An “Additional” Challenge to California’s GHG Cap-and-Trade Regime

April 12, 2012

In the latest swipe at California’s greenhouse gas (GHG) cap-and-trade program (hereinafter “carbon market”), on March 28, 2012, two environmental groups filed suit specifically challenging the compliance eligibility of emission reduction offset credits issued to certified offset projects (stand-alone projects that reduce GHG emissions that would not have otherwise occurred) under California’s Global Warming Solutions Act of 2006 (AB 32). California’s Air Resources Board (ARB), the entity charged with implementing AB 32, to date has approved four protocols governing offset credits that market participants can purchase, involving livestock, ozone-depleting substances (ODS) and forestry. Once the emissions reductions from an offset project are verified, ARB will issue offset credits that can be traded and ultimately used by a regulated entity for compliance with its GHG budget cap.

This new case, Citizens Climate Lobby and Our Children’s Earth Foundation v. California Air Resources Board, is the first to raise front and center whether reductions achieved through the ARB protocols will produce reductions “additional” to those that would otherwise occur. Under AB 32, emissions reductions achieved in ARB’s climate market must be in addition to those that would otherwise have occurred, either as a result of market forces or as required by a different legal obligation.

If the plaintiffs prevail, California’s regulated entities (initially electric utilities, refineries and large industrial facilities) would not be able to use ARB-approved offsets to meet their compliance obligations. These entities instead would have to rely on meeting their compliance period emissions limit or hope for excess emission allowances to be available from other regulated entities.

The first legal issue the court will likely consider is whether plaintiffs’ claims can be assessed before the first offset project is formally verified and an offset credit is issued by ARB and any compliance or regulated entity attempts to use offset credits for compliance purposes by retiring them. The court could conclude that evaluating the substantive challenge is premature and that any “additionality” challenge must wait for the initial compliance period to commence on Jan. 1, 2013. If and when a court addresses the substantive challenge, the main legal issue will be whether ARB acted outside the authority it was delegated by AB 32 in establishing the offsets program and its associated protocols and whether those protocols produce reductions that are additional. Given the complexity and novelty of this nascent area of environmental regulation, the court may show significant deference to ARB’s program.

The first auction for emissions allowances is scheduled for this November. If offsets are severed from California’s climate market, there is little doubt that compliance and transaction costs will increase, but we must wait to see by what degree. The California market is already self-constrained in terms of compliance products. As recently as this week, Mary Nichols, chair of the ARB, stated that California will never have a big offsets market and will have an especially small number of international offsets being available. These statements come on top of existing challenges with overall emission reduction goals. In December a federal district judge rejected the state’s low carbon fuel standard for the transportation sector, which was eyed as achieving approximately a quarter of overall emission reductions by 2020.

An adverse outcome on this new offsets litigation would also likely hurt the chances that other states will reconsider adopting climate markets like California’s, particularly before the economy fully rebounds and further empirical evidence is available on the cost and success of California’s program. With seven months remaining, we expect additional challenges to California’s cap-and-trade program to arise before the first allowance is auctioned off. Observers should also recall that the California Court of Appeal is currently presiding over a case that was initially filed in 2009 that concerns whether ARB’s AB 32 plan of implementation (the Scoping Plan) complies with the California Environmental Quality Act. It is likely that litigation will be ongoing leading up to November’s auction, and challengers will likely ask the judiciary to stay the onset of the program.