The California Air Resources Board (ARB) released this week its second series of draft changes to the rules implementing the state’s cap and trade program under AB 32.

The proposed revisions reflected extensive public comments and, in part, sought to clarify allocation for the refining sector, calculate the compliance obligation for first deliverers of electricity, streamline the conversion process for early action offsets, and tighten language on holding limits, conduct of trading, and buyer liability for offsets.

The latest revisions build upon an initial round of changes to the AB 32 regulations, which were proposed in July. More details on the most recent proposed changes are below.

ARB will take public comments on the draft rule modifications until September 27. The Board is scheduled to consider the proposed regulations for final approval on October 20, and the finalized regulation must be filed with the California Office of Administrative Law by October 28.

If you have any questions regarding the proposed rule changes, their impact on the market, or would like to transact in the market, please contact our US Carbon Markets team at: +1 415.963.9137, +1 914.323.0265, or uscarbon@evomarkets.com.

AB 32 15-Day Rule Changes: Round 2

Compliance Penalty

• Offsets can now be used to meet up to one-fourth of the untimely surrender penalty, as long as offset usage does not violate the quantitative usage limit for the compliance period.

Allocation

• Allowances will be placed into the accounts of electric distribution utilities and industrial facilities in November of the year prior to the allowance budget year being distributed.
• There will be a special allocation in July 2012 of 2013 vintage allowances, which should enable spot trading of California carbon allowances (CAA) by next summer.

 Refining Allocation

• ARB proposed changes to the refining sector allocation methodology. The change was in response to stakeholder comment that the previously proposed method would result in an unequal initial distribution of allowances among refiners.  Initially, the allocation methodology was focused on a simple output barrel benchmark that evaluated the emission intensity of primary products from the sector – aviation gasoline, motor gasoline, kerosene-type jet fuel, distallate fuel oil, renewable liquid fuels, and asphalt.  It was argued that the methodology would result in unequal distribution of allowances due to differences between “complex and simple” refineries, or new, efficient refineries and older refineries.  
• The new approach will allocate allowances based on both the simple output barrel method plus the Solomon Energy Intensity Index, which is a measure of energy efficiency within the refining sector. ARB believes this two-pronged approach will more evenly spread allowance distribution across California refining facilities.
• Noteworthy in the rule change, the ARB cited that maximizing Offset Credits will likely lead to competitive advantage for more efficient facilities.  Purchasing offsets at a discount to the allowance price will enable refiners to bank excess allowances or sell them in the market and use Offsets in their place for compliance. The same trading opportunity is expected to be taken advantage of by variety of regulated entities under California’s program. 

Auction

• Allowances unsold at auction (both current and future year vintages) will be returned for re-auction, rather than sent directly to the Reserve. These unsold allowances can be re-auctioned after two consecutive auctions settle above the auction reserve price. The limit on the amount of re-auctioned allowances is 25% of the number of allowance already designated for the auction.
• The purchase limit in the first compliance period for industrial facilities was raised to 15% from 10%.

 Holding Limits

• ARB clarifies that the holding limit is calculated using “requests for transfers” of a compliance instrument from one entity’s account to another – not “transactions”, which are considered an agreement to transfer compliance instruments. This change distinguishes between secondary market trading in forward contracts or futures and actual transfers, and it should ease regulatory restraints on market liquidity.

 Conduct of Trade

• Changes to this section of the regulations sought to clarify the regulatory review process for transfers of compliance instruments. The ARB Executive Officer will review requests for transfers to ensure they meet basic criteria for reporting. Deficient transfer requests will be given three days to resubmit the request before transfers are executed. Transfer requests that are deemed deficient after transfer occurs will be given five days to resubmit the request, or the transfer will be reversed. Previously, ARB only had the authority to reverse trades, which would have forced entities to automatically unwind trades in the event of a deficiency.

Offsets

Early Action Credits (EACs)

In general, changes were made to rules governing the conversion of EACs to ARB-issued offsets streamlining the process and making it easier for the holders of credits to affect this conversion. Key provisions include:

• New language will allow the holders of EACs in non-forestry projects, in addition to project operators and authorized project designees, to register projects for conversion. This provides credit buyers the ability to manage the conversion process without relying solely on the project owner.
• The desk review of EACs submitted for issuance as ARB offsets has been streamlined. New language requires the verifier simply review the verification statement for issuance under an approved early action protocol and eliminates a threshold of a 3% material misstatement as a trigger for full re-verification.
• For forestry projects, ARB stipulates that credits used for the projects buffer account under the Climate Action Reserve must be transferred to ARB for similar use under their offset program. Vintage 2001-2004 offsets can still be used as part of the forest buffer account, but they will reside in a segregated ARB account and can only be used for compliance in the event of an unintentional reversal.

Buyer Liability

Significant changes were made to provisions allowing ARB to invalidate offsets after issuance. Important elements of these changes include:

• Reduction in the statute of limitations for invalidations from ozone depleting substances projects (ODS) to three years from five years.
• Reduction in the statute of limitations for invalidations from livestock and forestry projects to three years from eight years, if these projects undergo a full re-verification within three years of issuance.
• Invalidation can only occur if the overstatement of reductions is more than 5%, the project activity was not in accordance with federal, state, or local environmental regulations, or the credits had already been used under another voluntary or mandatory program.
• ARB also now has the ability to invalidate only the amount of credits actually overstated, and these invalidations will be imposed on all holders of credits from the project in question on a pro rata basis.
• Entities that used invalidated credits for compliance now have six months to replace these credits.