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.
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