Most weekdays, a long line of rail cars delivers thick slabs of steel to a factory about 40 miles east of Los Angeles. Deep in the bowels of California Steel Industries, the slabs are toasted until they glow white-hot and then rolled into thin sheets used to make shipping containers, metal roofing and car wheels.
The plant churns out more than 2 million tons of flat rolled steel each year, using enormous amounts of natural gas and electricity and releasing over 190,000 metric tons of climate-altering carbon dioxide annually. Now, California Steel and many other businesses have to pay for their carbon emissions under California's new cap-and-trade law, the first of its kind in the nation.
Last November, the company participated in the state's first auction of carbon allowances, purchasing an undisclosed number, each worth one metric ton of carbon dioxide and selling for $10.09. The online auction went fairly smoothly, says Brett Guge, executive vice president of finance and administration at the company. But for Guge, the long-term challenge is finding ways to meet California's ambitious greenhouse-gas reduction targets (down to 1990 levels by 2020) while remaining profitable.
The Golden State forged ahead with the carbon dioxide cap-and-trade program despite the U.S. Senate's 2010 failure to pass a national program. Given the state's history of implementing environmental regulations that later become national policy, a successful cap-and-trade system could serve as a federal model. If cap-and-trade in California "fails, or is perceived to have failed, then that could be the nail in the coffin for cap-and-trade consideration as a policy instrument in Washington," says Robert Stavins, a Harvard professor who studies climate policy.
While its overall impact on U.S. emissions won't be major, the California experiment makes several improvements to existing cap-and-trade strategies. It covers more sources of pollution than the five-year-old Regional Greenhouse Gas Initiative in the Northeastern U.S., which applies only to power plants. The European Union started the world's largest carbon cap-and-trade program in 2005, but it had a significant flaw: the initial stage of the program gave away too many free credits, resulting in some power companies raking in windfall profits by raising electricity prices even though they didn't have to pay for their allowances. It also contributed to low prices for carbon allowances, which provides scant incentive to cut emissions.
Mary Nichols, head of the California Air Resources Board, the agency steering the state program, is confident that California's effort will be different. The program covers 360 businesses, which represent about 600 facilities that each release more than 25,000 metric tons yearly -- enough to put a big dent in California's total carbon output. The EU's difficulty, Nichols notes, was that authorities didn't have an accurate measure of the total quantity of emissions initially. California, though, has had a greenhouse-gas reporting requirement in place since 2008.
"We knew (what polluters) were actually putting into the atmosphere," says Nichols. "That gave us the assurance that if we started a (cap-and-trade) program … we would be able to implement it in a way that would not cause the kinds of problems that occurred in Europe."
Fraud could be another obstacle, but experts agree the state is equipped to keep that to a minimum. The Air Resources Board uses third-party verifiers to check reported emissions, and has a system to track allowances and prove their authenticity. Companies that fail to supply enough credits to cover their emissions are fined by having to purchase four times the number of outstanding allowances. While not flawless, the program is unlikely to suffer from market manipulation and fraud, according to an analysis by the University of California, Los Angeles.
But even if the cap-and-trade system works as intended, its economic impacts are a big unknown. Because of its many regulations, high electricity rates and taxes, California is already a costly place to do business.
Guge is worried there won't be a feasible way to reduce the carbon dioxide output of his company's gas-powered furnaces, which account for 75 percent of the plant's total releases. Without reductions, his company will have to pay for more allowances as the cap tightens, but it's reluctant to pass those increased costs on to customers because that might put it at a competitive disadvantage.
Proponents of cap-and-trade hope the system will drive innovations, with new companies popping up to provide emissions-curbing breakthroughs. In late January, the Sacramento-based firm Clean Tech Advocates launched to do just that. It works to help clean tech developers get state funding, generated from the carbon credit auctions, for their projects, and its consultants help companies reduce emissions. Founder Patrick Leathers says that, over time, the auctions will bring in "billions of dollars," which will boost the state's clean tech industry and result in carbon-cutting solutions for companies dealing with cap-and-trade. Environmentalists -- and businesses -- are hoping he's right.