Cap-and-Trade Basics

Cost Effective Greenhouse Gas Emission Reductions

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

Under AB 32, California is required to cut its greenhouse gas (GHG) emissions to 1990 levels by 2020.  As part of this effort, the cap-and-trade program (program) establishes a hard and declining cap on GHGs and a carbon price signal needed to drive long-term investment in cleaner fuels and more efficient uses of energy.  To keep the state within the cap, a total of 360 companies (representing about 600 facilities) responsible for generating 85 percent of GHGs in California will be issued allowances, or permits for each ton of carbon dioxide, methane and other greenhouse gases they emit into the atmosphere.  The program is designed to provide covered entities the flexibility to seek out and implement the lowest-cost options to reduce GHGs. 

The program is divided into two phases: the first, beginning in 2013, will include all major industrial sources along with electricity utilities; the second, starting in 2015, brings in distributors of transportation fuels, natural gas and other fuels.

Why cap emissions?

The cap refers to the limit on GHGs that will be gradually reduced over the next eight years, enabling California to reach the AB 32 target.  The regulation puts a cap on GHGs while providing covered entities flexibility in how they comply.  The enforceable cap on GHGs is the central part of an effective cap-and trade-program and is critical to protect public health and the environment. The cap also serves to provide stability and certainty to the carbon market.  The cap is based on the best available information that included reported facility-specific information collected as part of the mandatory GHG reporting regulation and improved statewide GHG forecasts.

Are there caps on individual facilities?

Regulated entities are not given a facility-level cap (or limit) on their greenhouse gas emissions but must supply a sufficient number of allowances (each the equivalent of one ton of carbon dioxide equivalents) to cover their annual GHGs per compliance period.  As the cap declines each year, the total number of allowances issued in California drops, requiring regulated entities to find the most cost-effective and energy efficient approaches to reducing their GHGs.  The first compliance year when covered sources will have to turn in allowances is 2013.

Is the regulation cost effective?

The cap-and-trade program does not specify how or where GHG reductions will be made.  GHG reductions will be made by regulated entities if the cost of making reductions is less than the cost of acquiring allowances, thereby minimizing price increases.  Furthermore, free allocation to some covered entities at the beginning of the program will assist with transition into the program and reduce the potential for economic leakage. The regulation is also designed with cost-containment mechanisms such as banking of allowances and an allowance price containment reserve.

Can offset credits help reduce compliance costs?

GHG reductions from offset credits can reduce the cost of compliance in a cap-and-trade program because offsets can cost less than GHG reductions made by entities subject to the regulation.  ARB’s recent economic analyses analysis cited the effectiveness of offsets as a cost control mechanism.

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