Introduction

California’s Cap-and-Invest Program is the state’s primary carbon pricing mechanism, placing a hard and declining limit on roughly 80% of California’s greenhouse gas (GHG) emissions. If your company operates in California as an industrial facility, transportation fuel supplier, or electricity generator above 25,000 metric tons CO2e per year, you carry a direct compliance obligation with real financial consequences. And with major amendments proposed in January 2026 that will tighten the program through 2045, understanding how this program works and what it means for your business has never been more urgent.

Key Takeaways

• The Cap-and-Invest Program (formerly Cap-and-Trade) covers approximately 80% of California’s GHG emissions and applies directly to facilities emitting 25,000 metric tons CO2e per year or more.
• The program has generated $32 billion for California’s Greenhouse Gas Reduction Fund and provided $15 billion in energy bill credits to utility customers since launch.
• Covered entities obtain compliance instruments through free allocation, quarterly auctions, and carbon offset credits, with offsets capped at 6% of their compliance obligation.
• The January 2026 proposed amendments tighten allowance budgets through 2045, restructure compliance periods, and shift how free allowances flow to utilities and industrial facilities.
• Companies not directly covered will feel the program through higher energy costs, supply chain pricing, and investor climate disclosure expectations.

How the Cap-and-Invest Program Works

The Cap-and-Invest Program sets an economy-wide ceiling on greenhouse gas emissions across California. CARB (California Air Resources Board) issues a fixed number of allowances equal to that ceiling each year and reduces the number every year. One allowance equals one metric ton of carbon dioxide equivalent, or CO2e, measured using the 100-year global warming potential. Covered entities must surrender one allowance for every metric ton of CO2e they emit. Each year, fewer allowances exist, making emissions progressively more expensive and creating a sustained financial incentive to decarbonize.

This is the core logic of a cap-and-invest system: the cap creates scarcity, scarcity creates a price, and the price creates the incentive to act. Unlike a prescriptive regulation that mandates specific technologies, the program gives businesses the flexibility to find the most cost-effective path to emissions reduction. CARB’s analysis finds the program is 4 to 6 times less costly than prescriptive regulations applied to the energy and industrial sectors.

The program was originally called Cap-and-Trade. AB 1207, passed by the California Legislature in 2025 with a supermajority vote, renamed it Cap-and-Invest, reflecting the legislature’s emphasis on reinvesting carbon revenues into clean energy and community programs. CARB administers the program under authority first established by AB 32 in 2006. The program has been operating for 12 years, has completed 8 regulatory updates, and has been linked with the Québec carbon market for 11 years. It currently covers approximately 80% of California’s total statewide GHG emissions.

An annually increasing auction reserve price, also called the floor price, reinforces the carbon price signal year over year. All covered entities remain subject to existing air quality permit limits for criteria and toxic air pollutants, independent of their Cap-and-Invest compliance status.

Who Is Covered and Who Is Not?

The direct compliance threshold is 25,000 metric tons of CO2e per year. Entities above that level fall into one of three covered categories:

• Large industrial facilities, including manufacturing plants, refineries, cement producers, and food processors
• Transportation fuel suppliers, meaning companies that supply gasoline, diesel, and other fuels into California
• Electricity generators and importers

Approximately 400 facilities currently hold a direct compliance obligation, alongside roughly 400 private investors active in the compliance market. Small businesses are generally below the 25,000 MTCO2e threshold and face no direct program costs.

Being below the threshold does not mean the program has no financial relevance to your business. When covered entities face compliance costs, those costs flow through in the price of electricity, the price of manufactured goods, the price of transportation fuel, and the price of industrial inputs. Any California-operating company that purchases energy, goods, or services from covered entities absorbs a share of program costs in its operating expenses.

For global companies with California operations, procurement functions, or customer bases, the program is a material input cost variable. It is also a material variable for climate disclosure. Companies reporting under IFRS S2 or the EU CSRD that include California in their regulatory scenario analysis should reflect the program’s carbon price trajectory in their assumptions.

How Covered Entities Obtain and Surrender Compliance Instruments

Covered entities obtain compliance instruments through three channels: free allocation, quarterly auctions, and carbon offset credits. Each channel has different cost implications and strategic uses.

Free allocation provides allowances at no charge to industrial facilities in emissions-intensive, trade-exposed sectors. The rationale is leakage protection: without free allocation, California manufacturers would face a carbon cost that competitors in other states or countries do not, creating an incentive to shift production out of state. CARB has issued $12 billion in free allowances to date to minimize this risk and protect California jobs. The allocation is product-based, meaning facilities receive allowances based on a benchmark for their specific product, not simply their historical emissions. This design rewards efficient producers and incentivizes improvement.

Quarterly auctions are where CARB sells state-owned allowances to covered entities and eligible market participants. Fifty auctions have been held since the program launched. The auction sets the market price for carbon, and the reserve price establishes a floor below which allowances cannot sell. Revenue from state-owned allowances flows into the Greenhouse Gas Reduction Fund.

Carbon offset credits allow covered entities to meet a portion of their compliance obligation through verified emissions reductions achieved outside the program. Offsets are capped at 6% of a covered entity’s total compliance obligation going forward. Half of all offsets used must deliver direct environmental benefits in California, a requirement known as DEBS. CARB has issued 273 million verified compliance offsets to date across 6 approved offset project types. The $1.5 billion in offsets issued to tribal projects represents one of the program’s more notable community investment outcomes.

Four cost-containment tools keep compliance costs from becoming destabilizing. The two-tier Allowance Price Containment Reserve, or APCR, functions as a set of price speed bumps: if allowance prices rise above defined thresholds, additional allowances are released from the reserve. A price ceiling caps the maximum allowance price. Multi-year compliance periods allow covered entities to smooth annual variability in emissions and procurement. Limited banking of allowances supports planning and hedging across compliance cycles.

Where the Money Goes: The Greenhouse Gas Reduction Fund

When CARB auctions state-owned allowances, proceeds flow into the Greenhouse Gas Reduction Fund, known as the GGRF. The California Legislature and Governor appropriate those funds for clean energy, transportation, housing, and community investment programs across the state.

The program has generated $32 billion for the GGRF since launch. Seventy-five percent of appropriated GGRF dollars have been directed to priority populations, communities that bear a disproportionate share of air pollution and climate impacts. Fifteen billion dollars has been returned to utility customers through energy bill credits, primarily through the California Climate Credit. Twelve billion dollars has been directed to minimize emissions leakage and protect California jobs.

For non-covered companies, this revenue stream matters in two ways. First, if your California operations purchase electricity from investor-owned utilities, a portion of your utility bill is offset by the California Climate Credit, which is funded through the GGRF. Second, GGRF investments in transit, clean energy infrastructure, and building efficiency directly affect the cost environment in which California-operating businesses function.

What Are the 2026 Proposed Amendments and What Do They Mean for Your Business?

On January 20, 2026, CARB published proposed amendments to the Cap-and-Invest regulation, triggered by AB 1207 and SB 840, both passed in 2025 with legislative supermajority votes extending the program through 2045. These are the most consequential proposed changes since AB 398 in 2017. The public hearing is scheduled for May 28, 2026.

The amendments span five areas. Here is what each means for your business.

Tighter Allowance Budgets: Higher Carbon Costs and Stronger Incentives

The most significant change is a reduction in the total supply of compliance instruments. CARB proposes removing approximately 118 million allowances from the 2027 through 2030 annual budgets, reflecting corrections to the GHG Emissions Inventory. Post-2030 budgets are set to decline smoothly from the adjusted 2030 level to a 2045 budget consistent with the AB 1279 carbon neutrality target. The total proposed allowance pool is approximately 2.1 billion, cumulative from 2027 through 2045.

For covered entities, fewer allowances in circulation means upward pressure on prices at auction and in the secondary market. Covered entities that rely on procuring allowances rather than reducing emissions will face higher compliance costs as budgets tighten.

The opportunity is equally real. Covered entities that invest in GHG reduction now, before budgets tighten further, will hold surplus compliance instruments of increasing value. CARB’s own projections estimate the amendments will reduce 953 million metric tons of CO2e from 2027 through 2046, with $123 billion in estimated public health benefits and $192 to $485 billion in avoided global climate damages over the same period.

For non-covered companies, tighter budgets mean a stronger carbon price embedded in California electricity rates and industrial goods pricing through 2045. This is a two-decade cost variable that belongs in your supply chain modeling and TCFD scenario analysis today.

A new offset accounting mechanism accompanies the budget changes. As required by AB 1207, allowances will be retired from future annual budgets corresponding to compliance offset use. This ensures offset use does not inflate the effective allowance supply above the intended level.

Compliance Period Restructuring: Reassess Your Procurement Timeline

Compliance period durations will be modified to align with California’s statutory GHG reduction milestone dates of 2030 and 2045. For covered entities, this changes the specific calendar windows within which allowances must be surrendered. Allowance procurement plans, banking positions, and offset portfolios built around current compliance period timing will need to be reassessed once the final amended regulation is adopted.

Utility and Industrial Allocation Shifts: Who Pays and Who Is Protected

Two allocation changes carry broad cost implications.

Starting in 2029, free allowances currently granted to natural gas suppliers will transition to electrical distribution utilities with residential ratepayers, as required by AB 1207. Under the current system, natural gas suppliers receive free allowances that offset part of their compliance cost, which is reflected in gas rates. Redirecting that value to utilities means more allowance revenue returns to electricity customers through the California Climate Credit and related programs. Industrial and commercial customers who purchase both gas and electricity should model how this transition affects their blended energy cost profile through the early 2030s.

For industrial facilities, the 2026 amendments confirm that assistance factors remain at 100% through 2035. This is the confirmed leakage protection window for emissions-intensive manufacturers in California. Cap adjustment factors are added for 2032 through 2035. New and revised product-based benchmarks are introduced for cement manufacturing, crude oil production, transportation fuels, food processing, and manufacturing sectors. A new allocation mechanism also provides allowances to covered manufacturing facilities that undertake on-site decarbonization actions, including electrification, renewable energy adoption, and switching to low-carbon fuels. This is the program rewarding early movers before leakage protections begin to phase down after 2035.

The responsibility for administering purchased electricity leakage protection transfers from the California Public Utilities Commission to CARB, with covered industrial facilities receiving their leakage protection allowances directly.

What the 2026 Amendments Mean if You Are Not Directly Covered

The amendments do not change the 25,000 MTCO2e coverage threshold. However, a tighter allowance budget strengthens the carbon price embedded throughout California’s economy. For Scope 3 accounting, this is most relevant to Category 1 (Purchased Goods and Services), Category 3 (Fuel and Energy-Related Activities), and Category 4 (Upstream Transportation and Distribution).

For companies above the $1 billion revenue threshold that are subject to California’s SB 253 corporate GHG reporting law, Cap-and-Invest pricing is a forward cost variable for Scope 1 and 2 disclosures covering California operations. The two programs are separate, but they share data infrastructure: consistent GHG measurement at California facilities supports compliance with both.

California’s 12-Year Track Record and Why the Program Is Not Going Away

Some companies treat California’s carbon market as a compliance item to manage quarter by quarter. The program’s track record and legislative history support a different read: it is a permanent feature of the California business environment, and its trajectory is toward greater stringency, not less.

The program has operated continuously for 12 years. It has completed 50 quarterly auctions without a market failure. It has been reauthorized twice by supermajority legislative votes, first through AB 398 in 2017 and again through AB 1207 and SB 840 in 2025. California achieved the AB 32 target of returning GHG emissions to 1990 levels by 2020, several years ahead of the statutory deadline, demonstrating that the program delivers real-world results rather than regulatory activity without emissions impact.

The program is explicitly cited by CARB as a model for other jurisdictions developing their own emissions trading systems. California’s carbon price has 12 years of verified price history, linked market data with Québec, and a regulatory record that informs policy development across North America, Europe, and Asia-Pacific. For global companies, that history is a leading indicator of where other carbon markets are headed.

CARB’s 2022 Scoping Plan projects that achieving California’s programmatic goals would deliver $200 billion in health benefits in 2045 alone from reductions in harmful air pollution. That scale of projected public benefit, combined with the political durability demonstrated by supermajority reauthorization, means the business environment surrounding this program will not soften. The companies that build carbon pricing into their capital allocation, supplier assessment, and long-range financial modeling today are positioning themselves for a cost environment that is now legislatively confirmed through 2045.

Conclusion: Four Actions for Your Leadership Team

The Cap-and-Invest Program has moved well past the stage of being a near-term compliance item to monitor once per quarter. With the program anchored through 2045 and tightening from 2027, it is a two-decade variable in the California operating environment. Four actions belong on your leadership agenda now.

Confirm your coverage status. Determine whether any California operation meets or approaches the 25,000 MTCO2e per year threshold. Growth in operations or changes in energy mix can shift that calculation.

Reassess your allowance and offset strategy. If you are a covered entity, the tighter budget trajectory from 2027 through 2045 changes the value of early action. Procurement plans, banking positions, and offset portfolios should be reviewed against the proposed budget removals and the new compliance period structure.

Model your indirect cost exposure. For non-covered companies, map how Cap-and-Invest pricing flows through your California energy costs, supply chain inputs, and transportation costs. This is a 2045-horizon variable and a relevant input to Scope 3 accounting and TCFD scenario analysis.

Track the May 28, 2026 hearing. The final regulation will set allowance budgets through 2045. The outcome of this rulemaking is one of the most significant cost and compliance variables in the California operating environment for the next two decades.

From Scope 1 and 2 measurement at covered facilities to full Scope 3 value chain visibility, ASUENE’s platform is built for the California regulatory environment. Contact us today to assess your coverage, model your carbon cost exposure, and build your path to compliance.

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