Attachment A
Attachment B
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COM/MP1/rbg Date of Issuance 10/22/ 2008

Decision 08-10-037 October 16, 2008

BEFORE THE PUBLIC UTILITIES COMMISSION OF THE STATE OF CALIFORNIA

Order Instituting Rulemaking to Implement the Commission's Procurement Incentive Framework and to Examine the Integration of Greenhouse Gas Emissions Standards into Procurement Policies.

Rulemaking 06-04-009

(Filed April 13, 2006)

FINAL OPINION ON
GREENHOUSE GAS REGULATORY STRATEGIES

TABLE OF CONTENTS

FINAL OPINION ON GREENHOUSE GAS REGULATORY STRATEGIES 22

ORDER 296296

ATTACHMENT A

Parties that Have Filed Comments in Phase 2 of Rulemaking 06-04-009

ATTACHMENT B

Compilation of Figures Showing Greenhouse Gas Modeling of California's Electricity Sector

FINAL OPINION ON
GREENHOUSE GAS REGULATORY STRATEGIES

1. Summary

The Global Warming Solutions Act of 2006 (Assembly Bill (AB) 32) caps California's greenhouse gas (GHG) emissions at the 1990 level by 2020. Meeting this target will require an 11% reduction from current emissions levels and about a 29% cut in emissions from projected 2020 levels on a statewide basis. AB 32 directed the California Air Resources Board (ARB) to adopt a GHG cap on all major sources to reduce statewide emissions to 1990 levels by 2020.

The electricity and natural gas sectors will play a critical role in achieving this ambitious goal. Indeed, ARB's Climate Change Draft Scoping Plan envisions that the electricity sector will contribute at least 40% of the total statewide GHG reductions, even though the sector currently creates just 25% of California's GHG emissions. This is before considering the additional emissions reductions that are projected to result from a GHG emissions allowance cap-and-trade system, if such a system is adopted and implemented. The electricity sector is expected to reduce its emissions further due to its participation in such a market-based system. While this decision demonstrates a path to achieve a disproportionate share of emissions reductions from the electricity sector through programmatic measures, we urge ARB to pursue all cost-effective measures within other sectors.

The electricity and natural gas sectors are vital to California's economy and have many unique characteristics. The electricity industry has a particularly complex market structure and the California Independent System Operator (CAISO) is in the midst of developing and implementing significant changes to wholesale energy markets.

The California Public Utilities Commission (Public Utilities Commission) and the California Energy Commission (Energy Commission) have undertaken this collaborative proceeding to develop and provide recommendations to ARB on measures and strategies for reducing GHG emissions in the electricity and natural gas sectors. This effort provides ARB with the benefit of the two Commissions' collective knowledge of the electricity and natural gas sectors and experience implementing the programmatic measures that will be the cornerstones of emissions reductions: energy efficiency and mandates that increase California's reliance on renewable energy sources. We retained consultants (Energy and Environmental Economics (E3)) to conduct scenario analyses and modeling to assist in our understanding of the potential contributions from, and impacts on, consumers in the electricity and natural gas sectors, from both programmatic measures and market-based approaches. There has been extensive stakeholder participation through a series of workshops, en banc hearings, and symposia, with all parties provided opportunities to participate and to file several sets of comments and legal briefs during the proceeding.1

Today's decision is the second policy decision to be issued pursuant to this effort. In an earlier decision, Decision (D.) 08-03-018 issued in March 2008, we provided our initial GHG policy recommendations to ARB. We emphasized the need for both programmatic and market-based mechanisms to reduce emissions in the electricity and natural gas sectors. We also identified the appropriate point of regulation for the electricity sector, should the ARB decide that a cap-and-trade program for the State is warranted. Today's decision goes further with information about the potential reductions and cost estimates associated with different policy scenarios, and the potential consumer cost impact of various cap-and-trade design scenarios.

We emphasize, as we did in D.08-03-018, that it is ARB's role to determine whether the implementation of a cap-and-trade program in California is the appropriate policy. The role of the two Commissions in this proceeding is to inform ARB regarding the potential impacts of various design elements on the electricity and natural gas sectors for the options ARB is evaluating, including additional programmatic mandates as well as cap-and-trade design. Our analysis is intended to inform and supplement, not supplant, ARB's AB 32 implementation process.

In today's decision, we make a set of interrelated recommendations to ARB regarding GHG regulations for the electricity sector and, to a lesser extent, the natural gas sector, which constitute our best judgement at this time, based on the extensive effort undertaken in this proceeding. However, our work is not finished and much remains to be done. We acknowledge that many uncertainties remain and the underlying analysis here, though extensive, is not definitive. We fully anticipate that new information will develop over time and that the current analysis may need to be updated to reflect innovations in technology, as well as revised assumptions for inputs such as forecasted fuel prices, demand forecasts, and technology costs. Moreover, additional modeling may be needed to evaluate market design elements and other factors not analyzed in the course of this proceeding.

As discussed throughout this decision and summarized in Section 8 below, numerous important implementation details will require additional consideration. Further, as ARB examines other sectors of the California economy in more detail and the Western Climate Initiative continues to develop, we may find it appropriate to revisit some of the recommendations made herein.

If a comprehensive federal or international market-based program develops, the design elements and their impacts on California would also need to be analyzed carefully. While some modeling of regional energy markets was conducted in this proceeding, a thorough assessment of the impacts of the Western Climate Initiative cannot be undertaken until its membership and market rules are finalized. In addition, modeling being undertaken by ARB of a multi-sector carbon market will provide context for our assessment of the impact of cap-and-trade on electricity markets. Ultimately, a multi-state, multi-sector market should be measured against the principles that underlie this Decision: environmental integrity, equitable treatment of all market participants, and overall cost containment. Additionally, we cannot yet know the impact of the global financial crisis.

Therefore, we submit this Decision to the ARB with the recommendation that it be viewed, not as a static document, but rather our assessment based upon the best information and analysis available at this time. We recognize that both our analyses and the conclusions we draw from them may need to be revisited as new information emerges.

The two Commissions will continue to analyze collaboratively the issues related to AB 32 and, as further information becomes available, will assess whether any of the recommendations included herein should change. We will provide further recommendations to ARB, as appropriate, as its implementation process proceeds.

1.1. The Need for Both Mandatory Emission Reduction Measures and Market-based Regulations

In D.08-03-018, we stated that the most prudent avenue for addressing California's climate change issues is to pursue both regulatory and market approaches to achieve significant GHG reductions. We are in strong agreement with ARB's Draft Scoping Plan, which calls for aggressive energy efficiency programs, obtaining at least 33% of California's electricity from renewable sources, and increased reliance on combined heat and power (CHP) facilities as principal strategies for reducing GHG emissions. We agree with ARB that a multi-sector cap-and-trade program that provides access to additional GHG emissions reduction opportunities through linkage with a West-wide regional cap-and-trade system should also be considered. We emphasize that the foundation for success to reduce GHG emissions in the electricity sector is more energy efficiency and further development of renewable energy sources such as wind, solar, geothermal, and biomass.

The two Commissions are committed to this two-fold strategy. We will aid ARB with additional analysis and modeling on how market-based elements would impact the electricity sector. And we are already aggressively pursuing the mandatory emissions reduction measures envisioned in this Decision. We are actively and collaboratively expanding the energy efficiency, renewable, and CHP programs that are under our existing jurisdiction.

1.2. Energy Efficiency: The Cornerstone of our Approach

Energy efficiency is the least expensive strategy available to reduce GHG emissions significantly in the electricity and natural gas sectors. The State's efficiency standards and the utilities' energy efficiency programs have made a significant difference in California energy consumption. California's per-capita electricity use has remained almost flat over the last 30 years, demonstrating the success of a variety of energy efficiency programs and cost-effective building and appliance efficiency standards. We believe that, in order to meet the GHG reduction goals of AB 32, more energy efficiency is required. With intensified efforts in building and appliance standards and utility programs, and with new strategies and technologies, the State can capture all cost-effective energy efficiency.

In this decision, we reaffirm our commitment to a bold and aggressive approach to realize significant new reductions in energy consumption and GHG emissions via energy efficiency measures. Recent actions by both agencies demonstrate this commitment. In September 2008, the Public Utilities Commission established energy efficiency goals for the investor-owned utilities through 2020 that are consistent with the AB 32 goals. In D.08-09-040 issued in Rulemaking (R.) 08-07-011, the Public Utilities Commission adopted the California Long-Term Energy Efficiency Strategic Plan setting forth a statewide roadmap to maximize achievement of cost-effective energy efficiency between the years 2009 and 2020. The Energy Commission has endorsed the Strategic Plan's vision and strategies as consistent with and complementary to its own findings and recommendations in its 2007 Integrated Energy Policy Report. The two Commissions' policy determinations have set the stage for our overarching goal of achieving sustained market transformation in the major end-use sectors across the State. Achieving this goal will require continual evolution in utility program design. The Energy Commission's standards-setting authority and its development of new efficiency technologies are essential to attainment of this goal. The two Commissions will work together to achieve our energy efficiency goals in the coming decade.

1.3. Renewable Energy: Stepping Stone to 2050 Goals

Renewable resources are essential for reducing GHG emissions and reaching AB 32 goals, and are a crucial aspect of the future low-carbon economy that will be required to meet California's 2050 climate goals. Over the last three decades, the State has built one of the largest and most diverse renewable portfolios in the world. Currently, about 11% of the State's electricity is from renewable energy sources, including solar, wind, geothermal, and biomass. The investor-owned utilities have enough renewable energy under contract and in negotiation to deliver 20% of their electricity from renewable sources soon after 2010. We believe that a target of 33% of the State's electricity from renewables by 2020 is achievable if the State commits to significant investments in transmission infrastructure and key program augmentation.

Both Commissions, along with the CAISO and publicly-owned utilities, are members of the Coordinating Committee of the Renewable Energy Transmission Initiative, to identify and help develop bulk transmission to deliver renewable energy to consumers. In addition, we are working to overcome contracting, permitting, and grid integration challenges to ensure that 33% of our electricity from renewables becomes a reality.

1.4. Market-based Regulations Complement and Reinforce Mandatory Measures

In addition to aggressive regulatory measures that maximize energy efficiency and expand renewable energy development, D.08-03-018 recommended that ARB consider a complementary market-based approach - a cap-and-trade program - to capture additional cost-effective reductions of GHG emissions. The adoption of a cap-and-trade program would depend on ARB finding that the program would meet certain conditions as specified in Part 5 of AB 32. In D.08-03-018, we also recommended that for the electricity sector the "deliverers" of electricity to the California grid - generally in-state power plant operators and entities that import power to California - have the compliance obligations under the cap-and-trade program.

In a cap-and-trade program, electricity deliverers would be responsible for surrendering permits (allowances) for emitting carbon dioxide (CO2) and other GHGs equal to their actual emissions. The deliverers would obtain allowances either through administrative distributions, through auctions, or through a combination of these approaches, as discussed further in this decision. We also expect that a secondary market would develop for allowance trading. The total supply of emission allowances would decline over time and this, in conjunction with the mandatory measures adopted by ARB, the two Commissions, and other governing entities, would ensure that the overall targets for 2020 and beyond are met. Under a cap-and-trade program, electricity deliverers would have the option of reducing their own GHG emissions or purchasing emission allowances from others who have made emissions cuts beyond their obligations, so long as the total emissions stay below the cap.

In D.08-03-018, we found that a well-designed cap-and-trade approach would have these attributes:

· Environmental integrity: The emissions cap ensures the targeted level of GHG emissions will be achieved with real reductions.

· Flexibility: Trading allows emitters to purchase additional emission rights, if they are needed.

· Incentive to reduce: Emitters may profit from aggressively reducing emissions by selling their excess allowances.

· Innovation: The program encourages creative approaches to achieving reductions at lower costs.

A cap-and-trade approach can reduce emissions at the lowest social cost by providing regulated entities with flexibility to procure the least-cost emission reductions available. However, such programs must be designed carefully and must include built-in safeguards, long-term monitoring, and strict enforcement to ensure a stable market and one which achieves real, verifiable, and permanent reductions in GHGs.

By recommending a combination of regulatory and market approaches, we seek to combine the best aspects of both regulation and market forces in a mutually reinforcing framework. While regulatory programmatic strategies are the foundation of our recommended strategy, a market would provide a backstop to the programs, should they fail to deliver sufficient GHG emissions reductions. Having a binding cap on emissions can ensure that the goals are met and that the ingenuity and creativity of the private sector are unleashed to find new and lower-cost alternatives to providing reductions.

1.5. This Decision's Recommendations for the Electricity and Natural Gas Sectors

As the next step in this collaborative proceeding, we build on our initial decision and ARB's Draft Scoping Plan to provide further recommendations to help achieve GHG targets in the electricity and natural gas sectors. In addition, this decision makes certain suggestions and outlines a variety of options for ARB to consider in deciding how to design a program and strategies to reduce emissions in these sectors. It focuses on the unique characteristics and needs of the electricity and natural gas sectors. The two Commissions have combined their expertise on the cost and feasibility of various aspects of the AB 32 framework as they relate to the electricity and natural gas sectors, in consultation with the CAISO, which is engaged in extensive wholesale market redesign for electricity, and with important assistance from E3, modeling consultants to the Public Utilities Commission.

1.5.1. Energy Efficiency and Renewables Resources

California's electricity and natural gas sectors will play a major role in meeting the State's GHG reduction goals for 2020 and beyond. The electricity sector produces about one-fourth of California's GHG emissions and is being asked, in ARB's Draft Scoping Plan, to contribute about 40% of the total GHG reductions that are expected to come from direct emission reduction measures. In addition, depending on the allowance allocation policy among sectors in the proposed cap-and-trade program, the electricity sector could be asked to contribute additional reductions.

To help achieve these ambitious cuts in GHGs, this decision reaffirms our commitment to energy efficiency standards and programs, and recommends an aggressive expansion of regulatory programs to pursue all cost-effective electricity and natural gas energy efficiency in the State, which represents nearly a doubling of efficiency goals. Energy efficiency is the cheapest and most effective resource for reducing GHG emissions in both the electricity and natural gas sectors. We recommend that ARB require comparable investment in energy efficiency from all retail providers in California, including both investor-owned and publicly-owned utilities, and assist in the implementation of the California Long-Term Energy Efficiency Strategic Plan to maximize savings opportunities Statewide.

We also recommend that California's reliance on renewables be expanded so that at least 33% of the State's electricity needs are met by renewable resources by 2020. It is not necessary that this goal be met exclusively through retail provider mandates. We support the California Solar Initiative and expansion of the Renewable Portfolio Standard (RPS) requirements, and also the exploration of other means of achieving increased renewables, including voluntary private sector investment and additional distributed renewables programs. To achieve the Statewide goal, we recommend that each retail provider be required to meet 33% of its electricity load using renewable energy sources by 2020. We believe that these goals are achievable with a serious commitment by the State to overcoming challenges such as transmission access and system integration.

Extensive modeling was conducted to calculate emissions, costs, and potential average rate impacts of multiple 2020 scenarios. Due to the substantial uncertainty associated with many of the model assumptions, we did not use the E3 model as a prescriptive tool but rather to obtain a general sense of the relative costs and emissions impacts of various policies, including efficiency, renewables, and several California-only (in-state electricity generation and imports) cap-and-trade allowance allocation options.

Overall, the electricity sector costs and rate impacts due to achieving 2020 GHG caps through more energy efficiency measures, greater use of renewable energy, and increased reliance on CHP may be significant but appear acceptable, against the backdrop of the economic and environmental costs of not acting to address the need to reduce GHG emissions. Total utility costs are expected to increase in excess of inflation between now and 2020 under all resource scenarios studied, including business as usual, due to load growth and expected real increases in capital and fossil fuel costs. At the same time, as described in Section 3.3.1, utility costs are actually expected to be less in the Accelerated Policy Case than under business-as-usual resource scenarios, largely due to the high levels of cost-effective energy efficiency we expect to achieve, which would offset the higher costs of renewable generation. However, with recognition of private customer costs, such as customer costs associated with the purchase of solar photovoltaic systems, the Accelerated Policy Case would be slightly more expensive than business as usual. This is all before taking into account the effects of a cap-and-trade program, which could have a large impact on consumer costs and rates, depending on the allocation of allowances or allowance value to the electricity sector as well as within the sector.

Average customer bills are estimated to be the lowest in the Accelerated Policy Case, consistent with the estimate of total utility costs. At the same time, average per-kilowatt-hour (kWh) retail rates would increase, because customers would purchase less electricity over which the utilities could recover their fixed costs. The actual impact of the rate increases would be felt differently by different types of customers: the rate increases may be more difficult for customers with little discretionary usage. However, customers with greater ability to take advantage of energy efficiency opportunities to manage their energy usage may see little or no bill increases.

The potential variability in customer impacts emphasizes the importance of well-designed programs, policies, and allowance allocation approaches to minimize overall consumer impacts.

1.5.2. Distribution of Greenhouse Gas Emission Allowances in a Cap-and-Trade Program

In considering how best to design a cap-and-trade program if one is adopted by ARB, we reviewed a number of approaches to the distribution of emission allowances, and considered extensive comments filed by the parties to the joint proceeding. Most of the focus of our work and parties' comments on allocation issues was on how to distribute allowances within the electricity sector.

Before turning to that issue, we address how allowances (or allowance value) should be allocated to the electricity sector in a multi-sector cap-and-trade program. We recommend that ARB assign allowances (or allowance value) to the electricity sector at the beginning of the cap-and-trade program in 2012 based on the sector's proportion of total historical emissions during the chosen baseline year(s) in the California sectors included in the cap-and-trade program (including emissions attributed to electricity imports). We recommend that, in subsequent years, allowance (or allowance value) allocations to each California sector in the cap-and-trade program be reduced proportionally, using the overall trajectory chosen by ARB to meet AB 32 goals by 2020. In this way, while the electricity sector may provide more than its proportional share of GHG emissions reductions through both mandatory programs and market-based reductions occurring due to the cap-and-trade program, the economic costs of the emissions reductions can be shared equally among all capped sectors. 2

Turning to allocation policy within the electricity sector, the criteria used to evaluate each approach included the ability to minimize costs to consumers, treat all market participants equitably and fairly, support a well-functioning cap-and-trade market, and allow reasonable administrative simplicity.

We examined potential approaches that would distribute allowances to electricity deliverers in proportion to their historical emissions or in proportion to the amount of electricity they deliver to the grid. We also considered auctioning of allowances, with the distribution of allowances or allowance value to retail providers in proportion to the historical emissions of their generation portfolios or in proportion to their retail sales. Other approaches that were considered include distributing allowances on the basis of economic harm (see Section 5.2.3 below) and distributing specified rights to purchase allowances at a set price (see Section 5.2.1.3). After considering the parties' arguments and the results of the analyses, we recommend that emission allowances be made available in a phased approach that allows parties to adjust their portfolios over time, minimizes wealth transfers, and ultimately has environmental integrity. This transitional process adds complexity, but better balances stakeholders' needs. We provide these recommendations to ARB:

· Beginning in 2012, 20% of the emission allowances allocated to the electricity sector should be auctioned, with 80% distributed administratively for free to electricity deliverers. The percentage auctioned would increase by 20% each year, so that by 2016, 100% would be auctioned.

· For the emission allowances distributed to electricity deliverers, the number of allowances given to individual deliverers should be determined using a fuel-differentiated, output-based allocation with distributions limited to deliveries from emitting sources, including unspecified sources. In determining the number of allowances for each deliverer, its output would be weighted based on the fuel source (such as coal or natural gas) of the electricity delivered.

· ARB may wish to retain a small portion of electricity sector emission allowances to fund statewide electricity programs consistent with AB 32.

· With the possible exception above, all of the electricity sector allowances that are to be auctioned should be given to the retail providers of electricity, on behalf of their customers. The retail providers should then be required to sell the allowances in a centralized auction undertaken by ARB or its agent. This would ensure open and equal access to allowances by all deliverers who require them.

· Each retail provider should receive all auction revenues from the sale of the allowances that were distributed to it. ARB should establish a centralized auction with safeguards to ensure that this result is obtained. If ARB cannot design an auction that is legally separated from other State revenues, we suggest an alternate mechanism be designed.

· The distribution of allowances to individual retail providers for subsequent auctioning should transition over time from being based initially on historical emissions in the retail provider's portfolio to being allocated based on sales by 2020.

· All auction revenues should be used for purposes related to AB 32, and all revenue from the auction of allowances allocated to the electricity sector should be used for the benefit of the electricity sector, including the support of investments in renewables, energy efficiency, new energy technology, infrastructure, customer bill relief (possibly through rebates), and other similar programs.

· The Public Utilities Commission, for load serving entities, and the governing boards, for publicly-owned utilities, should determine the appropriate use of retail providers' auction revenues consistent with the purposes of AB 32.

As described below, issues that warrant further consideration include the fuel-based weighting factors to be used for allowance allocations to deliverers, and whether additional steps are needed to ensure that allowance distribution policies do not impede new entrants, the voluntary market, or the achievement of cost-effective energy efficiency.

1.5.3. Treatment of Combined Heat and Power Projects

We recognize the value of higher fuel efficiency provided by CHP projects. In this decision, we consider ways to encourage CHP installations as a way to reduce GHG emissions and the manner in which GHG emissions from CHP projects should be regulated.

CHP projects that produce both electricity and useful thermal output offer a viable GHG reduction option. When compared to generating usable thermal output and electricity separately, their co-generation achieves greater fuel efficiency and emits fewer GHGs. We considered a number of options for addressing CHP as a strategy for reducing GHGs. While certain efforts are underway, we recognize that further investigation is necessary regarding market and regulatory barriers for CHP. We commit to working to develop rules, programs, and policies to achieve higher CHP goals.

We also consider the manner in which GHG emissions associated with CHP-generated electricity should be regulated, but do not address the regulatory treatment of emissions associated with CHP's usable thermal output. We encourage ARB to consider treatment of GHG emissions related to CHP's thermal output in a manner consistent with its treatment of thermal output from other sources in the commercial and industrial sectors. To ensure equitable treatment of CHP compared to other entities in the electricity market, we recommend that emissions associated with CHP-generated electricity be included in the electricity sector for GHG regulatory purposes, subject to a minimum size threshold. Conceptually, we recommend that CHP facilities be treated like deliverers for all electricity they generate that is consumed in California, whether the electricity is delivered to the grid or used on-site, and that CHP facilities also be treated like retail providers for the portion of their electricity that is used on-site.

With this conceptual framework, we recommend that the deliverer of CHP electricity delivered to the grid and the CHP operator for CHP electricity used on-site (recognizing that they are likely to be the same entity) be responsible for surrendering allowances for the portion of CHP-generated electricity delivered to the grid and the portion used on-site, respectively. To the extent that allowances are distributed for free to deliverers, the deliverer for CHP delivered to the grid and the CHP operator for CHP electricity used on-site should receive allowances on the same basis as deliverers of electricity from other sources.

We also recommend that ARB treat CHP operators comparable to retail providers for the portion of CHP-generated electricity that is used on-site. To the extent that allowances are distributed to retail providers, the CHP operator should receive allowances on the same basis as retail providers and should be required to sell the received allowances through the centralized auction undertaken by ARB or its agent.

1.5.4. Market Design and Flexible Compliance

In this proceeding, we reviewed market design and flexible compliance options that ARB could consider if it implements a cap-and-trade program. Maintaining environmental integrity for achieving AB 32 GHG emission reduction goals is the primary driver for market design. The market design should also allow for transparent allowance trading with many participants.

A number of characteristics of the electricity sector, including unpredictability of emissions year-to-year due to variable weather and hydrologic conditions, make flexible compliance options particularly important for this sector. Flexible compliance options can reduce costs by allowing entities to pursue alternative means of meeting GHG emission requirements. Parties commented on a broad range of issues including price triggers and other safety valves, linkage with other GHG emissions allowance trading systems, compliance periods, banking and borrowing of GHG emissions allowances, penalties, and offsets.

Many uncertainties remain about the framework for GHG regulation. ARB is still in the process of determining many aspects of the overall GHG program as well as features of the potential cap-and-trade market design. Therefore, we cannot yet make specific recommendations on some aspects of market design, pending more detailed knowledge of the overall regulatory framework.

The market design and flexible compliance elements should maximize liquidity and transparency in a GHG emissions allowance market, while maintaining the integrity of allowances and the emissions cap. To achieve these goals, we support bilateral linkage of any California cap-and-trade program with other states in the Western Climate Initiative to create a multi-sector, regional cap-and-trade market. A regional or, better yet, national or international market is critical in order to broaden opportunities to find real, cost-effective emission reductions, to smooth the effects of localized weather and hydrologic variations, and to avoid leakage3 and other potential drawbacks of a California-only system.

We encourage ARB to allow unlimited participation in the cap-and-trade system, with adequate safeguards to prevent market manipulation and anti-competitive behavior. To ensure environmental integrity of the system, no safety valves or price triggers - such as increasing the number of allowances automatically when a set price is reached - should be offered.

Overall, we conclude that flexible compliance mechanisms should be designed taking into account the scope of the GHG trading market and the emissions reductions required of market participants, elements that are not yet determined. More detailed rules and regulations for most flexible compliance options will be needed after the market details become known.

For now, to increase flexibility and reduce compliance costs, we encourage ARB, should a multi-sector, regional cap-and-trade market develop, to establish three-year compliance periods to allow entities that deliver electricity from emitting generation resources time to implement emission reducing measures. We similarly encourage ARB to allow unlimited banking of GHG emissions allowances and offsets. We encourage ARB to allow limited use of high-quality offsets that comply with AB 32 requirements, without any geographic restrictions. To be acceptable, offsets should be real, additional, verifiable, permanent, and enforceable.

We recognize that further work is required in this area and propose that the Commissions work with ARB to evaluate the usefulness of other market design and flexible compliance features.

1 Attachment A to this decision contains a list of parties that have filed comments in this collaborative proceeding, and the related acronyms used herein.

2 As described in more detail in Section 4.3.2.1 below, it may be appropriate to increase allowance allocations to the electricity sector to reflect increased electricity demand and GHG compliance obligations due to electrification in other sectors, including the transportation sector.

3 Section 38505(j) added to the California Health and Safety Code by AB 32 defines "leakage" to mean "a reduction in emissions of greenhouse gases within the state that is offset by an increase in emissions of greenhouse gases outside the state."

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