The California Air Resources Board (CARB) has published a draft Initial Statement of Reasons (ISOR) for the Cap-and-Invest Program Review. Once the ISOR is published in the state Register, expected January 23, 2026, this will signal the transition of the rulemaking process from the informal phase into the formal rulemaking phase. This release outlines major proposed changes to the Cap-and-Invest regulations, which are designed to align the program with the state’s ambitious 2030 and 2045 climate targets. Note the program is no longer referred to as Cap-and-Trade, per the extension legislation in September 2025.
The 45-day formal comment period will begin when the regulatory package is officially published. The Board is tentatively scheduled to consider the amendments on May 28, 2026, with the new cap trajectory targeted to take effect on January 1, 2027. This timeline allows for additional comments after the initial 45-day period.
The following is a breakdown of the key proposals in the ISOR and their implications for the Western Climate Initiative (WCI) market.
1. The New Cap Trajectory
The ISOR proposes a new cap trajectory for the program extending through 2045. As anticipated, the proposal calls for the removal of 118.3 million allowances from the 2027 to 2030 budgets.
Crucially, the removal schedule is not equally distributed across the four years as some stakeholders had expected. Instead, the allowances will be removed in a back-loaded schedule:
- 2027 cap: 15 million allowances removed
- 2028 cap: 26.5 million allowances removed
- 2029 cap: 35.1 million allowances removed
- 2030 cap: 41.7 million allowances removed
This revision represents a substantial tightening of the program’s long-term supply. The cumulative supply of allowances from 2027 to 2045 in the ISOR comes to 3.79 billion, a 1.02 billion decline compared to the 4.81 billion available under the original California regulations.
The ISOR also proposes diverting a small portion of the post-2030 budget—1% of each year's budget—to the first Allowance Price Containment Reserve (APCR) tier, totaling 13 million allowances diverted from the 2031 to 2045 budget years.
2. Implementation of the "Offset-Under-Cap" Rule
One of the most highly anticipated changes addresses the "Offset-under-cap" rule, which was introduced by AB 1207 and aims to integrate the usage of compliance offsets into the program's overall allowance cap.
To implement this, CARB will establish a new “Allowance Removal for Offset Use Account.” The process for adjusting the cap will follow two main steps:
Annual Allowance Removal
Starting on December 8, 2027, CARB will annually transfer a specific number of allowances from the subsequent year’s budget into this new account. The quantity to be transferred is determined by calculating the maximum potential offset use (currently 6% annually between 2026 and 2045) multiplied by the actual verified emissions from two years prior.
For example:
- Transfer on December 8, 2027 (Allowances diverted from the 2028 budget): 14.4 million allowances, calculated as 6% of the 2026 covered emissions (240.4 million tCO2e).
These allowance transfers represent an upfront reduction in the program cap, based on the assumption that compliance entities will use the maximum available offset quota.
The True-Up Process
Since covered entities have historically used less than their maximum offset quota, a “true-up” accounting exercise will be conducted following the conclusion of each compliance period, beginning on December 8, 2029.
- Permanent Retirement: Only the number of allowances that matches the actual amount of compliance offsets surrendered (excluding pre-2026 emissions and invalidated offsets) will be permanently retired from the program cap.
- Market Reintroduction: Any excess allowances that were initially removed but were not required for permanent retirement will be transferred back to the program’s Auction Account. These units will then be designated for sale in equal installments over the subsequent three calendar years.
3. Changes to Compliance Periods
To enhance alignment with major state and international climate milestones (such as the 2030 and 2045 statutory targets), the ISOR proposes an update to the program’s compliance periods. The program will shift from a continuous three-year compliance cycle to an alternating series of two-year and three-year periods. While this change does not alter the fundamental supply and demand balances of the program, it may influence the allowance and offset procurement behavior of compliance entities.
4. Other Key Rule Changes
The ISOR introduces several other changes with varying impacts on the market structure:
Corporate Association Group (CAG) Rule Changes
The ISOR proposes expanding the criteria that trigger a corporate association, with a phased-in implementation period to protect market stability. The new rules aim to enforce physical holding limits more effectively.
- Entities must identify new CAG affiliations within 30 days of a change.
- Entities will have until December 31, 2029, to disclose the percentage shares of holding and purchase limits assigned to each member of a newly formed CAG.
CARB staff estimate that these new rules should increase liquidity. It is important for market players to understand that any allowances flowing into market supply because of these limitations do not represent supply in excess of the program caps.
Utility Allocation Transition (NGUs to EDUs)
In line with AB 1207, the ISOR proposes a gradual transition of allowance allocation from natural gas utilities (NGUs) to Electricity Distribution Utilities (EDUs).
- Beginning in 2029, 20% of the NGU allocation will be transitioned to EDUs.
- The transition rate will then increase by 10% per year, reaching 100% by 2037.
- Publicly owned EDUs must consign 100% of the allowances they receive from EDUs to auctions.
Reserve Sale Trigger Rule
The Reserve Sale Trigger Rule will be changed to make it harder to trigger a reserve sale. Under the new proposal, CARB will only offer a reserve sale (including the APCR and ceiling tiers) if the previous current auction settlement price is at least 80% of the lowest reserve tier price, an increase from the previous threshold of 60%.Coverage of Denaturant Portion Fuel Ethanol Emissions
The ISOR includes a proposal to place the denaturant portion of fuel ethanol emissions under the program’s coverage. This is expected to result in a small increase in covered emissions, as denaturant typically makes up only 2 to 5% of ethanol by volume.Voluntary Renewable Electricity Reserve (VRE) Diversion
The ISOR clarifies that California will not be diverting additional allowances to the VRE, adjusting an earlier suggestion in the Standardized Regulatory Impact Assessment (SRIA) to divert 5.5 million allowances from the 2025–2030 budget.
5. Next Steps for the WCI Market
With California moving ahead in its formal rulemaking process, market attention is also turning to Quebec, which has not yet released its own complementary rulemaking documents. The conclusion of California’s rulemaking—particularly if it results in tighter caps for 2027—is expected to facilitate the process for California and Quebec to begin the Washington linkage rulemaking later in 2026 or early 2027. This timeline could potentially keep the door open for an eventual linkage to be in effect prior to Washington’s first major compliance surrender in November 2027. The proposed changes within the ISOR are not yet final and will undergo at least one public comment period, suggesting that further adjustments may occur before final adoption.
ClearBlue views the draft ISOR as largely in line with market expectations. The rulemaking package should materially tighten program balances.
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