California’s top air regulator wants to overhaul the state’s two-decade-old carbon market. But key lawmakers and environmental groups say the effort will undermine the program — and the state’s decarbonization goals.

Last month, the California Air Resources Board proposed major changes to the state’s cap-and-invest program. The system was put in place in 2006, becoming the country’s first economy-wide emissions-trading mechanism for refineries, factories, power plants, and other major industrial sites. Together, these sources account for about 80% of California’s greenhouse gas emissions.

The program effectively taxes major emitters and uses the proceeds to fund climate and decarbonization solutions throughout the state. CARB is in charge of managing the program, and ensuring it supports the state’s legal mandate to reduce its carbon emissions by 40% from 1990 levels by 2030.

But critics say the agency’s latest proposal would instead put those targets out of reach.

Topping their list of concerns is CARB’s novel plan to grant a total of 118 million metric tons of extra emissions allowances to oil refineries and other industries, in exchange for a promise to invest in decarbonization projects in the future. That could allow polluting industries to keep pumping carbon dioxide into the atmosphere at volumes that will blow past the state’s 2030 targets.

What’s more, giving away that many allowances could dramatically reduce cap-and-invest revenues, potentially by as much as $4 billion over the next four years. That could eliminate billions of dollars meant to fund state programs to defray the impact of rising utility rates and protect disadvantaged communities suffering the greatest harms of climate change.

CARB, for its part, has argued that its proposed changes will not have such dire effects. The agency is set to vote on its new plan on May 28.

Environmental advocates and a group of 28 state lawmakers who helped reauthorize the cap-and-invest program last year are now pushing CARB to revise its plan and offer an alternative that can be implemented in the next few months.

“That’s what we need, because this proposal undermines the integrity of the program so substantially,” said Chloe Ames, a policy adviser at NextGen California, one of 45 environmental groups that signed a letter to California Gov. Gavin Newsom, a Democrat, and CARB Chair Lauren Sanchez calling for the agency to abandon its plan.

In a separate letter to Newsom and Sanchez, the lawmakers wrote that the proposed changes ​“depart from the spirit of our landmark agreement” to reauthorize the program last year, and demanded that CARB ​“amend their Cap-and-Invest proposal to push back on pressure from an oil industry that is making hundreds of billions in wartime profits.”

CARB’s April proposal is dramatically more lenient on polluters than the initial plan it put forth in January.

Following that original proposal, major oil and gas companies, including Chevron, pushed hard for CARB to take a more lenient approach. Republican and moderate Democratic lawmakers in the state amplified those pleas.

That’s why environmental groups have blamed the new proposal on ​“massive lobbying efforts by fossil fuel interests — some of the most profitable companies in the world.”

Some lawmakers criticized the proposal along similar lines in a May 6 Senate hearing with Sanchez. In the hearing, Sen. Caroline Menjivar, chair of the Senate Democratic Caucus, put a fine point on it, referring to the program as a ​“slush fund” for polluters.

California’s cap-and-invest program works like this: Companies covered by the program must either reduce their carbon emissions below a certain state-mandated limit or buy allowances from the market to offset emissions in excess of that limit. The number of allowances available for purchase declines over time — it’s ​“capped,” hence the name. As the supply of available allowances falls, the price of each allowance, and so the cost of compliance, tends to rise.

In CARB’s January proposal, the agency determined that the state’s previous carbon accounting had undercounted how many million tons of emissions it needed to eliminate between 2027 and 2030 to hit California’s decarbonization targets. That discrepancy added up to roughly 118 million metric tons.

CARB’s January plan proposed to remove the equivalent amount of allowances from the program entirely. But that spurred an outcry from polluting industries, which warned that such a move would drive up consumer costs and push jobs and investment out of the state.

The Western States Petroleum Association, a trade group, and Chevron, the state’s largest oil refiner, warned that failing to loosen the program’s emissions limits may force companies to close refineries and further increase the state’s highest-in-the-nation fuel prices.

That message has been echoed by California Republicans and some moderate Democrats. Rajinder Sahota, CARB’s deputy executive officer for climate change and research, cited similar concerns during a press briefing after the April proposal was unveiled.

As Sanchez told senators at the May 6 hearing, ​“We heard a clear message — we must support the ability for California businesses to stay in state while delivering on our statutory climate goals.”

CARB presented its new proposal — known as the manufacturing decarbonization incentive (MDI) — as the solution to those problems.

Its primer on the plan described it as a ​“first of its kind feature for a carbon market,” one that ​“would provide $4 billion to support investment and doing business in California,” as well as ​“make up for the loss of federal incentives” for industrial decarbonization that have been cut by the Trump administration.

The new plan would not only keep the 118 million metric tons’ worth of allowances in circulation; it would also allow companies to claim them for free, rather than force them to purchase the allowances.

Granting some free allowances is a standard practice in carbon markets and has been part of California’s approach from the start. The idea is to give carbon-intensive industries some buffer against the increasingly high costs of complying with emissions limits and to avoid driving these polluting but economically important industries to other states.

But critics say CARB’s math doesn’t add up.

The agency has not ​“provided evidence to justify the rather large increase in production subsidies” that the MDI program would provide, Meredith Fowlie, a professor at the University of California, Berkeley, and faculty director at its Haas School of Business’ Energy Institute, wrote in an April blog post. ​“Increasing these output subsidies may further reduce leakage — or it may just transfer more value to incumbent producers without materially changing production decisions.”

And regardless of its efficacy in preventing leakage, environmental advocates say that CARB’s own prior analysis shows that the MDI program would undermine climate goals.

“Creating 118 million additional allowances effectively cancels out the 118 million they’re supposed to be reducing by 2030,” said Caroline Jones, manager of energy transition and carbon markets at the Environmental Defense Fund, which opposes CARB’s plan. ​“Removing these allowances was initially proposed by CARB as the lowest threshold of change required to meet 40% reductions by 2030.”

CARB’s counter is that these free allowances will flow only to participating companies that pledge to invest in future emissions reductions. But it’s unclear whether CARB will have the ability or the desire to force companies to make good on those promises.

At the May 6 Senate hearing, Sanchez said that CARB would ​“monitor, evaluate, and propose adjustments to this program to ensure that it is working as intended and delivering on those emissions reductions.”

So far, CARB has provided very little in the way of clear rules for how the MDI would accomplish this, Jones said. ​“There are no guardrails on how they need to account for the emissions reductions they’re achieving — or even if they are achieving them,” she said.

Concerns loom over the ​“invest” side of the program as well.

California uses the revenue raised by selling cap-and-invest allowances to fund statewide climate and decarbonization efforts. But that funding mechanism is only as effective as the underlying market for the emissions allowances being traded — and environmental groups and lawmakers fear CARB’s plan will seriously undermine those dynamics.

Over the past two years, prices in the program’s quarterly allowances auctions have fallen from what Jones described as a relatively healthy range in the mid-$30s to low $40s per ton to the mid-$20s range. In fact, recent auction prices have been within a dollar or two of the minimum price set through a complex regulatory formula, she said.

“Prices in this program are already at a floor,” she said. CARB’s new proposal would ​“effectively flood the market with additional allowances, dragging down the market even further.”

The MDI program could have a particularly pernicious effect because it would open the door for companies to secure allowances on top of those they’ve already been allocated. In some cases, that could allow individual companies to ​“receive free allowances well in excess of their emissions,” wrote Fowlie, who is chair of the state’s Independent Emissions Market Advisory Committee.

According to Fowlie’s math, refineries tapping into the MDI program could rack up 6.1 allowances per barrel of oil, compared with the benchmark GHG emissions rate for refineries of about 3.89 tons per barrel. That windfall supply of allowances could be sold to other emitters, including other oil companies, depressing program revenues and industry compliance costs while turning a profit for polluters.

If those market dynamics play out, it would put a dent in funding for key climate and energy initiatives in California.

The cap-and-invest program helps fund a Climate Credit program that utilities use to reduce customer bills, as well as the state’s Greenhouse Gas Reduction Fund (GGRF), which has been a go-to source for programs that have faced funding cuts over the past several years of tight state budgets.

As part of last year’s negotiations over reauthorizing the state’s cap-and-invest program, lawmakers and Newsom’s office agreed to prioritize GGRF funds for a variety of purposes. The governor’s proposed 2026–2027 budget calls for $1 billion for the state’s high-speed rail project and $1.6 billion to backfill state forestry and fire protection, among other higher-tier funding priorities.

Money left after those priorities would flow to ​“Tier 3” allocations, including hundreds of millions of dollars over the next four years for the state’s Affordable Housing and Sustainable Communities Program, the Community Air Protection Program, the Low Carbon Transit Operations Program, the Safe and Affordable Drinking Water Fund, and the Transit and Intercity Rail Capital Program.

CARB, for its part, has argued that the doomsday scenario painted by critics is unlikely. After all, it’s hard to predict how an untested program like the MDI might impact a market that relies on buyers and sellers making their own decisions about what allowances are worth.

The agency ​“cannot predict auction revenues or results,” Sanchez emphasized in the May 6 Senate hearing.

But analyses from independent experts and from the state Legislative Analyst’s Office estimate that MDI would add up to billions of dollars in lost auction revenue.

The proposal could lead to a $4 billion loss in auction revenue, equating to $2.3 billion less for the GGRF and $1.7 billion less for the Climate Credit from 2027 to 2030, according to an analysis by data scientists Kyle Meng and Jordan Wingenroth of UC Santa Barbara’s Environmental Markets Lab. In a report to lawmakers, the Legislative Analyst’s Office also found it ​“could somewhat reduce the overall amount of Climate Credit” funding, and would cut annual GGRF revenues to about $2 billion per year — roughly half what they’ve been in recent years.

That ​“would be inadequate to fully support Tier 2 programs” the report found, ​“and leave no funding for Tier 3 programs.”

During the May 6 hearing, Sen. Eloise Gómez Reyes, a Democrat and chair of the Budget Subcommittee on Resources, Environmental Protection, and Energy, grilled Sanchez on the risk of losing this funding. ​“Do you believe the legislature intended to eliminate funding for affordable housing, transit, drinking water, wildfire prevention and clean air programs with the reauthorization?” she asked.

When Sanchez responded that CARB hasn’t proposed to ​“defund any of those specific programs,” Gómez Reyes interrupted her. ​“Let me stop you for a moment,” Gómez Reyes said. ​“That will be the effect. … There’s nothing left to fund Tier 3, and those are the most important programs that have served the community.”

Sen. John Laird, a Democrat who chairs the Senate Budget and Fiscal Review Committee, noted that such a drastic reduction in funding would force lawmakers to ​“put everything back on the table” for upcoming negotiations over the governor’s revised budget plan.

“It really affects what we do, to what level we do it, how the different pieces fit together,” he said. ​“So I want to call out the budget side of the equation, because this is a big deal.”

Jeff St. John

is chief reporter and policy specialist at Canary Media. He covers innovative grid technologies, rooftop solar and batteries, clean hydrogen, EV charging, and more.