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U.S. Climate Change Legislation and Regulation – State of Play and Cross-Border Aspects

July 2009 Andrew Shoyer Washington [email protected]

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Overview

• Governmental challenge in addressing climate change – How to deal with the big externality • Current treaty-based rules – UN and WTO • US experience – Legislative and regulatory – National and state-level • International negotiations

A truly global problem and solution

The problem “Greenhouse gas (GHG) emissions are externalities and represent the biggest market failure the world has seen.” - Sir Nicholas Stern, “The Economics of Climate Change” (2008) The objective Stabilization of global temperatures – avoid higher than 3.4 degree Celsius increase per G8 (2 degree per European Union) The solution “At the heart of good policy will be a price for GHGs—this is a classic and sound approach to externalities and is crucial for an incentive structure both to reduce GHG emissions and to keep costs of abatement down.” - Sir Nicholas Stern, “The Economics of Climate Change” (2008) 3

4 Source: Environmental Defense Fund

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US Starting Point – What Produces Emissions?

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Major Concerns

The cross-border policy concerns associated with the regulation of greenhouse gas emissions range across a spectrum, from the purely economic to the purely environmental Economic Environmental

<-------------------------------------------------------------------> Loss of Competitiveness Carbon Leakage Loss of Effectiveness

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Policy Options

• Internal measures – Free allowances – Output-based rebates • External measures – Border tax – Allowance requirement – Sectoral carbon-intensity standard

Treaty Rules - UNFCCC

• “Measures taken to combat climate change, including unilateral ones, should not constitute a means of

arbitrary or unjustifiable discrimination or a disguised

restriction on international trade.” - Article 3 (Principles), paragraph 5, UN Framework Convention on Climate Change (1992) - Highlighted text is taken from Article XX, WTO General Agreement on Tariffs and Trade 1994 • “All Parties, taking into account their common but differentiated responsibilities and their specific national and regional development priorities, objectives and circumstances, shall . . . .” – Article 4 (Commitments), paragraph 1, UNFCCC 8

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Treaty rules – WTO Internal regulation or import measure?

• If it is considered an internal regulation (affecting domestic and imported goods), then – GATT Ad Article III – Generally permitted if “applies to an imported product and the like domestic product” • WTO-UNEP Report (2009) -- Border tax adjustments permitted, under certain conditions, on imports and exports goods • Distinction between indirect taxes (e.g., on products or value added) and direct taxes (e.g., on income) – GATT Article III:4 -- A government may not treat imported goods less favorably than like domestic goods, so as to afford protection to domestic production.

• Emphasis on conditions of competition • But are goods made with different levels of GHG emissions “like products” – process or production method (PPM)?

Treaty rules – WTO Internal regulation or import measure? (2)

• If it is a border measure (affecting imports), then – GATT Article II: A government may not impose customs duties or other duties or charges on imports in excess of its scheduled tariff concessions.

– GATT Article XI: A government may not impose restrictions, other than duties, taxes or other charges, on imports.

• BUT either way, if the measure distinguishes between the goods of different countries (e.g., based on their GHG emissions), then – GATT Article I: Most-favored-nation treatment 10

Treaty rules – WTO General exceptions

• Even if a measure violates a GATT rule, a government may impose it anyway if – GATT Article XX(b): necessary to protect human, animal or plant life or health, OR – GATT Article XX(g): relating to the conservation of exhaustible natural resources, taken in conjunction with restrictions on domestic production or consumption, AND – GATT Article XX chapeau: not applied in a manner that would constitute • Means of arbitrary or unjustifiable discrimination between countries where same conditions prevail, or • Disguised restriction on international trade 11

Treaty rules – WTO Free allowances - Subsidies

• A measure is actionable as a subsidy if – SCM Article 1: a government provides a financial contribution, e.g., revenue is foregone, and confers a benefit – SCM Article 2: it is specific to certain enterprises – SCM Article 5: it creates adverse effects to the interests of another Member government, including injury to a domestic industry, or – SCM Article 6: serious prejudice, which could include price supression in a third country market • A subsidy could be challenged – – in a countervailing measure proceeding or – in a WTO dispute settlement proceeding 12

13 Source: Environmental Defense Fund

14 Source: Environmental Defense Fund

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Overview

Legislative Action National Waxman/Markey bill State - CA

Regulatory Action National - Environmental Protection Agency (EPA) State - CA International Negotiations

16 Climate Change Regulation The Way It Should Work Federal Legislation Federal Regulation Regional and Local Implementation Litigation

17 Climate Change Regulation The Way It Is Working in the United States Federal Legislation Federal Regulation Regional and Local Implementation Litigation

The Transition to a Carbon Constrained U.S.

Who will get there first?

EPA’s path is a virtual certainty.

• President Obama has committed to finalizing the first GHG regulations • EPA is presently pursuing three climate change rulemakings simultaneously; more proposals this summer • Environmental NGOs will use courts to force action Quick developments in the House , but less certain future. • House of Representatives has passed American Clean Energy and Security Act • Passage by Senate appears more challenging And then there’s Copenhagen… 18

The Transition to a Carbon Constrained U.S.

What will carbon controls look like?

EPA will use command and control approach • Will try to adapt existing Clean Air Act provisions to regulate energy use • Will develop micro-sector-specific approaches • Will aim to control energy by requiring technology redesign and workplace standards • Will lead to unintended consequences under Clean Air Act Congress will develop market based system • Focus has been on cap and trade, but carbon tax is favored by some • Will impose industry-wide restrictions on GHGs • In theory, should be comprehensive and preempt Clean Air Act command and control approach, but House bill leaves much Clean Air Act authority in place 19

The Transition to a Carbon Constrained U.S.

When will controls be enacted?

EPA intends to enacts finalize first GHG in March 2010 • First GHG rules will apply to cars and light duty trucks, but will trigger regulation for virtually all sectors • EPA currently laying regulatory foundation for broad Clean Air Act regulation • Mandatory GHG reporting rule will take effect January 1, 2010 H.R. 2454 would implement cap on

emissions in 2012

• 2012 emissions could not exceed 97 percent of 2005 emissions • But 2012 target assumes passage in 2009 20

Waxman-Markey Bill American Clean Energy and Security Act of 2009

• 110 th Congress saw a number of cap-and-trade bills – many of them with border measures, none voted on • 111 th Congress: “dramatically improved” prospects for climate change legislation – President Obama called on lawmakers to send him “legislation with a market-based cap on carbon pollution” – Well-placed advocates in Congress • Waxman/Markey bill passed House on 26 June – Very close vote of 219 to 212 – Now focus moves to Senate, markup by end July 21

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Waxman-Markey Bill “A legislative Susan Boyle”

Chairman Waxman

Waxman-Markey Bill Main Elements

• Renewable Energy Standards • Energy Efficiency • Emissions Trading Scheme (“cap-and-trade” regime) • Transition to a Clean Energy Economy (including competitiveness and adaptation provisions) 23

Waxman-Markey Bill Impacted Industries • Section 722 prohibits emissions of GHGs unless owner or operator holds necessary allowances for “capped emissions” from the following “covered entities”: – Electricity sources – Fuel producers and importers (>25,000 tons/year) – Industrial gas producers and importers (>25,000) – Nitrogen trifluoride sources (>25,000) – Geological sequestration sites – Industrial stationary sources (see 700(12)(F)-(H)) – Industrial fossil fuel-fired combustion devices (>25,000) – Natural gas local distribution companies – Algae based fuels – Fugitive emissions 24

Waxman-Markey Bill Non-Capped Sources

• For most non electricity generating sources, Bill establishes threshold of 25,000 tons/year CO2e.

– But Section 811 mandates EPA to regulate certain sources between 10,000 and 25,000 tons/year CO2e through Clean Air Act Section 111 New Source Performance Standards.

– And Section 722(g) authorizes EPA to lower the threshold to 10,000 tons/year CO2e in 2020.

• Thus, smaller sources not subject to cap today could

face EPA regulation immediately or be subject to cap in future.

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Waxman-Markey Bill How the Cap and Trade Works • “Covered Entities” much generate an allowance for each ton of CO2 equivalent of “Capped Emissions” • Some facilities will not be “covered entities” unless they emit above specified threshold.

• For covered entities, emissions are generally “capped emissions” if they are generated by fossil fuel combustion. Renewable biomass and liquid fuels generally do not generate “capped emissions.” 26

Waxman-Markey Bill Carbon reductions

• Reductions under the cap-and-trade regime and overall economy – 3% below 2005 levels by 2012 – 17% by 2020 (overall economy 20%) – 42% by 2030 – 83% by 2050 • Creates a market-place for allowances – allows banking and borrowing • Start 2012, phase in complete by 2016 27

Offsets

• Permits capped sources to use up to 2 billion offsets of allowances annually (split between domestic and international offsets) • Title V (Peterson Amendments) apply to domestic agricultural and forestry projects; Title VII applies to other projects.

• Steps to generating offsets – (1) USDA or EPA rulemaking; – (2) project certification; – (3) project verification.

– But ACESA (Section 795) also allows exchange for early action offset credits from certain state and voluntary programs.

• Offsets as cost containment – CBO: Together, the provisions allowing the use of domestic and international offsets would decrease the price of GHG allowances by $35 (69 percent) in 2012.

– EPA: Without international offsets, costs of allowances would increase 96 percent.

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Waxman-Markey Bill Rebates to address carbon leakage

• Specifies distribution of emission allowances to key sectors or for certain key purposes; rest auctioned off • Carbon-based rebates (i.e., free allowances) – Available to eligible industrial sectors with • 5 percent – energy or GHG intensity • 15 percent - trade intensity • Which sectors? Determined by 2011 – Rebate calculated based on sum of • direct carbon factor • indirect carbon factor • Designed to cover compliance costs from 2012 through 2025, then rebates will phase out from 2025 until 2035.

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Waxman-Markey Bill Allowance requirements on imports

• Soon after enactment, the President must – notify other countries that it is US policy to address climate change through international agreements, – request that other countries take appropriate measures to limit their GHG emissions, and – indicate that imported goods may be subject to international reserve allowance requirements beginning in 2020.

 The President will report to Congress by 2017 on the effectiveness of rebates in preventing carbon leakage and the usefulness of imposing an international allowance requirement on imports of covered goods, defined as - industrial goods that are energy- and trade-intensive, or - manufactured goods if EPA determines they should be covered.

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Waxman-Markey Bill Purpose of international allowance requirement

• What is the stated purpose of the program?

– “To induce foreign countries, and in particular, fast-growing developing countries, to take substantial action with respect to their greenhouse gas emissions consistent with the Bali Action Plan” under the UNFCCC, and – “to ensure measures . . . are designed and implemented in a manner consistent with applicable international agreements.” - “Congress finds that the purposes . . . can be most effectively addressed and achieved through [negotiated] agreements.” – “Work proactively under the [UNFCCC] and other fora to establish binding agreements, including sectoral agreements, committing all major [GHG]-emitting nations to contribute equitably to the reduction of [GHG] emissions.” 31

Waxman-Markey Bill Establishment of allowance requirement

   If by 2018 the United States has not entered into an international climate change agreement, then the President shall establish an international reserve allowance program  UNLESS the President determines it would not be in the national interest AND  Congress passes an affirmative joint resolution within 90 days.

EPA would create a pool of international reserve allowances separate from the allowances that domestic entities must use to comply with their cap-and-trade obligations EPA would sell the international reserve allowances at the same price at which the domestic allowances are offered for sale 32

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Waxman-Markey Bill Sectoral coverage of international allowances

To identify the industrial sectors subject to the international reserve allowance requirement, the President shall by July 2018 determine whether, for any carbon-intensive sector, more than 85 percent of imports come from countries that meet one of three criteria: (1) the country has taken in an international agreement a nationally enforceable, economy-wide emissions reduction commitment at least as stringent as the US commitment; (2) the country and the US are parties to a sectoral international agreement; or (3) the energy or carbon intensity of the sector is equal or less than in the US

Waxman-Markey Bill Sectoral coverage of international allowances (2)

• If the President identifies an eligible sector where the percentage/criteria are not met, then he must extend rebates and impose an international reserve allowance requirement.

– But EPA must adjust to as low as zero the international reserve allowance requirement for a sector to account for the benefit to that sector of free allowances to electricity providers and rebates to industrial sectors.

• If, on the other hand, the President identifies a sector for which the percentage/criteria are met, then the President is prohibited from applying an international allowance requirement.

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Waxman-Markey Bill Country exemptions from international allowances • The goods of a country would be exempt from an international reserve allowance requirement if it – meets any of the three criteria on slide 17 (for a sector); – is listed by the UN as a least developed developing country; or – is responsible for less than 0.5 percent of global emissions and 5 percent of imports of covered goods with respect to the eligible sector.

• SO . . this creates strong incentive for a country to – – enter into a post-Kyoto multilateral climate change agreement AND take a carbon reduction commitment, OR – enter into agreements (at least bilateral) with the US on its key sectors 35

Waxman-Markey Bill Support and next steps

• What is the support for such legislation?

– Administration and well-placed advocates – Difficult economic times – Party lines not a wholly accurate predictor • Further steps: – Mark-up in EPW Committee (Boxer), review by Finance, others – Consideration and vote by Senate – Conference between House and Senate – Passage by House and Senate – Signature by President 36

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Overview Legislative Action National Waxman/Markey bill State - CA

Regulatory Action Environmental Protection Agency (EPA) Clean Air Act

International Negotiations

Regulatory Action by the EPA under the Clean Air Act

• In 2007 Supreme Court rules that CO2 fits within the definition of “air pollutant” in the Clean Air Act • Pres. Bush directs EPA to respond • In 2008, EPA issued an Advance Notice of Proposed Rulemaking (ANPR) • In April 2009, EPA published a proposed endangerment finding – Comments received through June 2009 38

Portfolio of EPA Rulemakings

GHG Controls

• Endangerment finding (proposed April 17, 2009; comment period closed June 23, 2009; finalized prior to March 2010) • •

Other Rules and Actions

• Greenhouse gas inventory rule proposal (proposed March 2009; comment period closed June 9, 2009; likely finalized November 2009; implementation January 1, 2010) • • Renewable fuels rule proposal (proposed May 5, 2009; goal of finalizing in August 2009 and implementation January 1, 2010) Stationary source permitting for new and modified units (Obama Administration reconsidering Bush Administration decision not to impose GHG controls on permits) • • Section 202 GHG regulation for cars and light duty trucks (proposed August 2009; finalized March 2010) PSD (“prevention of significant deterioration”) threshold rule (to be proposed and finalized prior to March 2010) California waiver decision (Obama Administration reconsidered Bush Administration denial of request for waiver to address GHGs; granted waiver on June 30, 2009) Carbon sequestration proposal (public comment period closed; possible final rule in early 2010) 39

Regulatory Action by the EPA under the Clean Air Act

• Far-reaching regulatory action – mobile sources (from lawnmowers to heavy-duty trucks) – stationary sources? (residential and industrial) – standards on renewable energy, energy efficiency – product lifecycle standards, e.g. for fuels (including GHG emissions during production) • But may not implement a cap-and-trade regime (?) and cannot provide subsidies to affected industries – also no authority to impose border measures 40

EPA action vs. legislative action

• EPA regulatory action runs parallel to legislative process, until legislation is enacted – Waxman/Markey bill would preempt EPA action • EPA regulatory process provides Obama administration with leverage to get legislation enacted – EPA regulation comes without any subsidies or cap-and-trade flexibility • However, EPA regulatory process might also be an incentive for Administration and Congress to avoid passing legislation that might cost a lot of jobs 41

How do these developments affect international negotiations?

• Enactment of legislation would signal willingness and ability of US to commit to binding reduction targets • What if by December a bill has cleared only the House, and not yet the Senate?

• Provision for border measures – its effects on international negotiations – source of leverage gone?

– less confrontational/unilateral 42

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Overview Legislative Action National Waxman/Markey bill State - CA Regulatory Action Environmental Protection Agency (EPA) Clean Air Act

International Negotiations

Current: Kyoto Protocol

• Kyoto Protocol to the UNFCCC (adopted 1994; entered into force 2005) – Sets binding targets for 37 industrialized countries and the European community for reducing greenhouse gas (GHG) emissions – Average of five per cent reduction against 1990 levels over the five-year period 2008-2012 – US never ratified • Conference of the Parties to the UNFCCC scheduled to be held in Copenhagen, Denmark, in December 2009 – Bali Action Plan to supplement UNFCCC, replace Kyoto Protocol with an agreement US can ratify 44

Road to Copenhagen

• Frequent negotiations under UNFCCC (Bali Action Plan) in Bonn, Germany • G8 and G20 (Major Economies Forum) meetings • Bilateral meetings – Including US-China Strategic and Economic Dialogue (July 2009) 45

Impact on National Efforts?

• If Congress passes climate change bill before international agreement reached, agreement not likely to determine national reduction targets – But could influence EPA regulation • Much more likely to affect international obligations on – funding developing countries – sharing technology – protection of intellectual property rights 46