By: Eva Raczkowski

September 2, 2021 — Capstone believes if California Governor Gavin Newsom (D) is removed from office after the September 14^th recall vote, the impact on cap and trade and the Low Carbon Fuel Standard (LCFS) would likely be limited, as there will be few opportunities for his successor to derail his administration’s programs. Keystone environmental policies in the state, including cap and trade program and the LCFS, have been a vital element—and in many cases the drivers—of investment theses for our hedge fund and private equity clients. After a string of polls ahead of the recall election revealed unthinkably close results, many investors will be watching the results to see if voters turn about and elect a Republican governor on September 14^th.

Polling

According to a late-July Berkeley Institute of Governmental Studies poll, 47% of voters favor the recall versus 50% who oppose recalling Newsom. FiveThirtyEight’s polling average shows Californians supporting keeping Newsom in place lead by about 8%. With Democrats dominating the state, polls expect higher Republican turnout—raising questions of whether history could repeat itself and California could once again elect a Republican governor in a recall election.

Margins for California’s recall election have narrowed in the past several weeks, based on recent polling. The recall vote has served as a venue for the public to vent frustration over pandemic mask and vaccine mandates, exacerbated by growing alarm about the COVID Delta variant and another season of unprecedented wildfires, droughts, and grid reliability concerns. Due to pandemic-related delays, petitioners were granted a longer timeline to vote for the recall, allowing more public frustration to build. Stakeholders in California we spoke with in recent weeks noted that if the spread of the Delta variant hampers school reopenings or if any of the other crises flare up at an inopportune time, it could threaten Newsom’s narrow margin in the polls.

Recall Process

To trigger a recall election, 12% of voters from the prior election (about 1,495,700) had to sign a petition to hold a recall vote. The state secretary certified the signatures on the petition in April 2021. Ballots were mailed on August 16^th, and the election is set for September 14^th. The ballot asks Californians to vote yes or no to whether Newsom should be recalled. It also includes an option to select a replacement candidate. If more than 50% of voters elect to recall Newsom, then the candidate with the highest percentage of votes will become the next governor in October, no matter how many votes they receive.

Potential Ramifications for Cap and Trade, LCFS

If a Republican takes control of the governor’s office, we believe the impacts on California’s key carbon policies—namely cap and trade and the LCFS—will be limited. We note the three leading Republican candidates have not directly indicated carbon pricing will be a top priority of their administration.

Three key factors will make it difficult for a Republican governor to unwind or meaningfully weaken the cap-and-trade program and LCFS:

Timing: A replacement governor would be serving a significantly shortened term with another gubernatorial election coming in 2022. This presents challenges given the timeline of the ongoing 2022 Scoping Plan Update. This catalogues progress toward California’s codified decarbonization targets, informs rulemakings in both the cap and trade and LCFS programs, and is scheduled to wrap up by the end of 2022. By this time, the scheduled 2022 gubernatorial election will have concluded. Legislative or administrative rulemaking to cap and trade and the LCFS will likely occur in late 2022 or early 2023, meaning even if a candidate who staunchly opposes carbon pricing wins this year, the process for program modification will likely extend well beyond their term.

Codification: Both cap and trade and the LCFS are codified in California law, limiting the governor’s ability to influence them and raising the credible threat that lawsuits from environmental groups could block any efforts to weaken the programs. Even if Republicans unseat Newsom, it is unlikely they will flip the state legislature, where Democrats currently hold a supermajority. S.B. 32 (2016) mandates the state ensures an overall greenhouse gas (GHG) emission reduction of a minimum of 40% by 2030, and the cap and trade and LCFS programs are critical parts of California’s compliance with this statutory goal.

Cap and trade: The mechanics of the cap and trade program are codified in A.B. 398 (2017). The law establishes a market-based mechanism to reduce GHG emissions through 2030, which includes the price ceiling, price tiers, reserve floor, percentages of offsets allowed for compliance, and analysis on the social cost of carbon to factor into carbon policy. The leakage risk factor—used in the calculation for free carbon allowances—is already set at 100%, per A.B. 398, leaving little room to allocate a greater amount of free carbon allowances to obligated parties.

LCFS: Like cap and trade, the Low Carbon Fuel Standard was named and codified with the passage of A.B. 398, which specifies the need for the LCFS to specifically target emissions associated with the production of transportation fuels in order to meet the state’s overall emissions reduction goals.

Limited Support for Repeal: Though the fossil fuels industry initially opposed both cap and trade and the LCFS, lobbying and legal efforts to challenge the programs have fallen off in recent years as more pressing threats from other state regulations emerged, and costs associated with compliance were largely passed through to consumers. As a result of this and the challenges discussed above, we believe fossil fuel industry efforts are more likely to be focused elsewhere if recall efforts are successful.