by Chris Busch and Hallie Kennan

California recently fortified its role as a global leader in climate policy with passage of Senate Bill (SB) 32 and Assembly Bill (AB) 197.  On September 8th, Governor Jerry Brown signed these bills into law, establishing a new ceiling on emissions by 2030 and new rules guiding regulators on how to accomplish emission reductions.
While these new laws clearly demonstrate California’s unprecedented ambition to decarbonize its economy (more so than any other jurisdiction in the Western Hemisphere), SB-32 and AB-197 also raise questions about the implications for California’s cap-and-trade system.  As Ethan Elkind, director of the Climate Change and Business Program at the University of California contends, “the passage of AB-197 makes the future of the [cap-and-trade] program even more murky.”

In fact, it is highly likely that cap-and-trade will be enabled under SB-32 and AB-197, as it is a necessary part of a policy package maximizing net social benefits.  However, policymakers will have to make some adjustments to cap-and-trade program design regarding, for example, new limits on out-of-state offsets and how allowances are to be allocated post-2020.

The new statewide target
SB-32 establishes a 2030 statewide limit for heat-trapping carbon emissions, now required to fall 40 percent below 1990 levels by 2030.  This law provides the California Air Resource Board (CARB) authority to set rules needed to drive down emissions, with AB-197 providing policy guidance on how to decarbonize.

This new 2030 target is exactly right for California: It’s strong but undeniably achievable and beneficial.  A bookshelf worth of research—from Energy + Environmental Economics, Lawrence Berkeley National Laboratory, the University of California, Berkeley, and Energy Innovation—has shown the clean technologies required to meet this goal are already commercially available and create net social benefits when full costs and benefits are considered.

While some low-carbon upgrades carry an added cost, these costs are rapidly falling and, on average, are outweighed by energy savings, better local air quality, and improved health.  In the end, California’s residents will be better off.

New marching orders for CARB
AB-197 requires CARB to prioritize local emissions reductions, and sets out a new analytical frame accounting for social costs, defined to include the impacts to public health and environmental risks, as well as energy system costs that are commonly included in cost-effectiveness measures.

AB-197 states CARB shall, “consider the social costs of the emissions of greenhouse gases, and prioritize both of the following:

  • (a) Emission reduction rules and regulations that result in direct emission reductions at large stationary sources of greenhouse gas emissions sources and direct emission reductions from mobile sources.
  • (b) Emission reduction rules and regulations that result in direct emission reductions from sources other than those specified in subdivision (a).”

In this case, “direct emission reductions” means more prescriptive actions with highly certain reduction outcomes, such as installing a specific air-cleaning technology on all exhaust pipes of at a particular type at oil refineries.  The first environmental regulations were of this type and are known as Best Available Control Technology (BACT) regulation.
For some sectors, like petroleum refining, the result seems likely to include detailed audits with action plans and BACT regulation.  These facilities by facility evaluations changes will drive discovery of new ways to lower on-site emissions.

The political pressure for prioritizing local climate solutions is entirely rational and exists because most climate solutions yield “co-benefits”—related social, environmental, or economic benefits in addition to lowering carbon emissions.  For instance, cutting carbon dioxide emissions simultaneously improves local air quality.   Yet, to date, most climate policy analysis – including in California, such as the main three analyses of the AB-32 package of policies, did not integrate the value of improved public health.
This is an important point.  Co-benefits are often the most immediate and tangible benefits for disadvantaged communities, as local climate investments improve local air quality, create jobs, and help improve socioeconomic equity: Consider state funding to expand electric vehicle car-sharing in some of Los Angeles’ lowest-income neighborhoods.

Cap-and-trade under AB-197
While the push for local-first climate solutions makes sense, precisely mapping out the technology transition through BACT regulation would be impossible.  Every sector of the state’s economy uses fossil fuels.  Imagine trying to map a precise decarbonization path taking into account the billions of energy-using devices in California.  Given the difficult challenge of decarbonizing an entire economy, flexible mechanisms like cap-and-trade have a valuable role.

Pricing tools like cap-and-trade capitalize on market incentives.  A cap-and-trade program establishes a market signal—the price of an allowance—and decentralized actors respond using knowledge of their own facilities.  As a result, cap-and-trade is a source of low cost emissions reductions.   Policy analysis will show that that cap-and-trade, with some modifications, helps overall program cost-effectiveness even when a broader social cost approach is used.

Other tools in the decarbonization toolbox
Cap-and-trade is not the only alternative beyond BACT regulation.  Performance standards, such as building codes for new homes or renewable energy minimums for electricity utilities, will also have a valuable role to play.

Since performance standards are more narrowly targeted, they can be thought of as providing more direct reductions.  For an economy-wide decarbonization program such as SB-32/AB-197, cap-and-trade has the important advantage of providing certainty around aggregate emissions.

The reductions performance standards on homes or utilities will deliver in the future vary based on behavioral or economic factors—they depend on the number of homes built or the amount of electricity consumed – making it easier for policymakers to hit the 2030 target with cap-and-trade in the mix.

Outlook offsets
Offsets, calculated as emission reductions from projects outside the sectors directly covered California’s program, have been controversial from the very beginning of cap-and-trade.  The program has prioritized offsets within the state’s borders, but allows for them to come from projects across the United States.   Consequently, the majority of offsets used so far have been from outside of California.

The rationale for their inclusion as part of the cap-and-trade program has been the necessity of avoiding unacceptably high decarbonization costs.  However, at low allowance prices, it is hard to justify the lost co-benefits that would come from sending money from California’s capped entities to out-of-state projects.  Low allowance prices are a signal California has not yet begun to exhaust the supply of low-cost in-state projects.

In a low allowance price context, out-of-state offsets will represent a failure to maximize in-state social benefits.  Therefore, the likely outcome under AB-197 is the introduction of new conditions before emitters in California would be offered these offsets as a compliance option.  Allowance prices would have to reach some price threshold much higher than the auction price floor before they would be allowed into the system.

Outlook for new auction authority
Auctioning authority under the current cap-and-trade program is provided under AB-32, adopted in 2006.  CARB has been careful to use auction revenue in ways that reduce carbon emissions, so it does not qualify as a tax but rather as a fee.  Proposition 26, passed by a slim majority in 2010, broadened the definition of a tax versus a fee, however it only applies to changes in statute.  SB-32 was written as an extension of AB-32, with the intention to avoid triggering Proposition 26.

The courts will have to sort out these legal questions around auctioning.  Even if CARB does not have the authority to auction allowances post-2020, SB-32 and AB-197 present other avenues for continuing cap-and-trade using various forms of free allocation, for instance “citizen permits”—the distribution of permits to people with an easy mechanism to enter these into auctions, perhaps run by CARB perhaps by a third party, where polluters can acquire them from the public.


Chris Busch is Director of Research at  Energy Innovation.  He graduated with an MPP (1998) from the Goldman School and a Ph.D. from Berkeley’s Agricultural and Resource Economics Department (2006).  He has been deeply involved in California climate policy over the last decade.

Hallie Kennan is Energy Innovation’s Communications and Social Media Lead, where she leads the firm’s communications activities and assists in developing outreach strategies. Hallie oversees Energy Innovation’s website and social media accounts, and manages its email campaigns and media relations.