Late yesterday, the California Air Resources Board (ARB) released a series of draft changes to the rules implementing the state’s cap and trade program under AB 32.

The most significant change in the draft rules is the addition of allocation details for covered entities. The draft rule changes provide an explicit allocation for sources in the utility sector. For industrial sources, allocation will be done using a benchmark formula, which is also provided in the revised regulations.

In addition, the package of rule changes included for the first time language on the early action offset credit program, including conversion of these credits to ARB-issued offsets that can be used for compliance. More details on these provisions, as well as other significant changes are below, and these changes can be compared to our report on the regulations first approved by ARB in December 2010.

ARB will take initial comments on the draft rule modifications over the next week. On Friday, July 15, the Board will hold a workshop to discuss the proposed changes, and it anticipates formally publishing them the week of July 18.

Once the rule changes are officially introduced, the public will have 15 days to review and comment on the package before it is adopted. This process, known as “15 day rule changes”, permits ARB to fine tune the AB 32 regulations before they must be finalized in October of this year. We anticipate at least one additional set of 15 day rule changes before the summer is over.

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

Allowance Budget

• As reported last week, ARB proposes to eliminate the allowance budget for calendar year 2012. The delay in the start of the program does not impact the statutory reduction targets or the annual caps. Obligations for 2013 and subsequent years do not change, and the 2020 target will not be pushed back.

Annual Surrender Obligation

• The annual deadline for surrender of compliance instruments has been changed to November 1, from either May 15 or July 15, depending on when the compliance entity was required to report emissions.

Auctions

• The schedule of allowance auctions has been changed. ARB will hold only two auctions in 2012 (August 15 and November 14), and will begin holding quarterly auction in 2013. Starting in 2013, auctions will be held in the second month of each calendar quarter.
• The amount of future vintage allowances that will be available at auction was increased to 10% from 2%. This should aid in future compliance, as well as increase liquidity in future year allowances.
• The purchase limit for future vintage allowances for a single entity was raised from 10% of allowance on offer to 25% for each auction. The 10% limit remains in place for current year vintages offered in the auction.

Holding Limits

• ARB clarifies that allowances held in limited use accounts will not be included within an entity’s holding limit and that the holding limits will be applied separately to allowances that can be used for current compliance and allowances for future compliance.
• A new formula for calculating the holding limit for current year compliance is proposed. It is:
  • Holding Limit = 0.1*Base + 0.025*(Annual Allowance Budget – Base) (In which: “Base” equals 25 million metric tons of CO2e and “Annual Allowance Budget” is the number of allowances issued for the current budget year.)
• A new formula for calculating the holding limit for future compliance periods is proposed. It is:
  • Holding Limit = 0.1*Base + 0.025*(Compliance Period Budget – Base) (In which: “Base” equals 75 million metric tons of CO2e and “Compliance Period Budget” is the number of allowances issued for the future compliance period from which the allowance were sold at the advance auction.)

Offset Provisions
Quantitative Usage Limit

• The quantitative usage limit on offsets (8%) will now apply to an entities’ biannual compliance obligation for the years 2013-2014 and triennial compliance obligation for future compliance periods, rather than the annual compliance obligation. This should provide compliance entities with greater flexibility in their use of various compliance instruments.

Early Action Credits (EACs)

• The draft rule changes provide, for the first time, rules for creating early action offset credits and converting these credits into ARB-issued offsets. Major components of this program are as follows:

• Verification Requirements
  • Project Operators/Owners must register with the Air Resources Board prior to being issued ARB offset credits
  • EACs submitted or exchanged for ARB offset credits must meet the following requirements:
    • EACs must be verified by an ARB-accredited verification body that is different from the verifier that conducted verification under the EAC Program
    • One desk review is required by an ARB-accredited verifier for all eligible data reporting years. The desk review must include:
      • Original project documentation, including all verification reports
      • Review of data checks
      • Verification body will assess the verification reports and conclude with reasonable assurance they concur or do not with the EAC Program verifications
        • Non-forestry projects must submit a Positive, Qualified Positive or Adverse Verification Statement
        • Forestry project must submit a Positive or Adverse Offset Verification Statement  
      • Verifier must attest in writing to ARB it has conducted the review and whether it concurs with the findings
      • Project operators/owners must provide all EAC program verification reports
  • If the ARB-accredited verifier concludes the offset documentation includes a material misstatement, in which reductions were misstated by 3% or more, or the offset misstatement equates to greater than 25,000 mtco2e (the smaller of the two) , then the verifier must conduct a full verification pursuant to the regulatory verification requirements for all years seeking ARB offset credits.
  • The verification for all years can be conducted by the same verifier doing the desk review and can be one verification for all years.
  • The ARB-accredited verifier must submit a verification report for all serialized EACs issued to the project for all years eligible.

• Issuance Ratio of EAC to ARB Offset Credit
  • Early action credits under the CAR U.S. ODS, livestock methane, and urban forestry protocols can be converted on a one for one basis. (Note: On a recent stakeholder conference call, ARB staff discussed the possibility of shaving livestock methane CRTs by 13% during the conversion process to ARB-issued offsets. This change has not been included in the proposed 15 rule package.)
  • CAR forestry protocol credits can be converted on a one for one basis provided that:
    • The percentage of the issued ARB offset credits is placed in the Forest Buffer Account pursuant to the project specific risk rating calculation in the ARB Forestry Protocol
    • Forestry buffer pool credits may come from Project Operators, the EAC Program or Forestry CRT holders

• Conversion of Forestry 2.1 Projects into ARB Forestry Projects
  • Forestry projects that have been verified under CAR’s 2.1 protocol and wish to convert into an ARB forestry project must recalculate their baseline and sum all the carbon reductions and enhancements from project commencement up to the transition pursuant to the following formula:
    • A = # of offsets awarded pursuant to the new baseline
    • B = # of CRTs issued from project start to transition
    • Project operator/owner must subtract B from A
    • If the different is positive ARB will issue ARB offset credit for the difference plus each EAC
    • If the difference is negative ARB will issue ARB offset credit just for A

• Early Action Credit to ARB Offset Credit Conversion Process
  • ARB will notify the EAC Program of the number of ARB offset credits
  • EAC Program will retire that amount
  • ARB will issue ARB offset credits into the Holding Account of the EAC holder
  • All EAC holders must prove ownership of the EACs and must be registered with the ARB
  • EAC projects have two years (2013-2014) to transition projects to ARB protocols
  • EAC projects transitioned to ARB protocols will begin new initial crediting periods

Buyer Liability

• This provision, which allows ARB to invalidate offset credits after issuance (and submission of the credits for compliance), has been controversial with compliance entities and offset project developers. ARB has proposed a handful of changes and clarification to the original language, which includes:
  • ARB has eight years from the time of issuance to consider invalidation of an offset credit. Previously, there was no limitation.
  • The criteria for invalidation has been clarified in the following ways:
    • Language has been changed  from “errors” in offset project documentation to “information provided to ARB…(that is) not true, accurate, or complete”.
    • Instances where errors in documentation overstated the amount of reductions by more than 5%.
    • ARB determines that the offsets have already been used in another voluntary or mandatory program.
  • ARB has provided more detail on the review process for invalidation, including notification to responsible parties.
  • Entities that have used invalidated offsets for compliance now have 90 days to replace these credits, a change from 30 days in the original regulations.