With California’s ground-breaking climate legislation, AB 32, now in the implementation phase, the Los Angeles County Economic Development Corporation and its seven-county Southern California Leadership Council recently released a report entitled, “The AB 32 Challenge: Reducing California’s Greenhouse Gas Emissions.” VerdeXchange News is pleased to present the following excerpts from the report’s introduction and a chapter entitled, “Business Principles for Implementing AB 32.” The report was written by Gregory Freeman, Nancy D. Sidhu, PhD, and Myasnik Poghosyan.
INTRODUCTION
California has embarked on a bold effort to reduce the state’s greenhouse gas emissions and its contribution to global climate change. Under AB 32, the state will attempt to lower its emissions of greenhouse gases to 1990 levels by 2020, and 80 percent below that threshold by 2050. California’s growing population makes these ambitious targets, particularly the latter, which will likely require a reshaping of everyday life. How the state will proceed—whether the reductions will be achieved through command-and-control regulations or some sort of market-based mechanism—is still up in the air, but will be decided within the next 12 months.
This report, an introduction to the challenges posed by the AB 32 targets, was prepared for the Southern California Leadership Council’s Future Issues Committee with the goal of helping the full council make an informed decision on whether & how to tackle the issue. The report does not dwell on the scientific links between climate change and greenhouse gases. Rather, the focus is on how the state will pursue greenhouse gas reductions and the likely consequences for the state economy.
The report consists of seven sections...Section six introduces business principles for implementing AB 32 (developed by a statewide coalition), and considers their economic rationale...
VI. BUSINESS PRINCIPLES FOR IMPLEMENTING AB 32
Implementation of AB 32 means changing the way Californians live and do business, perhaps dramatically. The process of adapting to AB 32 will occur over a period of years. Change of this magnitude increases uncertainty and will impose costs and other burdens on those [firms and individuals] charged with implementing the new rules and regulations. Thoughtful design of the goals and processes is needed to turn the AB 32 targets into reality. They also can help to reduce uncertainty and costs.
The AB 32 Implementation Group, a coalition of businesses throughout California, developed the following set of business principles to guide regulators and other interested stakeholders as we move the initial regulatory design process. The principles reflect a certain point of view. Given the targets set by AB 32, (1) how can California achieve the targets for reducing emissions at the lowest cost? Simultaneously, (2), how can we maintain our strong California economy and avoid potential harm? Finally, (3) are there ways for California business firms to grow and profit by reducing greenhouse gas emissions?
1. Reduce global emissions and keep jobs in California
• In designing the implementation plan for AB 32, California must give equal emphasis to retaining jobs and reducing emissions, since focusing exclusively on one will almost certainly cost it the other. [Favoring job retention suggests policies that do little to reduce emissions; blindly reducing emissions could cause firms (and jobs) to leave the state.]
• In the worst case, a company leaves California, moving the associated jobs and emissions to another state or country with a less intrusive regulatory regime. The state loses jobs without any net global reduction in emissions. New emissions may even increase if new jurisdiction is less stringent than California.
• What types of businesses may leave the state? Firms in “export” industries sell goods and services to out-of-state customers. Key export industries in California include: high technology, direct international trade (goods moving through the ports and carried out-of-state by rail and truck), tourism, defense/aerospace, agriculture/food processing, motion pictures, and higher education. Many of these firms (except for tourism and education) can serve their customers from locations in or out of California. Thus, they are the most likely candidates to leave if the AB 32 regulations prove unduly burdensome.
• Developing a strategy to mitigate the risk of employment losses to other locations is a good idea. At minimum, California needs to sign up other states and countries to play by the same rules we do. This will be crucial as a matter of program effectiveness, i.e., actually reducing global emissions. Also as a matter of fairness: California firms want to compete with firms in other regions based on economic factors, not their willingness to tolerate pollution.
2. Provide regulatory certainty
•By its very nature, the process of developing from scratch an AB 32 implementation plan raises concerns about the types of changes business firms will have to make—to their plants, their equipment, and their operating methods—and the costs of making such adjustments.
•Unfortunately, the risk of undertaking any investment rises with the level of uncertainty. An uncertain regulatory structure can create a riskier investment climate, which translates into lower capital expenditures and potentially lower economic growth.
• Put simply, firms will be reluctant to make expensive (even billion-dollar) investment decisions if they fear some or all of the activity will be penalized or disallowed after the new equipment is in place.
• This issue is particularly important for firms in the capital-intensive energy industries, which will likely be required to spend enormous amounts to bring their emissions into compliance with the new regulations.
• Beyond that, all California firms face the added uncertainty and burden that come with operating in a ‘first-mover’ regulatory environment. Europe has introduced a cap-and-trade market for greenhouse gas emissions, but that program is still working the kinks out. In any event, California will be the first in the U.S.
3. Use sound scientific methods
• The whole field of GHG involves serious scientific issues. Both the science and the measurements it requires are new. Rigorously established, “cold, hard facts” are in particularly short supply. As an important example, the GHG inventory, the analytic foundation of the AB 32 rule-making process, was until recently a work in progress. The 1990 baseline GHG level (the target mandated by AB 32) has changed at least four times since 1997, with estimates ranging from 425 MMT CO2 to 468 MMT CO2.
• In this situation, the state needs to take care in setting new emission standards, rules, and policies. Caution is required to avoid unintended consequences. Again, business firms’ biggest fear would be wasting large amounts of time, effort, and money on new equipment that doesn’t meet the target.
• The state is in an uncomfortable position, having to establish new emission reduction strategies to reach targets—not yet well measured—from a starting position that is only a little better understood. Any rules developed during the initial round will, of necessity, be no better than “first, best guesses.”
• It is important not to run ahead of the science, developing rules that are unsupported by the fact. The scientific method, based on sound research and proper test of hypotheses, offers the most powerful tool for evaluating proposed policies and emissions standards.
• All of these considerations suggest a concerted program of basic and applied research and development should be undertaken, funded jointly by the state and the private sector as appropriate. Knowledgeable scientists in the private sector and the state’s universities both should participate. The research could be followed by small-scale demonstration projects to test (and measure!) the effectiveness of various proposed new emissions reduction strategies.
4. Impose only cost-effective and technologically feasible regulations
• Everyone agrees reducing global greenhouse gas emissions will be expensive. There are ways, however, to minimize needless expense and the cost burdens borne by California’s residents and business.
• Cost-benefit analysis must be the standard for evaluation proposed regulations. The appropriate metric is: How much carbon will we keep out of the atmosphere for each million dollars in costs? Use of this or a similar metric will focus efforts first on the lowest hanging fruit, and then on the next-lowest-cost solutions, etc.
• Minimizing the total program costs in this way will minimize the overall burden on Californians and is critical to keeping jobs in California. Otherwise, we will be penalizing firms for locating here.
• A separate but related issue concerns technological feasibility. New technology may be required the meet the goals of AB 32. If so, it makes sense to address the unknowns first through systematic research and development, and then develop testable strategies to resolve questions of cost-effectiveness.
5. Promote innovation and market-based strategies
• The advantage of market-based solutions is that they allow the state to set targets and then let individual businesses figure out what are their most cost-effective GHG reduction strategies. This general approach helps to minimize the program’s administrative burden on the state and simultaneously allows businesses to minimize their compliance burdens.
• As an example, consider a firm with a fleet of buses or trucks. The company must decide how best to replace its old equipment. Assuming some form of market for carbon, the company could choose a) to buy the same buses as before and purchase carbon offsets; b) to buy cleaner vehicles that allow the fleet to meet (barely) the GHG emissions standards; or c) to buy zero- or ultra-low emission vehicles that allow the fleet to exceed its reduction target and then sell the resulting credits/offsets. Note that reducing CO2 emissions has become an important factor in vehicle purchasing decisions, but the decision of how to pursue the reductions remains with the company. Note further that the purchasing decision might change from one year to the next depending on the prices of the different types of vehicles and carbon credits/offsets. The extra flexibility provided by reliance on the price/market system reduces the inherent risks of the GHG reduction program to the firm.
• Why should the AB 32 program promote innovation? First, because California-based firms may generate new lower-cost methods to reduce GHG emissions. Also, given the state’s first-mover position, these firms can “export” to other states and nations the new products they develop. And finally, because growing businesses generate more jobs.
• There are a number of ways the AB 32 program can promote innovation. As stated above, the state can fund R&D research into GHG reduction strategies. It can sponsor contests to generate new ideas. A DARPA program to develop driverless vehicles (driven by computer) found it cost-effective—and improved results—to switch from R&D contracts to offering prizes for the winners of annual competitions.
• Currently, there is considerable venture capital money available for “green technology” projects. The state might consider supporting some of these private-sector efforts with grants and perhaps testing facilities.
6. Minimize and fairly allocate compliance costs
• Adherence to the first five business principles should result in minimization of the costs of the AB 32 program.
• The different costs associated with developing and researching the AB 32 targets include: 1) the cost of devising and administering the GHG reduction program, which will be borne by the state and its taxpayers. 2) the costs of complying with the new rules and regulations, which will be born largely by the private sector. And possibly, 3) the costs of GHG-related research and development programs, which would be borne by both public and private sectors.
• The benefits of the greenhouse gas reduction program will be distributed across the state. It’s only fair to distribute the costs as widely as possible. Public costs fit that prescription, as they are borne by taxpayers in general.
• However, the composition of the carbon inventory in California necessarily means the initial burdens of compliance will fall more heavily on some sectors than on others unless explicit strategies are developed to shift some of the compliance burdens elsewhere.
• Designing an appropriately broad distribution of compliance cost burdens will be difficult, but the task is important for reasons of equity and to support the California-based industries involved. One strategy for the regulated industries would be to spread the compliance costs over all customers—commercial, industrial, and residential. Strategies for the independent energy and other industrial sectors will require some creative thought but, for example, could involve GHG surcharges on certain activities to fund some private-sector compliance costs.•••