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California Scores Another Cap-and-Trade Victory

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[Originaly published as a Snell & Wilmer Legal Alert, February 15, 2013]

The California Air Resources Board (CARB) scored another victory in its ongoing effort to reduce greenhouse gas (GHG) emissions in the state to 1990 levels under the mandate of AB 32 (the “Global Warming Solutions Act of 2006”). In a decision by San Francisco Superior Court Judge Ernest H. Goldsmith in the case of Citizens Climate Lobby and Our Children’s Earth Foundation v. California Air Resources Board, Case No. CGC-12-519554 (January 25, 2013), Judge Goldsmith rejected a challenge by two environmental groups to a technical component of CARB’s cap-and-trade program. Cap-and-trade is the market-based mechanism by which CARB seeks to enable industry to reduce emissions.

The cap-and-trade program affects about 600 facilities in California. Among the “covered entities” that must participate in the cap-and-trade program are those in the following industrial sectors, if their annual emissions exceed 25,000 metric tons of carbon dioxide (or equivalent) (CO2E):

  • Electricity-generating facilities
  • Suppliers of natural gas or liquefied petroleum gas
  • Suppliers of carbon dioxide
  • Refineries
  • Cement plants
  • Glass plants
  • Iron and steel plants; and
  • Pulp and paper manufacturing plants

(17 Cal. Code Regs. Section 95811.)

In a nutshell, cap-and-trade works as follows. CARB initially allocates “allowances” to covered entities. The allowances are registered and are considered to be tradable permits that represent one metric ton of CO2E each. By the end of subsequent biennial or triennial compliance periods, each covered facility either must have reduced its emissions to below the then-applicable cap or must have purchased additional allowances to make up the difference. Allowances may be purchased either from CARB (at quarterly auctions) or from others (on the open market).

An additional option available to a covered entity is to acquire approved carbon offset credits that represent an emission reduction of one CO2E each. Offset credits are generated by sources not subject to the cap-and-trade program. Currently, the following four offset credit protocols have been approved by CARB:

(1) the livestock protocol (which involves trapping methane from dairy and swine farm manure);

(2) the ozone depleting substance protocol (for example, destroying, rather than recycling, refrigerants);

(3) the urban forest protocol (the planting of trees (and consequent sequestration of carbon) in urban settings by municipalities, educational campuses and utilities); and

(4) the U.S. Forest Protocol (forest conversation, conservation-based management and reforestation projects).

In an effort to ensure that emission reductions are genuine, AB 32 requires that emission reductions be “real, permanent, quantifiable, verifiable and enforceable.”  California Health & Safety Code Section 38562(d)(2). As that applies to offset projects, emission reductions must be “in addition to any greenhouse gas emission reduction that otherwise would occur.”  Id. (emphasis supplied).

The legality of how CARB addressed the question of “additionality” in designing the offset portion of the program was the issue presented in the Citizens Climate Lobby case. As the Court observed, “[a]dditionality is the linchpin of an offset program.”

The theory behind this is that if emission reductions are not “additional,” the cap-and-trade program would not reduce emissions beyond what would have occurred in the absence of the program. This was the concern raised by the environmental groups in Citizens Climate Lobby – that, under a number of scenarios, offset credits could be awarded in situations where no “additional” emission reduction actually had been achieved. This would, it was argued, be unfair because it could create windfalls for reductions that would have occurred in the ordinary course of business. Ultimately, the groups argued, the effectiveness of the program would be undermined by allowing the substitution of illusory emission reductions for real ones.

The Court recognized that there was some appeal to the concerns voiced by the environmental groups that offsets could be awarded for projects that were, in fact, non-additional. In this regard, the Court noted that the Kyoto Protocol’s Clean Development Mechanism (CDM), the world’s most mature offset scheme, “has been heavily criticized for not delivering on its environmental objectives and exemplifies the difficulty of determining additionality.” The Court further noted that a survey of 93 randomly selected CDM projects suggested that “the additionality of a significant number of projects seems unlikely or questionable.”

The Court used as an example the practice of trapping methane from manure on dairy and swine farms using anaerobic digesters. According to a report developed as part of the AB 32 process, only .07 percent of all dairy farms and .02 percent of all swine farms in the United States used anaerobic digesters to dispose of manure. A 2010 USEPA report found that digesters are installed in 1.9 percent of dairy and swine farms where it is feasible to do so.  For this reason, CARB adopted as a technology-specific additionality threshold the installation of anaerobic digesters to demonstrate additionality – essentially acknowledging that digesters likely would not be installed in most (but not all) cases absent the financial incentives presented by the opportunity to create offset credits.

Ultimately, however, and although the Court noted that additionality in a particular case may be debatable, the Court concluded that CARB’s adoption of the additionality standards under consideration was legally sufficient:

Determining additionality is difficult, and it is impossible to precisely delineate between additional and non-additional projects. All additionality determinations suffer from this limitation, not just standards-based approaches. Petitioners ignore this reality and insist Respondent must use a perfect additionality mechanism or none at all. This argument is inconsistent with the science behind additionality and Petitioners own statements.

Given that the question of determining additionality in any given case was admittedly uncertain, an integral element of the Court’s decision was the standard of judicial review that it applied to CARB’s regulations. In fact, in this regard the Court presented an unusually detailed analysis of California law governing judicial review of agency action. In this case, the Court agreed with the environmental groups that the less deferential de novo standard of review applied to the question whether the legislature delegated to CARB the authority to use a standards-based approach to determine additionality. However, the Court applied the highly deferential “arbitrary and capricious standard” to the determination of whether the protocols selected and approved were reasonably necessary to effectuate the purpose of AB 32. On this basis, the Court approved the four offset protocols and denied the petition for writ of mandate.