Editor’s note: This article, from law firm Baker McKenzie, is authored by Richard M. Saines, Marisa Ann Martin Lewandowski, Daniel Rafeollo Design Deo, and Daniel Firger.
Part I: Greenhouse Gas Regulation
Renewed focus on GHG reductions a key priority in the Aministration’s second term impacts and opportunities
Reducing greenhouse gases throughout the U.S. economy is shaping up to be a key priority of the Obama Administration’s second term. In his fifth State of the Union address on February 12, President Obama called for a “bipartisan, market-based solution to climate change.” The President mentioned Senator McCain’s prior work on an economy-wide cap-and-trade bill as an example of what he urges Congress to develop. He also vowed to move forward on his own if Congress does not act, and proposed new initiatives to support state energy efficiency efforts with federal funding and strengthen renewable energy targets.
Pointing to his Administration’s establishment in 2012 of ambitious new vehicle fuel efficiency standards as an example, the President promised to “come up with executive actions we can take, now and in the future” to cut greenhouse gas (GHG) emissions, help communities prepare for the consequences of climate change, and facilitate the “transition to more sustainable sources of energy.” Such administrative actions include pending rules limiting carbon dioxide (CO2) emissions from new power plants and widely anticipated rules extending such limits to existing stationary sources, as well as a recently published draft adaptation plan, discussed in greater depth below.
Following the President’s legislative call to action, Senators Barbara Boxer and Bernie Sanders unveiled new legislation. Based on a summary of the proposal, the legislation would initially price carbon at $20 a ton, and then raise the price at 5.6% a year over a ten-year period. The tax would be imposed on upstream fossil fuel producers (at the coal mine, the oil refinery, the natural gas processing point, or at the point of importation). A portion of the revenues from the tax would be distributed to U.S. residents as a “dividend” to offset any concomitant rise in energy prices caused by the program, as upstream producers pass costs down to fuel providers and utilities, that will in turn pass costs on to consumers at the pump and on their monthly power and gas bills.
In addition to the uphill battle this legislation will likely face on the basis of continued political opposition to a price on carbon, the Boxer-Sanders proposal will also draw ire for its provisions on hydraulic fracturing. The proposed legislation would end an exemption for hydraulic fracturing activities under the Safe Drinking Water Act, which would upend what is already an extremely fragile balance of power between states and the federal government on this issue. In general, it appears extremely unlikely that the Boxer-Sanders legislation as currently proposed will be likely to draw bi-partisan support.
Notably, Congressman Henry Waxman (sponsor of the 2009 federal cap-and-trade legislation which narrowly passed the House of Representatives) and Senator Sheldon Whitehouse recently launched a bicameral climate change task force anticipating the President’s call for action. The task force has solicited input from over 300 businesses and organizations on ideas for “action that can be taken using the Administration’s existing authority as well as ideas that might need congressional approval,” according to a January 31 press release.
It remains to be seen whether a legislative, market-based approach has any realistic chance of passage, but with the Obama Administration emboldened by recent court victories affirming the U.S. Environmental Protection Agency’s (“EPA”) authority to regulate GHG emissions, regulated industries must either prepare for increased EPA regulation or perhaps take a fresh look at a flexible legislative approach. Either way, it is now clear that the Obama Administration’s second term agenda will prioritize a wide range of actions on climate change and clean energy.
Below we provide an overview of key elements of the evolving U.S. policy agenda on GHGs. Subsequent client alerts will address issues related to renewable energy and clean technology, energy efficiency and smart grid measures, and the U.S. approach to international climate change law and policy. For a more in-depth analysis of these developments and their implications for your business, please contact our Climate Change and Environmental Markets team.
Recent and Anticipated Federal Regulatory Activity
Federal regulation of greenhouse gases began early in President Obama’s first term with EPA’s “Endangerment Finding”, in which the EPA Administrator, acting pursuant to Clean Air Act (“CAA”) Section 202(a), found that GHGs constitute a threat to public health and welfare. This finding triggered a raft of further EPA actions under the CAA, including a “Tailpipe Rule” for emissions from motor vehicles and a “Tailoring Rule” for GHG emissions from stationary sources. EPA’s actions on GHGs under the CAA were subject to a series of legal challenges from multiple industry stakeholders and interest groups. In June 2012, the U.S. Court of Appeals for the District of Columbia Circuit dismissed these challenges and found that the Agency’s actions on GHGs were valid.(1) This ruling affirmed EPA’s existing authority under the CAA to regulate GHGs and cleared the way for an increasingly ambitious EPA agenda in President Obama’s second term.
1. EPA regulation of CO2 from new power plants
In April 2012, EPA proposed its first-ever carbon dioxide emission standards for new fossil fuel-fired power plants.(2) The proposed rule under CAA Section 111(a) essentially requires all new fossil fuel-fired power plants meet the emissions profile of a combined cycle natural gas plant (i.e., 1,000 lbs CO2/MWh). While most new natural gas plants will not be required to include any new technologies, the rule will mean that no new coal plant can be constructed without carbon capture and sequestration (“CCS”) capabilities. EPA has yet to finalize its proposed rule but is expected to do so later this year. The rule applies only to new fossil fuel-fired power plants, but once finalized, will trigger a requirement under CAA Section 111(d) to address CO2 emissions from existing sources. With more than 1,200 existing coal-fired generating units in the U.S., the regulation of CO2 emissions from existing sources is a subject of significant interest for a wide variety of interested parties.
2. Controlling CO2 from existing power plants
The regulation of CO2 from existing sources under Section 111(d) will be a process led by EPA but requiring active and ongoing state involvement. In regulating existing sources, EPA issues “emission guidelines” establishing binding requirements that the states must address in the development of their own plans to regulate existing sources. States must adopt the emission guidelines for existing sources through a state rulemaking action with EPA review and comment similar to that employed under the State Implementation Plan (“SIP”) process under CAA Section 110. If a state fails to submit a satisfactory plan, EPA has the authority under Section 111(d)(2) to prescribe a plan for it and to enforce the provisions of such plan.
3. Equivalency of state regulatory program
Many states have already begun implementing programs aimed at controlling GHG emissions from power plants, including renewable portfolio standards, cap-and-trade programs, and state-based CO2 emission limits for power plants.
Several states have explicitly indicated certain existing programs should be deemed equivalent to any emission guidelines for existing sources issued by the EPA and considered to be acceptable state plans under Section 111(d). In particular, the State of California has stated that its GHG cap-and-trade program—which covers CO2 emissions from power plants—should be considered equivalent for the purpose of applying EPA’s CO2 NSPS to existing sources. The EPA has not stated whether any of the state-based programs that control GHGs would be deemed equivalent, but it has authorized market-based approaches in other contexts under Section 111(d).3 If California is successful in its pursuit of an equivalency determination by the EPA Administrator, other states or multi-state programs such as the Regional Greenhouse Gas Initiative (RGGI) may be encouraged to develop their regulatory initiatives in such a way as to mimic California’s approach to be deemed equivalent for purposes of compliance with the CAA. Notably, RGGI just announced a 45% tightening of its multi-state cap of GHG emissions, a move many view as early positioning it for an equivalency determination and linking with the California program.
Due to the lack of significant precedent in the area of state-based equivalency determinations under Section 111(d), whether state-based GHG trading programs (or other state rules that limit CO2 emissions from existing sources) will be considered equivalent to a federal CO2 NSPS remains an open question. EPA has been meeting with industry and state representatives as it develops CO2 emission guidelines for existing sources even in advance of its publication of the final CO2 NSPS for new sources.
4. Potential GHG Rule for Refineries
EPA is also obligated under a 2010 Settlement Agreement with several states and environmental groups to issue a GHG NSPS for refineries. Pursuant to the terms of the Settlement Agreement, the Agency was required to issue a GHG rule for refineries by November 10, 2012. The Agency has not yet acted on GHGs from this source category and has not said when a new rule may be proposed. In the absence of a legislative solution, we expect EPA to develop these expanded GHG regulations in the coming months.
5. Potential GHG Rule for Oil and Gas Operations
In April 2012, EPA finalized new emission standards for oil and gas (“O&G”) operations, including drilling, transmission and storage facilities. The new air rules include an NSPS for volatile organic compounds (VOCs) and sulfur dioxide (SO2). The control measures included in the NSPS for VOC emissions would also significantly reduce emissions of methane, a potent GHG, but the Agency did not include a specific methane emission standard in its final rule.
Late last year, seven Northeast states impacted by Hurricane Sandy filed a notice of intent to sue EPA over the Agency’s failure to directly regulate methane, citing the destructive hurricane as an indication of the need for additional regulation in this area. The states are alleging that because EPA has determined that GHG emissions endanger human health and welfare, the Agency is required to make a determination as to the appropriateness of NSPS for methane emissions from O&G operations. In January, amid several pending challenges to the finalized rule, EPA announced its intention to revise its NSPS for the sector and issue new rules later this year.
Importantly, EPA explicitly stated in its final rule: “we are not taking final action with respect to regulation of methane. Rather, we intend to continue to evaluate the appropriateness of regulating methane with an eye toward taking additional steps if appropriate.” One of the ways EPA stated it would continue to evaluate this issue was through analysis of GHG reporting from O&G operations under EPA’s Mandatory Greenhouse Gas Reporting Rule. Earlier this month, EPA released the first GHG reporting data collected from this sector. The new data shows the O&G sector is second only to power plants in terms of reported GHG emissions.
EPA may decide to take a more formal position on methane emissions from O&G in its revised rules later in light of its intention to reconsider its O&G air rules, the states’ suit to compel the Agency to assess whether GHG regulation is appropriate for the sector, and the new GHG reporting data indicating O&G operations are significantly contributing to domestic GHG emissions.
6. EPA’s climate change adaptation plan
On February 7, 2013, EPA released its Draft Climate Change Adaptation Plan for public comment in the recognition that climate change may pose significant challenges to EPA’s ability to fulfill its mission to protect human health and the environment. The release of this draft plan coincides with greater international, national, state, and municipal attention to climate change adaptation, including President Obama’s strong call in his State of the Union address to “prepare our communities for the consequences of climate change” and recent initiatives launched by New York Governor Andrew Cuomo and others following Superstorm Sandy. The plan discusses the impact of climate change on EPA’s ability to undertake a number of its core initiatives, and identifies priority measures EPA will take to integrate adaptation into its future policies. Public comments on the draft plan are due by April 9, 2013. Businesses and investors should watch how this plan develops as climate adaptation measures increasingly will be included in new regulations and may affect a broad range of business planning issues and infrastructure investment opportunities.
Select state and regional GHG regulatory activity
California’s Global Warming Solutions Act of 2006, known as Assembly Bill 32 (“AB 32”), called on the California Air Resources Board (“ARB”) to develop and implement a broad raft of measures designed to reduce the state’s GHG emissions to 1990 levels by 2020. These measures include ambitious renewable energy and efficiency targets, advanced clean car standards, a low carbon fuel standard, and a cap-and-trade program covering GHG emissions over 25,000 metric tons of CO2 equivalent per year from sources in the power, transportation and manufacturing sectors. The first compliance period for California’s cap-and-trade program began on January 1, 2013, and ARB is scheduled to hold its second auction of GHG emission allowances, worth over $240 million, on February 19. The California carbon market is a close second to the European Emission Trading System (“EU ETS”) in terms of value, and as such has become the subject of much attention both in the U.S. and internationally as a potential template for future market-based climate policymaking at the sub-national level.
In the absence of federal legislation and an international agreement on climate change (the subject of a future client alert), California regulators are contemplating linkages between the cap-and-trade program and equivalent markets in foreign jurisdictions. Under the auspices of the Western Climate Initiative (“WCI”), California is expected to soon approve regulations establishing formal linkage with Quebec’s cap-and-trade program. Such a linkage will allow trading fungible carbon credits between covered entities in the two jurisdictions, and will serve as an important proof of concept for potential further linkages between other programs. Other jurisdictions that in theory may be eligible for linking include RGGI, other potential provinces in Canada, additional U.S. states and perhaps one or more of the international regimes, such as those in the EU, and Australia as well as emerging programs in South Korea, Japan, Brazil, China and elsewhere around the world.
RGGI is a cooperative effort among nine Northeastern states to reduce GHG emissions from the power sector. The RGGI cap-and-trade program began with an auction of carbon allowances in 2008. Since that time, according to RGGI, the program has yielded $617 million in auction proceeds going to the participating states, which the states have in turn put towards investments in renewable energy and energy efficiency measures. It has also reduced GHG emissions by more than 12 million short tons of CO2. Nonetheless, as a market, RGGI has been chronically over-allocated , meaning that the number of allowances circulating in the market exceeds the demand by covered entities, which is determined by their annual GHG emissions.
On February 7, 2013, RGGI’s participating states announced the results of a comprehensive program review process, including a set of long-anticipated final recommendations for changes to the program to take effect from 2014 onwards.
Among other things, RGGI’s GHG emissions cap in 2014 will be equal to 91 million short tons, down from 165 million short tons in 2012, a 45% reduction. This cap, along with each participating state’s emissions budget will decline by 2.5% each year from 2015 through 2020. Additionally, RGGI will address the glut of banked allowances held by market participants with two interim adjustments; one will be made over a 7-year period (2014 to 2020) for allowances banked from the first control period, while the other will be made over a 6-year period (2015 to 2020) for banked allowances from 2012 to 2013, the first part of the second control period. Mimicking California’s approach, participating states have also agreed to establish a cost containment reserve mechanism to make allowances, in addition to the cap, available if market prices exceed certain levels.
RGGI participating states are expected to implement regulations or pass new legislation, as necessary, to bring each state’s rules into line with the program review recommendations by December 31, 2013, in time for the cap reduction and new cost containment reserve to take effect as of January 1, 2014. While it is still too early to tell how these changes will affect the market for RGGI allowances, it seems clear that the 45% downward cap adjustment indicates a newfound willingness among participating states to remain relevant to the national debate on market-based approaches to climate change. We anticipate a range of further discussions among RGGI, California regulators and the EPA on CAA Section 111(d), potential linkage mechanisms, and other issues.
While the details of U.S. GHG policy emerging in the coming months and years are not yet known, it is clear that the Obama Administration intends to take significant actions to reduce GHG emissions across the country. Our view is that the Obama Administration’s second term will involve a combination of cooperative state-based actions, hard fought and highly contested new EPA regulations and one or more legislative measures, which, taken together, will achieve meaningful GHG reductions and have significant impacts on the U.S. economy. Industry and investors should pay close attention to these evolving developments as they will create material new risks for many companies as well as new opportunities for low-carbon technologies and businesses predicated on achieving an economic transition to a low carbon future.
Filed Under: News, Policy