Climate Change: Washington State Considers Regional Cap-and-Trade Program

The Washington State Legislature is considering a proposal by Gov. Christine Gregoire to authorize Washington to participate in a regional cap-and-trade program designed to address climate change by reducing greenhouse gases (GHG).¹ If enacted, it would apply to a broad range of entities, including electricity generating facilities, industrial and commercial facilities, and sellers of fuel for transportation or residential use.

Each entity would be required to reduce its emissions dramatically over the coming years, buy excess emission allowances from other regulated entities, or buy “offset credits” from entities, such as forest landowners, that are not regulated by the legislation. Failure to do so would result in substantial civil penalties.

I. Background and context

Frustrated by inaction at the federal level during the Bush years, Gregoire and the governors of four other Western states created the Western Climate Initiative (WCI) in February 2007, and it soon grew to seven states—Arizona, California, Montana, New Mexico, Oregon, Utah, Washington—and four Canadian provinces.²

The goal of WCI is to create a cap-and-trade program that would reduce GHG emissions within the region by 15 percent below 2005 levels by 2020. Each member jurisdiction committed to set its own reduction requirements to meet at least its proportionate share. In 2008, Washington committed to reduce its emissions to 1990 levels by 2020, by 25 percent below 1990 levels by 2035, and by 50 percent below 1990 by 2050.³

With input from stakeholders, staff from the member jurisdictions have been working since 2007 to craft a set of recommendations on the scope and structure of the regional cap-and-trade program. Those recommendations, submitted last September, are intended to form the basis for consistent legislation to be enacted by each jurisdiction, thereby allowing the cap-and-trade program to function across state and provincial lines beginning in 2012. The Gregoire proposal largely reflects those recommendations.

With the election of President Obama, however, the situation has changed dramatically. Obama and the Democratic leadership in Congress have committed to enacting an ambitious nationwide cap-and-trade program, which would obviate the need for regional programs. But it is unclear how soon Congress will act, particularly given the severity of the recession.

Thus, timing becomes critical: Will Congress act before WCI becomes operational? If so, to what extent is Congress likely to preempt WCI? If, on the other hand, WCI becomes operational before Congress acts, will Congress be less inclined to preempt? None of these questions have easy answers, although it seems safe to say that early federal action would tend to favor preemption, while later federal action would tend to favor deference to WCI.

Meanwhile, the states are facing the same economic woes as the federal government. Although Gregoire and other proponents of a regional cap-and-trade program predict that it will produce tens of thousands of “green” jobs, many of the entities that would be regulated are concerned about costs and would prefer a single, national program that would create more liquidity and efficiency than a regional market. This debate is ongoing in each of the WCI capitols, and the outcome will determine which members actually enact the legislation necessary to implement the regional program.

II. Major provisions

A. Who's regulated, and when?

The program would be implemented in two phases. Starting in 2012, it would cover electricity generation, combustion at industrial and commercial facilities, and industrial processes that emit in excess of 25,000 tons of CO² equivalent annually.⁴ Starting in 2015, coverage would extend to transportation and residential fuel combustion, via regulation of those who sell or import fuel containing in excess of 25,000 tons of CO² equivalent.⁵

In addition, the 2015 phase would include fuel delivered to industrial and commercial facilities with annual emissions of less than 25,000 tons of CO² equivalent.⁶ Emissions from the industrial combustion of biomass in the form of fuel wood, wood waste, wood by-products and wood residuals are excluded.⁷

WCI estimates that the first phase would include about half of the economywide emissions in the WCI jurisdictions, and that the second phase would raise that amount to about 90 percent.⁸ Beyond that, the legislation authorizes Washington State's Department of Ecology (“Ecology”) to lower the 25,000-ton threshold, or to expand the types of emitters covered, “as necessary to ensure that the emissions covered by the program are consistent with the regional cap-and-trade program.”⁹

In light of the current financial crisis, the legislation also authorizes the governor to delay the start of the program, to delay the inclusion of additional sectors, or to suspend the program once operational “to address economic emergencies.”¹⁰

B. Who makes the rules?

The Director of Ecology, with advice from a variety of stakeholder and work groups, is given responsibility for adopting the rules with respect to “all requirements” of the new law by the end of 2010.¹¹ The new rules would include: (a) the criteria for the distribution of allowances, including the percentage to be auctioned;¹² (b) the design of the allowance auction, including measures to guard against market manipulation;¹³ and (c) the role of offsets as an alternative means of compliance.¹⁴ However, the new rules must be developed in coordination with other WCI jurisdictions and be “consistent with the regional cap-and-trade program.”¹⁵

C. Will Washington play if other states drop out?

It is likely that some of the current WCI members will drop out prior to implementation. This could shrink the geographic scope of WCI substantially, perhaps to as small as California, Oregon and Washington, the states that seem most committed to the program. Some in Washington and Oregon are concerned that this scenario would result in a California-centric program.

In an attempt to address this concern, the legislation provides that Ecology cannot participate in the WCI program until it covers a majority of the emissions of the 11 WCI jurisdictions as of January 2009, or until it is linked to another regional or national program that covers an equivalent emissions load.¹⁶ Because this rather vague requirement might be satisfied by a West Coast-only WCI, it is unlikely to assuage concerns that California could exercise regulatory hegemony over its northern neighbors.

D. How would the cap-and-trade system work?

The cap-and-trade system can be thought of as a three-step process.

First, Ecology will establish annual allowance caps, i.e., the total amount that can be emitted in a given year. For 2012, the cap will be the best estimate of the actual emissions for that year, but for each succeeding year the cap will be steadily reduced as necessary to accomplish the above-mentioned targets set by the Legislature in 2008.¹⁷ In other words, the cap will be reduced enough to achieve 1990 emission levels by 2020, then 25 percent below 1990 levels by 2035, and then 50 percent below 1990 by 2050.

Second, Ecology will distribute allowances consistently with the declining annual cap. After hearing from a stakeholder group, Ecology is to determine the methodology and processes for distributing allowances, including the percentage of allowances to be auctioned.¹⁸ Transition to full auction appears to be the eventual goal.¹⁹ Any auction design is to be “consistent with” the WCI cap-and-trade program.²⁰ Although it seems likely that most of the allowances will go to entities that have a compliance obligation, nothing in the legislation requires that. Hence, Ecology is required to take steps to guard against market manipulation.²¹

Third, at the end of each three-year compliance period, entities with a compliance obligation must submit to Ecology a number of allowances that matches their emissions for that period. Entities that find themselves “short” must either buy allowances from another entity with excess allowances, or buy offset credits from an entity that is not regulated under the program. Entities that expect to be “long” can either sell their excess allowances or bank them for use in a future compliance period.

E. What other options for compliance are available?

The purchase of offset credits is the primary compliance option for those entities lacking allowances. Offset credits are generated by projects that reduce GHG emissions but are outside the cap-and-trade program. In particular, the legislation makes the creation of forestry offset credits a priority. For example, a timber company could generate offset credits by agreeing to lengthen its harvest cycle, thereby increasing carbon sequestration. Those credits would then be purchased by an emitter, and submitted to Ecology in lieu of an equal number of allowances.

Subject to Ecology's rules, emitters may also submit offset credits from other WCI jurisdictions, as well as from outside the WCI. Entities could submit offset credits from projects in developed countries that would be outside the scope of the WCI cap-and-trade system,²² or from projects in developing countries in accordance with the Clean Development Mechanism of the Kyoto Protocol.²³

However, Ecology must adopt rules limiting the use of offset credits that are consistent with the limitations established by the regional cap-and-trade program.²⁴ WCI has recommended that all offsets, as well as allowances from other trading systems, be limited to 49 percent in order to ensure that a majority of emission reductions occur at facilities within the WCI.²⁵

F. What are the penalties for noncompliance?

If an emitter does not meet the obligation, a penalty of three allowances is assessed for every required allowance not submitted. Failure to submit penalty allowances will result in a fine of $5,000 per penalty allowance. Ecology is authorized to issue a compliance order, and failure to comply with that order will result in a fine of $10,000 per day. The Pollution Control Hearing Board will have jurisdiction over appeals of orders and penalties.

G. How will the money from the auctions be used?

Auction proceeds and penalties would be deposited into a dedicated fund within the state treasury.²⁶ Funds in the account could then be appropriated by the Legislature to pay for the costs of the program (including a share of the cost of the regional program), to reduce the price impacts of the program on moderate-to-low income consumers, to create jobs, to support transit and transportation projects, and to provide incentives for energy efficiency and renewable energy projects.

H. Does the legislation include additional reporting requirements?

Yes. Washington law currently requires some reporting of GHG emissions starting in 2011. The new legislation would expand those requirements to include the importer, seller, deliverer or distributor of fuels associated with greater than 10,000 tons of GHG emissions per year, and the importer, seller, deliverer or distributor of electricity from outside Washington for consumption in Washington, provided that electricity is associated with greater than 10,000 tons of GHG emissions per year. Reporting must begin in 2011 for 2010 emissions. Ecology is authorized to issue penalties of up to $10,000 per day for violations of the reporting deadline.

I. What role does the WCI regional organization play?

The legislation authorizes Ecology to enter into an agreement with the other WCI jurisdictions to form a regional organization to coordinate a regional auction, track emissions, and monitor market activity, including potential market manipulation.²⁷ The agreement must authorize Washington to withdraw from the agreement without penalty “if the organization fails to meet its obligations under the agreement.”²⁸

The nature and scope of authority to be exercised by the regional organization is less than clear. Although the legislation states that the regional organization is not a state agency and has no regulatory or enforcement authority,²⁹ it also provides, as noted above, that all regulations adopted by Ecology must be consistent with the regional program.³⁰

This ambiguity raises a number of practical and legal issues. If the regional organization has no enforcement authority, how is enforcement to occur across state lines, much less across international boundaries? In particular, how can any individual state or province effectively prevent manipulation of the secondary allowance market, which will function across the entire region?

The consistency requirement is also likely to create tension with Ecology's rulemaking process. For example, if Ecology were out-voted in a meeting of the regional organization on a crucial issue, such as auction design or offsets, would the consistency requirement nevertheless require it to adopt a rule embodying the approach that it opposed? If so, isn't the regional organization exercising a form of regulatory authority?

J. Is WCI vulnerable to challenge on constitutional grounds?

Yes. Anytime a group of states attempts to exercise regulatory authority over interstate commerce—in this case, carbon emitted from the production and consumption of energy—serious questions arise under the U.S. Constitution, particularly the Commerce Clause, Supremacy Clause, and Compact Clause. When you add a foreign country as a regulatory partner, the likelihood of unconstitutionality substantially increases. Without extending state authority into the interstate and international realm, however, it seems impossible to effectively police compliance with the proposed regional program.

If Congress enacts a nationwide cap-and-trade program before 2012, it will determine in the text of that law the extent to which WCI is either preempted or integrated, thereby resolving the constitutional issues. On the other hand, if Congress does not act by 2012, the constitutional issues are likely to end up in court.

One possibility is that Congress will offer incentives to encourage states to voluntarily dismantle their cap-and-trade programs. For example, a proposal by Senate Environment and Public Works Committee Chair Barbara Boxer, D-Calif., last year would have given free allowances in a federal cap-and-trade system to states that end their individual programs. It is also expected that any preemption by Congress will emphasize that states remain free to adopt other emissions-reducing measures, such as conservation measures, land-use controls, and stronger building codes.

In addition to the issues that arise under the U.S. Constitution, the Washington State Constitution prohibits the delegation of legislative authority to entities beyond the control of the state.³¹ Whether the consistency requirement crosses that line is an open question. If a violation were found, the enactment of federal legislation would not cure this defect.

K. Does the legislation anticipate action by Congress?

Yes. The members of WCI are, of course, keenly aware that Congress is likely to enact a federal cap-and-trade program before the WCI program becomes operational in 2012. In anticipation of that, the Washington legislation specifically recognizes “the importance of linking to or participating in a federal cap and trade program when one is implemented,” and authorizes Ecology to modify or repeal the rules it adopts as necessary to “link to, avoid duplication with, or participate in a federal cap and trade program.”

The legislation also urges Congress to recognize Washington's “unique emissions profile,” including its hydroelectric system, its abundant forests and agricultural land, and the state's leadership in energy efficiency, which has already had the effect of reducing GHG emissions. Washington's participation in WCI could be viewed as creating leverage for achieving consideration of these factors in the federal legislation, although other WCI states will not necessarily share the same perspective on these issues.

FOOTNOTES

1 At the governor's request, identical bills were introduced in the Senate and House, S.B. 5735 and H.B. 1819, respectively.

2 The Canadian members of WCI are British Columbia, Manitoba, Ontario, and Quebec. Other jurisdictions having observer status are Alaska, Colorado, Idaho, Kansas, Nevada, Wyoming, Saskatchewan, and the Mexican states of Baja California, Chihuahua, Coahuila, Nuevo Leon, Sonora, and Tamaulipas.

3 RCW 70.235.020.

4 S.B. 5735 and H.B. 1819, Section 9(1).

5 S.B. 5735 and H.B. 1819, Section 9(2).

6 S.B. 5735 and H.B. 1819, Section 9(2)(c).

7 S.B. 5735 and H.B. 1819, Section 9(3)(a). However, this exclusion applies only “as long as the region's silviculture sequestration capacity is maintained or increased.” Id. There is no indication as to how this would be measured.

8 Design Recommendations for the WCI Regional Cap-and-Trade Program, Sept. 23, 2008, at p. 17.

9 S.B. 5735 and H.B. 1819, Section 9(4)(b).

10 S.B. 5735 and H.B. 1819, Section 21.

11 S.B. 5735 and H.B. 1819, Section 19. However, the rules may not go into effect until June 1, 2011, after approval of the governor. Id.

12 S.B. 5735 and H.B. 1819, Section 8.

13 S.B. 5735 and H.B. 1819, Section 11.

14 S.B. 5735 and H.B. 1819, Section 12.

15 S.B. 5735 and H.B. 1819, Section 19.

16 S.B. 5735 and H.B. 1819, Section 4.

17 S.B. 5735 and H.B. 1819, Section 6.

18 S.B. 5735 and H.B. 1819, Section 8.

19 S.B. 5735 and H.B. 1819, Section 8(2).

20 S.B. 5735 and H.B. 1819, Section 11(2).

21 S.B. 5735 and H.B. 1819, Section 8(1)(b).

22 S.B. 5735 and H.B. 1819, Section 12(3) refers to Annex I countries, which are those countries with GHG cap obligations under the Kyoto Protocol.

23 S.B. 5735 and H.B. 1819, Section 12(4).

24 S.B. 5735 and H.B. 1819, Section 12(1).

25 Design Recommendations for the WCI Regional Cap-and-Trade Program, Sept. 23, 2008, at p. 10.

26 S.B. 5735 and H.B. 1819, Section 16.

27 S.B. 5735 and H.B. 1819, Section 17.

28 S.B. 5735 and H.B. 1819, Section 17(2).

29 S.B. 5735 and H.B. 1819, Section 17(3).

30 S.B. 5735 and H.B. 1819, Section 19(1).

31 Wash. Const. art. II, Section 1.