California’s revamped carbon market takes effect on 1 September, and climate advocates are using the final weeks to warn that two design features could quietly weaken it. At a briefing on 13 August titled “Maintaining Climate Integrity in California’s Cap and Invest Program”, environmental groups and carbon market experts argued that the new Manufacturing Decarbonization Incentive (MDI), together with long-unresolved gaps in the offset program, threatens the environmental integrity of one of the world’s largest carbon markets, according to Carbon Pulse. For compliance buyers and offset developers, the dispute is not academic: it goes to how many allowances and credits will actually exist, and what they will be worth.
A Genuinely Tighter Cap, on Paper
The regulatory updates the California Air Resources Board (CARB) adopted on 29 May are, by the headline numbers, a real tightening. According to ICAP’s summary of the rulemaking, roughly 118 million allowances are being removed from annual budgets between 2027 and 2030, after the state’s 2022 greenhouse gas inventory showed the 2016-era budgets had been set too high. The cap now declines by 11% per year through the end of the decade, then by an average of 7% per year from 2031 to 2045.
The updates also close a structural loophole on offsets. When a covered entity surrenders offset credits for compliance, CARB will retire an equivalent number of allowances from the following year’s budget, keeping total emissions inside the cap. That change addresses a long-standing criticism that offsets let entities comply without the capped volume actually falling.
The program, extended through 2045 and renamed Cap-and-Invest by legislation signed in September 2025, covers more than 75% of California’s emissions and has been linked with Québec since 2014, with Washington now exploring a three-way link.
The Side Door: 118 Million Allowances Outside the Cap
The concern at the centre of the advocates’ briefing is the MDI. The mechanism takes approximately 118 million allowances, the same volume removed from the 2027-2030 budgets, and places them in a dedicated reserve account outside the cap. Industrial facilities that invest in on-site emissions reduction projects can receive these allowances, a design CARB says minimizes carbon leakage risk and backfills reduced federal decarbonization funding.
Critics, including environmental groups, academic experts and state lawmakers, argue the mechanism could undermine the cap’s integrity and cut revenues for the Greenhouse Gas Reduction Fund. The symmetry is what makes the critique legible: the regulator tightened budgets by 118 million tonnes on one line and created a 118 million tonne pool on another. Whether the net position is tighter depends entirely on how stringently MDI allowances are awarded.
CARB’s board accepted a set of guardrails in response. The Executive Officer must evaluate the MDI and report to the board before any allowances are issued, at least one public workshop must precede any award, issuance must be reported annually, and by July 2028 CARB must evaluate the mechanism and propose amendments so that facilities failing to deliver promised reductions return their allocations.
The Older Problem: Offset Protocols Still Pending
The briefing’s second fault line predates the MDI. Gaps in California’s offset program have been flagged for years, and a workshop on updating compliance offset protocols, required under state legislation, is only now planned for summer 2026. The new under-the-cap accounting raises the stakes: if offsets now displace real allowances one-for-one, weak protocols translate directly into higher actual emissions rather than just questionable credits.
For offset developers, this cuts both ways. Tighter protocol review raises the bar for eligibility, but offsets that survive it become more valuable, because every credit used now forces an allowance out of the system. Scarcity of credible supply is the likely direction of travel.
What It Means for Market Participants
Compliance buyers face a market where headline stringency and delivered stringency may diverge. The 11% annual cap decline argues for structurally higher allowance prices, and California Carbon Allowance futures were already holding above $33 this week ahead of the third-quarter auction. But an aggressively awarded MDI would recycle supply back to industry, muting the price signal the tighter cap is supposed to send. Positioning decisions now hinge on how the guardrails operate in practice, not on the cap trajectory alone.
Offset project developers should treat the protocol workshop as the key event. Protocols updated toward conservativeness will shrink eligible supply and reward early movers with verified, defensible projects. For investors, the July 2028 MDI review is the checkpoint that determines whether the incentive becomes a permanent allocation channel or a conditional one with clawbacks.
What to Watch
Three markers will show whether the integrity concerns bite. First, the first MDI evaluation report and public workshop: the criteria CARB sets for “on-site emissions reduction” will define how hard the side door is to open. Second, the offset protocol workshop this summer: scope and stringency of the revisions will signal whether old gaps get closed or carried forward. Third, the Washington linkage talks: adding a third jurisdiction multiplies the volume riding on whatever integrity standard California sets.
California built its carbon market’s credibility on being the regulated alternative to the voluntary market’s quality problems. The MDI debate is a test of whether that credibility survives contact with industrial policy.
