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California Carbon

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California Carbon

In 2006, then-governor Arnold Schwarzenegger passed AB32, California’s Global Warming Solutions Act. In this mandate, the state is required to cut its current greenhouse gas emissions to 1990 levels by 2020. One way the state is trying to achieve this goal is through the introduction of a cap-and-trade program developed by the state’s Air Resources Board (ARB). This multi-sector scheme covers some of the state’s biggest polluters, covering more than 85% of California’s total greenhouse gas emissions. An entity must emit at least 25,000 metric tons of CO2e in a given year to be held liable under this program. This includes the state’s largest electric utilities, manufacturers and refineries. Over 360 companies covering 600 installations will be participating in the system with the overall scheme ending in 2020.

The program officially began in 2012 with compliance beginning in 2013 for the first phase when companies will be held responsible for their emissions. The first compliance period ends in 2014, covering the state’s electric utilities and manufacturing facilities.

The next phase begins in 2015 and ends in 2017, where the cap increases 2.5 times. The reason is that the second period incorporates transportation fuels (such as the gasoline you use to drive your car) and home heating oils (like natural gas). The third and final phase then begins in 2018 and wraps up in 2020 with the program finally ending.

In order to comply with your obligation, an entity may use allowances, which are ARB-issued permits to pollute and are both handed out for free and auctioned off by the state. The auctions are scheduled quarterly in 2013 onwards and a reserve price is built in to ensure a minimum price for each allowance sold. The auction platform is run by Markit and the Financial Services Administrator is Deutsche Bank. One must register with the Compliance Instrument Tracking System Service (CITSS) in order to hold possession of any such compliance instruments. As part of the process, California runs its own Know Your Customer (“KYC”) check and BGC is the only environmental brokerage firm that runs its own KYC checks on all of its clients to get setup to do business with. The true-up period for each annual compliance year is November 1st of the following year. During this true-up, at least 30% of the compliance year’s emissions must be surrendered in the form of offsets and allowances. At the end of the compliance phase, the entire phase’s emissions must be reconciled depending on the shortfall from prior years.

As just mentioned, another vital tool within the program for compliance is offsets. Offsets are emissions reductions made offsite that can count towards one’s compliance obligation. The benefit of offsets is that they are traditionally cheaper and serve as a cost mitigation tool for compliance entities in dealing with the added expense of carbon. Only 8% of one’s annual compliance obligation can be used with offsets, and thus far there are only 4 approved methodologies for offsets in which credits can be created, and they must all occur within the United States. These include emissions reduced from1) the flaring of livestock manure 2) ozone-depleting substances being destroyed and 3) carbon stocks such as forestry storing carbon from the atmosphere. Offsets carry an element of invalidation risk-where ARB can come invalidate these credits based on factors such as additionality concerns, double-counting or fraud-thus leaving the need for some sort of replacement mechanism to substitute the lost credit. Offsets are transacted on a bilateral basis.

Futures contracts for allowances trade on the InterContinental Exchange (ICE), one of the world’s largest trading bourses, thus adding transparency and liquidity to the market. Contracts are traded based on their delivery and vintage dates and trade in lots of 1,000 allowances per contract. BGC Financial L.P. is a regulated Futures Commission Merchant (FCM), which is regulated with the Commodity Futures Trading Commission (CFTC). BGC carbon brokers are Series 3 registered to conduct carbon futures transactions on exchanges, such as ICE.

On an Over-the-Counter (OTC) basis, BGC specializes in complex compliance structures to help facilities manage risks associated with the developing carbon market. Our long lasting connections with many investment grade entities helps us to bring deal structures with minimized risk at the best rate in the market. BGC can help to customize a compliance structure which uniquely accommodates each facility’s compliance obligation tied to the financial requirements which fit best with their power contracts. Power contracts are very unique per facility and our experience in the market allows us to create structures with monthly, quarterly and annual payments which best fit an entity’s specific financial exposure.

For more information on California Carbon please call BGC at 646-346-6899.