Environmental Leader

“It is one of the happy accidents of the federal system that a single courageous state may, if its citizens choose, serve as a laboratory, and try novel social and economic experiments without risk to the rest of the country.” (New State Ice Co. v. Liebman, 285 U.S. 262, 311 (1932) (dissent).

California embodies Justice Brandeis’s famous metaphor of states as the laboratories of democracy, particularly when it comes to progressive environmental regulation.  California’s climate change law, the Global Warming Solutions Act of 2006, also referred to as Assembly Bill (or “AB”) 32, is the state’s most recent laboratory experiment.  AB 32 mandates a statewide reduction in greenhouse gas (“GHG”) emissions.  The California Air Resources Board (“CARB”), which must implement AB 32, has rolled out a plan that includes 68 different measures designed to achieve the statutory goal of reducing GHG emissions to 1990 levels by 2020.  Two of the most important programs – namely, the low carbon fuel standard (“LCFS”) and the cap-and-trade program – may not survive legal challenges.  On December 29, 2011, a federal district court in California granted a preliminary injunction preventing the state from enforcing the LCFS.  Many believe that California’s cap-and-trade program will be the next casualty of litigation.  Thus, it appears that California’s climate change experiment is not off to the best of starts.

LCFS Blocked

Adopted by CARB in 2009, the LCFS is intended to reduce GHG emissions by reducing the “carbon intensity” of transportation fuels used in California.  Carbon intensity is a measure of the lifecycle GHG emissions associated with a fuel.  The LCFS assigns carbon scores to each type of fuel (based on the source of a fuel, how it is manufactured and how it is transported), and ethanol from the Midwest received a higher score than chemically identical ethanol produced in California.  The reason is that Midwestern ethanol must be transported greater distances to be used in California than California ethanol.  Thus, the GHG emissions associated with transporting ethanol from the Midwest into California would be higher than ethanol produced in California.

Separate lawsuits by ethanol producers, truckers and petrochemical refiners challenged the LCFS in federal district court asserting that it violates the Commerce Clause of the federal Constitution.  The U.S. Constitution grants Congress the power to regulate interstate commerce, and a rich body of case law holds that states may not interfere with interstate commerce (under the so-called “dormant Commerce Clause doctrine”).  The Plaintiffs asserted that California’s LCFS discriminates against out-of-state sources of ethanol because it ascribes a higher carbon score to it, making it more expensive than in-state ethanol.

In a December 29, 2011 decision, US District Court Judge Lawrence O’Neill agreed with the plaintiffs and issued a preliminary injunction barring enforcement of the LCFS.  Rocky Mountain Farmers Union v. Goldstene, No. CV-F-09-2234 (E.D. Cal., 2/29/11). (In a separate opinion, Judge O’Neill granted summary judgment to the National Petrochemical & Refiners Association, who also argued that California’s low-carbon fuel standard violates the dormant commerce clause and discriminates against out-of-state and foreign crude oil sources.  National Petrochemical & Refiners Ass’n v. Goldstene, No. CV-F-10-163 (E.D. Cal. 12/29/11).  Judge O’Neill noted that the LCFS “offends” the dormant Commerce Clause.  California has appealed the decision to the Ninth Circuit, and observers predict the ruling will eventually reach the U.S. Supreme Court.

Cap-and-Trade

The ruling against California’s LCFS does not bode well for California’s cap-and-trade regulation.  California’s cap-and-trade scheme is similar to the one that the U.S. Congress failed to pass in 2010.  California sets a cap on the amount of carbon dioxide and other GHGs that utilities, refineries, chemical companies, cement plants and other businesses may release.  It then issues allowances to those firms, which authorize them to emit a certain amount of GHGs.  If a regulated firm exceeds its GHG emission allowance, it must either acquire allowances from other regulated entities or offset the excess emissions by undertaking carbon footprint-reduction measures or by acquiring a carbon offset from a third party.  Because some companies can rein in their emissions more easily or at less cost than other businesses, they can profit by selling extra allowances through the market to companies that find the cost of pollution-control technology prohibitive.  In theory, this should ensure that GHGs are reduced at the lowest possible cost.

The first phase of the program commences January 1, 2013.  Electric utilities, importers of electricity and facilities in specified energy-intensive industries (such as refineries, cement kilns and other manufacturing facilities) will be required to possess an “allowance” for each metric ton of GHGs it emits.  Allowances will be allocated for free to some entities, but must be purchased by others.  The primary means of allocating allowances will be by auctions, in which CARB has set minimum prices of $10 per metric ton.  CARB will award the allowances to the highest bidders.  In 2015, the cap-and-trade program will expand to include importers and distributors of natural gas, transportation fuels, and other fossil fuels used in California.

The blogosphere is positively atwitter with theories for invalidating California’s cap-and-trade program, beginning with the dormant Commerce Clause doctrine.  The cap-and-trade scheme’s imposition of compliance obligations on imported electricity (i.e., the requirement to acquire allowances) arguably is an impermissible burden on interstate commerce. Other legal theories for challenging the cap-and-trade scheme include: the cap-and-trade allowance purchase obligation constitutes a tax prohibited by Proposition 26; and the Federal Energy Regulatory Commission has exclusive jurisdiction over interstate electricity under the Federal Power Act, which preempts CARB’s authority. A burden on interstate commerce can be justified if there is a compelling state interest, such as protection of health and safety.  Such a compelling interest, however, will be hard to prove in the case of California’s cap-and-trade scheme.  California’s share of global GHG emissions is minuscule, and reducing those emissions will not materially affect climate change, much less the well-being of Californians.

The US should act in a comprehensive, economy-wide manner on climate change.  A patchwork approach as reflected by California’s cap-and-trade law will only lead to a confusing morass of inconsistent laws and uncertainty for businesses while making only negligible dents at best in cumulative global greenhouse gas emissions.

Peter L. Gray is a partner with McKenna Long & Aldridge LLP, where he chairs the Environment, Energy and Product Regulation department.

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