Leakage refers to a reduction in emissions of GHGs within the California State that is offset by an increase in GHG emissions outside the State. Risk of leakage is highest for industries in which production is highly “emissions intensive” (leading to high compliance costs) and trade exposed (i.e., that face competition from out-of-state producers).
Leakage risk for industrial sectors is determined based on an evaluation of industry emissions and trade exposure. The results of the analysis informed the allocation of additional allowances to reduce compliance costs and maintain incentives to produce in California.
One of the factors that is utilised to calculate the number of free allowances for each industrial covered entity is GHG emissions efficiency. Emissions performance standards are used that evaluate the efficiencies for similar operations in the same industrial sector. The more efficient facilities within a sector receive a larger percentage of their estimated compliance obligation for free as compared to less efficient facilities in the same sector.
Under the california cap-and-trade scheme two distinct types of allocation methodologies are developed: (1) product-based, which is tied to production activity and applies to specific industry sectors listed in the Regulation, including the oil and gas extraction and refining sectors; and (2) energy- based, which is tied to fuel use and applies to those industry sectors without a product- based benchmark, including the food processing sector. thus, California GHG emission trading scheme, like EU ETS, uses benchmarks to allocate free emission allowances, however – unlike EU ETS, where there are four types of benchmarks in use – under the California scheme there are only two: product and energy based.
The California cap-and-trade also makes use of the cap adjustment factor (an equivalent for linear reduction factor “LRF” in the EU ETS), which is a fraction that decreases to reflect a tightening emissions cap. For most sectors under the California scheme cap adjustment factor declines linearly each year through to 2020.
When in comes to free allocation of emission permits to industrial covered entities (i.e. the matter addressed under the European emission trading scheme by the Benchmark Decision) under the California cap-and-trade the percentages of allowances allocated for the purposes of industry assistance as well as the eligible industrial sectors are specified in Table 8-1 of subarticle 8 (Article 5: “California Cap on Greenhouse Gas Emissions and Market-Based Compliance Mechanisms” Subchapter 10 of Title 17 of the California Code of Regulations).
So, for the purposes of California legislation covered industrial sectors that are eligible for industry assistance specified in Table 8-1 are “Listed Industrial Sector” category and consequently eligible for an annual individual allocation on or before November 1, or the first business day thereafter, of each calendar year 2012-2019 for allocations from 2013-2020 annual allowance budgets.
Allocation to eligible covered entities are to be conducted using the assistance factors specified for each listed industrial activity found in Table 8-1 (methodology used is not encompassed by this post – for details see section 95891 of the above-mentioned legal act).
An industry assistance factor is a percentage based on an industry’s leakage risk.
Industrial sectors are divided into three leakage classifications:
1) high leakage, which covers among others oil and gas extraction, paper mills, chemical, glass and cement manufacturing as well as iron and steel mills;
2) medium leakage, which covers among others petroleum refineries and food, gypsum product, mineral wool and rolled steel shape manufacturing;
3) low leakage, such as pharmaceutical, medicine, aircraft manufacturing as well as support activities for air transportation.
It follows from the California carbon leakage legal architecture that for the first compliance period, 100% of allowances will be freely allocated to all industry sectors regardless of classification.
In contrast to free allocations for high leakage entities which remain at 100% through all compliance periods, for the second compliance period entities in the medium category are allocated for free only 75%, and in the low leakage 50% of their allowances.
During the third compliance period the said difference is even more contrasting as free allocation declines to 50% and 30% for medium and low leakage entities, respectively.
The salient, regulatory feature of the EU ETS carbon leakage list are periodic updates of the sectors covered. Will the California’s equivalent be also so frequently amended? We’ll see.
However, as regards potential future devopments the California Air Resources Board (ARB) annual report issued in January 2013 contains the mention that in collaboration with economic researchers from Resources for the Future and University of California at Berkeley, ARB will continue leakage research efforts to establish a baseline for how industries have historically responded to energy price changes and to identify metrics to evaluate future leakage risk. Any changes in leakage risk determinations would require regulatory amendments, which would need to be in place before industrial allocation occurs in Fall 2014 for the second compliance period.
Significant milestones anticipated by the said annual report in the first half of 2013 include updates to benchmarks and allocation assistance factors to provide more free allowances to existing sectors in the second compliance period to reduce the risk of leakage.
The California carbon leakage list, i.e. the above-mentioned Table 8-1 can be viewed in attachment.