Republican Gov. Arnold Schwarzenegger, who helped assemble the plan, called Wednesday's agreement "an example for other states and nations to follow as the fight against climate change continues."
The plan came after weeks of difficult negotiations and was sent to the state Senate, which approved it late Wednesday with a 23-14 vote. If approved as expected by the Democrat-controlled Assembly, the bill would then go to the governor's desk.
"My main objective was getting a bill that the environmental community can champion around the country and say, 'California did this, and you should be too.' And we did that," said Assembly Speaker Fabian Nunez, a Democrat.
25 percent cut by 2020
The bill requires the state's major industries -- such as utility plants, oil and gas refineries, and cement kilns -- to reduce their emissions carbon dioxide and other greenhouse gases by an estimated 25 percent by 2020.
One of the key mechanisms designed to drive the reductions is a market program that will allow businesses to buy, sell and trade emission credits with other companies.
"Today it feels as if the whole world is watching, and I hope they are," said Ann Notthoff of the Natural Resources Defense Council, one of the environmental groups involved in the negotiations.
The agreement was announced simultaneously by the governor's office and Democratic leaders in the Senate and Assembly. It gives the governor a key environmental victory as he seeks re-election this fall.
The bill states that the California Air Resources Board -- an 11-member panel appointed by the governor -- must identify "market-based compliance mechanisms" that might be used as part of its plan to reach the cap.
Environmentalists praise bill
The cap was praised by environmentalists as a step toward fighting global climate change. It was criticized by some business leaders, who say it will increase their costs and force them to scale back their California operations.
Republicans blasted the bill, saying the bill would have little effect and make California an expensive place to do business. "This bill is the road to economic ruin for California," Sen. Dennis Hollingsworth said.
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. (The process of global warming)
In the absence of federal action, much of the effort to combat climate change has been focused in the states. More than 100 climate-related bills have been held up in Congress, including one that calls for a national cap on greenhouse gas emissions.
State a leader in cutting auto emissions
California has led the country in reducing greenhouse gas emissions through its renewable energy policies and a 2004 law reducing tailpipe emissions from vehicles.
Ten other states are poised to enact California's auto rule, while more than 20 states have required utilities to eventually generate some power from renewable sources such as solar, wind and geothermal.
The bill includes a so-called "safety valve" sought by Schwarzenegger that would allow California's governor to delay the emission-cap mandate if the state is hit with a natural disaster, terrorist attack or some other emergency.
In addition to the emissions cap, California lawmakers voted to approve related global warming legislation. That bill would prohibit the state from entering long-term contracts with any out-of-state utility that fails to reduce its carbon dioxide emissions. The bill passed by a 43-30 vote in the Assembly. It goes to the Senate for final approval.