Not All Carbon Credits are Created Equal: The Constitutional and the Cost of Regional Cap-and-Trade Market Linkage

Abstract

I. INTRODUCTION II. THE CURRENT STATUS OF CALIFORNIA'S CAP-AND-TRADE PROGRAM III. THE BASICS OF LINKAGE IV. THE BENEFITS AND COSTS OF LINKAGE A. Benefits of Linkage B. Costs of Linkage 1. Costs Associated With Any Linkage 2. Costs Associated With Linking With a Poorly Designed Cap-and-Trade Market V. DESIGNING CALIFORNIA'S CAP-AND-TRADE MARKET A. California Should Link With Other Well-Designed Cap-and-Trade Markets B. California Should Seek to Avoid Linkage With Poorly Designed Cap-and-Trade Markets C. How to Avoid Linkage With Poorly Designed Cap-and-Trade Markets 1. Proposed Set Standards Law 2. Proposed Discretionary Discount Law 3. Evaluating Proposed Laws Under the Dormant Commerce Clause 4. Analyzing the Set Standards Law Under the Dormant Commerce Clause 5. Analyzing the Discretionary Discount Law Under the Dormant Commerce Clause 6. Seeking Congressional Approval to Enact the Set Standards Law or Discretionary Discount Law VI. CONCLUSION I. INTRODUCTION In the absence of federal leadership, states have banded together into regions to address the issue of climate change. (1) This patchwork approach has raised serious legal questions. As states seek to create independent cap-and-trade markets, they must avoid constitutional pitfalls. One issue that has yet to gain much attention is the question of how these independent regional cap-and-trade markets will, or will not, interact. Each of these regional groups has chosen to create its own cap-and-trade market that will trade in credits equaling one metric ton of C[O.sub.2]e. (2) Because these regional markets will trade in credits of equal carbon value, any carbon credit could be traded between regional markets and satisfy any regional market's carbon requirements. This trading between cap-and-trade markets--commonly referred to as linkage--is likely to take place through formal agreements. Yet it is possible that one state or regional group could refuse to link and refuse to honor another state's carbon credits. It is also possible that one state will honor another state's carbon credit only at a fraction of its stated carbon value. Given that carbon credits are, at first glance, a fungible good, (3) this type of restraint on interstate trade appears to be directly at odds with the Dormant Commerce Clause. And yet, there is a good reason why a state might want to avoid linkage with another state. The differences in the way regional markets are designed have a substantial effect on the value of the carbon credits. In a cap-and-trade scheme, the market auctions or distributes a certain number of carbon credits that equal a cap. Regulated entities can then conduct a cost-benefit analysis and choose to either purchase carbon credits or reduce their greenhouse gas emissions. If a cap-and-trade market is not well designed--due to poor monitoring and enforcement, low standards for carbon offsets, or through excessive use of safety valves--more greenhouse gases will be emitted than are allowed under the cap. This could undermine the market's ability to reduce greenhouse gases to the desired level and cause carbon credits to become undervalued, reducing the effectiveness of market signals. Linking with a poorly designed cap-and-trade market allows these deficient carbon credits to flood an otherwise sound market. The end result is to decrease the effectiveness of two cap-and-trade markets instead of one. This Comment will focus on issues that arise with linkage and poorly designed cap-and-trade markets. With one regional cap-and-trade market already in action, and several more in the planning and design phases, it is important to consider how to structure these markets in order to allow for beneficial trade while protecting market integrity. …