California Cap-and-Trade and International Forest Carbon Offsets for Institutional Investors

Terra Global
December, 2012

In 2006, the State of California passed the most expansive greenhouse gas (GHG) reduction plan in the United States, titled the Global Warming Solutions Act (or AB 32, shorthand for “Assembly Bill 32”). The legislation requires California to reduce economy-wide emissions to 1990 levels by 2020. As the world’s ninth largest economy, California’s cap will be on par with those of the United Kingdom and Germany. The legislation may have a material impact on the valuation of companies with an energy footprint in California, and California is often a precursor to legislative changes in other states and at the federal level. To decrease emissions, California’s lead air regulatory agency – the California Air Resources Board (ARB) – has developed a variety of emissions reductions strategies, including direct regulations, monetary and non-monetary incentives, voluntary actions, and market-based mechanisms. A key strategy is a broad “cap-and-trade” program that limits the amount of GHGs certain entities can emit, while allowing trading of GHG permits that can be used to comply with the cap. 

AB 32 and the cap-and-trade program present risks, as well as opportunities, for institutional investors. Although compliance costs could impact portfolio holdings, new avenues for investment are emerging. Companies subject to the program, along with other market participants, may spend $2 billion to $14 billion during the allowance auctions in some years. However, the cap-and-trade program will also create investment opportunities for offset-generating activities, among which are activities such as emission reductions from avoiding deforestation and degradation (REDD).