The agreement marks a clear break with the Bush administration and puts California on a path to reducing its emissions of carbon dioxide and other greenhouse gases by an estimated 25 percent by 2020.
It also gives Schwarzenegger a key environmental victory as he seeks re-election this fall.
"We can now move forward with developing a market-based system that makes California a world leader in the effort to reduce carbon emissions," the governor said in a statement.
The agreement came after weeks of difficult negotiations and was announced simultaneously by the governor's office and Steve Maviglio, spokesman for Assembly Speaker Fabian Nunez, D-Los Angeles.
The bill, expected to go to the Senate floor later today, requires the state's major industries — such as utility plants, oil and gas refineries, and cement kilns — to reduce their emissions of the pollutants widely believed to contribute to global warming. The key mechanism driving the reductions will be a market program that will allow businesses to buy, sell and trade emission credits with other companies.
Schwarzenegger had insisted that the California Air Resources Board, which will oversee the program, be required to implement the market-based strategy.
The cap was praised by environmentalists as a step toward fighting global climate change but criticized by some business leaders. They say it will increase their costs and force them to scale back their California operations.
Republicans in the Legislature say climate change should be addressed at the national level, not on a state-by-state basis.
"Adopting costly and unattainable regulations will drive businesses and jobs out of California into other states and even into other countries with no commitment to improve air quality," said Assembly Republican leader George Plescia, R-La Jolla.
Schwarzenegger and the Legislature's Democratic leadership have embraced a state emissions cap on vehicles and industries as a way to make California a trendsetter in combatting global warming.
The nation's most populous state is the world's 12th largest emitter of greenhouse gases and could suffer dire consequences if global temperatures increase only a few degrees. Reports by state agencies indicate a 2- to 3-degree rise in temperature could melt the Sierra snowpack earlier each year, lead to flooding in the Central Valley and threatening the state's long-term water supply for cities and farms.
"This is not anecdotal legislation; this is rooted in fact," Senate President Pro Tem Don Perata, D-Oakland, said during a news conference called by Democratic leaders to announce the deal. "... The facts are if we do not do something to stop carbon emissions in this world, we will see a diminution in the quality of life."