California cap and trade program likely to face legal challenges

By Paul Conable The Daily Record Newswire On Oct. 20, 2011, the California Air Resources Board adopted administrative rules to implement California's "cap-and-trade" program for industrial emissions of greenhouse gases. It's the first of its kind at the state level, and is set to take effect in 2013. Before it does, however, it is likely to face significant legal challenges that, like the canary in the coal mine, may provide a hint of what other states may expect if they attempt to impose a similar program. California's cap-and-trade program is part of AB 32 - the California Global Warming Solutions Act. It was passed in 2006, and is an ambitious, multifaceted law designed to limit emissions of carbon dioxide and other greenhouse gases. Cap-and-trade is focused on industrial facilities and power plants that emit greenhouse gases. The goal is for approximately a 15 percent reduction in emissions from those sources, to 1990 levels, by 2020. Under rules adopted by the Air Resources Board, cap-and-trade will be implemented in two phases. First, in 2013, the program will apply to major industrial sources and electric utilities -- about 350 companies operating 600 facilities. The second phase, in 2015, will apply to distributors of transportation fuels and natural gas. Cap-and-trade does not impose specific limits on emissions by covered facilities. Instead, it requires each facility to have sufficient "allowances" -- each equaling one ton of carbon dioxide -- for its annual emissions. The total number of available allowances is capped and decreases annually by 2 to 3 percent, forcing each user to obtain allowances from a shrinking pool. Initially, the Air Resources Board will provide free allowances sufficient to cover a majority of the average emissions for each industrial sector. These will be distributed based on a formula designed to reward efficiency. If a facility doesn't receive enough free allowances to cover its emissions, it may buy more at periodic state auctions. The first auction, tentatively set for August 2012, is projected in the governor's recent draft state budget to raise as much as $1 billion. Facilities may also obtain allowances in the market. Facilities that receive more allowances than they need can sell them to other facilities, creating an additional incentive to reduce emissions. California's cap-and-trade program has already come under fire. The primary criticism has come from industrial groups, but others have already brought legal challenges. In 2009, a group of environmental plaintiffs filed suit in San Francisco County Superior Court. It challenged cap-and-trade on several grounds, including concern that the program would result in disproportionate environmental impacts on lower-income and minority Californians. The group won an initial victory last May, when the court ruled that the Air Resources Board's analysis of alternative approaches was inadequate. But the board performed additional analysis; on Dec. 5, the court concluded that the analysis was adequate and lifted its May order. Although cap-and-trade passed that legal hurdle, more challenges are likely. Industry groups have suggested publicly that they may soon file suit to stop the program from taking effect. Several possible grounds for a lawsuit have been proposed. First, cap-and-trade may violate Proposition 26, which requires that new taxes be approved by two-thirds of the California Legislature. While cap-and-trade is not structured as a traditional tax, some groups have argued that it is effectively a backdoor tax on carbon use. The program may also be challenged on the ground that it imposes limits on interstate electricity sales, an area of exclusive federal control. Another likely challenge is under the Commerce Clause of the United States Constitution, which prohibits states from placing undue burdens on interstate commerce. On Dec. 29, 2011, a federal judge in the Eastern District of California struck down another provision of AB 32 -- the Low Carbon Fuel Standard -- under the Commerce Clause. The court concluded that California had unduly imposed limits on out-of-state shippers and producers of fuel and thus infringed on interstate commerce. Although this ruling applies to a different provision of AB 32, it is likely to encourage groups contemplating a challenge to cap-and-trade under the Commerce Clause. With passage of new administrative rules, California's pioneering cap-and-trade program is set to take effect in 2013. However, given the controversy surrounding the program, it is virtually certain to face significant legal challenges before the first emission allowance is ever traded. ---------- Paul Conable is an attorney in the energy practice group at Tonkon Torp LLP and a co-chairman of the firm's litigation department. Contact him at 503-802-2188 or paul.conable@tonkon.com. Published: Fri, Jan 20, 2012