[Senate Hearing 110-1113]
[From the U.S. Government Publishing Office]
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
__________
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COMMITTEE ON ENVIRONMENT AND PUBLIC WORKS
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
BARBARA BOXER, California, Chairman
MAX BAUCUS, Montana JAMES M. INHOFE, Oklahoma
JOSEPH I. LIEBERMAN, Connecticut JOHN W. WARNER, Virginia
THOMAS R. CARPER, Delaware GEORGE V. VOINOVICH, Ohio
HILLARY RODHAM CLINTON, New York JOHNNY ISAKSON, Georgia
FRANK R. LAUTENBERG, New Jersey DAVID VITTER, Louisiana
BENJAMIN L. CARDIN, Maryland JOHN BARRASSO, Wyoming1
BERNARD SANDERS, Vermont LARRY E. CRAIG, Idaho
AMY KLOBUCHAR, Minnesota LAMAR ALEXANDER, Tennessee
SHELDON WHITEHOUSE, Rhode Island 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 GEORGE V. VOINOVICH, Ohio,
HILLARY RODHAM CLINTON, New York JOHNNY ISAKSON, Georgia
BERNARD SANDERS, Vermont LAMAR ALEXANDER, Tennessee
BARBARA BOXER, California, (ex JAMES M. INHOFE, Oklahoma, (ex
officio) officio)
------
Note: 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.
C O N T E N T S
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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
ECONOMIC AND INTERNATIONAL ISSUES IN GLOBAL WARMING POLICY
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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?
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.
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 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.
[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.
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 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
ground-breaking 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 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
Lieberman-McCain 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 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 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 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 limits 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 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:]
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 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 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 mechanisms. 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 climate 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:]
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 two-way 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 reducing
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 lowest-cost 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.
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 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 market-based 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.
[GRAPHIC] [TIFF OMITTED] 61977.139
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-and-trade. 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 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\GATT Article XX(g).
---------------------------------------------------------------------------
(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-and-trade 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.
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
reductions, 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, 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.
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.
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 creating 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.
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.
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.
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 get-go 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.
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 benefits, 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 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.''
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.
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
[GRAPHIC] [TIFF OMITTED] 61977.140
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
Bingaman-Specter 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.
[GRAPHIC] [TIFF OMITTED] 61977.141
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.
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 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 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 allowances 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 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
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.
--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-by-step 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.
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 long-term 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.
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. 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 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 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 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.
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\1\The 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: [email protected]; website: www.accf.org
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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 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 two-thirds 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 projection period. Coal overtook oil in 2003 as the
leading contributor to global energy-related 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.
[GRAPHIC] [TIFF OMITTED] 61977.142
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 social 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 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 cost-effectiveness 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.
[GRAPHIC] [TIFF OMITTED] 61977.143
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 industrial 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).
[GRAPHIC] [TIFF OMITTED] 61977.144
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 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)
[GRAPHIC] [TIFF OMITTED] 61977.145
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 post-
2012 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
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 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.
[GRAPHIC] [TIFF OMITTED] 61977.146
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.
[GRAPHIC] [TIFF OMITTED] 61977.147
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.
[GRAPHIC] [TIFF OMITTED] 61977.148
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.
[GRAPHIC] [TIFF OMITTED] 61977.149
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 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
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 off-ramp 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.
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?
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 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 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.
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 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 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 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 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?
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 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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