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S. HRG. 110–1113 

ECONOMIC AND INTERNATIONAL ISSUES IN 

GLOBAL WARMING POLICY 

HEARING 

BEFORE THE

SUBCOMMITTEE ON PRIVATE SECTOR AND 

CONSUMER SOLUTIONS TO GLOBAL WARMING 

AND WILDLIFE PROTECTION 

OF THE

COMMITTEE ON ENVIRONMENT AND 

PUBLIC WORKS 

UNITED STATES SENATE 

ONE HUNDRED TENTH CONGRESS 

FIRST SESSION 

July 24, 2007 

Printed for the use of the Committee on Environment and Public Works 

( 

Available via the World Wide Web: http://www.access.gpo.gov 
(II) 

COMMITTEE ON ENVIRONMENT AND PUBLIC WORKS 

ONE HUNDRED TENTH CONGRESS 

FIRST SESSION 

BARBARA BOXER, California, Chairman 

MAX BAUCUS, Montana 

JOSEPH I. LIEBERMAN, Connecticut 

THOMAS R. CARPER, Delaware 

HILLARY RODHAM CLINTON, New York 

FRANK R. LAUTENBERG, New Jersey 

BENJAMIN L. CARDIN, Maryland 

BERNARD SANDERS, Vermont 

AMY KLOBUCHAR, Minnesota 

SHELDON WHITEHOUSE, Rhode Island 

JAMES M. INHOFE, Oklahoma 

JOHN W. WARNER, Virginia 

GEORGE V. VOINOVICH, Ohio 

JOHNNY ISAKSON, Georgia 

DAVID VITTER, Louisiana 

JOHN BARRASSO, Wyoming1

LARRY E. CRAIG, Idaho 

LAMAR ALEXANDER, Tennessee 

CHRISTOPHER S. BOND, Missouri 

BETTINA POIRIER, Majority Staff Director and Chief Counsel 

ANDREW WHEELER, Minority Staff Director 

SUBCOMMITTEE ON PRIVATE SECTOR AND CONSUMER SOLUTIONS TO GLOBAL

WARMING AND WILDLIFE PROTECTION

THOMAS R. CARPER, Delaware, Chairman 

JOSEPH I. LIEBERMAN, Connecticut 

HILLARY RODHAM CLINTON, New York 

BERNARD SANDERS, Vermont 

BARBARA BOXER, California, (ex officio) 

GEORGE V. VOINOVICH, Ohio, 

JOHNNY ISAKSON, Georgia 

LAMAR ALEXANDER, Tennessee 

JAMES M. INHOFE, Oklahoma, (ex officio) 

1Note: During the 110th Congress, Senator Craig Thomas, of Wyoming, 

passed away on June 4, 2007. Senator John Barrasso, of Wyoming, joined 

the committee on July 10, 2007. 
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C O N T E N T S 

Page 

JULY 24, 2007 

OPENING STATEMENTS 

Lieberman, Hon. Joseph I., U.S. Senator from the State of Connecticut ........... 1 

Warner, Hon. John, U.S. Senator from the Commonwealth of Virginia ............. 4 

Boxer, Hon. Barbara, U.S. Senator from the State of California ........................ 5 

Inhofe, Hon. James M., U.S. Senator from the State of Oklahoma .................... 7 

Sanders, Hon. Bernard, U.S. Senator from the State of Vermont ....................... 10 

WITNESSES 

Profeta, Timothy, Director, Nicholas Institute for Environmental Policy Solutions, Duke University ......................................................................................... 13 

Prepared statement .......................................................................................... 17 

Masters, Blythe, Managing Director, JP Morgan Securities ............................... 23 

Prepared statement .......................................................................................... 27 

Response to an additional question from Senator Sanders .......................... 29 

Baugh, Robert, Executive Director, Industrial Union Council, AFL-CIO ........... 30 

Prepared statement .......................................................................................... 34 

Edward, Garth, Trading Manager, Shell International Trading and Shipping 

Company ............................................................................................................... 40 

Prepared statement .......................................................................................... 42 

Thorning, Margo, Senior Vice President and Chief Economist, American 

Council for Capital Formation ............................................................................ 48 

Prepared statement .......................................................................................... 51 

ADDITIONAL MATERIAL 

Letter, Congressional Budget Office, Peter R. Orszag, Director .......................... 89 

Report, Analysis of the Climate Stewardship and Innovation Act of 2007, 

U.S. Environmental Protection Agency Office of Atmospheric Programs ....... 93 

Testimony, American Electric Power Company .................................................... 193 

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ECONOMIC AND INTERNATIONAL ISSUES IN 

GLOBAL WARMING POLICY 

TUESDAY, JULY 24, 2007 

U.S. SENATE, 

COMMITTEE ON ENVIRONMENT AND PUBLIC WORKS, 

SUBCOMMITTEE ON PRIVATE SECTOR AND CONSUMER

SOLUTIONS TO GLOBAL WARMING AND WILDLIFE PROTECTION

Washington, DC. 

The subcommittee met, pursuant to notice, at 2:30 p.m. in room 

406, Dirksen Senate Office Building, Hon. Joseph I. Lieberman 

(chairman of the subcommittee) presiding. 

Present: Senators Lieberman, Boxer, Craig, Inhofe, Sanders and 

Warner. 

OPENING STATEMENT OF HON. JOSEPH I. LIEBERMAN, U.S. 

SENATOR FROM THE STATE OF CONNECTICUT 

Senator LIEBERMAN. Good afternoon and welcome to this hearing 

of our Subcommittee on Climate Change. I am delighted to welcome everyone. I am particularly happy that the Chairman of the 

overall Committee, Senator Boxer, is with Senator Warner and me. 

As many of you know, a while ago, Senator Warner and I joined 

in a collaboration and really a commitment to bring forth from both 

of us to this Subcommittee, and then hopefully from the Subcommittee to the full Committee and on, an effective legislative 

proposal that will impede the forward movement of climate change 

and the role that the United States is playing in it, in a way that 

is fair. 

I am very pleased to say that since we joined together in this, 

we and our staffs have been working closely. It has been a pleasure 

to work with my dear friend with whom I have served for so many 

years on the Armed Services Committee, and really under whose 

leadership I have served and learned a lot on this matter. Our 

staffs have been reaching out to stakeholders on all sides of this 

challenge and learning a lot. 

We issued a set of principles. We are committed to bring forth 

an economy-wide cap and trade climate change legislation. But we 

want to listen. This hearing is part of that listening which will 

focus on two of the main questions and concerns that people ask 

us as we go ahead with this process. Those two are, what do we 

do if there is an economic emergency? How do we create what Senator Warner I think wisely calls emergency off-ramps, not just easy 

off-ramps, but emergency off-ramps if there is a real economic problem? 
2 

And the second is, this is a global problem. It is global climate 

change. Yes, let’s say that we are going to get America to take a 

leadership role in dealing with the problem, but unless other rising 

economic superpowers like China and India also do so, our hard 

work to reduce our emissions of greenhouse gases will have little 

affect on the overall global problem. So how do we deal with that? 

I am going to suggest briefly two things. On the first, the question of the emergency off-ramps, and we will hear more about them 

in testimony today, this morning Senator Warner, joined by Senators Landrieu, Graham, and Lincoln, introduced a new cost containment or emergency off-ramp provision that they have said they 

hoped to see included in any cap and trade legislation. I myself 

found it to be a very impressive, thoughtful, sophisticated piece of 

work. I think it has the flexibility to deal with a genuine economic 

crisis, while not being so rigid as to undercut the power of the market which we are trying to harness in our approach to reducing 

American greenhouse gas emissions. 

Second, earlier this month Senators Bingaman and Specter introduced an economy-wide cap and trade bill. It had some very interesting and thoughtful provisions in it. Senator Warner and I have 

given close attention to it. I think one of its most interesting provisions addresses the second question, which is the need to ensure 

that once the U.S. joins of the developed world in controlling and 

attempting to reduce greenhouse gas emissions, that rising economic superpowers like China and India will in fact follow suit so 

that together we can forestall warming of our planet that could 

mean catastrophe for all of us. 

We are very appreciative of the section of the Bingaman-Specter 

bill that deals with this problem and we are very fortunate to have 

with us today some witnesses who can describe the way it would 

work. 

Finally, I do want to say on the question of cost, there is a very, 

very significant report issued by the Environmental Protection 

Agency today, published earlier today, appearing on its website 

earlier. Senator McCain and I asked the EPA to do an evaluation, 

an economic analysis of our climate change legislation. I am very 

pleased by what it says, both in terms of the effectiveness of the 

proposal and the affordability, if I can call it that. EPA finds that 

if the U.S. Government enacted the climate stewardship act of ours 

in 2007, and concentration—and this is with conservative estimates—concentration of greenhouse gases in the atmosphere will 

remain below 500 parts per million at the end of this century. According to the IPCC, the international body that has the most experts, keeping the concentration below that 500 parts per million 

will avoid a high risk of global warming that could cause extremely 

severe impact. So the first judgment of EPA on this proposal does 

what it needs to do. 

Second, if enacted, they say that the U.S. gross domestic product 

would increase 111 percent over the 2005 level by 2030. That increase is 1 percent lower than the increase projected in the absence 

of our legislation. Of course, the analysis does not take into account 

the negative influence that a failure to curb global warming would 

have on U.S. GDP. 
3 

This EPA report also finds that the Climate Stewardship Act if 

enacted average annual per-household consumption in the U.S. 

would increase 103 percent by 2030. Here is the point: that increase is 2 percent lower, only 2 percent lower than the increase 

projected in the absence of the climate change legislation. 

EPA also says that while the models do not represent benefits, 

it can be said that as the abatement of greenhouse gas emissions 

increases over time, so do the benefits of abatement. EPA also finds 

that if this climate change legislation is enacted, electricity rates 

will over 15 years rise from about 8 cents per kilowatt hour to 

about 8.5 or 9 cents per kilowatt hour. In other words, yes, there 

is a cost to doing something about this problem, but it is manageable and quite affordable when one thinks of the benefits and the 

catastrophe avoided. 

Detailed power sector modeling finds that if the legislation were 

enacted, coal will remain economically viable in the United States 

as a fuel for electricity generation, with coal production remaining 

essentially constant until around 2030, when coal use will begin increasing because of the escalating deployment of carbon capture 

and storage technology. 

The report also found that this climate change legislation would 

have no effect on natural gas prices through 2030, at which point 

it would start reducing natural gas prices below what they would 

otherwise be. 

And finally, with regard to gas prices, the projection is that over 

the next 23 years, the increase in gas prices as a result of this legislation would only be 9 percent over 23 years. Obviously, that is 

well within the fluctuations that have already occurred because of 

market movements and manipulation. 

So I congratulate EPA for a first rate piece of work analytically. 

Second, I am grateful that this is a matter of choice. Nothing is for 

free, but facing the potential for real disaster and enormous costs 

associated with a disaster, this now says to us that we can do this 

in an affordable way and avoid the worst impacts of climate 

change. I think that is very important as we go forward with this 

process. 

I apologize for taking a little longer than I thought I would. 

Senator Warner? Thank you very much. 

[The prepared statement of Senator Lieberman follows:] 

STATEMENT OF HON. JOSEPH LIEBERMAN, U.S. SENATOR FROM

THE STATE OF CONNECTICUT

Good morning, and welcome to this hearing on economic and international issues 

in global warming policy. 

When Senators Lincoln and Coleman cosponsored the climate bill that I wrote 

with Senator McCain, they urged refinement and strengthening of the cost-containment and international provisions. When Senator Warner announced his partnership with me on a new climate bill, he made clear his interest in doing just that. 

When Senator Warner says he is going to do something, he does it. This morning 

he and Senators Landrieu, Graham, and Lincoln introduced a new cost containment 

provision that they hope to see included in cap-and-trade climate legislation. I think 

the provision is very impressive. I congratulate my four colleagues for designing it. 

Their contribution comes in the nick of time. Senator Warner and I have made 

rapid progress on our new bill. We will make the particulars of it public before the 

Senate recesses late next week. Then we will spend several weeks incorporating the 

comments of many Senate climate leaders on and off this committee, prior to introducing the bill in early September and marking it up in this subcommittee shortly 
4 

thereafter. It is my hope that, under the expert leadership of Chairman Boxer, a 

bill containing strong, greenhouse-gas reduction mandates will be reported to the 

Senate floor this fall, for the first time in U.S. history. 

Earlier this month, Senators Bingaman and Specter introduced an economy-wide, 

cap-and-trade climate bill. It is an impressive piece of work. Senators Warner and 

I have been giving it close attention. One of its most interesting provisions addresses the need to ensure that once the U.S. joins the rest of the developed world in 

reducing its greenhouse gas emissions, rapidly developing nations such as China 

and India will follow suit, so that together we can forestall warming of a degree that 

would spell catastrophe for all of us. 

Senator Warner and I are intrigued by this international provision in the Bingaman-Specter bill. We are fortunate to have here today witnesses who can describe 

the way it would operate and say whether they think it would help protect America’s strong position in the global economy. 

Also, several of our witnesses are prepared to describe various cost containment 

provisions that have been proposed in bills to curb global warming. A couple of our 

witnesses are particularly well qualified to describe the ways in which the different 

options for containing costs might interact with what might be the greatest cost control measure of all: a large, liquid emissions trading market. 

Finally, I seek unanimous consent to place into the record the economic analysis 

that EPA published earlier today on the climate bill that I wrote with Senator 

McCain. EPA’s analysis finds that if the U.S. Government enacted that bill this 

year, then—making conservative assumptions about the pace of emissions reductions in the rest of the world—the concentration of greenhouse gases in the atmosphere would remain below 500 parts per million at the end of this century. EPA’s 

detailed power-sector modeling also finds that if that bill were enacted, coal would 

remain economically viable in the U.S. as a fuel for electricity generation, with U.S. 

coal production remaining constant until around 2030, when it would begin increasing due to the escalating deployment of carbon capture and storage technology for 

coal-fired power plants. 

I thank all the witnesses for coming today. With that, I will invite my friend and 

colleague, Senator Warner, to make an opening statement. 

OPENING STATEMENT OF HON. JOHN WARNER, 

U.S. SENATOR FROM THE COMMONWEALTH OF VIRGINIA 

Senator WARNER. Thank you, Mr. Chairman. 

I want to associate myself with the remarks that you have just 

made. To achieve a little brevity, I will introduce into the record 

my statement. I would simply say that we have been partners in 

quite a few ventures since we have been in the Senate together. 

This is an extraordinary challenge. I look upon this as an old Marine, we are going to lay a beachhead, and we will revisit that 

beachhead in ensuing Congresses in the future. 

I also think that this goal of ours can only be achieved if we 

forge—I say we, that is the Congress working with the executive 

branch—form the strongest partnership that I can recall between 

Government and the private sector and our citizens. We cannot 

hope to do it unilaterally, either the Government doing it, with the 

private sector sitting out there trying to manage their affairs, without the necessary regulatory framework. 

So this is a start. It is an honest, well-intentioned start, a bipartisan start. From here on in, I think that success is directly related 

to the cooperation, the advice and consent, I might say, that we 

achieve from the private sector. 

I thank our distinguished Chairman for her participation in this. 

I respect my old friend and colleague here, and his thoughts on it. 

I also appreciate you referring to the legislation that I joined with 

Senator Graham of South Carolina and two very fine Senators, 

Landrieu and Lincoln, on the other subject. I hope it will become 

a part of this bill. 
5 

[The prepared statement of Senator Warner follows:] 

STATEMENT OF HON. JOHN WARNER, U.S. SENATOR FROM

THE COMMONWEALTH OF VIRGINIA

Welcome, members of the panel and thank you to my friend and colleague, Senator Lieberman, for agreeing to hold this hearing today. He and I created quite a 

stir with our announcement that we are writing a climate change bill together and 

today’s witnesses will help guide a critical part of that process. 

Two issues of concern to me in crafting climate change legislation remain: how 

do we prevent severe impacts on the economy and how do we account for emissions 

from developing nations, both from an American competitiveness perspective and an 

effectiveness perspective. 

Our reductions will only constitute a drop in the bucket if the rest of the world 

does not follow suit, but I reject that as an excuse for the U.S. to do nothing. Today, 

we are the largest greenhouse gas emitter. We are also a world leader, a nation that 

does not shy away from challenges. The time for us to show leadership is now. 

Before I turn the stage over to the panelists, I would like to make an announcement. This morning, I joined three of my colleagues, Senators Graham, Landrieu, 

and Lincoln, in introducing the ‘‘Containing and Managing Climate Change Costs 

Effectively Act of 2007.’’ This bill will minimize negative impacts to consumers and 

industry by providing the market with flexibility to help reduce potential costs. Our 

bill, which we designed in a way so it could serve as an amendment to any climate 

bill, would create a Carbon Market Efficiency Board, modeled after the Federal Reserve. 

This Board will monitor the market, and if/when necessary, choose from a suite 

of ‘‘emergency off ramps’’ in times of economic distress. The key element is that 

these emergency off ramps provide clear paths back onto the main road. 

We were not alone in devising this concept. Our four offices worked in consultation with the Nicholas Institute for Environmental Policy Solutions at Duke University. I am pleased to see them on the panel today, and I am hopeful that this bill 

will be incorporated in the Lieberman-Warner bill. 

Mr. Chairman, I will conclude by saying thank you for your support and cooperation through this process. I cannot think of another member with whom I’d rather 

be taking this journey. 

I look forward to the testimony. 

Senator LIEBERMAN. Thanks very much, Senator Warner, for 

that very thoughtful statement. I agree. We have worked together 

a lot, almost always on national security matters, so I appreciate 

the national security reference because I know you and I both see 

climate change as a threat to our national security. I like the ‘‘laying the beachhead’’ metaphor, too, because you can’t advance unless you lay a beachhead, and there is certainly no chance of victory unless you first lay a beachhead. I think that is exactly what 

we are hoping to do in a way that is united. Thank you. 

Chairman Boxer, we are honored to have you here and we would 

welcome any comments you would like to make now. 

OPENING STATEMENT OF HON. BARBARA BOXER, 

U.S. SENATOR FROM THE STATE OF CALIFORNIA 

Senator BOXER. Thank you so much, Mr. Chairman and Ranking 

Member Warner. I am so pleased at the leadership you are both 

showing. Since we are using war metaphors, I would say you are 

on a great mission. It is a mission that is important for our grandchildren and their children. So thank you for your leadership. 

I also want to thank the private sector for being so far out ahead 

of us in many ways. I think you are a driving force. This has nothing to do with partisanship at all. This is about the future. 

I would ask unanimous consent that my full statement be placed 

in the record. I will just highlight a couple of my statements, in addition to the one I have already made. 
6 

Senator LIEBERMAN. Without objection, so ordered. 

Senator BOXER. This is a ground-breaking hearing. These are 

two people who came together and we needed that to happen. We 

are so pleased, all of us who want to see global warming legislation 

move forward. I look forward to working not only with my two 

friends here, but every member of this Committee and every member of the Senate. 

We are going to go to Greenland if we don’t have to be here this 

weekend. The hope is we can go Saturday and Sunday, Friday 

night, Saturday and Sunday, to get a better look at what is really 

happening out there. I hope that type of a trip is going to just put 

some more wind behind us as we move ourselves forward. 

I note that Senator Warner has been working hard on an innovative cost containment provision based on borrowing of emission allowances. I am very interested in this. We need this kind of new 

idea as we move forward. I want to commend him for that and his 

colleagues that he worked with on that notion. 

We have to address the economic impacts of global warming from 

all sides. Sir Nicholas Stern, former Chief Economist at the World 

Bank indicated the cost of failing to take action on global warming 

will outweigh greatly the cost of action. According to Stern, a dollar 

spent a day will save at least $5 tomorrow. That doesn’t mean we 

are not going to have to deal with some of the issues here at home. 

We must. But I firmly believe at the end of the day, we will see 

a great increase in our energy independence. We will grow our 

green collar job industry. We will increase our competitiveness by 

developing technologies that will not only be wanted by the rest of 

the world, they will be desperately wanted by the rest of the world. 

As we develop a greenhouse gas control program, we should do 

it in a way to give the business sector certainty, and that is important. And let me just quickly go through, without elaborating because I am going to speak very fast if I can, some of the things that 

I think are key, that Bernie Sanders and I worked on together in 

our bill which we hope that you, Senators Lieberman and Warner, 

will look at. 

Senator LIEBERMAN. Absolutely. 

Senator BOXER. Certainly, a cap and trade. We know that can 

work with standards. Certainly, the borrowing of emission permits, 

which as I said, Senator Warner has talked about. We can allow 

facilities that reduce emissions in early years to bank their reductions and use them later. We can distribute the proceeds from allowances auctioned to help reduce the cost on consumers and other 

entities that are most affected, because we hear colleagues always 

talk about the impacts. We need to mitigate those impacts and we 

can. 

We need to make sure that whatever cost containment mechanisms we have don’t create a disincentive for investment in the 

technologies that we so need in this fight. 

In terms of international emissions, obviously, obviously, we have 

to make sure that other countries do their part. We have Senators 

Lugar and Biden taking a great lead on the Foreign Relations 

Committee on this point, but I think Senator Bingaman deserves 

some recognition here because he is looking at a cost that would 

be borne by countries such as China when they import their goods 
7 

into our country, and they are not doing anything about global 

warming. There has to be a cost to that. So I hope you will look 

at that, because I think in fairness some people are saying we need 

to look at that. 

Last, I met with you and Secretary General Ban Ki-moon and I 

joined the Secretary in asking the President, our President, if he 

would come to the U.N. on the 24th of September for a groundbreaking meeting with all the nations of the world. I was very glad 

that the President’s people said that he is going to do something 

I suggested, which is invite the 12 largest emitting nations to the 

White House, to Washington at least, to discuss steps that can be 

mutually taken. 

So all in all, I have to say I couldn’t be more pleased with the 

progress we are making. When I took the gavel, I only could hope 

for this day, that we would have this bipartisan breakthrough and 

we will be making progress. I stand ready as the Chair to work 

with each and every member, address everyone’s concern as we 

make history in fighting global warming. 

Thank you, Mr. Chairman. 

Senator LIEBERMAN. Thank you, Madam Chair. 

Senator Inhofe, thanks for taking the time to be here. We would 

be happy to hear an opening statement if you would like. 

OPENING STATEMENT OF HON. JAMES INHOFE, 

U.S. SENATOR FROM THE STATE OF OKLAHOMA 

Senator INHOFE. Thank you, Mr. Chairman. 

This is our 16th, I believe if my count is right on the number of 

hearings we have had on global warming, but this one is different. 

I am pleased that you are having it because this is the first hearing 

I believe that we have had where we really are addressing substantive issues. We have been unwilling to do that in the past, it 

seems, and I hope that we can follow this pattern at the overall 

Committee level. 

It seems clear to me, though, that the carbon cap and trade approach itself doesn’t work. The Kyoto Protocol is an international 

beacon warning to our Nation of what not to do. The failure of the 

United Nations’s grand experiment is not a lesson in how better to 

tinker with its structure so that the next time it might possibly, 

hopefully work. I just don’t think it has been working at this point. 

The body has now passed two resolutions on climate change that 

are similar. One was the Byrd-Hagel amendment that passed 95 to 

zero. The other was the Bingaman amendment. Byrd-Hagel said 

that we would not want to ratify any kind of a treaty that would 

inflict very serious economic damage to the Country, and also one 

that would not affect—and I would think that you would be interested in this, Mr. Baugh—developing countries. I mean, if we do 

it, developing countries should do it. The Bingaman amendment 

was very similar to that. It resolved that the United States should 

address global warming as long as it will not significantly harm the 

United States economy and encourage comparable action by other 

nations that are major trading partners with and key contributors 

on global emissions. 

Not a single bill before Congress meets these criteria, not one of 

them. Now, maybe this one will. I don’t know, because I don’t know 
8 

anything about it. I think there has been some discussion. I missed 

your entire opening statement. Maybe you covered some of that. I 

will be interested to look at it and see, because so far they have 

not met this criteria. 

For instance, according to the MIT study, the Sanders-Boxer bill would cost the energy sector consumers an amount equal to $4,500 

per family of four. Now, the same study found that the LiebermanMcCain bill, and of course we don’t have the information for anyone to perform any type of an analysis on the current bill that you 

are talking about with Senator Warner, but the McCain bill would 

have been $3,500 per family of four. 

A new EPA analysis released less than an hour ago shows 

Lieberman-McCain bill would cost up to a half trillion dollars by 

2030 and $1.3 trillion by 2050. That was based on assumptions designed to lowball the number, making me wonder how high the 

real figure would be. 

It does nothing to encourage reductions from the world’s largest 

emitter of carbon dioxide, and that is China, as currently they are 

not the No. 1 emitter and we are not. In fact, like all these bills, 

it would worsen the problem. Even the Bingaman bill would export 

hundreds of thousands of jobs, Mr. Baugh, mostly to China. But 

the U.S. emissions as a measure of productivity are far lower than 

China’s or Europe’s, for that matter. So every job sent there will 

increase emissions. 

This is an interesting concept. It is bad enough that we have job 

flight to places like China, but when those jobs are performing 

functions that they used to perform in the United States, they are 

doing so under conditions where they are emitting more CO2 or 

more greenhouse gases. 

As Lu Xuedu, the Deputy Director General of China’s Office of 

Global Environmental Affairs said last October, ‘‘You cannot tell 

people who are struggling to earn enough to eat that they need to 

reduce emissions.’’ 

Cap and trade in theory offers certainty in emissions, but volatility in price. But in practice, it has offered certainty in neither. 

Taxes offer a more certain price. I have often said, if we are going 

to do this, let’s be honest with the American people and let’s have 

a carbon tax, so you can’t hide it. It is there. I think that would 

be a better alternative. 

That said, we can’t ignore that Congressman Dingell is right that 

taxes are a more straightforward and efficient approach than cap 

and trade, and would at least probably work. I don’t want a tax, 

but given the choice between the two, I think I would take it. I 

think it is a more honest approach. 

There are two other issues, and I will make this real quick, Mr. 

Chairman, I would like to raise, which are that these bills also fail 

on. The first is the issue of layered climate regulatory mandates. 

We are in the process of crafting an international agreement on 

how to proceed on greenhouse gases that should be complete within 

18 months or so. We are also debating national mandates on greenhouse gases and many States must comply with their own new 

mandates. 

Now, it makes no sense to have national mandates with States 

having different requirements. I support States’s rights, but it 
9 

makes no sense for a State program to supersede a national program any more than it makes sense for us to unilaterally sign up 

to national caps without ensuring developing countries have to join 

us at the same time. 

The last issue in the question is of why we are even doing this. 

Hypothetically, for argument’s sake, even if there really is a manmade problem, shouldn’t any legislation, especially legislation 

which will enrich China at our expense, solve the supposed problem? None of the bills before Congress even do this. We remember 

when then-Vice President Al Gore had his scientist Tom Wigley answer the question: if all developed nations were to sign onto the 

Kyoto Treaty and comply with its emission requirements, which 

they don’t do, I might add, in Europe, but if they did, what effect 

in 50 years would that have on the climate? The answer was 0.07 

of 1 degree Centigrade. That tells you. 

So I really think we need to look at these things logically and 

hopefully this hearing is going to examine some of these things 

that I am bringing up in my opening statement, Mr. Chairman. I 

thank you for allowing me to go a little bit over. 

[The prepared statement of Senator Inhofe follows:] 

STATEMENT OF HON. JAMES M. INHOFE, U.S. SENATOR FROM

THE STATE OF OKLAHOMA

Thank you for holding this hearing, Mr. Chairman. It is refreshing that we are 

beginning the process of examining substantive issues that need to be examined before any individual piece of legislation can be seriously considered. It is my hope 

that this approach will be adopted at the full Committee as well so that all the 

Members of the Committee can begin examining the nuts and bolts of how various 

approaches would operate. We need to begin looking at the economics—both at what 

works and what doesn’t work. 

It seems clear to me, though, that the carbon cap-and-trade approach itself is 

what doesn’t work. The Kyoto Protocol is an international beacon warning our nation of what not to do. The failure of the United Nations’ grand experiment is not 

a lesson in how better to tinker with its structure so that the next time it might 

possibly, hopefully work. No, the lesson is more fundamental. It is the lesson of a 

failed approach. Let me be clear: carbon cap-and-trade systems will never work. 

This body has now passed two resolutions on climate change that are similar. The 

Byrd-Hagel Sense of the Senate, which passed 95—0, resolved that the U.S. should 

not be a signatory to any international agreement that would result in serious harm 

to the U.S. economy or did not mandate reductions from the developing world. Similarly, the Bingaman Sense of the Senate resolved that the U.S. should address global warming as long as it will not significantly harm the United States economy and 

encourages comparable action by other nations that are major trading partners and 

key contributors to global emissions. 

Not a single bill before Congress meets these criteria—not one. They range from 

costly to ruinous. But they all fail to meet the requirements of Byrd-Hagel or Bingaman. 

For instance, according to an MIT study, the Sanders—Boxer bill would cost energy sector consumers an amount equal to $4,500 per American family of four. The 

same study found the Lieberman—McCain bill would cost consumers $3,500 per 

family of four. And a new EPA analysis released less than an hour ago shows the 

Lieberman—McCain bill would cost up to half a trillion dollars by 2030 and $1.3 

trillion by 2050—and that was based on assumptions designed to low-ball the number, making me wonder how high the real figure would be. 

It does nothing to encourage reductions from the world’s largest emitter of carbon 

dioxide—China. That’s right, China just surpassed the United States as the world’s 

largest emitter. 

In fact, like all these bills, it would worsen the problem. Even the Bingaman bill 

would export hundreds of thousands of jobs—mostly to China. But the U.S. emissions as a measure of productivity are far lower than China’s, or Europe’s for that 

matter. So every job sent there will increase emissions, not lower them. China has 

made it abundantly clear that it will be decades before it signs onto mandatory lim-
10 

its because it wants to grow—and unilateral global warming bills will help them do 

so at our expense. 

As Lu Xuedu, Deputy Director General of China’s Office of Global Environmental 

Affairs, said last October: 

‘‘You cannot tell people who are struggling to earn enough to eat that they need 

to reduce their emissions.’’ 

Cap-and-trade in theory offers certainty in emissions, but volatility in price. But 

in practice, it has offered certainty in neither. Taxes offer certainty in price, but not 

emissions. I oppose unnecessary taxes as a matter of principle, and putting a price 

on carbon is clearly in my mind unnecessary. But that said; we cannot ignore that 

Congressman Dingell is right that taxes are a more straightforward and efficient 

approach than cap and trade, and would at least probably work. 

I don’t want a tax. But given a choice between the two, a tax is the more honest 

approach because at least we know what we’re singing up to. 

There are two other issues I would like to raise, which are two that these bills 

also fail on. The first is the issue of layered climate regulatory mandates. We are 

in the process of crafting an international agreement on how to proceed on greenhouse gases that should be complete within 18 months or so. We are also debating 

national mandates on greenhouse gases and many States must comply with their 

own new mandates. 

It makes no sense to have national mandates with States having different requirements. I support States’ rights, but it makes no sense for a State program to 

supersede a national program, any more than it makes sense for us to unilaterally 

sign up to national caps without ensuring developing nations join us. If it is a global 

problem, and we have a national approach to the issue, State programs should be 

pre-empted. 

The last issue is the question of why are we even doing this? Hypothetically, for 

arguments sake, if there really is a man-made problem, shouldn’t any legislation— 

especially legislation which will enrich China at our expense—solve the supposed 

problem? None of the bills before Congress do so. Even the Kyoto Protocol, according 

to Gore’s scientist Tom Wigley, if fully implemented and complied with, would only 

reduce temperatures by 0.07 degrees Celsius in 50 years. If the answer is that these 

bills are just the first installment and that more will follow, shouldn’t we be debating what the total cost of going down this road will be? 

Thank you. 

Senator LIEBERMAN. Thanks, Senator Inhofe. 

Senator Sanders, thank you for being here and for the bill that 

you have introduced, which will be an important part of our considerations. 

OPENING STATEMENT OF HON. BERNARD SANDERS, 

U.S. SENATOR FROM THE STATE OF VERMONT 

Senator SANDERS. Thank you very much, Mr. Chairman. We 

thank you and Senator Warner for holding this very important and 

timely hearing. 

I think while we want to look at what the costs are associated 

with preventing and reducing greenhouse gas emissions, it is also 

important to understand what happens if we do not go forward aggressively. I would argue, and I think the scientific community 

would strongly support me, that not going forward aggressively, 

not substantially cutting greenhouse gas emissions, not dealing 

with global warming, can cause not only huge, huge global environmental problems that will impact billions of dollars, but also catastrophic economic problems. 

So I don’t think the choice is either/or. I think we have to act. 

I think Senator Warner’s use of the term, the warlike metaphor, 

is exactly right. We are in a war that we cannot afford to lose. The 

good news is I think we now know how to win it. 

What the World Health Organization tells us is that today some 

one million people have already died as a result of global warming, 

and that number will clearly escalate if we do not get a handle on 
11 

this problem. The CIA is now examining the political implications 

of what happens when drought and hunger take over, and there is 

massive migration from one country to the other, and the increased 

likelihood of war. That is what happens if we do not get the handle 

on this. 

Now, I am optimistic about the situation because I believe we do 

know how to address this crisis, and I believe that from an economic perspective, we can in fact create millions of good paying 

jobs. Will there be economic dislocation? Of course there will be, 

but let me give you some examples. 

What scientists tell us is that if we move forward in terms of energy efficiency, we can reduce energy use in the average home by 

some 40 percent. Think of the number of jobs that are created 

there. I recently talked to a major light bulb manufacturer who 

talks about the huge savings that will be available if we move to 

LED light bulbs in the future. 

Right now in terms of job creation, where are we getting our 

photovoltaics from, those units from? More often than not, we are 

not producing them in this Country, but we are importing them despite the fact that we helped create that technology. California now 

proposes to have one million units of photovoltaics on their rooftops 

in the next 10 years. If as a Nation we did 10 million units, think 

about the jobs that are created in production, as well as installation. 

In terms of wind turbines, we are on the verge of producing 

small wind turbines for $12,000 or $13,000 that could produce half 

the electricity that the average home needs. Think of what it 

means to our economy when we are beginning to produce wind turbines. 

Public transportation, compared to Japan, compared to Europe, 

even to China, we have a rail system which is way, way behind. 

Think of the jobs that we create as we have an efficient rail system, as we have subway systems all over America in terms of jobs. 

The evidence is overwhelming that if we substantially increase 

our CAFE standards to compare with Europe or China even, we 

can save huge amounts of carbon and energy in general. 

I must say that in the midst of all that, I cannot support a safety 

valve as currently put forward by some of our colleagues. To my 

mind, the safety valve represents a white flag of surrender and I 

do not think, given the crisis that we are facing, that we should 

do that, with the implications of what it means to our children and 

grandchildren. I remain open to the ideas of banking and borrowing, but have withheld final judgment on that. 

Mr. Chairman, I think this is a historical integral moment in 

American history. I think if we do the right thing, we cannot only 

save this planet. We can be a model for China and for India. We 

can create jobs as we help transform their economies. We can create jobs in our own Nation. We can do it if we have the political 

will, and I certainly look forward to working with you and Senator 

Warner to make that happen. 

[The prepared statement of Senator Sanders follows:] 
12 

SUPPLEMENTAL STATEMENT OF HON. BERNARD SANDERS, U.S. SENATOR FROM

THE STATE OF VERMONT

During the hearing on Tuesday, I failed to make a very important point. 

In the area of international competitiveness, I am, quite literally, thrilled by the 

strong foundation that Senator Bingaman and Senator Specter have put forward in 

their Low Carbon Economy Act of 2007. They approached the issue in a very 

thoughtful manner and their leadership in bringing attention to the topic is well 

recognized. I know that the AFL–CIO was engaged in that process and I commend 

their work and the work of all those involved in crafting the language. 

Senator LIEBERMAN. Thank you very much, Senator. 

Senator Craig? 

Senator CRAIG. Thank you, Mr. Chairman. If this is the beachhead, I am here to spot the land mines. Please proceed. 

[Laughter.] 

Senator LIEBERMAN. Semper Fi. OK. Let’s go ahead. 

Senator WARNER. Mr. Chairman? 

Senator LIEBERMAN. Just in case anybody doesn’t know—— 

Senator WARNER. Probably that is for the best, though. You can 

get the land mines. 

[Laughter.] 

Senator WARNER. The Chairman and I, and I want you to amplify my remarks, have decided that to forge this partnership we 

have to, again, get the advise and consent, and we are going to put 

out a study document, rather than a bill, before we leave in August, such that during that period of time, we hope to have our 

staff and indeed myself and the Chairman working to receive the 

benefit of your comments. 

Now, would you like to add to that? 

Senator LIEBERMAN. No, absolutely right. We are working very 

hard on that now. Our staffs are working very hard reaching out, 

talking, listening to a lot of people. That is right. Before we leave 

next week, we want to put out essentially a draft proposal and 

then give folks the time to work it over and tell us what they like 

and they don’t like. Then we will come back after Labor Day having absorbed all that. We will put together the best proposal we 

can to deal with this problem. 

Senator WARNER. A bill. 

Senator LIEBERMAN. A bill, right, and then offer that to this Subcommittee as early as we are ready in September. And then report 

to the full Committee. I am encouraged to believe that under the 

leadership of Chairman Boxer, a bill containing strong greenhouse 

gas reduction requirements will be reported to the Senate floor this 

fall for the first time ever. 

Senator BOXER. Senators, if I just might take a moment to thank 

you for your timetable. I think it is important. Everyone is always 

asking me, and I am sure you now, almost every day. A couple of 

you followed us around and tried to get the timeframe. Assuming 

you do make this timeframe and your study document is available, 

which is sort of the map to your bill, our plan, and I will discuss 

this with Senator Inhofe of course, to run by the schedule, would 

be to look at then all of the economy-wide proposals when we get 

back. 

At that point, my goal is to look to you as a basic document, because frankly you are going to be the last ones up. You will be able 

to look at the Bingaman proposal, the Sander-Boxer proposal, the 
13 

Kerry-Snowe proposal. Who am I missing? And of course, your own 

Lieberman-McCain proposal. 

I am therefore trusting to get the best of these ideas. So that 

would be a very good vehicle for us. So it all works, and I want 

to again thank you for that. 

Senator LIEBERMAN. Thank you, Madam Chairman. That is exactly what we intend to do. We are trying to draw from the experience and the thoughts that others have had, both here in the Senate, where there is an enormous amount of activity and very productive work going on, in the university communities, in the business community, groups like the Climate Action Partnership, obviously in the environmental community. 

So this is a global problem. We want to come up with a national 

response to it that is as much as possible by the time we present 

it really a consensus recommendation. 

Now we will go to our witnesses. First, I am going to from my 

left to right. We begin with Tim Profeta, who comes to us as the 

Director of the Nicholas Institute for Environmental Policy Solutions at Duke University. He has risen above a rather checkered 

past during which time he was my legislative assistant for environmental matters. I am very proud that in an extremely competitive 

process, Tim was chosen to be the Director of this new institute. 

Mr. Profeta, welcome. 

STATEMENT OF TIMOTHY PROFETA, DIRECTOR, NICHOLAS INSTITUTE FOR ENVIRONMENTAL POLICY SOLUTIONS, DUKE 

UNIVERSITY 

Mr. PROFETA. Thank you, Mr. Chairman. 

Chairman Lieberman, Senator Warner and members of the Subcommittee, thank you for the opportunity to testify today. It is an 

honor to be here. 

Two years ago, I left Washington to found the Nicholas Institute 

at Duke University. Our institute is intended to be a two-way 

bridge between knowledge and community power of Duke and decisionmakers such as yourselves. In undertaking our mission, we focused our resources on the key environmental challenges facing our 

planet, and no topics demand greater attention than global climate 

change. 

In particular, we have concentrated on just what we have perceived to be the key sticking points that prevented the passage of 

mandatory climate legislation. No issues have been more difficult 

than the two raised by today’s hearing. 

First, which I will call cost containment, pertains to how we 

could provide economic relief if a program to reduce greenhouse 

gases resulted in unexpectedly high costs to the economy. The second, which I would term competitiveness protections, is a question 

of how we can create a U.S. greenhouse gas control program that 

does not lead to a competitive disadvantage for the United States. 

The importance of these two concerns in the broader climate debate is underscored by last Congress’s Sense of the Senate resolution, to which Senator Inhofe referred, in which 53 Senators voted 

that the Congress should create a mandatory system to address climate change so long as it did not significantly harm the United 
14 

States economy and encourages comparable action by our major 

trading partners. 

Thus, the issues you seek to address today are the same ones 

that the Senate set as preconditions to action on climate change, 

true sticking points if ever there were ones. 

So permit me to address these issues and our efforts to design 

policies to address them one at a time. 

First, the issue of cost containment. When you consider the challenge of global climate change, it is not surprising that there is 

great concern about cost. Climate change is no ordinary environmental challenge. As opposed to other relatively localized environmental issues, the problem of global warming is entwined with 

every aspect of our life. Of course, as the science has mounted, it 

is clear that costs of inaction will dwarf the costs of a greenhouse 

gas reduction program. 

So it is now inevitable that our Government, likely under the 

leadership of this Committee, will act. Fortunately, several members of this Committee already have embraced a number of policies 

that will ensure that we achieve our greenhouse gas reductions as 

efficiently as possible. Just the fact that most proposed legislation 

embraces a cap and trade system may be the most significant cost 

containment provision in any final legislation. An efficient cap and 

trade system will naturally seek out the lowest cost greenhouse gas 

reductions in the economy and provide a continual stimulus to innovate cleaner and cleaner technology. 

Beyond the basic architecture, a cap and trade system can also 

decrease costs by including provisions that allow banking and borrowing and offsets. The utility of these provisions is outlined in my 

written testimony, so I will refrain from discussing them further 

here. 

However, many believe we need to go farther than manage costs 

and promote investment in long-term solutions. That is where the 

institute’s recent work comes in. Earlier this year, the institute 

was engaged by four Senate offices, the offices of Ranking Member 

Warner, Senator Landrieu, Senator Graham and Senator Lincoln, 

seeking assistance in the development of some new and innovative 

means of providing protection against unforeseen high costs of a 

cap and trade system. 

All four offices were familiar with the proposal to cap the price 

of carbon in the market, using what is called a safety valve. While 

all the offices were sympathetic to the safety valve’s goal of controlling the overall costs to the economy, they were all concerned about 

the safety valve’s potential to frustrate the program’s environmental goals, to quell investment in climate-friendly technologies, 

and to limit the ability to link the U.S. system to other markets. 

Thus, they sought an alternative means to address unanticipated 

costs. 

With some assistance from the institute, the four offices began 

by developing five principles for any proposal. I would like to review them. First, any proposal should maintain the environmental 

integrity of the program. Second, any proposal should avoid unexpectedly high costs to the economy. Third, any proposal should 

focus on sustained price departures, rather than short-term volatility. Fourth, it should maximize the use of market-based mecha-
15 

nisms. And fifth, it should provide effective incentives for long-term 

investment. 

Using these criteria, institute staff met with these four offices 

regularly since January, providing necessary analyses and feedback 

as they developed their proposal, which was released today. Fundamentally, the proposal provides the market with cost relief measures and an oversight board to employ them. More specifically, the 

board will be given several authorities to reduce the cost of greenhouse gases in the market. 

First, the board would be empowered to increase companies’ 

flexibility in determining when and how to meet the reduction 

goals by broadening their ability to borrow permits against future 

years. 

A second lever at the board’s disposal would be the ability to adjust the pace of the national emissions reductions temporarily, 

while still achieving the overall reductions over time by increasing 

emission allowances available in the short term. Again, this remedy would be employed by borrowing against future years, but at 

a nationwide level, guided by the board, rather than at a firm level, 

and keeping in mind the overall reductions. 

A third remedy was also considered, by which the ability of 

emitters to account for their emissions through real and verified 

offsets could be expanded, provided those offsets were somehow 

limited in the underlying legislation. But because not all offices 

wished to assume that such limits would exist, we have not included that concept. However, if offsets are limited, it could provide 

a third lever for controlling costs. 

After determining the means by which the board could provide 

relief in the event of potential harm to the economy, the group 

carefully crafted a structure by which the board could be made a 

neutral, trustworthy, and knowledgeable overseer of the market, 

with a particular view to the precedent of the Federal Reserve. 

That, in sum, is the offices’ economic protection proposal, to create market-based measures for cost relief and to create an independent market overseer to implement those measures. 

I must State that I believe there is an elegance to this proposal. 

At bottom, it is the first proposal for cost containment that does not 

claim to know the unknowable. We cannot know right now what 

the proper price of a carbon allowance will be that will successfully 

balance our environmental and technological economic goals. While 

our models were the best available, our models simply can’t know 

what that price is, especially when dealing with long-term projections of technology. 

So this plan cleanly addresses the need to make decisions under 

the unavoidable uncertainty, by providing the levers necessary to 

stop economic harm, without undercutting the market or the program’s environmental integrity. 

Now, if we successfully implement a market-based cost relief program, we still must address the second paragraph of the Senate’s 

resolution, the need to ensure that the climate program encourages 

comparable action by major trading partners. About a year ago, we 

at the institute engaged in high level conversations with a number 

of major corporations to assess their sticking points on Federal cli-
16 

mate policy and concerns about trade disparity came screaming out 

at us. 

Working with Professor Joost Pauwelyn at Duke Law School, we 

evaluated a range of proposals that could re-level the international 

playing field should the U.S. create a domestic cap and trade program for greenhouse gases, with an eye to compliance with the 

WTO. Our efforts focused on provisions under Article XX of the 

GATT, which allows trade measures related to the conservation of 

natural resources. 

In general, the legal analysis led to the conclusion that such a 

provision could be sustained if, first, the United States first engaged in good faith efforts to achieve an agreement with any nation 

whose products were targeted; second, it applied even-handedly to 

domestic products and imports; and third, it was adjusted based on 

the local conditions in other countries. 

At the same time we were working on this proposal at Duke, 

AEP and a number of unions were undertaking similar projects, 

which were incorporated in the Bingaman-Specter Act that was introduced last week. Our assessment of that provision is that it is 

consistent with our work and provides a good start for language to 

equalize the playing field in international trade once the United 

States creates its own cap and trade program. 

Under that proposal, the United States is required at the outset 

of the program to negotiate an agreement with all other nations to 

create programs comparable to our own to control greenhouse gas 

emissions. If it is not successful by 2020, however, their proposal 

would require importers to the United States to submit allowances 

to cover the greenhouse gas emissions released during the production of the imported goods. These allowances, called international 

reserve allowances, would be set at a price equivalent to the price 

of domestic allowances, thereby ensuring equal treatment of domestic and foreign manufacturers of energy-intensive goods under the 

WTO. 

There are a few important points to make about this proposal. 

First, it does not affect the pool of allowances available to domestic 

companies. The first version of the proposal would have done so, 

which may have driven up the costs for our domestic companies. 

That promised to be politically unpopular, and Senators Bingaman 

and Specter appear to have modified it in the bill’s current version. 

Second, the proposal only covers the biggest emitting nations and 

only applies to a limited class of primary products, such as steel, 

cement and pulp. And finally, our legal reading is that this approach respects the WTO ground rules I described earlier by, first, 

exhausting efforts to find a less trade-restrictive alternative; second, ensuring equal treatment between foreign and domestic companies; and third, by creating differential treatment depending on 

an individual country’s situation. 

In the two provisions I describe here today, the Subcommittee 

has the ability to address the fundamental concerns about climate 

legislation expressed in the 2005 Sense of the Senate resolution. 

We hope these ideas are a help to the Subcommittee. I would be 

happy to answer any questions that you may have. 

Thank you. 

[The prepared statement of Mr. Profeta follows:] 
17 

STATEMENT OF TIMOTHY H. PROFETA, DIRECTOR, NICHOLAS INSTITUTE FOR

ENVIRONMENTAL POLICY SOLUTIONS, DUKE UNIVERSITY

Chairman Lieberman, Senator Warner, and members of the subcommittee, thank 

you for the opportunity to testify before the Subcommittee today. It is an honor to 

be here. 

Two years ago, I left Washington to found the Nicholas Institute for Environmental Policy Solutions at Duke University. The Institute is intended to be a twoway bridge between the knowledge and convening power of Duke and decisionmakers such as yourselves. The Institute has focused its resources on the key environmental challenges facing our planet, and no topic has demanded greater attention than global climate change. 

In particular, the Institute has concentrated on addressing what we have perceived to be the ‘‘sticking points’’ that have prevented the passage of mandatory climate legislation. No issues have been more difficult than the two raised by today’s 

hearing: 

(1) the first, which I will call cost containment, pertains to how we could provide 

economic relief if a program to reduce greenhouse gases resulted in unexpectedly 

high costs across the economy; and 

(2) the second, which I will term ‘‘competitiveness protections,’’ is the question of 

how we can create a U.S. greenhouse gas control program that does not lead to a 

competitive disadvantage for U.S. firms as compared to firms in nations that have 

not limited greenhouse gas emissions. 

The importance of these two concerns to the broader climate change issue is underscored by last Congress’ Sense of the Senate resolution on climate change, in 

which 53 Senators voted that the Congress should create a mandatory system to address climate change so long as it: 

(1) will not significantly harm the United States economy; and 

(2) will encourage comparable action by other nations that are major trading partners and key contributors to global emissions. 

Thus, the issues that you seek to address today are the same ones that the Senate 

set as preconditions to action on climate change legislation—true ‘‘sticking points’’ 

if ever there were ones. 

To tackle these two challenging issues, the Institute went beyond traditional academic circles. We engaged congressional offices, corporate CEO’s and nonprofit leaders to appraise the issues, to guide our research in answering them, and to engage 

in the development of the answers. On the Institute’s end we engaged Duke law, 

economics, and science faculty. I am happy with our progress, and believe that this 

group collectively has designed policy solutions that can work to address these 

‘‘sticking points’’ in the legislation that the subcommittee is developing. 

So permit me to address these issues one at time, discussing first the challenges 

inherent in each, then the approach the Institute has taken to address them, and 

finally some proposals and concepts for tackling these concerns in final legislation. 

I. COST CONTAINMENT

When you consider the challenge of addressing global warming, it is not surprising that there is great concern about the cost. Climate change is no ordinary 

environmental challenge. As opposed to other relatively localized environmental 

challenges, the problem of global warming is in many ways a direct result of our 

way of life. Fundamentally, processes that produce greenhouse gases exist in every 

corner of our economy. Most of our energy sources produce substantial amounts of 

greenhouse gases. Other major sectors of our economy, such as the forestry and agricultural sectors, control the ebb and flow of greenhouse gases in the atmosphere. 

But, of course, no other environmental problem promises to be as costly to us as 

climate change if we allow it to go unabated. As the science has mounted, it is clear 

that the costs of our inaction will dwarf the costs of a greenhouse gas reduction program. So it is now inevitable that our Government, likely under the leadership of 

this Committee, will act. 

Thus, as the Nation tackles this daunting issue, it must take care to ensure that 

it is done in a way that embraces the economic opportunities that change undoubtedly will beget, and minimize any economic harm. This sentiment was clear in the 

2005 Sense of the Senate Resolution, which stated that the Congress must act to 

reduce greenhouse gas emissions, but impose that limit in such a way that ‘‘will not 

significantly harm the U.S. economy.’’ 

The Institute’s view is that these goals are not necessarily in conflict and can be 

achieved with careful attention to them both. We must set the course toward reduc-
18 

ing our nation’s greenhouse gas emissions, and we can use that leadership to encourage developing nations to do the same. We must also provide measures to avoid 

imposing excessive costs on our industries, companies, and consumers. And finally, 

we need to encourage investment in the solutions that will reduce costs and present 

opportunity over time. We need a plan that will do all three of those things. 

Fortunately, several members of this Committee already have embraced a number 

of polices that will ensure that we achieve our greenhouse gas reductions as efficiently as possible. In the Lieberman/McCain bill, there are a number of cost containment provisions. Just the fact that the legislation embraces a cap-and-trade system may be the most significant cost containment provision in any final legislation. 

If designed appropriately, a ‘‘cap and trade’’ system is the market-based policy design that helps control costs. Because companies must purchase emission permits, 

or ‘‘allowances’’ to account for the emissions they generate, the ‘‘per ton’’ cost of 

emitting carbon and other greenhouse gases above the limit is an expense that a 

company can work to eliminate. A company that develops ways to reduce emissions 

below the limit will generate emission credits it can sell for profit to companies with 

higher emissions. 

Designing a cap-and-trade program that will limit costs and increase profits also 

will stimulate the development and deployment of technologies to either reduce 

emissions or capture and store them away from the atmosphere. As long as there 

appears to be a potential that greenhouse gas reductions will be valuable in the future, investors will seek to own the technologies that create those reductions. This 

will drive the innovation and deployment of advanced technologies necessary to 

meet our objectives of reducing or mitigating greenhouse gas emissions. Moreover, 

that driver could provide economic stimulus, and competitive advantage, for the 

most innovative sectors of the U.S. economy. 

As a result, an efficient cap-and-trade system will naturally seek out the lowestcost greenhouse gas reductions in the economy—and it will avoid the costs that 

would come from less efficient, source-by-source regulations. To achieve the greatest 

efficiencies, a cap and trade system should at least contain these key features: 

First, the policy must provide the ability to bank and borrow emission allowances. 

Specifically, banking would allow any emitting firm that, at the end of a year, held 

more allowances than it needed to cover its own emissions the choice of ‘‘banking’’ 

the allowances for future years. Borrowing is just the reverse, allowing emitting 

firms to ‘‘borrow’’ emission allowances from future years if they are short the allowances they need in the present year. If emitters have the freedom to bank or borrow 

allowances, the ability of entities to find the cheapest compliance option is increased. This is so because it allows emitters not only to seek the cheapest opportunities for reductions in the present year, but also across time. 

Second, the approach should allow some ability to offset emissions from sectors 

of the economy that are not included in the cap, like agriculture and forestry. Some 

are concerned that too many offsets in the market will allow the major sources of 

greenhouse gas emissions to buy their way out of their compliance obligation and 

refrain from investing in transformational technologies or processes necessary to 

create the needed long-term reductions. Yet a sufficiently aggressive long-term emissions goal should dissuade any company from such a strategy. In the interim, some 

ability to access these offsets should provide a bridge to the next generation of technological innovation. 

What is more, a strong long-term emissions goal—if it is handled with flexibility 

and phased in on a reasonable schedule—also will stimulate the development and 

deployment of technologies to either reduce emissions or capture and store them 

away from the atmosphere. As long as there appears to be a potential that greenhouse gas reductions will be valuable in the future, investors will seek to own the 

technologies that create those reductions. That driver could provide economic stimulus, and competitive advantage, for the most innovative sectors of the U.S. economy. 

In sum, designing a cap-and-trade system with these features will go a long way 

toward helping the market naturally avoid excessive costs in the short term, and 

develop the solutions that will keep costs down in the long-term. In many policymakers’ view, however, more robust measures are still needed to manage costs and 

promote investment in the long-term solutions. That is where the Institute’s work 

comes in. 

Earlier this year, the Institute was engaged by four Senate offices—two Republican, two Democrat. All of these Senators had voted in favor of the 2005 Sense of 

the Senate Resolution to act on climate change, but none had ever voted in favor 

of a mandatory climate proposal. All four offices were focused on their desire to develop some new and innovative means of providing protection against any unforeseen high costs of a cap-and-trade system to the economy. 
19 

All four offices were familiar with the proposal to cap the price in the carbon market, using what is called a ‘‘safety valve.’’ A safety valve creates a parallel carbon 

tax regime, whereby an entity always has the ability to pay a set fee to the Government rather than have to go to the market to buy allowances. While all the offices 

were sympathetic to the safety valve’s goal of controlling the overall costs to the 

economy, all were concerned about the safety valve’s potential to frustrate the program’s environmental goals, to quell investment in climate-friendly technologies, 

and to limit the ability to link the U.S. system to international markets. Thus, they 

sought an alternative means to address unanticipated costs. 

With some assistance from the Institute, the four Senate offices developed principles to guide their deliberations. The offices determined that whatever proposal 

was created should meet five criteria: 

1. It should maintain environmental integrity. 

2. It should avoid unexpectedly high costs to the economy. 

3. It should focus on sustained price departures rather than short-term volatility. 

4. It should maximize the use of market-based mechanisms. 

5. It should provide effective incentives for long-term investment. 

Using these criteria, Institute staff met with these four offices regularly since January, providing necessary analyses and feedback as they developed their proposal. 

We are now ready to discuss that proposal. 

Fundamentally, the proposal provides the market with cost-relief measures and 

an oversight board to employ them. The measures are focused on adjusting the market to relieve sustained—not short term—high prices that threaten economic harm. 

The oversight board, which would be called the Carbon Market Efficiency Board, 

would have the discretion to use these measures to influence the market price for 

greenhouse gases. It would operate in a manner similar to the Federal Reserve, 

charged with protecting the market from runaway prices while preserving the market’s stability and continuity for investors. 

Specifically, the proposal would empower the Board with three authorities to administer relief when it finds that economic conditions require it to act: 

• First, the Board would be given the authority to increase companies’ flexibility 

in determining when and how to meet their emissions reduction goals—by broadening their ability to borrow permits against future years. This lets individual firms 

make decisions based on the availability of technology that is expected to come on 

line and give the flexibility to make a transition to new technology with timing more 

in line with their own capital planning. For example, if a company is having trouble 

meeting a current year’s goal, but is investing in a low-carbon solution that will be 

ready in years hence, it might decide to borrow a little more against those years. 

This remedy would increase the company’s ability to do that, by increasing the 

amount of allowances it is permitted to borrow, lengthening the time into the future 

from which an allowance can be borrowed or altering the interest rate that applies 

to the payback of the allowances. 

• The second lever at the Board’s disposal would be the ability to adjust the pace 

of national emissions reductions temporarily—while still achieving overall reductions over time—by increasing emission allowances available in the short term. 

Again, this remedy would be employed by borrowing against a future year or years, 

but at a nationwide level, guided by the Board, rather than at a firm level, and always keeping in mind overall reductions in the long term. Increases in allowances 

in the short term would result in reduced allowances available in later years, thus 

preserving the long-term environmental goal while providing short-term economic 

relief. 

• A third remedy was also considered, by which the ability of emitters to account 

for their emissions through real and verified offsets could be expanded, provided 

these offsets were somehow limited in the underlying legislation. But because not 

all offices wished to assume that such limits would exist in final legislation, we have 

not included the concept. However, if offsets are limited, it could provide a third 

lever for controlling costs. 

Each of these measures would be taken incrementally, minimally, and temporarily by the Board to preserve market certainty and continuity. 

Finally, we also considered the ability of Board oversight to reduce costs. The 

Board would be required to report quarterly on the status of the market—on investment trends, technology availability, and economic effects in different regions of the 

country. This type of information should greatly aid the market in seeking out the 

best efficiencies, calm the market from overreaction to short-term changes, and aid 

Congress in understanding the effect of the program. 

After determining the means by which the Board would provide relief in the event 

of potential harm to the economy, the group discussed at length the means by which 
20 

the Board could be made a neutral, trustworthy and knowledgeable overseer of the 

market, with a particular view to the precedent of the Federal Reserve. As a result, 

under the proposal, the Board’s primary mission would be to uphold the ultimate 

environmental and investment goals of the legislation while having the ability to 

make market corrections as needed to protect the economy. It would not be empowered to change the goals of the underlying legislation, or engage in administering 

relief to individual firms or sectors. 

To carry out these goals, the Board would be appointed by the President and 

serve full-time terms in which it would behave similarly to the Federal Reserve. It 

would observe and report regularly to Congress on the status of the market, and 

it would be empowered with these limited tools to help regulate the market when 

necessary. 

Moreover, the proposal provides an initial period in which the Board could study 

the market to learn its trends, but still provide some means of relief. Thus, to avoid 

overreaction to normal short-term price spikes, and to preserve investment certainty, the proposal recommends using an estimated price range as a benchmark 

during the first 2 years, with the intention of applying the market remedies only 

when spot market prices are sustained on average above the range. 

To establish the range, the proposal requires that Congress request an estimate 

of expected price ranges during the first 2 years of the market, estimated through 

trusted economic models and based on the terms of the underlying legislation. It 

was our view collectively that the range of numbers that the Congressional Budget 

Office (CBO) could provide would be the most appropriate on which to base the program, as those numbers would be based on the economic studies that were before 

Congress when it chose to pass a mandatory climate policy. 

That, in sum, is the offices’ economic protection proposal: (1) to create marketbased measures for cost relief, and (2) to create an independent market overseer 

that will provide market information critical to keeping costs low and which is be 

empowered to mitigate unacceptably high costs in the economy without undercutting the program’s environmental performance or motivation for investment in solutions. 

I must State that I believe that there is elegance in the four offices’ proposal. At 

bottom, it is the first proposal for cost containment that does not claim to know the 

unknowable. We cannot know right now what the proper price of a carbon allowance 

will be that will successfully balance the desire to make environmental and technological progress and not harm our economy. 

In fact, the Institute convened a conference of some of the nation’s best economic 

minds just last week (available at www.nicholas.duke.edu/econmodeling), and the 

inability to forecast the market over the long term was the number-one take-home 

message. While our models are the best available, our models simply cannot know 

what that price is, especially when dealing with long-term projections of technology. 

So this plan cleanly addresses the need to make decisions under this unavoidable 

uncertainty. It provides the levers necessary to stop economic harm without requiring new congressional action, and does so in a way that preserves and enhances the 

market, heightens its transparency, and maintains both its environmental integrity 

and the stimulus for long-term investments. 

II. COMPETITIVENESS PROTECTIONS

If we successfully implement a market-based cost relief program, we still must address the second paragraph of the Senate’s resolution—the need to ensure that the 

climate program ‘‘encourage[s] comparable action by other nations that are major 

trading partners and key contributors to global emissions.’’ This is a challenge on 

which the Institute has focused independently from our work with the four Senate 

offices. 

First, let me underline the importance of getting other nations and our trading 

partners to act, beyond the political. As the top emitter of greenhouse gases in the 

world, the United States is clearly a key part of the solution. And we very much 

need to lead the world in this area, both because we have done much to create the 

problem and because we have always led the world’s technological advancement to 

address global problems. 

But action by a number of other countries is almost as equally important, with 

action by China being particularly essential. At Duke, we have struggled with how 

much of the task of addressing greenhouse gases needs to fall on the shoulders of 

the United States, and how much on others. As the figure below indicates, all nations must play a major part for the world to get on a path toward stabilizing greenhouse gases at safe levels. This figure represents one possible emission scenario for 

global emissions on a nation-by-nation basis. 
21 

As the Committee knows, developing countries, including China and India, have 

argued that they should not be obligated to take on a cap until the United States 

and other industrialized countries—which have emitted most of the greenhouse 

gases that are currently in the atmosphere—take initial action. This situation creates a paralyzing chicken-or-egg dynamic for some policymakers, where fear over 

loss of competitiveness to China prevents them from supporting a domestic cap-andtrade. On the other hand, international negotiations prevent a truly global solution 

until the United States takes domestic action. 

At the Institute, we realized that resolving this chicken-or-egg situation required 

special attention. About a year ago, we at the Institute engaged in high-level conversations with a number of major corporations to assess their ‘‘sticking points’’ on 

Federal climate policy, and concerns about trade disparity came screaming out at 

us. 

As we dove deeper into the companies concerns, and expanded our outreach to 

Senate and House offices, we realized there are in fact three factors involved in addressing concerns about international disparities: 

1. Equal Treatment. At a minimum, we must develop policy that assures that any 

costs imposed on domestic emissions will be equally imposed on imports from countries that refuse to enact a similar cap. 

2. Engagement. It is in the U.S.’s interest, and is legally required under World 

Trade Organization (WTO) rules, that we seek to engage our uncapped counterparts 

to encourage them to develop a similar domestic program before we impose any obligation on imports. 

3. Opportunity. Opportunity has been the least considered and yet likely the most 

important in thinking about competitiveness. We know China and other developing 

nations will need lower-carbon technologies, particularly technologies used by the 

U.S.’s electric utility sector, and that they are behind us in development of those 

technologies and lack the capital to invest. When considering international competitiveness we should evaluate our policies to encourage the development of those technologies here, sooner, in order to facilitate their sale to developing nations. There 

is substantial opportunity for U.S. patents and U.S. profits generated by U.S. leadership. 

The Institute began by paying particular attention to the first concern: what provisions could be made to re-level the international playing field should the U.S. create a domestic cap-and-trade program for greenhouse gases. Working with Professor 

Joost Pauwelyn of Duke Law School, we evaluated a range of such proposals with 

an eye to their compliance with the WTO. Our efforts focused on provisions under 

Article XX of the General Agreements on Tariffs and Trade (GATT), which allows 
22 

1GATT Article XX(g). 

trade measures ‘‘relating to the conservation of natural resources.’’1 In general, the 

legal analysis led to the conclusion that such a provision could be sustained if 

(1) the United States first engaged in a good faith effort to achieve an agreement 

with any nation whose products were targeted; (2) it was applied even-handedly to 

domestic products and imports; and (3) it was adjusted based on local conditions in 

the other countries. 

At the same time that Duke was undertaking this analysis, American Electric 

Power (AEP) and a number of unions, led by International Brotherhood of Electrical 

Workers (IBEW), were undertaking a similar analysis. Working with Andy Shoyer, 

who for years served as the United States’ principal negotiator of the rules governing disputes under the WTO, and whose analysis of the AEP and IBEW proposal 

was submitted to the record by the Chairman, AEP and IBEW developed their own 

proposal under Article XX to address the same issues. 

The Institute’s assessment of the AEP/IBEW provision, which was incorporated 

into the Bingaman/Specter Low Carbon Economy Act that was introduced last week, 

is that it provides a good start for language to re-equalize the playing field of international trade once the United States creates its own cap-and-trade program. Under 

the proposal, the United States is required at the outset of the program to negotiate 

an agreement with all other nations to create programs comparable to our own to 

control greenhouse gas emissions. If it is not successful by 2020, however, the AEP/ 

IBEW proposal would require importers to the United States to submit certificates 

to cover emissions released during production of the imported goods, adjusted to the 

emissions burden required of similar U.S. products under the domestic cap-andtrade system at the U.S. border. These certificates, called ‘‘international reserve allowances,’’ would be set at a price equivalent to the price of domestic allowances, 

thereby ensuring equal treatment of domestic and foreign manufacturers of energy 

intensive goods under the WTO. 

There are a few important points to make about this proposal, as it has been outlined in the Bingaman bill. First, the proposal does not affect the pool of allowances 

available to domestic companies. The first version of the proposal would have let 

importers meet their allowance obligations at the border by buying allowances out 

of our domestic market, which may have driven up the price of the allowances for 

our domestic companies. That promised to be politically unpopular, and Senators 

Bingaman and Specter appear to have modified it in the bill’s current version. 

Second, the proposal only covers the biggest emitting nations, and it only applies 

to a limited class of primary products. It does not apply to final manufactured goods, 

but it addresses the needs of particularly energy intensive—and thus, particularly 

sensitive—industries such as steel, cement and pulp. 

Clear rules also would be set for calculating the annual required amount of certificates for each good from each country, based in part on emissions generated during 

production. The amount of certificates required would be adjusted in proportion to 

the amount of allowances distributed for free in the U.S. system and the level of 

economic development of the country of production. The Subcommittee might also 

want to consider other means of calculating the emissions burden, such as creating 

a default obligation to submit an amount of allowances equal to the U.S. average 

emissions rates but allowing individual firms to prove their own lesser rates, if possible. 

Finally, our legal reading is that this approach respects WTO ground-rules in 

completing its mission to ensure fair trade. Such ground rules require: 

• That the U.S. first exhausts any alternative that is less trade restrictive, such 

as direct negotiations. The U.S. would therefore vigorously pursue a good-faith effort 

to negotiate bilateral or multilateral climate agreements to include these nations, 

and the U.S. would only implement these procedures in 2020 only if those negotiations failed; 

• That imported goods be treated similarly to domestic goods because both must 

hold emission allowances; and 

• That America’s remedy be directly related to the objective of curbing greenhouse 

gas emissions, for example, requiring that imports that are accompanied by emission allowances actually addresses the environmental objective. 

Through this proposal it is possible to successfully tackle the first concern of international competitiveness: re-levelizing the playing field. In addition, this sets the 

table for addressing the second concern: requiring engagement. It will be important 

for the Committee to consider how to further encourage engagement with developing 

nations, and how to pursue competitive advantage by encouraging the development 

of technology for sale to those nations. 
23 

III. CONCLUSION

In these two provisions—the market-based cost relief and oversight proposal and 

the international allowance reserve—the Subcommittee has the ability to address 

the fundamental concerns about climate legislation expressed in the 2005 Sense of 

the Senate resolution. The Board will provide the oversight and ability for self-regulation and market correction measures that has been lacking to date in climate proposals, and thereby would ensure that worst cost estimates would not come to pass. 

The international reserve requirement proposed by AEP and IBEW will provide a 

backstop against fears that the program will simply result in the leakage of our 

greenhouse gas emissions, and jobs, to facilities overseas. 

There are other costs that the system must contain, of course. The Institute has 

worked closely with the exceptionally broad range of religious groups concerned 

about the poor’s ability to address global warming and will be designing policy solutions that will ensure that the ‘‘least of us’’ are not left behind in a climate regime. 

This Committee heard from the religious community about their fears on July 7, 

and I commend their testimony to you. Concerns about the cost to particular industries and sectors are also well founded, and Chairman Lieberman has designed programs to recycle revenue from the cap-and-trade system into the technology programs and transition assistance needed to minimize those costs. 

In conclusion, in calling this hearing, you have taken head on the greatest sticking points that have prevented climate legislation to date. At the Nicholas Institute, 

we have tried to provide at least the beginnings of a solution to each of these ‘‘sticking points,’’ and to do so in a way that brings not only a strong analytical basis but 

the political support of members of the Senate and the corporate and labor worlds. 

We offer our ideas in that spirit, working first to mitigate any chance for causing 

harm to the economy, and second to realize the competitive opportunity before us 

and approach the development of climate legislation with an eye toward this country’s strengths. Thank you again for the opportunity to testify before you today. We 

hope that these ideas are helpful to the Subcommittee. I would be happy to answer 

any questions you may have. 

Senator LIEBERMAN. Thank you very much for an excellent opening statement. 

This is an excellent panel, very diverse and experienced. 

Blythe Masters is the Managing Director in charge of the Global 

Commodities Group at JP Morgan Chase. Welcome. 

STATEMENT OF BLYTHE MASTERS, MANAGING DIRECTOR, JP 

MORGAN SECURITIES 

Ms. MASTERS. Thank you. It is an honor to be here today. 

As you said, my name is Blythe Masters. I am responsible for the 

global commodity business at JP Morgan Chase. Of particular relevance to today’s hearing, I manage the trading and marketing of 

JP Morgan’s energy and emission credit trading businesses. 

I am also a member of CAPS, which is a joint effort including 

JP Morgan, Environmental Defense, and the Duke Nicholas Institute, whose mission is to provide intellectual capital and resources 

in the crafting of a U.S. greenhouse gas framework. 

In nearly 2007, our Global Commodities Group established an 

environmental product subgroup dedicated to helping clients reduce emissions and manage associated risks. Today, we have a 

team focused on the origination, marketing and trading of carbon 

emissions covering the EU ETS, European Emissions Trading 

Scheme, essential elements of the Clean Development Mechanism, 

emerging regional compliance and pre-compliance markets in the 

United States, as well as voluntary emissions markets. 

We have a dedicated team of sales and trading experts in London 

covering EU allowances, or EUAs, and certified emissions reductions, or CERs; in New York, covering verified emissions reduc-
24 

tions, VERs; and in Tokyo covering CERs. We are also actively expanding to meet growing client demands for environmentally related projects and advisory services. 

We are also leaders in the U.S. acid rain or sulphur dioxide and 

nitrogen oxide emissions markets and in 2006 we were recognized 

by Environmental Finance as the best trading company in sulphur 

dioxide emissions. 

On a professional level, I have direct experience in markets with 

significant similarities to the growing emissions markets. I have 

been a trader in commodities markets, a trader and manager of our 

global credit derivatives business, the head of global credit portfolio, the head of credit policy and strategy, and just prior to my 

current position, I was the Chief Financial Officer of JP Morgan’s 

Investment Bank. 

I would like to thank Senators Lieberman and Warner for their 

leadership on an issue of such worldwide importance. JP Morgan 

operates in over 55 countries and has clients in every sector of the 

international economy. We recognize that the climate change poses 

grave risks to the global environment and to the international 

economy that need to be urgently addressed. 

We are working with our clients to ask the right questions about 

climate change and the environment generally when making investment decisions. We can’t dictate to our clients. We are not the 

Government, but we can engage in a dialog that surfaces the right 

issues and considers alternatives that help the environment. 

Congress is studying whether to create a so-called cap and trade 

emissions framework. JP Morgan supports a framework that caps 

greenhouse gas emissions and establishes a price for those emissions. 

For the private markets to most effectively address the problem 

of climate change, greenhouse gas emissions, which practitioners 

refer to as carbon, must have a price. By establishing a price for 

carbon through a cap and trade system, Congress will essentially 

unleash the forces of supply and demand. There are precedents for 

this. 

As you know, Congress created the first cap and trade program 

in 1990 to combat acid rain. It is my understanding, Senator Warner, that you played a key role in creating this legislation. Well 

done. It has worked transparently and more cheaply than expected, 

and it has delivered the needed environmental benefits. 

By setting a price on SOx and NOx emissions, market forces 

drove down the cost of compliance significantly below original projections. The market rewarded emitters that reduced their emissions, penalized those that could not or did not, and spurred the 

development of technologies that made further reductions possible 

in the most cost-effective way. 

Like any new program of Government regulation, the cost of 

compliance was a very important and worrisome issue. So it is the 

case with today’s proposed cap and trade system for greenhouse 

gases. Given the uncertain cost of the emissions allowances that 

would be required under any cap and trade program and its potentially wide reach, Congress is justifiably searching for ways to moderate expected compliance costs. To be sure, there are legitimate 

economic concerns that make cost containment a priority. Indeed, 
25 

some of my fellow panelists will be speaking to one of the implications of compliance costs, that of international competitiveness. 

Having said that, there are multiple approaches to cost containment. In any free market, costs or prices are a reflection of supply 

and demand. Prices will tend to be lower the more supply there is. 

The most effective way to expand supply, and hence to reduce 

costs, is to allow a larger percentage and wider variety of emissions 

offsets to meet emission reduction targets. 

As a result, there are two issues. One, what percentage of an 

emitter’s reduction requirement can be met by purchasing carbon 

offsets, instead of actually reducing his or her own emissions? And 

two, what kind of projects are eligible to be considered as offsets? 

As for the first question, I don’t have a precise recommendation 

today, but there is an optimal number that effectively balances 

achieving real and verifiable reductions and minimizing compliance 

costs. JP Morgan would be pleased to provide intellectual resources 

to the Committee as it contemplates that balance. 

As for eligible offset projects, I believe we can learn from one of 

the mistakes of the Kyoto Protocol. The Kyoto Protocol currently 

prohibits using the preservation of tropical rain forest as a carbon 

offset. This is a mistake. Deforestation accounts for 1.5 billion tons 

of carbon dioxide equivalent annually, and makes up approximately 

20 percent of annual greenhouse gas emissions. In fact, deforestation is the largest source of emissions in the developing world. 

Allowing tropical forest preservation to count as an offset would 

expand the supply for carbon reductions significantly, act to contain compliance costs, and provide a huge bonus in preserving biodiversity. Congress should give serious consideration to the depth 

and breadth of how offsets can be used in any cap and trade system. 

Let me digress for a moment. There has been recently some controversy over whether a small proportion of offset projects actually 

achieve the emission reductions for which the offsets were granted 

credit. Some of the controversy is well founded. Like any new and 

fast moving market, standards can take some time to develop. 

JP Morgan is at the forefront of industry efforts to harmonize 

meaningful industry standards to ensure that actual reductions do 

take place, to eliminate double counting, and to require effective 

monitoring. We have recognized the legitimate challenges and are 

rising to them. 

In addition to offsets, a greenhouse gas cap and trade program 

can be designed to minimize costs using a variety of approaches, 

including the banking of allowances and offsets, where banking 

means saving of offsets for future use; the borrowing of allowances, 

where borrowing means using future allowances today in return for 

over-achieving them in the future; linkage with other trading systems, a subject to which I will return; staggering of compliance 

deadlines; extending of compliance deadlines; and other complementary policies that drive energy efficiency and technological 

innovation. 

This is a long list, but cost containment essentially boils down to 

three things. The cap and trade program must be flexible. It must 

be broad. And it must be long term. 
26 

Perhaps the most discussed approach is that of the so-called safety valve. Under a safety valve provision, exemplified by the recommendation of the National Commission on Energy Policy, covered entities would be allowed to pay the implementing agency a 

specified amount per ton of greenhouse gas, instead of submitting 

emissions allowances, thus capping the cost per ton at the specified 

safety valve level. 

From the perspective of greenhouse gas emitters, a safety valve 

provides certainty of the upper limit of the cost of compliance. 

However one characterizes this approach, in economic terms it is 

a price control. It has been argued that a price control on emissions 

credits may be justified in the initial phases of a cap and trade program given the relatively higher degree of uncertainty over compliance costs. However, in both the near and the long term, the case 

for such price controls is not compelling. 

Commodity markets exist to buy and sell commodities. High 

prices tend to incent an increase in supply in that commodity and/ 

or to reduce demand. Carbon markets are no different. Obviously, 

carbon markets do not exist to incent an increase in the supply of 

carbon, but rather to increase the supply of capital allocated to expanding low carbon technology. By controlling the maximum price 

an emitter must pay for emissions, Congress would quite directly 

be decreasing the available capital to invest in new and innovative 

low carbon technology. 

The effect of such price controls on investors and emitters should 

not be underestimated. For example, a frequently proposed price 

cap for carbon is $10/ton of carbon dioxide equivalent. At the same 

time, the International Energy Agency estimates that the cost of 

carbon capture and storage, known as CCS, technology at between 

$30 and $90 per ton of carbon dioxide equivalent. 

With that differential, it is hard to see the economic logic of investing in CCS. And given that over 50 percent of U.S. electricity 

generation comes from coal, that demand is still increasing, and 

that over 150 coal-fired plants are in the pipeline, a price cap that 

retarded the commercialization of a technology that would allow 

the U.S. and the rest of the world to safely use its most abundant 

fossil fuel would seem inappropriate. 

It is not too dissimilar to wonder how much exploration and production activity would be occurring in the global oil markets if the 

price of crude was capped at $30 per barrel. It is safe to say that 

the oil majors would be returning most of their exploration budgets 

to their shareholders and that recoverable reserves would, at best, 

slowly continue to decline. No new supply would be coming to the 

market. 

Sadly, a price control has another drawback. It may prevent the 

U.S. market from linking to the EU ETS and other international 

carbon markets. Other systems, principally the EU ETS, will be 

unlikely to allow carbon credits and offsets from outside the EU if 

the cost of those credits is artificially low due to price controls and 

if the price control simply acts as a carbon tax that allows emitters 

to bust the cap. 

Quite apart from the diplomatic fallout of such a policy, failure 

to link to other carbon markets will reduce liquidity and therefore 

raise compliance costs to U.S. emitters. 
27 

It is worth noting that neither the acid rain program or the EU’s 

ETS have used price controls. In the case of the acid rain program, 

there have been price spikes, but they have been temporary and 

self-correcting. Moreover, the cost of compliance in the SOx and 

NOx markets was initially estimated from $3 billion to $25 billion 

per annum. After the first 2 years of phase one, costs were around 

$800 million per year. 

In the case of the EU ETS, despite not having a price control in 

place, neither emissions allowance volatility nor high prices have 

caused major dislocation to either emitters or consumers. Importantly, the experience of the EU framework has also identified a 

number of lessons in exactly the manner that its first phase was 

intended and designed to do. 

I realize that I am out of time, so I will stop here and look forward to your questions. 

[The prepared statement of Ms. Masters follows:] 

STATEMENT OF BLYTHE MASTERS, MANAGING DIRECTOR, JP MORGAN SECURITIES

Thank you. It’s a pleasure to be here today on behalf of JP Morgan Chase. 

My name is Blythe Masters and I am the Managing Director in charge of the 

Global Commodities Group. Of particular relevance to today’s hearing, I manage the 

trading and marketing of JP Morgan’s energy and emission credit trading businesses. 

In early 2007, JPMorgan’s Global Currencies and Commodities Group (GCCG) established an Environmental Products group dedicated to helping clients reduce 

emissions and manage associated risks. 

We have a team focused on the origination, marketing and trading of carbon emissions, covering the EU ETS (European Emissions Trading Scheme), essential elements of the Clean Development Mechanism (CDM), emerging regional compliance 

/ pre-compliance markets in the U.S., and voluntary emissions markets. We have 

dedicated teams of Sales and Trading experts in London (covering EU Allowances 

(EUAs) and Certified Emissions Reductions (CERs)), New York (covering Verified 

Emissions Reductions (VERs)), and Tokyo (covering CERs), and are actively expanding to meet growing client demands for environmental-related products and advisory 

services. 

We are also leaders in the U.S. acid rain or SO2 and NOx emissions markets and 

in 2006 were recognized by Environmental Finance for Best Trading Company in 

SO2 Emissions. 

On a professional level, I have direct experience in markets with significant similarities to the growing emission credit markets. I have been a trader in the commodities markets. A trader and a manager of our global credit derivatives and structured products business. The head of Global Credit Portfolio and Credit Policy and 

Strategy. And just prior to my current position, the Chief Financial Officer of JP 

Morgan’s Investment Bank. 

I would like to thank Senators Lieberman and Warner for their leadership on an 

issue of such worldwide importance. JP Morgan operates in over 55 countries and 

has clients in every sector of the international economy. We recognize that climate 

change poses grave risks to the global environment and the international economy 

that need to be urgently addressed. 

We are working with our clients to ask the right questions about climate change 

and the environment generally when making investment decisions. We can’t dictate 

to our clients. We’re not the Government. But we can engage in a dialog that surfaces the right issues and considers alternatives that help the environment. 

Congress is studying whether to create a so-called cap and trade emission framework. JP Morgan supports a framework that caps greenhouse gas emissions and establishes a price for those emissions. 

For the private markets to most effectively address the problem of climate change, 

greenhouse gas emissions, which practitioners refer to as carbon, must have a price. 

By establishing a price for carbon—through a cap and trade system—Congress will 

unleash the forces of supply and demand. There are precedents. 

As you know, Congress created the first cap and trade program in 1990 to combat 

acid rain. It’s my understanding, Senator Warner, that you played a key role in cre-
28 

ating the acid rain program. Well done. It’s worked—transparently, more cheaply 

than expected and it’s delivered the needed environmental benefits. 

By setting a price on SOx and NOx emissions, market forces drove down the cost 

of compliance significantly below projections. The market rewarded emitters that reduced their emissions, penalized those that could not or did not, and spurred the 

development of technologies that made further reductions possible in the most cost 

effective way. 

Like any new program of Government regulation, the cost of compliance was a 

very important and worrisome issue. So it is with the proposed cap and trade system for greenhouse gases. 

Given the uncertain cost of the emission allowances that would be required under 

any cap and trade program and its potentially wide reach, Congress is justifiably 

searching for ways to moderate expected compliance costs. And to be sure, there are 

legitimate economic concerns that make cost containment a priority. Indeed, some 

of my fellow panelists will be speaking to one of the implications of compliance 

costs—international competitiveness. 

Having said that, there are multiple approaches to cost containment. In any free 

market costs—or prices—are a reflection of supply and demand. Prices will tend to 

be lower the more supply there is. One way to expand supply is to allow a larger 

percentage and wider variety of emission offsets to meet emission reduction requirements. 

As a result, there are two issues: One, what percentage of an emitter’s reduction 

requirement can be met by purchasing carbon offsets—instead of actually reducing 

his or her own emissions? And two, what kind of projects are eligible to be considered offsets? 

As for the first question, I don’t have a precise recommendation but there is an 

optimal number that effectively balances achieving real and verifiable reductions 

and minimizing compliance costs. JP Morgan would be pleased to provide intellectual resources to the Committee as it contemplates that balance. 

As for eligible offset projects, I believe we can learn from one of the mistakes of 

the Kyoto Protocol. The Kyoto Protocol currently prohibits using the preservation 

of tropical forest as a carbon offset. This is a mistake. Deforestation accounts for 

1.5 billion tons of CO2 -equivalent annually and makes up approximately 20 percent 

of annual greenhouse gas emissions. In fact, deforestation is the largest source of 

emissions in the developing world. 

Allowing tropical forest preservation to count as an offset would expand the supply for carbon reductions significantly, act to contain compliance costs and provide 

a huge bonus in preserving biodiversity. Congress should give serious consideration 

to the depth and breadth of how offsets can be used in any cap and trade system. 

Let me digress for a moment. There has recently been some controversy over 

whether a small proportion of offset projects actually achieve the emission reductions for which the offsets were granted credit. Some of the controversy is well 

founded. Like any new and fast moving markets, standards can take some time to 

develop. 

JP Morgan is at the forefront of industry efforts to harmonize meaningful industry standards that ensure reductions take place, eliminate double counting and require effective monitoring. We have recognized the challenges and are rising to 

them. 

In addition to offsets, a greenhouse gas cap-and-trade program can be designed 

to minimize costs using a variety of approaches including: 

• banking of allowances and offsets; 

• borrowing of allowances; 

• linkage with other trading systems—a subject to which I’ll return 

• staggering compliance deadlines; 

• extending compliance deadlines; and 

• complementary policies that drive energy efficiency and technological innovation 

But perhaps the most discussed approach is that of the so-called safety valve. 

Under a safety valve provision, exemplified by the recommendation of the National 

Commission on Energy Policy (NCEP), covered entities would be allowed to pay the 

implementing agency a specified amount per ton of GHG instead of submitting 

emissions allowances, thus capping the cost per ton at the specified ‘‘safety valve’’ 

level. 

From the perspective of greenhouse gas emitters, a safety valve provides certainty 

of the upper limit of the cost of compliance. However one characterizes this approach, in economic terms this is a price control. It has been argued that a price 

control on emission credits may be justified in the initial phases of a cap and trade 

program given the relatively higher degree of uncertainty over the compliance costs. 
29 

In both the near and long term, however, the case for price controls is not compelling. 

Commodity markets exist to buy and sell commodities. High prices tend to incent 

an increase in supply in that commodity and/or reduce demand. Carbon markets are 

no different. Obviously, carbon markets do not exist to incent an increase in the 

supply of carbon but rather to increase the capital allocated to expanding the supply 

of low carbon technology. By controlling the maximum price an emitter must pay 

for emissions, Congress would be quite directly decreasing the capital available to 

invest in new and innovative low carbon technology. 

The effect of such price controls on investors and emitters should not be underestimated. For example, a frequently proposed price cap for carbon is $10/ton/ CO2 

equivalent. At the same time, the International Energy Agency estimates the cost 

of carbon capture and storage technology at $30 to 90/t CO2. 

With that differential, it’s hard to see the economic logic of investing in CCS. And 

given that over 50 percent of U.S. electricity generation comes from coal, that demand is still increasing, and that over 150 coal fired power plants are on the drawing board, a price cap that retarded the commercialization of a technology that 

would allow the U.S.—and the world—to safely use its most abundant fossil fuel 

would seem inappropriate. 

It is not too dissimilar to wonder how much exploration and production activity 

would be occurring in the global oil markets if the price of crude was capped at $30 

a barrel. It’s safe to say that the oil majors would be returning most of their exploration budgets to their shareholders and that recoverable reserves would, at best, 

slowly continue to decline. No new supply would be coming to market. 

Sadly, a price control has another drawback—it may prevent the U.S. market 

from linking to the EU ETS and other international carbon markets. Other systems, 

principally the EU ETS, will be unlikely to allow carbon credits and offsets from 

outside the EU if the cost of those credits is artificially low due to price controls 

and if the price control simply acts as a carbon tax that allows emitters to bust the 

cap. 

Quite a part from the diplomatic fallout of such a policy, failure to link to other 

carbon markets will reduce liquidity and, therefore, raise compliance costs to U.S. 

emitters. 

It is worth noting that neither the acid rain program or the EU’s ETS have used 

price controls. In the case of the acid rain program, there have been price spikes 

but they have been temporary and self correcting. Moreover, the cost of compliance 

in the SOx and NOx markets was initially estimated from $3-$25 billion annually. 

After the first 2 years of Phase I, the costs were around $800 million per year. 

In the case of the EU ETS, despite not having a price control in place emission 

allowance volatility and/or high prices have not caused major dislocation to emitters 

or consumers. 

I realize that I’m almost out of time, so I’ll stop here. I look forward to your questions. 

Thank you. 

RESPONSE BY BLYTHE MASTERS TO AN ADDITIONAL QUESTION

FROM SENATOR SANDERS

Question. It is clear that we are moving toward a cap and trade approach to dealing with greenhouse gas emissions. I strongly believe that there are supplemental 

policies that we must address at the same time that we promote cap and trade. For 

example, we must push energy efficiency to the utmost maximum. Additionally, we 

must require greater use of renewable sources of energy. I am wondering if you can 

provide information about the importance of including supplemental policies for energy efficiency and renewable energy in global warming cap and trade legislation. 

Also, can you provide examples of particular policies you think we should consider? 

Response. Thank you for your question on energy efficiency and alternative energy. We share your view that policies in addition to a cap and trade system are 

required for the transaction to a low-Greenhouse Gas (GHG) economy. 

JPMorgan Chase believes that the Congress should increase investments and create incentives for low-GHG Technology: Policy should reward energy efficiency and 

emissions avoidance and promote rapid low-GHG product and service research, investment, development, and deployment to help drive emission reductions. We believe that policy should provide U.S. companies greater opportunity in the energy 

and technology options. JPMC also believes Congress should increase investments 

in basic research into alternative energy as well as carbon sequestration. 
30 

A specific example of energy efficiency is ensuring that power generators and distributors have incentives to engage in energy efficiency activities. In certain parts 

of the U.S., some jurisdictions do not permit utilities to recover costs incurred in 

furtherance of energy efficiency. In some cases, utilities’ profits suffer when conservation is implemented. This should be changed. 

JPMC also shares your view that alternative energy has a key role to play in combating climate change. As a leading financer of alternative energy projects, we recognize the crucial role Federal support plays in the economics of energy deployment. 

As a result, JPMC supports the extension or permanence of the Production Tax 

Credit. 

We appreciate the opportunity to share our views. 

Senator LIEBERMAN. Thank very much, Ms. Masters. 

Senator WARNER. We always say the balance of your remarks 

may be included in the record. 

Senator LIEBERMAN. Yes, and they will be. That was a very impressive and helpful statement. 

Our next witness is Robert Baugh, Executive Director of the 

AFL–CIO Industrial Union Council. Thank you for being here. 

STATEMENT OF ROBERT BAUGH, EXECUTIVE DIRECTOR, 

INDUSTRIAL UNION COUNCIL, AFL–CIO 

Mr. BAUGH. Senator Lieberman, on behalf of the—— 

Senator WARNER. That is a proud name. Best football player we 

ever had was Sammy Baugh. 

[Laughter.] 

Mr. BAUGH. He is supposedly a very distant relative. 

Senator WARNER. Hang onto it. 

Senator LIEBERMAN. This will allow us to transition from military metaphors to football metaphors. 

[Laughter.] 

Mr. BAUGH. Senator Lieberman, on behalf of the 10 million members of the AFL–CIO, I want to thank you and the members of this 

Committee for having us testify this afternoon on such an important subject. 

America needs an energy policy for the 21st century that will result in a cleaner planet, greater energy efficiency, and the revitalization of our manufacturing base. Climate change is a serious environmental threat in need of prompt legislative response by the 

U.S. Congress. It is an opportunity for our Nation to prove that 

economic development and environmental progress can and should 

go hand in hand. 

Our Energy Task Force has been informed by science and economic reality to come to this conclusion. Global warming is a problem and we need balanced measures to address it. Our energy system must maintain diversity in the utility industry to include all 

fossil fuels, nuclear, hydro and renewables as part of a solution to 

this problem. 

The third piece is that our Nation needs a strong manufacturing 

base, but it is one that is in deep, deep trouble. We are awash in 

record-setting trade deficits. We have lost more than 3.5 million 

manufacturing jobs since 1998, and 40,000 manufacturing facilities 

in this Country have closed in the last 6 years. The manufacturing 

drops and the off-shoring of skilled work, R&D, design and engineering and more erodes our innovative and technical capabilities 

and capacities. This is about the foundation of our national security 

and our national economic security. 
31 

Over the past year, our interaction with Congress, the National 

Commission on Energy Policy, the Apollo Alliance, and many other 

business, environmental and labor organizations has helped focus 

the thinking of the AFL–CIO Energy Task Force. It has also helped 

us establish the principles to address carbon emissions. We need a 

balanced approach with a diverse, affordable energy supply that 

creates good jobs and improves the environment. 

We need an economy-wide approach with standards that allow 

for the development and deployment and financing of new technology. We need a cap and trade system designed to clean the environment, create new jobs, and discourage the off-shoring and sale 

of assets. 

We need investments that capture cutting edge technologies and 

are manufactured here. We need an international component to assure that the major developing nations participate. 

It is on this basis that we last week endorsed the Low Carbon 

Economy Act of 2007 introduced by Senators Bingaman and Specter. They have five important interrelated actions that speak to 

those principles. One, it made a significant statement about the environment. Two, it has a timetable for reductions that balances 

concerns about the economy with our ability to develop and deploy 

new technology and makes those subject to a system of regular reviews. 

It provides pricing certainty for long-term investment decisions, 

the conservation we have been having, and assures a modest effect 

on fuel and electricity prices, and avoid short-term price fights that 

can lead to fuel switching. They do this through the technology accelerator payment, the safety valve. 

It provides resources for early and major investments in clean 

coal, renewable energy, advance technology vehicles and components, and the modernization of manufacturing facilities. It has an 

international perspective with incentives and penalties to encourage the participation of major developing nations in a global solution. 

I will focus the remainder of my comments on those last two 

items. 

One of the most important aspects of the Low Carbon Economy 

Act of 2007 is its commitment to major long-term domestic technology investments, and the fact that this is self-financing. There 

will be no further demand on the Federal budget to do this. The 

cap and trade program in the bill sets aside 47 percent of the allowances for auction for public benefit and investment. This will 

gradually rise over time to 100 percent. Eight percent from the getgo is set aside for carbon capture and storage; 20 percent of the 

total credits, up to $25 billion a year, are set aside for research and 

development and deployment of low and no-carbon technologies. 

Four percent is set aside for assistance to low-income households. 

Five percent of the allowances are for agricultural sequestration, 

with another 1 percent for bonuses for firms that do some carbon 

reductions in advance of the implementation of this bill. And 9 percent is set aside for States to look at their own regional differences 

and issues and needs, and for technology or energy efficiency and 

for security purposes. 
32 

Another critical element to this bill that we demanded as part of 

the labor movement in looking at the economy are prohibitions to 

prevent firms from gaming a system. Firms cannot collect credits 

for reductions achieved through closures, cutbacks or the 

outsourcing of work. Only actively operating manufacturing facilities will receive allowances based on the number of production employees at those U.S. facilities. 

The point of the system, the point of the allowances, the point 

of the prohibitions, is to encourage a positive change in the domestic behavior of energy producers and manufacturers. That is the 

point of the major investments we cite in this legislation. 

The Bingaman-Specter bill primarily targets conversion to clean 

coal, carbon capture and sequestration, renewable energy, manufacturing upgrades, and the auto products market. Simply, look at 

my own testimony and the charts that are in there, we cannot 

achieve energy independence nor meet carbon reduction goals without utilizing the existing coal resources in the United States. 

Today, they provide over half of our electrical energy, and frankly 

it is what the world uses. If we can solve this problem, we will help 

everybody. 

We must use our coal cleanly and more efficiently by accelerating 

the development and deployment of carbon sequestration and other 

energy efficient coal technologies. The targets and timetables of the 

Bingaman-Specter bill work hand in hand with its technology incentives, provisions to assure that essential capture and storage 

technologies are available in time to meet the bill’s substantial 

2030 emissions reductions targets. 

On the renewables side, we are a Nation with a huge fertile land 

base, a moderate climate, rivers, coasts and mountains. The U.S. 

has an untapped abundance of potential renewable energy resources. In the early 1980’s, we led the world in renewable technology like solar, batteries, biomass, and wind, but we failed to follow through. I think this is a critical point here. Germany, Japan 

and Brazil as a matter of industrial and energy policy, which is 

what we should be talking about, targeted these technologies and 

invested in them. Today, they lead the world and export these 

products around the globe. This is the way we need to act. It is 

time to go back to the future for this Country. 

But we must have no illusions about the timing and real technical challenges ahead. We need early investment and development 

and then deployment, and deployment takes time. As the auto industry and the UAW have sat before these committees and said, 

it takes 15 to 18 years to turn over the entire U.S. fleet. The same 

is true for power production, and that is what we are talking about 

here. For wide scale deployment of these new technologies, whether 

it is in coal or renewables, it will take time and it will take decades 

and it will take major investments. We have to keep that in sight. 

Targeting investments toward our domestic manufacturing and 

processes and automotive products is critical because transportation and the industry account for approximately 50 percent of today’s energy usage. Investing in manufacturing is in the Nation’s 

interest because it is the foundation of our Nation’s economic and 

national security. It has been a vital engine for productivity 

growth, technology development, innovation, good jobs, good bene-
33 

fits, tax revenues and additional job creation in local communities, 

up to four jobs. 

The automotive sector is at the heart of manufacturing. It accounts for 25 percent of all manufacturing, roughly 4 percent of our 

GDP. Currently, many advanced technology vehicles are assembled 

overseas and virtually all the key components are built in foreign 

countries. We have joined with the UAW in calling on Congress to 

establish a Marshall Plan to help re-tool the U.S. auto industry. 

The Bingaman-Specter bill has responded with critical investments targeted to upgrading manufacturing to be more energy efficient, as well as on specific investments in the domestic production 

of advanced hybrid, diesel and fuel cell vehicles, as well as vehicles 

that can run on ethanol and other alternative fuels, as well as their 

component parts. It answers both the energy efficiency question in 

terms of how we manufacture. It also answers the question of having advanced automotive vehicles that achieve high energy efficiency and clean technologies. This will help create tens of thousands of automotive jobs, while reducing global warming and our 

reliance on foreign oil. 

From the economic development perspective, the Low Carbon 

Economy Act of 2007 has a number of positive payouts: the retention of good manufacturing jobs; the creation of new jobs in these 

new technologies and industries; and the capturing of cutting edge 

technology for domestic production and export. 

The inclusion of an international section in the Bingaman-Specter bill was critical to our support for the legislation. The AFL–CIO 

believes that having a dynamic and healthy industrial base is in 

the best interest of the Nation, and we must do our best to cut our 

carbon emissions. However, this cannot be a go it alone proposition. 

Mexico and Brazil account for more than half the emissions from 

Central and South America. Deforestation, as we already heard, is 

estimated to account for at least 20 percent of that. Much of this 

is coming from the burning of the Amazon and clearing for deforestation. It is a major contributor. 

China passed the United States, as we heard someone else today 

earlier, in 2006 in terms of carbon emissions. They have 500 coal 

plants coming online over the next 10 years, one a week. They are 

based on 1950’s technology that is dirty, but cheap to build. 

Unabated by 2030, China’s emissions will grow 139 percent and 

make up 26 percent of the world’s total. 

China, India and the other major developing nations must be 

part of the solution or everything that we do, or that the European 

Union does, or that other nations do to cut emissions, will be for 

naught if they do not participate. 

There is a second economic implication. China, India and the 

other rapidly developing countries are already a magnet for manufacturers seeking to avoid labor, environmental, currency and other 

standards. Most of China’s new energy resources will be dedicated 

to the manufacturing export strategy which accounts for 40 percent 

of their GDP, and 70 percent of the foreign direct investment in 

China is actually in the export markets and the export platforms. 

Since 1997, our trade deficit with China has ballooned from $50 

billion a year to $235 billion last year, and they hold $1.5 trillion 

in U.S. securities and dollars. They account today for 47 percent of 
34 

our total trade deficit in manufactured goods. So to put it bluntly, 

Senators, it is not in our national interest to see our efforts to reduce carbon emissions become yet another advantage that a developing nation uses to attract business. However, it is in our interest 

and the world’s interest to have developing nations become part of 

the solution because the problem cannot be solved without them. 

The Bingaman-Specter bill takes this into account in several 

ways. It will take me 2 seconds, and then I will do this. 

The executive branch is directed to negotiate with the developing 

nations over implementing a system of carbon control. The bill provides incentives—this is an important piece—to fund joint research 

and development, technology transfer, ways in which to incent the 

partners to move to cleaner technology. The bill provides for 5 year 

reviews to reassess our domestic actions base upon international 

and based upon the science and technology that we put in place for 

our own goals and standards. 

If the President would deem that the actions of the trading partners to be inadequate, the U.S. Government can require these 

countries to purchase carbon allowances for their exports to the 

U.S. If there is sufficient international effort on the greenhouse 

gases, the President could recommend further reductions of emissions and move our standards upward. 

We believe, the AFL–CIO believes that climate change is a crisis 

and an opportunity for our Nation. By taking the right steps—time 

lines, goals, a safety valve sensitive to the economic impacts on 

business, workers and communities, assuring that our investments 

capture the intellectual property of cutting edge technology, by producing these new technologies and goods domestically, and by engaging the developing world in solving this problem we can have 

a cleaner planet, greater energy efficiency, and a revitalized manufacturing base for this Nation. 

Thank you. 

[The prepared statement of Mr. Baugh follows:] 

STATEMENT OF ROBERT BAUGH, EXECUTIVE DIRECTOR, 

INDUSTRIAL UNION COUNCIL, AFL—CIO 

Chairman Boxer, on behalf of the 10 million members of the AFL—CIO, I want 

to thank you and the members of the Environment and Public Works Committee 

for the opportunity to testify this afternoon on this important subject. 

America needs an energy policy for the 20 first century that will result in a cleaner planet, greater energy efficiency and the revitalization of our manufacturing base. 

Climate change is a serious environmental threat in need of a prompt legislative 

response by the U.S. Congress. It is also an opportunity for our nation to prove that 

economic development and environmental progress can and should go hand-in-hand. 

CRISIS AND OPPORTUNITY

Embodied in our position is a set of ideals that reflects a major change of direction 

for the AFL—CIO on energy policy. They grew out of the recognition by the AFL— 

CIO Energy Task Force that ‘‘A growing body of scientific evidence has confirmed 

the environmental challenges posed by global warming. Human use of fossil fuels 

is undisputedly contributing to global warming, causing rising sea levels, changes 

in climate patterns and threats to coastal areas. Because of these dangers, the 

AFL—CIO supports balanced measures to combat global warming.’’ 

The task force also recognized that ‘‘reliable and affordable electrical energy is the 

lifeblood of the manufacturing, transportation, construction and service industries;’’ 

and that we must ‘‘maintain diversity in the electric utility industry, by retaining 

all current generating options, including fossil fuels, nuclear, hydro and renewables, 

to ensure a stable, reliable and low-cost supply of electricity for the United States.’’ 
35 

We also believe that a strong and diverse manufacturing base are in the national 

interest but the reality is this sector is in a deep and ongoing crisis. The nation is 

awash in record setting trade deficits. Since 1998 more than 3.5 million manufacturing jobs were lost and over 40,000 manufacturing facilities have closed. The 

offshoring of skilled work, R&D, design, engineering and more continues to erode 

our innovative and technical capacities. Solving the climate change crisis is an opportunity to address the manufacturing crisis 

POLICY AND PRINCIPLES

Over the past year, our interaction with Congress and many other businesses, industry, environmental and international labor organizations have helped evolve and 

sharpen the thinking of the AFL—CIO Energy Task Force. The work of the National Commission on Energy Policy, the Apollo Alliance, House and Senate energy 

legislation, the broad and open stakeholder process initiated by Senators Bingaman 

and Specter as well as Chairman Dingell’s detailed questionnaires regarding cap 

and trade programs forced our thinking about how these systems can and should 

work. 

The task force recognized that any discussion about climate change was a discussion about the nation’s industrial policy because energy and the environment are 

at the nexus of manufacturing and trade policy. As a result, the AFL—CIO established a set of principles to guide our participation in the carbon emission discussion. 

1) Our Nation should embrace a balanced approach that assures diverse, abundant, affordable energy supplies, creates good paying jobs for American workers, improves the environment, and reduces our dangerous dependence on foreign oil. 

2) We support an approach to carbon emissions that does not advantage one sector over another, is economy wide, has timetables and standards that allow for the 

development and deployment of new technology, and helps finance the new technologies that can provide clean energy at prices close to conventional sources. 

3) Energy incentives and investments by the Federal Government must be based 

upon a set of economic development principles that cleans the environment and creates jobs but will not encourage offshoring of manufacturing or the sale of assets. 

4) Investments must be used to identify, develop and capture cutting edge technologies and to manufacture and build these technologies here for domestic use and 

export 

5) The international component of any carbon emission/cap and trade program 

must provide a system of incentives and penalties to assure that major developing 

nations, like China and India, participate. 

We have applied these principles in every discussion held with staff and Members 

of Congress. Two weeks ago, after months of dialog with Senate staff about new carbon emission legislation we endorsed the Low Carbon Economy Act of 2007 introduced by Senator Bingaman and Senator Specter. 

We believe this legislation represents and important step forward with five interrelated actions: 

• It makes a significant environmental statement with a 2050 goal of final emission reductions of 60 percent or more below current levels. 

• It has a timetable for reductions that balances concerns about the economy with 

our ability to develop and deploy new technology and makes those subject to a system of regular reviews of the targets and technological capability. 

• It provides pricing certainty for long-term investment decisions, assures a modest effect on fuel and electricity prices and avoids short-term price spikes that can 

lead to fuel-switching through a Technology Accelerator Payment. 

• It provides resources for early and major investments in new technology from 

clean coal and renewable energy technologies to advanced technology vehicles and 

components and the modernization of manufacturing facilities for energy efficient 

production. 

• It provides an international perspective that includes both incentives and penalties designed to encourage the participation of major developing nations in a global solution to the problem of carbon emissions. 

I will focus the remainder of my time on the last two points investment policy 

and international aspects. 
36 

INVESTING FOR THE FUTURE: RESOURCES, ENERGY, MANUFACTURING

AND AUTO

Meeting the future energy needs of the Nation while reducing our carbon footprint 

offers difficult choices and huge opportunities. It requires a commitment to major 

long term investments, that these be invested domestically and that the technology 

and products resulting from the investments be produced domestically. In this way 

the Nation can maximize the outcomes from its investments by assuring that those 

dollars recirculate through the domestic economy. This is environmental and industrial policy working in harmony. 

New Resources for New Investments 

One of the most important aspects of S. 1766, the Low Carbon Economy Act of 

2007, is that it does not place additional demand on the Federal budget for financing new technology investments. The cap and trade program in S. 1766 is self-funding. It creates a large pool of capital by initially setting aside a 47 percent of the 

allowances available for auction for public benefit/investment. This will gradually 

rise over time to 100 percent. 

• 8 percent of allowances will be set aside annually to create incentives for carbon 

capture and storage to jump-start an intensive strategy to sequester GHG emissions. Approximately $35 billion by 2020. 

• 20 percent of the total credits, up to $25 billion per year will be auctioned by 

the Government to generate much-needed revenue for research, development, and 

deployment of low-and no-carbon technologies; to provide for climate change adaptation measures; 

• 4 percent of the allowances are set aside to provide assistance to low income 

households 

• 5 percent of allowances are reserved to promote agricultural sequestration, and 

1 percent of the allowances will reward companies that have reduced emissions before program implementation. 

• 9 percent of the allowances are left to be distributed by States to address regional impacts, promote technology or energy efficiency, and enhance energy security. 

Another important element of this cap and trade proposal are the steps taken to 

impede the ability of manufacturing firms to game the system simply for financial 

gain or to drive them offshore. Firms cannot collect credits for reductions achieved 

through closures, cutbacks or outsourcing works. Only actively operating manufacturing facilities (including new facilities) will receive allowances, and their allocation is based on the number of production employees at those U.S. facilities. The 

point of the system is to encourage a positive change in the domestic behavior of 

energy producers and manufacturers while retaining jobs and our technical capability to produce goods. 

Targeting Energy Production 

The revenues generated under the Bingaman—Specter bill are primarily targeted 

to finance improvements in technology that will allow clean energy to be produced 

at prices close to what consumers pay for energy from conventional sources, and to 

encourage deployment of this technology in manner that promotes domestic production and jobs for American workers. The investments and incentives are targeted 

for conversion to clean coal technology, carbon capture and sequestration, domestic 

production of advanced technology vehicles and their components, energy efficiency 

and renewable energy resources 
37 

We cannot achieve energy independence nor meet carbon reduction goals without 

utilizing existing coal resources. This nation is blessed with the largest known coal 

deposits in the world, a resource that provides over half of the electrical energy in 

the U.S. But, we must use our coal cleanly and more efficiently. To do so we must 

accelerate development of carbon sequestration technologies and the deployment of 

more efficient coal burning technology. The targets and timetables of the BingamanSpecter bill work hand in hand with its technology incentive provisions to ensure 

that essential capture and storage technologies will be available in time to meet the 

bill’s substantial 2030 emission reduction target. 

The conversion to clean coal technologies is an opportunity both domestically and 

internationally. It is in our interest to develop these new technologies and export 

them to China and the rest of the world. But, we must be as equally committed to 

rapidly developing carbon capture and sequestration as we are to developing renewable sources of energy. 

With a huge fertile land base, moderate climate, coastal and mountain lands the 

U.S. has an untapped abundance of renewable energy resources available such as 

wind, solar, hydro and biomass-derived fuels. There was time in the early 1980’s we 

led the world in solar, battery and wind turbine technology but we failed to follow 

through on those commitments. On the other hand, Germany and Japan, as a matter of industrial and energy policy, targeted those technologies and invested in 

them. Today they lead the world and export these products around the globe. It is 

time for our nation to go back to the future. 

We believe the investments targeted for energy production in the Bingaman-Specter bill can provide a path to reducing our reliance on foreign oil and cut CO2 emissions while promoting broad-based economic development. Each of these resources 

faces technical hurdles and it would be wrong to assume that it is simply a matter 

of technology deployment. There is the need for matching up early investment in 

technology development and then deployment. For example, the auto industry often 

cites that it will take 15—18 years to replace the entire U.S. fleet. The same is true 

in energy production. It will take decades and major investments to convert to clean 

coal technologies as well as to achieve large-scale deployment of renewable technology. 

Targeting Auto and Manufacturing 

Linking the energy production investments to domestic manufacturing is only one 

part of national energy/environment/industrial strategy. The other half is targeting 

investments in our domestic manufacturing processes and the automotive products 

we produce because transportation and industry account for approximately 50 percent of our energy usage. 
38 

Investing in manufacturing is in the nation’s interest because of the broader role 

this sector plays throughout the economy. It is the productivity leader that helps 

expand the economic pie. It accounts for two thirds of all R&D investment and is 

the primary source of innovation. It is the leading purchaser of new technology and 

financial and technical services. It is the leader in new work organization and work 

process. At the community level manufacturing jobs have been a critical economic 

ladder with rungs at all levels. And, because of the web of supplier industries and 

the relatively high wages and benefits, each manufacturing job, it is estimated, is 

associated with up to four additional jobs. 

The automotive industry is the single most important industry to American manufacturing. Manufacturing accounts for 16 percent of the nation’s GDP, and the 

automotive sector makes up 25 percent of all manufacturing, some 4 percent of 

GDP. Auto is the cornerstone of an advanced manufacturing economy, not only because of its enormous economic impact but also because it involves the most complex 

integration and assembly of leading edge technologies and products. From the glass, 

rubber, steel, and electronics to engines, transmissions, design, engineering, R&D 

and more, an automobile encompasses the critical elements of this nation’s industrial infrastructure. 

Currently, many advanced technology vehicles are assembled overseas, and virtually all of the key components are built in foreign countries. However, a study by 

the University of Michigan’s Transportation Research Institute demonstrates that 

Federal incentives to encourage domestic production can reverse this trend, create 

jobs and result in higher tax revenues for the Federal and State Governments. 

The AFL—CIO Energy Task Force has called for the U.S. Government to pursue 

measures to improve energy efficiency. We have called upon Congress to establish 

a Marshall Plan to help re-tool the U.S. auto industry to accelerate domestic production of advanced technology and alternative fuel vehicles and their key components. 

The Bingaman—Specter bill has responded with critical investments targeted to 

upgrading manufacturing as well as auto specific investments in domestic production of advanced hybrid, diesel and fuel cell vehicles, as well as vehicles that run 

on ethanol and other alternative fuels. This initiative will help create tens of thousands of automotive jobs for American workers, while at the same time helping to 

reduce global warming emissions and our reliance on foreign oil. 

From the economic development perspective, the Low Carbon Economy Act of 

2007 has a number of positive payoffs. The upgrading of manufacturing facilities 

will help retain good manufacturing jobs. The investments in clean coal, renewables 

and advanced automotive technology and component parts will create new jobs. All 

the investments will help capture cutting edge technology for use in domestic production and export. 

INTERNATIONAL ASPECTS: THE NEED FOR A GLOBAL SOLUTION

The inclusion of an international section in the Bingaman-Specter bill was the result of many hours of discussion. It was a critical issue in our support of the legislation. The AFL—CIO believes that having a dynamic and healthy industrial base is 

in the best interest of the Nation and we must do our best to cut our carbon emissions. However, this cannot be a go it alone proposition. 
39 

The participation of developing nations is critical to solving this problem while assuring the competitiveness of U.S-based manufacturing. Mexico and Brazil account 

for more than half the emissions from Central and South America. Deforestation is 

estimated to account for 20—30 percent of carbon emissions with the burning of forests in the Amazon basin acting as a major contributor. 

By some estimates, China passed the United States in carbon emissions in 2006. 

They have a new ‘‘1950’s technology’’ coal plant coming online every week with 500 

plants being planned. They are dirty but cheap to build. Unabated, by 2030 China’s 

emission will grow 139 percent and make up 26 percent of the world’s total. They 

and other major developing nations must be part of the solution or everything we 

the EU and other nations do to cut carbon emissions will be for naught. 

There is a second economic implication of the non-participation of these nations. 

China, and other rapidly developing countries are already a magnet for manufacturers seeking to avoid labor, environmental, currency and other standards. Seventy 

percent of China’s foreign direct investment is in manufacturing, with heavy concentration in export-oriented companies and advanced technology sectors. Much of 

this energy resource will be dedicated to China’s manufacturing export platforms, 

which already account for nearly 40 percent of Chinese GDP. 

In 1997 when the AFL—CIO rejected the Kyoto protocol because it did not include 

the developing world the federation took a lot of criticism but our concerns were 

well founded. Since Kyoto the Chinese Government has said they will be a developing county for at least the next 50 years and will not agree to be restricted by 

this framework. In that time our trade deficit with China soared from $50 billion 

in 1997 to $235 billion in 2006. They now hold $1.5 trillion in U.S. dollars and securities. This year China overtook the United States as the No. 1 exporting nation in 

the world, and it now accounts for 47 percent of the U.S. trade deficit in manufactured goods. 

In a May 2, 2007 study the Economic Policy Institute estimates that ‘‘the rise in 

the U.S. trade deficit with China between 1997 and 2006 has displaced production 

that could have supported 2,166,000 U.S. jobs. Most of these jobs (1.8 million) have 

been lost since China entered the WTO in 2001. Since China entered the WTO in 

2001, job losses increased to an average of 441,000 per year—more than the total 

employment in greater Dayton.’’ 

To put it bluntly, it is not in our national interest to see our efforts to reduce carbon emissions become yet another advantage that a developing nation uses to attract business. However, it is in our interest and the worlds interest to have developing nations become part of the solution because the problem cannot be solved 

without them. 

The Bingaman—Specter bill takes an evenhanded approach to this issue: 

• The Executive branch is directed to negotiate with the major developing nations 

over implementing a system to control carbon emissions. • To effectively engage developing countries the bill provides incentives to developing nations. For example, it would fund joint research and development partnerships and technology transfer programs similar to the Asia Pacific Partnership. • The bill also provides for a Five-Year Review Process to reassess domestic action based on an assessment of efforts by our major trade partners (as well as climate science and available technology). • If the President deems the actions of these trading partners nations to be inadequate then the U.S. Government can require that imported products from these 

countries purchase carbon allowances from a separate pool. • If there is sufficient international effort on greenhouse gases, the President 

could recommend further reductions of emissions at least equal to 60 percent below 

current levels. 

The AFL—CIO believes climate change is both a crisis and an opportunity for our 

Nation. By taking the right steps—timelines, goals and a safety valve sensitive to 

the economic impacts on business, workers and communities; assuring that our investments capture the intellectual property of cutting edge technology, by producing 

these new technologies and goods domestically, and engaging the developing world 

in the solution—we can have a cleaner planet, greater energy efficiency and a revitalized manufacturing base. 

Senator LIEBERMAN. Thank you, Mr. Baugh. Excellent statement 

that raised some thoughts which I am sure we will want to question you about. 

Next, we have Mr. Garth Edward, Trading Manager for Environmental Products at Shell Energy Trading. I must say, listening to 

the witnesses, particularly Ms. Masters, and having you here, it is 
40 

really both noteworthy and encouraging the effort that the private 

sector is putting into both dealing with the problem and, frankly, 

getting involved in the solution in a way that might actually be 

profitable. 

Mr. Edward? 

STATEMENT OF GARTH EDWARD, TRADING MANAGER, SHELL 

INTERNATIONAL TRADING AND SHIPPING COMPANY 

Mr. EDWARD. Thank you, sir. 

Good afternoon, Chairman Lieberman, Ranking Senator Warner 

and members of the Subcommittee. My name is Garth Edward. I 

am the Trading Manager, as you said, over at Shell for environmental products. I thank you for this opportunity to speak to you 

all today. My remarks will focus on the components of a cap and 

trade system that will facilitate economic growth and ensure that 

the United States remains competitive in a global market. 

For a more thorough discussion, as well as a discussion of related 

policy tools, I will refer you to my written testimony. 

Since the 1990’s, Shell’s refining and power generation installations in the U.S. have been covered by SO2 and NOx market legislation under the Clean Air Act. In Europe, Shell has over 30 regulated installations under the EU emissions trading system, including oil rigs, refineries, and chemical plants. 

So I am speaking here today as a representative of a company 

that has some hands-on experience of operating its business under 

cap and trade. 

On the purely trading side of the business, Shell was the first 

company to transact CO2 allowances under the EU system and 

today we run a global environmental trading business that transacts in nine different emission markets with teams in Houston, 

London, Beijing and Tokyo. 

So first, let me say that Shell believes that a cap and trade system is ideally suited to managing direct emissions in large industrial facilities and power stations. Second, Shell does not believe 

that a cap and trade system is suitable for the transportation market. In particular, we believe that a cap and trade system is most 

effective at achieving environmental goals when the point of regulation is also the point where those emissions occur. 

So in Shell’s view, a successful cap and trade program is one that 

achieves its environmental goals in a manner that ensures economic growth, international competitiveness, and energy security. 

Today, I will first set out our view on what a cap and trade system enables us to do. Second, from the perspective of maintaining 

competitiveness, I will emphasize the importance of accessing a 

supply of domestic offsets and international credits. Third, I will 

also mention how allocation approaches can impact cost. And finally, I will explain why we believe that straight price caps may 

not offer a helpful way forward. 

On the first point, an emissions market by its very existence 

drives capital toward the most efficient way of reducing emissions. 

For example, if Shell can reduce emissions internally by investing 

in a new technology or changing our operations for, say, $10 a ton 

while the market price is $15 a ton, then we would certainly deploy 

our capital internally on Shell projects. But if the projects inside 
41 

our business cost $15 a ton and the market was trading at $10 a 

ton, then it is certainly more cost efficient for us to buy the allowances from the open market and effectively finance other companies to reduce their emissions on better terms. Either way, we are 

going to use our capital to find the most efficient way to reduce 

emissions. 

It is worth noting that an emissions market does itself function 

as a basic cost containment mechanism, since it drives capital to 

find the lowest cost abatement opportunity. 

In terms of regulated entities, the wider the pool of possible 

emission reduction activities, then the more opportunities there are 

to find low cost emission reductions. If the pool of regulated entities 

is spread across different industry sectors and locations, then there 

will be many possibilities to find emission reductions and the overall market will be less exposed to short-term impacts on local emission levels due to weather or economic turbulence. 

Another way in which overall compliance costs can be constrained is through access to offsets from domestic projects, such as 

gas caps for coal mine methane capture, agriculture waste management, and reforestation. In the future, Shell expects that a major 

source of emission reductions will come from the geological sequestration of CO2 or carbon capture and storage. It seems necessary 

that these kinds of offsets must be recognized in future programs. 

Clearly, the use of offsets has to be built on a robust system of 

rules and procedures for generating these offsets. The integrity of 

the underlying allowance market itself will depend on the vigor of 

these offset rules. Regulators, investors and the public all have a 

vested interest in making sure that these rules are rock solid and 

that real reductions take place. 

In effect, the rules for the creation of offsets should be every bit 

as robust as the rules for monitoring and reporting emissions from 

regulated entities. 

The United States can further stabilize compliance costs and ensure the competitiveness of its companies by making certain that 

a U.S. cap and trade system interfaces with existing international 

systems. This would allow U.S. companies to buy credits from 

international projects in the same way that overseas competitors 

are already doing. International credits already exist, and notably 

the EU has made good use of this international credit market as 

a way to reduce their cost exposure to high compliance costs in the 

EU. The EU has done this by initially authorizing EU companies 

to buy credits from projects in developing countries and in the future from 2008 onwards from Russia and Ukraine. 

The EU, however, has not allowed unlimited access to these 

international credits, but the current level of supply has certainly 

reduced EU allowance prices and dampened volatility. So EU companies have therefore reduced their compliance costs, but also 

found significant opportunities to transfer technology and implement emissions reduction projects with developing country partners. 

Before closing the discussion on cost containment, I should emphasize that Shell believes allowances should be granted free at the 

start of any cap and trade program, and should initially be based 

on existing emissions. If the Government auctions most of the al-
42 

lowances up front, then this will require large initial payments 

from companies who must buy enough allowances to maintain their 

license to operate, but this would result in taking capital out of the 

very same companies that must implement the new technologies 

and practices to reduce emissions. 

Let’s turn to the issue of price caps. Shell does not support the 

issue of price caps as a form of cost containment for two reasons. 

First, price caps sacrifice the basic environmental goal that is the 

very foundation of a cap and trade system. A fundamental advantage of cap and trade versus tax, for example, is that it enables the 

public to get a guaranteed environmental result. Cap and trade 

does this by limiting the emissions of all regulated entities to the 

size of the total emissions cap. A price cap compromises this emissions cap because it offers a buy out. Companies may pay a fine, 

rather than simply reduce their emissions, and in effect you can 

have a guaranteed emissions level or a guaranteed price level, but 

you can’t have both. 

Introducing a price cap converts the cap and trade system into 

something like a tax system where the environmental results can 

no longer be guaranteed. 

A second problem with the price cap approach is that it effectively caps the return on investment. In a free market, higher allowance prices will drive the flow of capital into more advanced 

technologies, larger projects, and more innovation. But with a price 

cap, the incentive to invest in new technologies and practices is 

also capped. 

So I appreciate this opportunity very much to share with you our 

views on cost containment. I thank you for your time, and will be 

happy, of course, to answer questions. 

[The prepared statement of Mr. Edward follows:] 

STATEMENT OF GARTH EDWARD, TRADING MANAGER, SHELL INTERNATIONAL

TRADING AND SHIPPING COMPANY

Chairman Lieberman, Ranking Senator Warner and members of the subcommittee, my name is Garth Edward. I am the trading manager for the Shell 

Group’s environmental trading business. In that capacity, I oversee Shell’s trading 

in the European Union’s Emission Trading System. 

The Royal Dutch Shell Group is an international group of companies engaged 

worldwide in all of the principal aspects of the oil and natural gas industry. Shell 

also has interests in chemicals, power generation and renewable energy. Shell’s environmental products trading business is active in over 15 environmental markets 

around the world. The markets in which Shell trades include: EU Greenhouse Gas 

Emission Allowance Scheme, the Danish CO2 quotas trading system, the Clean Development Mechanism Greenhouse Certified Emission Reductions, the UK Greenhouse Gas Emissions Trading System, the Houston/Galveston Area (HGA) NOx

Emission Allowance Program, the California South Coast Air Quality Management 

District (SCAQMD) Regional Clean Air Incentives Market (RECLAIM) for NOx; the 

U.S. EPA expansion of the Eastern States Ozone Transport Commission NOx trading program under State Implementation Plans (SIPs) to a total of 19 States; the 

Netherlands NOx emissiehandel and the U.S. EPA Acid Rain Program (Title IV of 

the 1990 Clean Air) SO2 Emission Allowance. 

I am pleased to appear before you today to testify on economic and international 

issues in global warming policy. In particular, I would like to share what Shell has 

learned from its experience with the EU’s emission trading system, a trading system 

that regulates emissions from more than 10,000 installations across 27 countries 

with more than USD $50 million worth of allowances traded each day through several exchanges and brokerage houses. 

I will identify the key elements of a successful cap and trade program. In Shell’s 

view, a successful program is one that achieves its environmental goals in a manner 

that ensures economic growth and energy security. Based on Shell’s experience with 
43 

the EU’s system, I will also identify some pitfalls to avoid in creating a program 

to regulate greenhouse gas emissions here in the U.S. 

Finally, I will address other policies that Shell considers important in reducing 

Greenhouse Gas emissions and should accompany a clear, workable cap and trade 

system. A single instrument like an economy-wide trading system is unlikely to deliver the necessary breadth of change that needs to start now. Rather, it may result 

in pockets of change. In particular, the carbon price set in a cap-and-trade system, 

say $50 per ton, may not be high enough to prompt change in the transportation 

sector. Therefore, a number of approaches will be required—but not many—to 

achieve environmental goals. 

In addition to cap-and-trade for large, stationary sources, these approaches would 

include a three-prong policy approach to reducing GHG emissions in the transportation sector that prompts change by fuel suppliers, vehicle manufacturers and consumers and a strong investment by the Government in the research, development 

and deployment of large-scale carbon capture and storage projects. 

In addition, Shell supports robust energy efficiency standards for buildings, appliances etc. with incentives that encourage consumers, businesses and industry to retrofit existing infrastructure. Shell also supports continued public/private partnerships for the research, development and deployment of new technologies that conserve energy and reduce emissions. 

First, let me congratulate you on your determination to act now to address the 

issue of climate change. Shell believes that now is the time to act on climate change. 

A clear, workable climate change policy implemented now that includes long-range, 

achievable environmental goals will have less impact on consumers, businesses and 

the economy than a more stringent policy with costlier mandates implemented years 

from now. 

The later action is taken, the more mandate-driven the outcome is likely to be. 

Shell supports the flexible, market-based approach that is on the table today. 

Shell supports a national U.S. climate change policy. We believe a national 

policymakes much better sense than dozens of regional policies or fifty State policies. 

ELEMENTS OF CLEAR, WORKABLE CAP AND TRADE PROGRAM: 

A cap-and-trade system is ideally suited to managing direct emissions in large industrial facilities and power stations. A cap-and-trade system is most effective at 

achieving environmental goals when the point of regulation is also the point at 

which emissions occur rather than separating these and relying on indirect price 

signals to encourage emission reductions. 

Shell believes that a clear, workable cap-and-trade program would include the following essential components: 

• The aim of a cap-and-trade system should be to provide an incentive for greater 

efficiency and to direct capital toward more CO2 efficient projects, via a market 

price for CO2 emissions. • The trading system should not withdraw that capital from the industries or 

firms covered by the system. Removing capital from the market would slow down 

the necessary investment in more CO2 2 efficient technologies and projects to the 

detriment of the environment in the long term. For this reason, Shell discourages 

the auctioning of allowances in the early years of a program. • Shell believes a workable cap-and-trade program sets clear, reachable goals 

then stays the course. Tinkering with carbon goals mid-course creates uncertainty 

in the marketplace and discourages investment due to concern that the Government 

will change the rules and diminish the value of the investment. Today, companies 

invest billions of dollars in projects that last twenty-five years or more. The Government must set a goal 20 years out or more, then include interim targets that bring 

the market to the final goal. • Cap-and-trade requires the application of a fixed cap across the covered sector 

for each compliance period, with the number of allowances in circulation equating 

to the cap and less than a ‘‘business as usual’’ expectation. This then creates the 

necessary scarcity for trade to develop. The extent of scarcity should be set with a 

view to the efficiency gains and low carbon investments that are technologically feasible within the compliance period. Once allocated the number of allowances in circulation should not be changed. 

• A compliance period could be up to 5 years in length. Allowance allocation for 

a given compliance period should be known 3—5 years before the start of the period. 

• Allowances should be granted free (a concept known as ‘‘grandfathering’’) at the 

start of an emissions trading system and this should be based on historical emissions from a fixed year or average over a number of years. The allocation process 
44 

must account for the entry of new facilities, significant expansions to existing facilities, or facility modifications required by regulation. 

• Shell does not favor auctioning particularly in an initial phase of a system. 

However, Governments may eventually use auctions because of the ease with which 

allowances can be allocated and to capture some of the value of the allowances. 

However, the system should not withdraw capital from the industries and firms covered by the scheme. Implementation of a profit-neutral system would require detailed information on each industry’s market structure and demand conditions, 

which could potentially be developed during an initial phase of the system when allowances are distributed for free. It should be recognized moreover that there is not 

a one-size-fits-all approach to achieving a profit neutral scheme and that conditions 

to achieve profit neutrality may well differ across industries and firms. Auctioning 

also raises a number of specific and significant concerns, namely: 

—Payment for allowances withdraws capital from the covered sector to the extent 

that this cost cannot be recovered from higher product prices. The impact of a system on profits depends on an industry’s market structure and demand conditions 

and consequently the arrangements to guarantee profit neutrality are likely to differ 

across industries. 

—Some methods of achieving profit neutrality are likely to be more efficient than 

others. For example, a system of mixed grandfathering and auctioning would be 

more efficient than a system that recycles auction proceeds through corporate profit 

tax credits. 

—The conduct of multiple auctions in the course of a continuous and free market 

has the potential to lead to price spikes and collapses. 

—The administration of auctions is a serious undertaking because participation 

must be open to the public but must also involve financial checks so that auction 

participants can guarantee to be able to pay for the allowances they bid for. 

• Should auctioning be used, two key design criteria must be incorporated: 

—The system be designed with the aim of profit neutrality at the industry and 

firm levels. Environmental objectives are not advanced by arbitrarily destroying 

shareholder value in existing firms; indeed this can act as a deterrent to necessary 

investment. The incentive for abatements comes from the carbon price signal. 

—There must be safeguards to ensure that this objective is delivered in practice 

and not just in principle. 

• The point of regulation (allocation) should be set by the ‘‘make or buy’’ principle. 

This means that the holder of allowances should be both the emitter and (even more 

importantly) the party that can launch projects that reduce emissions. Under a system where the allowance holder is the project developer, the allowance holder can 

use the emissions market to help finance the project by selling the future reduction 

in the forward market and bringing capital back. Alternatively, if no reduction opportunities present themselves, the allowance holder can purchase allowances for 

compliance and thus channel capital into the market for others to use for their 

projects. This is called ‘‘make (reductions) or buy (allowances)’’. ‘‘Make or buy’’ is 

fundamental to the operation of an emissions trading system. 

• The system should operate as other commodity markets do. While an emissions 

market can only be created by regulation and the creation of a scarcity, such regulation should not affect the trading behavior of the market. For example, regulation 

should not be used to manage price (e.g. through caps or floors) or limit the trading 

of any of the instruments created for the market (e.g. flow to/from linked schemes). 

Doing so may lead to market distortions (e.g. price spikes), which in turn may lead 

to the call for additional regulation (e.g. price caps). 

• There should be a design review process within 5 years of startup to correct any 

design oversights or anomalies. The review should not be used to change the environmental goal. 

• Key abatement technologies should be recognized from the outset. The program 

should embrace technologies as they mature (e.g. Carbon Capture and Storage— 

CCS). CCS is one of the few technologies that is entirely climate change driven. 

Other zero carbon power generation alternatives exist, such as wind. But they are 

also driven by factors such as energy costs, security of supply concerns and local 

air quality standards. This is not the case for CCS. Without carbon emission targets, 

CCS technology will not develop or be deployed. To develop and deploy CCS, the 

Government must: 

—Provide suitable financial encouragement to a number of large-scale pilot 

projects in the United States in the period 2007—2015. Similar projects should be 

encouraged China and India. This will facilitate the development of a global CCS 

industry, accelerate technology cost reduction and promote economies of scale. 
45 

—Introduce additional tools to better manage the long-term carbon market risk 

associated with CCS. 

—Include CCS in the cap-and-trade system and coordinate the development of 

standard rules and measurement protocols. 

—Include CCS in any project-based offset mechanism linked to the cap-and-trade 

system. 

—Address the issue of long-term liability for stored carbon dioxide. 

• Policies should be designed so that activities such as cogeneration are 

incentivized. 

• Project offset mechanisms, such as the international Clean Device Mechanism 

(CDM) offset program should be linked to a cap and trade program. The program 

should not limit their use. It would be better to recognize the existing international 

project mechanism rather than developing a parallel system. The effort involved in 

establishing a good mechanism should not be underestimated. CDM works today as 

a result of such effort. 

• A cutoff for small facilities should be established in order to avoid an inefficient 

system that would require an immense effort in respect of administration and 

verification. 

• It should be built on a sound infrastructure base, which includes clear definitions, measures and reporting protocols and adequate information technology to support the registries. 

PITFALLS TO AVOID: 

In my experience, there are five pitfalls to avoid when creating a cap-and-trade 

system. 

• First, don’t try to legislate ‘‘safety valves’’ into your cap-and-trade program. Set 

the basic rules of your cap and trade system, make them as clear and simple as 

possible, then leave the system alone. Let it self-regulate. Don’t implement barriers 

to trade. For example, don’t create offsets, then limit how much they can be used. 

Offsets are your natural safety valve when prices start climbing. A market-based 

cap-and-trade system will use offsets as needed to achieve both environmental goals 

and economic growth. 

• Don’t rush into measures like the full-auctioning of allowances. Take a step-bystep approach. Prime the pump first. Start out by giving allowances away then consider how you might introduce auctioning or create benchmarks. 

• Recognize that some changes take time to implement. For example, implementing a major efficiency project within a refinery may require the refinery to shut 

down. Full-scale shutdowns are expensive, can impact gasoline prices and only occur 

every 5 years or so. Bringing forward a refinery shut down, with its related impacts 

on price and supply, to implement efficiencies may be problematic. 

• Don’t expect a single policy instrument to do everything. For example, the most 

effective cap-and-trade system is one where the regulation occurs at the point of 

emission. But it is difficult to regulate at point-of-emission in the transportation sector. No one expects personal drivers to hold carbon allowances and manage their 

emissions. Another policy instruments, such as vehicle efficiency and a low carbon 

fuel standard, may achieve better results. 

• Don’t reinvent the wheel where you don’t have to. A vibrant international offset 

system exists and should be embraced. This international offset system has generated 549 projects underway in 120 countries, including India and China. Another 

1,600 projects are in the pipeline, according to the May 2006 report by the U.N. 

Commission on Sustainable Development. These projects will send approximately 

$6.62 billion dollars every year to developing countries, lifting these nations out of 

poverty by providing to electricity while also reducing global greenhouse gas emissions. 

SUCCESS OF THE EU-ETS: 

I would like to talk briefly about the success of the EU-ETS since its launch on 

January 1, 2005. The price volatility in the first 2 years of operation and the low 

prices earlier this year have been seen by some as evidence that the EU trading 

system is not working well. 

Shell disagrees. The EU-ETS is structurally sound, with a framework that broadly 

matches the ideal arrangement for a cap-and-trade system. It was largely modeled 

on the U.S. Sulphur cap-and-trade system, which is seen as one of the most successful pieces of environmental legislation ever enacted in the United States. 
46 

If the EU-ETS could be improved in one key area (apart from some more minor 

harmonization fixes) it would be to give a longer-term perspective on the reductions 

required. This is slowly developing but has not been implemented with the very 

clear and pragmatic approach used in the U.S. sulphur scheme, where allowances 

were issued many years into the future. 

The EU-ETS started with very little data on the emissions of facilities across the 

EU. This lack of data led to the price volatility and low first-period price, not the 

underlying structure of the system. When EU Member States formulated the first 

allocation plans, they erred on the side of caution rather than over-constrain the 

system. The result is that the first period has likely suffered from over allocation. 

This became clear to the market on the day of release of the first year compliance 

data, and the market reacted as expected, with prices moving sharply down. 

The market can only be absolutely certain of over-allocation on the very last day 

of trading in the period when more sellers than buyers remain. Then the price will 

be effectively zero. Until that time the market will trend slowly downwards as increasing certainty of a surplus is gained with the passing of time. This is currently 

being seen. 

However, this trend is no different than, say, the period in an oil market where 

the market becomes aware that one or more traders are holding a surplus cargo. 

The discovery can result in very low prices that are hardly reflective of the overall 

price in the market. The difference is that the oil market trades in days and 

months, not years, so these periods of very low prompt price are short lived. 

Meanwhile, the further out prices remain robust in the emissions trading market. While 2005—2007 is trading at less than 1 Euro—less than $1.38 cents, the 2008— 

2012 price is at 20 Euros, or $27.63. This is the real price in the market today and 

the one that is driving investment and operational change. 

The EU-ETS has managed this early volatility well. It has reacted promptly and 

clearly to market information, it has provided sufficient depth and liquidity for traders to execute their business and it has developed a forward price that reflects the 

longer-term supply and demand. These are all characteristics of a market that is 

working, not one that is failing. 

TRANSPORTATION THREE-PRONG APPROACH: 

As already indicated, cap and trade works best when the point of regulation and 

the point of emission are the same. But apart from aviation or large vehicle fleets, 

that’s not feasible in the transportation sector. You would have to require every 

driver to hold allowances and manage their emissions. The best approach is to break 

the transportation carbon dioxide challenge down into its three basic components— 

fuel, vehicle and driver—then use a three-prong approach to address each. 

The first prong: One way to address fuel is to reduce the carbon footprint of the 

fuel’s lifecycle. Shell sees some merit in a national low carbon fuel standard that 

encourages a broad range of technologies that can reduce the well-to-wheels CO2

emissions per unit of energy supplied. 

Shell supports a low carbon fuel program that assigns a carbon value to existing 

fuel mixes and volumes then reduces that value over time, prompting fuel makers 

to reduce the amount of CO2 released in the production and consumption of fuel. 

Fuel makers should be given the maximum amount of flexibility to reach their 

CO2 goals, helping to ensure that energy prices remain stable while environmental 

goals are achieved. 

Fuel makers should be able to get carbon credits for: Implementing efficiencies 

that reduce carbon; switching to lower-carbon fuels such biofuels or alternative fuels 

like hydrogen; or using lower-carbon processes when making fuel, such as processing ethanol using methane from a cattle feedlot. 

A workable program sets feasible goals on an achievable timeline and has longterm predictability that encourages fuel makers to make long-range investments in 

lower-carbon technologies, is easy to comply with and easy to enforce. Given that 

technologies expected to be used to comply with a low carbon fuels standard are not 

yet all-commercial, there must be a clear process for reviewing progress and making 

necessary adjustments to the program. 

Shell prefers a standard that assigns a carbon value to various classes of fossil 

fuels because the global fossil fuel market is too complex to accurately measure actual carbon content. However, the ethanol market, which is largely domestic, should 

be measured by actual carbon content. This will drive the market for second-generation biofuels with low carbon footprints, helping to achieve environmental goals. 

Calculation of the well-to-wheels CO2 footprint of different fuels must be determined using scientific, peer-reviewed methodology and assumptions in consultation 

with relevant stakeholders. 
47 

Compliance with a low carbon fuel standard is likely to require a substantial increase in renewable fuel use. Policy makers should consider the full economic, environmental and societal impact of such an increase, including the effect on the food 

chain, fuels supply and distribution systems. 

Shell believes that minimizing potential supply chain complexity by having one 

national fuel program versus many different State and local Government programs 

is preferable. State ‘‘boutique’’ fuel requirements undermine the flexibility that Congress established in the Federal renewable fuels program, which calls for a nationwide program that encourages the most economic use of renewable fuels for the benefit of consumers by not dictating where renewable fuels must be used and by allowing credit trading. 

The second prong: An effective carbon dioxide reduction program also requires 

Federal regulations to make vehicles more energy efficient. The program should include a higher CAF standard or regulations/incentives to encourage the increased 

production of hybrids, plug-in hybrids, diesels and vehicles powered by batteries, 

fuel-cells or other low-carbon technologies. 

Third prong: Finally, an effective program includes a national educational campaign and empowers consumers to make wise transportation choices that result in 

less fuel consumption such as purchasing fuel efficient vehicles, carpooling or using 

public transportation. 

CARBON CAPTURE AND STORAGE: 

Finally, I would like to address carbon capture and storage at greater length. A 

workable climate change program encourages the development of innovative technologies like the capture and storage of carbon, which can dramatically reduce the 

amount of carbon emitted in the production of electricity and fuels from fossil 

sources. 

The InterGovernmental Panel on Climate Changes estimates that carbon capture 

and storage could play a role in as much as 55 percent of the total carbon mitigation 

effort until year 2100. The panel also estimates that carbon capture and storage 

technology applied to a modern conventional power plant could reduce CO2 emissions to the atmosphere by approximately 80—90 percent compared to a plant without this technology. 

Hence, a sound U.S. climate change program must include policies to encourage 

the development and deployment of CCS technologies. 

As I mentioned, Shell supports the creation of credits for the capture and storage 

of carbon dioxide that can be traded in a cap-and-trade program. This requires developing standard rules and measurements for carbon storage. 

Shell urges the U.S. Government to help fund the development and deployment 

of CCS technologies, including CO2 storage demonstration projects. Such funding 

can be critical to success of first-of-a-kind technologies. We believe the United States 

must have at least 10 large-scale CO2 storage demonstration projects up and running by 2015. Several projects are needed to test and refine different technologies 

and storage methods. 

We believe the carbon storage component of the U.S. climate change program 

must interface with international efforts. Shell believes the reduction of carbon 

emissions anywhere in the world is a victory for the global environment. A U.S. program that encourages carbon storage projects in other parts of the world encourages 

the development of a global CCS industry and reduces the cost of the CCS technology, a savings ultimately passed on to consumers. 

Because CCS technology is still evolving, Shell supports Federal regulations that 

address the liability of leakage or migration of carbon once it has been stored. Shell 

believes these regulations must encourage the deployment of CCS technologies. 

Companies faced with unending liability for CO2 stored in the ground will be discouraged from investing in carbon storage facilities. In the long run, this may diminish the important role CCS can play in reducing global carbon emissions. 

Carbon storage operators expect to be responsible for monitoring and maintaining 

the integrity of a site and would encourage the active involvement of regulatory authorities in the monitoring process. 

Senator LIEBERMAN. Thank you, too, Mr. Edward. Very detailed. 

That is exactly the point we are at. I thought your analysis of the 

tax was interesting, particularly the way you phrased it. I wrote 

it down because people compare. Our friend, Senator Inhofe, mentioned that he didn’t favor it, or said he wouldn’t support it, but 

the cap and trade actually guarantees an environmental result. 
48 

That is the cap. As opposed to the tax increase, which does not 

guarantee a result. There is speculation as to what would the effect 

be of a tax increase, but it doesn’t have the same guarantee of a 

result. I appreciate your pointing that out. 

Our last witness on this panel, and we thank you very much for 

being here. Dr. Margo Thorning is Senior Vice President and Chief 

Economist at the American Council for Capital Formation with 

which I have had the pleasure of working on matters over the 

years. Thank you for being here. 

STATEMENT OF MARGO THORNING, SENIOR VICE PRESIDENT 

AND CHIEF ECONOMIST, AMERICAN COUNCIL FOR CAPITAL 

FORMATION 

Ms. THORNING. Thank you, Mr. Chairman, and thank you for 

your kind words. It has been a pleasure to work with you over the 

years. I appreciate very much the chance to appear in front of this 

Committee. Senator Warner and other members of the Committee, 

I am very grateful for the opportunity. I would like to present this 

testimony and ask that it be submitted for the record. 

The American Council for Capital Formation is a group that has 

over the years focused on cost-effective approaches to tax issues, 

environmental issues, regulatory issues. So listening to the testimony of the earlier witnesses, I am reminded of the fact that if we 

do want to address climate change, we really must focus on the 

most cost-effective ways to achieve our goals. I appreciate very 

much the work and the testimony that the other witnesses have 

submitted. 

I would like to raise three issues before I get into commenting 

on some of the specific points that the bills that have been introduced have raised. I think we need to keep in mind that we have 

three challenges here in the U.S., and in fact globally. One is energy security of supply. Second is environmental protection. And 

third is the reduction of global energy poverty. 

Developed countries have devoted a lot of attention to the first 

two goals, but not so much attention to the third goal, reducing 

global energy poverty. Since energy use goes hand in hand with 

economic development, many experts think that we ought to be focusing more time and more resources on that. According to the 

International Energy Agency, by 2030 one-third of the world’s population will still be relying on biomass—wood, charcoal and animal 

dung—for cooking and there will still be 1.4 billion people in the 

world without any electricity. Shockingly, about 1.3 million women 

and children die every year because of exposure to indoor air pollution. 

Another thing we need to keep in mind is that the IEA and the 

recent report by the National Petroleum Council point out that fossil fuels are going to remain the dominant source of energy for the 

next several decades, and the carbon emissions in spite of our best 

efforts are probably going to increase substantially. In fact, China’s 

CO2 emissions exceeded those of the U.S. by about 8 percent, so 

China is now the No. 1 emitter of CO2. 

Another key point we need to be mindful of is that energy security will require massive investment. Meeting the world’s growing 
49 

demand for energy will require over $20 trillion in 2005 dollars 

over the next 25 years. 

So as we approach climate change, we need to be mindful of the 

impact that the drag that some of these policies might exert on our 

economy by raising energy prices, and we need to balance these 

goals. 

Points to consider before we adopt a cap and trade approach, I 

think some of the previous witnesses have raised the issue about 

the impact of a cap and trade on price volatility. Price volatility, 

according to many studies, is responsible for much of the economic 

downturns that we have experienced, particularly after the oil price 

shock of the 1970’s. So when we design a system, we want to avoid 

price volatility if at all possible because producers are already subject to price volatility in the energy sector because of the global nature of energy supplies now and the fact that prices, even without 

a carbon tax, do tend to vary quite a bit. 

The impact of a cap and trade system if allowances are not sold, 

if they are just given out, will tend to confer windfall benefits on 

the recipients of these allowances and worsen the distribution of income in the sense that upper income people who are shareholders 

in these companies will benefit. A tax, on the other hand, could 

provide the funds to mitigate some of the price changes caused by 

trying to reduce carbon emissions. 

Thinking more broadly about the international front, the question of how to involve developing countries in a cap and trade system present some obstacles also. For example, Bill Nordhaus of 

Yale recently released a new study that talks about the pros and 

cons of a tax versus a cap and trade system. One of the telling 

points that he makes in this new study is that a cap and trade system is a positive sum game for both Government and business. 

Let’s take for example a developing country like China, both producers and the Government benefit if they cheat in terms of reporting actual emissions, whereas a tax on carbon, if such a system 

were in place, is a zero sum game because the Government has 

quite a bit of interest in getting the tax revenue from the company. 

So a tax tends to build in some incentives for keeping the system 

honest, a tax system does. 

Another point that some of the previous witnesses have talked 

quite a bit about, the European emissions trading system. In my 

testimony, I have several charts showing that right now the European Environmental Agency shows that the EU–15 who have a target of 8 percent below 1990 levels are not on track to meet that. 

So by 2012, they will not have met their 8 percent reduction. They 

are projected to be 7 percent above 1990 levels. So without strong 

new measures, the EEA says they are not going to meet their target. 

The EU–12, the 12 new member States, have because of their 

economic collapse after the 1990’s, have reduced emissions by about 

27 percent, but that is due to economic collapse and it is to be 

hoped that situation will not continue. So I think looking at the EU 

emission trading system as an effective mechanism for reducing 

greenhouse gases is not necessarily accurate. 

Looking in general at mandatory systems as opposed to voluntary approaches to reducing greenhouse gas emissions, in the 
50 

U.S. with our growing population, a fixed cap on emissions will inevitably collide with our population growth. Europe is not really 

growing in terms of population and they are still having trouble 

meeting their emission cap. 

In addition, if we adopt caps here without involving China and 

India, they will have every incentive to accelerate their development of energy-intensive industries because, of course, of the price 

advantage that they would enjoy. 

With respect to some of the plans that were discussed earlier in 

terms of trying to monitor what type of a carbon content is coming 

in with, say, Chinese or Indian goods so that we could try to be 

sure that under the regime that was discussed earlier that China 

and India were complying, it strikes me as a very difficult challenge because right now we can’t even control the pet food or the 

toothpaste that comes in from places like China. To think that Government regulators would be able to ascertain with any accuracy 

that the products coming in from India and China and other developing countries have a certain carbon content just strikes me as 

highly unrealistic. 

Last, to look at strategies that I think I would urge our policymakers to look at as they try to reduce not only greenhouse gas 

emissions in the U.S., but also abroad, we really have to put more 

effort into carbon capture and storage. Some of the previous witnesses made that case. It is not technologically cost effective right 

know, but with hope and research in time that will be a powerful 

force that will enable us to burn coal without damaging the atmosphere. We probably should spend more than we do on renewables. 

We probably will have to rely more on nuclear power for electricity 

generation. 

U.S. policymakers should also take a look at the tax code. The 

ACCF just released a study by Ernst and Young comparing capital 

cost recovery allowances for 11 different energy assets across 12 

countries: China, India, Brazil, Germany, the U.S., et cetera. That 

table is in my testimony. It shows that for investment in combined 

heat and power, we have the worst cost recovery practically in the 

world—29 cents after 5 years, versus much higher returns in other 

countries. Smart meters, which we need to increase efficiency, 

again, we are about the worst in the world. In fact, if you look at 

that table, we are the worst in the world in terms of capital cost 

recovery for energy investment, almost without exception. We also 

have the highest effective tax rates on these new investments. So 

I would urge our policymakers to take a look at how the tax code 

could be used to incentivize the kind of investments that we need. 

Last, and I realize I am out of time, but last if we could build 

on what we already have here in the U.S. which is international 

partnerships. The Asia Pacific partnership has made a start at encouraging the reforms in developing countries that would enable 

technology to flow to them at a higher rate. The Administration, 

I understand, is working to expand that group. The G–8 meeting 

is looking at involving the top 15 emitters in the world in technology transfer and reforms. 

If we could continue to focus on encouraging the technology 

transfer that would enable China and India to modernize their capital stock. There is a table in my testimony that shows that they 
51 

1The mission of the American Council for Capital Formation is to promote economic growth 

through sound tax, environmental, and trade policies. For more information about the Council 

or for copies of this testimony, please contact the ACCF, 1750 K Street, N.W., Suite 400, Washington, DC. 20006—2302; telephone: 202.293.5811; fax: 202.785.8165; e-mail: info@accf.org; 

website: www.accf.org 

are four times less energy efficient than we are. So modernizing 

their capital stock could go a long way toward reducing the global 

growth in greenhouse gas emissions. 

So I think we need a variety of approaches. I would encourage 

policymakers to take a look at the positive impact that economic 

growth itself can have on environmental protection, and also will 

give us the resources we need to reduce global energy poverty and 

promote energy security. 

Thank you. 

[The prepared statement of Ms. Thorning follows:] 

STATEMENT OF MARGO THORNING, SENIOR VICE PRESIDENT AND CHIEF ECONOMIST. AMERICAN COUNCIL FOR CAPITAL FORMATION

INTRODUCTION: 

Mr. Chairman and members of the Senate Committee on Environment and Public 

Works Subcommittee on Sector and Consumer Solutions to Global Warming and 

Wildlife Protection, my name is Margo Thorning, senior vice president and chief 

economist, American Council for Capital Formation (ACCF)1, Washington, DC. I am 

pleased to present this testimony to the Subcommittee. 

The American Council for Capital Formation represents a broad cross-section of 

the American business community, including the manufacturing and financial sectors, Fortune 500 companies and smaller firms, investors, and associations from all 

sectors of the economy. Our distinguished board of directors includes cabinet members of prior Republican and Democratic administrations, former Members of Congress, prominent business leaders, and public finance and environmental policy experts. The ACCF is celebrating over 30 years of leadership in advocating tax, regulatory, environmental, and trade policies to increase U.S. economic growth and environmental quality. 

SECURITY OF ENERGY SUPPLIES, ECONOMIC GROWTH AND

ENVIRONMENTAL PROTECTION

High energy prices in recent years have drawn policymakers’ attention to the key 

role that energy plays in maintaining strong economic growth. In the United States, 

each 1 percent increase in Gross Domestic Product (GDP) is accompanied by approximately a 0.3 percent increase in energy use. Security of energy supplies and 

protection for the environment are two important policy goals on which developed 

countries have focused significant amounts of time and money in recent years. Since 

energy use goes hand-in-hand with economic development, many experts think increasing the supply of clean energy for the poor, many of whom live on less than 

a dollar per day, should be a top priority as well. As Fatih Birol, Chief Economist 

of the International Energy Agency, noted in a recent article in The Energy Journal, 

(Volume 28, Number 3, 2007), policymakers have devoted considerable time and resources to the goals of energy security and environmental protection while the need 

of the world’s poor for clean energy has received much less attention. 

My testimony attempts to put these three policy objectives in perspective and suggests ways to move forward on all three fronts. The testimony also reviews the effectiveness of current policies in the European Union and in the United States in reducing greenhouse gas emissions (GHGs) and reviews mandatory and voluntary policy options to reduce the threat of human-induced climate change. 

A REALITY CHECK ON TRENDS IN ENERGY USE AND CARBON

EMISSIONS

• Energy Use 

Globally, fossil fuels will remain the dominant source of energy to 2030, absent 

sharp changes in consumption and technological breakthroughs, according to the 
52 

2006 International Energy Agency (IEA) report. The IEA report projects that global 

primary energy demand will increase by an average annual rate of 1.6 percent between now and 2030. 

Almost half of the increase in global primary energy use stems from generating 

electricity and one-fifth from meeting transport needs, almost entirely in the form 

of oil-based fuels. Coal will see the biggest increase in demand in absolute terms 

over the next two decades, driven mainly by power generation. China and India account for almost four-fifths of the incremental demand for coal. Coal will remain the 

second-largest primary fuel, its share in global demand increasing slightly. The 

share of natural gas also rises. Hydropower’s share of primary energy use rises 

slightly, while that of nuclear power falls. The share of biomass falls marginally, 

as developing countries increasingly switch to using modern commercial energy, offsetting the growing use of biomass as feedstock for biofuels production and for 

power and heat generation. Non-hydro renewables—including wind, solar and geothermal—grow quickest, but from a small base, the IEA report states. 

The IEA’s energy demand projections are similar to those in the new draft report 

by the National Petroleum Council (NPC). The NPC report notes that world energy 

demand has increased by about 60 percent over the past 20 5 years and most forecasts project a similar increase (from a much larger base) over the next twenty-five 

years. (Facing the Hard Truths about Energy, National Petroleum Council, July 18, 

2007.) • The Threat to the World’s Energy Security is Real and Growing 

Rising oil and gas demand, if unchecked, will accentuate the consuming countries’ 

vulnerability to a severe supply disruption and resulting price shock. OECD and developing Asian countries are projected to become increasingly dependent on imports 

as their indigenous production fails to keep pace with demand. Non-OPEC production of conventional crude oil and natural gas liquids is set to peak within a decade. 

By 2030, the OECD as a whole will import two-thirds of its oil needs in the IEA’s 

base case scenario compared with 56 percent today. Much of the additional imports 

come from the Middle East, along vulnerable maritime routes. The concentration of 

oil production in a small group of countries with large reserves—notably Middle 

East OPEC members and Russia—will increase their market dominance and their 

ability to impose higher prices. An increasing share of gas demand is also expected 

to be met by imports, via pipeline or in the form of liquefied natural gas from increasingly distant suppliers. The share of transport demand, which is relatively 

price-inelastic compared to other energy services, in global oil consumption is projected to rise. 

Oil prices still matter to the economic health of the global economy. Although 

most oil-importing economies around the world have continued to grow strongly 

since 2002, they would have grown even more rapidly had the price of oil and other 

forms of energy not increased. Most 

OECD countries have experienced a worsening of their current account balances, 

most obviously the United States. The recycling of petro-dollars may have helped 

to mitigate the increase in long-term interest rates, delaying the adverse impact on 

real incomes and output of higher energy prices. An oil-price shock caused by a sudden and severe supply disruption would be particularly damaging—for heavily indebted poor countries most of all. 

• Investment Needed to Promote Energy Security 

Meeting the worlds growing hunger for energy requires massive investment in energy-supply infrastructure, according to the IEA report. The IEA base case calls for 

cumulative global investment of just over $20 trillion (in 2005 dollars) over 2005— 

2030. The power sector accounts for 56 percent of total investment—or around twothirds if investment in the supply chain to meet the fuel needs of power stations— 

is included. Oil investment, three-quarters of which goes to the upstream, amounts 

to over $4 trillion in total over 2005 030. But the impact on new capacity of higher 

spending is being blunted by rising costs. Expressed in cost inflation-adjusted terms, 

investment in 2005 was only 5 percent above that in 2000. Planned upstream investment to 2010 is expected to slightly boost global spare capacity. Beyond the current decade, higher investment in real terms will be needed to maintain growth in 

upstream and downstream capacity. 

Energy investment needs in the U.S. are also quite large. For example, the electric utility sector will need to invest approximately $412 billion dollars over the next 

twenty-five years to meet rising demand. (U.S. Department of Energy, Energy Information Administration, Annual Energy Outlook, February, 2007). 

• Impact of Global Energy Demand on Carbon Dioxide Emissions 

Global energy-related carbon-dioxide (CO2 ) emissions will increase by 55 percent 

between 2004 and 2030, or 1.7 percent per year, in the IEA’s base case scenario. 

Power generation contributes half of the increase in global emissions over the pro-
53 

jection period. Coal overtook oil in 2003 as the leading contributor to global energyrelated CO2 emissions and consolidates this position through to 2030. Developing 

countries account for over three-quarters of the increase in global CO2 emissions between 2004 and 2030 in the base case scenario (See Figure 1) . They overtake the 

OECD as the biggest emitter around 2010. The share of developing countries in 

world emissions rises from 39 percent in 2004 to over one-half by 2030. This increase is faster than that of their share in energy demand, because their incremental energy use is more carbon-intensive than that of the OECD and transition 

economies. In general, the developing countries use proportionately more coal and 

less gas. 

China alone is responsible for about 39 percent of the rise in global emissions. 

China’s emissions more than double between 2004 and 2030, driven by strong economic growth and heavy reliance on coal in power generation and industry, according to the IEA. In fact, China’s CO2 emissions in 2006 were 8 percent larger than 

those of the United States, according to a new report by the Netherlands Environmental Assessment Agency report. (Netherlands Environmental Assessment Agency 

(June 22, 2007). Other Asian countries, notably India, also contribute heavily to the 

increase in global emissions. The economies and population of developing countries 

will grow much faster than those of the OECD countries, shifting the center of gravity of global energy demand and carbon emissions. 

• Bringing Modern Energy to the World’s Poor Is an Urgent Necessity 

Although the IEA projects steady progress in expanding the use of modern household energy services in developing countries, many people will still depend on traditional biomass in 2030. Today, 2.5 billion people use wood, charcoal, agricultural 

waste and animal dung to meet most of their daily energy needs for cooking and 

heating. In many countries, these resources account for over 90 percent of total 

household energy consumption. 

The inefficient and unsustainable use of biomass has severe consequences for 

health, the environment and economic development. Shockingly, about 1.3 million 

people—mostly women and children—die prematurely every year because of exposure to indoor air pollution from biomass. The data show that in countries where 

local prices have adjusted to recent high international energy prices, the shift to 

cleaner, more efficient ways of cooking has actually slowed and even reversed. In 

the IEA’s base case scenario, the number of people using biomass increases to 2.6 

billion by 2015 and to 2.7 billion by 2030 as population rises. That is, one-third of 

the world’s population will still be relying on these fuels in 2030, a share barely 

smaller than today, and there will still be 1.4 billion people in the world without 

electricity. Action to encourage more efficient and sustainable use of traditional biomass and help people switch to modern cooking fuels and technologies is needed urgently. According to Dr. Birol, providing LPG cylinders and stoves to all the people 

who currently still use biomass for cooking would boost world oil demand by a mere 

1 percent and cost at most $18 billion a year. The value of the improvements to so-
54 

cial welfare, including saving 1.3 million lives each year, is surely worth the cost, 

he notes. Vigorous and concerted Government action, with support from the industrialized countries, is needed to achieve this target, together with increased funding 

from both public and private sources, he concludes. 

PROS AND CONS OF MANDATORY GREENHOUSE GAS EMISSION

REDUCTION PROGRAMS

• Cap and Trade Systems versus a Carbon Tax 

As a recent paper by Ian Perry of Resources for the Future observes, there is considerable interest in the U.S. Congress in mandating reductions in U.S. greenhouse 

gas emissions. (Weathervane, March 23, 2007). He notes that as a result of the success of the U.S. sulfur dioxide trading program and the startup of the European 

Union’s Emission Trading System, many in Congress have expressed support for a 

cap and trade system in the U.S. Perry cautions however, that other options, such 

as tax on carbon emissions may be a superior instrument if a mandatory Federal 

carbon emission program were to be established. 

A cap and trade system puts an absolute restriction on the quantity of emissions 

allowed (i.e., the cap) and allows the price of emissions to adjust to the marginal 

abatement cost (i.e., the cost of controlling a unit of emissions). A carbon tax, in contrast, sets a price for a ton of emissions and allows the quantity of emissions to adjust to the level at which marginal abatement cost is equal to the level of the tax. • Pros and Cons of a Cap and Trade System compared to a Carbon Tax 

Price volatility for a permit to emit CO2 can arise under a cap and trade program 

because the supply of permits is fixed by the Government, but the demand for permits may vary considerably year to year with changes in fuel prices and the demand 

for energy. As mentioned above, price volatility for energy has negative impacts on 

economic growth. In contrast, a CO2 tax fixes the price of CO2, allowing the amount 

of emissions to vary with prevailing economic conditions. 

For example, in the EU the price of a permit to emit a ton of carbon has varied 

by 17.5 percent per month over the first 22 months’ operation of the ETS. As a new 

study by Dr. Michael Canes, senior research fellow at LMI, points out, volatility in 

fossil energy prices have strong adverse impacts on U.S. economic growth. Even a 

reduction in the rate of growth from such a shock of as little as 0.1 percent per year 

implies costs of over $13 billion per year. (Why a Cap &Trade is the Wrong Policy 

to Curb Greenhouse Gases for the United States, The Marshall Institute, July, 

2007). 

In addition, studies have shown that under a cap and trade program which gives 

away (rather than auctioning the permits) can be highly inequitable; the reason is 

that firms receiving allowances reap windfall profits, which ultimately accrue to individual stockholders, who are concentrated in relatively high-income group. 

Furthermore, it makes economic sense to allow nationwide emissions to vary on 

a year-to-year basis because prevailing economic conditions affect the costs of emissions abatement. This flexibility occurs under a CO2 tax because firms can choose 

to abate less and pay more tax in periods when abatement costs are unusually high, 

and vice versa in periods when abatement costs are low. Traditional permit systems 

do not provide similar flexibility because the cap on economy wide emissions has 

to be met, whatever the prevailing abatement cost. 

Regardless of how the allowances were distributed (unless they were all auctioned 

and the proceeds rebated to low income households), most of the cost of meeting a 

cap on CO2 emissions would be borne by consumers, who would face persistently 

higher prices for products such as electricity and gasoline. Those price increases 

would be regressive in that poorer households would bear a larger burden relative 

to their income than wealthier households would. In addition, workers and investors 

in parts of the energy sector—such as the coal industry—and in various energy-intensive industries would be likely to experience losses as the economy adjusted to 

the emission cap and production of those industries’ goods declined. (congressional 

Budge Office, Economic and Budget Issue Brief, April 25, 2007.) In contrast, carbon 

tax revenues could be rebated to low income individuals to offset the impact of higher energy prices caused by the tax on fossil fuels. 

Finally, caps on U.S. emission growth are unlikely to succeed unless all the relevant markets exist (in both developed and developing countries) and operate effectively. All the important actions by the private sector have to be motivated by price 

expectations far in the future. Creating that motivation requires that emission trading establish not only current but future prices, and create a confident expectation 

that those prices will be high enough to justify the current R&D and investment 

expenditures required to make a difference. Motivating new investment requires 

that clear, enforceable property rights in emissions be defined far into the future 
55 

so that emission rates for 2030, for example, can be traded today in confidence that 

they will be valid and enforceable on that future date. The EU’s experience over the 

last 2 years, with the price of CO2 emission credits fluctuating between 1 and 30 

euros per ton of CO2 does not inspire confidence in companies having to make investment decisions. The international framework for climate policy that has been 

created under the UNFCCC and the Kyoto Protocol cannot create that confidence 

for investors because sovereign nations have different needs and values. 

A carbon tax, as a system of inducing emissions reductions, is not without drawbacks. First, revenues from a CO2 tax (or auctioned permits) might end up being 

wasted; for example, if the revenue went toward special interests, rather than substituting for other taxes. Second, progress on emissions reductions is uncertain 

under a CO2 tax because emissions vary from year to year with economic conditions. • European Union Greenhouse Gas Emissions: Myths and Reality 

As we attempt to balance the sometimes conflicting goals of energy security, environmental protection and energy poverty reduction it is useful to examine the costeffectiveness of current policies to reduce GHG emissions in developed countries. In 

the European Union, reduction of GHGs has become a major policy goal and billions 

of Euros, from both the private and the public sector, have been spent on this policy 

objective. Many policymakers, the media and the public believe that the European 

Union’s Emission Trading System (ETS) has produced reductions in GHG emissions 

and that their system could serve as a model for the U.S. The ETS, created in 2005, 

is a market-based, EU-wide system that allows countries to ‘‘trade’’ (i.e., buy and 

sell) permits to emit CO2. The ETS covers about 12,000 installations and approximately 40 percent of EU CO2 GHG emissions. 

The EU 15 (the major industrial countries) have a target of an 8 percent reduction 

in GHGs by 2010. As shown in Figure 2, CO2 emissions in the EU 15 have risen 

sharply since 1990. Overall emissions (including all 6 of the greenhouse gases) have 

held constant only because of one-time events like the collapse of industry in East 

Germany after the fall of the Berlin wall and the switch away from coal to gas. In 

2005, overall emissions were about 6 percent above the target. The main reason the 

ETS has not had much impact in reducing EU emissions is due to the fact that permits were ‘‘over allocated’’ to the approximately 12,000 industrial facilities covered 

by the system. 

The European Environmental Agency’s latest projections (October 2006) for the 

EU 15 show that without strong new measures, EU 15 emissions will be 7.4 percent 

above 1990 levels in 2010, rather than 8 percent below as required by the Kyoto 

Protocol. (See Figure 3). Further evidence of the challenge the EU faces in meeting 

its Kyoto Targets is found in a just released report by the European Commission 

showing that electricity consumption continues to rise. Over the 1999—2004 period, 

residential and commercial electricity consumption increased by 10.8 percent and in-
56 

dustrial electricity use rose by 6.6 percent in spite of numerous incentives to increase EU energy efficiency(Electricity Consumption and Efficiency Trends in the 

Enlarged European Union, Joint Research Centre, European Commission, July, 

2007). 

Now that the ETS has been operational for 2 years, industry and households are 

feeling some of the effects of the system, even though its overall impact on emission 

growth has been small. As the Washington Post reported in ‘‘Europe’s Problems 

Color U.S. Plans to Curb Carbon Gases’’ (April 9, 2007), the ETS has been a bureaucratic morass with a host of unexpected and costly side effects and a much smaller 

effect on carbon emissions than planned. 

Many companies complain that the ETS system is unfair. For example, Kollo 

Holding’s factory in the Netherlands, which makes silicon carbide, a material used 

as an industrial abrasive, is regarded by its managers as an ecological standout: the 

plant uses waste gases to generate energy and has installed the latest pollution-control equipment. But Europe’s program has driven electricity prices so high that the 

facility routinely shuts down for part of the day to reduce energy costs. Although 

demand for its products is strong, the plant has laid off 40 of its 130 employees and 

trimmed production. Two customers have turned to cheaper imports from China, 

which is not covered by Europe’s costly regulations, the Post reports. 

‘‘It’s crazy,’’ said Kusters, the plant director, as he stood among steaming black 

mounds of petroleum coke and sand in northern Holland. ‘‘We not only have the 

most energy-efficient plant in the world but also the most environmentally friendly.’’ 

Of all the effects of the new rules, the rise in the price of power has aroused the 

most outrage. Much of the anger of consumers and industries has been aimed at 

the continent’s utility companies. Like other firms, utilities were given slightly 

fewer allowances than they needed. Utilities in much of Europe charged customers 

for 100 percent of the tradable allowances they were given—even though the Government handed them out free. Electricity rates soared and environmentalists 

claimed that the utilities were garnering windfall profits. 

The chief executive of one utility, Vattenfall, which owns a coal plant that is one 

of the continent’s biggest carbon emitters, defended the decision. Lars G. Josefsson, 

who is also an adviser to German Chancellor Angela Merkel, said higher electricity 

prices are ‘‘the intent of the whole exercise. . . . If there were no effects, why 

should you have a cap-and-trade system?’’ 

An examination of the actual European emissions data, combined with anecdotal 

reports on its actual operation in the EU like those above, reinforce the idea that 

a cap and trade system is probably not an effective way to reduce GHG growth in 

the U.S. 

Further, several different economic analyses show that if the EU were to actually 

meet its emission reduction targets under the protocol, the economic costs would be 
57 

high. For example, macroeconomic analyses by Global Insight, Inc. show the cost of 

complying with Kyoto for major EU countries could range between 0.8 percent of 

GDP to over 3 percent in 2010. (See Figure 4) 

Levels under the Kyoto Protocol and under More Stringent Targets on Major Industrial Economies 

Source: International Council for Capital Formation ‘‘The Cost of the Kyoto Protocol: Moving Forward on Climate Change Policy While Preserving Economic 

Growth,’’ November, 2005, (www.iccfglobal.org) and unpublished estimates for the 

U.S. prepared by Global Insight, Inc. 

According to Global Insight, the reason for the significant economic cost is that 

energy prices, driven by the cost of cap/trade emission permits, have to rise sharply 

in order to curb demand and reduce GHG emissions. Tighter targets for the post2012 period will also be costly. For example, a target of reducing emissions to 60 

percent below 2000 levels of emissions in the year 2050 would cause losses ranging 

from 1.0 percent to 4.5 percent of GDP in 2020. (This target is less stringent than 

the post-2012 targets adopted by the European Commission in January, 2007.) Even 

the EU’s Commission for the Environment admits that emission reductions could 

cost as much as 1.3 percent of GDP by 2030. The fact that the European Environmental Agency projects that the EU 15 will be 7 percent above 1990 levels of emissions in 2010 (instead of 8 percent below) demonstrates that the mandatory ETS 

system as currently structured is not providing the desired results and that much 

stronger measures will be required to meet the Kyoto Protocol target as well as the 

new post-2012 target. 

CHALLENGES IN IMPLEMENTING A MANDATORY PROGRAM TO REDUCE

U.S. GREENHOUSE GAS EMISSIONS

Trying to reduce U.S. emissions through a cap and trade system or a carbon tax 

could have significant consequences for the U.S. economy, including reduced GDP 

and increased unemployment rates. For example, various economic models show 

that the imposition of the Kyoto Protocol (a target of reducing emissions to 7 percent 

below 1990 levels) would reduce U.S. GDP levels by 1 to 4.2 percent annually by 

2010. In addition, a fixed cap on emissions inevitably collides with U.S. population 
58 

growth. The EU—15 countries are having difficulty meeting their Kyoto targets and 

they have negligible population growth. In sharp contrast, U.S. population is projected to grow more than 20 percent over 2002—2025, according to the EIA. More 

people means more mouths to feed, more houses to warm, more factories to run, all 

of which require more energy and at least some additional GHG emissions. • Impact of a Cap and Trade System on Innovation 

Caps on emissions are not likely to promote new technology development because 

caps will force industry to divert resources to near-term, ‘‘end of pipe’’ solutions 

rather than promote spending for long-term technology innovations that will enable 

us to reduce GHGs and increase energy efficiency. An emission trading system will 

send exactly the wrong signals to investors because it will create uncertainty about 

the return on new investment. A ‘‘safety-valve’’ price of carbon (designed to create 

a sense of confidence about future energy costs) can easily be changed. Such uncertainty means that the hurdle rate, which new investments must meet, will be higher (thus less investment will occur) and they will be less willing to invest in the 

U.S. Now is the time to provide incentives for companies to voluntarily undertake 

additional carbon dioxide intensity reducing investments, rather than promoting a 

system that raises the risk premium for any investment in the United States. • Developing Countries Not Likely to Accept Emission Reduction Targets or Energy Taxes 

Many U.S. policymakers are aware that even if the U.S. were to adopt a cap and 

trade system or a carbon tax, it is unlikely that developing countries, where most 

of the future growth in emissions will occur, would decide to follow suit. In fact, if 

we adopt emission caps or carbon taxes, higher energy prices will make U.S. industry less competitive vis-a-vis China, India and other developing countries. As a result, China and India, whose primary focus is economic growth, will see it in their 

interest to accelerate the development of industries that depend on a competitive 

advantage in energy prices. As this process proceeds, it will be harder and harder 

for China and India to reverse course and undertake policies (emission caps or 

taxes) which threaten these industries. Adopting GHG caps or taxes in the U.S. will, 

therefore, have the perverse effect of creating disincentives for developing countries 

to curb emissions. In addition, because developing countries use much more energy 

per dollar of output than does the U.S., global carbon emissions could increase due 

to ‘‘leakage’’ of U.S. industry and jobs. 

STRATEGIES TO INCREASE ENERGY SECURITY AND REDUCE EMISSION

GROWTH AND ENERGY POVERTY

Increased energy security in the developed countries including the U. S. and the 

EU will depend on factors such as increased economic growth, energy efficiency, 

technology developments in both fossil fuels (carbon capture and storage, for example) and renewable fuels (wind and solar, in particular) and possibly increased reliance on nuclear power for electricity generation. However, in order to reduce the 

potential threat of global climate change, it will be necessary to increase energy efficiency and reduce the growth of greenhouse gas emissions in the developing world 

since that is where the strong growth in emissions is coming from. Reducing the 

extreme energy poverty in the world’s poorest nations will take a combination of 

technology transfer and public-private partnerships between wealthy nations and 

less developed countries. Making progress on all three objectives will require a significant commitment of resources, much of which will need to come from the private 

sector. • The Role of Economic Growth and Technology in GHG Reduction 

Many policymakers overlook the positive impact that economic growth can have 

on GHG emission reductions. For example, in 2006, while the U.S. economy grew 

at 3.3 percent, CO2 emissions fell to 5,877 MMT CO2 , down from 5,955 MMT CO2

in 2005, a 1.3 percent decrease. Overall energy use only declined by 0.9 percent, indicating the U.S. economy is becoming less carbon intensive even without mandatory emission caps. 

Internationally, the U.S. compares well in terms of reducing its energy intensity 

(the amount of energy used to produce a dollar of output). The U.S., with its voluntary approach to emission reductions, has cut its energy intensity by 20 percent 

over the 1992—2004 period compared to only 11.5 percent in the EU with its mandatory approach (see Figure 5). Strong U.S. economic growth, which averaged over 

3 percent per year from 1992 to 2005 compared to about 1 percent in the EU, is 

responsible for the U.S.’s more rapid reduction in energy intensity in recent years. 

Technology development and deployment offers the most efficient and effective 

way to reduce GHG emissions and a strong economy tends to pull through capital 

investment faster. There are only two ways to reduce CO2 emissions from fossil fuel 
59 

use—use less fossil fuel or develop technologies to use energy more efficiently to 

capture emissions or to substitute for fossil energy. There is an abundance of economic literature demonstrating the relationship between energy use and economic 

growth, as well as the negative impacts of curtailing energy use. Over the long-term, 

new technologies offer the most promise for affecting GHG emission rates and atmospheric concentration levels. 

• Accelerating the Uptake of New Technology by Private as Well as Nonprofit Entities. 

The development of various high technology programs can be accelerated through 

Government programs as well as by encouraging private sector investment. For example, some policies may be of particular help to taxable entities while others would 

be of more benefit to cooperatives (which pay little or no Federal income tax). 

Companies Subject to the Federal Income Tax 

The efforts of U.S. industries to increase energy security and efficiency and to reduce growth in GHG emissions are hindered by the slow rate of capital cost recovery 

allowed under the U.S. Federal tax code and by the high U.S. corporate tax rate. 

As a new Ernst&Young international comparison shows, the U.S. ranks last or 

nearly last among our trading partners in terms of how quickly a dollar of investment is recovered for many key energy investments. For example, a U.S. company 

gets only 29.5.cents back through depreciation allowances for each dollar invested 

after 5 years for a combined heat and power project (see Table 1). In contrast, in 

China the investor gets 39.8 cents back, in Japan, 49.7 cents, in India, 55.6 cents 

and in Canada the investor gets 79.6 cents back after 5 years for every dollar invested. (See full report at: http://www.accf.org/pdf/Energy-Depreciation-Comparison.pdf.) 

In addition to slow capital cost recovery allowances, U.S. industry faces the highest corporate income tax rates among our primary trading partners. Of the 12 countries in the E&Y survey, only Japan had a higher corporate tax rate than the U.S. 

Reforms to the U.S. tax code to speed up capital cost recovery allowances and reduce 

the corporate tax rate would reduce the cost of capital and could have a positive 

impact on energy sector investment, help ‘‘pull through’’ cleaner, less emitting new 

technology, increase energy efficiency and promote U.S. industrial competitiveness. 
60 
61 

Non-Taxable Entities 

For non-taxable entities such as electric utility cooperatives other incentives could 

be provided to encourage the more rapid adoption of new technologies to reduce 

GHG emissions. For example, electric cooperatives and their consumers cannot 

apply or benefit from traditional tax incentives because as not-for-profit utilities, 

they do not have significant Federal income tax liability to offset. However, to ensure that the not-for-profit electric utility sector is able to participate in incentives 

for advanced low carbon technologies, incentives comparable to those offered to for 

profit entities can be created. One example is the successful Clean Renewable Energy Bond program that permits electric cooperatives and others to issue bonds that 

act as interest-free loans for the purpose of building qualified renewable generation. 

The CREB program can be adapted for other technologies that achieve carbon reduction goals.’’ Grants are another avenue to assist not-for-profits in adopting new 

technology. 

• The Role of International Partnerships in Promoting Institutional Change and 

Favorable Investment Climate in Developing Countries 

New research by Dr. David Montgomery and Sugandha Tuladhar of CRA International makes the case that agreements such as the Asia-Pacific Partnership on 

Clean Development and Climate (AP6), an agreement signed in 2005 by India, 

China, South Korea, Japan, Australia and the United States, offers an approach to 

climate change policy that can reconcile the objectives of economic growth and environmental improvement for developing countries. (See www.iccfglobal.org for the full 

paper.) Together, the AP6 partners have 45 percent of the world’s population and 

emit 50 percent of man-made CO2 emissions. The projections of very strong growth 

in greenhouse gases in developing countries over the next 20 years mean that there 

is enormous potential for reducing emissions through market-based mechanisms for 

technology transfer. 

Dr. Montgomery and Tuladhar note that there are several critical factors for ensuring the success of an international agreement which relies strongly on private 

sector investment for success. Their research shows that institutional reform is a 

critical issue for the AP6, because the lack of a market-oriented investment climate 

is a principal obstacle to reducing greenhouse gas emissions in China, India and 

other Asian economies. China and India have both started the process of creating 

market-based economic systems, with clear benefits in the form of increased rates 

of economic growth. But the reform process has been slow and halting, leaving in 

place substantial institutional barriers to technological change, productivity growth, 

and improvements in emissions. The World Bank and other institutions have carried out extensive investigations about the role of specific institutions in creating 

a positive investment climate. These include minimizing corruption and regulatory 

burdens, establishing an effective rule of law, recognition of intellectual property 

rights, reducing the role of Government in the economy, removing energy price distortions, providing an adequate infrastructure and an educated and motivated labor 

force. 

• Quantifying the Importance of Technology Transfer for Emission Reductions 

As described above, technology is critically important because emissions per dollar 

of income are far larger in developing countries than in the United States or other 

industrial countries. This is both a challenge and an opportunity. It is a challenge 

because it is the high emissions intensity—and relatively slow or non-existent improvement in emissions intensity—that is behind the high rate of growth in developing country emissions. 

Opportunities exist because the technology of energy use in developing countries 

embodies far higher emissions per dollar of output than does technology used in the 

United States; this is true of new investment in countries like China and India as 

well as their installed base (See Figure 6.) The technology embodied in the installed 

base of capital equipment in China produces emissions at about four times the rate 

of technology in use in the United States. China’s emissions intensity is improving 

rapidly, but even so its new investment embodies technology with twice the emissions intensity of new investment in the United States. India is making almost no 

improvement in its emissions intensity, with the installed base and new investment 

having very similar emissions intensity. India’s new investment also embodies technology with twice the emissions intensity of new investment in the United States. 
62 

CRAI calculations show that emission reductions can be achieved by closing the 

technology gap. The potential from bringing the emissions intensity of developing 

countries up to that currently associated with new investment in the United States 

is comparable to what could be achieved by the Kyoto Protocol. (See Table 2.) These 

are near-term opportunities from changing the nature of current investment and accelerating replacement of the existing capital stock. Moreover, if achieved through 

transfer of economic technologies it is likely that these emission reductions will be 

accompanied by overall economic benefits for the countries involved. 

In the first example in Table 2, the CRAI study assumed that in 2005 new investment in China and India immediately moves to the level of technology observed in 

the United States, and calculates the resulting reduction in cumulative carbon emissions through 2012 and 2017. This is the technology transfer case. In the second 

case, the CRAI analysis assumes that policies to stimulate foreign direct investment 

accelerate the replacement of the oldest capital with new equipment, giving even 

larger savings. In the third case, the assumption is that the new technology continues to improve over time, as it will if policies to stimulate R&D into less emissions-intensive technologies are also put in place. Even the least aggressive of these 
63 

policies has potential for emissions reductions comparable to those that would be 

possible if all countries (including the U.S.) achieved exactly the emission reductions 

required to meet their Kyoto Protocol targets. 

• Strategies for Promoting Institutional Change 

Although it is clear that there is a relationship between institutions, economic 

growth, and greenhouse gas emissions, there is no general formula that can be applied to identify the specific institutional failures responsible for high emissions per 

unit of output in a specific country. If there is to be progress on institutional reform, 

at a minimum the key actors or stakeholders—concerned businesses, other groups 

with influence on opinion and policy in China, India and other developing countries 

(including local and regional Governments), and national Governments—must agree 

on the nature and scope of the problems and on reforms required to address the 

problems and identify concrete actions that each Government will take to bring 

about institutional reforms. 

For example, making progress on implementing the AP6 can be accelerated if the 

Governments of Australia, Japan and the United States would fund research on topics such as the investment climate, the level of technology embodied in new investment, the role of foreign direct investment and potential energy savings from technology transfer, and the nature and impacts of pricing distortions on energy supply, 

demand and greenhouse gas emissions in China and India. Government support for 

research to make clear the direct consequences of proposed reforms for energy efficiency and the benefits of a market based investment climate for the overall process 

of economic growth would also be helpful. 

• Broadening the International Partnership to Include all Major Emitters 

At the recent G—8 Summit in Germany, policymakers agreed to take a series of 

steps toward GHG reductions. Recognizing that 85 percent of all emissions come 

from about 15 countries, G—8 leaders agreed convene the major energy consuming 

countries to agree on a new international framework by the end of 2008. The leaders agreed to work toward a long-term global goal for reducing GHGs and to accelerate the development and deployment of clean energy technologies. They also 

agreed to work toward the reduction and/or elimination of tariff and non-tariff barriers to environmental goods and services through the WTO Doha negotiations. 

Other points of agreement included developing and implementing national energy 

efficiency programs and advancing international energy efficiency cooperation as 

well as pursuing joint efforts in key sectors such as sustainable forestry, power generation, transportation, industry, and buildings. Finally, they agreed to enhance cooperation with developing countries to adapt to climate change. 

CONCLUSIONS

To be successful, international partnerships will need to bring forth a sufficient 

set of offers from each country to bring about meaningful changes in institutions 

with significant and quantifiable effects on greenhouse gas emissions. These offers 

would be embodied in an agreement on actions to be taken by all parties, and a 

framework under which actions would be monitored and additional steps could be 

agreed. This is the place where the current efforts of the AP6 partnership’s 

taskforces on clean fossil energy, renewable energy and distributed generation, 

power generation and transmission, steel, aluminum, cement, coal mining and 

building and appliances to identify technologies and investments that have profit 

potential and could also reduce emissions would become most useful. These investments would become in a way the reward to China and India for progress on institutional reform. The voluntary nature of private sector actions in the AP6 underscores 

the need for institutional reform to turn these potentially profitable investments 

into real projects. 

The Marshall Plan is a good example of such a process. After World War II, Europe pledged various actions with the money provided by the U.S. and, when it 

made good on those pledges, the program was extended and broadened. Exactly the 

same could be undertaken by the members of the Asia Pacific Partnership. Future 

actions by Australia, Japan and the United States desired by China and India 

would be contingent on success in implementing near term reforms agreed in the 

process. 

The recent G—8 agreement suggests that developed countries are moving closer 

to achieving a consensus on how to reduce global GHG growth in a more cost-effective way than that embodied in the Kyoto Protocol. Extending the framework of the 

AP6 to other major emitters will allow developed countries to focus their efforts 

where they will get the largest return, in terms of emission reductions for the least 

cost. By focusing on the key emitters, developed countries may find they have more 
64 

resources for promoting both energy security of supply and reducing global energy 

poverty. 

Finally, if the United States does adopt a mandatory greenhouse gas emissions 

reduction program, serious consideration should be given to implementing a carbon 

tax rather than an EU style cap and trade system. A key component of any mandatory U.S. program should be allowing emissions to increase as both economic growth 

and U.S. population increase. 

Senator LIEBERMAN. Thank you, Doctor. Thanks very much for 

your testimony. 

We will have rounds of questions now of 7 minutes for each 

member. 

Mr. Profeta, let’s see if we can turn some of what you have said 

about the proposal that was made by Senator Warner and others 

this morning into fact situations to help us understand it. I have 

been calling it an emergency off-ramp system. Is that what you all 

call it? 

Mr. PROFETA. I think actually the naming rights are still out 

there. It is really an economic protection proposal to allow an offramp of some sort if we really have bad economic effects. So maybe 

we could change the title. 

Senator LIEBERMAN. OK. You didn’t want to see whether JP Morgan Chase or Shell wanted to make an initial bid for naming 

rights? 

Mr. PROFETA. JP Morgan? We will have to talk later. 

Senator LIEBERMAN. OK. 

Let’s just talk about what are the kinds of emergencies? We hope 

that this all works, but this is really aimed at creating a mechanism complying with a law that causes real economic dislocation. 

Right? 

Mr. PROFETA. Yes. 

Senator LIEBERMAN. I don’t like to think of worst case scenarios, 

but what is one of them that might occur? 

Mr. PROFETA. If the board decided that there was sufficient economic dislocation, if something was happening in terms of energy 

prices were spiking to a level that was unacceptable that low-income consumers couldn’t handle even with the provisions in the 

bill—— 

Senator LIEBERMAN. Would it have to be as a result of the law? 

Mr. PROFETA. Yes. 

Senator LIEBERMAN. OK. 

Mr. PROFETA. A result of the greenhouse gas reduction program. 

The board would have the authority then to go in and change the 

borrowing rates to allow a lot more flexibility. 

Senator LIEBERMAN. The borrowing on the allowances? 

Mr. PROFETA. On the firm level borrowing. I think a better example, frankly, would be if a technology wasn’t penetrating quickly 

enough; if carbon cap sequestration wasn’t coming in as we hoped 

and we think there is a little more time necessary, the board could 

go in and change each firm’s level of borrowing rights, so now years 

in the future they could borrow at an interest rate at which they 

could pay back to make it a little easier for them to borrow from 

the future, but really in the law of supply and demand, bring more 

supply of future credits into the market and allow them to have 

lower costs of compliance. 
65 

Senator LIEBERMAN. OK. So a key component of what you are 

proposing is to set up this board, and the board would make judgments that are based on fact, but which are judgments at the moment, as opposed to the so-called safety valve provision which is in 

the Bingaman-Specter bill, which sets a price beforehand, and 

when you hit that price—— 

Why don’t you talk a little bit about comparing the two, and why 

the proposal you have made for emergency off-ramps is preferable. 

Mr. PROFETA. Let me go back to what I said in my testimony. 

The safety valve tries to know the unknowable. We don’t know 

what the effect of a certain price anywhere would be. We need to 

make sure that there is a long-term investment, a desire to invest 

in technologies. Now, if the safety valve sets a price where it 

wasn’t—— 

Senator LIEBERMAN. The price is set in the legislation. 

Mr. PROFETA. It is set in the legislation. 

Senator LIEBERMAN. And that is? 

Mr. PROFETA. In the Bingaman-Specter, it is $12 rising. 

Senator LIEBERMAN. It is $12 per? 

Mr. PROFETA. Per tonnage of carbon dioxide equivalent. 

Senator LIEBERMAN. OK. 

Mr. PROFETA. If you set that safety valve at a level that isn’t sufficiently high to encourage the investment in something like CCS, 

which we have heard here by the EPA. 

Senator LIEBERMAN. CCS, for the record? 

Mr. PROFETA. Carbon capture and storage. 

Senator LIEBERMAN. Right. 

Mr. PROFETA. Which we have heard here where EPA announced 

that it is absolutely essential for us to be able to address our climate situation. Then the investment won’t flow now in anticipation 

of higher costs in the future to develop the technology. Our proposal allows that investment to flow now and if that doesn’t happen as fast, and we can’t know how well that will happen, but if 

it isn’t happening as fast and it is creating economic harm, the 

oversight board in the future will have the discretion to change 

these levers on the market to make it a little bit more permissive 

to borrow from the future and thus make it a little easier to comply 

and allow the transition time, that bridge time between the imposition of the program and the penetration of technologies like carbon 

cap sequestration. It allows that time to move back and forth a little bit if it proves to be a harder lift than we think for our economy. 

Senator LIEBERMAN. OK. So I can understand why you chose not 

to embrace the so-called safety valve price pre-set in the statute 

and hard to imagine all the circumstances that might arise. But 

most significantly, the pre-set price totally makes it not a market 

system and probably inhibits the investment of the money necessary. It eliminates the certainty and the range necessary for the 

money to be invested to really have the technological solutions. 

What are the standards your proposal sets for the oversight 

board? In other words, it has the benefit of flexibility and it encourages all the market activity that we think is the best solution here. 

But does it have any standards that you would set in your proposal? 
66 

Mr. PROFETA. The standard longer term is just the avoidance of 

significant economic harm. 

Senator LIEBERMAN. OK. 

Mr. PROFETA. I think from the four offices’ standpoint, this is an 

opening proposal and they are willing to look at whether that 

standard can be tightened up a bit. In the short term, it looks to 

the economic modeling data that is out there when the bill passes 

and says if it is above the high end of that range, that is the economic harm, so it triggers some automatic reliefs, and that is only 

for the first 2 years. But the offices really wanted to create some 

certainty that there would be relief if we were outside the bounds 

of what was predicted in terms of costs. 

Senator LIEBERMAN. Right. 

Mr. PROFETA. Beyond that first initial period, the discussion really falls to the board. But the hope is that the board will have 

learned the market well enough by then to realize what market 

and what price points it needs to avoid reaching in the market. 

Senator LIEBERMAN. OK. With your indulgence, Senator, I just 

want to ask another related question. I would ask Ms. Masters or 

Mr. Edward, based on the international experience of your two 

companies, for instance, how, if at all, has the EU dealt with this 

problem? On their trading systems as they exist now, are there 

safety valves? Is there an emergency off-ramp? Or have they not 

dealt with it at all at this point? 

Mr. Edward? 

Mr. EDWARD. Sure. Thank you, sir. To be clear, there is no safety 

valve or price cap per se at all. What there is access to international markets. So there is a specific authorization by the EU for 

regulated companies to use credits from outside of the EU for compliance. 

Senator LIEBERMAN. Right. 

Mr. EDWARD. So their view would be that it is an increased 

source of supply which will lead to lower prices, rather than an 

interventionist price cap per se. 

Senator LIEBERMAN. Ms. Masters? 

Ms. MASTERS. I think the other point to note is that the EU 

framework had a trial run, if you will, in the pre-2008 period, 

which was intended among other things to be used as a period in 

which adjustments occurred and lessons were learned about not 

only market behavior, but costs of technology and so on. I think 

what is terrific about that is that we have the opportunity to learn 

from that experience here, in addition to European standards improving as a result of that. 

There was an instance of a significant price adjustment in 2006 

in the EU ETS scheme where essentially the baselines or the starting points were proven to be incorrect, resulting in a large downward price adjustment, which I don’t think generally speaking is 

the primary source of concern in this debate. People are generally 

concerned about upward price spikes that could increase costs. 

But in that case, that is the kind of situation that I think Tim’s 

proposal contemplates, which is where something that was previously assumed to be facts—what is the baseline, what is the 

starting point for allowances—turns out to have been erroneously 

established. That, to my mind, would be the type of situation in 
67 

which it might make sense to have some kind of regulatory body 

able to make adjustments to an overall framework. I think the type 

of subjective judgment that, for example, $30 per son is too high, 

is a very slippery slope to head down and could easily be politicized 

and have all of the adverse consequences that both Garth and I 

have referred to. 

Senator LIEBERMAN. Good point. Thank you very much. 

Senator Warner? 

Senator WARNER. If you would tell me a little bit, I started late 

as a lawyer, looked at a Federal circuit judge, and then into a large 

U.S. Attorneys office for 5 years, trying many cases of white collar 

problems. That experience is still with me. I am concerned that as 

we move forward, we have to figure out how to do it. As we move 

forward, and I address this to Blythe Masters and Mr. Edward, 

what do we do to ensure that these markets are not fraudulently 

manipulated? People posture themselves with all the types of 

things that go on. In the extraordinary experience that each of you 

have, what has been the system that prevent this? Perhaps it occurs, but certainly it hasn’t been brought to the attention of the 

public, to my knowledge. How do you work this thing? Is it an 

honor system like we had in my college? 

Ms. MASTERS. I think just a point of clarification, which is that 

in arguing against a safety valve involving a specific price cap, we 

are certainly not arguing that these markets should be unregulated 

altogether. On the contrary, as you point out, there is significant 

risk of cheating or fraudulent behavior by virtue of the fact that 

it is difficult to verify the existence of an otherwise invisible substance. 

The best way in which to achieve an orderly market is to ensure 

that there are oversight mechanisms, and in particular a body or 

forum which establishes standards that can subsequently be independently verified. Indeed, the EU mechanism has achieved just 

that. There are essentially two broad categories of carbon markets 

that exist today. One is compliance markets, which the EU ETS 

scheme is one. The other are the voluntary carbon markets where 

certain corporations or individuals have chosen to use offsets 

against their activity purely for voluntary reasons. 

There have been some instances of fraud, not significant, but 

there are instances of involuntary carbon markets which don’t have 

the same standards of verification that the European ETS mechanisms established. 

Senator WARNER. Were those instances prosecuted under the indigenous framework? 

Ms. MASTERS. Not that I am aware of. 

So to cut a long answer short, I think it is important that there 

is regulation, that there is transparency, that there are standards, 

that there is monitoring, and that those are uniformly applied 

across all instances of carbon markets. 

Senator WARNER. Well, we are looking at our Federal Reserve 

system, which has been, as far as I know, an impeccable system 

in terms of anyone challenging it for wrongdoing throughout its existence. 

And by the way, the off-ramp, I am guilty of that. A good deal 

of my State has mountains in it. As a matter of fact, just this past 
68 

weekend I was down delivering a speech to the bar association in 

one of the little hotels. When you come down with a heavy truck 

and suddenly your brakes are failing, you need an off-ramp to 

catch yourself and check yourself. So I don’t know whether we will 

stick with it, but I plead guilty on off-ramps. 

Mr. Edward, on the question of how do we deal with it, we are 

talking about a lot of money that is going to be involved. 

Mr. EDWARD. Yes, Senator. 

Senator WARNER. A lot of value. 

Mr. EDWARD. I think the first thing is the starting point. We are 

talking here about environmental markets, but they are not significantly different from any other kind of market, whether they are 

financial or commodity markets. First of all, there is some experience, of course, in the U.S. We have traded NOx and SO2. We understand the way in which that is dealt. We understand the regulation around that, registry systems, validation of actual physical 

emissions, and indeed, for that matter, the accounting and tax 

treatment all around it. So there is a starting point. 

Basically, emission markets will be audited in the same way as 

financial markets, so there is a need for everybody involved, primarily for investors, that there is integrity in the market. Obviously, my dollar of capital committed to this market would be a 

pointless dollar of commitment if the rules were proved to be open 

to abuse and open to fraud and so on. So I, as a participant in the 

market, have every interest in the rules being clear. 

Senator WARNER. In other words, generally you have a confidence this thing can be made to work and it will gain the public 

trust. 

Mr. EDWARD. Yes, that is the experience and that is the absolute 

requirement for everybody in the market. 

Senator WARNER. All right. The second area where I am concerned is the goddess of the carbon capture and storage technology. 

Can we expedite it to build a bridge to get to what I would hope 

to be another level of technology? So first, do you think that this 

capture system largely going into old gas wells and so forth, will 

provide the bridge? And what is on the drawing boards out there 

that gives you hope that we will get another generation of concepts 

in the future? 

Mr. PROFETA. I would regard carbon capture and storage as even 

more than a bridge. It is one of the essential elements of a longer 

term strategy. Sometimes I have said we have to bridge to it. I 

think we have heard from just about every witness about how essential it is. According to the EPA analysis that came today, there 

is no way, and every other economic modeling analysis I have seen, 

there is no way that this Country with its robust supplies of coal 

can manage this transition if we don’t master this technology. 

We really do need to prove carbon cap sequestration and the 

Government can’t do it alone. We need to get the private sector investment in to make it across the bridge. And that is where I think 

you have heard the testimony of Ms. Masters and Mr. Edward 

about the fact a price cap would not get us our investment sufficiently, private capital sufficiently into this sector to get CCS here. 

So that has to be one of our major public/private priorities. 
69 

We have a number of studies. We are doing studies at the Nicholas Institute of the capability of laying out this technology. I think 

that Garth and some others would be better to talk to on some of 

the experiments going on around the world. We have a major demonstration project right now in Pennsylvania called Future Gen. It 

is not up to a full scale plan, but we are proving the workability 

of the technology. And we are working on sort of infrastructure 

would be necessary to transport the CO2 to the depositories, because they are not everywhere. But we are looking to see if we 

have a pipeline that can get the CO2 to the Appalachians and to 

the Gulf Coast and places we can dispose of it. 

As to carbon cap sequestration, I would say there is no silver bullet technology, but there is silver buckshot. There are a number of 

technologies. There is a famous paper out at Princeton by Pacula 

and Chaloupka that talks about the various technologies that are 

necessary to get us there. We need to have some nuclear. We need 

to have some efficiency. We need to have some renewables. 

Senator WARNER. I understand all that, but we have to show a 

path. Maybe the bridge won’t be so long. 

Does anybody else want to comment quickly on the new technology that could be in the works? 

Mr. BAUGH. I would just add, there are certainly technologies 

that are out there for the more efficient burning of coal and getting 

more energy out of every ton of coal you use. There are companies 

doing that and building plants and using that. That is also bridge 

technology, just for greater efficiency. But the CO2, the capture and 

sequestration, has got to be our Manhattan Project. 

Senator WARNER. That is a good comparison. 

Mr. BAUGH. We have to solve it. 

Senator WARNER. We have to have a Manhattan Project. 

Mr. Chairman, I think that I must leave. We have had an excellent hearing. 

Senator LIEBERMAN. I totally agree. I thank you. 

I want to ask one other series of questions, with your permission. 

Senator WARNER. Go ahead. Yes. 

Senator LIEBERMAN. Thank you very much. 

Senator WARNER. If I could add, I leave with Mrs. Thorning’s observation about the Chinese food and so forth. That is something 

we have to keep one eye open on. We can’t let that invade this system. 

Senator LIEBERMAN. Absolutely. Thanks, John. 

Mr. Baugh, let me just take a minute or two to you and anyone 

else who wants to help on the panel, just to develop this question 

of how we deal with other countries in the world, because this is 

a real point of anxiety among Members of Congress on this. Even 

as we move, the debate over whether climate change is real is not 

totally over. I know not everybody agrees, but almost everybody 

does. 

So the people are now really looking for a solution. But one of 

the anxieties here obviously is that we will finally take the steps 

to do something about this that will, some fear, affect the American 

economy, American jobs—although I must say that the EPA report 

is very encouraging today, that the risks of that are not great— 

while the other countries in the world, particularly China and 
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India, with China now by some estimates emitting more than we 

are, or certainly heading rapidly in that direction, whether so now 

or not. 

So the Bingaman-Specter bill has a way to deal with this. As you 

described it, it starts with the executive branch negotiating with 

the major developing nations over implementing a system to control carbon emissions. So say a little more. What does that mean? 

Mr. BAUGH. Well, I think there are probably any number of opinions of how you get at it, whether they implement a cap and trade 

program that is similar to ours, or whether they institute a tax regime, or another way of looking at it. I think the idea is that they 

have to do something comparable, and you know, I don’t think it 

had to exactly mirror what we have, but the intent and the effect 

would be the same, that it would ultimately deal with the issue of 

carbon emissions and limiting their growth, and in fact turning 

back the clock on them. 

Senator LIEBERMAN. Yes. And then another step is if the President of the United States deems the actions of these trading partners to be inadequate, then the U.S. Government can require that 

imported products from these countries purchase carbon allowances 

from a separate pool. In other words, basically if we determine that 

because those host countries are not asking the same of companies 

within their countries, then the U.S. has the power to compel those 

companies in so far as they are selling into the United States, for 

the right to do that, presumably at a lower price, to buy carbon allowances that would equal the price, or at least make it competitive between U.S.-produced goods and those foreign-based goods. 

Do I have it right? 

Mr. BAUGH. Yes, Senator. But I would also urge that the other 

steps that are there be considered before that. 

Senator LIEBERMAN. Go ahead. 

Mr. BAUGH. And that really is this conversation about what do 

you do in terms of negotiations and what do you put on the table 

in terms of carrots and incentives to make these changes, and this 

idea of entering into maybe forms of technology transfer. Say we 

solve the carbon question, all right? And we come up with an excellent solution. This becomes the technology that we own and we can 

export that to the rest of the world, and we should, to solve some 

of our trade problems. 

On the other hand, we could have a very serious conversation 

with developing nations around we would like to have you begin to 

implement this technology; we want to work with you to get it 

done. It becomes an incentive. It is a carrot rather than the stick. 

The last thing you do is actually get to the point that you want 

to implement the trade solution, but I frankly, given all our experience on the trade front and on this issue, is that you actually have 

to have the ability to take action if it is necessary for people to believe you. It happens in labor negotiations around contracts. It certainly happens in our trade dealings throughout the world. Frankly, China doesn’t believe us about anything we say. They will do 

and continue to act in their own self-interest rather than take action. 

There is a direct conflict between what is happening to their 

country environmentally and the country’s economic policies. I said 
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this in front of the Senate staff when I participated in the briefing. 

The driving force in the Chinese economy is their economic strategy and their export platforms. That is the choice they keep making. That is where their energy investments are going. Unless 

there is something there to say that we will take action to make 

something different, they won’t believe us. 

So we would absolutely encourage the incentives as the way to 

negotiate for solving a problem for the world. On the other hand, 

you have to have action available. 

Senator LIEBERMAN. Understood. Right. 

Ms. Masters, how do you react to this proposal? And how would 

you distinguish it from a tariff that might be considered to be protectionist? 

Ms. MASTERS. I think first of all that the notion of requiring another country to purchase allowances at presumably the prevailing 

market price is preferable to imposing a straightforward border 

tax. Implicit in that, it is a fixed price for the allowance, which we 

can’t know today whether that will be the right price or the wrong 

price. So in that sense, I think there is some logic and some merit. 

I think that second the overall issue of addressing the fact that 

in the future China, for example, or any other rapidly developing 

nation could swiftly become such a significant emitter of carbon as 

to render our own efforts meaningless is absolutely a very critical 

issue. It is a big hole to leave in the bucket unaddressed. So something needs to be done to address that. 

I think there was one word that was referred to that, just thinking out loud, gave me pause for thought, which was the notion of 

this being a separate pool of allowances. I think the whole merit 

of a cap and trade program and the notion of trying to maximize 

supply into it is that there shouldn’t be separate pools. Carbon molecules are fungible. 

Senator LIEBERMAN. Right. 

Ms. MASTERS. It doesn’t matter whether carbon is contained 

somewhere in the United States, in Brazil, or in China, as long as 

it is contained. And once it is not contained and it is in the atmosphere, it sticks around for a long time. 

So the notion of separating pools I think needs to be thought 

carefully about, and I would need to think some more. 

Senator LIEBERMAN. OK. We would welcome that. There is still 

some time. 

Mr. Profeta, I have about a minute left. Do you think this is the 

best answer yet to this question about the international consequences of the U.S. adopting a cap and trade system? 

Mr. PROFETA. Yes, I would say that I would embrace how you 

asked the question, Mr. Chairman. It is the best answer yet, and 

it is a good first start. I think it is important to stress that it is 

really not a protectionist measure. It is desire is to stimulate engagement, as Mr. Baugh was saying, with these countries and find 

a way where we get a global trading pool like Ms. Masters desires, 

where we have liquidity across the markets. 

So I think the key here is that it intends first to stimulate engagement, and even when it does get triggered, if it does, I think 

it is very important to look at the detail that was put into this 

about how the drafters of this bill are trying everything they can 
72 

to ensure equal treatment between the domestic manufacturers 

and those in the importers. 

Senator LIEBERMAN. Right. 

Thank you. Very interesting. 

Senator Inhofe, it is all yours. 

Senator INHOFE. Thank you, Mr. Chairman. 

First of all, let me apologize to our witnesses. I sometimes get 

scheduling conflicts and it makes it very difficult. I know all of you 

made a great sacrifice to be here and I appreciate it very much. 

I think I kind of walked in at a time here that we were discussing something that I have not really heard discussed before. I 

would repeat what I said in my opening statement, just the one 

quote by the Deputy Director General of China’s Office of Global 

Environmental Affairs. He said you cannot tell people who are 

struggling to earn enough to eat that they need to reduce their 

emissions. 

Now, I have a lot of other quotes I could use, but I have come 

to the conclusion that China is not going to voluntarily do anything 

that is going to be helpful to us. They are the beneficiary of efforts 

that we have over here. I would just say to Mr. Baugh that I am 

kind of surprised at the AFL–CIO’s position here. On the one hand, 

you lay out reasonable principles such as the need to include developing countries in any legislation, yet you have endorsed the 

Bingaman bill which unilaterally caps our own emissions, while 

really doing nothing to address those in China. 

The Congressional Budget Office found that CO2 allocation 

schemes, which is what we are talking about here, will disproportionately burden the poor, raise taxes, increase Government spending, raise gas prices, raise home energy costs, and decrease rate 

wages. Now, it did say decrease wages. 

It is hard to imagine the CBO issuing a more devastating indictment of proposed CO2 cap and trade schemes. How can you support 

such a thing? 

Mr. BAUGH. Well, Senator, I think we absolutely agree that the 

legislation is the only one, and the first one that takes a step to 

address our international trading partners, and especially the developing world’s non-participation in the system. Frankly, we agree 

with you, the Chinese aren’t going to listen to us unless they have 

a reason to listen to us. 

This is not a unilateral step. In fact, that is why we demanded 

language in the legislation that began to address the international 

aspects and provide incentives in place to move people to participate, as well as have authority to act if and when they don’t. 

Senator INHOFE. Are you talking about doing this with tariffs? Is 

this the idea? 

Mr. BAUGH. It is through the purchase of carbon allowances, the 

equivalent of. 

Senator INHOFE. I consider that to be about the same thing. 

Ms. Thorning, you are the President of the International Council 

for Capital Formation. You know a little bit about this, and I 

should say Dr. Thorning. Do tariffs work? 

Ms. THORNING. Tariffs will have somewhat of a negative impact 

in terms of price of products here in the U.S. That would, of course, 

mean that low-income people will be especially impacted. So in my 
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view, a tariff, there might be some good in terms of encouraging 

some change in behavior from other countries, but I am not sure 

about that. I know for sure it will have a drag on U.S. economic 

growth. 

Just to digress for a minute, you know, the Wal-Mart effect that 

is often discussed. According to many scholars, institutions like 

Wal-Mart have kept our inflation rate relatively low. If we begin 

to put tariffs based on carbon content on imported products, it will 

certainly make it more difficult to sustain the kind of economic 

growth we need. 

So I think there are probably more efficient ways to encourage 

developing countries to reduce their emissions. A paper on the 

ACCF website by CRA International, David Montgomery, demonstrates the positive impact. It encourages intellectual property 

reform, reduction in corruption, reduction of bureaucracy, better infrastructure. In China and India, it could have a very powerful impact on helping them get access through private sector investment 

in less-emitting technologies. I think that would be a more fruitful 

approach than imposing tariffs. 

Senator INHOFE. OK. I think you have answered that. 

The European Union has adopted cap and trade. Do you want to 

tell us how it is working there? 

Ms. THORNING. Well, their current cap and trade system covers 

approximately 12,000 emitters and about 40 to 45 percent of all 

emissions. The challenge that they face is how to actually meet 

their Kyoto target, because they basically have imposed cap and 

trade on the industrial sector, but the transport sector hasn’t been 

included and neither has the household sector. So they are faced 

with the issue of how to, in the second commitment period, get 

emissions down and, of course, if they don’t meet their target in the 

first commitment period, that casts even further doubt. 

So recently the European Commission released a paper, it was 

March 9th, calling for a look at carbon taxes as a way to beef up 

their current emission trading system, because they see that the 

ETS is simply not up to the job and the political uncomfortableness 

of having to ratchet the allocation allowances down tighter and 

tighter and tighter on this limited number of installations. The 

competitive impact is a real challenge for them. So the European 

Union is looking for other ways. 

Senator INHOFE. What do you think about carbon taxes? 

Ms. THORNING. Well, in my view, and I think most economists 

support this, the most efficient way to send a price signal is to tax 

something. So a carbon tax could be set at a rate and perhaps increased over time to provide a signal to households, to the industrial sector, energy producers, that the price of carbon was going 

to rise, and in time if the capital stock turns over, for example 

when you buy a new car, you might not buy it the next day, but 

3 years down the line you might buy a car that is substantially 

more energy efficient. So I think a carbon tax would be a more efficient way. 

Senator INHOFE. Do you think maybe a more honest way? 

Ms. THORNING. Pardon? 

Senator INHOFE. A more honest way? 
74 

Ms. THORNING. More honest because people would see, people in 

industry would see the price of emitting carbon and could respond 

to it. A cap and trade obfuscates that. 

Senator INHOFE. Yes. What about technology transfer? We have 

China now passing the United States as being the major emitter. 

Ms. THORNING. Well, for example, a Chinese electric utility at a 

coal-fired plant might have a boiler right now that is 25 percent 

efficient. We have boilers that are 35 percent or even more efficient. If our companies, and there are German companies or companies around the world, were willing to sell their best technology 

into places like China and India or Russia or other places, the technology would get transferred without the need for a Government 

program. So protecting intellectual property rights, according to the 

Montgomery study, lack of protection for intellectual property in 

China is the key factor that impedes high quality investment flowing in there. 

So I think technology transfer is the cost-effective way. If we can 

incentivize behavioral changes in Chinese and Indian companies, it 

will be certainly more cost effective and involve the private sector 

in ways that a cap and trade system might not. 

Senator INHOFE. I am going to go over here. Can I take a little 

more time? 

Senator LIEBERMAN. Go ahead. 

Senator INHOFE. If we were to let’s say establish and try to enforce a global cap and trade system or global taxes, what problems 

would we have? 

Ms. THORNING. I think the first problem with a global cap and 

trade system is guaranteeing the property right in that emission 

reduction credit. Because you might expect that you did a contract 

for emission reductions over a five, ten, or 15 year period and perhaps they might occur, but a current Government can’t guarantee 

a future Government’s or future company’s performance. So the 

property right issue would raise the cost of capital for that type of 

transaction substantially. Lack of property rights would mean that 

a cap and trade system would probably be less effective than simply taxing carbon. 

Senator INHOFE. Yes. 

Ms. THORNING. And of course, there are other issues that I mentioned in my testimony. For example, the fact that cap and trade 

unless you auction all the allowances, it confers windfall gains on 

the companies that receive these allowances, and there is a lot of 

gaming of the system. So I think it is a more straightforward way 

to simply tax carbon and lets everybody know what the real price 

is of trying to protect the environment. 

Senator INHOFE. The Kyoto clean development mechanism, I 

think it is called, has that worked, or how is that working? 

Ms. THORNING. Well, there is a recent article by Michael Wara 

of Stanford University that is pointing out that so far the clean development mechanism hasn’t really accomplished much net emission reduction, and in fact the Chinese are finding it so profitable. For example, with HFCs, Wara states that it cost perhaps $31 

million to actually reduce the emissions that are being produced, 

but the Europeans are paying between $250 million to $750 million 

Euros for these emission reductions. So the Europeans are paying 
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vastly more. It is not an efficient way of getting these emissions 

down. The Chinese Government, in fact, has imposed a 65 percent 

tax on the companies in China that are selling these CFCs. The 

companies can still make money even when the Chinese Government takes 65 percent of their profit away from them. 

So I think that is an example of the gaming of the system that 

the clean development mechanism has led to. To think that we can 

police that sort of thing thousands of miles away I think is a real 

challenge. 

Senator INHOFE. Yes, a real challenge. 

Thank you, Mr. Chairman. 

Senator LIEBERMAN. Thank you, Senator Inhofe. 

I thank the panel. I want to enter a few documents in the record 

before we adjourn, by unanimous consent. The first is the EPA report that I mentioned earlier. The second is written testimony submitted for the record by the American Electric Power Company. 

The testimony is a detailed legal description of the international 

provision that is contained within the Bingaman-Specter climate 

bill which we have discussed. 

The third is a statement from the European Environment Agency 

which reaches the conclusion that latest projections for 2010 show 

that the combined effect of existing and additional domestic policies 

and pressures, Kyoto mechanisms, and carbon sinks would bring 

emissions below the EU–15 base year level, which corresponds exactly to the reduction required under the Kyoto Protocol. 

[The referenced information follows:] 
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Senator LIEBERMAN. I thank each of you for the work you are 

doing, each in your own way in this area, and for sharing that expertise and experience with us. It is practically helpful to Senator 

Warner and me as we work. We have told our staff to not expect 

to sleep for the next seven to 10 days because we are very anxious. 

Senator Warner and I, however, will sleep occasionally. 

[Laughter.] 

Senator LIEBERMAN. We had our pajama party for the month last 

week. We are now going to get our normal sleep. 

This has been, I want to repeat, particularly helpful as we move 

forward to present climate change legislation to our colleagues on 

this Committee, and then, I am confident, to the full Senate this 

fall. 

I thank you all very, very much for your time and your contribution. We are going to leave the record of the hearing open for 7 

days if any of the members want to submit additional questions or 

statements or any of you want to submit additional statements for 

the record. 

With that, I adjourn the hearing. 

[Whereupon, at 4:45 p.m., the subcommittee was adjourned.] 
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