California’s Cap-and-Trade Program and Local Climate Action Plans
Local jurisdictions in California could take the lead in rapidly reducing statewide greenhouse gas emissions through local Climate Action Plans — if the California Air Resources Board allows them to do so.
California has been at the forefront of environmental regulation since it established the nation’s first vehicle emission standards in 1966. In 2006 California enacted the nation’s first comprehensive greenhouse gas regulations with the goal of reducing statewide emissions to the 1990 level by 2020. That objective was achieved in 2016, four years ahead of schedule, and the state legislature then tasked the California Air Resources Board (CARB) with the goal of reducing statewide emissions to at least 40% below the 1990 level by 2030. California has a longer-term goal of achieving carbon neutrality by 2045.
The centerpiece of CARB’s climate regulations is its cap-and-trade program, which covers sources responsible for approximately 80 percent of California’s greenhouse gas emissions. Regulated entities are issued emission allowances, each authorizing emission of one metric ton of carbon dioxide-equivalent greenhouse gases (1 MTCO2e). Allowances are distributed in part by free allocation and in part by auction, they can be bought and sold on the open market, and they can be banked for future use. Total statewide emissions in capped sectors are determined by the number of issued allowances, which is controlled by CARB, but trading and banking give regulated entities flexibility in how, when, and where emissions reductions are achieved.
Although California is doing more than other states to reduce its greenhouse gas emissions, it is debatable whether its cap-and-trade regulations are achieving the “maximum technologically feasible and cost-effective greenhouse gas emissions reductions” required under CARB’s legislative mandate. The 2020 goal was achieved in 2016 in large part due to economic contraction after the 2008–2009 recession, and the ease with which the target was achieved allowed industry to accumulate a large number of banked allowances (over 300 million), comparable to the cumulative mitigation expected from the program from 2021 through 2030. Those banked allowances constitute a legal entitlement, a license to pollute, which will make it difficult to achieve the 2030 or later targets. Moreover, California’s greenhouse gas regulations, unlike its vehicle emission standards, have not been adopted nationally and they are insufficient to limit global warming to at most 1.5°C, the level beyond which catastrophic and irreversible climate change would become increasingly likely according to the IPCC. The 1.5°C threshold might be surpassed as early as 2030.
The imperative of climate change has led a number of local jurisdictions in California (San Diego County and City, Santa Clara County, Palo Alto, San Jose, Santa Barbara, San Francisco, Irvine) to initiate their own Climate Action Plans with more ambitious goals, e.g., net-zero by 2035. Rapid decarbonization of the U.S. economy on that scale would be feasible and could be accelerated by rapidly evolving energy technologies (e.g., solar cells, batteries, green hydrogen). If a few California cities and counties take the lead in spearheading coordinated climate action, others might follow and the climate action coalition could expand to other states. However, there is a little-understood characteristic of cap-and-trade that could put the brakes on those efforts.
Public support for local climate action could evaporate when people realize that their efforts would merely allow and facilitate increased emissions elsewhere. … The question for California cities and counties with Climate Action Plans is whether they intend and expect that their actions will actually reduce statewide emissions.
Local and individual climate initiatives are generally considered to be complementary to state policies, but cap-and-trade actually operates to undermine and nullify such actions. While local jurisdictions can act to reduce their own emissions, statewide emissions within capped sectors would be unaffected because statewide emissions are determined by the supply of emission allowances, which is predetermined and controlled by CARB. If a jurisdiction’s Climate Action Plan results in reduced local emissions, the allowances that would otherwise have been surrendered to cover its emissions will instead be used to allow increased emissions elsewhere and there will be no net reduction in emissions.
While local actions would not change the supply of allowances, they would reduce the demand, causing allowance market prices to drop and reducing the cost of emitting greenhouse gasses. (For example, if multiple jurisdictions implement Climate Action Plans that are alone sufficient to achieve CARB’s 2030 goal, then other jurisdictions will have no need to reduce their emissions and allowance prices would collapse to the auction floor price.) Thus, local Climate Action Plans would not only allow emissions in other jurisdictions to increase, they would also have the perverse effect of partially subsidizing those increased emissions. Public support for local climate action could evaporate when people realize that their efforts would merely allow and facilitate increased emissions elsewhere.
This perversity of cap-and-trade stems from its fundamental incompatibility with California’s legislative policy. Rather than incentivizing “the maximum technologically feasible and cost-effective greenhouse gas emissions reductions”, cap-and-trade operates to achieve a predetermined emission target at least cost. The benefits of unanticipated market opportunities, whether from economic conditions, technology advances, or local and individual climate actions, are channeled toward reducing compliance costs, not toward further reducing emissions.
The question for California cities and counties with Climate Action Plans is whether they intend and expect that their actions will actually reduce statewide emissions. If so, they would need to collectively petition CARB to accommodate such actions in its cap-and-trade program. The policy choice for CARB is whether to support, rather than impede and deter, local efforts to achieve statewide emissions reductions beyond CARB’s 2030 target.
CARB could accommodate such efforts by reducing the number of allowances issued, based on quantified, additional emissions reductions achieved by local Climate Action Plans. Or CARB could use some of its allowance auction revenue to buy back and permanently retire the surplus allowances. Proceeds from CARB’s auctions are currently deposited into a Greenhouse Gas Reduction Fund (GGRF), which supports a variety of carbon-abatement projects at an average cost of $125/MTCO2e. By contrast, the current market price for emission allowances is $28/MTCO2e. Relative to GGRF expenditures, CARB could achieve more than four times as much reduction in emissions, at the same price, by simply purchasing and retiring allowances.
CARB justifies the GGRF’s high abatement cost, in part, because “some programs … focus specifically on delivering benefits to priority populations …”. But the regulatory system creates a conflict of interest by making those benefits dependent on continued greenhouse gas emissions. If local Climate Action Plans succeed in achieving net-zero emissions well in advance of state targets, then the funding source supporting priority populations would disappear. Expedited decarbonization would benefit disadvantaged communities that are most affected by the adverse impacts of climate change, not to mention the direct and immediate public health impacts of fossil fuel pollution. That benefit is diluted by the diversion of GGRF resources for purposes other than maximizing greenhouse gas emissions reductions, per the statutory mandate.
CARB also justifies the $125/MTCO2e cost “to support the long-term transition to a low-carbon future …” because “public funding is often critical to spur next generation technologies that are typically more expensive than commercially available technologies”. A good example of this is Germany’s Feed-in-Tariff (FIT) program in the early 2000’s, which subsidized renewable energy at a rate of 45¢/kWh, equivalent to a carbon price of about $450/MTCO2e (based on substitution for coal). That incentive level was far higher than any existing or contemplated carbon price, but it was financed by a modest surcharge on consumer electricity bills initially amounting to only 0.56¢/kWh, or 3% of household electricity costs, which is roughly equivalent to a $5.60/MTCO2e carbon price. That was possible because renewables at the time comprised only a small fraction of Germany’s energy market, the financing costs were distributed over a large ratepayer base, and the surcharge revenue was used for the sole purpose of financing renewable energy.
Germany’s FIT program catalyzed rapid capacity expansion and cost reductions in renewables to the point where unsubsidized wind and PV are now the least costly utility power sources and are expected to continue dropping in price until 2030. A similar approach could be used by California state and local jurisdictions to support other nascent renewable energy technologies such as green hydrogen, green cement, green steel, and sustainable aviation fuel.
CARB currently has very little investment in these types of foundational technologies, and its GGRF investments are too diverse and fragmented to have the kind of broad-scale commercial impact that Germany’s FIT did. Jurisdictions with Climate Action Plans targeting net-zero emissions by 2035 will need to rely primarily on mature commercial technologies for near-term decarbonization, but multiple jurisdictions could pool their resources to provide support for emerging technologies, e.g., via equity investments.
With effective regulatory incentives …, the new, renewable economy will create monumental investment opportunities … .
The cost of accelerated decarbonization could be quite high, but Climate Action Plans could leverage the high investment potential of clean energy for the benefit of tax payers and utility ratepayers. (Case in point: If the U.S. Department of Energy had taken equity for the half-billion dollars it loaned Tesla in 2010, its shares would now be worth over $100 billion.) With effective regulatory incentives such as Germany’s FIT, the new, renewable economy will create monumental investment opportunities, and first movers in the clean energy transition could reap substantial “green dividends” (in more than one sense) from their early investments.
A 100%-renewable energy economy is doable, and we know how to do it. (Australia is even taking the first steps toward a “2700%-renewable” economy — no exaggeration.) But rather than relying entirely on federal and state governments to provide leadership on climate action, much more might be accomplished more quickly through state support and coordination of regional Climate Action Plans, which would channel and focus communities’, corporations’, and individuals’ collective resources toward building their own local economies and renewable energy infrastructure.
