On 6 April 2017, California’s Third District Court of Appeals ruled in favor of the Californian Air Resources Board (ARB), upholding its authority to auction emission allowances in its cap-and-trade program. Under the Californian cap-and-trade program, allowances are distributed for free or are auctioned. In the first compliance period (2013-2014), six percent of allowances were auctioned and around ten percent are to be auctioned in the second compliance period (2015-2017).

The lawsuit has created a degree of uncertainty over the last four years, since it was first filed by the California Chamber of Commerce and the Morning Start Packing Co, a tomato processing company whose entities are regulated by the cap-and-trade program. They alleged that the auctioning exceeded the ARB’s authority to design a market-based emissions reduction system and that the auctioning revenue constituted a tax, which would have required a two-thirds legislative majority in line with the Californian Constitution (Art XIII A, s 3).

In a 2-1 decision, the court upheld the lower court’s decision, finding that AB32 gave the ARB broad discretion to design a market-based system and that the inclusion of auctioning did not exceed this authority. The court also found that the auctioning system does not constitute a tax. The court argued that the hallmark criteria of a tax are that it is compulsory and that the tax payer receives nothing of value in return for paying the tax. In the case of the cap-and-trade program, the court held that the purchase of allowances is a voluntary decision as regulated entities also have the option to reduce their emissions. Furthermore, once purchased, the allowances are valuable, tradable commodities that confer the right to pollute.

However, on 16 April, the Pacific Legal Foundation filed an appeal against the ruling to the California Supreme Court. They were joined on 15 May by the California Chamber of Commerce, who also decided to appeal. However, the Supreme Court denied their appeals on 28 June, thereby confirming the legality of the California Cap-and-Trade System and the right for ARB to conduct auctions.

The allowance market reacted positively to the news of the ruling, and it is likely that it will also have a positive effect on efforts in the Californian legislature to extend the program beyond 2020. Proposals for the extension, currently being drafted by California’s legislators, aim at garnering a two-thirds majority, which would protect it from similar legal challenges in the future.

This news piece has been updated to its current version on 29.06.2017.