On May 12, 2010, US Senators John Kerry (Democrat-Massachusetts) and Joseph Lieberman (Independent-Connecticut) introduced a discussion draft of new climate and energy legislation, entitled the "American Power Act." The nearly 1000 page bill is the culmination of many months, and in fact years, of effort in the United States Congress to address climate change and carbon emissions. The bill addresses the gamut of major energy and environmental issues, including mandatory caps on greenhouse gas emissions, carbon capture and sequestration, carbon allowances and markets, offshore drilling and nuclear power, among others.
Although no longer a sponsor of the legislation due to political wrangling regarding potential immigration reform, Senator Lindsey Graham (Republican-South Carolina) was a key figure in the back-room negotiations intended to garner Republican support for the bill. Many provisions in the bill reflect concessions secured by Graham, such as expanded offshore oil and gas drilling (which remain in the bill despite the ongoing oil sill catastrophe in the Gulf of Mexico) and a delayed phase-in of compliance obligations for the US manufacturing sectors. Although the bill was launched without Senator Graham's express endorsement, it is likely that the senator will eventually re-join his colleagues with whom he worked on the bill for nearly a year. However, Republican support is likely to be limited and even support from some moderate Democrats is uncertain, making passage of the bill in the Senate highly uncertain, particularly given upcoming mid-term Congressional elections later this year as well as competing legislative priorities. Senate Majority Leader Harry Reid (Democrat-Nevada) has indicated that he will confer with the key Senate committee chairs to determine timing and evaluate support for the bill following the Memorial Day recess at the end of May.
In the event the Senate does manage to pass the Kerry-Lieberman bill, it will need to be reconciled with the cap-and-trade bill passed by the US House of Representatives in June 2009, known as the American Clean Energy and Security Act (H.R. 2454), sponsored by Rep. Henry Waxman (Democrat-California) and Rep. Edward Markey (Democrat-Massachusetts). Speaker of the House, Nancy Pelosi (Democrat-California) has indicated that she would be willing to again debate climate change legislation on the House floor, although signals have been mixed at times. Should climate legislation pass both houses of Congress, President Obama will undoubtedly sign such legislation. International pressures will also factor into the push for US legislation, as the US desires to continue its leadership role in global discussions leading up to the next UNFCCC conference of the parties in Cancun, Mexico at the end of this year.
"Cap and Trade" In Sheep's Clothing
In a concerted attempt to move away from the concept of "cap-and-trade", which has become tarnished in the US by fallout from the Wall Street financial crisis and general distrust of the Kyoto Protocol mechanisms, the Kerry-Lieberman bill rebrands the approach as "tonnage limits", yet remains strikingly similar to the Waxman-Markey cap-and-trade bill. The cap-and-trade component of the bill would amend the federal Clean Air Act to establish an economy-wide cap on greenhouse gas emissions and distribute a limited number of permits ("allowances") to control emissions. The program will be administered primarily by the US Environmental Protection Agency (EPA) but with a role for a variety of other federal agencies. The number of allowances will be less than current industrial emissions and will be reduced each year to achieve overall emissions reductions of 4.75% by 2013 (the first compliance year), 17% by 2020, by 42% in 2030 and by 83% in 2050 (compared to 2005 levels). Emissions allowances can be traded (hence cap and trade) allowing emitting facilities (known as "covered facilities" under the bill) that can reduce emissions more inexpensively to sell excess allowances to sources for which emissions controls are more expensive. The legislation also sets a "price collar" floor for carbon of US$12 (upped by 3% over inflation each year) and an initial ceiling price for carbon of US$25 (upped by 5% over inflation each year) by way of a strategic reserve mechanism.
The bill focuses first on reducing emissions from the electric power sector (i.e., power plants) and provides for a "phase-in" of the industrial manufacturing and natural gas sector beginning in 2016. The legislation attempts to ease the transition to a carbon-constrained economy by providing free allowances for electric power sector entities, with 75% being distributed based on historic emissions and 25% based on retail sales, phased out over time. This differs from the House-passed version of the bill which adopted a 50/50 split for allowances (50% based on historic emissions and 50% based on retail sales) reflecting a compromise that had previously been blessed by the leading electric sector trade association. The industrial sector must purchase allowances for process and combustion emissions, but a rebate program is established for energy-intensive or emissions-intensive industrial sectors that are most exposed to international trade competition. In addition, the bill retains the ability to establish tariffs to level the playing field with imports from countries such as China and Brazil that may not take on comparable greenhouse gas reductions.
The US "allowance pool" begins in 2013 at 4.722 billion tons decreasing to 2.043 billion tons by 2050. The bill allows unrestricted allowance trading and banking of allowances, as well as borrowing in the form of a two-year rolling compliance period and further borrowing up to 15% of the quota drawing from a five-year window with 8% interest. A notable exception to the cap-and-trade approach is the treatment of the petroleum fuels sector (primarily gasoline and fuel oil), which is regulated under a "fixed fee" mechanism requiring the petroleum industry to pay a fee corresponding to the auction price of allowances, but which would not permit trading. Fuel suppliers would be responsible for emissions resulting from combustion of fuels by downstream fuel users. The Kerry-Lieberman bill also allows covered entities to use international allowances and domestic and international offsets to meet compliance obligations, with some restrictions. International emission allowances may be substituted, provided the associated foreign climate change program imposes a mandatory absolute tonnage limit on greenhouse gases, the international program is at least as rigorous as the US program, and the allowance has not already been used to comply with another program. Covered entities may meet a portion of their allowance quota employing domestic and international offsets, within certain parameters and restricted to an aggregate limit across the program of 2 billions tons per year. A wide array of offset project types are potentially eligible, which a strong focus on agricultural and forestry offsets, which would be overseen by the US Department of Agriculture, while the overall offsets program will be administered by the EPA. While domestic offsets are credited on a 1:1 basis, international offsets are discounted at a 1.25:1 ratio (as in the House bill) beginning in 2018.
Pork Barrel Politics
In addition to cap-and-trade provisions, the Kerry-Lieberman bill contains a cornucopia of incentive programs designed to pick up support for the bill from a cross-section of sectoral and regional interests, such as funding for consumer rebates, job creation, clean energy development, transportation infrastructure, free allowances for the oil industry, programs for state climate programs, and money for natural resource adaptation. The bill also incorporates by reference an energy-focused bill approved by the Senate Energy and Natural Resources Committee earlier this year sponsored by Senator Jeff Bingaman (Democrat-Arizona) (S. 1462), which includes a national renewable energy standard, incentives for carbon capture and sequestration, appliance efficiency standards, green building codes, and a variety of other programs. It is expected that both of these bills will be moved together to further debate in the Senate, together forming a counterpart to the Waxman-Markey bill passed by the House of Representatives.
Carbon Markets
Under the proposed Senate bill, the Commodity Futures Trading Commission (CFTC) would have jurisdiction over greenhouse gas "instruments," which will be treated like agricultural commodities under the federal Commodity Exchange Act. This is a significant development as jurisdiction over carbon markets has been a continuing point of debate, centered around whether such authority should fall to the EPA, the CFTC, the Federal Energy Regulatory Commission, the Treasury, or new agency. The bill does require the CFTC and EPA to execute a memorandum of understanding within a year of the bill becoming law, addressing information sharing, enforcement and jurisdiction. Initial auction and physical/cash market trading would be restricted to registered carbon market participants and compliance entities, which is also a point of contention. Although the bill would allow free trading of agreements, contracts, or transactions that do not require physical delivery, futures and derivatives based on greenhouse gas instruments must be exchange-traded and cleared with real-time trading information reporting. Participants and trading organizations involved in such a market would be required to register with the CFTC. This proposal differs from another bill (S. 2877) offered by Senators Maria Cantwell (Democrat-Washington) and Susan Collins (Republican-Maine), which seeks to narrow the greenhouse gas market to upstream fuels producers.
Winners and Losers
The Kerry-Lieberman bill appears to create more "winners" than "losers." The most notable potential "losers" may be the states, whose current cap and trade programs will be pre-empted by the federal government under this legislation, although the bill does provide for compensation for states for related lost revenue. State faired better with regard to offshore drilling, whereby the states were given veto power over offshore drilling within 75 miles of their shores. In the event a state does not object to such drilling, the state would be entitled to share 37.5% of the royalties collected by the federal government.
Nuclear power may very well be the big winner under the Kerry-Lieberman bill as most of that industry's "wish list" items were contained in the bill, including tax incentives, expanded regulatory risk insurance, a loan guarantee fund and an expedited licensing process, and as a basic element, a price on carbon which favors non-emitting generation. The inclusion of these nuclear provisions was intended in part, to draw in Republican "fence-sitters" that might otherwise vote against the bill should it reach the Senate floor.
Other "winners" include biomass electricity and biofuels, whose carbon emissions would not count against the national cap on carbon, and would thereby relieve such producers from the obligation to buy allowances for their carbon emissions. However, the bill does require monitoring and study of climate and environmental impacts of biomass and biofuels, with modifications as necessary.
Farmers are also arguably "winners" under the proposed legislation. First, the bill exempts farmers from mandatory pollution compliance obligations. Second, it provides for agriculture offsets, which would be administered by the U.S. Department of Agriculture, and not the EPA, which had previously been a sticking point for the agriculture industry. Finally, the legislation allows for voluntary offset projects that would pay farmers and other landowners for carbon sequestration activities.
The transportation sector could be viewed as a loser, but some (including the drafters of the bill) argue that as a result consumers win. Under the bill, gasoline and fuel oil are subject to an emissions cap and are required to purchase allowances at a fixed auction price, which will tend to increase prices. Moreover, while refiners are required to buy allowances, they are not allowed to trade, sell, bank, or loan such allowances, which may further affect prices. On the positive side, the bill also provides for a "Clean Vehicle Technology Fund" to allow EPA to provide grants to manufacturers to improve their facilities to produce advanced technology vehicles, and other federal programs, such as the recent vehicle fuel-economy standards, will tend to lower fuel use such that consumers may ultimately spend less of their overall income on transportation costs.
Observations
The prospects for the Kerry-Lieberman bill passing the Senate this year are at best uncertain. And while legislation did pass on the House side in 2009, challenges remain for reconciling the two bills (assuming the Senate bill gets the votes it needs to pass). These challenges are both substantive and political, and intersect with a complex dynamic outside the particular issue of climate change. For example, given the recent oil spill off the coast of Louisiana, offshore drilling has become an even more controversial topic. In addition, the United States is facing many challenges right now, including financial reform, the fallout from healthcare reform, and the whispering about immigration reform, which make climate and energy legislation fall back in the legislative queue. Nonetheless, there is still some momentum and Congressional leaders still appear motivated to pass climate and energy legislation, as does the Obama Administration.
Max Williamson and Allison Hull specialize in energy, environmental and carbon markets in North America and are based in the Washington, D.C. office of Andrews Kurth LLP.
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