California’s 2006 Global Warming Solutions Act (AB 32) requires that California’s greenhouse gas (GHG) emission levels be reduced to the 1990 level by the year 2020. To meet this goal, AB 32 instructs the California Public Utilities Commission (CPUC) and the California Energy Commission (CEC) (collectively, the Commissions) to provide recommendations to the California Air Resources Board (CARB) for reducing GHG emissions in the electricity and natural gas sectors.

The Commissions have held workshops, meetings and conferences with various stakeholders and analysts to determine the best strategies for lowering GHG emissions in these industries. Furthermore, the Commissions have retained Energy and Environmental Economics (E3), an energy consulting company, to help them better understand the impact of various policy decisions. The Commissions released an Interim Opinion on potential strategies in March 2008, and released the Proposed Final Opinion on Greenhouse Gas Regulatory Strategies (Proposed Final Opinion) on September 12, 2008. The Proposed Final Opinion offers recommendations to the CARB in draft form. After considering public comments, the Commissions will finalize and adopt the Final Opinion. While the CARB will be responsible for designing the final GHG regulations, the Commissions’ opinions recommend to the CARB a mix of regulatory requirements and a cap-and-trade system to achieve GHG reductions from the electricity and natural gas sectors.

The September 2008 Proposed Final Opinion

Energy Efficiency and Renewable Resources

In the Proposed Final Opinion, the Commissions reaffirm their commitment to energy efficiency as the “cheapest and most effective strategy for reducing GHG emissions” and recommend that the “[C]ARB require comparable investments in energy efficiency from investor-owned and publicly owned utilities.” The Commissions further recommend requiring all retail providers to ensure that 33 percent of the electricity delivered to their customers is generated from renewable sources by 2020. The Commissions maintain that this can be achieved by improving transmission access and system integration, challenges that currently inhibit the growth of renewable generation.

Cap-and-Trade

In the Interim Opinion, the Commissions also recommended the adoption of a market-based cap-and-trade program to help reduce GHG emission levels. Under the recommended cap-and-trade program, First Deliverers, as defined below, would have the option of either reducing their own GHG emissions or purchasing emission allowances from others that have made emission cuts beyond their obligations, so long as the total emissions stay below the cap. The Commissions determined in their Interim Opinion that the point of regulation for the purposes of AB 32 should be the first deliverer of electricity to the California grid (the First Deliverer). This means that for electricity generated in-state, the regulated entity typically would be the power plant owner; for imported electricity, the deliverer typically is the entity that imports the electricity into the state. The Commissions have retained this concept in the Proposed Final Opinion.

In the Proposed Final Opinion, the Commissions added further detail to the proposed cap-and-trade program and addressed the method of allowance distribution. The Commissions recommend that, although the preferred method of distribution is auctioning, initially CARB should distribute some allowances for free to provide time for the electricity sector to adjust to the cap-and-trade program. Therefore, CARB should allocate 80 percent of the allowances in the first year to the First Deliverers based on the proportional historical emissions of that sector during CARB’s baseline, and auction the remaining 20 percent of allowances. The Commissions suggest that over the following five years the percentage of allowances auctioned should increase by 20 percent per year, so that by 2016, 100 percent of allowances will be auctioned. Importantly, the Commissions recommend that the free, administratively allocated allowances distributed in the early years of the cap-and-trade program should only be distributed to those First Deliverers that are also emitting entities. Thus, it appears that under the Commissions’ recommended plan, any First Deliverers that import power into California would be ineligible to receive freely distributed allowances.

All or most of the allowances to be auctioned first would be granted to the electric retail providers on behalf of their consumers. The retail providers then would be required to sell the allowances in an independent, centralized auction and would receive the revenues from the auction. Such revenues would be used to support required investments, as determined by the CPUC, by the investor-owned utilities and the governing boards for publicly owned utilities, in renewables, efficiency, new energy technology, infrastructure development, customer bill relief and other similar programs related to the goals of AB 32. The emitting First Deliverers that reduce the carbon content of the electricity they generate can sell their unused free allowances to other entities in the private market.

Combined Heat and Power

The Proposed Final Opinion recognizes the importance of combined heat and power (CHP) projects as an attractive GHG reduction option. For CHP projects larger than CARB’s minimum size threshold for AB 32 compliance, the Commissions recommend that their emissions be included in a multi-sector cap-and-trade program consistent with other electricity providers.

Compliance Flexibility

Because of the unpredictable nature of emissions and the immense burden emissions reduction places on the regulated industry sectors, the Proposed Final Opinion acknowledges the importance of flexibility in any compliance program. For example, the Proposed Final Opinion recommends a three-year compliance period for a multi-sector cap-and-trade market to allow emitting entities to develop and implement emissions reduction measures. Further recommendations include allowing unlimited participation in the cap-and-trade system, with adequate safeguards to prevent market manipulation and anticompetitive behavior. The Commissions also recommend that no safety valves or price triggers be offered to ensure that the ultimate goal of reducing GHG emissions is met.

Conclusion

The Commissions have received the parties’ comments and will consider them before their meetings on October 16, 2008, at which they will consider adopting the Final Opinion. They anticipate delivering the final opinion to CARB on October 17, 2008.