For the past 10 years, California has struggled with huge budget deficits and wrenching cuts. Suddenly, however, the state is poised to raise billions from an unusual new source: the proceeds from its landmark global warming law.

The windfall could come as soon as this fall, when state officials are set to begin auctioning off pollution credits to oil refineries, power plants and other major polluters as part of a new "cap-and-trade" system.

The amounts are potentially enormous: from $1 billion to $3 billion a year in 2012 and 2013, jumping to as high as $14 billion a year by 2015, according to the nonpartisan state Legislative Analyst's Office. By comparison, the state's current budget deficit is $9 billion.

But like thirsty castaways on an island surrounded by ocean water they can't drink, Gov. Jerry Brown and state legislators face strict constraints on how they can spend the money. More than 30 years of court rulings and ballot measures -- dating to Proposition 13 in 1978 -- limit its use, probably only to projects that reduce greenhouse gas emissions.

To add another hurdle, major business groups are preparing lawsuits, arguing that the state cannot collect the money at all.

Still, Brown and others in the Capitol are cautiously making plans. On Monday, the state's High-Speed Rail Authority slipped into a news release that the money would be used as "a backstop" that could save the struggling bullet-train project. And in a follow-up interview with this newspaper, Dan Richard, chairman of the rail authority, asserted that a large portion of the money could go to fund high-speed rail.

Everyone from environmentalists to utility companies are jostling for ways to spend the money. The wish lists include renewable energy projects, bus systems and forest restoration.

"This is a moment of significant historic importance," said V. John White, director of the nonprofit Center for Energy Efficiency and Renewable Technology in Sacramento. "But we need to be careful about how we spend it until we know for sure that it is going to be there."

Business and taxpayer groups contend that the state has no right to auction off the permits. They argue that AB 32, the state's global-warming law signed by Gov. Arnold Schwarzenegger in 2006, does not specifically authorize auctions and that permits to pollute must be handed out free. They say if the state wants to charge money for the permits, it will need a two-thirds vote of the Legislature -- a political impossibility because Republicans oppose the law and raising any new fees or taxes.

"This wasn't intended. It wasn't discussed," said Dorothy Rothrock, vice president of the California Manufacturers and Technology Association. "It's outrageous and probably illegal."

However, some legal experts say the state stands a good chance of winning in court. They note that AB 32 requires the California Air Resources Board to reduce emissions that contribute to global warming by using "market mechanisms" -- and that auctions are a common market tool used in places such as Europe and the Northeast with cap-and-trade programs.

"I think the most fair reading of AB 32 is that it did allow the Air Resources Board to create market mechanisms that do include an auction," said attorney Cara Horowitz with UCLA's School of Law. "The Legislature gave the Air Resources Board very broad authority."

Even if the state wins a lawsuit, expected to be filed this summer, it almost certainly cannot spend the new billions on schools, roads, health care or other needs.

That's because of a 15-year-old state Supreme Court ruling involving paint. In 1991, Gov. Pete Wilson signed a law placing a fee on companies that made lead paint. The money was used to fund programs reducing lead poisoning in children.

Sinclair Paint sued, arguing that Proposition 13 required a two-thirds vote in the Legislature to approve such fees. But the state's high court ruled that California can charge industries with fees as long as the money is used to offset the health or environmental effects of the industry's behavior.

The Brown administration argues that spending the global-warming money on bullet trains complies with the ruling because the trains would cut pollution by reducing car and airplane trips.

"These funds are being raised for reducing greenhouse gases and cannot be spent outside of that purpose," said H.D. Palmer, a spokesman for the state Finance Department. "It's like the way you can't spend money from school bonds to build highways."

A similar program in 10 Northeastern states raised $912 million from industry auctions from 2008 to 2011. The most common way the states used the proceeds was to fund programs to help provide insulation, new windows, efficient appliances and lighting to homes and businesses.

Brown's budget for the fiscal year beginning July 1 includes $1 billion from cap-and-trade auction revenues, but doesn't specify exactly how they would be used.

The first phase of the bullet-train project, from Merced to Los Angeles, is estimated to cost $32 billion. But the state now has just $12 billion from state bonds and federal grants. Richard, the rail authority's chairman, said the global-warming funds could potentially make up $10 billion or more. "If it's an insurance policy, it needs to be able to insure the whole thing, and I think it does," he said.

The project's critics are fuming that it might be saved by AB 32. "It's the perfect melding between two boondoggles," said Jon Coupal, president of the Howard Jarvis Taxpayers Association.

Critics also argue that the global-warming fees will be passed on to consumers, raising gasoline prices and utility bills. But AB 32 supporters note that the law has broad public support: Voters defeated a ballot attempt in 2010 by oil companies to block it.

Environmentalists also point out that cap-and-trade was originally a Republican idea, originated by business interests and first put into law by President George H.W. Bush in 1990, when it was used to offer incentives to industry to reduce emissions that cause acid rain.

Since then, those emissions have been cut by 65 percent.

"Our goal for the new revenue is to speed and encourage California's transition to cleaner sources of energy," said Alex Jackson, an attorney with the Natural Resources Defense Council. "There's a lot of things that could fit that mold."

IN THE BUDGET

$1B

Amount of revenue from the auction of pollution credits that Gov. Jerry Brown included in his 2012 budget.

The problem: Critics argue that the government isn't allowed to sell the credits. And the money may be restricted to use on environmental issues.
HOW CAP-AND-TRADE WORKS » PAGE A8