California Adopts Dramatic New Greenhouse Gas Statutes


By Thomas R. Wood
9/15/2006

Emissions to be Reduced to 1990 Levels & Restrictions Placed on Long Term Out-of-State Power Purchase Agreements

The 2006 California legislative session will be known for more than just passing a statute mandating a maximum amount of time you can tie up your dog (3 hours), requiring a warning on cat litter packages not to flush it down the toilet (it hurts otters) and legalizing the growing of hemp (sorry--industrial grade only).  On the night of August 31, 2006, the California legislature made national news when Assembly Bill 32 (“AB 32”) was approved by the Assembly on a 47 to 32 vote.  The name of this bill, the California Global Warming Solutions Act of 2006, gives a subtle hint as to what the law is about.  A companion bill, Senate Bill 1368 (“SB 1368”), similarly addresses global warming, but from the perspective of generators selling power into the state.  Both bills were the subject of great controversy.  However, Governor Schwarzenegger has indicated that he will sign both bills, much to the consternation of many of his supporters in both California and Washington D.C.   This article offers a brief overview of the statutes and the potential repercussions in both California and other western states. 

Global Warming

Hardly anyone can be unaware of the debate that has raged over global warming in the last several years.  Global warming is the process whereby heat-trapping gases build up in the atmosphere and result in increased global temperature.  Although there is tremendous disagreement as to the speed of global warming and the extent of the impacts attributable to human activities, most agree that there is a direct link between increased emission of so-called greenhouse gases and long term global temperature.  In 2001 the United Nation’s Intergovernmental Panel on Climate Change concluded that the global average surface temperature increased by 1 degree F over the course of the twentieth century.  This increase is believed to have led to a variety of impacts, but it is worth noting that the speed of global warming of concern to many scientists is unrelated to the press hype that attributes all manner of short term temperature increases to global warming.  Nonetheless, many scientists believe that the phenomenon of global warming is causing significant changes over the long term to weather patterns and water levels.  As a result, many have been concerned about the potential long term affects of the phenomenon.

Several gases are considered “greenhouse gases.”  The gas that is most frequently associated with global warming is carbon dioxide—a natural byproduct of combustion.  However, other gases can act as greenhouse gases and are potentially much more potent at trapping heat than carbon dioxide.  Primary among this group are methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons and sulfur hexafluoride.  Several of these classes of gases are also stratospheric ozone depletors, although this is not an issue associated with carbon dioxide. 

Both Congress and EPA have made headlines over the past several years regarding efforts (or lack thereof) to regulate greenhouse gases.  Congress has witnessed multiple bills that would regulate greenhouse gas emissions on a national scale.  None of those bills has passed out of Congress to date, leaving a void in greenhouse gas policy that is increasingly being filled by the states.  EPA was petitioned to regulate carbon dioxide emissions from automobiles.  The agency refused to do so in a 2003 decision based on the conclusion that it lacked jurisdiction to do so, but noting that even if it had such jurisdiction it would not exercise it.  This refusal was unsuccessfully challenged in the federal courts with the D.C. Circuit issuing a 2-1 decision upholding EPA’s position on July 15, 2005.  In August 2005 the full court was asked to review the decision, but that request was denied in a 4-3 decision.  In March 2006 this decision was appealed to the Supreme Court, with the appellants’ brief filed on August 31st—the day after AB 32 and SB 1368 were passed. 

Proponents of greenhouse gas regulation (and even some foes) have repeatedly urged action on a national level so as to avoid a system of inconsistent local regulations.  A national solution is considered by many to make sense given that the issue is global and that many of the key sources of greenhouse gas emissions operate across state lines.  However, the absence of action has resulted in state action, such as California’s, which may make a more coherent national program more difficult to implement.

AB 32:  Return to the Past

The California bill that attracted the greatest public attention was AB 32 which requires a 25 percent cut in greenhouse gas emissions from within the state by 2020 in order to reduce emissions back to what they were in 1990.  This statute is striking in the way in which it vests extensive regulatory authority in the California Air Resources Board (“CARB”).  The statute tasks CARB with monitoring and regulating sources of greenhouse gases.   The first task for CARB will be to create a carbon dioxide emissions inventory.  The agency is instructed to begin with sources or categories of sources that contribute the most to statewide emissions.  Electrical generation is a key target of this inventory step, but it will also include other sources such as refineries and cement kilns.  By January 1, 2008 CARB must establish the 1990 carbon dioxide emission levels from the state.  This level will then serve as the program baseline with measures to be implemented to return emissions to this level no later than 2020.   The intent of the law is to ensure that California’s greenhouse gas emissions are capped permanently at the 1990 level.

The statute requires CARB to reach the 1990 baseline through limits on sources and categories of sources primarily responsible for greenhouse gas emissions.  An advance set of greenhouse gas emission reduction measures are required to be proposed no later than June 30, 2007.  These “early action” measures must be incorporated into regulations no later than January 1, 2010.  While the early action measures are being developed and debated, CARB is supposed to simultaneously develop a scoping plan for meeting the requirement of reducing greenhouse gas emissions to 1990 levels.  This plan is to be developed in consultation with other sate agencies, including the California Public Utilities Commission (“CPUC”).  This plan must be approved by CARB no later than January 1, 2009.  Based on this plan, CARB is supposed to then promulgate a broader set of measures by January 1, 2011 that will achieve the requisite reductions.  These rules must become effective no later than January 1, 2012.  The statute leaves it open to CARB whether the reductions will be achieved through source and source category limits or whether the plan could include a market based trading program such as that used to limit sulfur dioxide emissions at the federal level.   The statute explicitly requires CARB to establish de minimis thresholds for greenhouse gas emissions below which emission reduction requirements will not apply.

Two points are particularly striking about the statute.  First, the statute states repeatedly that cost-effectiveness must be considered in developing the emission reduction measures.   This mandate is of great concern to both industrial sources and consumer groups as there are tremendous concerns about how any measures could impact the cost of electricity, gasoline and other staples of the California economy.  Second, the statute requires that CARB act to minimize “leakage.”  Leakage is the term used to recognize that emitters can always choose to move out of the state thus transporting emissions of these global pollutants out of the state to the benefit of no-one.  How CARB can stem this flight of capital is unclear, but they are explicitly tasked to do so.

SB 1368:  Target on Coal

SB 1368 arguably garnered less attention but could have much more sweeping impacts on both utilities and consumers across the western U.S.  SB 1368 prohibits an electricity provider from entering into long term power purchase agreements unless the baseload generation complies with greenhouse gas emission performance standards.  The state contains much shorter timelines than AB 32, with the specific requirement that by February 1, 2007 the CPUC establish a greenhouse gas emission performance standard for baseload generation from investor owned utilities.  That must be followed no later than June 30, 2007 by a rule from the California Energy Commission establishing a similar standard for local publicly owned utilities.  These standards cannot be any higher than the greenhouse gas emission rate from a baseload combined-cycle natural gas fired plant. 

While the prohibition on future contracts is a potential shock to the utility industry in California, there are much more immediate and serious potential ramifications of the statute.  Although advertised as only impacting future contracts, SB 1368 also has potential impacts on existing generation assets.  The statute states that upon establishment of the greenhouse gas standards, any generation assets of a California utility must immediately comply with the standards.   While the devil will be in the detail of the rules, this strongly suggests that those remaining California utilities that own generation assets will have to find a means of demonstrating that all of their assets emit at the same level or less than a natural gas fired combined cycle generating plant.  Whether the standards will be phased in over time and whether a utility can net across all of its generation assets are among many crucial details to be worked out in the rulemaking. 

The key goal of SB 1368 was to shackle coal-fired generation assets that transmit power into California.  California, which does not have any coal fired power plants, imports approximately 20 percent of its electricity from coal-fired power plants in nearby states.  Although estimates vary, many believe that coal fired power plants emit roughly twice the greenhouse gases of a combined cycle natural gas fired power plant on a pounds per megawatt basis.  SB 1368 will clearly make it extremely difficult to sell conventional coal-fired generation into California for use as baseload power..

It is noteworthy that this statute does not extend to short term power purchases or spot market purchases.  These purchases can still be made from coal fired power plants that do not meet the newly mandated standard.  What this statute does ensure, however, is that new coal fired power plants being built to provide baseload power to California utilities will comply with stringent greenhouse gas limits.  Given the proliferation of new coal-fired power plants, many of which would like to use long term power purchase agreements with California utilities as a basis for obtaining financing, SB 1368 will likely have a material impact on plant design. 

Impact on California

Impacts within the state of California are predicted by many to be significant.  Implementation of this statute is anticipated to require a substantial increase in CARB’s regulatory staff.  This alone will have significant monetary impacts.  Much more serious economic impacts to many industry sectors are anticipated based on the mandate to require the installation of the maximum technologically feasible greenhouse gas emission reduction controls.  While cost-effectiveness is supposed to be taken into account, the overwhelming mandate is to reduce emissions to 1990 levels.  In the face of such a direct requirement, the cost-effectiveness evaluation will be relative.  Ultimately the decreases will have to be found somewhere.  This means that portions of California’s industry may well be driven out of state.  As noted above, AB 32 is statute intended to avoid such “leakage,” but it will be difficult to avoid.  While some companies such as Calpine and Pacific Gas & Electric have spoken in favor of the two statutes, others are not so pleased.  As a result of the anticipated negative impacts, a legal challenge to the statutes is already being discussed.

Pundits are already lining up to declare the winners and losers from SB 1368.  Early on the Senate Energy, Utilities and Communications Committee noted: “depending on the level of allowable greenhouse gas emissions and how existing plants' emissions are calculated, this bill could render many existing  conventional natural gas, co-generation, biogas, and biomass plants, as well as coal plants, ineligible for [long-term] contracts unless they improve their emission performance by rebuilding or adding pollution controls."  In apparent response to this concern, the bill was subsequently amended to state that all existing natural gas fired combined-cycle generation plants or such plants that have received a final permit to operate from the California Energy Commission, automatically meet the standard.  In addition, the bill was amended to state that for biomass, biogas and landfill gas generation the net greenhouse gas emissions from growing, processing and generating the electricity from the fuel source must be considered.  This will presumably allow such sources to take advantage of the lack of “new carbon” being placed into the atmosphere.  The extent to which these benefits are outweighed by fossil fuel emissions associated with planting, processing and harvesting the fuels will depend on the rules implemented.  It would be ironic if the standard made it more difficult to use power generation resources that are considered by many to be environmentally preferable.

In the face of expanded coal-fired generating capacity in the western U.S., there is some question as to whether the two statutes will incentivize the construction of cleaner coal or whether it will simply cause California to monopolize the more expensive, lower greenhouse gas emitting generating options while leaving the remaining states more dependent on coal.  The cost of power has nearly doubled in Germany as it moved to reduce its greenhouse gas footprint in response to the Kyoto Protocol.  California statutes clearly authorize utilities to recover costs associated with complying with the two statutes which means that industrial and residential consumers will be left footing the bill.  Utilities could purchase more power under shorter term agreements that are outside the scope of SB1368.  However, this will potentially leave the generation market less stable.  Even if the impacts of SB 1368 are mitigated in this manner, minimizing the impact of AB 32 may be more difficult.

Impacts Outside California

Multiple western states have established goals of reducing greenhouse gases by specific amounts or to particular baseline years.  In 2003, Oregon’s and Washington’s governors joined California’s governor to endorse the idea of  adopting coordinated strategies to address greenhouse gas emissions.  When California adopted carbon dioxide standards for automobiles, Oregon and Washington followed suit.  It is quite possible that these and other states could now follow suit and adopt statutes similar to AB 32 and SB 1368.  Therefore, states nationwide have more than a passing interest in the California legislation.

As noted above, SB 1368 is going to increase the competition, and therefore the cost, of lower greenhouse gas emitting baseline generation.  Most states rely heavily on coal-fired power for their baseload needs and peak and mid-term needs are satisfied through more expensive natural gas fired and oil fired resources.  If many states leap on the California bandwagon it would be very difficult for the market to respond to the need for a significant surge in lower greenhouse gas emitting baseload power in just a few years.  As prices were bid up, the use of natural gas for generating baseload power would become more attractive, increasing the economic pressure on other industries that are dependent on natural gas and increasing the need for new natural gas supplies.

There are sharply divided opinions as to how AB 32 and SB 1368 will impact California.  Many groups have indicated a belief that the California economy can still grow vibrantly after the implementation of the two statutes.  However, many fear that the increased costs associated with the statutes will drive many businesses out of the state.  Were other states to adopt these programs, the same concerns about business and consumer impacts would similarly apply.  Many anticipate that California’s actions will result in increased pressure on the federal government to act.  However one feels about the debate, a unified national policy seems clearly better than inconsistent actions by a few states.

Copies of AB 32 and SB 1368 can be found at Stoel Rives’ web page:  www.stoel.com.

Stoel Rives will present a webinar addressing the new California greenhouse gas statutes on September 21st.  Information about the webinar is available at: www.infocastinc.com/greenhouse/home.htm

For Additional Information, Contact:  Tom Wood at 503-294-9396.  Tom is a partner at Stoel Rives LLP who helps industrial clients across the Western United States obtain permits and comply with the myriad requirements of state and federal environmental regulations. 


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