California is currently debating the future of its cap and trade program, which will play an important role in reaching its climate goals. The future of the system is controversial, but there have been a couple of important key reform proposals made by members of the California legislature, notably State Sen. Bob Wieckowski (D-Fremont) and Senate President pro Tempore Kevin de León (D-Los Angeles) that build on international experience on carbon markets and aim to ensure that California continues to be at the forefront of climate policy. Two of the most important proposals are for measures to bring prices into the range of what is needed to achieve the goals of the Paris Agreement and exclude offsets from the system.

Despite a lack of action from the federal government at the time, California put a price on carbon by establishing a cap and trade program as part of the landmark 2006 Global Warming Solutions Act. The scheme, which became operational in 2013 included a number of key features that differ from the EU’s key climate instrument, the EU Emissions Trading System (EU ETS), which started in 2005. The most notable difference is the price certainty provided by the minimum auction price floor which is the reason why the California scheme continues to have among the highest carbon prices in emission trading schemes around the world.

The carbon price signal is the single most important element determining the effectiveness of the carbon market: are prices high enough to provide an incentive to reduce emissions? The international High Level Commission on Carbon Prices suggests that a carbon price per ton of CO2 of $40-$80 is needed by 2020 and $50-100 by 2030 to efficiently reach the goals of the Paris Agreement to limit global warming. California’s cap and trade system is closer to these prices than other schemes but recent auctions have cleared at or near the auction price floor, showing the system to be oversupplied. To live up to the system’s potential, as proposed by Senators Wieckowski and de León, law makers must set the carbon price floor so that its future trajectory moves towards these levels.

California also pioneered a more conservative approach to carbon offsets, which give emitters a cheaper option than buying allowances to comply with their obligations by purportedly reducing emissions elsewhere outside of the cap and trade program. While California developed its own offset system and limited eligibility to project types within the United States (California now also accepts Canadian offsets via its link with Quebec), the EU ETS started out with a blanket approval for the UN’s so-called Kyoto mechanisms namely Joint Implementation (JI) and the Clean Development Mechanism (CDM). Many projects under these mechanisms have been shown to have problems in terms of their actual reduction of emissions and even in cases where they may have actually reduced emissions, they undermined the price signal of the EU ETS by contributing to a huge oversupply of allowances in the system. California’s floor price has provided some resilience to this effect, but Californian offsets are not subject to the price floor so thereby undermine the effectiveness of the system as a whole, and the climate revenue raising ability of the state.

In addition to their effect on prices in the system, there are questions about the extent to which offsets fully compensate for increased emissions in particular when it comes fundamental assumptions determining the actual reductions, as well as permanence, leakage, and perverse incentives. A recent study commissioned by the European Commission found that 85% of Kyoto Protocol offset projects do not represent real, additional emissions reductions. This offset program claimed responsibility for large numbers of projects that were already being built, and allowed countries to use those false reductions towards their emissions targets thereby increasing emissions. Academic experts at the Berkeley Energy & Climate Institute say that California’s offset program has similar problems, allowing projects that would have happened anyway to generate credits.

Another problematic issue is who is taking credit for what emission reductions. Buying and selling reductions across state and national borders is complicated because if emission reductions are counted twice they can lead to an increase in the overall emissions pumped into the atmosphere. ‘Double counting’ or claiming happens when one emission reduction is counted towards multiple targets. Severin Borenstein at UC Berkeley has analyzed the issue for renewable energy certificates. It is a little different for offsets, but it is the same problem. When California buys offset credits from projects in other states (or Canadian provinces), the emissions in those places (ideally) are reduced. Those reductions show up in the inventory of that state or province, but California also takes credit for them and thereby allows more emissions in California. Since as many as 20 other US states also have climate targets, if they reach them by showing reductions in their inventory levels, but California or its linked partner, Quebec, is also taking credit for them and allow more emissions because of it, this increases emissions. The Paris Agreement recognizes this problem and calls for “corresponding adjustments” to the accounting of who is reaching what target. In the US this exists neither domestically nor internationally, especially since President Trump has indicated a US exit from the Paris Agreement.

The EU is still in talks about key reforms with regard to the market price of the system but has addressed the issues with offsets by making it clear that it would no longer allow these credits in the EU ETS after 2020. Senators Wieckowski and de León follow this logic and also proposed excluding offsets from the system. That doesn’t mean that all the activities currently supported by offset programs should be stopped. Many could and should be supported with auction revenue from the cap and trade system i.e. a form of climate finance for those activities that are vulnerable to stopping their emission reduction activities.

The imperative to guarantee a resilient carbon price and not allow additional emissions for questionable reductions or those that others are taking credit for means that California should continue to bump up its auction floor price and exclude offsets from its system. In doing so it would future proof its climate leadership, raise increased revenue for a fair low-carbon transition, and ensure it is on the forefront of climate and carbon pricing policy both domestically and internationally.