Risky business – going it alone with AB 32

Loren Kaye
President of the California Foundation for Commerce and Education

The effort to regulate greenhouse gas emissions in California has evolved from grand statements of global leadership to the nitty-gritty chores of program design, regulation writing, and selection of economic winners and losers.

In 2006 the authors of AB 32 could confidently write, in the bill’s findings and declarations, “(A)ction taken by California to reduce emissions of greenhouse gases will have far-reaching effects by encouraging other states, the federal government, and other countries to act.”

But it hasn’t quite worked out that way, and California now faces a crossroads: should the state implement far-reaching, costly regulations to reduce GHGs ahead of other efforts by neighboring states, Canadian provinces, and the national government? Four years ago it seemed the world – or at least America – was moving inevitably toward a unified regulatory scheme for carbon emissions, and just needed a nudge from California. Today, even after the election of a President and Congress who declaim the urgent need for these policies, California is still alone in its legislative commitment to action.

A just-released study emphasizes the risk to California from going it alone.

Todd Schatzki of the Analysis Group and Robert Stavins of Harvard have concluded that California faces “a number of adverse consequences” from being unable to integrate its cap-and-trade system into a wider regional or national system.

Most important, to the extent that AB 32’s command-and-control and market-based policies are implemented outside regional or national systems, they “would be less environmentally effective due to emissions leakage.” First, economic activity that is chased out of state may create new emission sources that would offset (or more) emissions reduction in California. Second, swapping low-GHG electricity imports for high-GHG imports may reduce locally-created emissions without resulting in any net emissions reductions for the overall Western electrical grid. Third, subsequent national regulations could negate the emissions benefits from California standards and impose a competitive disadvantage on California producers by setting a lower standard in other states for, say, fuel formulations or other regulated manufacturing.

The risks for a California program are compounded as the US EPA is developing its own command-and-control regulations of GHG emissions from stationary sources, under the Clean Air Act.

Given the likely risks of emission leakage and increased cost to the California economy that would accompany solo implementation of a state-only program, California should adopt policies that would mitigate these risks in advance. This would not only reduce economic impact but improve environmental effectiveness by reducing leakage. In particular, according to Stavins and Schatzki, a California program implemented ahead of national or regional programs should:

· Expand the use of offsets (emission credits) within a cap-and-trade system by eliminating or relaxing quantitative limits.

· Set ceilings and floors on allowance prices to reduce volatility and prevent uneconomic investments.

· Allow banking of emission allowances for future use.

· Allow borrowing of allowance from future compliance periods.

· Add flexibility to timing of emissions reductions by gradually imposing requirements through 2020, which is the hard deadline for emission reductions.

Use of these cost-containment measures can somewhat mitigate the inevitable adverse economic consequences of AB 32 regulations without sacrificing emissions targets. Indeed, it would improve outcomes if it reduces out-of-state leakages.

California has set out on a tricky path, in effect betting our economy on the prospect that other states and provinces, and the national government, will join with us. Since that has yet to happen, our policy implementation must seek to both hedge our economic risk as well as demonstrate to others the benefit for their also taking on these commitments.

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