniformly under CEQA. Moreover, each air basin’s attainment (or lack thereof) with the federal National Ambient Air Quality Standards and California’s corollary standards means that the same levels of criteria pollutant emissions in different air basins could be considered to have different health impacts. The same probability of disparate outcomes applies with regard to emissions of toxic air contaminants. Finally, CEQA tends to be forward-looking, measuring an impact from a baseline scenario. It is unclear against what baseline a facility’s emissions would be measured. In short, if this particular language in the April Amendments were to become law, then there would be a great deal of uncertainty concerning ARB’s ability to restrict a facility’s compliance flexibility under the Cap-and-Trade Program.
Air Pollutant Emissions Standards Applicable to Industrial Facilities
AB 378 also proposes to amend Section 3856.2(c) of the Health and Safety Code so that ARB would be prohibited from allocating allowances “to an industrial facility that does not meet the air pollutant emissions standards for criteria air pollutants and toxic air contaminants adopted pursuant to subdivision (b).” This proposal would require ARB to: (1) evaluate each facility’s compliance with a range of air pollution standards and requirements, including emissions control measures (BARCT and BACT) and various performance standards for individual pollutants; and (2) adopt new facility-specific criteria pollutant and air toxics standards that would become the qualification criteria for receiving GHG allowances to which a facility otherwise would be entitled.
This proposal raises significant issues both for facilities attempting to comply with the regulations ARB will issue pursuant to this provision, and for enforcement agencies themselves. There are hundreds (or potentially even thousands) of standards applicable to individual facilities from which ARB could choose to use as criteria for eligibility to receive allowances, and each facility’s receipt of allowances would become contingent upon meeting each standard selected by ARB. From the regulatory point of view, it is unclear how ARB will determine compliance with these standards, or how ARB will interact with local and regional air districts, which currently have responsibility for regulation of most air criteria pollutants and air toxics. A parallel structure in which ARB and local and regional districts separately oversee each facility would be enormously costly, and create the potential for significant inconsistencies (for instance, if a facility received a variance from a local air district, but not from ARB). The burden created by this two-track stationary source review would be enormous, and could potentially chill economic activity across a wide range of public and private entities.
In sum, the April Amendments to AB 378 would reshape not only California’s Cap-and-Trade Program but also implementation of federal and state clean air regulations. Either of these changes alone would create significant economic impacts and administrative challenges. Together, they represent an uncertain future for affected facilities and industries.
Latham & Watkins will continue to track the Legislature’s efforts to extend the Cap-and-Trade Program post-2020. Please return to the Clean Energy Law Report for updates.
 An act to amend Section 38562.5 of, and to add Sections 38562.6 and 38567 to, the Health and Safety Code, relating to air pollution, https://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201720180AB378.
 An act to add Section 38566 to the Health and Safety Code, relating to greenhouse gases, https://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201520160SB32.
 Legislative Counsel Bureau, California Global Warming Solutions Act of 2006: Executive Branch Authority – #1609054 (April 19, 2016), available at https://www.eenews.net/assets/2016/04/25/document_cw_02.pdf.
 There are two pools of allowances offered for sale at each quarterly auction: (1) state-owned allowances, the proceeds from which are deposited in the state’s GHG Reduction Fund; and (2) utility-consigned allowances. Importantly, the second pool is sold first.
 An act to add Article 7.6 (commencing with Section 9147.10) to Chapter 1.5 of Part 1 of Division 2 of Title 2 of the Government Code, and to amend Sections 39510 and 39607 of, and to add Sections 38506, 38531, 38562.5, and 38562.7 to, the Health and Safety Code, relating to air resources, https://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201520160AB197. AB 197 was signed by the Governor on September 8, 2016.
 See supra note 1 (February Version).
 See supra note 1 (April Amendments).
 An act to add Division 25.5 (commencing with Section 38500) to the Health and Safety Code, relating to air pollution, http://www.leginfo.ca.gov/pub/05-06/bill/asm/ab_0001-0050/ab_32_bill_20060927_chaptered.html.
 See supra note 1 (April Amendments).