On September 19, 2025, California Governor Gavin Newsom signed AB 1207California Global Warming Solutions Act of 2006, AB 1207 (Cal. 2025), https://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=202520260AB1207. and SB 840California Global Warming Solutions Act of 2006, SB 840 (Cal. 2025), https://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=202520260SB840. into law. Together, the new laws re-authorize and extend California’s cap-and-trade program — now renamed the “cap-and-invest” program — through December 31, 2045 (the Program). The new legislation arrives after several years of uncertainty about post‑2030 Program design and legal durability. That uncertainty dampened market confidence and contributed to significant allowance-price reduction and volatility, negatively impacting state auction revenues. The new laws restore long‑term statutory authority, largely maintaining the market architecture that has governed the Program since 2017, and preserve significant discretion for the California Air Resources Board (CARB) to implement the Program through rulemaking.
This Client Alert summarizes the statutory package and describes how the extension will require changes to certain features currently in the regulations governing the Program.
The Global Warming Solutions Act of 2006California Global Warming Solutions Act of 2006, 25.5 H.S.C. § 38500 et. seq. (AB 32) directed CARB to adopt regulations to achieve the maximum technologically feasible and cost-effective reductions in greenhouse gas (GHG) emissions, targeting statewide emissions at 1990 levels by 2020 and a subsequent 40% reduction below 1990 levels by 2030. Although AB 32 did not require CARB to adopt a market mechanism to address GHG emissions, CARB ultimately chose this approach and, in 2012, established a cap‑and‑trade program, building on a mandatory GHG reporting regime that started in 2007. By design, the statewide emissions cap declines annually. Covered entities must surrender allowances and up to a certain quantity of offsets based on reported emissions, following a schedule that includes annual partial surrenders with triennial true-up deadlines when entities need to cover the entirety of their emissions over the past three years.
Prior to 2017, there was legal uncertainty as to whether AB 32 authorized CARB to continue the Program beyond 2020. AB 398,California Global Warming Solutions Act of 2006, AB 398 (Cal. 2017), https://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201720180AB398. adopted in 2017 with a two‑thirds supermajority, expressly re-authorized the Program, but only through 2030. AB 398 also introduced a number of market design changes, including an allowance price ceiling, a reduction in offset usage limits and offset requirements for in-state benefits, new industrial allocation factors to mitigate leakage, and two allowance price containment points (i.e., “speed bumps,” which are specific price points where CARB will release additional allowances in the market to contain rising prices). Passage with a supermajority was an important feature of AB 398 because it reduced the perceived risk of litigation under California’s constitutional requirements for tax‑like measures, which is discussed further below.California Proposition 13 (1978).
AB 1207 extends the Program through December 31, 2045, providing long-term regulatory certainty for compliance entities, investors, and project developers. Both AB 1207 and SB 840 include urgency clauses and therefore became operative upon the governor’s signature on September 19, 2025 (aside from certain provisions with specified later operative dates). The extension addresses the post‑2030 “cliff” created by AB 398’s sunset, and is expected to stabilize auction expectations and compliance planning.
Because of the urgency clauses, each bill required a two‑thirds vote of each chamber. The Legislature approved the package with supermajorities: 29-6 in the Senate and 55-10 in the Assembly. The California Constitution requires that any act that would raise taxes on taxpayers must be passed by a two-thirds majority of both houses of the Legislature.California Constitution, Article XIIIA, Section 3. As with AB 398, the two‑thirds vote posture is intended to preempt litigation that would have alleged certain Program features operate as a tax under California law. The supermajority also renews the strong support for climate policies in Sacramento despite the recent focus on affordability.
As required by AB 398,California Global Warming Solutions Act of 2006, AB 398 (Cal. 2017), https://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201720180AB398. CARB implemented a gradually escalating price ceilingCal. Health & Safety Code § 38562(c)(2)(A). along with allowance price containment reserve tiers,Id. at § 38562(c)(2)(B). and proceeds from sales at the ceiling were to be used to achieve equivalent or greater emissions reductions.Id. at § 38562(c)(2)(A). Although never implemented, the general expectation was that CARB would use the proceeds to cause, or pay the reduction of emissions to compensate, for the issuance of allowances at the ceiling price beyond the emission cap.
AB 1207 refocuses these tools on consumer affordability. All revenues from sales of allowances at the price ceiling now flow into a new California Climate Mitigation Fund to support affordability measures (e.g., bill credits and cost-mitigating investments), replacing the prior statutory language. AB 1207 also authorizes CARB to amend the allowance price containment reserve and the price ceilingThe 2025 price ceiling is $94.92. if it finds those mechanisms are not adequately protecting consumers. In addition, AB 1207 directs CARB to design regulations that transition allowances from gas corporations to electrical distribution utilities by January 1, 2031, to minimize ratepayer impacts, aligning with broader State electrification policy.
The treatment of offsets within the Program has evolved significantly since its inception. AB 32 authorized CARB to develop the Program to include the use of carbon offsets, provided that such credits are “real, permanent, quantifiable, verifiable, and enforceable.”Cal. Health & Safety Code § 38562(d). AB 32 further required that credited reductions be “in addition to” any reductions required by law or regulation or that would otherwise occur, thereby establishing a rigorous additionality standard.Id. However, AB 32 did not specify a particular percentage limit on the use of offsets for compliance purposes, instead leaving the determination of quantitative limits to CARB’s regulatory discretion.
In the initial regulatory framework adopted by CARB, covered entities were permitted to use offsets for up to 8% of their compliance obligations. This limit was intended to provide cost containment and flexibility, recognizing that offsets are a mechanism to direct capital to sectors not directly regulated under the cap, such as forestry, agriculture, and methane-destruction projects. The 8% limit was significant in that it was comparable in magnitude to the emissions reductions CARB anticipated from the Program itself through 2020. Offsets could also be banked indefinitely, just like allowances, and there was no restriction on the total number of offsets an entity could hold.
In 2017, AB 398 reduced the offset usage limit to 4% of a covered entity’s compliance obligation for emissions generated from 2021 through 2025, which then increased to 6% for emissions from 2026 through 2030. Importantly, AB 398 also required that no more than half of the offsets surrendered for compliance could be sourced from projects that do not deliver direct environmental benefits to air or water quality within California. This “direct environmental benefits in the state” (DEBS) requirement was a legislative response to concerns that the use of out-of-state offsets could undermine local air quality and environmental justice objectives.
AB 1207 extends the 6% limit on the use of offsets from January 1, 2026, through December 31, 2045, while maintaining the 50% DEBS requirement. This approach sends a strong signal globally regarding the continued viability of offsets to address carbon emissions.
AB 1207 includes a new statutory requirement that CARB must now remove and retire a number of allowances equal to the offset credits actually used for compliance in the prior year from the following year’s allowance budget. This “offsets under the cap” approach is different from CARB’s historical practice of pre-adjusting the cap on a forward-looking basis to reflect a conservative assumption of 100% permitted offset use. By requiring a one-for-one reduction in future allowance supply for each offset surrendered, AB 1207 aligns California’s approach with that of other jurisdictions, such as Washington State. CARB is likely to clarify how these mechanisms will operate together in future rulemakings to avoid adjusting the cap twice to account for offset usage.
Further, in recognition of potential additionality, permanence, and leakage concerns, SB 840 establishes a comprehensive quality and governance roadmap for offsets under the Program. By December 31, 2026, CARB is required to conduct a detailed study and report on the contribution of offsets to the state’s climate goals, potential refinements to the DEBS definition, strategies to increase the attractiveness and supply of in-state offset projects, and alternative valuation methodologies for in-state offsets. Furthermore, SB 840 mandates that CARB update all existing compliance offset protocols by January 1, 2029, ensuring that protocols reflect the best available science and incorporate lessons from other carbon markets, the Paris Agreement, academic research, and industry best practices. Beginning January 1, 2034, and at least every five years thereafter, CARB must reevaluate each offset protocol and consider whether further updates are warranted.
In October each year, CARB allocates allowances from the upcoming budget year to eligible industrial facilities.Cal. Code Regs. tit. 17 §§ 95870(e), 95871(d), 95890(a) and 95891(a)–(c). The number of industrial allocations that a company receives is determined by multiplying the Company’s output, its Emissions Efficiency Benchmark, the Industry Assistance Factor, and the Cap Adjustment Factor. The Industry Assistance Factor assigned a percentage to industries at high (100%), medium (75%), and low (50%) risk of leakage. Through 2017, CARB applied a 100% Industry Assistance Factor to all industries as a form of transition assistance, and CARB amended the Program to maintain all Industry Assistance Factors at 100% from 2018 through 2020.
AB 1207 maintains all Industry Assistance Factors at 100% from 2021 through 2030. After 2030, CARB is instructed to distribute industrial sector allowances in a manner that minimizes emissions leakage risk to cost-effectively achieve the State’s climate targets. Maintaining the Industry Assistance Factors at 100% through 2030 provides regulatory consistency to industry. In addition, since the cost of procuring allowances is passed on to consumers in a manner that can be regressive, maintaining the Industry Assistance Factors helps to address affordability issues. This is the case, for example, with the transportation fuel sectors where allowance prices have a direct impact on the price of gasoline at the pump.
AB 398 embedded oversight via California scoping plan updates, Legislative Analyst’s Office reviews, and the Independent Emissions Market Advisory Committee. It also required CARB to consider the social cost of carbon and economic impacts when setting price containment.
One of the concerns by both the Assembly and Senate going into the 2025 extension negotiations was a perception that CARB had too much discretion and too little oversight in its administration of the Program, despite the guardrails included in AB 398.
AB 1207 enhances consumer-focused analysis and certain financial disclosures. When revising market-based compliance mechanism regulations, CARB must evaluate consumer cost impacts. In addition, local publicly owned electric utilities must disclose to CARB how they use all revenues — including any accrued interest — received from the direct allocation of allowances to electric utilities.
Historically, auction proceeds flowed to the Greenhouse Gas Reduction Fund (GGRF) with a mix of continuous and discretionary annual budget appropriations across transportation, housing, air quality, wildfire, energy, and other programs.
SB 840 establishes ongoing appropriations from the GGRF beginning in FY 2026–27 across priority sectors including clean transportation, housing and community investment, clean air and water, wildfire prevention and resilience, agriculture, clean energy, and climate-focused innovation. For example, $400 million is directed to the Transportation Agency for the Transit and Intercity Rail Capital Program.
As with prior legislative changes, CARB will implement AB 1207 and SB 840 through rulemakings that integrate with the Scoping Plan and related regulatory processes. Rulemakings are expected to address adjustments to price containment features, the design and timing of allowance transitions from gas corporations to electric distribution utilities, the interaction of retrospective offset retirements with cap setting, and the protocol study and update schedule mandated by SB 840. Stakeholders should anticipate workshops, formal notices, economic and environmental analyses, and multiple opportunities for comment.
Leadership changes may shape policy direction. Governor Gavin Newsom has appointed Lauren Sanchez, formerly his Senior Advisor for Climate, to serve as CARB Chair, succeeding Liane Randolph. Chair Sanchez is expected to oversee the forthcoming rulemakings to operationalize the new statutes.
Latham & Watkins is available to assist with assessing bill impacts, evaluating rulemakings, developing offset and allocation strategies, and positioning projects for GGRF funding opportunities. Should you have any questions or would like further information on any of these topics, contact one of the authors below, or another member of your Latham team.