In September 2007, the California Public Utilities Commission (CPUC) in collaboration with the California Energy Commission (CEC) adopted proposed regulations for the reporting and verification of GHG emissions that assume the existence of a load-based regulatory approach for achieving emission reductions. AB 32 obligates the California Air Resources Board (CARB) to consider these proposed regulations and to adopt reporting and verification regulations no later than January 2008.
The adoption of reporting and verification protocols represents the first key decision point in the AB 32 implementation schedule and is critical to ensuring that emission reductions will be real, permanent, and quantifiable. Although no one expected the implementation of AB 32 to be easy, the threshold debate over reporting and verification protocols has exposed several key issues, both procedural and substantive, that until resolved, will complicate investment and business decisions for generators, power marketers, and utilities, and threaten the adoption of actual, meaningful GHG reduction measures. Thus, as the one year anniversary of Governor Schwarzenegger’s signing of AB 32 passes, it is a good time to examine the challenges that lie ahead.
Too Many Chefs?
Given the expansive scope of AB 32 and its interface with multiple State agencies and boards, it’s no surprise that the California Legislature envisioned a broad stakeholder process involving environmental groups, industry sectors, business, and academic institutions. Confusion, however, has emerged regarding the appropriate forum where these interests should participate. AB 32 tasks CARB with the primary responsibility for adopting the rules and regulations to meet the State’s GHG reduction goals. The law, however, also requires CARB to “consult” with, among others, the CPUC, CEC, and a Market Advisory Committee (MAC) formed by the State’s Secretary for Environmental Protection. While laudatory, the objective of achieving regulatory consensus has unfortunately resulted in a series of overlapping, and not necessarily well coordinated, rulemakings and workshops before different administrative bodies – all of which feed into CARB’s decision making process. Importantly, CARB may – or may not – follow the recommendations which emerge from these proceedings.
The discretion AB 32 provides CARB to pick and choose among the agencies’ recommendations has challenged parties to determine where to best focus their participation and resources, a challenge exacerbated by the large cost to participate in proceedings in multiple forums, and the individualized politics and divergent perspective of these various bodies. As a result, some parties have been reluctant to set forth detailed positions on key implementation issues in any forum and instead focus on broader policy messages that can play across different agencies. The net effect has been that, one year into AB 32, the debate on several key threshold issues remains at the 5,000 foot level.
Who Gets Regulated?
In February 2006 – more than 6 months before AB 32 was signed - the CPUC issued Decision 02-032 stating its intent to establish a “load-based” regulatory approach to achieve GHG emission reductions. Specifically, the CPUC proposed to cap GHG emissions for all load serving entities (LSEs) subject to the CPUC’s jurisdiction. This load-based approach has been at the core of subsequent AB 32 implementation efforts by the CPUC and CEC and, as a result, has led many parties to assume that CARB would adopt the CPUC’s load-based regulatory approach for the electricity sector.
However, in June, the MAC issued a report recommending that CARB adopt a “first-seller” approach. This alternative would make the entity that first sells or delivers power to the California transmission grid the point of regulation. Contrary to a load-based regime, the first seller approach would expand GHG regulation to include marketers and generators, in addition to LSEs. By imposing GHG regulation on generators that deliver power directly to the California grid, the first seller approach would, in some ways, function similar to source-based programs adopted in the eastern United States and Europe.
In response to the MAC report, in July the CPUC amended the scope of its GHG rulemaking to consider the first-seller approach, in addition to its load-based approach. The CPUC is expected to further amend its rulemaking in the near future to incorporate additional issues related to the first-seller approach. Although the CPUC has not taken a final position on whether CARB should adopt a load-based, first-seller, or some other approach, the reporting and verification regulations which the CPUC and CEC jointly presented CARB in September are designed to compliment a load-based regulatory approach.
With the January 2008 deadline for CARB to adopt reporting and verification procedures approaching, the lack of any consensus, much less a decision, on the underlying regulatory approach for achieving emission reductions injects significant uncertainty into the process and foreshadows a likely need for “mid-term” adjustments to the reporting and verification procedures. Uncertainty and the likely need for future adjustments to the procedures complicates the investment and business decisions that need to be made today so that new, cleaner, resources will be available to meet the emission reductions mandated by AB 32.
What to do about Out-of-State Resources
Significantly, AB 32 requires CARB to address GHG emissions associated with all electricity consumed in the State. Since California imports about half of the electricity consumed in the State, the AB 32 reporting and verification requirements will essentially regulate emissions from both in-state and out-of-state generation.
AB 32’s extraterritorial scope has understandably raised legal issues and evoked practical concerns. Several parties have argued that any purported regulation of out-of-state generation is preempted by federal law and/or violates the Commerce Clause. While to date the merits of such arguments have not proven persuasive at the CPUC and CEC, the specter of legal challenges remains a very real threat to regulations ultimately adopted by CARB.
Legal issues aside, the need to account for out-of-state emissions poses significant practical challenges. The current lack of any region-wide emission reporting standards and requirements renders it nearly impossible to accurately link imported power with actual emission levels, forcing regulators to apply default emission factors and proxies. However, because default emission factors do not reflect a source’s actual emissions, reliance on such factors may result in sources with very different emission profiles being treated identically for reporting and verification purposes – for instance both coal and modern natural gas fired generation being assigned the same emission levels.
The challenge then is to set default emission factors at levels that will best approximate actual emissions without inviting high emitting resources to game the system or prejudice in-state resources required to report actual emissions. Striking the right balance is also important because emissions – whether actual or a proxy – will be a key determinant of a source’s relative value under an emissions cap system.
Here Comes the Feds
Among its more ambitious goals, AB 32 envisions the adoption of a GHG emission reduction program that can be replicated and adopted by other states and/or the Federal government. This objective, however, is a double edge sword. To the extent a comprehensive regional or federal approach is adopted that is not consistent with the approach being contemplated by California (e.g., a source-based approach as opposed to load-based), investment or operating decisions made by generators, power marketers, and utilities based on the California program will be at risk. Given increasing activity in Congress and the prospects for Democrats in the 2008 elections, there appears to be a real chance that California’s efforts could be preempted by Federal regulations. The mere chance that AB 32 could be preempted will likely result in market participants “hedging their bets.”
Over the past year, the initial phases of AB 32 implementation have revealed several areas of concern that must be resolved if the goals of AB 32 are to be met. Nevertheless, it seems clear that, at least so far, California is not going to wait for answers before moving forward. In light of the mandate to reduce GHG emissions to 1990 levels by 2020, CARB, the CPUC, and others seem willing to support regulations that are clearly flawed in order to show some “progress.” Whether their efforts to adhere to AB 32’s ambitious schedule represents the right policy choice for California remains to be seen. Stay tuned…