Washington State Enacts Cap-and-Trade and Clean Fuels Legislation

In an historic move, the Washington State Legislature passed two major pieces of climate change legislation in the closing days of its recent session over the weekend of April 24-25, 2021.

Once signed by Governor Inslee, the Climate Commitment Act creates a market-based, economy-wide, cap-and-trade program. The other legislation (HB 1091) creates a program to reduce the carbon in transportation fuels.¹ These bills follow on the heels of the 2019 Clean Energy Transformation Act (CETA), which requires that the electric generating sector be completely decarbonized by 2045.

Together, these three laws place Washington firmly in the top tier of states addressing climate change. They also strengthen the policy alignment along the West Coast by opening the door to linkage with California's cap-and-trade program and adopting a clean fuels program similar to that of British Columbia, Oregon, and California.

Big Picture

As shown below, Washington State currently emits roughly 100 million metric tons of anthropogenic greenhouse gases (GHGs) annually. Consistent with the Paris Agreement and what the science says is necessary to avoid a global temperature increase greater than 1.5 degrees C, Washington's legislature in 2020 committed to achieving net-zero GHG emissions by 2050.

To achieve this, the legislature established interim GHG emission limitations of 50 million tons by 2030, 27 million tons by 2040, and five million tons by 2050 (with the remaining five million tons of emissions to be offset by an equal amount of GHG capture and sequestration).² In combination with CETA, the two new bills are designed to meet these ambitious goals.

Cap and Trade

Under the cap-and-trade legislation, the Washington Department of Ecology (Ecology) is first required to impose a cap on GHGs emissions from "covered entities," those that annually emit more than 25,000 metric tons of carbon dioxide equivalent. Ecology is then required to adopt a budget of allowances to be made available to covered entities for a series of compliance periods, with the first running from January 1, 2023, through the end of 2026.

Allowances authorize the holder to emit up to one metric ton of GHGs per allowance and are tradeable. The allowance budgets will decline over time so as to achieve the emission limits established for 2030, 2040, and 2050.

Auctions

Allowances are then distributed through auctions, with Ecology establishing a price ceiling to protect covered entities from excessive compliance costs. Auctions are open to both covered entities and other entities without a compliance obligation. The latter are referred to as "general market participants" and must register with Ecology. Presumably to avoid market manipulation, general market participants in the aggregate may not own more than 10 percent of the allowances issued in a calendar year.

EITE Industries and Utilities

Special treatment is given to emission-intensive, trade-exposed (EITE) facilities that might otherwise relocate to jurisdictions that do not regulate GHG emissions. They will receive free allowances in the early years, but the quantity of those allowances will decline over time. Utilities subject to CETA are also provided free allowances to mitigate the cost burden of that program on electricity customers.

Allocation of Auction Revenue

Beginning in 2023, the allowance auctions are projected to generate $460 million annually, climbing to about $590 million by 2040. The legislature will determine the use of these funds through future appropriations. The money will be available for an extremely wide range of purposes and activities, including reducing the impacts of GHGs and co-pollutants on overburdened communities, programs to support fossil fuel workers affected by the transition to a clean energy economy, and programs to increase forest and community resilience to wildfires.

Auction proceeds can also be spent on programs to deploy more solar and wind power, and to promote distributed generation, energy storage, demand-side technologies, and other grid modernization projects—as well as on emission reduction efforts in the industrial sector, the agricultural sector, and the built environment. Because the bill requires that auction proceeds be "invested" in such climate-related projects and programs, supporters of the bill chose to brand it as "cap and invest," notwithstanding that allowances can be traded. The appropriate allocation of this immense stream of funding will undoubtedly be the subject of lively public and legislative debate in the coming years.

Environmental Justice

Unlike the California cap-and-trade program, Washington's legislation includes a strong environmental justice component. Ecology must conduct an environmental justice review every two years to ensure achievement of reductions in criteria pollutants as well as GHG emissions in overburdened communities highly impacted by air pollution.

When allocating funding, agencies are further directed to invest not less than 35 percent (and with a goal of 40 percent) to provide direct and meaningful benefits to vulnerable populations within overburdened communities. "Vulnerable populations" and "overburdened communities" are defined at some length in the legislation, but the scope of those terms is nevertheless likely to be the subject of considerable discussion.

Linkage

Ecology is also authorized to create linkage with other jurisdictions with GHG emission trading programs. California is currently the only other state with a cap-and-trade program, which began operating in 2013 and is linked to Quebec's program. The European Union has operated a cap-and-trade program since 2005.

Linkage is intended to provide covered entities with a more cost-effective way to meet their compliance obligations. It could include joint auctions and the ability to transfer allowances between programs. The obvious first move would be linkage between Washington and California, but the negotiation of a linkage agreement is likely to take time.

Among other things, the Washington legislation includes a long list of criteria, including a requirement that the agreement "ensure that the linking jurisdiction [e.g., California] has provisions to ensure the distribution of benefits from the program to vulnerable populations and overburdened communities." The legislation also requires that any agreement be subject to a public comment process and review by relevant stakeholders and other interested parties.

Penalties

At the end of each compliance period, a covered entity is required to submit to Ecology an allowance for each ton of GHGs it emitted during the period. A covered entity that fails to do so will be required to submit four allowances for each missing one within six months.

If a covered entity fails to submit the penalty allowances, Ecology must issue a civil penalty of up to $10,000 for each penalty allowance that is not submitted per day. Ecology will also issue a penalty of up to $10,000 per day per violation for failure to comply with program rules and may issue a penalty up to $50,000 per day per violation in cases of market manipulation.

Clean Fuels

Due to Washington State's abundance of hydropower, its transportation sector accounts for an unusually high percentage of its GHG emissions (45 percent as compared to 29 percent for the nation as a whole). With the low carbon fuel standard (LCFS) programs in California and Oregon as models, Washington's legislation aims to reduce those emissions by reducing the carbon intensity of fuel used in Washington. The goal is to reduce the GHG emissions attributable to transportation fuels by 20 percent below 2017 levels by 2038, with interim goals along the way.

To get there, the legislation focuses on the producers and importers of transportation fuels with high carbon intensity (e.g., gasoline and diesel). Regulated parties will incur "deficits" for producing, importing, or dispensing transportation fuels that have a carbon intensity above a standard that Ecology will set by regulation.

To offset such deficits, producers, importers and others can acquire credits through the production, importation, or dispensing of transportation fuels with carbon intensity lower than Ecology's standard. Those credits can then be sold to parties with deficits.

In addition, credits can be created through carbon capture projects, biofuel projects, non-utility electric vehicle charging, and infrastructure programs. The legislation also calls for the generation of credits through other transportation infrastructure initiatives that may be enacted by the legislature in the future.

Next Steps and Beyond

The enactment of this legislation is just the beginning of a very long process. The development of the implementing regulations will be contentious and will almost certainly give rise to litigation.

These processes will bring to light unanticipated questions and unintended consequences. For starters, the programs required by these three complex pieces of legislation must be crafted so that they work together effectively as a whole. Integrating the legislation's first-of-its-kind environmental justice programs and requirements will be particularly challenging.

If successfully implemented, this legislation could well make Washington a magnet for innovation and the deployment of next-generation technologies. This, in turn, could revive the political stock of cap and trade as a regulatory tool, both at the state and federal level.

Could Oregon be next, creating a West Coast coalition of states operating under complementary cap-and-trade and clean fuels programs? Cap-and-trade efforts have failed in dramatic fashion in recent Oregon legislative sessions, but a scaled-back "cap-and-reduce" administrative effort is currently under development.

DWT's energy and climate change team will be tracking these develops as they unfold and stands ready to assist stakeholders interested in embracing the challenges and pursuing the opportunities presented by the transition to a net-zero GHG economy.

FOOTNOTES

1  Although neither bill becomes fully effective until subsequent transportation legislation is enacted, the likelihood that such legislation will be enacted appears to be very high.
2  RCW 70A.45.020.