[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

                              ----------                              
                                                                   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

                              ----------                              


                         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.
---------------------------------------------------------------------------
    \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
---------------------------------------------------------------------------
    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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