Q2 was a busy one for carbon markets. On the international front, talks to develop the Paris Rulebook advanced, but progress was slower than hoped. Ontario announced withdrawal from the Western Climate Initiative, while Canada’s federal government advanced plans for a nationwide price on carbon, setting up a potential showdown. Mexico also took steps to further its carbon market. Numerous U.S. states are considering additional carbon pricing programs in the wake of federal inaction, while a few under-the-radar developments could impact both federal and state climate policies.

United States

States Continue to Advance Carbon Pricing Strategies

With the federal government unlikely to act to meaningfully regulate greenhouse gas (“GHG”) emissions during the Trump administration—which has announced its intention to withdraw from the Paris Agreement—states and major cities have increased their own efforts to regulate and reduce GHG emissions. On June 1, the U.S. Climate Alliance announced new efforts to “meet their share of the Paris Agreement emissions targets by 2025.” The U.S. Climate Alliance is comprised of 17 states, whose governors have all committed to taking additional steps to reduce GHG emissions through a variety of state-level and coordinated efforts, such as advancing renewable energy and reducing emissions of potent GHGs, such as HFCs.

Numerous states also are considering new legislation aimed at reducing GHG emissions. Many of those bills take the form of carbon tax proposals, which are viewed as easier to implement and more readily applied to the transportation sector. About 30 carbon tax bills are pending in at least 10 statehouses around the country, largely in the northeast and northwest. Since carbon taxes are largely new territory for state legislators, proposals vary widely in their scope, level of taxation, and in designating how the resulting revenue must be spent. Where many of these proposals will end up is uncertain, as many of the states in which they are pending also are considering other GHG-related strategies, such as offshore wind generation (in the northeast) and cap and trade programs (in the northwest). But certain states, such as Massachusetts, seem increasingly likely to enact a carbon tax as they reach the limit of GHG reductions from the power sector and look for ways to achieve GHG reductions from other sectors, such as transportation.

RGGI Turns 40 (Sort Of)

The Regional Greenhouse Gas Initiative (RGGI) announced the results of its 40th auction on June 15, 2018. The auction saw 13,771,025 CO2 allowances sold at a clearing price of $4.02, representing a slight uptick in both volume and price from the prior auction. As we previously reported, recent RGGI reforms will tighten emissions targets through 2030 and provide a mechanism to allow states with draw surplus allowances from auctions, both of which may bolster prices in coming years. As noted above, many states are stepping up climate change regulatory actions in the absence of much action at the federal level. For RGGI, this means continued movement by Virginia and New Jersey to join (or, in NJ’s case, rejoin) the program.

In January, the newly elected Governor of New Jersey, Phil Murphy, signed an executive directing executive agencies to begin the process of rejoining RGGI. Rulemaking in NJ is underway, and the New Jersey Department of Environmental Protection currently anticipates rejoining RGGI in time to participate in the first quarterly auction of 2020. New Jersey’s Global Warming Solutions Fund Act authorizes the New Jersey to implement a market-based CO2 emissions trading program (i.e., RGGI) and directs how proceeds from the auctions must be used. In particular, the law directs 60% of auction revenue to be spent on programs supporting energy efficiency and the development of offshore wind—another current initiative of Governor Murphy. New Jersey’s re-entry into RGGI will mean continued funding for those programs.

Virginia also is well along the path to join RGGI. On April 9, the nine current RGGI member states submitted comments on the compatibility of Virginia’s proposed regulation with the RGGI states’ existing 2017 Model Rule. Under the Model Rule (which governs RGGI), a RGGI Participating State must have established a CO2 Budget Trading Program regulation that conforms to certain parameters, both to protect the integrity of the market and ensure fungibility of allowances across RGGI states. RGGI’s comments focused on conforming certain definitions, the treatment of offsets, trigger and reserve prices, and the retirement of unsold allowances. The comments also sought clarity on applicability of the program. It is widely expected that the final Virginia regulation will conform to the Model Rule and be approved by RGGI member states, with Virginia likely entering RGGI by 2020.

Will The Washington State Supreme Court Resurrect Cap and Trade?

In April 2018, a Washington trial court invalidated the Department of Ecology’s (Ecology’s) Clean Air Rule. The rule would have capped GHG emissions attributed to larger stationary sources and to petroleum producers and importers and natural gas distributors, which the court referred to as “indirect emitters” that could not be regulated by Ecology under the authority granted by the state Clean Air Act. Ecology and intervenor-environmental groups have sought a direct appeal of the decision to the Washington Supreme Court.

A related federal court challenge to the Clean Air Rule in the Eastern District of the U.S. District Court of Washington, which is based on alleged constitutional issues with the rule, has been stayed since October 2016 while the state court litigation has played out. Recently, Ecology sought to lift the stay, arguing that the pending federal case would create uncertainty over the future of the rule even if the Washington Supreme Court were to decide in Ecology’s favor. On a motion by the rule challengers, the court decided to continue to hold the case in abeyance at least until “final adjudication of the Washington Supreme Court decision.”

Even if the Clean Air Rule cannot be resurrected, actions are still being taken in Washington to reduce GHG emissions. Ecology finalized updates to GHG emissions standards for fossil-fueled power plants in February 2018. See Chapter 173-407 WAC – Greenhouse Gas Mitigation Requirements and Emissions Performance Standard for Power Plants. And a coalition of interest groups is seeking to add a carbon tax initiative (No. 1631; the Protect Washington Act) to the ballot this fall. On July 2, 2018, initiative supporters submitted a reported 380,000 signatures to the Washington Secretary of State, likely more than enough to place the measure on the ballot.

Update on the Oregon Clean Fuels Program

Oregon adopted a Clean Fuels Program to reduce the state’s contribution to GHG emissions from transportation fuels. Oregon’s Program is modeled, in part, after California’s low carbon fuel standard (LCFS) regulations. It establishes annual, average carbon-intensity standards for fuels sold for use in the state—standards that become more stringent over time. These standards account for GHG emissions from all stages of a fuel’s lifecycle, including production, transportation, distribution and consumption.

The Program was challenged in court by trade associations representing petroleum refining, petrochemical manufacturing, trucking, and other transportation fuel interests. These parties allege that Oregon’s Program discriminates against out-of-state petroleum fuels and ethanols in violation of the dormant Commerce Clause, unconstitutionally regulates extraterritorially, and is preempted by the EPA’s Reformulated Gasoline Rule. The district court dismissed these claims, and an appeal to the Ninth Circuit followed. See American Fuel & Petrochemical Manufacturers, et al. v. O'Keeffe et al., No. 15-35834. A Ninth Circuit panel held oral argument on March 6; a decision is pending.

A key issue for the Ninth Circuit to determine is whether the challenges to the Oregon Program should fail, because they are not meaningfully distinct from claims the Ninth Circuit resolved previously in connection with California’s Low Carbon Fuel Standard (LCFS), on which Oregon’s Program is modeled. See Rocky Mountain Farmers Union v. Corey, 730 F.3d 1070 (9th Cir. 2013). Notably, the U.S. Supreme Court declined to review the decision in Rocky Mountain.

On the regulatory side, the Oregon Department of Environmental Quality (DEQ) is in the initial stages of evaluating proposed changes to the Program to: (1) develop mechanisms to incorporate verification into various parts of the Program; (2) update the models used to determine the carbon intensities of fuels; and (3) consider including additional sources of credit generation in the program. DEQ held advisory committee meetings on February 1 and June 28. DEQ is expected to release proposed changes for public comment in late August. We currently expect DEQ to propose several options for additional credit generation. For example, DEQ will likely add alternative fueled forklifts and truck refrigeration units (TRU) as eligible sources of credit generation under the Program. If adopted, the eligible credit generator will be the forklift fleet operator or the operator of the electric truck refrigeration unit. DEQ is also considering adding alternative jet fuel as an opt-in fuel to the Clean Fuels Program. Alternative jet fuel is produced in a similar process to renewable diesel.

EPA Declares Biomass Carbon Neutral

On April 23, 2018, EPA Administrator, Scott Pruitt, announced that the agency will treat biomass from “managed forests” as carbon neutral. He described the move as a way to increase the “economic potential” of U.S. forests and increase the nation’s “energy dominance. This announcement followed provisions in the 2018 Consolidated Appropriations Act directing multiple agency heads to adopt policies reflecting the carbon neutrality of forest bioenergy and recognizing biomass as a renewable energy source.

EPA’s move follows years of debate over how to properly account for emissions produced when burning biomass. The announcement also largely ignores EPA’s Science Advisory Board, which has struggled for years to create an accounting framework for biomass emissions. Some environmental groups and scientists argue that while biomass is technically “renewable,” some forms of biomass are renewable only over long time horizons (i.e., sufficient time for replacement trees to sequester the same amount of carbon that their predecessors contained when they were harvested and burned). Currently, much of the wood raised and harvested for energy purposes in the United States is exported to the European Union. In Germany, for example, biomass is treated as a carbon neutral energy source and is burned in power plants in order to comply with the Kyoto Protocol and Germany’s goal of reducing GHG emissions by 80-95% by 2050. U.S. science and environmental groups have objected to this biomass export as a net increase in global GHG emissions.

Nevertheless, using biomass as an energy source can provide GHG benefits when derived from certain sources, such as waste residuals from product mills. Indeed, in the forest products industry, energy created from biomass residuals is integral to the manufacture of products such as pulp and paper. The impact of EPA’s recent policy announcement remains to be seen, but it could have implications in the context of GHG permitting. Significant impacts on existing carbon markets is unlikely because they are managed at the state level. However, the newly-announced carbon neutrality of biomass is likely to feature in any future move to replace the Clean Power Plan or establish a federal price on carbon emissions.

Canada and Mexico

Canada Adopts the Greenhouse Gas Pollution Pricing Act

On June 14, Canada’s Senate passed the government’s proposed budget bill, which contained the federal carbon pricing scheme initially proposed earlier this year. As a result, the Greenhouse Gas Pollution Pricing Act (which was included as Part 5 of the budget bill) will become law, establishing a national carbon price regime that will apply in provinces and territories that lack an equivalent carbon tax or cap-and-trade policy. The new law will set a price on GHG emissions of $10 per ton beginning in January 1, 2019. That price will rise to $50/ton by 2022. The tax will apply to fossil fuels used in transportation, heating, electricity, manufacturing, and other industries. The tax will be paid by fuel producers, distributors, and importers, but likely passed on to businesses and consumers purchasing the fuel.

Part 2 of the bill further establishes a regime governing Industrial Greenhouse Gas Emissions that applies to certain covered facilities and sets emissions limits for those facilities. Covered facilities must register, report GHG emissions, and pay “compensation” to the government for any GHG emissions above the GHG emissions limit established for that facility during each compliance period. The “compensation” may take the form of a compliance unit or an excess emissions charge. This allows provinces to establish a cap-and-trade programs, or simply set a cap and implement a tax above the cap. The bill also grants certain powers to the federal government to establish a registry system for issuing, transferring, and retiring compliance units. Finally, provisions are made for the implementation of a system for creating and using GHG offset credits as part of the compliance program.

Provinces have until the end of 2018 to submit carbon pricing plans or become subject to the new law. Right now, Alberta, British Columbia, Quebec, and Ontario (but perhaps not for long—see below) have carbon pricing schemes and a few other provinces are considering them. The Greenhouse Gas Pollution Pricing Act is extensive, and its implementing regulations not yet established, but one thing is certain: it paves the way towards a national price on carbon across Canada.

Ontario Withdraws from Western Climate Initiative

Just 18 months after joining the Western Climate Initiative (WCI)—the economy-wide cap and trade program established by California and joined by Quebec—Ontario has announced its withdrawal. The new premier-designate, Doug Ford, made the announcement on June 15, following elections on June 7 in which Doug Ford and the Progressive Conservative Party of Ontario won a majority government in Ontario.

Mr. Ford also announced plans to resist the federal government’s efforts to impose a nationwide carbon tax. Gerry Butts, Prime Minister Justin Trudeau’s principal secretary, suggested via twitter that Mr. Ford’s action has left the province open to lawsuits. Without a price on carbon, Ontario will not be in compliance with the national program, and could face a mandatory price on carbon under the federal Greenhouse Gas Pollution Pricing Act. Initially seen as a backstop to provincial efforts, the national program may end up having a larger impact in Canada in the wake of Ontario’s withdrawal from the WCI. As a result, businesses subject to the tax could end up paying more than they would under the WCI. Right now, GHG allowances trade for about $18 in Ontario, and while the initial carbon tax would be set at $10/ton, that price would quickly rise to $50/ton by 2022.

Following Mr. Ford’s announcement, California and Quebec acted swiftly to close the joint trading market to entities registered in Ontario. While Mr. Ford will not be sworn in until June 30, that move prevents entities holding Ontario allowances from dumping them into the California-Quebec markets, a move that could severely disrupt prices and trading. Over two billion dollars in emissions allowances now hang in limbo while parties await final action on withdrawal and the litigation that is likely to follow. Ultimately, the courts may decide whether Ottawa has the authority to impose its carbon tax, or whether Ontario is right to resist such national efforts.

Mexico Advances Plans for Carbon Market

Mexico, the world’s tenth-largest emitter of GHGs, has moved closer to establishing a cap and trade program. In April, Mexico’s Senate reportedly passed a measure that would pave the way towards a national carbon market, while also aligning Mexico’s GHG targets with its commitments under the Paris Agreement. Mexico also plans to launch a pilot cap and trade program later in 2018. Mexico already has a carbon tax (albeit a relatively low one) and a voluntary carbon market.

Additional International Developments

The Paris Rulebook Advances Slowly; May Miss Goal of Adoption in October, 2018

The Paris Agreement—ratified in 2015—does not contain much in the way of implementation details. Instead, those details are to be included in the “Paris Rulebook” currently under development by the Parties to the Paris Agreement, and slated for adoption at COP24 in Katowice at the end of 2018. Development of the Paris Rulebook is underway in a series of meetings known as the Talanoa Dialogues.

In November, 2017, during two weeks of talks at COP23 in Bonn, the development of the Paris Rulebook progressed slowly, concluding with a mandate for a draft negotiating text to be ready by March, 2018. In particular, discussions regarding Article 6—which sets up market mechanisms and contains provisions for the use of carbon offsets—got off to a positive start but ended on a rocky note, with few decisions about the structure of the trading and offset program. Progress seems similarly sluggish in 2018. The 48th meeting of Subsidiaries Bodies to the UNFCCC (SB48—the first formal meeting since COP23) concluded in Bonn on May 10, 2018, again with little progress towards development of a firm Paris Rulebook. As a result, the parties agreed to meet in Bangkok from August 31 to September 8, 2018. While several parties sought interim meetings to continue development of key aspects of the Paris Rulebook—such as the market based mechanism—there was no agreement to hold any intersessional working sessions. As a result, the parties will head to Bangkok later this summer with little more than a set of “informal notes” (essentially, discussion outlines) of what the Paris Rulebook will contain, potentially setting the stage for continued delays in development. The informal note addressing the Article 6.2 cooperative market mechanism is available here, while the informal note addressing the Article 6.4 offset mechanism is available here.

The Carbon Offsetting and Reduction Scheme for International Aviation Advances

The Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) saw continued development during the first half of 2018. Established by the International Civil Aviation Organization (ICAO) by Assembly Resolution A39-3, and joined by most counties, CORSIA is aimed at achieving carbon-neutral growth in international aviation from 2020 onwards. To accomplish this, CORSIA establishes a “basket of measures” that includes lower-carbon fuels (such as biofuels) and a market-based emissions offsetting mechanism.

ICAO is in the process of developing rules to implement the offset program and other aspects of CORSIA. In December, 2017, ICAO released its draft Standards and Recommended Practices (“SARPs”) for CORSIA. And in June, 2018, ICAO adopted a revised version of those SARPS, which will be effective beginning on January 1, 2019. The SARPS, which are contained within Annex 16 of the Chicago Convention (an international civil aviation treaty), describe parameters for monitoring, reporting, and verifying GHG emissions (known as CORSIA’s “MRV scheme”), which certain airlines governed by CORSIA will need to begin doing in 2019. Notably, ICAO included “lower carbon conventional fuels” within these carbon accounting rules, which will allow certain fossil fuels to be recognized under CORSIA if they meet certain criteria, including a 10% (or greater) reduction in lifecycle GHG emissions. That move paves the way for perhaps more accurate overall carbon accounting (that takes into account the carbon intensity of fossil fuels, which varies by source and location), but some environmental groups have criticized the move.

Additional rules and details of CORSIA remain under development, including the ground rules for how CORSIA will interact with the market based mechanism established by the Paris Agreement, and the approval of offset programs for eligibility under CORSIA. ICAO will need to work quickly to ensure that all CORSIA program rules are complete and adopted before key milestones, such as emissions reporting beginning in 2019 and initial offsetting obligations beginning in 2021.

European Union Carbon Prices Reach Recent Highs but Face Headwinds

Prices for emissions allowances on the European Union Emissions Trading System (EU ETS) reached a 7-year high this year, consistently trading above €12 in Q2 and briefly clearing €16. As of publication, prices are in the mid-€14 range, as compared with about €5 at this time last year. But the party may not last long. Despite recent reforms to the EU ETS, including plans to raise its 2030 targets and measures to curb an over-supply of allowances and offsets, some analysts have cut their EU carbon price forecasts over concerns that the recent reform measures will be insufficient to address the forecast oversupply in the EU ETS.

International Maritime Organization Adopts Climate Strategy for Shipping

The UN’s International Maritime Organization (IMO) adopted an initial climate change strategy for shipping in April, 2018. Shipping emissions are not included in the Paris Agreement, and the IMO sought to fill that gap by adopting a strategy aimed at the goal of reducing GHG emissions from shipping by 50% (from a 2008 baseline) by 2050. While the strategy describes general parameters and goals, details have yet to be worked out. The strategy calls for the development of short-term measures during 2018-2023; mid-term measures during 2023-2030, and long term measures beyond 2030. Increased use of low and zero-carbon fuels are one central focus of the strategy. Notably, the strategy’s discussion of mid-term measures also calls for consideration of market-based measures “to incentivize GHG emission reduction.” Discussion of appropriate market-based measures has been ongoing since 2011, and the initial strategy reaffirms those potential measures, which include (among other things) financing adaptation and mitigation in developing countries and the use of carbon offsets to achieve emissions reduction goals. The full text of IMO’s initial strategy is available here.