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BENEFITS OF EMISSIONS TRADINGEmissions trading achieves the environmental objective – reduced emissions – at the lowest cost.

Emissions trading incentivizes innovation and identifies lowest-cost solutions to make businesses more sustainable.

Cap and trade has proven to be an effective policy choice.

Emissions trading is better able to respond to economic fluctuations than other policy tools.

Cap and trade is designed to deliver an environmental outcome – the cap must be met, or there are sanctions such as fines. Allowing trading within that cap is the most effective way of minimising the cost – which is good for business and good for households. Determining physical actions that companies must take, with no flexibility, is not guaranteed to achieve the necessary reductions. Nor is establishing a regulated price, since the price required to drive reductions may take policy-makers several years to determine.

By allowing the open market to set the price of carbon allows for better flexibility and avoids price shocks or undue burdens. For example, as seen in Europe, prices will fall during a recession as industrial output, and thus emissions, fall. A centrally-administered tax does not have the same flexibility.

The combination of an absolute cap on the level of emissions permitted and the carbon price signal from trading helps firms identify low-cost methods of reducing emissions on site, such as investing in energy efficiency – which can lead to a further reduction in overheads. This helps make business more sustainable for the future. Imposing technology on business does not allow for creativity and can actually lead to higher costs as companies look merely to comply with regulations.

Cap and trade has proven its effectiveness in the US through the acid rain program, where it quickly and effectively reduced pollution levels at a far lower cost than expected. The EU Emissions Trading System has shown that cap and trade can be extended to carbon, and in doing so creates a price on carbon that drives emissions reductions. Reductions in pollution that industry feared would be excessively costly were achieved at a fraction of the original estimates. The International Carbon Action Partnership’s 2015 status report found that 40% of the world’s GDP is now subject to emissions trading, with systems active in South Korea, China, California and Kazakhstan, among several others.

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Emissions trading can provide a global response to a global challenge.Cap and trade provides a way of establishing rigour around emissions monitoring, reporting and verification – essential for any climate policy to preserve integrity. Allowing for the use of offsets, which lowers compliance costs, can help involve other jurisdictions in the fight against climate change – and may even inspire them to establish their own emissions trading system, as the Clean Development Mechanism offset program inspired China.

As emissions trading spreads around the world, there are a number of opportunities to link systems, which enhances their effectiveness and reduces costs.Connecting emissions trading systems, as California and Québec have done, widens the pool of participants to trade with, which reduces costs. This can allow for even greater emissions reductions to be achieved at a lower cost than previously.

CAP AND TRADE: THE BASICSCap and trade program overviewA cap-and-trade system places a limit on the amount of greenhouse gas emissions that industry can emit in a single year. Emissions of gases such as Carbon Dioxide (CO2), Methane (CH4) and Nitrous Oxide (N2O) are measured by industry and reported to the government or regulator who monitors emissions and runs the cap and trade program. In order to control emissions, the government sets a cap on emissions of these gases. It does this by giving or selling companies “allowances” (or permits).

What industry sectors are covered under cap and trade?Most existing cap-and-trade systems apply to the power sector and heavy industry (e.g., cement manufacturers, metals, chemicals, the oil and gas industry, ceramics, pulp and paper, mining, etc). An increasing number of programs - including California, Québec, China pilots and Korea - also cover transport fuels, New Zealand’s covers forestry, and the European Union Emissions Trading Systemnow applies to flights within the bloc. China will also consider including aviation under its national program, set to launch in 2016 and building-on experience gleaned from its seven existing pilot cap-and-trade programs. The US Regional Greenhouse Gas Initiative (RGGI) is the only existing cap-and-trade program that only applies to the region’s power sector.

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Allowances are distributed via allocation and/or auctioning. The free allocation of allowances helps to reduce cost and competitiveness burdens to affected industries, especially those competing with regions not subject to regulatory carbon constraints. Companies that are required to reduce emissions are called regulated entities. They must demonstrate that they comply with the cap and trade program every year.

How does a regulated entity comply?At the end of the compliance cycle (eg, calendar year, financial year etc), regulated entities covered by the cap-and-trade program must submit a verified emissions report, developed by independent third parties. Companies will then have to surrender emissions units - allowances or, if permitted, offsets - equal to their emissions; by acting to reduce their emissions, regulated entities can reduce their carbon liability.

Those which have reduced their emissions could also potentially end up with surplus emissions units, which can be sold to those which have exceeded their expected emissions; this can typically be done via exchange or intermediary.

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How does Cap and Trade achieve the environmental objective?The cap typically declines each year, gradually phasing-down towards the emissions reduction goal. This is essential in ensuring the environmental outcome is met at lowest cost.

PERMITS

Where have emissions trading systems been implemented?Jurisdictions accounting for around 40% of global GDP have implemented an emissions trading system, according to ICAP’s Emissions Trading Worldwide Status Report 2015. This includes China, South Korea, Kazakhstan, the EU, 10 US states (including California and New York) and Tokyo. Other systems are being considered in Brazil, Chile, Mexico, Washington State, Russia, Ukraine and Thailand, among others. These global climate markets and finance developments are further showcased and analysed in IETA’s 2014 Greenhouse Gas Markets Report.

OFFSETS: THE BASICSCO2GHGs

What are offsets?An offset represents the reduction, removal or avoidance of greenhouse gas emissions, measured in tonnes of CO2 equivalent (tCO2e). Offsets are important not only in environmental terms, but also in providing improved prospects for linking of emissions trading systems in the future. Offsets provide a vital cost-containment tool or safety valve for each system - and each system can implement the filters it deems necessary, according to predefined criteria.

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Offsets achieve real emission reductions.Governments can encourage emission reductions from specific activities, such as forestry, agriculture and waste management, which are outside the cap. Emissions reductions from these activities can be used to generate offsets that can be sold and used to comply with an emissions trading system.

Offsets help maintain domestic competitiveness in the regional and global marketplace.Offsets help business stay competitive by keeping both energy and compliance costs down. By keeping costs down, offsets help help companies become greener and better stewards of the environment. Offsets provide economic certainty that companies want. This means that companies can flourish, generating more jobs and money for the communities they operate in.

Offsets are an effective way to reduce emissions in an efficient cost-effective manner. Allowing the use of offsets in a cap-and-trade system will lower the cost of emission reductions throughout the market and provide a financial incentive to reduce greenhouse gas emissions..

Offsets help lower costs for business and households.

Offsets generate the greatest emissions reductions in the least time at the lowest cost. Maximum environmental benefit is gained by eliminating the greatest quantity of emissions as quickly as possible. The use of offsets provides an efficient means of reducing greenhouse gas emissions in the near-term. The revenue generated from the sale of offsets can be used to develop and implement transformative technologies that will achieve longer-term reductions.

Offsets can help cut emissions faster while encouraging innovation.

Offsets promote innovation and cooperation, both domestically and internationally.Offsets allow key actors - including foresters, farmers, and other clean project developers - to earn revenue for the greenhouse gas emission reductions they achieve, while at the same time stimulating innovation in areas that are outside a cap.

Especially in today’s bottom-up climate policy world, sub-national and national climate policy coordination, harmonization and innovation is more important than ever. The use of robust, eligible offsets for these actors to fully or partially link their bottom-up programs (ie, via offset linkages and trading) will become an increasingly critical step towards putting a real and lasting dent in the climate challenge.

Offsets can link markets together to achieve even greater reductions.

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Essential Offset Criteria:Offsetting must demonstrate actual emission reductions compared to what would have otherwise happened, ensure emissions are not simply released at a later date, or are displaced elsewhere. Some of the consistent essential criteria used in existing greenhouse gas offset progams include:

OFFSETS: THE BASICS

• Real: offsets must represent real emission reductions that have already occurred (ie, the reduction is not projected to occur in the future)• Additional: offsets must represent emission reductions that are in addition to what would have occurred otherwise• Permanent: offsets must represent emission reductions that are non-reversible or must typically be sequestered for X number of years in the case of carbon bio-sequestration projects. • Verifiable: sufficient data quantity and quality must be available to ensure emission reductions can be verified by an independent auditor against an established protocol or methodology• Quantifiable: emission reductions must be reliably measured or estimated, and capable of being quantified• Enforceable: offset ownership is undisputed and enforcement mechanisms exist to ensure that all program rules are followed and the program’s integrity is maintained

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GREENHOUSE GAS MEASUREMENT, REPORTING AND VERIFICATION (MRV)

Overview

Entity & Facility-Level Reporting & Measurement

MRV is a general term describing the process of measuring and collecting data on greenhouse gas (GHG) emissions or mitigation actions, compiling and reporting this information to a respective program, and then subjecting this reported data to a third-party review and verification.

The MRV process is applied to: 1) the reporting of GHG emissions by an entity or facility; and 2) the generation of carbon offset credits through the development and implementation of GHG offset projects.

A variety of GHG reporting programs exist at the entity level and facility level. Typically, entity-level reporting is voluntary and facility-level reporting mandatory. Current mandatory reporting programs for facilities in North America include:

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• Alberta• British Columbia (WCI)

• Ontario (WCI)• Québec (WCI)

• Saskatchewan• California (WCI)

• Massachusetts

Programs have many similarities, but do have some differences in their structure and criteria. The basic criteria for GHG measurement and reporting include:

• GHGs reported CO2, CH4, N2O, SF6, HFCs, PFCs, biogenic

• Reporting Thresholds The most common thresholds for who has to report GHGs are either 10,000 metric tonnes carbon dioxide equivalents (tCO2e) or

25,000 tCO2e on an annual basis. Program thresholds can range from a low of 5,000 to 50,000 tCO2e.• Sectors Included

A wide variety of industrial sectors are included in programs including power generation, refineries, gas & electric utilities, manufacturing, mining & minerals, chemical production, metals production, fuel distribution and upstream oil/gas.

• Reporting Timing Programs usually require entities/facilities to report their GHG emissions for the previous year within 6 months of the end of the

previous year, with verifications completed within 6-12 months of the end of the previous year.• Emission Factors

Programs use a variety of emission factors for different GHG sources and fuels that can be updated over time with the release of new data. Emission factors are typically published by governmental agencies (e.g. Environment Canada, U.S. EPA) or GHG registries (e.g. The Climate Registry).

• Specific Calculation Methodologies Most programs provide reporters with specified methodologies for the calculation of their GHG emissions, especially for common

and large sources of GHGs, and for certain energy-intensive industries.

Common Features

Verification - GHG Reporting and Carbon OffsetsVerification Bodies (VBs or Verifiers) are third-party companies that are either accredited or approved to review the submitted reports of GHG reporters or carbon offset projects. The concept of verification has been present since the first GHG programs initiated in the 1990s. VBs assess whether the submitted reports meet all requirements of the GHG reporting or carbon offset program as well as the applicable protocol. Typical verification criteria include program-specific requirements, a reasonable level of assurance, and 5% materiality thresholds.

In most programs, VBs are required to be accredited to the International Organization for Standardization (ISO) standards of 14065, 14064-3 and 14066. VBS are certified to these standards by an appropriate accreditation body.

In North America, the American National Standard Institute (ANSI), Standards Council of Canada (SCC) and the Mexican Entidad Mexicana de Acreditación (EMA) are accreditation bodies for VBs. Accreditation of VBs is an important aspect of any GHG program, ensuring that the VBs are conducting the reviews in a uniform manner and that the verification team members are competent and able.

Carbon Offsets Reporting & Measurement

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Similar to GHG reporting, a variety of carbon offset programs exist as part of compliance programs or for voluntary purposes. Compliance offset programs present in North America include:

• Alberta• British Columbia (WCI)• Québec (WCI)• California (WCI)• Regional Greenhouse Gas Initiative (RGGI)

While each program allows a specific list of offset projects to be eligible for credits, many of the same project types are eligible across multiple programs. Examples of offset project types found across several North American compliance programs include:

• Capture and destruction of methane at livestock operations• Destruction of ozone depleting substances• Forestry• Landfill gas capture and destruction

Specific offset methodologies (protocols) are developed for each offset project type. Protocols can be developed on a project-specific basis or use a standardized approach (performance-based or activity-based). Performance-based and activity-based protocols each have their own pros and cons.

Offset projects must follow the accepted protocols, which ensure that each project meets the essential offset criteria (real, additional, permanent, verifiable, quantifiable, enforceable). An important component of any protocol is the methodology and equations to calculate the amount of emissions reductions generated by an offset project.

GREENHOUSE GAS MEASUREMENT, REPORTING AND VERIFICATION (MRV)

CARBON PRICING & ADDRESSING COMPETITIVENESS

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Companies which are covered by carbon pricing programs and which compete with national or international firms that are not subject to carbon constraints do not have the leeway to raise product prices or recoup compliance costs. These companies, many of which are “energy intensive and trade exposed” (EITE), are vulnerable to ‘carbon leakage’ (ie, corporate decision to relocate production to jurisdictions where no carbon pricing program is in effect).

In contrast, regulated companies that have more captive, local consumers and therefore not subject to leakage concerns (eg, power generators, fuels) are typically mandated to purchase all rights to emit and meet compliance.

Unlike other carbon policy measures like taxation and command and control, cap-and-trade programs can effectively address these competitiveness and carbon leakage concerns linked to a domestic carbon pricing. Many existing cap-and-trade programs, including the EU, California, Québec and Korea, freely allocate allowances to identified EITE sectors based on an agreed-upon percentage of the company’s regulatory compliance obligation.

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Carbon pricing – and the economics of policy decisions – should aim to preserve, if not enhance, a region’s economic performance and competitiveness.Addressing real or perceived competitiveness impacts to affected industries is a critical dimension to smart carbon pricing design.

Allowance allocation is the process of distributing allowances to covered entities in an emissions trading system (ETS). There are two basic options for allocation: allowances can be either given away (freely allocated) or sold at auction. Because allowances have value, the allocation process is governed by rules to ensure their fair distribution. A simple, transparent and credible process facilitates this politically contentious part of operating a trading scheme.

Some programs have also considered border carbon adjustments, whereby a carbon price is levied on imports of goods from outside the jurisdiction that are from a non-carbon constrained region. Such proposals are complex and open to legal and diplomatic challenges – as the EU experienced when it proposed including aviation in its ETS, and California has faced with efforts to level the playing field for fuel suppliers.

To address competitiveness concerns, a defined number of free allowance allocations is usually delivered to EITE sectors. The free allocation typically starts high, depending on the industry and susceptibility to leakage. Allocations then gradually decline (eg, 1-2% per year); this approach provides incentive to reduce emissions while lending incremental support to enable low-carbon transitions yet remain competitive in the global marketplace.

For example, in the EU ETS industry received 80% of its allocation for free in 2013 – but this will fall to 30% by 2020. Allocations are determined by benchmarks, set at the best available technology, ie so the most efficient plants in theory receive most of their allowances for free.

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CARBON REVENUE & CLEAN TECHNOLOGY FUNDSOverviewA clean technology fund (“tech fund”) can be established to achieve a number of climate change and greenhouse gas (GHG) reduction goals. Typically, a fund may be one or more of the following:• A financing and technology innovation mechanism; • A compliance mechanism under a GHG reduction regulation; and/or• A compensation mechanism (e.g., funding for climate adaptation or resilience, socio-economic support programs to offset carbon costs or

climate impacts etc.)

The following focuses on these mechanisms in a regulatory compliance context, though it is important to note that non-regulatory funds and other financing initiatives can also hold important lessons and models for future tech fund design and implementation.

Alberta offers an important Canadian working model of a tech fund in the context of a regulatory compliance tool under provincial GHG regulations. Covered entities can choose to make a compliance payment into the tech fund at a specified price per tonne of CO2e (currently set at $15/tonne). The fund is administered through the Climate Change and Emissions Management Corporation (CCEMC). Saskatchewan has also developed a tech fund framework, with the intention of implementing the mechanism as compliance tool under its future provincial regulatory approach. British Columbia has also signalled that a tech fund will likely be part of its new regulatory package for the province’s growing Liquefied Natural Gas (LNG) sector.

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Key Design ConceptsCollaboration, Harmonization, Innovation, Flexibility, Effective Access, Transparency, Shared Benefits

$Pricing Structure• The carbon price set for tech fund payments can impact both the use and the development of a GHG offset market (as another compliance

option). • Consistency in overall cost structures across jurisdictions could help encourage future.

Governance• Funds are typically governed by Board of Directors – size and structure varies.• Important to clearly define the intended goal(s) of the fund and shape board representation accordingly. Can include representation from

government, industry or other stakeholders (community, NGOs, other sectors).

Outcomes Achieved • As the concept of a tech fund is still relatively new, there is still a good deal of “learning by doing”.• Tech fund investments can help drive additional emissions reductions, but also valuable role for adaptation, land use and forestry projects to

help achieve broad climate goals. • Continuous improvement should be built into the design through established milestones and/or review triggers to increase certainty for

industry and government. Consistent evaluation of outcomes against objectives is critical.

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CARBON REVENUE & CLEAN TECHNOLOGY FUNDSAccess to Funding• Efficient processes to choose projects and disperse funds improves timeliness of investment and outcomes• Flexible limits on funding to ensure adequate funding provided relative to total capital required and associated risk• If a goal is to drive in-sector reductions and to incentivize early use by covered entities, a phased approach to tech fund access over time may

be beneficial.

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Funded Activity Scope• The overarching goal of a tech fund directly impacts the extent to which firms that have contributed to the fund can expect to potentially shape

or benefit from its use.• Tech Fund may include a portfolio of projects across the technology development and deployment chain. Diversified activities could have

multiple benefits, including: • Improve the viability of certain abatement options by moving them along a firm’s Marginal Abatement Cost Curve. • Incentivize additional investments in higher risk and early R&D activities that would not otherwise be invested in, but could have transformative impacts over time. • Ensure healthy project pipeline across the development chain to achieve: • ‘Quick wins’ and near term emissions reductions by commercializing new low-carbon technologies. • Longer-term emissions reduction potential, social license, and additional sustainable development co-benefits.

Cap-and-Trade Auction Revenue & Funds

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Auctions are one way of distributing allowances – with the revenue accruing to the system’s regulating authority. Most cap-and-trade programs sell some, if not all, allowances at auction (rather than freely distribute 100% to covered entities). An analysis by Resources for the Future (RFF) on the use of auction revenues (published in IETA’s 2014 GHG Market Report, Markets Matter) found that nearly all market systems studied invested some carbon revenue in low-carbon R&D and support, such as renewable energy and energy efficiency.

CARBON REVENUE & CLEAN TECHNOLOGY FUNDSSmart use of auction revenues to support further mitigation and resilience projects. Planned infrastructure investments that could lead to emission reductions or climate resilience (e.g. clean infrastructure funding, energy efficiency upgrades etc.) can be supported by auction revenues.

“Climate dividends” to support public buy-in for emissions trading and auctions.Recycling auction revenue to consumers and business to incent greener choices or offset higher costs drives public support for carbon pricing. For example, RGGI uses a share of auction revenues to effectively provide a rebate on electricity prices.

Under the linked Quebec-California cap-and-trade models, allowance auction revenue channels into sub-nationally managed “green funds”.

In Quebec, revenue generated by the carbon market is allocated to the province’s Green Fund and re-invested for full implementation of Quebec’s Climate Change Action Plan (CCAP 2013-2020). CCAP measures aim to reduce Quebec’s GHG emissions, adapt to climate change impacts and ac-celerate the shift towards a “strong, innovative and increasingly low-carbon economy”.

In California, the legislature and Governor appropriate auction proceeds for projects that support the goals of AB-32. Strategic investments are used to reduce state GHG emissions, providing net GHG sequestration, and support long-term transformative efforts to drive the state’s clean energy economy. California’s Legislative Analyst’s Office (LAO) projects revenues from the state’s allowance auctions in FY15-16 to be at least $2 billion – and potentially as high as $4.9billion.

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THE GLOBAL WARMING SOLUTIONS ACT:Assembly Bill 32

AB 32 Overview

Mandatory Reporting of Greenhouse Gases

Early Action Measures

The Scoping Plan

2020 Emissions Limit

The Global Warming Solutions Act, or AB 32, was passed in 2006 and directs the California Air Resources Board (ARB) to develop a set of measures to reduce statewide greenhouse gas (GHG) emissions to 1990 levels by 2020 (the “2020 emissions limit”). AB 32 authorized, but did not require, the ARB to adopt market-based compliance mechanisms such as cap and trade. AB 32 included the specific requirements described below that set in motion a series of actions to lower emissions from all sectors of California’s economy.

AB 32 directed the ARB to develop a roadmap, or Scoping Plan, for the state to meet the 2020 target. In 2008, the ARB adopted the original Scoping Plan that lays out a suite of measures, including a market-based mechanism which evolved into the cap-and-trade program, designed to achieve the 2020 Emissions Limit. AB 32 requires the ARB to update the Scoping Plan every five years. The ARB approved the first such update in May 2014.

To establish the 2020 statewide GHG target, the ARB needed to determine the statewide GHG emissions level in 1990. To do this, the ARB performed an analysis of GHG emissions in the state and created the GHG Inventory. The GHG Inventory combines estimates that rely both on state, regional or national data sources, and on aggregated facility-specific emissions reports from the Mandatory GHG Emissions Reporting Regulation (MRR). The 2020 emissions limit is 431 million metric tons of CO2 equivalent (CO2e), about 15% below 2020 business-as-usual emission forecast of 509 million metric tons of CO2e.

Under AB 32, the ARB was required to adopt regulations for the reporting and verification of statewide GHG emissions. The ARB adopted MRR in December 2007 which requires the largest emitters to report annual emissions to ensure accurate and consistent tracking of GHG levels. The MRR differs from the GHG Inventory in how emissions are reported and calculated: the MRR relies on facility and entity level reporting, while the GHG Inventory provides statewide estimates based on the regional, state, and national data sources, as well as aggregated facility-specific emissions reports.

Because AB 32 did not mandate the Scoping Plan implementation until 2012, AB 32 empowered the ARB to identify a number of discrete, early action measures to reduce GHG emissions. The ARB developed and adopted enforceable regulations around these measures, which include reducing compounds with considerable global warming potential (GWP).

AB 32 Requirements:

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LOW CARBON FUEL STANDARDLow Carbon Fuel Standard Overview

Who is regulated by the LCFS?

The California Global Warming Solutions Act of 2006 (aka Assembly Bill 32 or “AB 32”) mandates a reduction in California statewide greenhouse gas (GHG) emissions to 1990 levels by 2020. The Low Carbon Fuel Standard (LCFS) is one of the primary Emission Reduction Measures promulgated by the California Air Resources Board (ARB) to achieve AB 32’s 2020 target. It is expected to contribute approximately 20% of the required statewide GHG reductions under AB 32.

The LCFS focuses on the transportation sector and requires a 10% reduction in the carbon intensity (CI) of gasoline and diesel from 2010 levels by 2020, with CI targets designed to become more stringent each year. The CI of fuels, expressed as grams of CO2e per megajoule, is calculated across the full lifecycle of transportation fuels (i.e., well-to-wheel) and includes all GHG emissions associated with producing, distributing, and using the fuel.

• Typically, a producer within California or the importer of a refined/final product constitutes the Regulated Party.• Suppliers of low-carbon fuels (e.g., electricity, biofuels, natural gas) can “opt-in” to Regulated Party status and generate LCFS credits that can

be sold to another party that needs them for compliance.

How does one comply?Each Regulated Party must ensure that the overall CI score for its fuel pool at least meets the annual target for the given year. Excess CI reductions from one type of fuel can be used to compensate for insufficient reductions in another fuel. A fuel that has a CI below the target for a given year will generate LCFS credits on a volumetric basis (i.e., the more low CI fuel one sells, the more credits one generates). Conversely, a fuel with a CI above the target will generate deficits, also on a volumetric basis. Each LCFS credit represents one metric tonne of CO2e avoided and each deficit represents one metric tonne of CO2e added – both as measured against the pertinent year’s CI target.

In each annual compliance period, a Regulated Party must balance its deficits with credits. The banking of surplus LCFS credits is allowed and credits do not expire due to passage of time. A negative balance for a calendar year that persists until April of the next year results in the Regulated Party being out of compliance. Regulated entities can comply by:

1. Lowering the CI of their fuels (e.g., via efficiency improvements anywhere in the lifecycle, blending lower carbon fuels); and/or2. Purchasing LCFS credits from other Regulated Parties.

The LCFS also imposes recordkeeping requirements (e.g., retention of Product Transfer Documents) and quarterly reporting requirements that must be followed to remain in compliance.

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LOW CARBON FUEL STANDARDRelationship with Cap-and-Trade Program

What’s next for the LCFS?

While the LCFS has surficial similarities to ARB’s other carbon trading regime, the Cap-and-Trade Program (e.g., both trade in increments of one metric tonne of CO2e), the two operate separately. Among other key differences, the two regimes: (1) establish distinct compliance instruments that are non-fungible across programs; (2) use different compliance instrument tracking systems; (3) require different registrations; and (4) have different rules regarding trading confidentiality. Entities covered by the LCFS and the Cap-and-Trade Program need to comply with both regimes, and cannot use over-compliance in one program to compensate for under-compliance in the other.

The LCFS has been challenged in both California state court and US federal court, and ARB largely has been successful defending the Program. However, due to procedural errors committed by ARB during the initial adoption of the LCFS regulations, the CI targets have been frozen at 2013 levels. ARB presently is attempting to cure these procedural flaws by readopting the Program. Concurrently, ARB also is overhauling many aspects of the LCFS, including but not limited to credit cost containment, credit invalidation procedures, and enforcement of violations.

ARB anticipates extending the LCFS beyond the scheduled 2020 sunset date, just as with the other AB 32 Emission Reduction Measures it implements. Finally, ARB has expressed interest in linking the LCFS with similar programs in Oregon, Washington, and British Columbia.

DisclaimerAlthough this fact sheet may provide information concerning potential legal issues, it is not a substitute for legal advice from qualified counsel. This fact sheet is not created or designed to address the unique facts or circumstances that may arise in any specific instance, and you should not and are not authorized to rely on it as a source of legal advice. This fact sheet does not create any attorney-client relationship between you and Latham & Watkins.

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OFFSETS IN CALIFORNIA’S CAP-AND-TRADE PROGRAM

What are offsets?

Key criteria for offsets

Benefits of offsets

Under the California cap-and-trade program, there are two types of compliance instruments: allowances and offsets. Allowances are initially generated by the government and initially distributed to sources subject to the cap (regulated entities) via auction or allocation. In contrast, an offset is an alternative compliance instrument voluntarily generated by a non-Regulated Entity (a private market particpant) pursuant to a California Air Resources Board (ARB) rules, and sold to regulated entities through bi-lateral purchase agreements. Both allowances and offsets can be traded on the secondary market.

An offset represents the reduction, removal or avoidance of one tonne of greenhouse gas (GHG) emissions that would not have otherwise occurred and which is generated from an ARB-registered project. Regulated Entities can use offsets to fulfill up to 8% of their compliance obligation under the cap-and-trade program. The 8% limit ensures that 92% of emission reductions under cap-and-trade are made directly by regulated entities at sources subject to the cap and not just compensated by offsets. Offsets must be generated from projects developed based on rules (called offset protocols) adopted by ARB and administered by Offset Project Registries (OPRs) which assist ARB by reviewing projects and providing expertise on the protocols. ARB also approves offset projects which private market participants undertook before the effective date of the cap-and-trade program (called early action offset projects) if they meet certain regulatory requirements, including registration under one of the approved early action protocols.

• Real: offset must represent real emission reductions that have already occurred (i.e. the reduction is not projected to occur in the future)• Additional: offset must represent emission reductions that are in addition to what would have occurred otherwise• Permanent: offset must represent emission reductions that are non-reversible or must be sequestered for 100-years or more• Verifiable: sufficient data quantity and quality must be available to ensure emission reductions can be verified by an independent third party

auditor (verifier) against an established protocol• Quantifiable: emission reductions represented by offsets must be reliably measured or estimated, and capable of being quantified• Enforceable: offset ownership is undisputed and enforcement mechanisms exist to ensure that all program rules are followed.

Offsets achieve completely voluntary GHG emission reductions at sources outside of the cap. And because ARB retains oversight of the offset approval process, it can encourage certain types of source reductions via approving offset protocols targeting selected uncapped sectors (e.g. forestry). Further, offsets can increase flexibility by giving regulated entities another option for compliance in addition to just allowances. Finally, and perhaps most importantly, offsets can help reduce compliance costs because reductions can often be generated outside of the cap less expensively than they could be within the capped sectors. Due to this and the risk of invalidation of offset credits (discussed below), offsets often sell at a discount to allowances. Less expensive emission reduction costs lead to overall lower compliance costs, this reduces the cost impact on consumers. Development of offsets can spur technology innovation in areas outside of capped sectors, and deliver economic benefit by creating new job opportunities for stakeholders involved in offset projects.

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ARB Adopted Offset Protocols

More information

How many offsets have been issued?

How do offset prices compare to allowance prices?

ARB has adopted five protocols to date covering: U.S Forest Projects, Urban Forests Projects, Ozone Depleting Substances (ODS) Projects, Livestock Projects, and Mine Methane Capture (MMC) Projects. ARB is continuously working to adopt new offset protocols and is now assessing rice cultivation projects as another offset protocol type.

ARB has issued over 17 million compliance offsets to date, far short of the supply needed to satisfy the maximum demand of 58 million offsets through 2015.

California Compliance Allowances: $12.50 - $13.00 | California Compliance Offsets: $9.00 - $11.00

More information is available at: http://www.arb.ca.gov/cc/capandtrade/offsets/issuance/issuance.htm

Risks associated with offsetsUnder the California program, offsets can be cancelled (or invalidated) for, inter alia, failure to comply with a given offset protocol even after offsets have been surrendered for compliance. This risk of cancellation is called “invalidation risk.” If invalidation occurs, the entity which used the invalidated offset for compliance must surrender another valid offset or allowance, thus increasing the costs. The ability to review an offset’s compliance with a given protocol after surrender for compliance ensures the environmental integrity of the compliance program, but makes offsets less attractive as a compliance instrument compared to allowances, which can never be invalidated. However, robust and efficient verification requirements and review by OPRs prior to issuance, as well as due diligence prior to purchasing offsets can reduce invalidation risk.

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OFFSETS IN CALIFORNIA’S CAP-AND-TRADE PROGRAM

ALBERTA’S CLIMATE CHANGE PROGRAM

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• Requires all facilities emitting more than 50,000 tonnes CO2e annually to report their emissions to Alberta Environment and SustainableResources Development (AESRD)

Specified Gas Reporting Regulation (SGRR):

In 2007, the Government of Alberta introduced the province’s Climate Change Strategy and committed to reduce its GHG emissions intensity by 50 million tonnes from “business as usual” by 2020 and by 200 million tonnes by 2050. To help achieve this target, Alberta introduced the first fully operational regulatory GHG emission reduction and trading program in North America. The Climate Change and Emissions Management Act (the “Act”) provides a framework for the implementation of this program. Two key regulations were implemented under the Act:

Target and Policy Context

Compliance options under SGER:1. Physically reduce emissions intensity at the facility by 12%; OR2. Purchase verified Alberta offsets or use/purchase emission performance credits (EPCs) generated at facility in previous years or from other

regulated facilities; OR3. Purchase Technology Fund (Tech Fund) credits (currently $15/tonne) for each tonne emitted over their target; OR4. Any combination of the above options.

There is no limit on utilizing any one of the aforementioned options to achieve compliance targets.

CO2• Facilities emitting more than 100,000 tonnes CO2e annually are regulated by AESRD and are required to reduce GHG emissions intensity by

12% per production unit from an established government approved baseline; • The resulting intensity based system is different than cap and trade approach which sets a hard cap on emissions at a facility;• Allows GHG emissions at a facility to grow in line with development or expansion as long as the emission intensity per unit decreases by 12%;• 8 compliance periods since the SGER came into force since 2007;• 106 regulated facilities in 2013;• The SGER expires June 30, 2015 and is expected to be amended and renewed prior to that date.

Alberta’s Specified Gas Emitters Regulation (SGER):

Program Results• As of the end of 2013, approximately 51 million tonnes CO2e have been reduced from business-as-usual (BAU) levels1 through operational

changes at facilities and purchases of verified offsets produced by non-regulated source CO2e reductions. • Equivalent to taking more than 10 million cars off the road for one year.• Data for the 2014 compliance year is not yet available, but is estimated to bring the total GHG emission reductions from BAU levels to at least

57 million tonnes CO2e based on previous years.

1 Alberta Environment and Sustainable Resource Development, http://esrd.alberta.ca/focus/alberta-and-climate-change/regulating-greenhouse-gas-emissions/greenhouse-gas-reduction-program/default.aspx.

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ALBERTA’S CLIMATE CHANGE PROGRAM

2 Alberta Environment and Sustainable Resource Development, http://esrd.alberta.ca/focus/alberta-and-climate-change/regulating-greenhouse-gas-emissions/greenhouse-gas-reduction-program/default.aspx.3 For more information about CCEMC, see: http://ccemc.ca/about 4 Alberta Environment and Sustainable Resource Development, http://esrd.alberta.ca/focus/alberta-and-climate-change/climate-change-and-emissions-manage-ment-fund.aspx 5 Climate Change and Emissions Management Corporation, http://ccemc.ca/about/performance/

2007 (1/2 year) 1.55 0.91 1.28 3.74 44.12008 1.25 2.91 2.57 6.73 85.42009 1.07 3.79 2.66 7.52 63.52010 1.20 3.86 2.56 7.62 69.32011 3.15 5.40 2.51 11.06 54.92012 1.50 3.00 3.41 7.91 86.72013 0.12 2.04 3.91 6.07 99.3

Total 9.84 21.91 18.90 50.65 503.4

Mt = Million TonnesTable Updated October 23, 20142 Note that figures are subject to change as a result of auditing and are rounded for presentation purposes.

The Climate Change and Emissions Management Fund (CCEMF) was created by the Government of Alberta to establish or participate in funding for initiatives that reduce emissions of greenhouse gases or improve Alberta’s ability to adapt to climate change. The Climate Change and Emissions Management Corporation (CCEMC) is an independent organization that manages the CCEMF and grants funding to organizations to support and build on the strategic direction established by the province. The CCEMC mission is to accelerate the achievement of actual and sustainable reductions in greenhouse gas emissions and support climate change adaptation through partnerships and collaboration in the discovery, development and deployment of technology for application in Alberta. 3 Through the $15/tonne contributions to the CCEMF, as of 2013, $503 million has been collected by CCEMF and $249 million has been invested into 100 innovative and clean energy projects4 CCEMC estimates its investments are leveraged almost 6:1 yielding projects valued at $1.7 billion, providing estimated cumulative emission reductions of 10.7 Mt CO2e by 2020.5 Data for the 2014 compliance year is not yet available, but is estimated to bring the total contributions to the CCEMF to over $600 million, based on previous year contributions.

Alberta Technology Fund

ComplianceCycle

EmissionsReductionsat Facility(Mt CO2e)

Offset CreditsSubmitted(Mt CO2e)

Recognitionof

Cogeneration(Mt CO2e)

Total Reductions(Mt CO2e)

Fund Payment($Million)

ALBERTA OFFSETS 101CO2GHGs

What is an offset?An offset represents the reduction, removal or avoidance of one tonne of greenhouse gas (GHG) emissions that would have otherwise occurred. In Alberta, offsets are generated by emission reductions occurring outside of regulated facilities through a registered offset project. These projects are implemented by a voluntary project developer pursuant to Alberta’s Specified Gas Emitters Regulation (SGER) and the guidance documents and offset protocols approved by Alberta Environment and Sustainable Resource Development (AESRD). One offset is created for each tonne CO2e reduced or sequestered by a non-regulated facility. Regulated facilities are not eligible to create offsets.

Key criteria for offsets• To qualify as an offset under the SGER, offsets must:

• Originate in Alberta• Be Additional to what would have otherwise occurred under a Business-as-Usual (BAU) scenario and not be required by law at the time

activity is started• Be from actions taken during the previous compliance year, i.e no historic offset creation can occur from actions occurring more than one

year prior• Be Real and Demonstrable emission reductions that have already occurred or are proven to occur in the future (avoided emissions)• Be quantifiable and verifiable emission reductions using approved quantification methodology, either through direct measurement or by

accurate estimation using replicable techniquesIn addition:• Ownerships of offsets must be clear and undisputed• Offsets must be verified to a reasonable level of certainty by approved third party verifiers pursuant to ISO 14064 standards contained in theVerification Guidance Document• Offsets must be registered and serialized on the Alberta Emissions Offset Registry (the “Registry”) in order to be submitted for compliance

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Alberta Offsets Market• Offsets have comprised approximately 43% of Alberta’s emission compliance since the program started in July 1, 2007 to the end of 2013• There are no limits on the percentage of offsets that may be used for compliance under the SGER• Offsets may be purchased from a project developer by a regulated emitter to meet its emission reduction target• Offsets can be purchased through bilateral purchase agreements or via the North American Climate Exchange. Offsets may also be sold in the

secondary market on the same basis.• The price per offset is variable and market driven. Normally priced at a discount to the Climate Change Emission Management Fund (CCEMF Tech

Fund) price (currently $15/tonne) to reflect the risk of invalidation and provide cost savings to emitters relative to their other compliance options.• AESRD audits offsets submitted for compliance by the regulated facilities and may invalidate offsets that do not meet the regulatory and program

requirements.• Offsets must be retired on the Registry if used to meet a facility’s compliance obligation

AESRD Adopted Offset ProtocolsAESRD has 33 approved offset protocols and several others in development covering a variety of activities including, Aerobic Composting, Landfill Bioreactors, Anaerobic Treatment of Wastewater, Biofuel Production and Usage, Conservation Cropping, Forest Harvest Practices, Distributed Renewable Energy Generation, Energy Efficiency for Commercial and Institutional Buildings, Enhanced Oil Recovery, Carbon Capture and Sequestration, Waste Heat Recovery, Nitrous Oxide Emission Reduction in Agriculture and many others. Guidance documents exist for protocol development, offset project development, and verification.

Risks associated with offsetsSimilar to the California system, under the Alberta program, offsets can be reversed (or invalidated) by AESRD for failure to comply with a given offset protocol. As offsets are not approved in advance of submission for compliance, the submitting emitter may not be certain that the offsets are valid for years after the offsets have been surrendered for compliance. This risk of cancellation is called “invalidation risk.” If invalidation occurs, the entity which used the invalidated offset for compliance must surrender another valid offset or purchase a CCEMF Tech Fund Credit, thus increasing the compliance costs. The ability of AESRD to review an offset’s compliance with a given protocol after surrender for compliance ensures the environmental integrity of the compliance program, but makes offsets less attractive as a compliance instrument compared to allowances, which can never be invalidated. However, stringent verification requirements and robust review by verifiers prior to serialization and submission, as well as due diligence from the buyer prior to purchasing offsets, can reduce invalidation risk. Invalidation risk has been reduced in the Alberta market as it has matured over the last seven years with the adoption of more stringent protocols, more robust requirements for the verification process, and the general increase in expertise of project developers, verifiers and the system regulators.

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BenefitsOffsets achieve emission reductions outside of the regulated emitters’ facilities, thereby expanding the opportunity for members of the community to participate in creating emission reductions. The ability to sell offsets in the carbon market motivates voluntary participation from all sectors in the emissions market, increasing its size and ability to meet market demand, and improving the overall impact of the market to achieve significant emission reductions. Since offsets are generated by project already implemented and actions that have already taken place, they stimulate technology deployment and immediate emission reduction results. Offsets can provide a more economically efficient way to reduce overall emissions since emission reductions may be obtained from voluntary action much less expensively than they can be by a regulated emitter implementing high capital, high risk projects at the facility, or through annual lump payments into the CCEMF for its emission overages. Less expensive compliance costs lead to a lower economic impact of the program on emitters and ultimately the end-consumers.

New offset protocols undergo a rigorous development process and must be approved by AESRD. The development of new offset projects further stimulates innovation and investment in new technologies to reduce emissions in the non-regulated sector. This in turn creates jobs, drives investment and increases exports in clean technology goods and services leading to further growth and diversification of the economy.

ALBERTA OFFSETS 101

ALBERTA OFFSETS 101

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How do offset prices compare to CCEMF Tech Fund prices?The current price for Tech Fund credits in Alberta is $15.00. The SGER expires June 30, 2015, with all aspects subject to change upon renewal. Offsets have sold in the range of $12.00 - $14.50, depending on the offset project activity and the terms of the purchase agreement. Wind offsets historically are priced the highest due to their foreseen low revocation risk and reportedly have sold up to $15.00, placing them competitively alongside the CCEMF compliance option. Offsets sold under longer term futures arrangements have sold for $12.00 or slightly less.

How many offsets have been generated and used?Between 2007 and 2013, 29 million offsets have been registered and 21.9 million offsets have been retired in Alberta lending to an offset sale rate of 75%. Offsets represent a significant method of compliance obligation, with 43% of facilities using them as a part of their emission reduction portfolio. Data for 2014 is not yet available.

BC CARBON OFFSETS

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Genesis of a Carbon MarketBritish Columbia has developed a vibrant carbon market spurred by the environmental leanings of its electorate, entrepreneurial drive of its businesses and the policy certainty provided by Government demand. When leadership was ready to act on climate, the province had head start as home to pioneering businesses and NGOs that had developed a diverse voluntary carbon market throughout the 2000’s.

In order to jumpstart carbon offset development and create a highly-visible financial signal to innovators in the province, BC committed that its government operations and publically funded institutions would be carbon neutral by 2010. An initial investment of $75 million into energy efficiency retrofits across multiple sectors allowed schools, universities and health authorities to drive down their fuel & electric costs, and reduce GHG emissions in the lead up to regulation. Emissions inventories and reporting structures were established to create an even playing field and gauge progress. Finally, a crown corporation called Pacific Carbon Trust was created to source and supply top-quality, made-in-BC offsets to the marketplace.

Putting Money Where Your Mouth Is

1 PricewaterhouseCoopers Economic Analysis of British Columbia Carbon Offsets, August 2012. http://ow.ly/JQwJZ

BC Government launched the “Greenhouse Gas Reduction Targets Act” in 2007 to reduce provincial greenhouse gas (GHG) emissions by 33% in 2020 and 80% by 2050. A carbon market was created under the BC Emission Offsets Regulation (BC EOR) to enable newly legislated public service carbon neutrality, and develop offsets for a future industrial Cap and Trade program that would capture the large greenhouse gas (GHG) emitters (over 25,000tCO2e/yr) in the province.

Target and Policy Context

The market for British Columbia carbon offsets creates a powerful innovation funding mechanism in the province. Business, NGOs, academia and citizenry have a direct pathway to finance rollout of emissions reduction projects and technologies. If you can get GHGs out of the atmosphere at scale, beyond business-as-usual, the carbon offset system can pay you to do so. By so democratizing access to the benefits of a carbon pricing policy, Government spreads opportunity, responsibility and ownership of climate successes across all citizens and sectors.

Overview and Benefits

Made-in-BC OffsetsGovernment investment spurred the development of a strong carbon market in the province by contracting projects that could deliver Verified, BC EOR compliant offsets that met both social & environmental goals. 1,564,777 tonnes of carbon offsets from 31 projects were delivered between 2008 and 2012, with significantly more held in other parts of the market. Wholesale offset prices paid for these offsets ranged from $9-$19/tCO2e – significantly more than the wholesale voluntary market, and in 2015, more than most regulated offset systems as well. This healthy, stable price for carbon has enabled project developers and asset owners to make significant investment in offset projects throughout the province. PricewaterhouseCoopers issued a special report titled “Economic analysis of British Columbia Offset Projects” in 2012 that included analysis on project sector breakdown, expenditure and volumes.1

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Economic Impact of BC’s Carbon MarketThe economic impact of carbon offset development goes far beyond the dollars spent on actual offset purchase. Offset revenue provides leverage on the business plan of emission reduction projects that go beyond business-as-usual, getting them over the investment hurdle that so often stands in the way of innovation.

The PricewaterhouseCoopers report conducted an economic impact assessment of capital project investment on the 31 emissions reductions projects developed in BC. Between 2008 and 2012, project proponents committed $317.3 million in capital expenditures to these offset projects.

BC CARBON OFFSETS

2 See ow.ly/JQl45 for Markit Environmental Registry public view of “Pacific Carbon Standard” projects. March 20153 BC Ministry of Environment’s “Investing in Carbon Offsets” reports ow.ly/JQodp March 2015

Figure 1. Portfolio of Carbon Reduction Projects by Industry Sector

Sector Projects Capital Expenditure Invested % Offsets tCO2e Industry %Forestry 12 $ 150,000,000 47% 1,080,439 69%Clean Technology 6 $ 110,200,000 35% 85,334 6%Mining, Oil and Gas 5 $ 38,100,000 12% 216,431 14%Agriculture 4 $ 10,100,000 3% 83,966 5%Waste Mgt. plus Mfg. 4 $ 8,400,000 3% 98,607 6%Total Projects 31 $ 317,300,000 100% 1,564,777 100%

Up-to-date lists of all projects and offsets Issued under the BC Emission Offsets Regulation can be publically viewed on the Markit Environmental Registry2, with offsets retired towards public sector carbon neutrality shown on the BC Ministry of Environment website.3

Figure 2. Economic Impact of Capital Expenditures on BC Offset Projects (2008-2012)

Direct Impact Indirect Impact Induced Impact Total Economic ImpactGDP $ 162,700,000 $ 52,400,000 $ 27,500,000 $ 242,600,000Govt. Revenues $ 30,600,000 $ 9,000,000 $ 9,200,000 $ 48,800,000Federal Taxes $14,400,000 $ 4,500,000 $ 4,000,000 $ 22,900,000Provincial Taxes $ 12,100,000 $ 3,700,000 $ 4,300,000 $20,100,000Municipal Taxes $ 4,100,000 $ 900,000 $ 800,000 $ 5,800,000Employment (Jobs) 1638 779 419 2836

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BC CARBON OFFSETSNumbers and economic analysis alone do not capture the wide benefit of carbon offset development delivered to the environment and people of British Columbia. Carbon finance has enabled First Nations to protect over half of the Great Bear Rainforest from logging, while maintaining sustainable livelihoods on the landscape for indigenous and non-indigenous citizens alike. A small town has been able to cap its landfill well ahead of regulation and generate offsets by diverting landfill gas into a scrubber and providing methane to the provincial natural gas grid. Cement producers have been able to rationalize biomass co-generation and “clinker” replacement at their facilities because of the financial impact of offsets. Throughout the province, innovation is inspired and people are put to work rolling out the future of a low carbon economy because their emissions reductions have an economic value, enabled by carbon offsets.

Projects of the BC Carbon Market

CO2GHGs On April 1, 2014, the provincial government transitioned the mandate to aggregate offsets for the public service to the BC Climate ActionSecretariat – Climate Investment Branch (CAS-CIB) at the Ministry of Environment. CAS-CIB continues to provide demand to the provincial carbon market by buying approximately 700,000 offsets each year for carbon neutral government through long-term offset purchase agreements. Government has further announced climate regulations for large emitters in the province, including Liquefied Natural Gas and Cement industries, which shall use carbon offsets for compliance purposes.

Provincial, State and Regional governments must show real emissions reductions achievements in the global fight against climate change. National and international cooperation is being built on the creativity, linkage and ambition of these systems. British Columbia’s carbon offset market is a strong, scalable, versatile example of how to reduce emissions, finance innovation and demonstrate climate leadership.

BC’s Carbon Market today

REGIONAL GREENHOUSE GAS INITIATIVE (RGGI)

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Cap and compliance mechanismsThe 2014 RGGI cap was revised down to 91 MTCO2 (short tons), from 165 MTCO2 in 2013. The cap is tightened by 2.5% every year, and the 2015 cap is 88.7 MTCO2. RGGI states distribute allowances equal to (adjusted) cap mainly through quarterly auctions. A limited quantity of additional allowances is kept in a cost containment reserve, to be auctioned if prices go above certain pre-defined levels. Covered entities can buy allowances from auctions or on the secondary market. Up to 3.3% compliance obligation can also be met by use of offsets.

RGGI states have accomplished a dramatic decline in CO2 emissions. Power generators in participating states emitted only 86 MTCO2 in 2014, compared to 120 MTCO2 in 2009. The generation fuel mix is significantly greener today compared to 2009. The following charts from the Energy Information Administration (EIA) illustrate this:

CO2

Emission reductions

RGGI program covers power sector in nine North-Eastern US states. Every facility of over 25 MW capacity that uses fossil fuel to generate power is included in the program. Launched in 2008, the program has successfully completed two compliance periods of three years each (2009-2011, 2012-2014). Emissions were reduced faster than anticipated during the first compliance period, and in 2014 the emissions cap was tightened to build on this success.

First multi-state cap-and trade program to target GHG emission reduction in the United States

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Economic net gainsRGGI states have raised over $2 billion in revenue from auctions, the majority of which has been channeled into strategic energy and consumer benefit programs. Program goals include mitigating electric rates, increasing energy efficiency, and promoting clean and renewable energy technologies. These investments support the local economy, generate jobs and growth. An independent report by the Analysis Group found that the program’s first control period (2009-2011) was generating net economic benefits of $1.6 billion. This economic benefit is fueled by $1.3 billion in consumer energy savings and is creating over 16,000 new “job years”. The report found the net present value economic benefit of RGGI’s auction proceeds exceeded RGGI’s overall costs.

REGIONAL GREENHOUSE GAS INITIATIVE (RGGI)