On July 17, 2017, California lawmakers passed AB 398, which extends California's cap-and-trade program beyond its current expiration date in 2020, until the end of 2030. A companion bill, AB 617, that was also passed bolsters monitoring, reporting, and control methods for criteria air pollutants and toxic air contaminant emissions. The two-bill legislative package was approved by a bipartisan super majority vote and was signed into law by Governor Brown in late July.  

California's cap-and-trade program, as implemented by the California Air Resources Board ("State Board"), imposes a statewide aggregate greenhouse gas ("GHG") emissions cap on covered entities. Covered entities—large emitters of GHGs—comply with the cap by surrendering compliance instruments in proportion to their annual GHG emissions. Compliance instruments include allowances purchased at public auctions or traded in private markets, free allowances to certain industry participants, and offset credits awarded for certain projects with positive effects on atmospheric GHGs (such as forest management and conservation). The cap-and-trade program has been subject to numerous legal challenges, including most recently a California Chamber of Commerce lawsuit, which unsuccessfully argued that the State Board's sale of emission allowances constitutes an illegal tax because it was not authorized by a two-thirds vote in the California Legislature. The California Supreme Court declined to hear an appeal of this case in late June 2017. AB 398's passage by a super majority vote now insulates the cap-and-trade program from this legal challenge.  

AB 398 extends the State Board's authority to implement California's cap-and-trade program through December 31, 2030, and requires the State Board to continue updating its Climate Change Scoping Plan, which outlines proposed strategies to reduce statewide GHG emissions to 40 percent below 1990 levels by 2030 pursuant to SB 32. The bill directs the State Board to set a price ceiling, price containment points, offset credit compliance limits, and industry assistance factors for cap-and-trade allowance allocation. The price ceiling must consider specified factors, such as the need to avoid an adverse impact on residents and businesses and the potential for environmental and economic leakage, or industry flight from California. Two price containment points will be set below the price ceiling, with non-tradeable allowances offered for sale by the State Board at these price containment points.  

AB 398 also will reduce the use of compliance offset credits and require more qualifying projects to have a direct environmental benefit on California. Offset credits may be used for a total of 4 percent of a regulated entity's compliance obligation from 2021 through 2025 and 6 percent from 2026 through 2030 (down from 8 percent under the current program). Half of the offsets used for compliance from 2021 through 2030 must have a direct environmental benefit in California. AB 398 also directs the State Board to apply a declining cap adjustment factor to industry allocation, which is estimated to reduce the number of free allowances given out by 40 percent by 2030. The bill further provides that money collected by the cap-and-trade program be appropriated in accordance with an expenditure plan. This plan must account for specified priorities, such as low- and zero-carbon transportation alternatives, climate and clean energy research, and sustainable agricultural practices.  

The bill also establishes a new Compliance Offsets Protocol Task Force to provide guidance to the State Board on new offset protocols with direct environmental benefits that prioritize disadvantaged communities, rural and agricultural areas, and Native American or tribal lands. A new Independent Emissions Market Advisory Committee is established to hold a public meeting and report to the State Board and the Joint Legislative Committee on Climate Change Policies on the environmental and economic performance of the cap-and-trade program and other relevant climate policies. The State Board is also directed to develop approaches to increase offset projects and make specified reports to the Legislature.