California Puts Offsets Under the Cap
The amended Cap-and-Invest rules took effect on 1 September 2026. Every offset credit used for compliance now retires an equivalent allowance from the following year's budget.
At a glance
In force 1 SEP 2026 Amendments adopted by CARB on 29 May 2026 took effect. The programme now runs to 2045 under the Cap-and-Invest name. | Budget cut 118 M ALLOWANCES Removed from the 2027 to 2030 annual budgets, correcting budgets CARB says the 2022 inventory update showed were set too high. | Structural change OFFSETS UNDER CAP Every offset credit used for compliance now retires an equivalent allowance from the following year's budget. |
Our view
The allowance-budget numbers will get the coverage, and they matter. But the change with the longest tail is the one-line arithmetic rule: an offset used for compliance now cancels an allowance a year later. That ends a fifteen-year argument about whether offset use expands the system, and it does so by construction rather than by assertion.
It also quietly changes what an offset is worth to a covered entity. The credit no longer adds a tonne of headroom to the market; it moves a tonne of headroom from next year into this one. Anyone modelling offsets as a pure cost arbitrage against the allowance price is now modelling the wrong instrument.
The amendments
What took effect on 1 September
The California Air Resources Board adopted regulatory updates to the Cap-and-Invest Programme on 29 May 2026, and they came into force on 1 September 2026. The package sets allowance budgets through 2045, introduces an industry incentive mechanism, and expands affordability measures for consumers. It follows the legislative reauthorisation that extended the programme to 2045 and renamed it from Cap-and-Trade to Cap-and-Invest.
118 M allowances removed from the 2027–2030 annual budgets | ~11% annual cap decline for the rest of this decade | 7% average annual cap decline, 2031 to 2045 | >75% of California emissions covered by the programme |
The 118 million allowance reduction is a correction rather than a tightening in the political sense: CARB attributes it to the 2022 greenhouse gas inventory update, which showed the budgets set in 2016 had been calibrated against emissions estimates that were too high. Removing the surplus restores the intended stringency rather than adding new stringency on top of it — a distinction that matters when forecasting how much of the price response is structural.
On the allocation side, roughly 80% of allowances are dedicated to consumer benefit, which CARB puts at an estimated USD 10 billion in electricity bill credits alongside about USD 8 billion for the Greenhouse Gas Reduction Fund. A new Manufacturing Decarbonization Incentive holds about 118 million allowances in a separate reserve, subject to guardrails: an Executive Officer evaluation and a public workshop before any award, annual reporting, and a review by July 2028.
The structural change
Offsets move inside the cap
Under the amended programme, when a covered entity uses offset credits for compliance, CARB removes and retires an equivalent number of allowances from the following year's allowance budget. The requirement is statutory, carried in AB 1207, rather than an administrative choice CARB could reverse at the next rulemaking.
The effect is to close the oldest objection to compliance offsets. The argument against them was never only about project quality; it was that an offset admitted into a capped system adds a tonne of permitted emissions that the cap did not authorise. Netting the allowance a year later removes that channel arithmetically. Whether an individual project is additional remains a project-level question, but the system-level leakage argument no longer applies in California.
For covered entities the internal economics change with it. Previously the offset-versus-allowance decision was a straight price comparison at a given compliance deadline. Now the offset displaces an allowance from next year's budget, which feeds back into auction tightness in the following period — a cost the entity partly bears itself, and one that a multi-year compliance model should carry explicitly rather than treating each year independently.
CARB has also flagged a workshop on updating the compliance offset protocols. For sellers of California-eligible offsets — US forestry, livestock methane, ozone-depleting substance destruction, rice cultivation — that is the process to watch, because protocol revision, not the cap arithmetic, is what determines whether a given project type still has a route into the largest compliance offset market in North America.
Washington and Quebec
The linkage question is now the live one
With California's rulemaking settled, attention moves to the parallel processes. California has been linked with Québec since 2014. Washington State signed a non-binding linkage agreement with both in June 2026 and filed its final rule amendments in September 2026, with its regulatory changes expected to complete by the end of that month. Washington's Department of Ecology expects a linked market to begin operating in 2027 and will give the market at least 90 days' notice before the effective date.
Linkage still needs steps in each jurisdiction that have not happened yet: in California, positive linkage findings by the Governor under SB 1018 and a CARB rulemaking adopting linkage amendments; in Québec, a formal rulemaking, National Assembly approval and an Order in Council. None of those is a formality, and the sequence is the reason the operating date is 2027 rather than now.
For anyone holding or forecasting North American compliance instruments, the combination is worth modelling together rather than separately: a tightened California budget, offsets netted against the following year, and a third jurisdiction joining a common auction. Those three move price in the same direction, and they arrive inside eighteen months of each other.
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