Climate Change: Comparison of the Cap-and-Trade Provisions in H.R. 2454 and S. 1733
Released: 2009-11-05T00:00:00

Background

On June 26, 2009, the House passed H.R. 2454 , the American Clean Energy and Security Act of 2009. In addition to establishing a cap-and-trade system to regulate greenhouse gas emissions, the bill addresses energy efficiency, renewable energy, and other energy topics. On September 30, 2009, Senator Kerry introduced S. 1733 , the Clean Energy Jobs and American Power Act, which was referred to the Senate Committee on Environment and Public Works. The committee held hearings on the bill starting October 27, 2009, and markup of the bill began November 3. On November 5, the committee approved Senator Boxer's "Manager's Amendment" as a substitute, and ordered S. 1733 reported.

Although there are significant differences in some portions of the House and Senate bills, both bills would require major reductions in greenhouse gas emissions from entities comprising roughly 85% of current U.S. greenhouse gas emissions. Covered sectors would include electricity production, natural gas distribution, petroleum refining, and industrial sectors. Both bills would also grant the Environmental Protection Agency (EPA) the authority to set greenhouse gas performance standards for some entities not covered by the cap-and-trade system. Through the cap-and-trade system and other programs, both bills aim to reduce U.S. greenhouse gas emissions to 83% below 2005 levels by 2050.

Key Differences Between the Cap-and-Trade Provisions of H.R. 2454 and S. 1733

There are many differences between the two bills, in both the establishment of their greenhouse gas reductions programs, and in other energy provisions (e.g., renewable energy, transportation). This report focuses on the major differences between the two bills' cap-and-trade systems, while the Appendix contains a side-by-side comparison of the cap-and-trade related sections of both bills.

There are six key differences between the two bills, which are discussed below:

The Senate bill contains a more stringent (i.e., lower) emissions cap between 2017 and 2029; Although the two bills allocate allowances and auction revenues to many of the same recipients, the amounts of those allocations are in some cases larger or smaller; The bills' treatment of offsets differs significantly; The House bill contains substantial provisions on regulating the carbon market. The Senate bill currently has a placeholder awaiting action by other Senate committees. The House bill contains provisions imposing a border measure (an international reserve allowance scheme) on countries with inadequate carbon reduction policies. The Senate bill currently has a placeholder awaiting action by other Senate committees. Both bills have provisions exempting various entities from certain provisions of the Clean Air Act with respect to greenhouse gas emissions. However, there are substantive differences with respect to some of those exemptions.

Emissions Cap

For most years, the two bills have identical emissions caps and cover the same sources. The key exception is that between 2017 and 2029, S. 1733 has a more stringent cap (i.e., a lower number of emissions allowances). Between 2017 and 2025, the Senate bill's cap is between 2% and 4% lower than the cap under H.R. 2454 . From 2026 through 2029 that gap narrows, and from 2030 onward both bills have the same cap on emissions. That slight difference can be seen in Figure 1 .

Allowance Allocation

An allowance under a cap-and-trade system is effectively a permit to emit—in the case of the two bills, a permit to emit one ton of carbon dioxide or its equivalent. These allowances represent significant value either in terms of a wealth transfer in the case of directly allocated allowances or government revenue in the case of auctioned allowances.

Both bills allocate allowances or auction revenue to support various purposes. Recipients of direct allocations include entities covered by the cap-and-trade program, such as petroleum refineries, and entities not covered by the program, such as states and electric and natural gas local distribution companies (LDCs). In the case of non-covered entities, those entities may only use the value generated from the sale of their allowances for specific purposes. For example, LDCs must use the value to mitigate the energy cost impacts of the cap-and-trade program on their customers (either through rebates or through investment in energy efficiency), while states must use the funds for energy efficiency, renewable energy, or other projects.

Over time, both bills reduce the share of allowances directly allocated in favor of auctions. Over the life of the Senate bill, a larger share of allowances is auctioned, as the Senate bill takes a portion of allowances off-the-top to be auctioned or directly allocated. The largest share of those off-the-top allowances is used for deficit reduction. In the early years of the program, 10% of allowances are auctioned off-the-top for deficit reduction under S. 1733 . In later years, that percentage increases to 25%. In 2016 (the first year of full implementation of the program in both bills), H.R. 2454 would auction roughly 16% of allowances (see Figure 2 ), with most of those revenues directed at assisting low-income consumers, while the Senate bill would auction roughly 32%, with about one third of those directed to low-income consumers and one third directed at deficit reduction (see Figure 3 ). The remainder of auctioned allowances in both cases is directed at worker assistance, public health, adaptation programs, and other policy objectives. By 2030, roughly 65% of allowances are auctioned under H.R. 2454 (see Figure 4 ), while roughly 75% are auctioned under the Senate bill ( Figure 5 ).

Under both bills, a portion of allowances is taken off the top for the use in a strategic reserve. The aim of the strategic reserve is to provide an "emergency supply" of allowances in the event that allowance markets become highly volatile. These reserve allowances would be auctioned separately from the standard quarterly auctions for all other auctioned allowances. The allocations in the figures represent the share of allowances for each purpose after the strategic reserve allowances have been removed.

In addition to the larger share of allowances directed to deficit reduction under S. 1733 , S. 1733 also allocates allowances/auction revenue for state programs to reduce greenhouse gas emissions from the transportation sector, for mid-sized refiners, and for nuclear worker training.

It should also be noted that under H.R. 2454 , a large share of allowances (e.g., 17% of 2030 allowances) are auctioned several years ahead of time for deficit reduction or consumer rebates. The revenue from these auctions would be generated in the year the allowances were auctioned, but entities could not use the allowances to cover their emissions until the "vintage year" or thereafter. If, for example, a 2030 allowance were auctioned in 2025, that allowance could not be used to cover an entity's emissions until 2030 or later. Therefore, the market value of allowances in those early auctions would likely be lower than allowances auctioned for use in the current year. This provision would lead to a forward shift in auction revenue for that share of allowances, but the potential revenue may be difficult to predict. The Senate bill allocates some allowances to states early, but has no similar auctioning provision.

Offset Treatment and Implementation

Both the House-passed legislation and the Senate bill would allow covered entities, in aggregate, to submit 2 billion tons of offsets each year. However, the two programs have different formulas for determining the annual percentage of offsets that each covered entity could use to meet its compliance obligation. The percentage in the House program is tied to the emissions cap and is known in advance: 27% in 2016, 36% in 2030, and 66% in 2050. In contrast, the percentage in the Senate bill is based on covered entities' actual emissions—which would depend on multiple factors, including banking and offset use/supply—and can only be determined using emission projections. Using EPA's estimates of covered entity emissions (results from the agency's H.R. 2454 analysis), the percentages would be 35% in 2016, 41% in 2030 and 48% in 2050.

The House and Senate programs would also differ in their allowable proportions of domestic and international offsets. In the House program, 50% of a covered entity's allowable offset submission could come from domestic projects, 50% from international sources (i.e., in 2016, 13.5% of a covered entity's allowance submission could be domestic offsets; another 13.5% could be international offsets). In the Senate, the ratio is 75% from domestic projects and 25% from international projects. Although both bills would provide conditional authority for EPA to increase (on an annual basis) the percentage of international offsets allowed, the annual volume of international offsets could not exceed 1.25 billion tons in the Senate bill, but could reach up to 1.5 billion tons in the House bill.

In addition, the House and Senate bills authorize different agencies to implement their respective offset programs. The Senate bill would delegate domestic program authority to the President and international program authority to EPA. The House bill would effectively create two offset programs: a domestic agriculture and forestry program would be implemented by the Department of Agriculture; other domestic projects and all international projects would be under the primary authority of the EPA.

Carbon Market Regulation

A major concern with respect to a cap-and-trade program is potential allowance market abuse and manipulation. The size of a U.S. carbon market could be in the hundreds of billions of dollars annually, and involve all of the financial instruments, particularly derivatives, that any other commodity market includes. To provide oversight of the newly created carbon allowance market, H.R. 2454 has detailed provisions for Federal Energy Regulatory Commission (FERC) oversight of the cash allowance market, and enhanced Commodity Futures Trading Commission (CFTC) oversight of allowance derivatives. With respect to the latter, the bill would remove energy commodities (including carbon allowances) from the category of "exempt commodity" and require that over-the-counter transactions be cleared through a clearing house (a standard feature of a futures exchange). In addition the CFTC is required to establish position limits, thus setting ceilings on the number of energy contracts that any person could hold.

The Senate bill currently has a placeholder awaiting action by other Senate committees.

Carbon Leakage and International Competitiveness

Many have expressed concern about U.S. greenhouse gas reduction legislation potentially resulting in firms choosing to shift investment and production from the United States to countries with less stringent carbon policies. The concern is both economic in terms of jobs being lost, and environmental in terms of net emission reduction benefits being compromised by the resulting increased greenhouse gas emissions in the less-regulated countries. This would happen, for example, if a GHG emitting industry moved from a country with an emissions cap to a country without a cap.

Two approaches to mitigating the potential impact of carbon leakage on the net greenhouse gas reductions have been proposed. The first is the allocation of allowances at no cost to energy-intensive, trade-exposed industries; this is included in both bills.

The second is an international reserve allowance scheme that essentially imposes a shadow allowance requirement on importers of energy-intensive, trade-exposed products, creating a de facto tariff. Basically, the scheme would require importers of energy-intensive products from countries with insufficient carbon policies to submit a prescribed amount of "international reserve allowances," or IRAs, for their products to gain entry into the United States. Based on the greenhouse gas emissions generated in the production process, IRAs would be submitted on a per-unit basis for each category of covered goods from a covered country. Whether the international reserve allowance scheme would actually work is unclear. The daunting administrative, informational, and analytical resources necessary to implement such a program would create significant issues in any attempt to implement it. Likewise, it is not clear that the potentially severe World Trade Organization (WTO) implications of the provision have been fully exposed and accommodated.

This second approach is currently only included in the House bill. The Senate bill has a placeholder stating the Senate's intention to include such a provision. That inclusion is awaiting action by other Senate committees.

Relationship to Existing Clean Air Act Authorities

Although new legislation to address greenhouse gases is a leading priority of the President and many Members of Congress, the ability to limit these emissions already exists under Clean Air Act authorities that Congress has previously enacted – a point underlined by the Supreme Court in an April 2007 decision, Massachusetts v. EPA . In response to the Supreme Court decision, EPA has begun the process of using this existing authority, issuing a proposed "endangerment finding" for greenhouse gases (GHGs) in April 2009, and proposing GHG regulations for new motor vehicles in the September 28, 2009, Federal Register .

There are five primary paths through which EPA could address greenhouse gases under the Clean Air Act: (1) to regulate GHGs as criteria air pollutants, (2) to regulate GHGs as hazardous air pollutants, (3) to regulate GHGs as designated air pollutants, (4) to regulate under the international pollution provisions of Section 115, or (5) to regulate under the stratospheric ozone provisions of Title VI. In addition, any motor vehicle GHG standards resulting from pending regulatory action would lead EPA and state permitting authorities to require permits for stationary sources: language in the act triggers permitting under the Prevention of Significant Deterioration (PSD) program and Title V of the act whenever a pollutant is "subject to regulation" under any of the act's authorities.

Both bills contain provisions to limit EPA's authority to regulate greenhouse gas emissions as criteria air pollutants, hazardous air pollutants, or under the international pollution provisions of the Clean Air Act. However, with respect to exemptions from the permitting requirements of the PSD program and Title V, the bills differ in the extent of their exemptions. With respect to the PSD program, the H.R. 2454 provision would prevent new or modified stationary sources from coming under the Clean Air Act's New Source Review solely because they emit greenhouse gases. In contrast, the Senate bill's provision would simply raise the threshold for regulation under PSD from the current 100 or 250 short tons to 25,000 tons with respect to any greenhouse gas or combination of greenhouse gases. Likewise, with respect to Title V permitting, the H.R. 2454 provision would prevent any source (large or small) from having to obtain a state permit under Title V of the Clean Air Act solely because they emit greenhouse gases. In contrast, the exemption under the Senate bill is restricted to sources that emit under 25,000 tons of any greenhouse gas or combination of greenhouse gases.

Appendix. Comparison of the Cap-and-Trade Provisions in the American Clean Energy and Security Act (H.R. 2454) as Passed by the House and the Clean Energy Jobs and American Power Act (S. 1733), as Ordered Reported