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A carbon market provides three elements to support the development of a clean energy economy:

 -  Declining cap on greenhouse gas (GHG) emissions

 -  Price on GHG emissions

 -  Trading gets environmental results at the lowest cost

The cap-and-trade regulation is projected to achieve about 20 percent of the total reductions needed to meet the AB 32 target.

?Frequently Asked Questions

Cap-and-Trade Program 101:

What are the goals of AB 32?

The primary goal of Assembly Bill (AB) 32 is reduction of greenhouse gases emitted in California.

Greenhouse gases include carbon dioxide, methane, nitrous oxide, ozone and others. These are gases that can trap heat in earth’s atmosphere, raising the overall temperature.

That global warming affects weather, crop patterns, migration patterns, raises sea levels and turns the Earth’s oceans acid. In short, those emissions threaten Californians’ health and financial stability by creating conditions for drought and other extreme weather, more severe wildfires, a less stable and secure food supply and large shifts in population.

AB 32 focuses on carbon dioxide because it is 90 percent of the excess greenhouse gas in the atmosphere.

AB 32 makes the Air Resources Board responsible for developing, implementing and enforcing specific regulations to protect California’s environment from greenhouse gases and to drive the state’s economy toward a low-carbon future to ensure reductions are permanent.

What do Californians gain from cap-and-trade?

Cap-and-trade provides real reductions in greenhouse gas emissions.

Cap-and-trade is gradual. There should be no unexpected economic shocks as reductions take effect.

Cap-and-trade will reduce reliance on foreign oil.

Cap-and-trade will drive development of new technology.

Cap-and-trade will drive development of new businesses and jobs.

What is cap-and-trade?

Cap-and-trade is a market-based approach to pollution control. The program makes industry a partner in controlling climate change. The carbon market is created this way: An upper limit or “cap” on greenhouse gas emissions is established for certain industrial sources, such as power plants and oil refineries. Emission allowances equal to the total amount of allowable emissions are distributed to the regulated sources. Businesses under the emissions cap are allowed to trade allowances. Supply and demand for these allowances determine their price.

Businesses that face higher pollution control costs have an incentive to reduce their compliance burden by purchasing additional allowances. Those that face lower pollution control costs have an incentive to reduce more emissions and sell their excess allowances.

Over time, the cap declines and fewer allowances are issued until the emissions reduction goal is met.

Why cap-and-trade?

Traditional, source-specific pollution controls such as vehicle emissions standards cannot adequately cover the full range of carbon emissions in our economy. A cap-and-trade system fills the gaps by putting an economy-wide “cap” on carbon emissions.

In addition to cutting down pollution, the cap-and-trade approach accelerates investment and development in cleaner energy technologies. It puts a price on carbon, making it a cost of doing business, and sending a clear signal that investment in carbon-reducing technologies will be financially rewarded.

A cap-and-trade system also gives companies the flexibility and financial incentive to reduce emissions in the most cost-effective way they can find – say, by switching to cleaner fuels or more efficient equipment – rather than being told what type of pollution control to install.

How does California’s cap work?

The California program places a cap, or ceiling on greenhouse gas emissions effective January 01, 2013. The cap is lowered by two to three percent each year through 2020 for a total statewide greenhouse gas reduction from industry of about 15 percent.

The cap first covers nearly 600 industrial facilities (refineries, cement plants, food processors, etc.) and investor owned electricity generators (PG&E, Southern California Edison, etc.). These facilities are responsible for nearly 85 percent of the greenhouse gas emissions in California. Each regulated facility emits more than 25,000 tons of carbon dioxide a year. In 2015, the cap will cover transportation fuels, as well.

How does California’s carbon trading work?

Each of California’s covered facilities must annually report its emissions to the Air Resources Board. Based on those reports, each facility must supply carbon allowances equal to the emissions it will generate that year. Each allowance is worth one ton of carbon dioxide.

In the early years of the program many of those allowances will be issued free of charge, but some must be purchased at a minimum price of 10 dollars each.

As the cap comes down, there will be fewer free allowances.

This puts a price on carbon, making it emitting it a cost of doing business.

More efficient facilities will have a surplus of allowances which they can sell to less efficient facilities.

The Air Resources Board will sell additional allowances at quarterly auctions to help facilities cover their shortfalls.

Each allowance can be used only once.

How are allowance prices set?

California Carbon Allowances are sold at auction where bids establish the market price. The Air Resources Board sets a floor price, below which allowance prices cannot fall. Bids presented above that price will then determine actual sale prices. Bids must be submitted 12 days before each auction, and a bid guarantee (collateral) must be posted and verified.

The Air Resources Board will also establish an allowance reserve in which a certain number of allowances are set aside for sale to regulated businesses at a fixed ceiling price to avoid price spikes which might threaten compliance.

How does emissions reporting work?

ARB has a very clear idea how much carbon dioxide is being emitted by each facility thanks to a rigorous reporting program that has been in place since 2008.

Reports from each facility are verified by independent third party professionals and posted on ARB’s website.

As a result, ARB knows the annual emissions from each facility to a very high level of accuracy.

How are utilities affected?

Investor-owned utilities are covered by cap-and-trade. They are issued all allowances free. They must then sell them at the Air Resources Board auctions and return the value of those sales to their customers. A utility might return allowance value by covering the cost difference between some higher priced renewable energy sources and conventional sources; provide new energy saving programs to customers or even supply rebates to cover possible rate increases. The California Public Utilities Commission will determine which methods are acceptable.

How does cap-and-trade reduce emissions?

The cap-and-trade regulations do not tell businesses how they must reduce emissions, just that they must present an allowance for each ton of carbon they emit. This allows the businesses to include the reductions in their planning, just like they do fuel, water and payroll to determine what is most cost-effective for them.

Owners of covered facilities must decide whether to pay for allowances and offsets, or invest in efficiency. Over the course of the program allowance cost is expected to send a market price signal that makes actual reductions more cost effective than use of allowance or offsets.

Additional Information:

How do covered facilities comply with cap-and-trade?

Cap-and-trade compliance periods are 2013-14, 2015-17 and 2018-20. Facilities must account for a minimum 30 percent of required reductions in each year of a compliance period. They must reconcile 100 percent by the end of the compliance period. Each year’s allowances are referred to as a vintage, and several vintages are sold at each auction.

Facilities may bank those allowances for use anytime between purchase and the end of the vintage year to achieve the most cost-effective reductions.

What are allowances and offsets?

An allowance is issued by the Air Resources Board and allows a facility to emit one ton of carbon dioxide, for a price.

An offset is sold by a private party to a company wishing to reduce emissions at their facility by reducing actual carbon dioxide emissions somewhere outside sectors covered by the cap. Offset reductions are carefully measured and tracked by third party verifiers using protocols, or rigorous approaches to measuring and accounting for the carbon involved in the projects that generate offsets.

The Air Resources Board has approved protocols for four types of offsets: forestry, urban forestry, livestock projects (manure destruction) and destruction of ozone depleting substances, such as refrigerants.

Offsets may be used to cover up to eight percent of a covered party’s compliance requirement.

How does an allowance auction work?

The Air Resources Board holds auctions every quarter in conjunction with the Canadian Province of Quebec starting in November 2012.

These linked auctions are entirely electronic. Anybody participating (covered companies and facilities, their representatives, third party brokers, etc.) must register with the auction operators 30 days before the auction. This registration establishes the accounts in which purchased allowances will be placed following the auction. Participants must then submit sealed bids 12 days before the auction.

Participants who have compliance obligations under cap-and-trade receive priority.

Allowances are sold in lots of 1,000 equal to 1,000 metric tons of carbon dioxide.

Bids are opened the day of the auction and the high bidder will receive their full allotment of allowances; the second highest bidder will then receive theirs, and so on until all orders are filled or all allowances are sold. The price of all allowances is set by the lowest price submitted above the floor price before any shortfall develops.

If the supply of allowances is seriously depleted and there are still unfilled orders, the remaining allowance lots will be broken up and the remaining bidders will receive a percentage of their request based on bid price.

Who tracks the market and runs the auction?

All potential auction bidders must register in the Compliance Instrument Tracking System Service (CITSS, pronounced kits). CITSS allows registered parties to establish their allowance accounts, and collects registration information similar to that required by banks and commodities exchanges.

CITSS can then track all auction transactions and the resale and trading of allowances after the auctions. There can be no legitimate allowance transactions without CITSS registration.

CITSS allows three kinds of accounts: (Graphic goes here)

• Compliance Accounts are used by regulated companies to collect and bank the allowances required to reach their emissions reduction obligations under cap-and-trade.

• Holding Accounts which allow regulated companies to bank a limited number of allowances for resale, trade of later use.

General Accounts are available to third party representatives, brokers and investors. These accounts are also subject to a holding limit. The auction is run by a contractor hired by ARB (Markit North America). This contractor has experience with auctions in the energy market.

Markit North America works with the contracted financial services provider (Deutsche Bank) and gathers information from the Compliance Instrument Tracking System Service for market purposes.

What keeps the auction secure?

The CITSS registration and tracking system gives the Air Resources Board and auction operator the means to follow every trade and transaction, as well as monitor the status of all auction accounts holding limits ensure no one party can assemble enough extra allowances to “corner the market”.

The carbon market will also be watched by trained market monitors and by federal market regulatory agencies, including the Commodities Futures Trading Commission and the Securities and Exchange Commission.

Is California ‘going it alone’ on cap-and-trade?

No. AB 32 directs the Air Resources Board to “facilitate the development of integrated and cost-effective regional, national and international greenhouse gas reduction programs.”

California has been coordinating its climate policies with those of six other western states and four Canadian provinces to make it easier to link and form a larger emissions trading market. The Province of Quebec adopted a cap-and-trade regulation similar to California’s.

Though the California market alone is large enough to have a successful carbon-trading program, enlarging the market lowers industries’ cost of compliance across the board.

California continues to reach out to other U.S. states. When Congress is ready to address the growing danger of climate change, California’s cap-and-trade system will serve as a model for a national program.

What is the Western Climate Initiative?

California is a founding member of the Western Climate Initiative, a group of governments exploring ways to reduce greenhouse gas emissions. At this time the Western Climate Initiative includes California, Quebec, British Columbia, Manitoba and Ontario.

All these jurisdictions are considering the cap-and-trade program, but California and Quebec are the first to have regulations in place. ARB is also in consultation with several western states on future emissions reduction efforts.

What is WCI, Inc.?

The Western Climate Initiative partners have incorporated a non-profit organization to establish and administer the mechanics of a multi-jurisdictional cap-and-trade program.

WCI, Inc. has no policy authority and exists solely to act as an administrative liaison between partners and manage contractors who run auctions and monitor the market.

WCI, Inc. is valuable tool as the Western Climate Initiative cap-and-trade program expands.