With only a few weeks to go until formal multilateral climate change meetings begin in Copenhagen, Denmark, the debate on Capitol Hill over health care reform has taken the wind out of the sails on comprehensive climate change legislation. The Obama administration had hoped to arrive at those meetings with a commitment by Congress to reduce greenhouse gases (GHG) already in place, but it’s clear that won’t happen.

Nevertheless, Congress is still moving forward on climate change, and the debate will heat up soon enough. The U.S. Senate Environment and Public Works Committee will hold a flurry of hearings later this month on climate policy and domestic cap-and-trade legislation. Committee chairman Sen. Barbara Boxer (DCalif.) has stated her intention to mark-up proposed legislation and bring it to a committee vote in early to mid-November. The path for climate change legislation reaching the full Senate floor remains unclear, and likely will not occur until 2010. Several other Senate committees have jurisdiction over portions of a final bill, and each will operate on its own timeline.

Climate change cap-and-trade legislation, if passed, will have a transformative effect on the focus and functioning of the U.S. economy — both good and bad. To garner the 60 votes necessary for Senate passage, each issue debated will likely revolve around two broad themes — (1) promoting cost-effective GHG emission reductions, energy efficiency and market-based innovations in clean energy, and (2) politics. The first theme is easy to understand; the second is more nuanced. Politics comes into play because key senators from, for example, coalproducing states and states with carbon intensive industries will ask for and obtain provisions in the bill that benefit their constituents in return for their votes. It happened in the House, and it will happen in the Senate. Stay tuned. From a policymaking standpoint, negotiations over the next few months around these two themes could have a significant and lasting effect on the way the U.S. does business.

Senate Releases Climate Change Discussion Draft. On Sept. 30, 2009, Sens. John Kerry (DMass.) and Barbara Boxer (D-Calif.) released a discussion draft of climate change legislation entitled the Clean Energy Jobs and American Power Act (S. 1733) (CEJAPA or “Kerry-Boxer” bill). The Kerry-Boxer bill duplicates a number of the provisions from the American Clean Energy and Security Act (H.R. 2454) (ACES) passed by the House. Both bills would establish a cap-and-trade system based on emission allowances and offsets, and would set up a regime for allocating, generating and trading these carbon market commodities.

The Kerry-Boxer bill, however, differs in a number of significant and important ways from ACES, and almost all of these differences go further to the left of ACES than to the right. Kerry-Boxer would require a 20 percent reduction of economy-wide GHG emissions by 2020, three percent more aggressive over the same period than the ACES bill. The remaining reduction targets are unchanged. The Kerry- Boxer bill would also preserve EPA’s authority to regulate GHG emissions on its own under the existing Clean Air Act, e.g., stationary source permitting. The Kerry-Boxer bill anticipates that the Commodities Futures and Trading Commission (CFTC) would have regulatory and oversight jurisdiction over both the cash carbon market as well as derivative products sourced from emission allowances or offsets. In contrast, ACES would split oversight between the Federal Energy Regulatory Commission and the CFTC.

Similar to how ACES was developed in the House, the Kerry-Boxer proposal intentionally leaves the issue of emission allowance allocation to later negotiation in committee, but it limits the ability of regulated entities to obtain allowances for free. A larger percentage (approximately 25 percent) of the total emissions “budget” would be auctioned under the Senate proposal to keep the bill revenue neutral. On the other hand, Kerry-Boxer enlarges the amount of “strategic reserve” allowances that would be available to regulated entities to keep industry costs low. There would be a cap on reserve allowances that could be released, and the president’s ability to replenish the reserve is also bolstered. While the strategic reserve trigger price is set at $28/ton as in ACES, how that ceiling price escalates over time is different.

Regarding offsets, up to two billion metric tons of carbon dioxide equivalent (CO2e) emissions would be eligible for compliance purposes, but 75 percent of those offsets must be sourced from domestic reduction projects. The percentage of international offsets allowed could be increased if there is a dearth of domestic offsets available. Offset sector eligibility is expanded from the ACES’s list of projects to include emissions from landfills, coal mine methane, fugitive natural gas from pipelines, manure management and biogas capture. The prospective environmental integrity of all offsets is bolstered by the Kerry-Boxer bill because it would allow the president, rather than the EPA, to set up an “offsets integrity office” housed in the Department of Justice.

Other major differences from ACES in the Kerry-Boxer draft include expanded incentives for clean coal, development of aviation sector emissions standards, expanded funding and regional planning authority for transportation sector GHG reductions, provisions on “green job” promotion and expansion, climate change adaptation funding, no express funding or allocation of allowances for energy efficiency, and finally, perhaps most politically impacting, placeholders for to-be-determined nuclear and natural gas incentives.

EPA Proposes “Tailoring Rule” to Regulate GHG Emissions from Large Sources. On Sept. 30, 2009, EPA took a further step toward regulating GHG emissions from stationary sources pursuant to its existing authority under the Clean Air Act. EPA Administrator Lisa P. Jackson announced a new proposed rule, entitled the “Greenhouse Gas Tailoring Rule,” that allows EPA to begin regulating GHG emissions from large stationary sources. The proposed Tailoring Rule would require a regulated facility to control its GHG emissions under the Prevention of Significant Deterioration (PSD) program by using best available control technology (BACT), and to obtain or modify applicable operating permits under Title V of the Act. The proposed rule makes no effort to define what would constitute BACT for CO2 or other GHG emissions.

The major purpose of the proposed Tailoring Rule is to increase the statutorily-required regulatory thresholds for regulating “pollutants” under the two applicable EPA air emission permit regimes. The PSD program applies to covered sources emitting 100 or 250 (depends on facility) tons of a “regulated pollutant” per year. Title V permitting requirements apply to facilities or sources emitting more than 100 tons per year. The Tailoring Rule proposes to increase these regulatory thresholds for six GHG emissions (CO2, CH4, N2O, HFCs, PFCs, SF6), on a six-year temporary basis, to the equivalent of at least 25,000 metric tons of carbon dioxide (“CO2-equivalent” or “mt CO2e”). In other words, the objective of the Tailoring Rule is to exclude thousands of smaller emissions sources from regulation.

If the exclusions sought by the Tailoring Rule are not finalized, and the existing statutory Clean Air Act thresholds were applied to GHG emissions by the EPA instead, millions of previously unregulated facilities, such as large office buildings, hotels, casinos, and malls, would suddenly be subject to air emission permitting requirements. EPA asserts that “…state permitting authorities would be paralyzed by permit applications in numbers that are orders of magnitude greater than their current administrative resources could accommodate.” EPA’s stated goal of proposing the Tailoring Rule, therefore, is to minimize the number of facilities that would be regulated, while still covering nearly 70 percent of the national GHG emissions from large stationary sources.

If issued as a final rule the Tailoring Rule would apply to, among others, most large fossil-fuel electric generating plants and refineries, large industrial manufacturing plants (e.g., cement, steel, pulp and paper), and some municipal solid waste landfills.

Some question whether EPA has the authority to change the thresholds for regulation of a “regulated pollutant” under the Act. Thus, if the proposed rule is made final, it’s a sure bet it will be challenged in court.

Stepping back, the proposed Tailoring Rule was announced the same day that Sens. Kerry and Boxer released their discussion draft of cap-andtrade legislation. Many view this proposal as a secondary political tactic to spur Congress to enact stand-alone legislation to regulate GHG emissions outside of existing Clean Air Act authorities. However, the Senate discussion draft (see discussion above) differs from the House climate bill in that it does not remove EPA existing authority over GHGs. That would allow EPA to move forward with regulating GHGs using existing authorities even if standalone legislation is passed. EPA Finalizes GHG Reporting Rule: Reporting Obligations Effective Jan. 1, 2010. Beginning Jan. 1, 2010, EPA will, for the first time, require approximately 10,000 emitters of large amounts of GHGs to collect and report their emissions data. This long awaited rule, known as the GHG Reporting Rule, was issued as a final rule on Sept. 22, 2009, and covers approximately 85 percent of the nation’s stationary source GHG emissions. There are many reasons EPA is instituting this rule, with the paramount reason being the collection and identification of critical information about what actual emissions levels are each year. In other words, the GHG Reporting Rule enables a national GHG baseline to be established against which future reductions can be measured, monitored and achieved. Establishing a national baseline is critical to the efficacy of implementing a GHG cap-and-trade regime and attendant carbon market.

As further described below, the GHG Reporting Rule requires suppliers of fossil fuels or industrial GHGs, manufacturers of heavyduty vehicles and engine equipment, and certain other facilities that emit the equivalent of 25,000 metric tons of CO2-equivalents to submit annual reports regarding their aggregate GHG emissions and to retain those records for at least three years.

The first annual reports must be submitted to EPA by March 2011 covering the 2010 calendar year, with additional reporting requirements being phased-in over the next several years. A change from the proposed rule is that covered entities will have a buffer compliance period during which they will be allowed to use “best available monitoring methods” rather than prescribed GHG monitoring equipment. This period runs from Jan. 1 through March 2010.

GHG reporting requirements generally apply at the facility level, except when it comes to certain suppliers of fossil fuels and industrial GHGs, and vehicle and engine manufacturers. Fossil fuel suppliers will have to report the emissions that would result from the complete combustion or oxidation of their product. Vehicles and engine manufacturers will have to report the emissions rates for their engine product(s) beginning with the 2011 model year. EPA estimates that the cost to the private sector of this new reporting requirement will be approximately $115 million in the first year and $72 million in subsequent years.

What Entities/Facilities Have to Report?

There are four general categories of industrial sectors that will have to monitor their GHG emissions beginning Jan. 1, 2010:

1. Mandatory Industrial Production Facilities

Regardless of threshold emission levels, facilities in the following sectors, or engaged in the following activities, must monitor and report their GHG emissions: adipic acid production, aluminum production, ammonia manufacturing, cement production, electric generation, HCFC-22 production, HFC-23 destruction processes1, lime manufacturing, manure management systems2, municipal solid waste landfills3, nitric acid production, petrochemical production, petroleum refineries, phosphoric acid production, silicon carbide production, soda ash production, titanium dioxide production.

2. Threshold Stationary Source Emissions

If a facility does not fall into any of the sector or source categories listed above, then the rule requires the owner of a facility (or facilities) in certain other source categories to determine whether the facility emits more than 25,000 metric tons of CO2- equivalents in combined emissions, before it is required to report its GHG emissions. Those source categories are: ferroalloy production, glass production, hydrogen production, iron and steel production, lead production, pulp and paper manufacturing, and zinc production.

3. Stationary Combustion Source Emissions

Stationary combustion sources include boilers, engines, process heaters, turbines or other fuel combustion equipment. If an entity owns a stationary combustion source with a total maximum rated heat input capacity above 30 million British thermal units per hour, the facility may have to monitor and report its GHG emissions depending on the results of certain required calculations.

4. Fossil Fuel and GHG Suppliers

In addition to the facilities described above that must report, there are certain suppliers that must report the annual quantities of fossil fuels and industrial GHGs supplied to others. The fuels include coal-based liquid fuels, natural gas and natural gas liquids, and petroleum products. The GHG products include fluorinated gases, nitrous oxide and carbon dioxide.

Finally, there are some source categories that have been removed from having to monitor and report since the GHG Reporting Rule was first proposed. These sources are ethanol production, electronics production, fluorinated GHG production, food processing, industrial landfills, magnesium production, oil and natural gas systems, SF6 from electrical equipment, underground coal mines, wastewater treatment and coal suppliers.

Second Circuit Reinstates Greenhouse Gas Litigation Against Power Utilities. On Sept. 21, 2009, the U.S. Court of Appeals for the Second Circuit reversed a lower court decision to dismiss a lawsuit brought against northeastern power utility companies for failing to control their greenhouse gas emissions. State of Connecticut v. American Electric Power Company Inc., 2009 WL 2996729 (2d Cir. Sept. 21, 2009). The original lawsuit was filed by New York City, several state attorneys general and a few environmental organizations. The case had remained unresolved for almost five years because the Second Circuit Court had not rendered a decision. In 2005, the district court dismissed the lawsuit, finding the issues raised in it were political questions and therefore not “justiciable” by the Court. Connecticut v. Am. Elec. Power Co., 406 F. Supp.2d 265 (S.D.N.Y. 2005).

In its Sept. 21 decision, however, the Second Circuit allowed the plaintiffs to move forward with their lawsuit. The lawsuit alleges that fossil- fuel fired electric power plants owned by the utility defendants are a public nuisance under federal common law causing damage to the plaintiffs and their respective citizens. The Court did not rule in the plaintiffs’ favor, but did conclude that they have standing to bring the case to trial. The impact of the holding is dramatic. It opens up the judicial system as another means for interested individuals and entities to seek to force industries and facilities, potentially at great expense, to control their GHG emissions. For this reason, the decision gives carbon-intensive industries an added incentive to prefer a federal cap-and-trade program or EPA regulations that can be tailored and uniformly enforced.

Republican Support for Cap-and-Trade Possible, With Nuclear Accommodations. Sen. Lindsey Graham (R-S.C.) recently asserted that more than a handful of Republican senators would be willing to support GHG cap-and-trade legislation if the final bill contains major provisions supporting nuclear energy and offshore drilling. He said, “I think most Americans believe the planet is heating up. They’d like to see us energy independent.… Just marry up these two ideas…It will be a long time before we get away from carbon, coal, gas and oil. So find what you can here in a responsible manner. Put clean coal technology on the table, but have a cap-andtrade system that pushes our economy away from carbon over time.” Senate leadership is going to need at least a few Republican senators to favor a Senate cap-and-trade package to clear the filibuster-proof threshold of 60 votes. The current version of the Kerry-Boxer bill in the Senate contains a modest set of “placeholder” provisions for nuclear energy that would provide incentives and funding for research and development. Republican support probably won’t materialize unless those provisions are beefed up.

Senators Push for Stronger Clean Coal Protections and Incentives in Senate Bill. Senators from states with large coal industries were successful in having significant aid for clean coal and carbon capture and sequestration (CCS) included in the Kerry-Boxer discussion draft. For example, the bill would award bonus emission allowances to first-generation coal power plants utilizing CCS technology (capped at the first 10 gigawatts brought online). Later generation CCS plants would receive support through a reverse auction of allowances and through performance-based incentives for achieving reductions over traditional coal-fired plants. In addition, $10 billion in federal funding will go to finance CCS development and deployment. These incentives are viewed as essential to gain the support of coal-state senators and to ensure passage of cap-and-trade legislation. We anticipate additional demands from the coal industry before a final bill is voted on, particularly demands for upfront financing of CCS plants and guaranteed cost recovery for participating utilities.

International Competitiveness Is a Priority, Too. In addition to clean coal protections, many moderate Democratic senators will support capand- trade legislation on the condition it has adequate cost containment protections for heavy industry in the United States. The mechanism proposed is a tariff that protects U.S. manufacturers from cheaper foreign goods not subject to a carbon price. A vocal proponent of such a tariff is Sen. Sherrod Brown (D-Ohio), one of 10 Senate Democrats who formally notified President Obama that support for cap-andtrade depends on the inclusion of such measures. Sen. Brown recently stated that it makes no sense for a U.S. plant to have to close down because of carbon costs just so it can move to another country. Border tariff provisions were included at literally the last minute in the House ACES bill that passed in June, but they do not yet appear in the Senate Kerry-Boxer discussion draft. However, the Senate bill does have a “placeholder” for such provisions (Section 765).

Carbon Market Industry Association Pans “Offsets” Allowed Under Senate Bill. The International Emissions Trading Association (IETA), a vocal advocate for market-based programs to address climate change, strongly opposes the limitation on international offsets in the Kerry-Boxer discussion draft. The Senate bill would allow for the inclusion of two billion offset credits in a domestic U.S. GHG cap-andtrade regime, but caps the eligibility of offset credits sourced from international projects to one quarter of that amount. The remaining three-quarters have to come from domestic offset projects. Market analysts don’t anticipate that many domestic credits to be available, but the Senate does allow international offset credit supplies to increase if there is a domestic shortfall. The ACES bill in the House that passed in June, on the other hand, allows two billion offset credits to be used, but splits the difference fifty-fifty between international and domestic. The international supply cap is not the only item that IETA disagrees with, however. It also opposes the Senate bill proposal to institute a 20 percent discount on international offset credits after 2018 and switch to sector-based offset crediting in 2016. IETA’s position is that the Senate bill creates uncertainty and inhibits the ability to source offset credits at the lowest possible cost.

Climate Action Reserve Adopts New Protocols. The California Climate Action Reserve (CCAR), a prominent voluntary carbon market registry and standards organization, has adopted new emission reduction offset protocols for organic waste digestion and coal mine methane (CMM) projects. CCAR offset credits, known as Certified Reduction Tons (CRTs or Carrots), are widely-traded in the U.S. voluntary market and are viewed as potentially qualifying as early action credits under any future U.S. cap-andtrade regime. The organic waste protocol will recognize verified emission reductions achieved through avoiding methane emissions resulting from organic waste decomposition at landfills and wastewater treatment facilities. Recognized waste projects will divert the gas into anaerobic digestion equipment for processing and beneficial use. The CMM protocol similarly will enable offset credit recognition for projects that capture or destroy certain carbon emissions at active underground coal mines.

International Climate Change Policy & Carbon Finance

Major Hurdles Remain on the Way to Copenhagen Climate Negotiations. In early December, developing and developed nations will descend on Copenhagen for multilateral negotiations under the United Nations (UN) Framework Convention on Climate Change (UNFCC) to develop a new regime for carbon emission reduction commitments. Initial forecasts are that the meetings will result in a very weak or ambiguous “post-Kyoto” deal, if anything. The reason is because there are a number of unresolved disagreements and no definitive leadership.

It had been conventional wisdom that the U.S. would seek to arrive at these negotiations and lead by example. The administration thought it was likely Congress would enact legislation before Copenhagen. But with the success of U.S. climate change legislation up in the air, and resolution of a final Senate bill months away, the U.S. will be arriving at the negotiations with far less leverage.

The delay in getting U.S. climate change legislation passed is far from the only difficulty for those interested in concluding a post-Kyoto deal in Copenhagen. There are significant hurdles to overcome, primarily in the area of developing country commitments. UN climate meetings to get ready for Copenhagen have been held over the past few weeks in Bangkok, Thailand (formally the Ninth Meeting of the Ad-hoc Working Group on the Kyoto Protocol and the Seventh Meeting of the Ad-hoc Working Group on Long-term Cooperative Action Under the UN Framework Convention on Climate Change). At those meetings, vast differences were revealed on international carbon market mechanisms that could play a role in any future deal.

The difficulties came about because developing countries were not required to make binding GHG emission reduction commitments under the 1997 Kyoto Protocol. In addition, Kyoto created the Clean Development Mechanism (CDM), which allowed developed countries to develop and finance emission reduction projects in developing countries, commercialize the reductions as offset credits, and then use those credits to meet emission reduction targets rather than investing in actual reductions at home. CDM has been the driving force behind the multi-billion dollar global carbon market in offset credits.

Going forward, developed nations want to reform CDM and have developing nations make binding emission reduction targets. Developing nations do not want to make binding commitments themselves, but they do want to reform CDM and have developed countries finance their low carbon technologies and climate chance adaptation initiatives. Finally, developing nations want developed countries to take action at home rather than relying so heavily on offset credits.

At the Bangkok meetings, delegates were trying to make progress reforming CDM and including new market mechanisms, most notably establishment of “sector-based” cap-and-trade regimes, e.g., aviation, transport, cement, as well as a market-based program to reduce emissions from deforestation and degradation (known as “REDD”). If market-based mechanisms are expanded, however, that would mean a greater supply of carbon credits will be available to developed countries. In turn, that means their regulated entities could use these credits for compliance purposes rather than investing in emission reductions domestically. There is also concern that an expanded international carbon market may affect direct foreign investment and multilateral financing for sustainable development in developing countries (e.g., clean energy projects). For these reasons, some developing countries are seeking to set percentage limitations on the use of international offsets credits by developed countries.

China and India, among others, are also explicitly and adamantly requiring that any “post- Kyoto” deal be negotiated under the existing rules and structures of the Kyoto Protocol rather than a new regime. The main problem with this position is that the U.S. never ratified the Kyoto Protocol, and therefore is advocating an entirely new regime. If the Kyoto Protocol is maintained going forward, the U.S. might not have access to CDM credits.

The European Union announced it will ensure that Kyoto will survive and be strengthened in any final legal post-Kyoto text. The U.S. may have a different perspective. At the Bangkok meetings, the U.S. delegation announced a list of negotiating positions, including:  

  • Developing countries need to commit to making emission reductions domestically;
  • Emissions monitoring, reporting and verification must be the same for all participating countries; and
  • The U.S. will not ratify the Kyoto Protocol. The U.S. has little interest in joining an international carbon market based on Kyoto-sourced emission allowances (known as Assigned Amount Units).

This hard-line is mainly because without binding commitments from countries like China and India, the U.S. would have serious difficulty bringing the deal back to the Senate for ratification (two-thirds vote in favor is required).

And this issue flows into the financing debate. Developed countries want developing countries to make binding commitments before they will discuss how much money they will devote to sustainable development efforts in the developing world. The developing countries, on the other hand, argue the funding issue needs to be resolved first before they will discuss binding commitments.

The outcome of Copenhagen is not clear yet. It does not look like negotiations will be easy, but it would be inappropriate to anticipate nothing will be resolved. The primary way for most developing countries to finance climate change mitigation and adaptation is through assistance from developed countries and multilateral institutions. Just like any negotiation, though, the extent to which developing countries agree to U.S. demands depends in large part on the amount of money put on the table.

Aviation and Maritime “Sector-Based” Cap-and-Trade Negotiations Heat Up. Over a dozen proposals have been formally submitted to UN delegations negotiating a post-Kyoto climate change agreement on how to measure, monitor and track GHG emissions from the aviation and marine transportation sectors. For example, two proposals are for new taxes on transport sectors of all kinds. Another would apply a fuel surcharge on maritime transport vessels. Under the Kyoto Protocol, responsibility for regulating aviation and maritime sector emissions was given to the International Civil Aviation Organization and the International Maritime Organization (IMO), respectively. Delegates in Bangkok for the first time agreed to take back responsibility for these sector emissions and to include them under the larger UN negotiation framework. In July, IMO’s Marine Environment Protection Committee adopted short-term voluntary guidelines on ship design and operational efficiency designed to reduce greenhouse gas emissions from maritime transport. On Sept. 22, 2009, the UK Chamber of Shipping, in concert with at least four sister organizations from other European countries, issued a proposal to treat the global shipping industry as a separate “virtual” or honorary country under a post-Kyoto deal. This proposal, as well as a similar one for the aviation industry, is being seriously considered in Bangkok.

Tropical Forest Groups Make REDD Recommendations. Two forestry offset groups recently proposed recommendations for carbon market-based mechanisms to protect forests. The Forests Dialogue, a non-profit international organization of forestry interests, published recommendations for market-based programs to reduce emissions from deforestation and degradation projects (REDD projects) under a post-Kyoto regime. The Commission on Climate and Tropical Forests (“Commission”), a bipartisan U.S.-based commission of policymakers and industry, published a report recommending U.S. and international solutions. Tropical forest deforestation accounts for approximately 17 percent of total global CO2 emissions. According to Forests Dialogue, any REDD project should be a performance-based emissions reduction program that includes conservation and sustainable management of forests. Forests Dialogue also calls for strong monitoring, verification, oversight and reporting mechanisms to be in place. The Commission, through its report entitled “Protecting the Climate Forests: Why reducing tropical deforestation is in America’s vital national interest,” published 13 recommendations for protecting tropical forests. Of those recommendations, four focus on designing a robust GHG cap-and-trade program that includes marketbased mechanisms and incentives. The Commission strongly urges the U.S. to enact strong domestic climate policy and lead an international effort to provide sufficient resources to ensure tropical deforestation is addressed. Internationl forestry offsets are included in both the House and Senate proposals for U.S. cap-and-trade legislation.

World Bank Finds Climate Change Adaptation Likely to Cost $75-100 Billion Annually. Climate change adaptation, the process of making targeted investments to infrastructure and development to adapt to the physical impacts from global warming, e.g., intense rainfall, frequent droughts, disease, flooding, heat waves, and other extreme weather events, will cost developing countries $75 to $100 billion every year over the next 40 years. That estimate is based on a 2-degree rise in global temperatures. In an Oct. 1, 2009 report entitled “The Cost to Developing Countries of Adapting to Climate Change,” the World Bank forecasts that the East Asia and Pacific region will be hardest hit economically, followed by Latin America, the Caribbean and Sub-Saharan Africa. The study examined the cost impacts on major economic sector spending, including infrastructure, coastal zones, water supply and flood management, agriculture, fisheries, human health, and forestry and ecosystem services.