What The Heck Is 'Cap-And-Trade,' Anyway?

California lawmakers on Monday will take up an extension of the state’s cap-and-trade program—a vote Gov. Jerry Brown has called the “most important” of their lives.

But cap-and-trade is also a complex regulatory system, which lacks the public appeal of other high-profile issues. A quick, informal survey on the street in Sacramento displayed a lack of clarity about the program.

"I don't remember studying that much economics, but I know it has to do with economics," says Sophia Goldsby.

“Something offsetting green credits, carbon credits?" guessed Ryan Shope.

"I believe you can trade if you use too much in your industry," said Rod Hanchett. "There’s a cap on it and you can trade whatever you have extra."

Even the governor admits cap-and-trade is hard to understand.

“I would venture that there aren’t five people in here who can give us a lecture on cap-and-trade," Brown said Thursday in a Senate hearing full of lawmakers, lobbyists, environmentalists and business representatives.

It’s a complicated program, but a relatively simple concept

Lawmakers took greenhouse gas emissions, which had no monetary value assigned to them, and put a limit on the total amount allowed from various industries. This is the cap. Each ton of emissions requires a state credit, and because there’s now a limit on the number of credits, the credits have value.

“That’s basic laws of supply and demand,” says Stanford energy law professor Michael Wara, who has consulted with lawmakers on the extension measure. “What cap-and-trade does is sort of apply that framework to the problem of pollution.”

The cap gets lower each year, which—provided the supply is tight enough—should increase the price. As California allots fewer emissions credits, industries must figure out how to make do with the total number that is allowed.

Companies can either reduce their emissions—so they need to purchase fewer credits—continue to obtain them from the state, or trade other companies for more credits.

The current cap-and-trade program took effect in 2012 and expires in 2020. The measure would extend the program through 2030, although with several changes.

The governor is seeking a two-thirds majority of lawmakers to pass the measure. Nearly all Republicans announced on Thursday they would not support the measure.

A few more details

California sells credits at quarterly auctions in a partnership with Quebec, which has its own cap-and-trade scheme.

The state typically estimates it will receive $500 or $600 million at each auction, although the number has varied significantly in the past year, falling as low as about $10 million. Many analysts attribute the fluctuating revenue to uncertainty about the program’s future.

The state uses the funds for a variety of clean energy projects, as well as the main funding source for the high-speed rail project.

Instead of purchasing credits or reducing emissions, companies have a third alternative: They can invest in offsets—in- or out-of-state projects that separately reduce emissions. This option can be used for 8 percent of a company’s emissions—a number that drops under the extension bill.

The program accounts for about 15 percent of the state’s total emission reductions, according to the California Air Resources Board. In addition to Quebec, Gov. Brown believes California’s program could serve as a model for other states and nations, some of which could ultimately link their programs, creating a wider emissions market. The state has consulted with China and Mexico, as they develop their own cap-and-trade programs.