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California Launches 'Pay-to-Pollute' Carbon Market, But Lawsuit Threatens

California's first cap and trade auction to reduce greenhouse gas pollution is set to take place Wednesday but it faces a new challenge. Tuesday, the California Chamber of Commerce filed a lawsuit against the Air Resources Board that runs the auction.

The suit alleges that California's climate change legislation, AB 32, does not give the board the authority to charge more than it costs to run the program. Loren Kaye is with the Chamber of Commerce.

"We believe AB 32, which we support the goals of, authorized a cap and trade mechanism, but it did not further authorize a revenue raising auction," explained Kaye. "The goals of AB 32 can be accomplished with the cap part of the cap and trade."


Cap and trade is designed to reduce greenhouse gas emissions by requiring businesses to purchase allowances to pollute. The first part of cap and trade is the cap. The state puts cap on how much pollution is allowed. If an industrial plant or a utility generates more greenhouse gases then it is allotted, it has to go onto market to buy allowances to pollute.

The Air Resources Board said it's confident the program will withstand the legal challenges. It's going forward with the auction Wednesday.

The state is running this big auction, managing the sale of the rights to pollute the way the NY stock exchange manages the sale of equities. Dave Clegern is with the California Air Resources Board, which designed the cap and trade program.

"We also learned that we do not want to allocate all the allowances free, because we need industry basically to have some skin in the game," commented Clegern.

More than 350 businesses including power companies, oil refineries and food processors are required to participate in the cap and trade program. But the state wants to ease participants in, so for the first two years they only have to pay for ten-percent of their allowances, the rest they're given for free.


"The number of free allowances declines with a cap every year," explained Clegern. "So while industry is getting ninety-percent free the first two years, by 2020 they'll only be getting about fifty-percent.”

So as time goes on, participants are allowed to pollute less and have to pay for a bigger portion of their pollution. By 2020, the state should be at 1990 levels of greenhouse gas emissions.

The cap on emissions goes down about two to three-percent each year.

"As the cap comes down, there are proportionately fewer allowances available," explained Clegern. This would likely drive the cost of allowances up. "And it would become more beneficial, ultimately, to invest in reductions."

So some businesses will likely invest in greener or more efficient technology - for a variety of reasons. And some will reduce emissions below their cap. That's where the trade - or the auction - comes in. These businesses will have extra allowances that they can sell to another business that hasn't been able to or chooses not to bring down emissions.

And businesses that over-pollute can also buy offsets. The Air Resources Board is verifying certain projects that actually absorb greenhouse gas emissions, such as planting trees. The idea is to give businesses some flexibility in when and how they reduce their emissions - and use the market to manage those costs.

Long before the first auction this week, the market was already moving. Samantha Unger Katz works for BGC Environmental Brokerage Services. Her company has been trading carbon allowance futures over the past year in anticipation of the auction.

"Rules were adopted in June, we started to see the market price continue to go up," said Katz. "It reached a high of just over $20 a ton."

But then she said news came out questioning the legality of California's cap and trade program. Some say it's efforts to control the greenhouse gas emissions of power used in California could be construed as an attempt to regulate markets in other states. That would be unconstitutional.

"And since that point, we've seen a pretty steady decline in the pricing," commented Katz.

Katz said rumors of potential litigation brought allowance prices to the lowest point since they started trading last year. She said the biggest risk for the market is the uncertainty of state regulations. Still, "I'm cautiously optimistic," Katz said.

It will take some time - likely years - to evaluate if the cap and trade program works. The system is designed to eventually regulate eighty-five percent of the greenhouse gases released in the state.

Even if it does succeed in reducing California's emissions - Anthony Eggert said climate change is a global problem. Eggert is a former advisor to the California Air Resources Board.

"What California is attempting to do is to become a model," said Eggert. "And if you look at history, Calif has done this many times in the past."

California regulators have designed the program so that other states - and even the county - could implement it. But long before that might happen, the nation is watching to see if California's attempt at cap and trade works.