CLIMATE CHANGE/ENVIRONMENTAL - U.S. Senate to Offer Own Energy, Climate Change Bill July 2009

CLIMATE CHANGE/ENVIRONMENTAL
July 2009

U.S. Senate to Offer Own Energy, Climate Change Bill
       U.S. Sen. Barbara Boxer (D-Calif.), Chair of the Senate Environment and Public Works, has
scheduled a series of four hearings over the next two weeks to assist Senate efforts to draft its own
climate legislation this summer that seeks a more comprehensive approach to U.S. energy and climate
change policy.

        This comes after the U.S. House of Representatives recently passed H.R.2454, the American
Clean Energy and Security Act of 2009 (ACESA), by a vote of 219 to 212. Sponsored by Rep. Henry
Waxman (D-CA), Chairman of the House Energy and Commerce Committee, and Rep. Ed Markey (D-
MA), the over 1500-page bill had undergone several revisions in recent months before its June 26th
passage. There are several significant aspects of House bill covered in the following alert, including
the political dimensions of its passage in the House, its prospects for Senate passage, and a summary of
key provisions within the bill’s four main sections.

Political Dimensions of ACESA Bill Passage

        Passage of the ACESA in the House of Representatives has significantly elevated the chances
of implementation of significant carbon reduction regulation. Over the past two years, a series of
unsuccessful Senate and House votes have drawn into question whether such initiatives would ever
become law. Last week's vote changed these perceptions. The bill passed by a deceptively narrow
margin, with eight Republicans joining the Democrats. However, the bill would have easily passed
without the GOP votes, as many conservative Democrats who voted “No” indicated they would have
willingly changed to assure passage of the bill.

        The focus on the climate change issue will now be in a far less-enthusiastic Senate. In
particular, environmental activists will apply pressure on Senate Democrats (like Senator Bayh) who
have refused to embrace the more radical provisions contained in Waxman-Markey. This group of
Senators, informally referred to as the "Gang," will determine what, if anything, becomes law.

        We anticipate that healthcare legislation will occupy the attention of Congress during July, and
believe a serious Senate vote will not take place on climate change until the fall. This will not keep the
matter from being a focus of lobbying in the Senate though, and if chances for passage of a Senate bill
were to improve significantly, there could yet be a Senate vote in July.
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The big question is whether a bill can be voted upon in the Senate, negotiated in a Conference
Committee between the House and the Senate, and signed by the President before Congress adjourns in
November. The critical factor will be how much political capital the President is willing to spend. Our
view is that he will make this attempt as long as it does not jeopardize his healthcare initiative.

        Those potentially affected by this legislation should review the following summary. If you see
a game-changing provision that could significantly improve or damage your business model, now
would be the time to consult your industry association, lobbyist, or attorney. If you would be impacted
in lesser ways, pay close attention to what happens in the Senate this July, and make your plans for the
fall. Barnes & Thornburg will continue to monitor this important legislation.

Summary of the ACESA

        The ACESA has four main sections: (1) Title I: Clean Energy; (2) Title II: Energy Efficiency;
(3) Title III: Global Warming Pollution Reduction Program; and (4) Title IV: Transitioning to a Clean
Energy Economy. Each of these Titles is discussed below.

I.     Title I: Clean Energy.

         Renewable Electricity Standard. The ACESA requires retail electric suppliers to meet an
increasing percentage of their load with electricity generated from renewable resources and electricity
savings. The bill creates a renewable electricity standard (“RES”) that would require large utilities in
each state to produce an increasing percentage of their electricity from renewable sources, or purchase
the equivalent credits. In general, the RES requires 6% of electricity to come from renewables by
2012, and 20% by 2020. Up to 5% may come from efficiency improvements. If a state determines
that its utilities cannot meet the target, the efficiency component can be increased to 8% and the
renewable component decreased to 12%.

        Qualifying renewable sources are wind, solar, geothermal, biomass, marine and hydrokinetic
energy, biogas and biofuels derived exclusively from eligible biomass, landfill gas, wastewater-
treatment gas, coal-mine methane, hydropower projects built after 1988, and some waste-to-energy
projects. RES has been criticized as taking too narrow a view of what constitutes renewable energy,
focusing on factors other than greenhouse gas emissions. The manager’s amendment adopted on the
House floor broadened the definition of renewable energy resource by broadening the definition of
renewable biomass (to match the definition in the 2008 Farm Bill), and the definition of qualified
hydropower. Some environmental groups have withdrawn support for the bill because it allows
efficiency reductions to count against the RES mandates. They were seeking a more complete
overhaul of U.S. energy production. Some in the renewable energy industry, such as the American
Wind Energy Association, also would like to see a more stringent RES. The bill does not count
nuclear energy as renewable energy.

         There also is concern that the RES will disproportionately impact some parts of the country due
to the limited availability of renewable fuels to meet the RES. In particular, the Southeast will likely
have to buy credits from other parts of the U.S., increasing energy costs more in that part of the
country.

      The expansion of the definition of biomass for the purposes of the RES was part of an
agreement negotiated between Chairman Waxman and the Chairman of the House Agriculture
Committee, Rep. Peterson. Under that agreement, the U.S. Environmental Protection Agency (EPA)

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also is prevented from calculating international land use changes that may result from increased use of
biofuels when determining the carbon footprint of biofuels under the existing Renewable Fuels
Standard, pending a study by the National Academy of Sciences and joint action by EPA and the
Department of Agriculture.

        Investments in Clean Energy. By 2025, the bill would direct an estimated total of $190 billion
to energy technologies and efficiency measures: (1) $90 billion to energy-efficiency and renewable-
energy technologies; (2) $60 billion to carbon-capture-and-sequestration technology; (3) $20 billion to
electric vehicles and other advanced automotive technologies; and (4) $20 billion for basic scientific
research and development. The bill also creates a Clean Energy Deployment Administration
(“CDEA”) within the federal government that would provide loans and loan guarantees to spur more
private investment in energy technology.

         Carbon Capture and Sequestration. The ACESA has several provisions designed to foster
the development of geologic carbon sequestration which involves capturing carbon emissions and
pumping them underground. The ACESA requires that EPA study and report on obstacles to geologic
sequestration and develop regulations for sequestration sites. The bill also provides funding for
sequestration demonstrations through assessments from retail customers of fossil-fuel-powered electric
utilities and provides incentives for deployment of sequestration technologies. Finally, the bill requires
EPA to establish strict new source performance standards for coal-fired power plants.

      Modernizing the Electricity Grid. The ACESA includes provisions to promote the
deployment of smart grid technology and enhanced transmission planning.

         Because many good locations for renewable energy generation are far from existing
transmission lines, siting of new transmission has been held up by multiple environmental reviews. In
the manager’s amendment, the bill addresses this issue in the West, by giving the Federal Energy
Regulatory Commission (FERC) authority to approve the siting of new transmission lines if a state
fails to act, denies an application, or imposes unreasonable conditions (commonly referred to as
“FERC backstop authority”). Although siting transmission lines also is an issue in other parts of the
country, the bill provides this authority to FERC only in states in the Western Interconnection.

II.    Title II: Energy Efficiency Provisions.

        Building Standards. The ACESA establishes national standards for building efficiency,
requiring new buildings to be 30% more efficient in 2012 and 50% more efficient in 2016 compared to
specifically enumerated commercial and residential building standards. States are offered allowances
that they may sell to support adoption and enforcement of the new standards. The Department of
Energy must enforce the standards in states that do not incorporate the building standards into their
state building codes.

        These building code energy efficiency provisions were advocated by standards organizations
but have been accepted by the part of the real estate industry represented by the Real Estate
Roundtable. Notwithstanding the upfront costs (defrayed in part by funding from the sale of
allowances dedicated to the adoption of these new standards), energy efficiency investments are
expected to recoup their costs in energy savings in a short time. Section 204 of the bill establishes a
Building Energy Performance Labeling Program, under which EPA will promulgate regulations
establishing labels for residential and commercial buildings that describe the energy efficiency

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performance of the building. There is concern over the effect of this labeling program on the resale
market for older homes

     Appliance Standards. The ACESA mandates new efficiency standards for lighting products,
commercial furnaces and other appliances.

        Vehicle Standards. The ACESA contains requirements for EPA to promulgate carbon
emission standards for heavy-duty vehicles and off-road vehicles, such as construction equipment,
trains and large ships. The bill also integrates consideration of climate change into the existing
transportation planning process to reduce transportation-related energy consumption.

        Additional Efficiency Measures. The ACESA contains measures to increase efficiency of
water use and promote energy savings by the federal government and other public institutions. The
legislation creates a new energy efficiency program for small utilities with dedicated funding.

III.   Title III: Reducing Global Warming.

        Emission Cap. The ACESA enacts a new Title VII of the Clean Air Act which will provide
declining limits on greenhouse gases from large domestic emission sources. The legislation requires
that emissions from a number of industrial entities, such as electricity producers, oil refineries, natural
gas suppliers, and stationary sources emitting more than 25,000 tons of carbon equivalent a year, be
reduced. The economy-wide emission reduction goals for the U.S. (from 2005 levels) include a 3%
cut by 2012, a 17% cut by 2020, a 42% cut by 2030, and an 83% cut by 2050.

        Emissions Allowances. ACESA requires that major emission sources obtain allowances for
each ton of carbon or equivalent emitted. If an emission source emits fewer tons of carbon or
equivalent than it has allowances, it can trade excess allowances or bank them for future use. In the
early years of the program, approximately 80% of allowances will be given to sources to ease the
burden of transition imposed by the new legislation. The transition period begins to phase-out in 2025
and by 2030, 70% of allowances will be auctioned. The total value of allowances is estimated at $70
to $80 billion in 2015 to $90 to $120 billion in 2030. Emissions allowances will be used for a variety
of purposes, including protecting consumers from energy increases, assisting energy intensive, trade
vulnerable industries in transitioning, investing in clean energy and energy efficiency, domestic and
international adaptation, assisting and training workers, preventing deforestation, and ensuring the
program is budget neutral. The agreement between Chairman Waxman and the Chairman of the House
Agriculture Committee included an increase in the allowances provided to rural electricity
cooperatives.

         The cap and trade program is the centerpiece of the bill and has garnered the most debate.
Many are concerned over the impact of these cap and trade provisions on the economy and consumers.
According to the Congressional Budget Office (CBO), the economy wide cost of complying with the
cap on greenhouse gas emissions is estimated to be about $110 billion in 2020 (when the U.S. is
mandated to achieve a 17% reduction in emissions), which averages out to $890 per household.
Approximately $85 billion in allowances in 2020 will be allocated in a way that CBO estimates will
result in benefits that flow back to consumers, resulting in a net economy-wide cost of about $22
billion, which averages out to $175 per household. The $85 billion in allowances that are estimated to
net out compliance costs include $13.7 billion for low income households in the form of tax credits and
energy rebates, $14.5 billion for electricity and natural gas distribution companies with instructions to

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pass the savings on to residential consumers, $14.1 billion for certain energy-intensive, trade-
vulnerable businesses to offset their costs (CBO uses this as an offset for consumers by assuming
consumers own stock in these companies), $27.1 billion for electricity and natural gas distribution
companies with instructions to pass the savings on to commercial and industrial customers (again CBO
uses this as an offset for consumers by assuming consumers own stock in these companies), and
another $5.5 billion for businesses and another $9.2 billion for the government for public purposes
(again CBO assumes this funding will offset costs to consumers).

        Consumers who do not meet the definitions of low income in the bill (above $23,000 for
singles and $42,000 for a family with two children, or 150% above the poverty line) and who do not
own stock in businesses receiving free allowances would incur net costs above the averages in the
CBO estimate. Also, CBO does not estimate the costs of transitioning from coal and oil to more
expensive, less greenhouse gas intensive energy sources, on individual sectors of the economy that are
not receiving free allowances, or the impact on the gross domestic product generally.

        Another issue that is the subject of continuing debate is the regulation of the market for
allowances. The bill allows a derivatives market for allowances. Concern over the potential for abuse
resulted in bill language giving the Commodity Futures Trading Commission the authority to regulate
the allowance derivatives market. This language is opposed by the House Financial Services
Committee, which intends to supersede it with legislation of its own.

       Emission Offsets. The ACESA also allows capped emission sources to increase their
emissions if they can obtain offsetting emissions credits from uncapped sources. At least half of the
emissions offsets can be obtained from international sources. However, if domestic offset sources are
unavailable, an even larger percentage of offsets can be obtained internationally.

       Although the availability of international offsets will decrease the cost of compliance with the
emission caps significantly, there is a concern that it will result in a transfer of wealth from the U.S. to
overseas. According to CBO, approximately $7.8 billion will be transferred overseas in 2020 for the
purchase of offsets and another $6.4 billion will be transferred overseas to fund efforts to prevent
deforestation, to encourage the adoption of more efficient technologies, and to help developing
countries adapt to climate change.

        As part of the agreement between Chairman Waxman and the Chairman of the Agriculture
Committee, the Department of Agriculture is given authority to administer a program for generating
and selling domestic offsets from agriculture and forestry. Notwithstanding these changes, many
agriculture and food groups continued to oppose the legislation due to concerns over energy costs, and
costs of compliance with the legislation. One issue is the inability to count emissions reductions as
offsets if the offset activity (such as no-till or low till farming practices) began before January 1, 2001.
Some argue that use of this date eliminates many agricultural offsets.

         The bill also provides credit for early action to reduce emissions. In section 740 of the bill, a
person participating in program approved by EPA can receive credits for emission reductions that
occur after January 1, 2009, from offset projects initiated after January 1, 2001. Under section 795 of
the bill, a person can exchange existing offset credits that were issued from an approved program
before January 1, 2009, for emission allowances created by the bill. A person can receive allowances
equal to the value of their credits during the period from January 1, 2006, and January 1, 2009,
resulting from actions that achieved emission reductions between January 1, 2001, and January 1,

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2009. Persons who are not participating in an approved program also can receive emission allowances
for early reductions if they demonstrate to EPA that the reductions occurred.

IV.    Title IV: Transitioning to the Clean Energy Economy

      This title of the ACESA seeks to monitor the effectiveness of the legislation and encourage
domestic and international adaptation to climate change and a clean energy economy.

         Allowance Rebates and Reserve Allowances and “Border Adjustment”. This section of the
bill creates a program within Title VII of the Clean Air Act to ensure reductions in industrial carbon
emissions through allowance rebates and international reserve allowances. Under the rebate program,
certain eligible industrial sectors will receive rebates to compensate them for costs incurred in
complying with new carbon pollution limits established in Title VII of the Clean Air Act. EPA will
develop a rule to determine which sectors will receive rebates based on economic, trade, and emissions
intensity factors. The international reserve allowance provision provides a reserve allowance program
that the President can implement beginning in 2020 if a finding is made that reserve allowances will be
effective in reducing global output of emissions. The purpose of the international reserve allowance
program is to protect energy intensive, trade vulnerable industries. Beginning in 2020, the bill requires
a tariff on energy intensive goods imported from other countries do not adopt emissions caps. This
“border adjustment,” i.e., a tariff in the form of a requirement that importers buy international reserve
allowances, will apply unless the President receives explicit permission from Congress to waive the
tariff. President Obama has spoken out against this provision, expressing concern that it will be
perceived as protectionist. The U.S. Chamber of Commerce has warned that the provision could spark
a trade war. The American Iron and Steel Institute has spoken out against the provision as not being
strong enough to protect energy intensive, trade vulnerable industries.

        Green Jobs, Clean Technology, Energy Tax Credits and Climate Change Adaptation.
This section of the ACESA seeks to create green jobs, encourage the export of clean energy
technologies, protect low income consumers from price increases, and foster adaptation to climate
change. This section provides funding and grants to colleges to develop clean energy curricula and
provides training for workers displaced as a result of Title VII of the Clean Air Act. Additionally,
provisions in this section provide tax credits and cash refunds to low income individuals to compensate
for reduced purchasing power that may result from the bill. In an attempt to encourage export of clean
energy technologies, this section of the ACESA also establishes a Clean Energy Account that can be
used to help developing nations establish clean technologies. Finally, this section provides for the
distribution of allowances to states and other countries to deal with the effects of climate change,
including drought and extreme weather events.

        Regulation of Uncapped Sources. While the bill precludes applying existing Clean Air Act
regulations to greenhouse gas emissions from capped sources, the bill does direct EPA to establish new
source performance standards for certain uncapped sources with greenhouse gas emissions over 10,000
tons per year (not including methane emissions from livestock, i.e., no cow tax).

If you would like more information on these developments, please contact the Climate Change Practice
Group or Environmental Department attorney with whom you work or one of the following Barnes &
Thornburg attorneys: Fredric P. Andes, Chicago (312-214-8310); Susan Bodine, Washington, D.C.
(202-371-6364); Mindy Boehr, Indianapolis (317-231-7789); Joel T. Bowers, South Bend (574-237-
1287); Craig S. Burkhardt, Washington, D.C. (202-408-6903); Charlie Denton, Michigan (616-742-

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3974); David Heger, Indianapolis (317-231-7938); Christina M. Landgraf, Chicago (312-214-5607);
Jeff Longsworth, Washington, D.C. (202-408-6918); Larry McHugh, South Bend (574-237-1191); and
Grant Peters, Chicago (312-214-8332).

        More information is available at www.btlaw.com/environmental.

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