On June 26, 2009, with exactly one more vote than necessary, H.R. 2454: The American Clean Energy and Security Act (ACES, or the Act) became the first climate change bill to pass either the Senate or the House. Introduced earlier this year by House Energy and Commerce Committee Chairman Henry Waxman (D-Cal.), ACES, commonly known as the Waxman-Markey bill, requires reductions in domestic greenhouse gas (GHG) emissions through a mix of regulatory and market-based proposals and incentives. Despite its success in the House, ACES must still clear the Senate before it can be signed into law.

In the final days leading up to the House vote, ACES underwent significant changes, adding 200-plus pages of amendments to the climate change initiative and substantially altering some of the initial proposals. Further changes to the bill will undoubtedly occur after it moves to the Senate for consideration. Though ACES' future is still uncertain, its passage in the House is a strong signal that some form of climate change legislation will soon be enacted in the United States, and it will most likely resemble ACES in many respects. Companies that emit significant amounts of GHGs or use substantial amounts of fossil fuels will face difficult decisions that may result in increased costs under ACES or another regulatory scheme designed to reduce GHGs. Consequently, businesses should begin identifying opportunities to reduce emissions and better understand the Act to capitalize on their most cost-effective options.

ACES' Key Components

ACES imposes an economy-wide limit on carbon emissions through a cap-and-trade program, while also creating various standards and incentives for developing and deploying clean energy and energy-efficient technologies. The bill has four titles: Clean Energy, Energy Efficiency, Reducing Global Warming, and Transitioning to a Clean Energy Economy. Now more than 1,200 pages long, the bill passed by the House contains several amendments and new provisions within the Act's original titles. The following are ACES' key provisions:

  • Reduction of carbon emissions from major U.S. sources. ACES will create a national cap-and-trade scheme to reduce GHG emissions from major sources 17 percent by 2020 and 83 percent by 2050, relative to 2005 levels. At the heart of the cap-and-trade scheme are emissions permits called "allowances," which will each cover one ton of carbon dioxide or its equivalent. Other complementary measures, such as investments in preventing tropical deforestation and upgrading the electricity grid, will aid in achieving carbon emission reductions.
  • Federal investments in energy efficiency and renewable technologies. ACES sets standards for conventional and renewable energy technologies, and provides funding to support the development of clean energy projects and technologies, primarily through revenues generated from the auction of emission allowances. Investing approximately $190 billion through 2025 in clean energy and energy efficiency programs, ACES provides: $90 billion in state programs to promote renewable energy and energy efficiency; $60 billion to develop carbon capture and sequestration technologies; $20 billion in electric and other advanced technology vehicles; and $20 billion for basic research and development into clean energy and energy efficiency.1
  • Utility renewable portfolio requirement. ACES creates a national renewable portfolio standard (RPS) requiring utilities by 2012 to generate 6 percent of their electricity from renewable energy sources like wind and solar, or from energy efficiency measures. The RPS increases by approximately 3 percent each year until 2021, when it reaches 20 percent. Moreover, the RPS standard would not preempt more stringent state RPS standards and associated policies, which is a key issue for businesses in California and other states that have historically been aggressive on environmental regulation.
  • Mandatory energy saving standards for buildings, transportation and consumer appliances. ACES requires new buildings to be 30 percent more energy efficient by 2012 and 50 percent more energy efficient by 2016. The Department of Energy (DOE) will enforce the green building standard in states that do not incorporate the new federal standard in their respective building codes. For the transportation sector, the Act requires regions to set GHG emission reduction levels and invest in public transportation, vehicle technology, and other emissions-reducing measures. ACES will also strengthen current DOE energy standards for appliances and will establish an incentive prize program for manufacturers of "super-efficient" appliances.

Regulatory Flexibility

ACES' cap-and-trade program includes several measures designed to provide the regulated community with economically attractive and cost-conscious compliance options to aid in the program's implementation. For example, the Act allows banking of unused emissions allowances for future use or sale, and limited borrowing of allowances from future compliance periods for use in the current period.

Additionally, the cap-and-trade program allows emitters to use offsets to comply with the regulations. Offsets are GHG reductions from projects performed by parties other than the regulated emitters, which may then be sold or transferred to the emitters, allowing them to meet their emissions reduction requirements. Thus, similar to the Kyoto Protocol's Clean Development Mechanism allowing industrialized nations to fund emission reduction projects in developing countries where costs are lower, offsets offer emitters the flexibility of choosing between reducing their own GHG emissions or financing projects undertaken by others in exchange for offsets.

ACES-regulated entities, such as electric utilities, can obtain credit for up to 2 billion tons of emissions using EPA-approved offsets obtained from a combination of domestic and international sources. The ability to use these offsets is divided pro rata among all regulated entities. Regulated entities may also use allowances from approved overseas programs like the EU's Emission Trading System (EU ETS) and compensatory allowances in place of domestic emissions allowances.

Allocation of Emissions Allowances

A significant issue remains concerning whether emissions allowances created under ACES' cap-and-trade system will be distributed via auction or free-of-charge. Early drafts of ACES were silent on how allowances would be distributed. Supporters of the Act, including President Obama, responded by calling for most of the allowances to be auctioned off and only a small percentage given away. Revenues from the auctioned allowances were to be used to fund various programs as specified in the Act. The free allowances would be distributed to public and private entities using complex formulas and subject to use restrictions.

In the version of the Act passed by the House, the initial balance favors free distribution, with 84 percent of the allowances distributed free-of-charge and only 16 percent available for auction in the first year. But over time, the percentage of allowances distributed at auction will slowly increase, allowing consumers, businesses and communities to more gradually transition to cleaner – but probably more expensive – sources of energy. Additionally, it is believed that gradually increasing the number of permits available at auction will help contain "emission leakage," increases in overseas emissions from competing companies not subject to similar GHG restrictions.

ACES and the Clean Air Act

ACES calls for the Environmental Protection Agency (EPA) to set new source performance standards for categories of emissions sources not covered by ACES' cap, pursuant to EPA's existing authority under the Clean Air Act. The Act also allows states to enact more stringent GHG emissions standards for those sources that are covered by ACES' cap. However, some critics are concerned that limiting EPA's regulatory authority over GHG emissions to ACES' provisions will undermine EPA's ability to effectively combat climate change under the Clean Air Act, by eliminating emissions sources subject to ACES from Clean Air Act regulation. In particular, some environmental groups believe that ACES may prevent EPA from setting technology-based emissions standards for sources subject to ACES' cap.

Energy Efficiency Initiatives

ACES contains several initiatives for energy efficiency, water use efficiency, smart grids, and alternative energy sources. In addition to the RPS standard noted above, the Act mandates new energy efficiency standards for appliances, buildings, transportation and industry.

Along with these new regulations, however, ACES provides a number of tax and funding incentives for renewable energy and energy efficiency projects, smart grid improvements, transportation programs, and programs to capture and sequester GHG emissions. Additionally, through provisions known as the Inslee-Doyle program, ACES provides special treatment for industries that are energy-intensive and trade-exposed, such as manufacturers of cement, paper, iron and steel. These industries, along with oil refiners and electricity utilities bound by long-term supply contracts, will receive free allowances to help cover their increased costs resulting from ACES' implementation.

Financial Programs Supporting Climate Change Measures

ACES contains several financial mechanisms to support the development of clean energy technologies and the implementation of climate change initiatives, including the following:

The Clean Energy Deployment Administration

ACES establishes the Clean Energy Deployment Administration (CEDA) within the Department of Energy, which is charged with promoting access to affordable financing for clean energy and energy efficiency technologies. CEDA provides more favorable terms to companies, including lower interest rates and a lower cost of debt, to offset the cost of financing new renewable energy projects in the private sector. CEDA's goal is to facilitate a clean-energy transformation by accelerating cost-effective and large-scale deployment of renewable energy. To do so, CEDA is designed to incentivize the transition to a clean-energy economy, while concurrently making renewable energy competitive with current electricity prices. CEDA is committed to keeping consumer prices low by facilitating the flow of private capital into renewable energy and efficiency projects.

State Energy and Environment Development (SEED) Funds

ACES creates a DOE repository to manage and account for the proceeds from states' sales of emissions allowances conducted pursuant to the Act, known as the State Energy and Environment Development (SEED) fund. SEED funds must be used by the states for clean energy, energy efficiency and climate change initiatives. For example, SEED funds may be used for weatherization assistance (improving energy efficiency of residences) and to support initiatives like Property Assessed Clean Energy (PACE) bonds, which provide loans to commercial and residential property owners for energy efficiency retrofits.

SEED funds not appropriated for specific uses may be used for loans, grants or other forms of financial support for energy-related programs authorized by the federal government. Repayment of principal and interest from SEED funds must be re-deposited into the fund, but the allocation of SEED money is at the discretion of state and local authorities.

Regulation of Carbon Credit Trading

ACES establishes a new regulatory program to govern the trading of carbon credits, including GHG allowances and offsets. ACES follows the Derivatives Markets Transparency and Accountability Act, passed earlier this year, which defines such carbon credits as commodities under the Commodity Exchange Act. Consequently, GHG allowances and offsets must be publicly traded subject to the jurisdiction of the Commodity Futures Trading Commission (CFTC).

ACES vests power in the CFTC and the Federal Energy Regulatory Commission (FERC) to regulate GHG allowances and offsets. CFTC has authority over the carbon credit derivative market similar to its regulation of SO2 and NOx futures transactions under the Clean Air Act Acid Rain Program. FERC is charged with developing regulations to ensure market transparency and prohibit market manipulation, with authority to levy civil penalties up to $1 million for trading rule violations.

Looking Ahead

Now that the House has passed the Act, it will be sent to the Senate for consideration, alongside a number of other competing, energy-oriented bills. One such bill is the American Clean Energy Leadership Act,2 introduced by the Senate Energy and Natural Resources Committee, chaired by Sen. Jeff Bingaman (D-N.M.). That bill addresses numerous energy issues, including many addressed under ACES, but also contains several key differences:

  • Increases the domestic production of offshore oil and gas through the opening of new resource-rich areas in the Eastern Gulf of Mexico to oil and gas production.
  • Provides for the establishment of a federal advisory commission to conduct a comprehensive study of alternative means for safe disposal of spent nuclear fuel and radioactive waste.

Ultimately, the ACES' provisions will have to be reconciled with the American Clean Energy Leadership Act before either bill can move forward.

ACES will also have to contend with other climate change initiatives still making their way through various Congressional committees. For example, the Senate Environment and Public Works Committee, chaired by Sen. Barbara Boxer (D-Cal.), has preliminary plans to act on a GHG cap-and-trade measure during the week of Aug. 3. Similarly, Rep. Chris Van Hollen (D-Md.) proposed a cap-and-dividend plan earlier this year, which would cap carbon emissions, require all emission allowances to be sold at auction, and distribute at least 90 percent of the auction revenues to consumers in the form of monthly dividend checks.