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Calif. cap-and-trade extension could reverberate to other regions

In the absence of federal climate legislation, California's recent move to extend the state's cap-and-trade program for greenhouse gas emissions could prove to be a model for other states and regions in their efforts to reduce emissions.

At the end of July, California Gov. Jerry Brown signed into law a package of climate bills that lengthen the state's cap-and-trade program another ten years. The program's legal authority expires after 2020.

The extension of California's cap-and-trade program solidifies the state's leadership on the climate front and could serve as a model for other states around the country, Allan Marks, partner at Milbank, Tweed, Hadley & McCloy and a member of the firm's Project, Energy and Infrastructure Finance Group, said in a July 31 phone interview.

A.B. 398 extends the California Air Resources Board's, or CARB's, cap-and-trade authority and requires the board to set a price ceiling on emission allowances. The measure also provides for additional tonnes of allowances to be offered to covered entities if the allowance price containment reserve is exhausted and establishes price containment points or "speed bumps," at which the board must offer covered entities nontradable allowances for sale.

Many market observers have indicated that the passage of A.B. 398 will inject confidence into the sometimes shaky California cap-and-trade market.

"The program should have more stability now that it has been extended. [CARB] just adopted some rule changes, and will have to amend the regulation again next year, but the basic structure of the program is retained," Jon Costantino, principal at Tradesman Advisors Inc., said in an Aug. 1 email.

California's cap-and-trade program began in 2012, covering large power and industrial facilities, before broadening coverage in 2015 to include transportation fuels and natural gas. The California cap-and-trade program, which currently caps 85% of the state's total emissions, was linked in 2014 with Quebec's market under the Western Climate Initiative.

Under the program in California, the CARB establishes a declining cap on total statewide emissions and issues allowances to polluters that are traded in quarterly auctions. The proceeds flow to the Greenhouse Gas Reduction Fund and are allocated through the state's annual budget process.

With all eyes having been on California ahead of the bill's passage, the extension of the cap-and-trade market will likely allow for the sharing of important information with other states and jurisdictions looking to devise their own markets, or possibly join existing markets.

"It goes without saying that IETA's delighted about the passage of [A.B.] 398 and heightened clarity not only for California's market post-2020 but other regions, including Ontario and beyond," Katie Sullivan, managing director for IETA, said in a July 31 email.

The combined California/Quebec market is expected to link to Ontario's new cap-and-trade program in 2018.

"Now that we have clarity on California's future direction, efforts to expand the reach of the linked market can ramp up," Sullivan said previously in a July news release from the IETA. "There is a great opportunity to build a market with sizeable impact — one which can lead to meaningful emissions reductions at a lower cost than if each jurisdiction acted alone."

Several other states and jurisdictions, such as Oregon, Washington, Nova Scotia and Mexico, have displayed interest in sharing information and possibly linking to the California market as well.

"California retains its global leadership with the enactment of A.B. 398. It also paves the way for linkage with Ontario, retains the linkage with Quebec and keeps alive the possibility of linking with Oregon," Costantino said.

Lawmakers in Oregon clamored for the passage of California's cap-and-trade extension bill, saying it was critical to the state's own efforts to introduce a market. In a July 12 letter to Members of the California Assembly and Senate, Oregon Sen. Michael Dembrow and Representative Ken Helm, the chief sponsors of a bill in that state to cap and price emissions, said California was "the anchor of North America's regional carbon trading system" and that "California's leadership to date means smaller states such as ours can more readily and cost-effectively adopt similar systems and link together."

A larger regional cap-and-trade market with additional partners would work to increase liquidity and enhance market price signals for allowances. Better price signals inform trading rules, allocations and allowance levels, Marks added.

But while the recent extension of the cap-and-trade program in California solidifies the state's position at the forefront on climate change, it remains unclear if other states and regions will, in the end, establish links to the state's established market.

"From a policy standpoint, California is reaffirming the use of a market-based approach to reduce greenhouse gas emissions," Jeffrey Fort, partner at Dentons US LLP, said in an Aug. 2 phone interview; however, it is too early to tell if other states might eventually link up with the Golden State.

Fort pointed to the initial size of the Western Climate Initiative when it launched in 2007 with the aim of forming a regional emissions-trading market. By 2009, the collaboration included Arizona, California, Montana, New Mexico, Oregon, Utah and Washington, and the Canadian provinces of British Columbia, Manitoba, Ontario and Quebec. However, since transitioning into the nonprofit corporation Western Climate Initiative Inc., only California, Quebec, Ontario and British Columbia remain as participating jurisdictions.

"How much the California market, which is one of the larger ones in the world now, will impact other states joining, I don't know that that will be the case. Whether [other states] join or not will depend on the governors of the states and the price of carbon reductions that the states are willing to require," Fort said.

"There are a lot of impediments to [forming] a larger market. The tendency will be for some alignment to occur, whether that is in the form of a tradable commodity or a recognized/uniform offset, or something else, is to be determined," Fort said.