The Californian emissions trading scheme commences on 1 January 2013 and will rival the EU ETS as the largest trading scheme in the world.

California has conducted its first auction of greenhouse gas pollution credits for its emissions trading scheme (ETS) which commences from 1 January 2013.

This is significant for two reasons. First, as the world's eighth largest economy, the Californian ETS has the potential to rival, if not exceed, the EU ETS as the largest trading scheme in the world.

Secondly, the Australian Government has already reached out to Californian authorities to commence high-level discussions on possible linking of the Australian Carbon Price Mechanism (CPM) to the Californian ETS, so what happens there may have implications for the Australian scheme as well as offset projects under the Carbon Farming Initiative (CFI).

The Californian auction of greenhouse gas pollution credits

Last week, the Californian Air Resources Board (CARB) conducted an auction of credits to be used by companies to meet their liability under the ETS in relation to the emission of certain greenhouse gases. The auction preceded notwithstanding a last minute law suit filed by the Californian Chamber of Commerce (CCC).

The Global Warming Solutions Act of 2006 (Assembly Bill 32 or "AB32") requires California to reduce its emissions to 1990 levels by 2020. CARB was established as the agency responsible to develop and implement the State's plan to reach that target. CARB developed the AB32 Scoping Plan which included among its strategies the establishment of a cap and trade style ETS. Since the making of the plan, various legal challenges and obstacles have been thrown up in an attempt to stop the commencement of the ETS. Significant administrative effort by CARB has also gone into designing the ETS.

The Californian emissions trading scheme

The Californian ETS will commence from 1 January next year, and shares many similar design elements to the CPM. The essential elements of the Californian ETS include:

  • It is based on a cap and trade design, which limits the emissions from covered sectors by putting a cap on the number of credits available, which will be either issued for free or auctioned;
  • The scheme initially covers large stationary sources that emit above 25kt CO2 in the energy and industrial sectors;
  • from 2015, the scheme will expand to include transportation and other fuels;
  • the initial cap is set at 2% below 2012 forecast emissions, reducing annually by 3% from 2015;
  • the scheme comprises three compliance periods. The first operates for two years and involves the free allocation of permits, and the second and third periods, each running for three years until 2020, require reductions to 50% and 30% respectively depending on sectors. Those industries considered "high leakage" (or what are described in Australia as emissions intensive and trade exposed) will continue to receive close to 100% free allocations;
  • additional allowances can be purchased at auction for a floor price of US$10, increasing 5% pa + CPI. Advance auctions of future vintage credits will also occur;
  • a reserve of credits from each period will be retained, and released to the market if predetermined trigger prices are reached, acting like a price cap;
  • eligible offsets can be used to meet up to 8% of obligations. Offsets are predominantly domestic although CARB does have the power to approve use of offset credits issued by a linked regulatory scheme. This raises the potential for offsets created under the CFI to be sold into the Californian market if approved by CARB;
  • given the likely limited availability of offsets, and the high marginal abatement costs for generators to reduce emissions, it is estimated that eligible offsets will trade between US$12-27 in 2013, and between US$60-131 in 2020; and
  • of concern is that CARB has power to invalidate offsets. This represents a potential risk in offset transactions.

California is part of the Western Climate Initiative (WCI) which was launched in 2007. The WCI is essentially a collection of ETSs established at the sub-national level. The purpose of the WCI is to encourage member provinces to adopt consistent rules to enable linking, and therefore provide broader opportunities for least cost abatement. At this time only California and Quebec in Canada have adopted cap and trade regulations, and negotiations are still continuing to link the two schemes.

The Californian scheme covers approximately 350 industrial businesses operating a total of 600 facilities throughout California. Emissions from all electricity "imported" into California from other US States will also attract a compliance obligation under the scheme if the source of the electricity exceeds the prescribed threshold.

The auctions under the scheme are to be held quarterly, and are expected to generate about $1 billion for the State in their first year. Last week's auction achieved a clearance price of US$10.09, reportedly raising more US$300m. The CCC in its law suit commenced the day before the auction has challenged the authority of the State to raise revenue from the sale of credits, over and above the cost to the State of operating the scheme.

As the eight largest economy in the world, California has the potential to spur activity in the international carbon market. In addition to providing a new compliance market, as well as demand for offset credits, the Californian ETS will introduce some much needed balance to the international market which is presently dominated by the EU ETS, and its economic travails.