California’s cap-and-trade program, officially renamed Cap-and-Invest in 2025, works by setting a statewide limit on greenhouse gas emissions, issuing a matching number of tradable allowances, and requiring the state’s largest polluters to surrender one allowance for every metric ton of carbon dioxide equivalent they release. The cap shrinks every year, which steadily reduces the supply of allowances and raises the cost of emitting. Roughly 450 facilities and fuel suppliers, together responsible for about 75 percent of statewide emissions, must play by these rules, and the quarterly auctions that distribute most allowances now raise billions of dollars annually for climate and community programs.1California Air Resources Board. Cap-and-Invest Program The program is authorized through January 1, 2046.
Who Has to Participate
Any facility emitting 25,000 metric tons or more of CO2e per year is a covered entity. That threshold pulls in refineries, cement plants, power plants, food processors, glass manufacturers, and other heavy industrial operations. Electricity importers are covered too, which closes the loophole of buying dirty power from out-of-state generators.1California Air Resources Board. Cap-and-Invest Program
Fuel suppliers face the same threshold, measured by the emissions their fuels will produce when burned. Distributors of gasoline, diesel, natural gas, and propane fall under the program, which is how California reaches tailpipe and furnace emissions that no single vehicle or building would ever trigger on its own.
Smaller facilities below 25,000 tons can join voluntarily as opt-in entities so they can trade in the market. Mandatory or voluntary, every participant keeps detailed emissions records, because the number of allowances owed each year is tied directly to a verified emissions total.
The Shrinking Cap and What an Allowance Is
The California Air Resources Board (CARB) sets a ceiling on total covered emissions and lowers that ceiling each year. One allowance authorizes one metric ton of CO2e. As allowances get scarcer, pollution gets more expensive, and that pressure is the engine of the program.2Legal Information Institute. California Code of Regulations 17 CCR 95820 – Compliance Instruments Issued by the Executive Officer
An allowance is not a property right. The regulation says so explicitly: a compliance instrument “does not constitute property or a property right,” and CARB can terminate or limit it at any time.2Legal Information Institute. California Code of Regulations 17 CCR 95820 – Compliance Instruments Issued by the Executive Officer It is a government-granted permission to emit, nothing more.
How Allowances Are Distributed
Free Allocation
Not every allowance goes to auction. CARB hands a portion out for free to industries considered at risk of “leakage,” meaning that if a California plant closes under the weight of carbon costs, the same product gets made somewhere with no carbon rules and emissions move rather than drop. AB 398 locked in 100 percent industry assistance factors for eligible sectors from 2021 through 2030, so qualifying manufacturers receive their full calculated allocation at no cost.3Legislative Analyst’s Office. Cap-and-Trade Extension: Issues for Legislative Oversight Electric and natural gas utilities also receive free allowances, but when they sell them, the proceeds must flow back to ratepayers rather than shareholders.
Quarterly Auctions
The rest of the allowances go to sealed-bid quarterly auctions run jointly with Québec on the WCI, Inc. Auction Platform. CARB posts notices 60 days before each sale with eligibility, format, and volume details.4California Air Resources Board. Auction Information Every winning bidder pays the same settlement price.
A reserve price (the floor) sits beneath each auction, and no allowance can clear below it. The floor rises every year by 5 percent plus inflation to keep upward pressure on costs. Above the floor are two intermediate price containment points and a hard price ceiling established under AB 398. If demand pushes prices to a containment point, CARB releases additional allowances from a reserve to slow the climb. If prices hit the ceiling, CARB can issue new allowances and must spend the revenue on equivalent emission reductions elsewhere.
Offset Credits as a Limited Substitute
Covered entities can satisfy part of their obligation with offset credits instead of allowances. Offsets represent verified reductions from projects outside the capped sectors. CARB approves six protocol categories: U.S. forest projects, livestock digesters, mine methane capture, destruction of ozone-depleting substances, rice cultivation, and urban forestry.5California Air Resources Board. Compliance Offset Protocols
The share of your obligation you can cover with offsets is capped. For the 2024 and 2025 data years, the limit is 4 percent; for 2026, it rises to 6 percent and stays there through 2045.6Legal Information Institute. California Code of Regulations 17 CCR 95854 – Quantitative Usage Limit on Designated Compliance Instruments Including Offset Credits At least half of the offsets a company uses must come from projects that deliver direct environmental benefits inside California.
Every project runs through verification before CARB issues credits. The reductions have to be real, quantifiable, permanent, and independently verified. AB 1207 added another twist in 2025: when a company surrenders offset credits, CARB now retires an equal number of allowances from the following year’s budget. Offsets no longer expand total allowed emissions beyond the cap; they sit under it.
Trading Between Auctions
Allowances and offsets can be traded entity-to-entity between auctions. Every transfer is recorded in the Compliance Instrument Tracking System Service (CITSS), the program’s official registry, which follows each allowance from issuance to retirement and keeps the ownership chain.4California Air Resources Board. Auction Information Participants must keep active CITSS accounts and respect holding limits intended to prevent any one party from cornering the market.
Linked Markets
California and Québec linked their programs in 2014. An allowance issued by either jurisdiction is valid in both, and the quarterly auctions are joint.4California Air Resources Board. Auction Information
Washington launched its own cap-and-invest program in 2023 and is negotiating linkage with the California-Québec market. The three governments issued joint statements of interest in 2024, drafted a linkage agreement in early 2026, and held public comment periods through May 2026. If regulatory changes stay on schedule, a three-way market could begin operating in 2027.7Washington State Department of Ecology. Cap-and-Invest Linkage
Reporting and Third-Party Verification
Nothing gets surrendered until emissions are reported and verified. California’s Mandatory Reporting Regulation (MRR) requires covered facilities to track fuel use, production, and thermal energy throughout the year and submit the data through the California Electronic Greenhouse Gas Reporting Tool (Cal e-GGRT).8California Air Resources Board. Mandatory Greenhouse Gas Emissions Reporting
Reporting thresholds vary by sector. Electricity generators, cement producers, refineries, and a few other named industries must report regardless of volume. Most other stationary sources report at 10,000 metric tons of CO2e or more, and fuel suppliers report at the same level measured by downstream combustion. Only entities at 25,000 tons or above face verification and cap-and-trade compliance obligations. Smaller reporters can file abbreviated reports.
After the report goes in, a CARB-accredited third-party verifier reviews facility records, inspects operations, and confirms the numbers meet regulatory standards. Verification statements are due by August 10 of the year after the emissions period.9California Air Resources Board. Mandatory GHG Reporting – Key Dates and Activities Missed deadlines and inaccurate data trigger penalties and enforcement.
Compliance Periods, Surrender Deadlines, and Penalties
The program runs on three-year compliance periods. The current fifth period covers 2024 through 2026. Each November 1, covered entities must surrender allowances equal to 30 percent of the prior year’s verified emissions. At the end of the three-year cycle, a full true-up surrender covers whatever’s left.10California Air Resources Board. California Cap-and-Trade Program – Preparing for the 2021 Annual Compliance Obligation
Surrender happens inside CITSS. The entity moves instruments from its Holding Account to its Compliance Account, and once the deadline passes, CARB retires them for good.
Falling short is expensive. An entity that fails to surrender enough instruments owes four times the shortfall. Being 100 allowances short means owing 400. This untimely surrender obligation replaces the original shortfall, and the entity still must deliver allowances rather than simply writing a check.11Legal Information Institute. California Code of Regulations 17 CCR 95857 – Untimely Surrender of Compliance Instruments Failure to meet even that triggers additional penalties under Health and Safety Code Section 38580.
Where the Auction Money Goes
All auction proceeds flow into the Greenhouse Gas Reduction Fund (GGRF). SB 840, signed in September 2025, rewrote the spending framework starting in the 2026–27 fiscal year. The new structure needs roughly $4.3 billion in annual auction revenue to fully fund its allocations.12Legislative Analyst’s Office. Cap-and-Invest: November 2025 Auction Update and 2026-27 Budget
Major annual allocations under SB 840 include:
- High-speed rail: $1 billion.
- Affordable housing and sustainable communities: $800 million.
- Transit and intercity rail capital projects: $400 million.
- Community air protection under AB 617: $250 million for monitoring and reducing pollution in the most impacted neighborhoods.
- Wildfire and forest resilience: $200 million.
- Low-carbon transit operations: $200 million.
- Safe and affordable drinking water: $130 million.
SB 840 also expressed legislative intent to fund transit passes, climate-focused technological innovation, and startup funding for a University of California Climate Research Center. If auction revenue falls short of the full amount needed, the Department of Finance must reduce the allocations proportionately.12Legislative Analyst’s Office. Cap-and-Invest: November 2025 Auction Update and 2026-27 Budget