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Curbing emissions, or doin’ the ‘resource shuffle’?

Unveiling its sweeping proposal to curb carbon emissions on Monday, the Obama administration repeatedly pointed to the success story unfolding in California as a model for how a national system could work. The cap-and-trade system the state adopted is aiming to return greenhouse gas emissions to 1990 levels by 2020—with a significant chunk of those savings coming from cleaner electricity.

But one researcher studying the state’s program says California regulators have opened a loophole in the law wide enough to allow all of the purportedly choked-off fumes from electric utilities right back into the atmosphere.

It boils down to a simple accounting trick: A California utility buying electricity from a dirty, coal-fired power plant in, say, Nevada should have to buy credits to “pay” for the resulting carbon emissions under the state’s new regime. But if the utility trades that contract with a Nevada utility generating power from cleaner natural gas, it can book a reduction in emissions while the coal-generated electricity gets redirected into a state with no such requirement. The deal results in no net reduction in air pollution, though it will appear that way in California—a phenomenon known as “resource shuffling.”

Danny Cullenward, a climate policy expert at the University of California, Berkeley, says California utilities are already making use of the trick to minimize the financial burden of the new climate rules. He cited three recent deals cut by California power companies, apparently kosher according to the state’s rules, that he estimates will move between 30 and 60 million tons of carbon off its books while pumping them into the atmosphere elsewhere.

“We’re looking at a pretty serious disaster in terms of what the policy actually does and the difference between the way people talk about it and what’s actually happening,” Cullenward says. “This practice is happening. If it continues, it will likely mean that a substantial amount of what the market does is just shuffle paper contracts around the Western electricity grid.”

Beyond failing to curb emissions, the practice has the effect of devaluing the California market’s carbon permits, which are expected to continue hovering around a floor price of $12 per metric ton. One of the purposes of a cap-and-trade program is to gradually raise the carbon price over time to encourage investments in efficiency and cleaner technology.

Michael Wara, an energy and environmental law expert at Stanford Law School, agrees that most of the emission reductions California utilities are booking exist only on paper—thanks to the contract swapping—and that the practice is suppressing the price of carbon. But he’s less bearish on what it means for the project’s longer-term success. “Getting a market going is hard,” he says. In part, he says, regulators have to be mindful not to let carbon prices rise too quickly and thereby threaten the viability of the whole program.

The Obama administration views the flexibility that California regulators have built into their system as a feature, rather than a bug, and are touting it as a model for how other states should go about developing their responses to the EPA push. Speaking to allied business leaders on a conference call Monday, White House counselor John Podesta said that “trying to get the reductions that are as complex as such a big economy as the state of California will kind of indicate a path forward for a lot of people.” He said utility company CEOs in the past two weeks have told him they appreciate the give in California’s approach. “I think there’ll be some pressure by the utilities themselves to look for those kinds of flexible mechanisms to get the best and most cost-effective mechanisms,” Podesta said on the call.

Wara says the fate of California’s program could be determined by the success of the EPA directive. If the states bordering California opt in to its system, utilities there will no longer be able to shuffle their emission liabilities around the Western electricity grid. But that remains a big “if.” As Wara notes, when it comes to climate policy, the politics of a state like Arizona are starkly different from its western neighbor. And once the EPA gets through its rule-making, the mandate is sure to land in the courts, where some of the states around California are likely to be lead plaintiffs. Which is to say, as Wara does, “it’s too soon to tell.”