Yesterday, (Wednesday, May 12th) Senators John Kerry (D-MA) and Joseph Lieberman (I-CT) introduced the “American Power Act”, their long-awaited energy and climate bill.

The legislation seeks to promote economic growth, energy independence, and a reduction in greenhouse gas emissions through a broad range of programs. The American Power Act contains provisions to encourage nuclear power generation, share revenues from oil and gas drilling in the Outer Continental Shelf (OCS), develop carbon capture and sequestration (CCS) technology, and promote renewable energy and energy efficiency.

The bill also seeks to establish for the first time in the U.S. caps on greenhouse gas emissions. It contains a comprehensive carbon cap and trade program covering a large part of the American economy and providing for trading of carbon allowances and offsets.

An initial overview of the bill’s climate change program is below. We will continue to provide updates on its progress in the Senate. If you have any questions regarding the legislation, its impact on global carbon markets, or are considering transacting in the market, we encourage you to contact our U.S. Carbon Markets group at: +1 914.323.0265.   Program Overview

• Program starts in 2013 with a 4.75% reduction in emissions from 2005 levels.
• Ramps up to a 17% reduction from 2005 levels by 2020, 42% reduction from 2005 levels by 2030, and an 83% reduction from 2005 levels by 2050.
  • The program begins in 2013 with 4.7 billion allowances, increases to 5.5 billion allowances in 2016 as the industrial sector is added to the program.
  • The cap ratchets down from 5.1 billion allowances in 2020 to 3.5 billion allowances in 2030. By 2050 it will have only 1 billion allowances.
• Utilities are covered from 2013, industrial sources covered from 2016
• Establishes a penalty for non-compliance of twice the auction clearing price for allowances for each ton of excess emissions, as well as the potential for civil or criminal penalties.

Allowance Auction

• Quarterly, uniform price format auction of allowances, with first auction to take place no later than March 31, 2012.
• Auction of current year allowances and up to 4 years forward.
• Only covered entities and “regulated greenhouse gas market participants” (see “Market Oversight” below) permitted to participate in the auction.
• Limits on amount a single entity can purchase at auction to be determined.
• $12 reserve price for 2013, increasing at 3% over CPI each year.
• Set aside of allowances for refining sector (see “Transportation Fuels” below), which shall be priced according to the most recent auction clearing price.

Banking/Borrowing

• Permits unlimited banking of allowances for use during future compliance years.
• Two-year rolling compliance period allows for one-year forward borrowing without interest.
• Compliance entities can borrow allowances for up to 15% of their compliance obligation.
  • Entities can borrow with interest for up to five years.
  • 8% per year "premium" in allowances borrowed.

Cost Containment Reserve

• To ensure market stability, EPA will establish a cost containment reserve.
• Only covered entities are permitted to buy from the Reserve, and these entities may purchase no more than 15% of their compliance obligation.
• Allowances purchased from the Reserve may only be used in the year they were purchased.
• Covered entities may not purchase from the Reserve if they have banked allowances or have sold allowances or offsets in the previous 90 days.
• Reserve is initially stocked with 4 billion emission allowances taken from future year allocations, and the Reserve is replenished over time through EPA purchases of offsets from international REDD projects. If REDD offsets are not available, EPA can purchase domestic offsets. REDD offsets are discounted 20% for compliance.
• Cost of allowances in the Reserve is $25 in 2013, escalating 5% plus CPI each year thereafter.

International Linkage

• Covered entities may use for compliance emissions allowances from foreign programs, as long as they are at least as stringent as the U.S. program and are from a qualifying program limiting emissions in 1 or more foreign countries or from 1 or more economic sectors in 1 or more countries.

Transportation Fuels

• Establishes a process for refiners to pay a fee to "demonstrate compliance" with emissions limits from refined products.
• EPA will use proceeds from this program to purchase and retire allowances equal to the compliance obligations of the refining sector, relative to the emissions from their products.
• Price is set each quarter by the EPA and will be equal to the auction clearing price for allowances in the most recent auction.

Clean Air Act Certainty

• Ensures greenhouse gases cannot be regulated under the Clean Air Act as criteria pollutants, hazardous air pollutants, or as international air pollution.
• Precludes EPA from issuing performance standards to reduce greenhouse gas emissions or considering GHG emissions during new source review or stationary source operating permits.

State Preemption

• Prohibits states from implementing cap and trade programs, although states are free to limit GHG emissions through other regulatory means.

Exchange of State Allowances

• EPA Administrator has one year to set rules for the exchange of allowances from RGGI, California, or the Western Climate Initiative issued before the start of the Federal program for conversion to allowances usable under the Federal program.
• Holders of state allowances will be given a quantity of Federal allowances “sufficient to compensate for the cost of obtaining and holding the State allowances”.
  • This cost is the average auction price for the State emission allowance for the year they were issued.

Early Action

• 1% of allowances are set aside in years 2013-2015 for early action.
• One third of these allowances are for offsets obtained before January 01, 2009 from an approved state, local, or voluntary program.
  • Projects must have been initiated between 2001 and 2009.
  • Early action allowances distributed equal to the value of the credits as averaged between 2006-2009.
• Two-thirds of these allowances are for state programs in place before enactment.

Offsets

• Covered entities may submit offsets for compliance.
• Cap of 2 billion tons of offsets annually, to be used on a pro-rata basis by covered entities.
• 500 million tons can be from international offsets, unless EPA determines there is insufficient supply of domestic offsets at a price equal to or less than emission allowances. If this determination is made, then a total of 1 billion international offsets will be permitted.
• Domestic offsets can be submitted on a ratio of 1:1 of credits to emissions.
• International offsets can be submitted on a 1:1 ratio of credits to emissions until 2018, when the ratio becomes 1.25:1.

Offset Program (Domestic)

• Establishes a “Greenhouse Gas Emission Reduction and Sequestration Advisory Committee” to recommend eligible offset types and methodologies.
• Directs the EPA and USDA to set up an offset program and requires credits be "additional, measurable, verifiable, and enforceable."
• Projects can generate offsets for reductions occurring after January 01, 2009.
• Issuance of offsets can be within 14 days of a regulatory approval.
• Requires standardized methodologies for determining additionality, setting baselines, measuring performance, and accounting for leakage.
• Lists project types for consideration under the program, including:
  • collection of methane emissions from coal mines, landfills, and oil and gas distribution facilities;
  • collection, combustion, or avoidance of methane emissions from organic waste streams, including manure management, composting, or anaerobic digestion;
  • afforestation or reforestation of acreage not forested as of January 01, 2009;
  • forest management resulting in an increase in forest carbon stores, including harvested wood products;
  • forest-based manufactured products;
  • carbon capture projects for uncapped sectors (including enhanced oil recovery);
  • recycling and waste minimization projects;
  • abatement of nitrous oxide from uncapped sources;
  • biochar projects;
  • destruction of ozone-depleting substances;
  • agricultural, grassland, and rangeland sequestration and management practices, including:
    • altered tillage practices;
    • winter cover cropping and other means to increase biomass returned to soil;
    • improved management of nitrogen fertilizer use;
    • reduction in methane emissions from rice cultivation;
    • organic farming;
    • reduction in greenhouse gases from animal management practices;
    • resource-conserving crop rotations of at least 3 years; and
    • practices to increase sequestration in grasslands or rangelands.
  • projects for changes in carbon stocks attributed to land management change, including:
    • improved management and restoration of grasslands, rangelands, and forest land;
    • avoided land conversion;
    • reduced deforestation;
    • restoration of peatland or wetland;
    • urban tree-planting;
    • tree crop management;
    • adaptation of plant traits that enhance sequestration; and
    • prevention of conversion or loss of marine coastal habitats.
  • projects that reduce emissions from manure and effluent, including:
    • waste aeration;
    • biogas capture and combustion;
    • improved management or application to agricultural land; and
    • products to reduce intensity of emissions per unit of agricultural production.
• To account for reversals from offset projects, the government can set up an offsets reserve for intentional and unintentional reversals.
• Establishes crediting periods for carbon projects, including;
  • 5-10 years for all projects, except forestry.
  • 30 years for forestry projects.
  • Projects can apply for new crediting periods.
• Approved third-parties verifiers must be used to generate verification reports.

Early Offset Supply

• Ensure early supply of offset credits by allowing for issuance of offset credits from regulatory or voluntary GHG offset programs that were established before January 01, 2009, developed standards through public consultation process, require verification of credits, require credits be placed in a registry, meet financial assurance requirements, and are free from conflicts of interest.
  • These programs must apply to the EPA for approval.
• Projects may issue credits under this program for reductions after January 01, 2004 for projects that commenced after January 01, 2001.
• Projects are limited to a 10-year crediting period.
  • Offset projects from the industrial sector under existing protocols will have shorter crediting periods, as the industrial sector becomes a regulated “covered entity” starting in 2016 and the production or import for sale of certain industrial gases are covered beginning in 2013.

Offsets (International)

• Establishes an International Offsets Integrity Advisory Committee to provide recommendations on offset project types and methodologies.
• Directs the EPA, State Department, and USAID to establish within 2 years an international offsets program and requires credits be "additional, measurable, verifiable, and enforceable."
• Offset credits can be issued from developing countries with bi-lateral or multi-lateral agreements with the U.S.
• Eligible project types include sequestration and emissions avoidance or reductions from methane destruction, chlorofluorocarbon or ODS destruction under certain circumstances.
  • Additional project types may be included if the price of allowances reaches the cost of the containment reserve for 2 consecutive years.
  • Additional project types must use standard methodologies and meet additionality requirements, including: the projects were not required by law; reductions did not commence prior to January 01, 2009, unless project is approved under the early offset supply provision; and the project exceeds established baselines.
• EPA will determine crediting periods for international offsets, but forestry projects are not to exceed 20 years.
• Provides for categories of credits under the international offsets program:
  • Sector-based Credits: reductions in specified sectors within qualifying developing countries beyond established baselines.
  • Credits Issued by an International Body: EPA can accept credits from international offset programs, such as the CDM, if the Administrator determines the program has integrity. These credits would be eligible only until January 01, 2016
  • REDD: EPA can accept REDD credits from developing countries with national forest plans, including a national deforestation baseline. REDD credits from state or provincial activities in developing countries can also be issued during the first 5 years of the program.

Market Oversight

• CFTC given clear jurisdiction over carbon markets.
• Restricts physical trading in allowances or other “greenhouse gas instruments” (definition determined by the EPA) to compliance entities or “regulated greenhouse gas market participants” (definition determined by the CFTC, but presumed to be select market makers)
• All physical trades must be conducted on a specially regulated exchange and cleared through a specially regulated clearinghouse.
• Bans the short sale carbon transactions under rules to be established by the CFTC.
• Presumes unrestricted trading of carbon contracts not for physical delivery (i.e. swaps).

# # #