June 23, 2021

Volume XI, Number 174

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Washington Adopts Economy-Wide Climate Legislation: “Cap-and-Invest” Approach Sets a Price For Carbon Emissions And Allows Washington To Join Existing Emissions Credit Markets

On May 17, 2021, Washington Gov. Jay Inslee signed the Washington Climate Commitment Act (CCA), which will create an economy-wide cap on greenhouse gas (GHG) emissions and create a system in which GHG credits are auctioned and can be traded. In combination with the Clean Energy Transformation Act, enacted in 2019, and the newly-enacted Clean Fuel Standard, the legislation sets a course for the state to decarbonize its economy by 2050.[1]

Key Takeaways

  • Beginning on January 1, 2023, Washington will adopt a cap-and-trade system for reducing GHG emissions economy-wide, with a declining cap on GHG emissions and a system for trading emissions credits that will tie into existing trading regimes in California, Quebec, and elsewhere.

  • Entities that emit more than 25,000 metric tons of carbon dioxide-equivalents will be subject to the cap, including industrial sources, in-state electric generation, natural gas utilities, and fuel suppliers.

  • The Washington Department of Ecology (Ecology) will establish an annual auction mechanism for the sale of GHG emissions credits, with the level established based on a benchmark established from recent emission levels, and with declining caps tied to the state’s GHG reduction goals.

  • The auction mechanism includes limits intended to ensure that GHG credits remain affordable, that prices are high enough to provide incentives for investments in decarbonization, and that prices are not distorted by market manipulation.

  • Following a “cap-and-invest” model, auction funds will be deposited into accounts that pay for transportation and climate projects, with approximately 50% of auction revenues going to each account.

  • Major emissions-intensive industries that are subject to foreign or out-of-state competition, dubbed “Emissions-Intensive Trade-Exposed” industries (EITE), receive specific statutory protections to prevent “leakage” of GHG-intensive industries to non-regulated regions, primarily a grant of GHG credits at no charge through 2035, with a declining cap on free allowances after that.

  • The legislation contains several mechanisms aimed at addressing environmental justice concerns, including, among others, a requirement that Ecology monitor pollution levels in overburdened communities, evaluate health impacts in those communities, and take further action if those communities do not benefit sufficiently from co-reductions in GHGs and criteria air pollutants. Agencies administering funds generated by the CCA are also expected to ensure that those funds are distributed according to several environmental justice criteria. 

  • Governor Inslee vetoed a portion of the CCA preventing it from going into effect until an “additive funding package” requiring at least a five cents per gallon increase in gasoline taxes is enacted by the Washington Legislature.

The Legislation in Detail 

  • GHG Cap and Reduction Mandates: The legislation directs Ecology to establish an emissions baseline based on total GHG emissions from covered entities from 2015-19, with an adjustment by October 1, 2026, to reflect the GHG emissions of newly covered entities. Each covered entity is then assigned a specific GHG allowance based on its proportionate share of GHG emissions compared to the baseline total. Allowances are then adjusted downward annually to achieve the GHG reduction goals set forth in RCW 70A.45.020. That statute sets progressively more strict state GHG reduction goals between now and mid-century, culminating in a statewide limit of five million metric tons of GHG emissions in 2050, equivalent to a 90% reduction below the state’s 1990 GHG emissions. The program may sunset in 2055 if Ecology determines that the 2050 emissions limit has been met for two consecutive years.

  • Covered Entities: The program will cover all entities that emit 25,000 metric tons of carbon dioxide equivalents annually, including entities who in the future build or modify facilities that exceed the metric ton threshold. Conversely, entities that are currently covered but reduce their emissions below the 25,000 metric ton threshold no longer have compliance obligations after the last compliance period in which they exceed the threshold. For electric utilities, natural gas utilities, and fossil fuel suppliers that import electricity or fuel supplies, the program covers the first Washington-jurisdictional importer if the fuel is consumed in Washington and results in emissions exceeding the 25,000 metric ton threshold. Railroads are also covered if they exceed the 25,000 metric ton threshold. Landfills are likewise covered entities if their emissions exceed the 25,000 metric ton threshold, although the legislature intends to adopt a program specific to landfills that would suspend application of the carbon cap. In the absence of such legislation, landfills will be subject to the carbon cap unless they capture at least 75% of their GHG emissions or produce renewable electricity or natural gas from their emissions. Entities that are otherwise not covered by the system may opt into it. Taken together, the covered entities are estimated to represent about 75% of Washington’s total GHG emissions.

  • Exemptions: Several categories of emissions are exempt from the cap, including emissions from the combustion of aviation fuels, combustion of fuels for watercraft if consumed outside the state, emissions from certain national security facilities, and emissions from the combustion of biofuels or biomass. There is also a limited exemption for fossil fuels consumed in agriculture. In addition, the Centralia Steam Plant, Washington’s sole remaining coal-fired plant, which will soon shutter its last generating unit under legislation adopted in 2011, is not covered by the CCA.

  • Compliance Obligations: Each covered entity must obtain GHG emissions allowances at least equal to its GHG emissions for each four-year compliance period. The first compliance period begins on January 1, 2023. Failure to comply may be punished by fines up to $10,000 per day.

  • Allowance Auctions, Rules, and Price Containment: Ecology will sell GHG emissions allowances in auctions, which may occur as often as quarterly. The legislation includes provisions intended to protect the financial integrity of the market by requiring bidders to post financial assurances sufficient to cover all bids. Similarly, the legislation requires Ecology to adopt rules to prevent manipulation of auction prices by, for example, prohibiting any one entity from cornering the market by obtaining more than 10% of the allowances in any one auction. In order to ensure that prices are sufficient to provide incentives for compliance, Ecology is directed to establish an auction floor price, which is to increase gradually. If auction prices threaten to fall below the floor price, Ecology must withdraw emissions allowances from auction and place them into a reserve account. In addition, allowances will be withdrawn and placed into the reserve account if a covered entity discontinues its operations in Washington or falls below the 25,000 metric ton threshold. The legislation also includes a reserve account that Ecology can tap to release extra allowances if auction prices threaten to exceed the ceiling price to be set by Ecology. The price ceiling must be set at a level that provides both cost protection to covered entities and creates incentives for accelerated compliance with GHG limits. Like the price floor, the price ceiling will escalate gradually over time. Extra allowances must also be released if new covered entities enter the auction.

  • Linkage to Other GHG Markets: The Act authorizes Ecology to enter into agreements that will link Washington’s emissions trading market with other GHG emissions trading markets so that emissions credits and offsets can be traded between these markets, provided that the linkage does not undercut the goals of the CCA. Thus, Washington’s program is likely to be linked with the existing GHG emissions markets in California, Quebec, and the Eastern states covered by the Regional Greenhouse Gas Initiative. Linkages are also possible with overseas markets such as those in Europe.[2]

  • Protection of Emissions-Intensive, Trade-Exposed Industries (EITE): To protect against “leakage” – the movement of industries subject to the Washington cap to jurisdictions without GHG regulations – the CCA includes provisions to minimize compliance costs for these industries. A broad swath of Washington’s major industries, ranging from pulp and paper to cement and computer manufacturing, are classified as EITE. These industries are provided with an allocation of free emissions allowances equal to their GHG emissions for the first compliance period, based on a benchmark set by measuring their GHG emissions in 2022. For the second and third compliance periods, the allocation of no-cost allowances will decline by three percent for each period for most EITE industries. If a new EITE industry meeting the 25,000 metric ton threshold opens a new facility in Washington, or an existing EITE industry expands its operations, that entity will be provided with no-cost allowances equal to its emissions during the first compliance period and be subject to the regime for EITE industries thereafter. The CCA directs Ecology, in conjunction with industry and environmental stakeholders, to propose legislation to further address EITE compliance. If that legislation is not adopted, the allocation of no-cost allowances will continue at the level set in the third compliance period.

  • Utilities: To protect utility ratepayers, the Act also provides for an allocation of cost-free emissions allowances to electric utilities, with the amount of allocation based on the utility’s forecast of its demand as approved by the Utilities and Transportation Commission for investor-owned utilities or by the governing board of publicly-owned utilities. The allowances issued may be used for compliance or consigned to auction by the utility, but if consigned to auction, the revenues generated must be used for the benefit of utility ratepayers, with first priority to mitigating the rate impacts of the Act on low-income ratepayers. Similar rules govern the allocation of no-cost allowances to natural gas utilities, but the rules governing auctions of allowances are far more prescriptive than for electric utilities. Beginning in 2023, gas utilities must consign at least 65% of their allowances to auction, with proceeds used to provide bill credits to low-income consumers, residential customers, and small businesses or used to support weatherization, decarbonization, or energy efficiency services. The requirement for consignment to auction increases by five percent per year for each year after 2023 until 100% is reached.

  • Offsets. The CCA also permits carbon offsets to be used for compliance with GHG limits, although a covered entity may use offsets for no more than five percent of its compliance obligation for the first compliance period (2023-27), and four percent in the second compliance period (2028-31), although Ecology may modify these limits to align them with requirements in other jurisdictions that are linked to the Washington market, to address air emission impacts in environmental justice communities, and for entities that are in violation of air emission permits. The CCA requires Ecology to ensure that any forestry-related offset program is consistent with HB 2528, which was passed into law last year. HB 2528 recognizes the forest product industry’s contribution to the state’s climate response, including the carbon sequestration benefits from forests and wood products. Projects generating offsets through, for example, capture of carbon in forestry projects, can generate offsets that can be sold to covered entities so long as the carbon reductions are permanent, quantifiable, verifiable, and enforceable. The CCA includes provisions for assistance to Native American tribes to generate offsets on tribal lands. It also includes a working group to assist owners of small forestlands to generate offsets. 

  • Auction Revenues: The auction is expected to produce revenues of approximately $480 million in the first year, rising to $580 million by 2040. The CCA directs that these funds be deposited into several new accounts that fund measures to reduce GHG reductions. These accounts are: (1) a “Carbon Emissions Reduction Account,” with funds to be spent on measures to reduce transportation-related GHG emissions; (2) a “Climate Investment Account,” where auction revenues are deposit and then distributed, 75% to the Climate Commitment Account and 25% to the Natural Climate Solutions Account; (3) a “Climate Commitment Account,” with funds to be expended on projects or financial support for renewable energy, including biofuels, biomass, and manure digesters for dairy farms, as well as energy storage, energy conservation, measures to reduce emissions in the agriculture sector, electrification and decarbonization of buildings, and support for workers to transition to new jobs in the clean energy and decarbonization sectors; (4) “Natural Climate Solutions Account,” with expenditures aimed at mitigating the impact of climate change on the state’s forests, estuaries, oceans, fisheries, and other ecosystems, as well as to harness the ability of these ecosystems to sequester carbon; and, (5) an “Air Quality and Health Disparities Improvement Account,” with expenditures aimed at reducing criteria pollutants and health disparities in disadvantaged communities. The CCA directs that $127 million from the first auction be deposited in the Carbon Emissions Reduction Account, with deposits in subsequent years to be in the range of $350 million. The remaining auction revenues are to be deposited in the Climate Commitment Account and the Air Quality and Health Disparities Improvement Account, with the intent that this account be funded at approximately $20 million per biennium. The intent is that these allocations would result in approximately 50% of auction revenues going toward transportation initiatives and the other 50% going toward other climate mitigation measures.

  • Environmental Justice — Reductions to Criteria Air Pollutants: To address concerns regarding environmental health disparities in certain communities, the Act also contains several provisions intended to reduce the disproportionate impacts from climate change and air emissions experienced by “overburdened communities” and “vulnerable populations.” To implement these provisions, Ecology must identify overburdened communities, deploy air monitoring networks in these communities to collect data to establish a baseline and assess progress in reducing criteria air pollutant emissions, and identify “high priority emitters,” which may become subject to stricter emissions controls.[3] In coordination with the Department of Health, Ecology must also review criteria air pollutant levels in each overburdened community, evaluate health impacts associated with these levels, and identify the “greatest contributors” to those emissions, including stationary and mobile sources. Then, Ecology, after consulting with local air pollution control authorities, must set ambient air quality “targets” as the National Ambient Air Quality Standards or at the air quality experienced by “neighboring communities that are not overburdened,” whichever is “more protective.” Ecology and the local air pollution control authorities are authorized to pursue emissions reductions to achieve the targets through various emissions control strategies, including more stringent air quality standards, emissions standards, or emissions limitations that may be mandated by enforceable orders issued to specific sources. To support these efforts, Ecology must also create a community engagement plan to ensure Ecology’s monitoring, source investigations, and health evaluations appropriately consider community input.[4]

  • Environmental Justice – Funding Targets: In addition to criteria air pollutant reductions, when allocating funding from various accounts created by the CCA, agencies administering these funds must conduct an “environmental justice assessment” and ensure that at least 35 percent of total investments “provide direct and meaningful benefits to vulnerable populations” in overburdened communities and 10 percent of investments must benefit tribes. The CCA includes specific criteria for how this funding should be distributed across the covered communities. 

  • Coordination with Environmental Justice Council: To ensure that implementation of the CCA follows best practices for environmental justice issues, the CCA requires reporting, recommendations, and ongoing advice from a newly created environmental justice council on most aspects of the regulatory program.

  • Rulemaking and Review: To carry out all these mandates, Ecology will be required to engage in extensive rulemakings in the next two to three years. The CCA includes authority for Ecology to engage in emergency rulemaking so that the administrative structure for the GHG cap and auction will be in place when the program is set to start up on January 1, 2023. The CCA also includes a provision requiring the Joint Legislative Audit and Review Committee to comprehensively review the program and recommend needed legislative changes no later than December 1, 2029. 

Outlook

The CCA, which is largely modeled on California’s cap-and-trade program is an ambitious attempt to decarbonize Washington’s economy almost completely, while at the same time addressing a range of environmental justice issues. In combination with the Clean Energy Transformation Act and the Clean Fuel Standard, the CCA, if successful, will change almost every aspect of economic life in Washington.


[1] The CCA also rescinds the Clean Air Rule, Chapter 173-442 WAC, a greenhouse cap-and-trade program that the Department of Ecology attempted to implement in 2016. As detailed in a prior B&D news alert, on January 16, 2020, the Washington Supreme Court invalidated a key provision of the Clean Air Rule, ruling that Ecology exceeded its statutory authority by seeking to regulate “indirect emitters” that contribute to emissions by importing and distributing products like natural gas. 

[2] Ecology must also complete an “environmental justice assessment” before entering a linkage agreement.

[3] Criteria air pollutants are those for which there is “National Ambient Air Quality Standard at 40 C.F.R. Part 50. The criteria pollutants are carbon monoxide (CO), particulate matter, ozone (O3) sulfur dioxide (SO2), lead (Pb), and nitrogen dioxide (NO2).” WAC 173-400-030(22). 

[4] The CCA utilizes several of the environmental justice tools and programs created by the Healthy Environment for All (HEAL) ActE2SSB 5141, which was also adopted by the legislature this year. These include community engagement plans, environmental justice assessments, agency funding goals, and guidance from a newly established environmental justice council. 

© 2021 Beveridge & Diamond PC National Law Review, Volume XI, Number 139
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