"Everybody talks about the weather, but nobody does anything about it" - Mark Twain
(a) What is California doing about Global Warming, and how will it affect your business?
The "California Global Warming Solutions Act of 2006" (AB32) became effective on Jan 1, 2007. Its goals are to establish the world's first comprehensive program of regulatory and market mechanisms for greenhouse gas (GHG) reductions.
The stated objective of AB32 is to reduce GHG emissions to 1990 levels by 2020. How is this reduction to actually be achieved - and who is going to do it? The legislation itself is quite concise. Under AB 32, the California "Air Resources Board" (ARB)1 is made responsible for monitoring and reducing GHGs. Simply put, it is the ARB's job to figure out how to reach this goal.
Below is an analysis of the legislation and some "tips" for businesses to successfully adapt to these evolving rules.
(b)What's the timeline?
AB32 simply tells the ARB when its rules have to be made, and when its final system has to be in force. The simplified timeline is that ARB will list "early actions" and develop mandatory reporting rules by 2008, put out a "scoping plan" by 2009; adopt the "early actions" by 2010; set forth the GHG limits and measures by 2011; and then make GHG limits and measures fully operative by 2012. (A full detailed schedule is found at: http://www.arb.ca.gov/cc/factsheets/ab32timeline.pdf)
The "scoping plan" is the ARB's overall comprehensive program to reduce GHGs. It comes into force by Jan 1, 2012. This scoping plan is expected to address "significant sources" of GHGs via direct regulations, alternative compliance mechanisms, monetary and non-monetary incentives, voluntary actions, and market-based mechanisms such as a cap and trade system.
The "early actions" are particular industry-specific actions that will be brought into force by Jan 1, 2010. The rationale behind these "early actions" is the recognition that some actions have to be taken immediately to reach AB32's GHG reduction goals in time.
The legislation itself says little about what ARB's final plan should look like, or how it will be organized.
Tip #1: 2008 is the year in which the ARB is formulating its GHG reduction strategy. Get informed and involved now to influence the ARB's strategy, or at least be prepared to comment on the draft plan the ARB will release in June 2008, prior to its going to the Board in November 2008 for adoption.
(c) What Types of GHG emissions does AB32 cover?
AB32 specifically covers the six major GHGs, being carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), hydroflurocarbons (HFCs), perfluorocarbons (PFCs), and sulfur hexafluoride (SF6).2
(d) Mandatory Early Actions:
In April 2007, three "discrete early action measures" were proposed. An Expanded List was published in Oct 2007 increasing the three existing early actions to the present total of forty four measures (all of which are to be enforceable by Jan 1, 2010). These forty four measures are in the "Transportation"; "Commercial"; "Fuels"; "Agriculture"; "Education"; "Cement"; "Forestry"; "Energy Efficiency"; "Waste"; "Oil and Gas"; "Electricity"; and "Fire Suppression" business sectors. The ARB is continuously updating these programs and putting more information on the web. However, as can be seen from the ARB's website3, most of these "early actions" are very specific and target specific products, and manufacturing systems.
Tip 2: Find out if your particular business is one of the forty four now on the "early action" measure list! (You don't want to be caught by surprise since these early actions come into force a year earlier than the rest of the ARB's full GHG reduction plan).
(e) Voluntary Early Actions:
The ARB states that voluntary early actions are critical in order to achieve the legislated GHG reduction goals of AB32. The ARB therefore wants to encourage all businesses to start reducing their GHG emissions now. However, the fear exists that ARB's final program could penalize those same companies that have reduced their emissions before the program is put into place. For example, such as by requiring the same percentage of GHG emission reductions regardless of what reductions an individual company has already done in the past.
Unfortunately, until ARB's scoping plan is fully implemented, there can be no guarantee as to how these voluntary early actions will be recognized. ARB states that they will eventually determine the appropriate credit to be given for voluntary early actions and the conditions under which voluntary reductions may be used to comply with mandatory requirements. So what do you do now if you want to start reducing your GHG emissions (either because of a desire to be a good corporate citizen, or due to shareholder pressures, or both)? How do you ensure you are not penalized in future?
Tip 3: Try to find out a way to get future credit for your "voluntary" early emissions reductions. The best solution is to keep detailed records of your GHG reduction programs, and keep your own "baseline" data. You wont get future credit for emissions reductions unless you can show that you achieved them. Also, check for future updates and information from the California Climate Action Registry.
(f) The Scoping Plan (a.k.a. "The Big Plan to Achieve the GHG Reduction Goals"):
The ARB's final "scooping plan" is to be published in June 2008 and brought into force in January 1, 2009. This only gives businesses six months to adapt to the new GHG reduction regime, and figure out how to respond. However, prior to imposing and mandates or authorizing any market mechanisms, AB32 states that ARB must hold public hearings and workshops.
Tip 4: Get your own corporate GHG reduction plan developed prior to ARB's enforcement of the scoping plan! You can always modify your plan in response to ARB's finalized Scoping Plan, but at least you'll be off to a good start.
Tip 5: If you are really concerned about ARB's effect on you business, start working with ARB now on the development of the Scoping Plan. Attend the ARB's public workshops, and show how different GHG reduction plans could affect your particular business, the economy, conflict with other laws, etc.
The development of the Scoping Plan has been organized into separate activities in each of the following "sectors": (1) Agriculture; (2) Electricity; (3) Forests; (4) High Global Warming Potential (e.g.: refrigeration, fire extinguishers, foam recovery); (5) Land Use and Local Initiatives; (6) Manufacturing; (7) Oil and Gas Refining; (8) Transportation; and (9) Waste Management and Recycling. Separate public meetings are being held for each of these different sectors.
Tip 6: Band together with others in your industry. You may want to approach "Tip 5" as a trade or industry group.
(g) Mandatory GHG Emissions Reporting - Does Your Business Have to Do It?
Mandatory emissions reporting is to begin in 2008 for all "significant sources" of GHGs. As such, many businesses will have to report their GHG emissions for up to 4 years prior to being forced to actually start reducing them (when full enforcement begins in 2012).
The ARB issued draft reporting regulations in October 2007, but this draft rule is presently under review again. The ARB expects to have completed a revised version soon "in April 2008." The initial draft regulation would have affected more than 800 industrial and commercial sources in California. (The ARB estimates that about 850 California businesses constitute about 94% of all state GHG emissions).
Tip 7: Anyone who is a competitor of these 850 businesses should be tracking and participating in what ARB is doing - as they may be next.
Businesses in the following sectors will have to provide detailed reports of their GHG emissions for sure: (1) Cement Manufacturing; (2) Electric Power Sector; (3) Cogeneration Facilities; (4) Petroleum Refineries, Hydrogen Plants, and Oil and Gas Production; and (5) Other stationary industrial sources that emit more than 25,000 metric tones of CO2 per year. This last catch-all category is broad and will cover many industries.
Specifically, this catch all category could include businesses that produce or consume significant amounts of energy, being: power production, educational institutions, chemical production, landfills, manufacturers, cement production, agriculture, forestry, land use, construction, transportation, shipping, food processing, goods transportation, water transmission, manufacturing of industrial gases, paperboard manufacturing, food processing, steel foundries, mineral processing, etc.
The reporting system will work in conjunction with the system already developed by the Climate Registry4. The Climate Registry was formed in 2007 and is supported by a number of US and Mexican states and Canadian provinces. It aims to standardize GHG accounting and reporting across multiple jurisdictions. Reporting Protocols were just announced in March 2008.
The first reports are due in 2009 (for 2008 emissions). No independent 3rd party verification is required for 2009 report - but some facilities (oil and gas, production, electricity production, etc.) will require 3rd party verification in 2009 (with all others requiring 3rd party verification in 2010). Verifiers are to be accredited by ARB.
Under the present draft rule, the reporting is facility-specific. (i.e.: you can't issue one report for all of your various business operations). One question to ask is whether a large company be hit by reporting rules, while its smaller competitors won't? Alternatively, could a company split its operations into two or more facilities to avoid the reporting rules? It would appear that having many separate facilities may be a strategy to avoid the reporting rules, but you have to question whether the rules could be changed or tightened in future.
Tip 8: The emissions thresholds are based on single facility emissions only (i.e. a "stationary industrial source". Therefore, companies with multiple facilities that are separately below the threshold would not be required to report.
(h) Cap and Trade - What Does It Mean?
Under AB32, ARB is specifically required to consider "market-based compliance measures". It is widely expected that ARB will institute a carbon cap and trade system that will allow companies to sell carbon emission credits where they are able to achieve reductions below pre-determined emissions baselines. This trading system will likely be part of the final scoping plan.
In a cap and trade system, a company complies by: (1) reducing its emissions to the "cap" level; (2) reducing its emissions to below the "cap" level, and then selling its credits to others; or (3) failing to reduce its emissions to the "cap" level and then purchasing credits from others.
The idea behind a cap and trade system is that the "good guys" make money from the activities of the "bad guys". This supposedly encourages more of the "bad guys" to become "good guys". As can be appreciated, a cap and trade system can therefore be problematic when there are not enough "bad guys". This situation could occur either when the "cap" is set too high, or when the technology is available such that many "bad guys" can cheaply adopt GHG reduction systems.
Tip 9: The big winners in a cap and trade system are those companies who can effectively reduce their emissions and make money selling their emissions credits to others. The secret to doing this well is to both pin down exactly how (as cheaply as possible) to reduce your emissions - and also develop excellent recording systems showing same.
There are a number of different cap and trade systems under study that could be brought into force. Different cap and trade systems have different features. In some, the price of carbon traded may be subject to either maximum or minimum prices. In some, carbon credits can be banked for future use. In others, they cannot. In some, the use of "offsets" may be possible, in others, offsetting may not be possible, or may be restricted to certain sorts of offsets or certain locations. Offsetting is a system whereby a GHG emitter calculates their GHG emissions, and then purchases on "offset" of this emission from a project that traps or prevents an equivalent amount of GHG emissions. Offsetting is very controversial and will likely become more controversial over time.
Another "wrinkle" to a cap and trade system is selecting the best point in the supply chain to be regulated. For example, should it be upstream at the point that produces or imports the fuel, or downstream at the entity that uses the fuel and emits the GHG? The point of commerce that is the best to regulate may be different for different sectors of the economy. Moreover, the best point of regulation may not be the point at which the GHGs are actually emitted. For example, commercial buildings do not lend themselves to being the best point of regulation in a cap and trade system (due to the large number of small sources of emissions).
In June 2007, ARBs' "Market Advisory Committee" recommended a cap and trade system that would: (1) incorporate all major GHG emitting sectors of the economy; (2) take a first seller approach to capping electricity emissions (i.e.: the owner or operator of a power plant, or the entity that first sells the electricity into California); (3) initially, most allowances would be allocated, but over time they would be auctioned off; (4) allow for offsets both inside and outside of California.
If you want to get involved in lobbying for a particular type of cap and trade system, or if you want to be best prepared for whatever type of cap and trade program is brought into force, where should you start?
Tip 10:
1. Start inventorying your GHG emissions right now.
2. Start determining GHG emission reduction programs right now. (Go after the low hanging fruit first)!
3. Purchasing offsets now can be risky. If you are going to do it - start with a local program (that can be monitored and verified). If you do anything before a real cap and trade system is brought in, make it as local as possible.
Tip 11: You may want to lobby for a cap and trade systems that: (1) has transparency in allocating allowances; (2) establishes a central emissions trading registry; (3) incorporates credits; (4) allows non-regulated entities to trade allowances; (5) has penalties for non-compliance; and (6) allows banking and borrowing.
The ARB is also very worried about the problem of "leakage" (being a reduction in GHG within the state that is offset by an increase in GHG emissions outside the state). For example, a company deciding to shift part of its operations out of California (to decrease emissions in California while simply increasing them outside of California). A proposed solution being discussed for energy utilities leakage is that the regulated entity is responsible for all GHGs related to the energy they sell to consumers, regardless of where and by whom it is produced. "Leakage" can also occur when there are more than one way to obtain a product and only one is covered by a cap (in a cap and trade system). For example, some industrial sources may attempt to generate their own power as a way to avoid the costs incurred by the larger energy producers under the cap and trade program. It's unclear what the ARB would intend to do (or could do) in this situation.
(i) Other Policy Directives To Watch For:
The ARB's design and enforcement of programs under AB32 will not only affect big business operations such as power generation and cement production. Instead, it will likely also impact fuel standards, development and land-use policies and electricity generation - which will in turn impact many other businesses. The effects of AB32 will also interact with other environmental legislation.
Tip 12: Can you show ARB how your own business would benefit the goals of California's AB32 or any other of California's climate change programs? Or, can you show how your own business would help others achieve these GHG reduction goals? Or, can you show how any of the ARB's proposed rules could conflict with other California climate change programs or initiatives? Businesses in sectors such as "renewable energy", "energy efficiency", "low-carbon fuels" or "cleaner power plants" should seriously consider having a positive story to tell the ARB regarding the benefits of their own business operations.
(j) Could The System Become Even More Stringent In Future?
AB32 commits California to reduce GHG emissions to 1990 levels by 2020. In addition, however, Governor Schwarzenegger also signed Executive Order S-3-05 in 2005 that committed California to a GHG reduction of 80% (below current levels) by 2050.
A growing number of scientists worldwide are stating that existing carbon cap goals (worldwide) are still too low and that any benefits that will be achieved under the present schemes may be still be "too little too late".5 In view of all this, the rules set forth by ARB under AB32 could potentially be changed to become more stringent in future. Should this happen, what we will probably see is an incredible amount of government and public investment into advanced low-carbon technologies. This future is very hard to predict, but under any scenario, continued tracking and documenting of your GHG emission reductions will be key.
(k) Avoiding Litigation:
Pressure to reduce GHG emissions is coming from ARB and also from shareholders, institutional investors, and the insurance industry. There have also been tort lawsuits files against utilities and auto companies regarding their contributions to global warming. Energy companies, auto manufacturers and coal mines are quickly becoming the next litigation targets (just like asbestos or tobacco was in the past).
Tip 13: Suggested ways to avoid litigation risk include: (1) doing a GHG emissions inventory; (2) reviewing your use of materials, construction practices, and supply chain; and (3) acquiring open space and maximize its uses.
Tip 14: Corporate Directors should: (1) determine and adopt corporate climate change strategies; (2) include climate change issues in diligence investigations and in the preparation of the corporations audited financial statements; and (3) provide periodic reports of climate change issues and shareholder proposals to board members.
(l) Considering Giving up on California and Moving out of the State?:
You can run - but you cannot hide. Moving part or all of your business operations out of California to avoid compliance with AB32 will likely not sound long term business strategy. California may be leading the way with AB 32, but many states and foreign jurisdictions are also developing similar climate change regulations. More states are being added by the month. At present, 50% of Americans are living in states that have proposed climate change rules.6 7 Even the US federal government is seriously considering climate change legislation.
In addition, American businesses will eventually have to adopt GHG reduction strategies if they have operations in many states or other countries (such as the European Union). The European Union's Emissions Trading Scheme (EU ETS) was adopted in 2003 and is the only large-scale system in operation worldwide for dealing with GHG emissions. It only covers carbon dioxide, but it covers 12,000 separate facilities in Europe. The European Union also recently announced a target to reduce GHG emissions by 20% below 1990 levels by 2020. (And to have a 20% share of renewable energy, up from 8.5% today). In March 2008, European Union Leaders threatened the US and China with trade sanctions if they wouldn't commit to "ambitious cuts" in GHGs by next year.8
(m) The "Take Home Message":
Tip 15: Your objectives in responding to any climate change or GHG reduction legislation is to: (1) reduce your emissions, and (2) get credit for it. The key to getting credit for it to is: (1) document your programs, and if possible (2) get involved now with the ARB and the Climate Registry in the development of these programs.
(n) Further Background Reading on Climate Change:
Here is a link to the PEW Reports on Climate Change. The ARB also has a link to these materials on their own website. They provide a good background about climate change: http://www.pewclimate.org/global-warming-basics/climate_change_101
1 See ARB's website on Climate Change: http://www.arb.ca.gov/cc/cc.htm
2 These are the same gases listed as Greenhouse Gases (GHGs) in the Kyoto Protocol.
3 At: http://www.arb.ca.gov/cc/ccea/reports/reports.htm
4 See: http://www.theclimateregistry.org/
5 See: "A Shift In The Debate Over Global Warming", New York Times, April 6, 2008 at: http://www.nytimes.com/2008/04/06/weekinreview/06revkin.html?_r=1&oref=slogin
6 For example, the "Western Climate Initiative" (WCI) is a regional (5 US states including California, 2 Canadian provinces and one Mexican state) carbon cap and trade system being set up to cover primarily the electricity sector.
7 Several northeastern states have formed a cap and trade system called the "Regional Greenhouse Gas Initiative" (RGGI). RGGI is a small cap and trade program involving only CO2 emissions from electric utilities (power plants).
8 "EU Tells US, China to Cut Emissions", San Francisco Chronicle, March 15, 2008.
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