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State Appeals Court Affirms California's Cap-and-Trade Program

Never far from controversy or criticism during its four-year history, California's market-based, multi-billion-dollar cap-and-trade auction was upheld on a 2-1 vote of a state appellate court in Sacramento on Thursday.

The Court of Appeal of California's Third Appellate District upheld the California Air Resources Board's (CARB) authority to hold carbon emission auctions, rejecting arguments by the California Chamber of Commerce and others that auctioning carbon allowances was in effect an "unlawful tax."

The Chamber and other plaintiffs, such as the Pacific Legal Foundation, could appeal to the California Supreme Court. They told local news media they are considering all their options.

Meanwhile, the appellate ruling was hailed by state officials and two environmental groups that intervened in the case, the Environmental Defense Fund (EDF) and the Natural Resources Defense Council (NRDC).

The state's cap-and-trade program is designed to put firm limits on carbon emissions and create a market for companies to buy and sell emission allowances. Proponents argued that this provides flexibility to businesses on how to comply cost-effectively.

A majority of the appellate court judges went along with an earlier state Superior Court ruling that rejected the opponents' arguments that auction sales exceed the legislature's designation of authority to CARB, and that the revenue generated amounts to a tax violating the state's requirement for a two-thirds super majority of state lawmakers.

The majority of judges concluded CARB had "broad discretion" from the lawmakers, and although they did not agree with the lower court's reasoning they reached the same conclusion that auction sales are not a tax.

As part of the broad powers the legislature gave to CARB, the judges said that they have subsequently specified how the auction's $3.2 billion proceeds will be distributed, something that Gov. Jerry Brown and the legislative leadership agreed to last fall.

Aside from the court developments, the cap-and-trade program faces the need for the state legislature to extend it beyond the current 2020 sunset provision.

EDF and NRDC attorneys said California's extensive climate change efforts were affirmed by the appellate ruling. "The world is looking to California to lead on climate," said NRDC's legal director Alex Jackson.

As part of Brown's aggressive climate change initiative, an extension of cap-and-trade from state lawmakers is part of the short-term goals. That extension is now being debated in the legislature and will require a two-thirds vote for passage.

CARB's emissions allowance auction program has never been far from controversy. A little more than two years ago, when gasoline and diesel were added to the cap-and-trade auction, the Western States Petroleum Association predicted disastrous results. Its concerns were based largely on a nine-page white paper it commissioned by an energy attorney at Latham & Watkins LLP to analyze the trading program's structure and vulnerabilities. The paper identified design flaws in five areas of the CARB program.    

Under current law, 60% of annual cap-trade auction proceeds are allocated to public transit, affordable housing, sustainable communities and high-speed rail.

As the centerpiece of the state's milestone2006 climate change law (AB 32), the cap-and-trade program was created to have electric generation plants, major industrial operators and refineries limit greenhouse gas emissions while allowing the trading of emissions credits over multiple years as the limits are gradually tightened.

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