Toward a Low-Carbon Economy: How Should Companies Prepare?

There are few areas of the law more daunting, ever-changing and increasingly complex than the newly emerging legal field of climate change.

At the federal level, the climate change bill that passed the House stands at more than 1,400 pages—within which it calls for development of new regulations to flush out its terms. Meanwhile, the U.S. Environmental Protection Agency is moving toward its own set of regulations under existing provisions of the Clean Air Act. And even if that effort falls short, numerous efforts at the state and regional levels are also underway.

Momentum is clearly gathering for some form of regulation of greenhouse gas emissions. And the result will likely have significant impact on the way many companies do business. To help ensure cost-effective and minimally disruptive compliance, businesses need to begin making preparations now.

The following article provides an overview of the status of federal efforts to regulate greenhouse gas emissions—both in Congress and at the EPA—and provide suggestions on how to approach this impending legal regime.

The Waxman-Markey Bill

In past years, action on legislative proposals for greenhouse gas regulations has originated primarily in the Senate, where several bills have been introduced calling for implementation of a cap-and-trade program to regulate greenhouse gas emissions. Thus far, none of these bills has survived.

Recently, however, the House has been leading the charge. On June 26, the House passed a massive bill called the American Clean Energy and Security Act of 2009 (ACES)—more commonly known as the Waxman-Markey bill. Growing from 648 pages to over 1,400 pages prior to passage, the bill reflects the increasing complexity of legislative proposals designed to address climate change at the federal level.

Moreover, the bill doesn't stop at climate change, but attempts to address the related issue of clean energy, as well.

Key Considerations for Businesses

Although there are some differences, the House bill is largely based on the Blueprint for Legislative Action proposed by the U.S. Climate Action Partnership, an alliance of businesses and environmental groups.

For potentially affected companies, there are several important things to note.

Relatively Broad Coverage

By some predictions, the bill will capture about 86 percent of U.S. greenhouse gas emissions by 2020. Nearly all companies emitting 25,000 metric tons of greenhouse gases per year would fall within the cap, reaching by some estimates more than 7,000 U.S. companies. Even companies that don't fall within the cap stand to be affected—particularly in industries such as energy and transportation.

Aggressive Long-Term Cap

The Waxman Markey bill places a relatively strong long-term cap on greenhouse gas emissions, with significant albeit somewhat attenuated short-term caps. The bill tracks the same long-term cap as a plan proposed by President Barrack Obama as part of his 2010 budget proposal—an 83 percent decrease by 2050 (over 2005 levels).

An interim cap calls for a 17 percent decrease by 2020 (over 2005 levels). This interim cap was lowered from 20 percent during the initial committee negotiations, yet still outpaces Obama's proposal, which called for a 14 percent decrease during the same period.

Free Allocation of Most Credits

The Waxman-Markey bill largely adopts, at least for the initial trading periods, a "free-allocation" strategy, whereby most of the credits will be given away for free, 15 percent will be auctioned, and some additional credits will be held in reserve. The bill has provisions for gradual phasing in of auctions, which would allow businesses to adjust to the operation of the new "carbon market."

Under Obama's plan, credits would have been auctioned as a means of raising government revenues—to the tune of an estimated $646 billion from 2012 to 2019. The projected cost for each allowance—namely, authority to emit one metric ton of CO2 or its equivalent—would have been roughly $13 to $20 per ton, which approximates current market pricing for allowances in the European Union Emissions Trading System.

Opponents of cap and trade in general argue that an auction for allowances is the equivalent of a tax on carbon emissions and will significantly increase the cost of doing business for entities covered by the cap, and ultimately for consumers. Nevertheless, most existing and proposed systems have tended to implement or phase in the auctioning of credits as the primary distribution mechanism.

While auctioning avoids problems associated with free-allocation—most notably, the politicization of who will get what number of credits—it will likely be a key issue for negotiation. For dissenting states, free allocation, along with a generous allocation of allowances, might be the ticket to gaining their support.

Provisions to Ease Burden

The bill has several provisions for easing the burden of meeting the cap. Most significantly, it allows for "banking" of allowances for use in a future compliance period. The bill also allows for a significant number of "offsets" by which businesses could meet part of their reduction goals by investing in reductions elsewhere, both domestically and internationally. Companies could also obtain offset credits for engaging in certain reduction programs now—as opposed to when the cap is ultimately established.

Implications for Agriculture and Forestry

The bill has potentially important implications for the agriculture and forestry sectors. Although the bill exempts both agriculture and forestry from the emissions cap, it does allow farmers, ranchers and forestland owners to participate in the carbon-offset program. Moreover, in a key compromise, oversight of the offset program was shifted from the EPA to the USDA. The bill also expands the definition of renewable biomass and provides funding for installation of blender pumps in an effort to increase availability of renewable fuels.

Outcome and Timing Uncertain

The debate now heads to the Senate, where the fate of the bill is anything but certain. There are two things to note.

First, political haggling in the Senate is likely to be contentious, even within the ranks of the Democrats. And it remains to be seen whether any legislation on clean energy and climate change will emerge from the Senate this year.

Second, if the Senate does pass a bill, it may well be a hybrid of the Clean Energy and Security Act and several proposals currently circulating in various Senate committees. If this is the case, a reconciliation process between the House and Senate versions will be necessary before a bill is ready for the president's signature. And since any new law will likely call for development of a significant body of new regulations by the EPA and other federal agencies, it may take an additional one or two years before the legislative scheme is fully formed.

Timing of the bill could also be impacted by external pressures. In particular, the EPA may move forward with developing its own set of regulations governing greenhouse gas emissions. And at least two major regional initiatives—the Midwest Greenhouse Gas Reduction Accord and the Western Climate Initiative—are proposed to come online in the year 2012.

In addition, international negotiations over the post-Kyoto treaty will occur in Copenhagen in December of this year. The United States may want or need to enter those negotiations with its own climate plan in hand in an effort to earn its seat at the table.

Regulatory Initiatives at the EPA

EPA efforts toward regulating greenhouse gas emissions began on April 2, 2007, when the Supreme Court issued its decision in Massachusetts v. EPA. In that decision, the Supreme Court issued two significant findings.

First, the court held that greenhouse gases were an "air pollutant" under provisions of the Clean Air Act relating to motor vehicle emissions. Second, the court required the EPA to decide whether greenhouse gases contributed to climate change and were thereby endangering public health or welfare, in which case the Clean Air Act required the agency to regulate the emissions.

Greenhouse Gas Findings

The EPA on April 17 of this year issued a proposal consisting of two primary conclusions: first, that current and projected concentrations of greenhouse gases did endanger the public health and welfare (the so-called "endangerment" finding); and second, that combined emissions of four of the six greenhouse gases (CO2, CH4, N2O, and HFCs) from new motor vehicles was contributing to atmospheric concentrations of greenhouse gases, and therefore, to the threat of climate change (the so-called "cause or contribute" finding).

While the EPA finding does not in itself impose any regulatory requirements, it paves the way for the agency to issue regulations. Although the finding is limited to motor vehicles, and specifically new motor vehicles, there is at least some possibility that the EPA would extend the reach of these regulations to cover stationary sources as well.

As a result, even if Congress does not pass legislation, businesses with significant greenhouse gas regulation still face the possibility of federal regulation.

Proposed Reporting Rule

On March 10, pursuant to a statutory directive from Congress, the EPA issued a proposed mandatory greenhouse gas reporting rule. In essence, the rule would require facilities with greenhouse gas emissions of 25,000 metric tons or more per year, as well as fossil fuel and industrial greenhouse gas suppliers and motor vehicle manufacturers, to submit annual reports documenting their emissions. The proposed rule predicts that roughly 13,000 facilities across the country would meet the reporting requirement threshold.

What Companies Should Do Now

Given regulatory uncertainty, companies that may be affected by a new legal regime should prepare but not overreact. The following tips can serve as a guide.

Be prepared. While significant elements of the program are left to be hammered out, there is growing consensus that at least some form of greenhouse gas regulation is coming, and that to meet prevailing scientific projections it will have to be roughly as comprehensive as the program described in the Waxman-Markey bill. Companies that fail to anticipate this change could find themselves at a competitive disadvantage to the many that are taking action now.

Understand the scope. Greenhouse gas regulation could have significant impact beyond restrictions on an organization's emissions. Any organization that depends heavily upon industrial sectors targeted by the cap—especially energy and transportation—will likely see financial impacts, some of which may be significant.

Take a systematic approach. Preparation begins with gathering information, so analysis can drive proper proactive measures. This process should include the following:

• Conduct an inventory to determine the quantity of the company's overall emissions and to learn where any "hot spots" in reduction opportunities might lie.
• Assess the likely impact of carbon regulation on the organization's energy and transportation costs. Determine whether proactive measures taken now might result in material savings in the long term.
• Evaluate potential business opportunities in a carbon-constrained economy. The carbon market in Europe alone surpassed $100 billion in value in 2008—and the U.S. market is likely to rival or outpace that.

Don't panic. In the initial trading period of the system operating in the European Union, an over-abundance of credits, coupled with an inability to use those credits in subsequent trading periods, resulted in a massive price decline towards the end of the credits. The lesson: pay attention to the mechanics of the system, and above all, do not over-react.

The cap on GHG emissions and certain elements of the trading system will be phased in over the course of the next decade, giving affected companies time to adjust to the new regulatory regime. Companies will want to take a measured approach. There is still opportunity for significant change before any bill is signed into law.

Secondary Benefits of Preparation

Even if a cap-and-trade system never comes online, companies that undertake a preparation initiative may gain greater understanding of their business operations and actually pinpoint inefficiencies within them. In many cases, greenhouse gas emissions are directly related to energy consumption, so identifying opportunities for reduced emissions can result in a net benefit to the company.

In addition, the potential dollar volume of the new carbon market may create enticing business opportunities for companies positioned to take advantage of them. Investing in technology relating to greenhouse-gas-curbing technologies, for example, could mitigate the costs for meeting reduction goals. And investing in the protection of that intellectual property could provide additional safeguards and benefits down the road.

Array of Legal Implications

Because the carbon market will be designed by a complex array of laws and regulations—including potentially at the federal, state and regional levels—it is critical to understand the legal implications of emissions, impacts and opportunities.

Particularly in corporate transactions and possibly even securities filings, companies need to consider potential impacts of greenhouse gas regulation. Who bears the potential costs and liabilities for emissions and meeting reduction goals? Who reaps the benefits for potential business opportunities? These are the types of questions that should be answered now, well in advance of whatever regulatory scheme might be imposed.

While current efforts to enact new legislation are largely a function of science and politics, once the legislation comes online, how companies comply with—or benefit from—a cap-and-trade program will be determined primarily by law.

Accordingly, companies that may be directly or indirectly impacted by this new and potentially far-reaching regulation need to be armed with the knowledge of what may be coming so that they can be prepared in the right way for it.