Legislatures the world over have made several attempts to provide incentives to reduce pollution.
The leading example may be California's more than a decade-old approach. But it's certainly come with its share of controversy.
Even so, the milestone reached by California late last month may usher in a stronger model for other jurisdictions. In the process, it has become the most populous state in the U.S. to reject the current policy preferences of Washington, D.C.
But the most striking aspect of it all is that California's new law came about with support from both parties, the oil industry, and environmentalists.
This is nothing short of a challenge to the way energy matters are being handled inside the D.C. Beltway.
In other words, California just threw down the gauntlet...
California Is Showing How to Move Forward on Energy Policy
This approach began as California's Global Warming Solutions Act of 2006 (AB32). That bill set policies and programs across all major sectors in order to return California's emissions to 1990 levels by 2020.
The California Air Resources Board (CARB) updates a Scoping Plan every five years to outline the state's strategy to meet AB32 goals.
One program adopted by the CARB is the cap and trade program (CTP), which limits greenhouse gas (GHG) emissions from key sectors in California.
It's designed to achieve cost-effective emissions reductions across the capped sectors. The CTP sets maximum, statewide GHG emissions for all covered sectors each year (the "cap") and allows covered entities to sell off "allowances" (the "trade").
An "allowance" is a tradable permit that allows the emission of one metric ton of carbon dioxide, and the state's carbon price is driven by allowance trading. By 2020, the CTP is expected to drive approximately 22% of targeted GHG reductions still needed after reductions resulting directly from AB32 policies.
The overall reduction targets were later extended by state legislation passed in September 2016 to 40% below 1990 levels by 2030.
The CTP covered the power and industrial sectors starting in 2013 and expanded to include natural gas and transportation fuels in 2015. Once fully in effect, the program will cover roughly 85% of California's GHG emissions.
All of this was dramatically expanded on July 25, 2017, with the governor signing an extension that was passed by more than a two-thirds super majority in the legislature.
This approach now virtually ensures that all carbon allowance auctions between now and 2020 will fully cover available allowances, generating at least $1.3 billion in additional revenue for the state's Greenhouse Gas Reduction Fund (GGRF).
This fund, in turn, invests revenue in clean energy and other emission-reducing projects. Some, but not all, of these funds will counterbalance two other aspects of the bill: extending a manufacturing tax credit and waiving a forest fire fighting fee.
After 2020, auction revenue expand considerably, with the newly passed legislation providing for at least $26 billion in new GGRF revenue through 2030. It does this by reducing the "cap" on emissions over time and steadily increasing the price floor for allowances.
This resulted from an intensive round of compromises among the governor's office, legislative leaders, environmentalists, and industry.
Achieving the supermajority in the state legislature largely protects the initiative from legal challenges. But that required negotiation with oil companies - which was seen as contentious by some environmental advocates.
In any event, the agreement resulted in the passage of two linked bills, one extending the CTP from 2021 to 2030 and the latter strengthening California's local air quality program.
That second part will increase community-level monitoring and require emission investments in communities burdened by high levels of local air pollutants.
One of the most criticized elements in the compromise, which received a concerted pushback from environmentalists, was this: the levels of free allowances for oil refineries were kept at current levels. Previously, these had been scheduled to decline in 2018.
But almost all objective observers have concluded that oil interests lost more than they won in the compromise.
Consumer advocates have said the accord will increase retail prices for gasoline and other oil products within the state. This claim has some merit, since companies (especially wholesale fuel suppliers) often pass on the cost of permits to consumers.
But these allowances need to be looked at in context.
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Everyone Had to Compromise
Additional free allowances for oil refineries will amount to less than 2% of the allowances issued from 2021-2030, or 50 million out of 2.6 billion.
The oil industry also suffered setbacks on other program design priorities: They could not establish a $50 per ton limit on allowance prices starting in 2021, nor were they able to use additional offsets (emission reduction credits from agricultural or forestry projects, including some outside of California) to cover emissions.
Increasing the ability to use offsets instead of buying allowances has been a primary goal for the industry from the start.
But a wide group of statewide environmental and other interest groups strongly opposed the approach as a clear example of corporate loopholes.
Under the system as it existed before the most recent legislation, polluters could cover up to 8% of their emissions with offsets (with the remainder covered by allowances). That is now reduced to 4% through 2025 and 6% until 2030.
Additionally, at least half of the offsets submitted must be from projects delivering in-state emissions reductions. That just happens to be a priority among progressive elements of the environmental community and serves to temper opposition.
Now, not only did the same bill get buy-in from both the oil industry and environmentalists.
In addition, a very bipartisan scene played out when Democratic Gov. Jerry Brown signed the new bill into law...
California Is Challenging D.C. on Bipartisan Solutions
Sitting right next to Gov. Brown was his predecessor, Republican Gov. Schwarzenegger, who had begun the process over a decade earlier with the passage of the initial legislation (AB32).
Brown, who has jousted directly with President Donald Trump's administration over its decisions to cut environmental protection, limited his comments to an emphasis on California's commitment to protecting the environment.
Schwarzenegger, however, was less conciliatory.
He challenged Republican lawmakers in Washington to "stop lying to the people" by claiming that measures like cap and trade can only be put in place at the expense of the economy.
He also touted the bipartisan support for the bill as a lesson for lawmakers in D.C. "We do not have to wait for Washington to take action," he added.
And when Brown promised that U.S. states and cities will continue to fight global warming, Schwarzenegger was more pointed, saying that "there's only one man who dropped out" of the Paris Accord. "America did not drop out."
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About the Author
Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.