Archived Content

Climate Change On Capitol Hill Memo

MEMORANDUM

February 12, 2007

TO: Business Roundtable Climate Change Contacts

RE: Climate Change On Capitol Hill: Legislative Proposals in the 110th Congress

Five major climate change bills have so far been introduced in the 110th Congress (four in the Senate and one in the House), and Senator Bingaman has circulated draft legislation that—while not finalized—has garnered significant attention. This memo provides a brief overview of the pending legislative proposals, coupled with a discussion of six key regulatory design questions that are likely to drive congressional deliberations. A chart comparing the key elements of the proposed bills is also available.

A Snapshot of the Major Pending Climate Change Proposals

The key features of the principal bills are as follows:

  • McCain-Lieberman (S. 280) and Olver-Gilchrest (H.R. 260). Senators McCain and Lieberman have introduced a revised version of their bill, which would establish a capand- trade regime covering approximately 85% of U.S. Greenhouse Gas (GHG) emissions. The bill would require a phased reduction in GHG emissions, achieving 2004 levels by 2012 and ultimately declining to roughly 60% below 1990 levels by 2050. Representatives Olver and Gilchrest have introduced a companion bill in the House, the cap-and-trade title of which is nearly identical to McCain-Lieberman. Significantly, however, Olver-Gilchrest would require steeper emissions reductions—to roughly 70% below 1990 levels by 2050.
  • Bingaman (Draft). Senator Bingaman, chair of the Senate Energy and Natural Resources Committee, has circulated a draft bill modeled on the recommendations of the bipartisan National Commission on Energy Policy. This proposal differs from all of the other bills in several regards: It is based on an economy-wide emissions intensity cap (tons of GHG emissions per dollar of GDP), rather than an absolute cap; allows regulated entities to pay the government a “safety-valve” price in lieu of holding emissions allowances if the market price exceeds that cap; focuses primarily on “upstream” regulation of the overall carbon content of fuels, rather than “downstream” regulation of GHG emissions; and assigns regulatory authority over the new regime to the Department of Energy (“DOE”) instead of the Environmental Protection Agency (“EPA”). In contrast to the other proposals, the draft Bingaman bill would allow GHG emissions to increase, albeit to a lower level than under a business-as-usual scenario.
  • Sanders-Boxer (S. 309). The bill introduced by Senators Sanders and Boxer (S. 309) is the most stringent of the various proposals. It would require economy-wide reductions in GHG emissions to 1990 levels by 2020 and ultimately to 80% below 1990 levels by 2 2050. (The 2020 cap is equivalent to the cap recent adopted by the California legislature in AB 32). The bill authorizes EPA to require accelerated reductions if the National Academy of Sciences (NAS) finds that atmospheric C02 concentrations have exceeded 450 parts per million or global average temperatures have exceeded pre-industrial average temperatures by 3.6 °F, or that one of these events is more likely than not to occur in the foreseeable future. Sanders-Boxer differs from all of the other proposals in the latitude it gives EPA to design the regulatory regime; the Agency is authorized, but not required, to establish a cap-and-trade regime, and can supplement that regime with other regulatory measures. Sanders-Boxer itself imposes a number of independent regulatory measures, including GHG emissions standards for new vehicles and for power plants, national quotas for renewable fuel use for transportation, and efficiency and renewable portfolio standards for retail electricity suppliers.
  • Kerry-Snowe (S. 245). Senators Kerry and Snowe’s bill caps GHG emissions at 1990 levels by 2020 and by 60-65% below 1990 levels by 2050, and requires EPA to implement the caps through a cap-and-trade regime. In other respects, the bill has much in common with Sanders-Boxer. It includes similar or identical vehicle GHG emissions standards, renewable transportation fuel quotas, and efficiency and renewable portfolio standards.
  • Feinstein-Carper (S. 317). The bill introduced by Senators Feinstein and Carper differs from the other proposals in that it regulates only power plants with a rated capacity of 25 megawatts or greater—though Senator Feinstein is expected to introduce a series of other sector-specific GHG reduction bills later in the session. The Feinstein-Carper bill would require covered power plants to reduce emissions to 2006 levels by 2011 and roughly 40% below 2001 levels by 2050.

All these proposals impose mandatory emissions caps on the six major GHGs: carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), and sulfur hexafluoride (SF6). All save one are economy-wide in their coverage, and all save one would mandate establishment of a cap-and-trade regime. But despite these general commonalities, the proposals differ greatly with regard to almost all of their fundamental design elements.

Key Design Elements In Climate Change Legislation

1. Scope of Coverage and Point of Regulation (Upstream versus Downstream)

Perhaps the most basic question in establishing a mandatory GHG reduction regime is who will be regulated. It is well established that broadening the scope of regulatory coverage increases opportunities to capture lower-cost emissions reductions, thus increasing the economic benefits of a cap-and-trade regime. Broader coverage also spreads the economic burden more equitably. These benefits, however, must be weighed against the greater complexity and administrative costs that come with regulating more sectors and smaller, more numerous sources within a given sector. The transportation sector or residential and commercial buildings, for example, are characterized by very numerous and diverse emissions sources, making regulation through a conventional cap-and-trade regime difficult if not impossible.

Closely related to the scope-of-coverage is the question whether GHG emissions will be regulated “downstream,” by requiring emission sources to hold allowances equivalent to their GHG emissions, or “upstream,” by requiring producers or importers of fossil fuels to submit allowances equivalent to the GHG emissions that fuel combustion will generate. Downstream regulation provides emissions sources with a direct incentive to reduce emissions, through fuelswitching, improved efficiency, purchase of offsets or carbon capture and storage to the extent possible. Upstream regulation, by contrast, relies on communication of price signals: In theory, at least, more GHG-intensive fuels will be more expensive, thus providing end users with an incentive to switch fuels or improve efficiency. (Carbon capture and storage could, of course, be accounted for under an upstream regulatory system through the awarding of offset credits.) Upstream regulation is less complicated in that it requires coverage of fewer sectors, entities, and facilities. But there is a lively debate about the extent to which real-life markets efficiently communicate price signals to end-users, so as to produce the desired emissions reduction benefits.1

The pending bills provide an interesting mix of approaches to scope-of-coverage and point-ofregulation. While Feinstein-Carper focuses exclusively on downstream regulation of power plants, the other bills are broader in their coverage and offer more nuanced approaches. Under McCain-Lieberman and Olver-Gilchrest, for example, sources in the electricity generation, industrial, and commercial sectors are subject to downstream regulation. But the transportation sector is addressed through upstream regulation of transportation fuel importers and refiners. By contrast, both Sanders-Boxer and Kerry-Snowe address transportation through (downstream) mandatory GHG emissions standards for new vehicles, while giving EPA broad discretion on how to structure economy-wide GHG caps. The Bingaman proposal is unique in focusing primarily on upstream regulation of “regulated fuel distributors”—including U.S. coal mines, petroleum refineries, and natural gas processing plants, and importers of petroleum products, coal, coke, or natural gas liquids.

2. Nature And Stringency Of Cap And Availability Of Safety Valve.

The most significant choices in adopting a regulatory cap on GHG emissions are (1) whether to impose an absolute emissions cap or an intensity-based cap, (2) whether to provide a “safetyvalve” to contain costs, and (3) how stringent to make the cap. Of the bills discussed above, only the Bingaman proposal provides for an intensity-based cap and a safety-valve; the others all impose absolute caps.

Intensity-based caps are intended to reduce economic costs: They require improvements in GHG efficiency (on a per dollar of GDP basis), but if the economy grows more rapidly than the required rate of emissions intensity reduction—as is likely under the current Bingaman proposal—overall emissions are permitted to grow along with it. The President’s voluntary GHG reduction goal is also intensity-based but the Bingaman targets are more aggressive (requiring a 2.6% reduction per year as opposed to the President’s 1.6% annual reduction). The Bingaman proposal also provides that if the market price for emissions allowances reaches a defined “safety-valve” price (initially set at $7), regulated entities can simply pay the government that price in lieu of submitting allowances to cover their emissions. The safety valve reduces the economic risks of regulation. But if the price is set low enough, it will also have the effect of relaxing any emissions caps that would otherwise apply. For example, the Energy Information Administration has projected that achieving the emissions-intensity targets in the current Bingaman proposal will require exceeding the safety-valve price after 2025.2

All of the other proposals impose absolute caps on GHG emissions and do not include safety valves. In general, these bills begin with relatively modest caps in the early years, with progressively more stringent caps through 2050. All of the bills call for reductions to 1990 levels by 2020; the McCain Lieberman and Feinstein-Carper proposals set initial targets of 2004 levels by 2012 and 2006 levels by 2011, respectively. The 2050 caps are all ambitious but do vary in stringency; for example, Sanders-Boxer requires reductions roughly 80% below 1990 levels while Feinstein-Carper (for covered power plants) requires roughly 40% reductions below 2001 levels. The various caps are as follows:

3. Method Of Allocating Allowances

Once the overall number of GHG emissions allowances to be issued has been determined based on the relevant cap, the next big question is how they will be distributed. There are actually two questions here: (1) What proportion, if any, of the allowances should be auctioned, and what proportion, if any, should be given away for free?; and (2) To the extent allowances are allocated for free, how should the pie be divided?

The auction-versus-free allocation question is a subject of heated debate. Advocates of auctioning argue that free allocation of allowances, depending on how it is done, may have the effect of rewarding the biggest emitters while erecting barriers to entry of new (and possibly cleaner and more efficient) market participants. Advocates of free allocation, by contrast, contend that auctioning increases the already significant costs of regulation and promotes inefficiency by transferring capital from the private sector (which is thought to be a more efficient investor) to the government.

Existing market-based regulatory schemes involve little or no auctioning. Under the acid rain title of the Clean Air Act, less than 2% of allowances are auctioned. No allowances are auctioned under the European Emissions Trading System. However, there appears to be increasing consensus that auctioning should play a significant role in any future federal cap-andtrade scheme. Feinstein-Carper, for example, provides for auctioning of 15% of allowances in 2011, increasing to 100% by 2036. The Bingaman proposal calls for auctioning of 10% of allowances beginning in 2012 and gradually increasing to 65%. The other bills largely avoid the issue—giving EPA, the President, and/or future Congresses responsibility for determining the proportion of allowances to be auctioned.

The next question is how to divide up whatever proportion of the allowances are to be given away for free. Will allocations be made based on historical emissions? Or will they be made based on some other baseline—for example a technology-based formula that would penalize less carbon-efficient entities? Should allowances be allocated based on the carbon content of fuel inputs (giving no preference to lower-carbon fuels), or based on units of output (rewarding carbon efficiency)? The answers to these and related questions will have a huge impact on how the costs and benefits of any cap-and-trade regime are distributed, and are certain to be politically divisive.

Here, again, the pending bills reflect a variety of approaches. McCain-Lieberman, Olver- Gilchrest, Sanders-Boxer, and Kerry-Snowe all essentially delegate the allocation methodology to EPA or the President. The Bingaman proposal, however, prescribes a rather detailed threetiered scheme. It first specifies the percentage of allowances to be allocated for free to industry and the States, respectively. Industry’s share of the pie begins at 55% and declines by 2% annually as an increasing proportion of overall allowances are auctioned. The proposal also prescribes how industry’s share of free allowances is to be divided among different sectors: coal mines (7/55), petroleum refiners (4/55), natural gas processors (2/55), electricity generators (30/55), carbon-intensive manufacturing sectors (10/55), and non-fuel regulated entities (2/55). Within each sector, allowances are allocated based on the ratio of the carbon content of the fuel produced or consumed by a given facility to sector-wide production or consumption. The Feinstein-Carper bill, by contrast, would allocate allowances to existing power plants based on each plant’s share of overall electricity generation—which should favor more carbon-efficient generators. Notably, Feinstein-Carper would prohibit allocation of allowances to any new coalfired unit unless it is powered by “qualifying advanced clean coal technology”—a standard to be determined by EPA.

4. Revenue Recycling—Subsidizing Technology And Adaptation

All the pending bills include provisions channeling auction revenues, as well as with payments of the safety-valve price and/or of civil penalties for failure to submit the required number of allowances in a given year, to a new trust fund or similar entity. And they all provide for the use of such funds to subsidize the development of new GHG reduction technologies and to assist with adaptation to the impacts of climate change and of climate change regulation. Some (notably McCain-Lieberman and Bingaman) offer rather detailed prescriptions for how revenues are to be divided among programs and technologies, while others defer such decisions to EPA (Sanders-Boxer) or to the President (Kerry-Snowe). Here, again, there are significant resources at stake, and the legislative debate is likely to be heated.

5. Biological Sequestration And International Credits.

Another key area to watch is the treatment of carbon sequestration offset credits and international credits. Atmospheric GHG loadings can be reduced either through emissions reductions (including physical capture and storage of emissions), or through measures that enhance biological sequestration of carbon in plants and soils (e.g., reforestation, forest conservation and management, low-till or no-till agricultural practices, etc). Biological sequestration has attracted strong interest in the United States, for several reasons. Sequestration measures are generally thought to achieve GHG loading reductions at a lower cost than direct emissions reductions, and they can provide important secondary environmental benefits including wildlife habitat, water quality, and soil conservation. In addition, awarding credits for biological sequestration— particularly in agricultural soils—can give farmers and rural communities the opportunity to profit from climate change regulation.

All the pending bills provide for the awarding of offset credits from domestic carbon sequestration projects. The Feinstein-Carper bill is especially noteworthy. It allows for unlimited use of domestic offset credits from agricultural, forestry, wetlands, and other land-use related sequestration projects, and prescribes detailed requirements to guide EPA’s development of standards for measurement, accounting, and avoidance of adverse environmental impacts. The Bingaman proposal requires the Secretary of Agriculture to establish a program to award offset credits for agricultural sequestration projects, but caps the number of credits at 5% of overall annual allowance allocations. McCain-Lieberman places a 30% cap (15% under Olver- Gilchrest) on the proportion of a regulated entity’s allowance requirements that can be met through the combination of (a) biological sequestration offset credits; (b) offset credits from domestic GHG emissions reduction by non-regulated entities; (c) EPA-approved foreign tradable allowances; and (d) EPA-certified international project-based credits. Both Sanders-Boxer and Kerry-Snowe require the Secretary of Agriculture to establish and periodically revise standards for accrediting certified GHG reductions through biological sequestration activities. To take advantage of lower-cost GHG reduction opportunities overseas, most of the pending proposals also provide for recognition of international allowances and offset credits. McCain- Lieberman and Olver-Gilchrest, for example, provide for acceptance of EPA-approved foreign tradable allowances, and for EPA certification of offset credits generated by overseas projects. The Bingaman proposal permits acceptance of credits certified under the Kyoto Protocol’s Clean Development Mechanism, and allows DOE—after a 2016 review of whether foreign countries have taken GHG regulatory actions comparable to those of the United States—to authorize acceptance of credits generated under foreign GHG regulatory regimes or through overseas offset projects. Feinstein-Carper allows existing entities to satisfy up to 25% (and new entrants up to 50%) of their allowance requirements through EPA-approved international credits. Similar to the Bingaman proposal, Feinstein-Carper requires a 2015 review of whether credits should be accepted from countries without mandatory GHG caps.

An issue of great interest to some companies is whether credits will be available for previously implemented GHG reductions. All of the bills expressly provide some credit for early reductions with the exception of Kerry-Snow, which is silent on this issue but presumably leaves it to EPA’s discretion. For example, McCain Lieberman provides that entities are eligible for allowances equal to pre-2012 emission reductions providing these reductions are registered (which may refer to the DOE §1605(b) program, the EPA Climate Leaders program or state GHG registries).

6. Non-Cap-And-Trade Regulation

Reflecting the strong support for cap-and-trade strategies to address climate change, all of the pending bills would establish (or permit, in the case of Sanders-Boxer) such a regime. But it bears emphasis that a cap-and-trade regime can be combined with other regulatory tools for reducing GHG emissions. The Sanders-Boxer and Kerry-Snowe bills, for example, both impose fleetwide average CO2 emissions standards for vehicles, national quotas for renewable fuel use for transportation, and efficiency and renewable portfolio standards for retail electricity suppliers. In addition, Sanders-Boxer would impose technology-based emission standards on new electric generating units coming online after 2011, and would extend those same standards to all existing units by 2030.

Conclusion

While the fate of the pending proposals discussed above is uncertain, the design questions outlined above are certain to play a leading role in the burgeoning legislative debate.

ENDNOTES

1 See, e.g., CERA Advisory Service, Design Issues for Market-based Greenhouse Gas Reduction Strategies (Feb. 2006), available at http://www.energycommission.org/files/contentFiles/CERA_SR_022106_full_report_440cc38ead7ad.pdf.

2 See Energy Information Administration, Energy Market and Economic Impacts of a Proposal to Reduce Greenhouse Gas Intensity with a Cap and Trade System vi (Jan. 2007), available at http://www.eia.doe.gov/oiaf/servicerpt/bllmss/pdf/sroiaf(2007)01.pdf.

We use cookies to give you the best experience when using our website. You can click “Accept” if you agree to allow us to place cookies. For more information, please see our Cookie Notice.