California Extends Cap-and-Trade Program Through 2045

In an 11^th-hour legislative push, California lawmakers passed AB 1207 and SB 840 over the weekend of September 13, extending the state's greenhouse gas reduction program through 2045 and rebranding it as “Cap-and-Invest” to underscore its role in funding climate initiatives. The program, originally set to expire in 2030, imposes a declining cap on emissions across major sectors and requires regulated entities to reduce emissions or purchase emissions allowances.

The extension introduces significant updates, including changes to allowance allocation, updates to the use of carbon offsets, and a revamped spending plan for auction revenues. These reforms align with California's broader climate objectives of achieving net-zero emissions and a fully decarbonized economy by 2045.

Legislative Details

• AB 1207: Reauthorizes and rebrands the cap-and-trade program; modifies allowance distribution; and establishes new offset rules.
• SB 840:  Overhauls the spending framework for auction proceeds.

Both bills passed after lawmakers extended the session beyond its scheduled adjournment on September 12. Governor Gavin Newsom worked with lawmakers during the legislative process and is expected to sign the legislation before the October 13 deadline.

Key Changes and Implications

Allowance Distribution

• Shift from Gas to Electric Utilities: AB 1207 directs CARB to transition free allowances from gas utilities to electric utilities by 2030. The stated rationale is to support electrification and reduce electricity costs, while maintaining affordability for gas customers through bill credits.
• Industrial Protections: Emissions-intensive, trade-exposed sectors (e.g., cement, pulp and paper, refining) remain protected from allocation changes.
• Small Business Credits: CARB is no longer required—but may choose—to provide direct credits to small businesses and certain retailers.

Electric Utilities

• Additional free allowances must be credited to ratepayers, with payments concentrated in up to four peak billing months.
• Utilities must allocate 5% of allowance revenue to the California Transmission Accelerator Revolving Fund to expand grid capacity.

Offsets

• Offset use remains capped at 6% of compliance obligations starting January 1, 2026, through 2045, with 50% delivering in-state benefits.
• CARB must study offset effectiveness by 2026 and recommend strategies to boost in-state projects.
• CARB must update all offset protocols by 2029 and review them every five years thereafter.
• A new Compliance Offsets Protocol Task Force will guide approval of new protocols, including nature-based climate solutions (NBS) such as reforestation, wetland restoration, and soil carbon sequestration.
• The Task Force will also examine ways to lower offset project transaction costs and increase California landowner participation, such as through jointly developed projects.

Auction Revenue Spending

• Ends existing continuous appropriations and establishes fixed allocations:
  • $1 billion annually for High-Speed Rail.
  • Dedicated funds for clean transportation, housing, wildfire resilience, clean energy, and climate innovation.
• Legislature retains discretion over $1 billion per year for additional priorities.
• National and International Context

California's move comes amid federal gridlock on climate policy and positions the state as a global leader in carbon market design. By extending Cap-and-Invest through 2045, California provides long-term market certainty for market participants and sets expectations for businesses regarding long-term emission reductions.

Client Takeaways and Next Steps

The extension of California's Cap-and-Invest program introduces significant compliance and strategic considerations for regulated entities and market participants. Companies should:

Review Allowance and Emission Reduction Strategies

• Assess how the shift in free allowance allocation may affect your cost exposure and procurement plans.
• Develop or update emission reduction strategies to align with California's long-term decarbonization goals and minimize compliance costs.
• Consider whether to adjust hedging strategies or participate in upcoming auctions.

Evaluate Offset Opportunities

• With new requirements for offset protocols and the introduction of nature-based climate solutions (NBS), companies should review existing offset portfolios and explore opportunities for in-state or NBS projects.

Engage Early on Project Development

• Entities interested in developing or investing in NBS projects should begin evaluating feasibility, financing, and compliance pathways now, given anticipated demand and evolving protocols.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.