"Climate Change Legislation: Major Policy Issues Before Congress," White Paper

This paper describes the major issues that Congress will need to resolve in crafting climate change legislation. It also describes how the Northwest may be affected by the resolution of at least some of these issues. For simplicity, this paper cites examples from bills that have been introduced in the Senate; the same issues are also addressed in bills introduced in the House.

Keep in mind that the current Congress is only a few weeks old, so the situation is very fluid. Climate change legislation was considered over the last few years while Congress was under Republican control, particularly in the Senate, but there was never any serious likelihood of enactment. With the Democrats now in control of Congress, the issue has moved to near the top of their agenda, and about a dozen bills have been introduced to much fanfare. But the legislation is very much in the formative stage, and the prospects and likely timing for enactment are uncertain. In the coming months, many additional issues and sub-issues will undoubtedly emerge, but it is not too early to identify the major issues that will require resolution.

Before turning to the unresolved major issues, it is important to note that two important issues may have already been resolved. First, the greenhouse gas (GHG) reduction program contained in the legislation almost certainly will be mandatory, not voluntary, in nature. The voluntary approach espoused by the Bush Administration is widely regarded by the Democratically-controlled Congress as inadequate, and many industry leaders and trade associations have recently endorsed the mandatory approach.

In addition to concern about climate change, these endorsements also reflect concern that continuing to oppose a mandatory approach would cause industry to have much less influence over the contents of the legislation that is ultimately enacted. Although some Congressional Republicans continue to support the voluntary approach, it is very likely that any legislation enacted under Democratic control will be mandatory in nature.

Second, it appears likely that the form of mandatory regulation for the electric generation sector will be a cap and trade system – similar to the system enacted by Congress to address acid rain by reducing SO2 -- rather than a tax on the production of carbon. Although there are respected economists and industry leaders who favor a carbon tax due to its simplicity and ease of administration, the widely-perceived success of the acid rain program, plus the fact that the word “tax” is so politically charged, makes it likely that a cap-and-trade program will be adopted instead. In particular, many Democrats believe they lost control of the House of Representatives in 1994 in part due to the political fallout from the ill-fated BTU tax advanced by the Clinton Administration in 1993. They are loathe to repeat that experience.

Now to the unresolved major issues:

Issue No. 1: How much GHG reduction is necessary, and how soon?

From a political perspective, the debate over whether climate change is occurring in response to human activity is largely over. Unless dramatic new evidence comes to light, it will be the operating assumption of many members of Congress that the future well-being of humanity may rest on solving this problem. The doubt relates to how serious the problem is, how much time we have to solve it, and therefore how radical the solution must be. Members of Congress are increasingly becoming convinced that time is relatively short, and that the actions to be taken must therefore be relatively vigorous.

Some of the key questions are: (1) how much of an increase in energy costs can the economy tolerate? (2) what are the economic consequences of unchecked climate change?, and (3) is there an environmental tipping point, i.e., is there a point where the effects of climate change either dramatically accelerate and/or become irreversible?

In light of these questions, there is substantial variation in the aggressiveness of the bills that have been introduced. In the Senate, the most aggressive bill, S. 309 (introduced by Senators Sanders, Boxer, and others) explicitly requires that GHG emissions be reduced by 2050 to 80 percent below 1990 levels. At the other end of the spectrum, a draft bill being circulated by Senators Bingaman and Specter uses a more complex regulatory mechanism that might not reduce GHG emissions below 1990 levels by 2050. According to the Energy Information Administration (EIA), the Bingaman-Specter draft bill would reduce carbon emissions by about 14 percent below 2004 levels by 2030.

Other Senate bills take a course somewhere between these two poles. S. 280 (introduced by Senators McCain, Lieberman, and others) is estimated to reduce emissions by about 65 percent below 1990 levels by 2050, and S. 317 (introduced by Senators Feinstein and Carper) would reduce emissions by about 40 percent below 1990 levels by 2050. By comparison, the Kyoto Protocol was intended to reduce GHG levels by about seven percent below 1990 levels by 2012. In other words, all but the most modest bill would far outstrip the reduction goals of the Kyoto Protocol, but over a much longer period of time.

In terms of costs, the EIA estimates that the Bingaman-Specter draft would increase electricity prices by less than 11 percent over forecasted levels in 2030. According to EIA, the gross domestic economy would be reduced by 0.1 percent, or $232 billion, between 2009 and 2030. EIA has not yet estimated the costs of the current versions of the other bills, although they all would be much more expensive than the Bingaman-Specter draft. For example, EIA estimated that the version of the McCain-Lieberman bill introduced in 2003, which is similar to the current bill, would cause electricity prices to increase by 46 percent over forecasted levels by 2025

For the Northwest electric utilities, estimating the cost of federal climate change legislation is complicated by the fact that Northwest utilities already produce far less carbon per unit of electricity than any other region of the country. Specifically, Oregon ranks 47th, Washington is 48th, and Idaho is 49th in the amount of CO2 per unit of electricity produced.

This means that Northwest utilities must accomplish any GHG reductions from a much smaller proportion of their generating resources than utilities in other regions. It is obviously not possible to reduce the GHG contribution of zero-emission hydropower facilities. In addition, there are few, if any, feasible opportunities to significantly reduce GHG emissions from the natural gas-fired combined cycle combustion turbines that several Northwest utilities have built in the past decade to serve load growth.

Unless these facts are somehow accounted for in the legislation, Northwest utilities and their customers will be among the hardest hit, an ironic result in view of the fact that the Northwest bears so little responsibility for creating the problem that Congress is trying to solve. One way to account for these facts is discussed below under Issue No. 3.

Issue No. 2: What sectors of the economy should be regulated?

Once one determines how much GHG emissions should be reduced and how soon, the next question is the scope of the regulation necessary to achieve those goals. The potential sectors are: (1) electricity production; (2) transportation; (3) industrial/manufacturing; (4) commercial buildings and activities; (5) residential buildings and activities; and (6) agricultural activities. For example, the same amount of GHG could be eliminated either by applying a cap-and-trade program on the electric generation sector, or by requiring that car manufacturers substantially increase fuel efficiency, or by mandating increased efficiency in all residential electrical appliances.

The sectors included in the legislation, and the regulatory demands placed on each sector, will affect not only the equities among sectors, but will also influence the likelihood of a successful overall strategy. For example, heavy GHG emission reduction mandates on electric utilities, without a substantial increase in auto fuel efficiency, would both place a disproportionate burden on electric utilities and overlook the “low-hanging fruit” that could be gathered by increasing vehicle fuel efficiency.

Among the pending bills, the Bingaman-Specter draft, and McCain-Lieberman and Sanders-Boxer bills are economy-wide in scope. The Feinstein-Carper bill applies only to the electric generation sector, but Senator Feinstein has pledged to introduce additional bills to cover the other sectors. In the end, it is in the interest of Northwest utilities to insist that all sectors be included, and that each sector bear a burden commensurate with its contribution to the problem.

Issue No. 3: At what point in the energy supply chain should GHG emissions be regulated?

Another key issue is the point in the energy supply chain that GHG emissions should be regulated. One option is to regulate emissions “upstream” in the energy supply chain, such as at the refinery or mine mouth. Under this approach, the responsibility for submitting emission allowances to the regulatory agency would be that of the fossil fuel producers. At the opposite end of the spectrum, the point of regulation could be “downstream” on individual energy consumers, making them responsible for submitting allowances. Alternatively, the point of regulation could be at some intermediate point in the supply chain, such as electric generation facilities.

The main advantage of the upstream approach is that it facilitates the regulation of all sectors of the economy through the imposition of regulatory requirements on a relatively small number of entities. On the other hand, advocates of a downstream point of regulation are concerned that placing the regulatory obligation upstream could obscure price signals necessary to change the behaviors that cause GHG emissions.

There are pluses and minuses to any point of regulation. However, the “upstream” approach could be more consistent with the interests of Northwest electric utilities because fuel producers, not electric generators, would have the obligation to submit allowances to the regulator, thus avoiding an additional regulatory burden on Northwest utilities. In addition, some of the cost of allowances may be absorbed by the fuel producer and not passed on to generators. This would benefit the Northwest, particularly given that the region is not a significant producer of fossil fuels.

Issue No. 4: Within the electric generation sector, how should the burden of reducing GHG emissions be distributed?

Once one determines how much GHG emissions should be reduced and how soon, what sectors of the economy should be part of the solution, and the point of regulation, the next question is the allocation of the burden within each sector. For example, within the transportation sector, should a mandated increase in fuel efficiency require the same percentage increase in efficiency from heavy trucks and hybrid cars?

In the electric generation sector, this is an extremely important question because, as noted, Northwest utilities have only a small fraction of the opportunities to cost-effectively reduce GHG emissions as utilities in other regions, particularly those regions that rely heavily on older, inefficient coal-burning facilities that are only operating because they were “grandfathered” under the Clean Air Act. If Northwest utilities were required to reduce their GHG emissions by the same percentage as utilities in those regions, Northwest utilities would bear a burden far heavier than their contribution to the problem. A region that has successfully harnessed clean energy resources should be rewarded, or at least not punished, for doing so.

In addition, such an outcome would be economically inefficient because the cost per ton of removing GHGs from the relatively small fossil fuel-burning generation base of the Northwest would be far higher than the cost of removing the same amount of GHGs from the much larger, much dirtier fossil-fuel generation base of utilities located elsewhere in the country. In short, Northwest utilities are the hybrid cars of the electric generation sector, and it would unfair and uneconomic to treat them the same as the heavy trucks of that sector.

And yet, this is a distinct possibility. Under the cap and trade approach, a cap or ceiling on total emissions would decline over time. Assuming that the point of regulation is the electric generators, each generation facility would initially be allocated a certain amount of emission allowances, and then that allocation would decline each year. Those utilities able to cost-effectively reduce their emissions would then be able to sell their excess allowances to those utilities that either could not reduce their emissions cost-effectively, or that incurred additional emissions in order to produce the additional power necessary to serve load growth.

The key is the method used to initially allocate the allowances. The two obvious methods are to allocate allowances based on either: (a) the amount of electricity produced by the generator in a recent year, or (b) the amount of GHGs emitted by the generator in a recent year. If based on the amount of electricity, Northwest utilities would have excess allowances for a period of time until the cap declined to the point that it matched the level of that utilities’ GHG emissions. This would mitigate the cost of GHG regulation for those regions using low-emission resources, and require those regions using high-emisssion resources to take the lead in reducing emissions.

If, on the other hand, the allocation is based on the amount of GHGs emitted, low-emission regions would receive few allowances to emit, while other regions would receive enough allowances to cover most of their inefficient, high-emission generating factilities. This would further exacerbate the negative impact of GHG regulation on Northwest electricity prices. As the cap declined in the succeeding years, the pressure to reduce emissions would be the same on both the high-emission and the low-emission regions, even though the high-emission regions are a bigger part of the problem, and have much bigger and more cost-effective opportunities to reduce their emissions.

For example, let’s take a Midwestern utility with extensive, inefficient coal-fired generation. Having received a large amount of allowances, that utility would have ample opportunity to free up allowances for sale by increasing the efficiency of its facilities, or by replacing those units with more efficient, lower emission generation. A low-emission Northwest utility, on the other hand, would have few allowances and even fewer opportunities to free up those allowances for sale because it has a relatively low percentage of generation that is fossil fuel-fired, and much of that is fired by relatively low-emission natural gas, rather than coal.

Consequently, the low-emission Northwest utility might have to purchase, at considerable cost, allowances from the high-emission Midwestern utility. This could lead to a perverse outcome where compliance with GHG regulation for the low-emission Northwest region would be far more costly than it would be for a high-emission region. In other words, regions that emit massive amounts of GHG into the atmosphere from power production would be rewarded, while regions that contribute few emissions would be penalized.

Therefore, it is absolutely essential to Northwest utilities and their customers that the initial allocation be based on the amount of electricity produced. In fact, as the attached graphs show, the difference between that method and allocation based on GHG emissions is almost $1 billion per year, assuming an allowance price of $10 per metric ton of CO2. This cost impact is in addition to the inherent disadvantage the Northwest faces due to its limited opportunities to reduce emissions.

Of the bills introduced thus far, only the Feinstein-Carper bill makes the initial allocation of allowances based on the amount of electricity produced. The draft Bingaman-Specter draft bill allocates allowances within the electric utility sector on the basis of GHG emissions, and the McCain-Lieberman bill simply delegates allocation authority to the EPA Administrator.

Issue No. 5: Should there be a “safety valve” to provide cost certainty?

One key feature of the Bingaman-Specter draft bill is that is contains a “safety valve” that may be exercised in the event that the price of allowances becomes too high for any reason. Following the recommendation of the National Commission on Energy Policy, the draft bill allows a regulated entity to purchased allowances from the federal government for $7 per ton in the first year, with an increase in the cost of five percent every year thereafter. Thus, regulated entities are assured of cost certainty – no matter how haywire the market for allowances becomes, or how technologically difficult it becomes to comply with the declining GHG cap, one can always resort to purchasing credits at a relatively modest price.

Instead of allowing regulated entities to buy allowances from the federal government at a fixed price, the McCain-Lieberman bill allows entities to borrow credits from the federal government for up to five years, subject to a carrying cost of 10 percent per year. That bill also allows regulated entities to bank excess allowances for use in future years.

For Northwest utilities, some sort of safety valve would be beneficial, particularly if allowances are allocated based on the amount of GHGs emitted. Under that unfortunate scenario, where the Northwest would be required to purchase a large amount of allowances, it could do so at the relatively low safety valve price.

Issue No. 6: What options should there be for complying with the new law?

The most obvious way to comply with a cap and trade system would be to simply reduce GHG emissions after the date of enactment from facilities owned or operated by the regulated entity, or purchase allowances. But the pending bills also allow several other ways to comply. First, several bills allow regulated entities to obtain credit for GHG reduction efforts undertaken before the new law is enacted. For example, the McCain-Lieberman bill allows credit for certain GHG reduction efforts occurring since 1990.

Second, the pending bills place much emphasis on geologic carbon sequestration, i.e., the permanent injection of carbon into the ground. Although this technology has not yet been proven on a commercial scale, it would theoretically allow the permanent storage of all carbon emissions from coal-fired generation facilities.

Moreover, all of the bills allow regulated entities to satisfy at least some of their obligations by submitting “offsets” from efforts to reduce GHG emissions in other nations if the other nation’s market and/reductions meets certain criteria. For example, the McCain-Lieberman bill allows entities to satisfy up to 30 percent of their obligations by submitting allowances from an overseas trading market if the EPA Administrator determines that such market is complete, accurate, and transparent, has enforceable GHG limits, and the regulated entity certifies that the credit has been retired in the other nation’s market. Both the McCain-Lieberman and Bingaman-Specter bills also allow regulated entities to earn allowances by conducting emission-reduction projects in developing countries. The offset issue will be particularly important to the Northwest because of the relatively modest level of cost-effective opportunities to reduce GHG emissions within the region.

Issue No. 7: What is the appropriate role of the states?

There are at least three questions regarding the appropriate role of the states in GHG reduction efforts. First, should states be allowed to have their own cap and trade programs once a federal trading program is in place? In the absence of a federal cap and trade program, California has led an effort to create programs at the state level, and the Northeast states have created a cap and trade system at the regional level. What should happen to those existing state and regional programs once the new federal law is enacted? Is it possible to reconcile the requirements of a federal program and the various state programs, or must the state programs be preempted in order to avoid the duplication and contradictions that result when a regulated entity is put in the position of trying to answer to multiple regulatory masters?

The Bingaman-Specter draft bill is silent on whether states may have their own cap and trade program, but the Feinstein-Carper bill appears to allow states to continue to operate their own cap and trade systems after a federal trading system is in place. The McCain-Lieberman bill authorizes states to require additional emission reductions, but does not clearly state whether the additional emission reductions can be achieved through a cap and trade program.

Second, if states are not allowed to have their own cap and trade programs, should they be able to implement other policies that either directly or indirectly reduce GHG emissions? For example, state requirements to reduce the emissions of SO2, NOX, and mercury could have the incidental effect of also reducing CO2 emissions. Similarly, state energy efficiency programs, generation performance standards, and renewable energy portfolio standards also reduce GHG emissions. None of the bills introduced to date directly address this issue, and it is not likely that Congress will curb state authority in these areas, at least not explicitly. It is likely, however, that states will ask Congress to clarify their continued authority in these fields of regulation.

Third, should state barriers to emission offsets be preempted? For example, the Washington Supreme Court recently struck down Seattle City Light’s purchase of an out-of-state emission reduction on the ground that it was beyond the authority of a municipal utility under state law. To what extent should such state-based limitations be swept away in order to facilitate the goals of the federal program?

Issue No. 8: How much money should be raised through the auction of allocations, and how should that money be used?

Many of the pending bills include a federal auction of emission allowances. Over time, the amount of allowances that are allocated without charge is gradually reduced to zero, and the amount of allowances that are auctioned is correspondingly increased. The proceeds from these auctions are then deposited in a national climate change trust fund. Money from the fund is then made available for various efforts related to climate change.

These provisions raise several important issues. First, how much money should be raised by these mechanisms? The trust fund authorized by the Bingaman-Specter draft bill is authorized to hold up to $50 billion, for example.

Second, should distribution of the funds be controlled by the federal government, states, or some other entity? Under the Bingaman-Specter draft bill, the federal government dispenses money from the trust fund, but the draft also gives states 29 percent of the initial allowances, which can be sold. Ninety percent of the proceeds must be used for various public purposes, including mitigating the impacts on low-income energy consumers, promoting energy efficiency, and avoiding distortions in competitive electricity markets. Perhaps evidencing ambivalence about having the states perform this role, the draft bill includes in brackets an alternative provision that authorizes the President to direct the proceeds instead of the states.

Third, how much of the money should be spent on reducing GHG emissions, such as new technology and energy efficiency, and how much should be spent on mitigating the effects of climate change, such as building new water supply facilities, fighting diseases exacerbated by climate change, repairing seawalls battered by rising sea levels, and fighting forest fires resulting from drought? None of the bills take a clear stand on this issue.

Issue No. 9: What is the appropriate nexus between the requirements of the new law and the GHG reduction efforts of other countries?

Perhaps the most important issue for this Congress and the next Administration is how to obtain the support and cooperation of developing nations in pursuit of substantial GHG emission reductions. Without an effective international strategy, particularly including China and India, the sacrifices required by domestic U.S. legislation are likely to be in vain. China derives almost 70 percent of its electricity from coal, and is expected to surpass the U.S. as the leading emitter of GHG by 2020. India, with its fast-growing economy and ample coal reserves, is not far behind.

Several of the pending bills address this issue. The Bingaman-Specter draft bill, for example, requires the President is to establish an interagency group to review the programs created under the bill and the GHG programs of other countries, including China, India, Brazil, Mexico, Russia, and Ukraine. As to those countries, the group is to determine whether they have taken action that is “significant, contemporaneous, and equitable compared to action taken by the United States.”

Based on this review, the President is to report to Congress every five years, beginning in January of 2017, describing any recommended changes to the programs contained in the bill. Not later than September 30 of a year in which the President reports, Congress may consider a joint resolution adjusting the requirements of the bill. The draft bill requires that the joint resolution be introduced within 45 days after the date that the report is to be submitted, but does not provide for any “fast-track” parliamentary procedures to ensure consideration by Congress.

Although the success or failure of an international GHG strategy seems beyond the realm of Northwest utilities, U.S. leadership on this issue is less likely to emerge in the absence of strong domestic support. In communicating with members of the Northwest Congressional delegation regarding the pending legislation, Northwest utilities may also want to express their support for strong U.S. leadership.