This article originally appeared on the Natural Resources Defense Council's Switchboard blog, and is reprinted with permission.

The California Air Resources Board today approved, by a vote of 9-1, the first economy-wide carbon market to reduce pollution in the nation. This comes just over a month after California voters overwhelmingly rejected Proposition 23, signaling strong support for clean energy and policies that will help the state reduce global warming pollution. The ARB action also comes just a week after nations around the world agreed on the urgent need to tackle the challenge of climate change (see my colleague Jake Schmidt's blog on Cancun here).

This newly adopted carbon market is one small but key part of California's comprehensive clean energy law, AB 32. It accounts for roughly one-quarter of the overall emissions reduction programs that will be accomplished by the package of policies developed under the landmark legislation to put California on a clear path to reducing emissions to 1990 levels by 2020.

The program sets a cap on global warming pollution for facilities in the industrial, electricity, transportation, and natural gas sectors and saves the overall economy money by letting facilities (such as power plants, refineries and industrial plants), use a market to find the cheapest ways to reduce pollution.

Let me illustrate with an example: if facility A and B need to reduce their emissions by a combined total of 20 tonnes, and facility A has a cheap way to reduce emissions (let's say by $10/tonne reduced), but it will cost facility B twice as much ($20/tonne), facility A can reduce its emissions by 20 tonnes for a total cost of $200 (20 tonnes x $10/tonne) and then sell its extra allowances to facility B who will not need to reduce at all. If A sells its 10 extra allowances to B at a price slightly higher than what A paid to reduce emissions, but lower than the price B itself could have achieved (say $15/tonne), A will have spent $50 and B will have spent $150 to reduce global warming pollution overall by 20 tonnes. In other words, the program will have reduced emissions at the lowest price in this market ($10/tonne), to the financial benefit of the cleanest emitter – A.

By contrast, as the chart below diagrams, if the government simply required facilities A and B to each reduce emissions by 10 tonnes, the overall cost of the program would rise. Under this scenario, facility A would pay a total of $100 (10 tonnes x $10/tonne) and facility B would pay a total of $200 (10 tonnes x $20/tonne) for a total cost of $300 – or $100 more than the cost of getting the same pollution reductions under a cap and trade program.

How Cap-and-Trade Works in California:

The program sets a limit on pollution, and requires facilities to submit to the Air Board one pollution allowance for every tonne of pollution they emit. There are a limited number of allowances available (similar to taxi medallions). Facilities are free to find the cheapest ways of reducing emissions and the Air Board only monitors whether facilities have enough allowances to match the pollution they emit, not how they reduced their emissions.

Every facility has three options for meeting pollution limits:

1) Reduce pollution by making facilities more efficient or finding alternative fuel sources

2) Get a pollution allowance either by getting it for free, buying it in an auction, or buying it from another facility that has an extra allowances

3) Buy an offset. An offset represents a pollution reduction from outside the program. A facility inside the program can invest in reductions elsewhere to offset their emissions.

There are many design elements of this program that we consider to be strong, and some that we believe should be improved over time.