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California Cap-Trade Faces Increased Risks, Report Says

At the start of next year, California will try to do something that to date has not been done anywhere: include gasoline and diesel fuel sales under its ongoing cap-and-trade emissions trading program that currently only involves power plants, refineries and large industrial complexes. A report released Thursday raises questions about the viability of the effort.

The Western States Petroleum Association (WSPA), which supports market-based approaches to curb emissions, hired an energy attorney at Latham & Watkins LLP to analyze the trading program's structure and vulnerabilities. The result was a nine-page white paper, "Outstanding Design Flaws in California's Cap-and-Trade Program," that calls out five areas that the California Air Resources Board (CARB) needs to address before motor vehicle fuels and natural gas are added to the emissions trading program.

WSPA is using the report to underscore its request that CARB postpone expanding the emissions trading program at the start of next year to correct inherent design flaws in the program.

A CARB spokesperson told NGI Friday that there is no chance state air regulators will postpone adding gasoline, diesel and natural gas to the emissions trading auction next year, and they have not acknowledged any design flaws that the state agency is considering correcting.

Latham & Watkins Partner Jean-Philippe Brisson, co-chair of the law firm's air quality/climate change practice, acknowledges that California's cap-trade program has often been deemed a success, but he thinks it remains basically untested in "certain fundamental respects." It is now scheduled to double in size next year and that is going to "put new pressures on the program."

This added pressure makes it more important that CARB address what Brisson considers inherent design flaws in the three-year-old program that has sold more than 240 million allowances at prices ranging from $10 to $14/allowance in eight previous auctions.

Brisson urges CARB to act quickly on five issues:

  • Limits on numbers of allowances that can be held "squeeze liquidity" from the market;
  • The auctions are too infrequent, meaning companies have relatively few chances to comply with greenhouse gas (GHG) emissions restrictions under CARB's implementation of the state climate change law (AB 32);
  • Brisson alleges the current cap-trade program has "inadequate protections" against price spikes;
  • The three flaws above are made worse by what Brisson called CARB's "draconian and potentially arbitrary enforcement practices" that he thinks disregard "market certainty and rule of law;” and
  • CARB's cap-trade program is inconsistent with pending federal GHG emissions rules.

"California's petroleum industry has long supported well-designed market-based programs to reduce GHG emissions, with an emphasis on 'well-designed'," said Catherine Reheis-Boyd, WSPA president. "The report shows what we fear most: design flaws that open the door for the kind of chaos and price volatility we saw in the disastrous attempt to deregulate our electricity markets in 200-2001."

Reheis-Boyd underscored Brisson's assessment that market design flaws can "lay dormant" for periods of time when there is no stress on the markets, but this is a "false sense of security to industry and regulators."

"When a program comes under pressure because of unforeseen conditions or simply because the program becomes increasingly stringent over time, latent market design flaws can significantly derail an environmental program, undermining both industries' and regulators' investments," Brisson wrote.

Another perspective from industry came at a recent LDC Gas Forum Rockies & the West in Los Angeles, when BP Energy executive Zachary Scott, a Houston-based North American emissions specialist, urged the natural gas industry to embrace CARB's cap-trade program, predicting that it was going to be around for a while.

Some critical deadlines are looming in California, Scott told the forum audience, and none could be bigger than beginning Jan. 1, next year when natural gas and transportation fuels will be added. Acknowledging that AB 32 has withstood numerous court and ballot initiative challenges, Scott said that he thinks the CARB emissions market is not going away. "It is highly likely the market will stay in place."

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