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Kerry and Lieberman Release Draft Climate Bill While EPA Issues Final Tailoring Rule

The Kerry-Lieberman climate bill has arrived (as previously reported by EL here). On May 12, 2010, Sen. John Kerry (D-Mass.) and Sen. Joe Lieberman (I-Conn.) released their long-awaited “discussion draft” of climate change legislation. The draft bill, which weighs in at 987 pages and is called the “American Power Act,” will inevitably face an array of political challenges.

While the bill initially had at least some bipartisan support, Sen. Lindsey Graham (R-S.C.) dramatically withdrew as a co-sponsor just before the bill was originally scheduled for release on April 26, citing reasons relating to immigration reform.

That by itself strikes a blow to the bill’s chances. But more, the release comes at a time of increasing rancor and unrest both across the political aisles and even within the Republican party itself, not to mention in the midst of a major and worsening oil spill in the Gulf of Mexico.

Complicating matters, the EPA recently announced the release of its final tailoring rule, which sets up an implementation scheme for regulating greenhouse gases under the currently existing PSD and Title V permitting programs of the Clean Air Act. Meanwhile, several lawsuits over the environmental impacts of climate change continue to percolate in the courts, creating the specter that judges and juries could impose their own form of greenhouse gas regulation.

Kerry has purportedly spent months meeting and negotiating with industry representatives in order to garner support for the bill. To that end, he has predicted that many of the country’s major greenhouse gas emitters will support the bill, although at least publicly that support has yet to materialize. Nevertheless, all things being equal, many of the major greenhouse gas emitters may still perceive federal legislation as the optimal solution.

Key Provisions of the Kerry-Lieberman Bill

Cap-and-trade System for Regulating Greenhouse Gas Emissions

The proposed targets are, for the most part, consistent with the Waxman-Markey bill that passed the House in June 2009. Kerry-Lieberman calls for a 17 percent reduction in economy-wide greenhouse gas emissions by 2020 (over 2005 levels), 3 percent less than the 20 percent reduction proposed in the Kerry-Boxer bill last fall. The remaining targets are the same as in both Waxman-Markey and Kerry Boxer—most notably, the 83 percent reduction target for 2050. The one exception is that Kerry-Lieberman proposes a slightly more rigorous 4.5 percent target for 2013 as opposed to a 3 percent target for 2012.

The Kerry-Lieberman proposal also extends the phase-in period over previous legislative proposals, with power plants, transportation fuels, and certain producers and importers of greenhouse gases subject to regulation in 2013, and large industrial sources and natural gas distributors subject to regulation in 2016. This extended phase-in period is one key difference over the Waxman-Markey bill, which began implementation in 2012 and phased in industrial sources by 2014.

Another important feature of the draft bill is a “price collar” on emissions allowances. Allowance prices initially start at $12 per ton (slightly higher than Waxman-Markey) and are effectively capped by a $25 per ton reserve price, escalating at 5 percent per year over the inflation rate. This, likewise, is lower than the $28 “minimum” price established in Waxman-Markey. Kerry-Lieberman also authorizes allowance trading in an open market for most allowances, although trading of allowances in the petroleum fuel sector is prohibited.

Some of the additional features of the cap-and-trade program are as follows:
• The bill defines “covered entity” nearly identically with Waxman-Markey, including stationary sources at or above the 25,000 metric ton CO2e/yr threshold along with several all-in categories in certain industrial sectors
• Like Waxman-Markey, the bill allows for unlimited “banking” of allowances, and some limited “borrowing” of allowances, in order to dampen fluctuations in allowance pricing across compliance periods
• The bill calls for the creation of a “Cost Containment Reserve” funded with 4 billion allowances, intended to cap the price of allowances to an initial price of $25, escalating by 5 percent plus inflation each year thereafter
• The bill includes a huge allowance for “offsets”—up to 2 billion tons annually—under a hybrid program to be jointly promulgated by the EPA and USDA. Waxman-Markey called for two distinct offset programs to be administered by these agencies
• Oversight of carbon markets is vested in the Commodity Futures Trading Commission, as opposed to Waxman-Markey, which placed oversight largely with the Federal Regulatory Energy Commission
• Like Waxman-Markey, the bill includes provisions to protect domestic industry from unregulated foreign competitors, by allowing the EPA to distribute rebates to eligible industrial sectors
• Like Waxman-Markey, many of the details on implementing the program are delegated to the EPA, which must promulgate regulations to carry out the program within two years of enactment

As expected, the bill also effectively prohibits the EPA from regulating greenhouse gases under the existing provisions of the Clean Air Act—a key point of contention for industry. The bill also prohibits any state from implementing a cap-and-trade program. Among other things, this would effectively end the regional cap-and-trade initiatives that are currently operating or under development, such as the Regional Greenhouse Gas Initiative and Western Climate Initiative, both of which would roll into the new federal program.

The Congressional Budget Office estimated that Waxman-Markey would cover roughly 7,400 facilities across the country, comprising about 85 percent of U.S. greenhouse gas emissions. Given the similar definition of “covered entity” between the bills, we can predict that the coverage for Kerry-Lieberman would be about the same.

Renewable Energy and Energy Efficiency

Kerry-Lieberman contains provisions intended to promote renewable energy, but they are somewhat weak as compared to those established in Waxman-Markey. The bill establishes a low-interest loan program for qualified consumers in rural areas to implement home energy efficiency measures. It also states that it is the policy of the United States to support the continued growth of voluntary renewable energy markets.

Importantly, the bill does not establish renewable and energy efficiency targets, a key feature of Waxman-Markey. It is at least possible that additional provisions regarding renewable energy will be added as the bill moves forward. With the Kerry-Boxer bill, which also omitted renewable energy standards, there was some speculation that such standards might be incorporated from other bills circulating in the Senate—most notably, the American Clean Energy Leadership Act (S. 1462), introduced in the Senate in June 2009. Whether and to what extent that happens here remains to be seen.

Other Investments in New Energy, Clean Coal and Transportation

The bill encourages the development of nuclear power by several means. The process for approving construction of new nuclear power generation facilities is simplified and expedited. The federal government provides a number of financial incentives to operators as well. These incentives include credits and other beneficial tax treatment, grants, funding for loan guarantees, and specialized insurance products. At the same time, research into developing advanced practices for the management of spent fuel is made a priority, with new funding and laboratory resources being allocated to this effort.

In addition to investing in nuclear power, the bill outlines a national strategy for carbon capture and sequestration (CCS). The bill provides research dollars for the development and commercial deployment of CCS and other “clean coal” technologies. In the deployment phase, emissions allowances are distributed to facilities based on the amount of carbon captured, a feature of the bill that is designed to encourage emitters to engage in CCS early in the program and to maximize the amount of carbon captured.

The bill addresses transportation by providing for a national low carbon transportation plan that projects the future infrastructure needs for electric automobiles, such as the location and density of recharging stations, and uniform standards for vehicle manufacturers and electricity providers. State and local governments are required to develop emission reduction targets and strategies to achieve them.

Offshore Drilling

In a likely effort to court Republican support, Kerry-Lieberman contains some provisions intended to promote domestic offshore drilling. The bill adds a revenue sharing concept from offshore oil drilling in areas of the Outer Continental Shelf previously closed to oil and gas leasing. The bill would allow states to receive 37.5 percent of revenues from drilling off of their coastline, and 12.5 percent of revenues would be reserved for implementation of programs under the Land and Water Conservation Fund.

Despite this incentive for states to embrace offshore oil drilling, responding to the recent Deepwater Horizon oil rig accident, the bill allows coastal states to opt-out of offshore drilling within up to 75 miles from their coastlines. The bill further provides coastal states the right to enact laws that would, in essence, “veto” offshore drilling projects if the states would be “significantly impacted” in the event of an accident.

We can expect this portion of the bill to get more attention as the debate moves forward.

Transitioning Programs

As the country transitions from reliance on fossil fuels to alternative energy sources, the bill provides some economic relief to predominantly low-income consumers in order to offset anticipated increases in energy costs during this period. These programs are funded by a portion of cap-and-trade allowance auction revenues. In later years, some of auction revenues are distributed to a broader group of consumers through a “Universal Refund” program.

The bill invests in the creation of green jobs by creating grants to develop programs of study in trade schools as well as in post-secondary educational institutions, in each case with the goal of preparing students for careers in energy and climate change-related fields. The bill also encourages investment in new transportation technology through grants and credits. Perhaps recognizing the potential for natural gas to be an important transitional energy source, the bill provides special economic incentives for the development and use of compressed or liquefied natural gas vehicles, and outlines a plan to study the use of these vehicles in the federal fleet.

International Provisions

The bill empowers the administration to cooperate with other nations in reducing greenhouse gas emissions worldwide. The first of two chief means of cooperation is a program to assist developing countries in reducing greenhouse gas emissions from deforestation. The bill requires that this program achieve emissions reductions of 720 million tons CO2e by 2020, and a cumulative total of 6 billion tons by 2025. In addition, the bill authorizes the executive branch to support programs that would prohibit the domestic sale of products made from illegally harvested timber.

The second significant area of international cooperation is in providing direct economic assistance to the developing countries that are the most vulnerable to adverse effects of climate change and have the least capacity to respond. The bill provides a means for developing assistance programs, as well as an oversight process, and leaves room for the program administrators to exercise discretion in the development of the program and awarding of assistance.

Other Developments

The Final “Tailoring” Rule

On May 13, 2010, the day after the release of the Kerry-Lieberman discussion draft, the EPA inched closer to directly regulating greenhouse gases itself by issuing its final Greenhouse Gas Tailoring rule. The rule establishes emissions thresholds defining when PSD and Title V permits under the Clean Air Act are required for greenhouse gas emissions. Although the EPA initially proposed a general regulatory threshold of 25,000 metric tons CO2e/yr (up from the 100 and 250 ton thresholds currently contained in the Clean Air Act, which the EPA has deemed unworkable), the final rule increases this threshold substantially.

Under the final rule, the phasing in of this program will occur in two steps.

First, between January 2 and June 30, 2011, the rule only covers sources currently subject to either of the permitting programs on the basis of other pollutants. Moreover, PSD permits will be required to address greenhouse gas emissions only if the project would increase such emissions by at least 75,000 metric tons CO2e/yr. Note, however, that this 75,000 metric ton threshold would not apply to permitting requirements under Title V during this phase.

Second, between July 1, 2011 and June 30, 2013, the rule requires PSD permits for new construction projects, and Title V operating permits for existing sources, with greenhouse gas emissions of 100,000 metric tons CO2e/yr or more. The threshold for PSD permits to modify existing facilities remains 75,000 metric tons CO2e/yr. However, in all such cases, the permitting requirements now apply regardless of whether permits would be required for other pollutants.

Beyond that, the final rule provides that the EPA will undertake another rulemaking by July 1, 2012, in order to address the further phasing in of greenhouse gas permitting. The EPA has, however, committed that it will not require permitting for sources with greenhouse gas emissions below 50,000 metric tons CO2e/yr as a part of this process.

According to the EPA, these permitting requirements will ultimately cover 70 percent of the national greenhouse gas emissions from stationary sources.

The Greenhouse Gas Reporting Rule

Announced in final form last fall, the EPA’s Final Mandatory Reporting of Greenhouse Gases Rule requires several of the source categories subject to the rule to begin monitoring emissions on January 1, 2010. Facilities required by the rule must monitor their emissions according to the methodologies applicable to the various source categories. Initial reports to the EPA are due March 31, 2011, and additional emissions data must be retained.

When first issued, the final rule included only 31 of the 42 source categories listed in the proposed rule. But on March 22, 2010, the EPA issued four new proposed rules for additional source categories, including rules applicable to oil and natural gas, fluorinated greenhouse gases, and carbon sequestration. More categories are expected to be on the way.
SEC Interpretive Guidance

On January 27, 2010, the Securities and Exchange Commission (SEC) announced it will be providing interpretive guidance on SEC disclosure requirements on the issue of climate change. The guidance covers potential impacts that both climate change regulation and climate change itself may have on a company’s operations, and in particular disclosures related to a company’s risk factors, business description, legal proceedings and management’s discussion and analysis.

International Negotiations

Currently, 126 countries (including the United States) have associated with or expressed support for the non-binding Copenhagen Accord, the document crafted at the United Nations Climate Change Conference in Copenhagen, Denmark in December of 2009. Emission reduction targets submitted by signers of the Copenhagen Accord, which were due January 31, 2010, have not yet met the overall goal stated in the Accord. In the Copenhagen Accord, the United States pledged to raise funding to assist countries that would be vulnerable to the effects of climate change, and the Kerry-Lieberman bill is already being criticized for lack of funding to meet this pledge.

Climate Change Litigation

Two federal courts of appeal have now ruled on much-watched petitions for rehearing en banc in climate change lawsuits. In Connecticut v. American Electric Power, the Second Circuit rejected the petition, effectively setting that case up to move forward into the discovery phase.

In Comer v. Murphy Oil, the Fifth Circuit initially granted an en banc petition, fueling speculation that the court might affirm the district court’s order to dismiss the case. In early May, however, the court recanted that decision, explaining to the parties that it had lost its quorum due to the recusal of an additional judge. While the court has requested additional briefing on the issue, the petition remains very much in doubt, which could push this case into discovery as well.

The appeal of the district court’s dismissal in a third climate case, Native Village of Kivalina v. ExxonMobil, remains pending before the Ninth Circuit. The developments in the Fifth Circuit could increase the importance of the Ninth Circuit decision. If the Ninth Circuit follows the other two circuits and overturns the district court dismissal, there would effectively be no circuit split among the three. This could decrease the chances that the U.S. Supreme Court would grant certiorari and decide on a national level whether these types of claims can proceed.

Underlying litigation on insurance claims relating to these cases also remains pending. One case to watch is Steadfast v. AES, currently pending in state court in Virginia, which involves how insurance coverage might apply to damages arising from climate change – here, specifically in the Kivalina case. We can expect to see more of this type of insurance litigation soon.

What All This Means

If successful, the Kerry-Lieberman proposal, like its predecessor in the Waxman-Markey bill, has the potential to be a game-changer for the energy, transportation, and manufacturing sectors of the U.S. economy. While Congress is likely to provide some time for preparation and adjustment, the main issue with phased implementation is, of course, that it could make the attainment of any imposed targets all the more difficult. That said, the extended phase-in provided in Kerry-Lieberman is likely a nod to the political challenges the bill will face.

In light of these developments, while companies that may be impacted by this legislation may not need to make drastic changes in the immediate term, it is important for those affected to have a comprehensive understanding of at least the basics, namely:

• The greenhouse gas emissions resulting from a company’s operations, by kind and source
• The regulatory risk, based on an analysis and understanding of any existing or proposed regulatory regimes
• Any significant indirect impacts, such as potential impacts to energy costs and changes within the supply chain

Failure to understand any of these could lead to economic or legal exposure down the road.

Likewise, it is critically important for companies to institutionalize any measures necessary for adjusting to this new regulatory environment across the enterprise, and not just leave it “siloed” within a sustainability or environmental compliance department. Many of the impacts of this regulation could go to the heart of a company’s operations—combustion sources and energy use being just two examples. The process for adjustment should be as inclusive, and should occur on the front end, as opposed to when the time for compliance is at hand.

It remains to be seen whether the Senate will pass this or any other climate proposal, especially given the current political climate and the fast approaching fall elections. While several of the legislative proposals are at least somewhat consistent in their approach, the rules of the game are not yet known. Equally uncertain is what might fill the gap in the absence of federal legislation: whether the EPA would regulate, whether regional initiatives would prevail, and whether judges or juries would levy injunctive relief or damages.

For now, the field of climate change law will remain highly dynamic, and the outcomes hard to predict. Perhaps the most prudent advice is succinctly captured by the old Scout motto: “Be prepared.”

Andrea Carruthers and Jonathan W. Dettmann are members of the Faegre & Benson new energy, clean technology, and climate industry team. The NECTC team consists of over 50 attorneys from the firm’s offices in the United States, United Kingdom, and China, collaborating to advise the broad range of businesses that face new regulatory mandates arising from energy and climate change legislation. NECTC attorneys Rachel Pollock, Jim Spaanstra, and Eric Triplett also contributed to this article.

Andrea Carruthers
Andrea Carruthers is a partner in the real estate group at Faegre & Benson. She can be reached at acarruthers@faegre.com or 612.766.8520.
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