[Senate Hearing 111-119]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 111-119
 
 INDUSTRIAL COMPETITIVENESS UNDER CLIMATE POLICIES: LESSONS FROM EUROPE

=======================================================================



                                HEARING

                               BEFORE THE

                    SUBCOMMITTEE ON EUROPEAN AFFAIRS

                                 OF THE

                     COMMITTEE ON FOREIGN RELATIONS
                          UNITED STATES SENATE

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               __________

                              JULY 8, 2009

                               __________

       Printed for the use of the Committee on Foreign Relations


 Available via the World Wide Web: http://www.access.gpo.gov/congress/
                                 senate



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                COMMITTEE ON FOREIGN RELATIONS         

             JOHN F. KERRY, Massachusetts, Chairman        
CHRISTOPHER J. DODD, Connecticut     RICHARD G. LUGAR, Indiana
RUSSELL D. FEINGOLD, Wisconsin       Republican Leader designee
BARBARA BOXER, California            BOB CORKER, Tennessee
ROBERT MENENDEZ, New Jersey          JOHNNY ISAKSON, Georgia
BENJAMIN L. CARDIN, Maryland         JAMES E. RISCH, Idaho
ROBERT P. CASEY, Jr., Pennsylvania   JIM DeMINT, South Carolina
JIM WEBB, Virginia                   JOHN BARRASSO, Wyoming
JEANNE SHAHEEN, New Hampshire        ROGER F. WICKER, Mississippi
EDWARD E. KAUFMAN, Delaware
KIRSTEN E. GILLIBRAND, New York
                  David McKean, Staff Director        
        Kenneth A. Myers, Jr., Republican Staff Director        

                         ------------          

                SUBCOMMITTEE ON EUROPEAN AFFAIRS        

            JEANNE SHAHEEN, New Hampshire, Chairman        

CHRISTOPHER J. DODD, Connecticut     JIM DeMINT, South Carolina
ROBERT MENENDEZ, New Jersey          JAMES E. RISCH, Idaho
ROBERT P. CASEY, Jr., Pennsylvania   BOB CORKER, Tennessee
JIM WEBB, Virginia                   ROGER F. WICKER, Mississippi
EDWARD E. KAUFMAN, Delaware

                              (ii)        




                            C O N T E N T S

                              ----------                              
                                                                   Page

Fries, Dr. Steven, chief economist, Royal Dutch Shell, The Hague, 
  Netherlands....................................................     7
    Prepared statement...........................................    10
Lieberman, Ben, senior policy analyst for energy and environment, 
  Thomas A. Roe Institute for Economic Policy Studies, Heritage 
  Foundation, Washington, DC.....................................    18
    Prepared statement...........................................    20
Matthes, Dr. Felix, research coordinator for energy and climate 
  policy, Institute for Applied Ecology, Berlin, Germany.........     2
    Prepared statement...........................................     5
Shaheen, Hon. Jeanne, U.S. Senator from New Hampshire, opening 
  statement......................................................     1
Weber, Dr. Wolfgang, head of energy and climate policy, BASF 
  Group, Ludwigshafen, Germany...................................    13
    Prepared statement...........................................    15

                                 (iii)


 INDUSTRIAL COMPETITIVENESS UNDER CLIMATE POLICIES: LESSONS FROM EUROPE

                              ----------                              


                        WEDNESDAY, JULY 8, 2009

                               U.S. Senate,
                  Subcommittee on European Affairs,
                            Committee on Foreign Relations,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 2:47 p.m., in 
room SD-419, Dirksen Senate Office Building, Hon. Jeanne 
Shaheen (chairman of the subcommittee) presiding.
    Present: Senators Shaheen, Boxer, Kaufman, and Risch.

           OPENING STATEMENT OF HON. JEANNE SHAHEEN,
                U.S. SENATOR FROM NEW HAMPSHIRE

    Senator Shaheen. Good afternoon, everyone. I apologize for 
the late start. We are--we've just come from a vote, and I am 
going to go ahead and begin. We may have other Senators joining 
us after the vote, but, so that we're not too much later than 
we had promised, we will begin.
    I'm Jeanne Shaheen. I'm the chair of the Subcommittee on 
European Affairs, which is the sponsor of this afternoon's 
hearing.
    We are here today to examine the European experience with 
climate change policies, with a particular focus on the effect 
that these policies are having on the European industrial base. 
As Congress endeavors to craft a comprehensive climate policy, 
the experiences and lessons learned from Europe will provide 
valuable insights in helping United States policymakers shape 
domestic legislation.
    Now, many of us in Congress, myself included, believe that 
enacting policies to address climate change and move our 
economy into a clean energy future will be a net benefit for 
our country. Millions of new jobs will be created if we do it 
right. Our national security will be improved by reducing our 
dependence on foreign oil. Public health will improve, and a 
cleaner planet will be left for our children and our 
grandchildren.
    However, we do know that certain sectors of our economy 
will be vulnerable under a clean energy incentives program that 
puts a price on carbon. Industries that produce cement, iron, 
and steel, aluminum, refined petroleum products, and chemicals, 
among others, use large amounts of energy in their production 
and face stiff global competition. These industries will be 
affected under a climate program because their ability to pass 
along additional costs will be limited.
    Maintaining the competitiveness of American business and 
growing American jobs are goals that we all share. Therefore, I 
believe it's prudent for Congress to consider policies to 
mitigate the adverse effects a domestic climate program will 
have on these industrial sectors. We need to learn from our 
friends in Europe what's working, what's not, and why.
    We're fortunate today to have with us a respected panel of 
experts.
    Welcome, Senator Kaufman.
    Dr. Felix Matthes is the research coordinator for energy 
and climate policy at the Institute for Applied Ecology in 
Berlin, and he's written extensively on these issues.
    Welcome, Dr. Matthes.
    Dr. Steven Fries is the chief economist for Royal Dutch 
Shell, in The Hague.
    Welcome.
    Dr. Wolfgang Weber is the head of energy and climate policy 
with BASF Group in--pardon me if I get this wrong--
Ludwigshafen, Germany. Not bad, huh?
    Dr. Weber. Very good.
    Senator Shaheen. And Ben Lieberman is the senior policy 
analyst at the Heritage Foundation's Roe Institute for Economic 
Policy Studies, here in Washington, DC.
    For our friends who have come such a long way from Europe, 
we very much appreciate your taking the time to be here this 
afternoon, and for coming such a long way to join us.
    And, Mr. Lieberman, even though you haven't come so far, 
we're equally pleased that you're here, too.
    We look forward to hearing from our witnesses today about 
their experiences of maintaining competitiveness under the 
European Union's Emissions Trading System, or EU ETS--I will 
try to limit all acronyms this afternoon--and how we might 
learn from them in crafting domestic climate legislation here 
in Congress.
    So, again, thank you very much. We would like to begin, Dr. 
Matthes, with your testimony.

STATEMENT OF FELIX MATTHES, RESEARCH COORDINATOR FOR ENERGY AND 
 CLIMATE POLICY, INSTITUTE FOR APPLIED ECOLOGY, BERLIN, GERMANY

    Dr. Matthes. Mrs. Chairman, members of the committee, thank 
you for the invitation to speak today and for giving me the 
opportunity to comment on the critical issues of industrial 
competitiveness under the EU ETS.
    This scheme is, without any doubt, one of the central 
pillars of Europe's policy to combat global climate change. I 
offer my personal thoughts today, based on my experience 
gathered from a broad range of work on conceptual and design 
issues, as well as the practical implementation and an ex-post 
evaluation of the EU ETS. In other words, I've spent the last 
10 years of my life as the European Union emissions trading 
scheme.
    We went through a steep learning curve, especially during 
the pilot phase, in the years 2005 to 2007. We raised 
vulnerable experiences and we can summarize some evidence.
    No. 1, the EU ETS creates a robust carbon pricing, even 
during the recent economic crisis.
    No. 2, we can prove abatement measures triggered by the 
carbon price signal even during the pilot phase of the EU ETS, 
before the allowance price collapsed.
    No. 3, design features beyond the cap, especially 
allocation of allowances, can have a significant impact on the 
economic efficiency of the scheme. Allocation can no longer be 
seen as a purely distributional measure.
    No. 4, the EU ETS has significantly changed the scene. 
Significant efforts to develop innovative mitigation options 
can be observed also in fields in which even the technical 
feasibility of major emission reductions was subject to heated 
debates for the--before the carbon price signal was created. 
And I can give you many, many examples, even from the cement 
industry or the iron and steel industry.
    No. 5, an evidence-based design of the scheme is crucial. 
If key design features are based on speculations or even on 
suspicions, as it was the case in the pilot phase of the EU 
ETS, the system becomes overcomplex and creates unforeseen 
drawbacks. In the end, simplicity and robustness are more 
valuable for all participating parties than efforts to achieve 
nonachievable microjustice. The scheme created rents and 
significant windfall profits arising from the free allocation 
of allowances mainly but not exclusively in the power sector. 
The windfall profits for the German power sector alone are 
estimated at 20 billion euro for the 2008 to 2012 period. An 
in-depth analysis of trade flows for the EU27 in the last few 
years indicates that no significant changes have come about 
which could have been triggered by the introduction of the EU 
ETS. However, industrial competitiveness and, more importantly, 
emissions leakage from the ETS-regulated sectors to 
nonregulated sectors or regions, are major concerns and must be 
addressed by suitable measures. This is especially important 
for the trading periods from 2013 onward, when the EU ETS caps 
are tightened significantly and the basic allocation approach 
is shifted toward auctioning.
    There are two key issues that must be carefully assessed 
with regards to carbon leakage. No. 1, for which sectors should 
significant leakage effect be considered if no complementary 
measures are taken? And, No. 2, which measures are appropriate 
to combating carbon leakage without distorting the carbon price 
signal and thus the incentives to implement cost-efficient 
emission mitigation measures?
    Many options were analyzed to identify leakage-relevant 
sectors. In the end, a robust three-step approach was 
developed, a bottom-up analysis of direct and indirect carbon 
costs for industrial sectors based on statistical data at a 
high level of disaggregation, a bottom-up analysis of trade 
intensity for the respective sectors, and a supplementary 
qualitative analysis.
    Although this approach is not perfect, it should be 
regarded as the most robust and appropriate one. The analysis 
of carbon cost for the EU, as well as for selected Member 
States--the United Kingdom, Germany, the Netherlands--show that 
the robust set of a few sectors which face significant carbon 
costs, about 30 euro per metric ton of CO2--I included a list 
of these sectors in my written testimony--the total share of 
these sectors and the gross domestic product is less than 1.5 
percent for Germany, as a heavily industrialized country, and 
less than 1 percent in the United Kingdom, a country with a 
more service-based economy.
    However, the political deal on the revision of the EU ETS 
directive led to a nonappropriate definition of ``leakage'' or 
``relevant sectors.'' Sectors with additional carbon cost, 
direct and indirect, of at least 5 percent, and a trade 
intensity with non-EU countries of at least 10 percent, that 
was the original intention. No. 2, sectors with an additional 
carbon cost, direct and indirect, of at least 30 percent. No. 
3, sectors with a trade intensity with non-EU countries of at 
least 30 percent and additional sectors which meet certain 
criteria laid down in the directive.
    This approach goes beyond the initial concept of a robust 
leakage sector identification. A significant increase of 
sectors which can claim special leakage provisions, to a large 
extent, solely based on a trade-intensity trigger is a problem. 
The high ranking of trade intensity as a singular indicator 
becomes even more questionable if the patterns of trade flows 
are considered. For many of the relevant products, the most 
important trade partners are OECD countries, like the USA, like 
Norway, like Turkey, or other industrialized countries--for 
example, Russia. Whereas, trade with China for the relevant 
product is less important for many carbon-intensive products. 
Thus, the introduction of carbon pricing in the OECD or other 
industrialized countries with carbon constraints could remove a 
key share of the relevant leakage concern.
    If an effective identification of leakage-relevant sectors 
has been carried out, the question arises, how to deal with the 
issue with an ambitious climate policy in an emissions trading 
scheme. Border adjustments are the most popular measures for 
limiting carbon leakage from the textbook perspective. By many, 
many reasons, the EU has rejected these options. Free 
allocation can be used as a compensation for carbon costs. The 
European Union has used this, based on a 10-percent best ex-
ante benchmarking scheme to compensate sectors for CO2 cost 
burdens. Using the revenues from allowance auctions for direct 
compensation can be an interesting option for providing 
compensation; thus, the EU allows the Member States to 
compensate industries with the high exposures to indirect 
carbon costs, the state-aid measures. And the introduction of 
broader climate policies in other industrial countries is 
obviously another option.
    If the EU would have to design the provisions to deal with 
the leakage concern from scratch, a more tailored approach 
would probably emerge. For the sectors with a significant 
potential for operational leakage--that is, cost-driven 
reallocation of production to nonregulated regions or sectors--
free allocation with plant-closure provisions could be seen as 
the most suitable approach. For the sectors with a significant 
potential for investment leakage--that is, cost-driven 
reallocation of investment to nonregulated regions or sectors--
direct subsidies for investments could provide a sufficient 
countermeasure to combat leakage.
    To summarize, all in all, it should be pointed out that 
leakage is a serious issue in a world of different carbon 
prices. Second, serious leakage concerns must be raised for 
only a few carbon-intensive products or sectors. Third, from 
the EU perspective, many leakage concerns are related to trade 
flows with other OECD or industrialized countries. Fourth, 
tailored approaches can be developed which remove incentives 
for leakage and maintain a nondistorted carbon pricing. Last, 
but not least, it should be also considered that carbon pricing 
provides strong incentives for the growth of new and future-
proof industries.
    I hope these comments are helpful, and look forward to your 
questions.
    Thank you.
    [The prepared statement of Dr. Matthes follows:]

Prepared Statement of Felix Matthes, Research Coordinator for Energy & 
     Climate Policy, Institute for Applied Ecology, Berlin, Germany

    Mrs. Chairman and members of the committee, thank you for the 
invitation to speak today and for giving me the opportunity to comment 
on the critical issues of industrial competitiveness under the European 
Union Emissions Trading Scheme (EU ETS). This topic is without any 
doubt one of the central pillars of Europe's policy to combat global 
climate change.
    I offer my personal thoughts today based on my experience gathered 
from a broad range of work on conceptual and design issues as well as 
the practical implementation and the ex-post evaluation of the EU ETS.
    After a steep learning curve during the pilot phase of the EU ETS 
from 2005 to 2007 which created valuable experiences on a large-scale 
emissions trading scheme for greenhouse gases and its introduction on 
the fast track, the key evidence can be summarized as follows:

   The EU ETS creates a robust carbon price signal, even during 
        the recent economic crisis;
   We can prove abatement measures triggered by the carbon 
        price signal even during the pilot phase of the EU ETS;
   Design features beyond the cap, e.g., allocation of 
        allowances, can have a significant impact on the economic 
        efficiency of the scheme (less efficiency today is equivalent 
        to higher allowance prices in the future); allocation can no 
        longer be seen as a purely distributional matter;
   The EU ETS has significantly changed the scene; significant 
        efforts to develop innovative mitigation options can be 
        observed, also in fields in which even the technical 
        feasibility of major emission reductions was subject to heated 
        debates before the carbon price signal was created (iron and 
        steel industry, cement production, industrial gases, etc);
   An evidence-based design of the scheme is crucial; if key 
        design features are based on speculations (or even suspicions), 
        the system becomes overcomplex and creates unforeseen 
        drawbacks--in the end simplicity and robustness are more 
        valuable for all participating parties than efforts to achieve 
        (nonachievable) microjustice;
   The scheme created rents and significant windfall profits 
        arising from the free allocation of allowances--mainly but not 
        exclusively in the power sector (the windfall profits for the 
        German power sector alone are estimated at 20 billion euro for 
        the 2008-2012 period);
   An in-depth analysis of trade flows for the EU27 in the last 
        few years indicates that no significant changes have come about 
        which could have been triggered by the introduction of the EU 
        ETS.

    However, industrial competitiveness and, more importantly, 
emissions leakage from the ETS regulated sectors to nonregulated 
sectors or regions are major concerns and must be addressed by suitable 
measures.
    This is especially important for the trading periods from 2013 
onward when the EU ETS caps are tightened significantly and the basic 
allocation approach is shifted toward auctioning.
    Two key issues must be carefully assessed with regards to carbon 
leakage:

   For which sectors should significant leakage effects be 
        considered if no complementary measures are taken?
   Which measures are appropriate to combating carbon leakage 
        without distorting the carbon prices signal and thus the 
        incentives to implement cost-efficient emission mitigation 
        measures?

    The evaluation of a wide range of modeling exercises showed the 
merits and demerits of such approaches:

   The models present consistent and fundamental insights on 
        systemwide effects;
   The results of the modeling exercises show a wide range of 
        different results, mainly depending on different input 
        parameters and different methodological results;
   The level of disaggregation in most of the models is not 
        suited to identifying the leakage-relevant sectors in the 
        necessary detail;
   Leakage effects are linearized in many models whereas 
        investment leakage is increasingly seen as the major leakage 
        route.

    Against this background, the identification of the leakage-relevant 
sectors within the EU ETS is based on a three-step approach:

   A bottom-up analysis of direct and indirect carbon costs for 
        industrial sectors based on statistical data at a high level of 
        disaggregation (4-digit NACE);
   A bottom-up analysis of trade intensity for the respective 
        sectors; and
   A supplementary qualitative analysis.

    Although this approach is not perfect, it should be regarded as the 
most robust and appropriate one.
    The analysis of carbon costs for the EU as well as for selected 
Member States (U.K., Germany) showed a robust set of (a few) sectors 
which face significant carbon costs (at 30 = per metric ton of 
CO2):
          1. Manufacture of paper and paperboard;
          2. Manufacture of coke oven products;
          3. Manufacture of refined petroleum products;
          4. Manufacture of other inorganic chemicals;
          5. Manufacture of fertilizers and nitrogen compounds;
          6. Manufacture of bricks, tiles, and construction products;
          7. Manufacture of cement;
          8. Manufacture of lime;
          9. Manufacture of basic iron and steel and of ferro-alloys;
          10. Aluminium production.
    The total share of these sectors in the gross domestic product is 
less than 1.5 percent for Germany (a heavily industrialized country) 
and less than 1 percent in the United Kingdom (a country with a more 
service-based economy).
    A more in-depth analysis of trade flows shows that the increase of 
carbon costs does not necessarily lead to leakage effects. Transport 
costs, other policies, other economic risks (currency, labor force, 
etc.), regulatory risks, customer links and relations are important 
factors which must be considered with regard to the relocation of 
productions possibly leading to leakage.
    Since existing trade intensities can be seen as a robust indicator 
for the broad range of factors influencing relotation decisions, the 
initial idea for the bottom-up assessment of potential leakage was to 
combine carbon costs with trade intensities. With this approach some of 
those sectors which are typically linked to regional markets (bricks, 
tiles, and construction products, cement, lime) would not have been 
assessed as leakage relevant.
    However, the political deal on the revision of the EU ETS Directive 
led to a nonappropriate definition of leakage-relevant sectors:

   Sectors with additional carbon costs (direct and indirect) 
        of at least 5 percent and a trade intensity with third-world 
        countries of at least 10 percent;
   Sectors with an additional carbon cost (direct and indirect) 
        of at least 30 percent;
   Sectors with a trade intensity with third-world countries of 
        at least 30 percent; and
   Additional sectors which meet certain criteria laid down in 
        the directive.

    This approach goes beyond the initial concept of a robust leakage 
sector identification. The significant increase of sectors which can 
claim special leakage provisions, to a large extent solely based on the 
trade intensity trigger, will have impacts on the efficiency of the 
scheme and thus the future allowance prices.
    The high ranking of trade intensity as a singular indicator becomes 
even more questionable if the patterns of trade flows are considered.
    For many of the relevant products, the most important trade 
partners are OECD countries (USA for paper and paperboard, fertilizers 
and nitrogen compounds, other inorganic chemicals; Norway for 
aluminium, fertilizers and nitrogen compounds; Turkey for basic iron 
and steel) or other industrialized countries (Russia for aluminium, 
basic iron and steel, fertilizers and nitrogen compounds) whereas trade 
with China is less important for many carbon-intensive products (except 
in the case of other inorganic chemicals, basic iron and steel).
    Thus, the introduction of carbon pricing in the OECD or other 
industrialized countries with carbon constraints (within national 
emissions trading schemes or within an OECD-wide carbon market) could 
remove a key share of the relevant leakage concerns.
    If an effective identification of leakage-relevant sectors has been 
carried out, the question arises of how to deal with the issue within 
an ambitious climate policy and an emissions trading scheme:

   Border adjustments are the most popular measures for 
        limiting carbon leakage effects from a textbook perspective. 
        However, the implementation of border adjustments faces a wide 
        range of practical, legal, and political challenges. Thus, the 
        EU has decided (driven by Member States with a strong focus on 
        international trade) not to go for this option.
   Free allocation can be used as compensation for carbon 
        costs. However, if the allocation is not adjusted for plant 
        closure or production levels, the incentive for leakage is not 
        removed on the one hand. On the other hand, the updating of 
        free allocation will distort the carbon price signal and 
        decrease the efficiency of the scheme. Thus, the EU decided to 
        offer free allocation based on a 10-percent best-benchmark 
        scheme to sectors regarded as having leakage concerns in 
        combination with a plant closure provision.
   Using the revenues from allowance auctions for direct 
        compensation can be an interesting option for providing 
        compensation for leakage incentives without major distortions 
        of the price signal taking place. Thus, the EU allows the 
        Member States to compensate industries with a high exposure to 
        indirect carbon costs (from increased electricity prices) with 
        state-aid measures.
   The introduction of broader climate policies in other 
        industrialized or developing countries can remove leakage 
        concerns on a broader scale. Thus, the EU will review the 
        compensation measures for the leakage-concerned sectors if the 
        global scene has changed.

    If the EU would have to design the provisions to deal with leakage 
concerns from scratch, a more tailored approach would probably emerge:

   For the sectors with a significant potential for operational 
        leakage (cost-driven relocation of production to nonregulated 
        regions or sectors), free allocation with plant closure 
        provisions could be seen as the most suitable approach.
   For the sectors with a significant potential for investment 
        leakage (cost-driven relocation of investments to nonregulated 
        regions or sectors), direct subsidies for investments could 
        provide a sufficient countermeasure to combat leakage.

    All in all it should be pointed out that leakage is a serious issue 
in a world of different carbon prices. Second, serious leakage concerns 
must be raised for only a few carbon-intensive products or sectors. 
Third, from an EU perspective many leakage concerns are related to 
trade flows with other OECD or industrialized countries. Fourth, 
tailored approaches can be developed which remove incentives for 
leakage and maintain a nondistorted carbon price signal--a fundamental 
basis for effective climate policies. Last, but not least, it should 
also be considered that carbon pricing provides strong incentives for 
the growth of new and future-proof industries.

    Senator Shaheen. Thank you very much, Dr. Matthes.
    Dr. Fries.

  STATEMENT OF DR. STEVEN FRIES, CHIEF ECONOMIST, ROYAL DUTCH 
                 SHELL, THE HAGUE, NETHERLANDS

    Dr. Fries. Chairwoman Shaheen and members of the committee, 
thank you for this opportunity to testify on the topic of 
European experience with industrial competitiveness under 
climate policies.
    The energy challenge and climate challenges facing the 
world are, indeed, formidable. Much more energy will be needed 
to support rising living standards, particularly in developing 
countries. At the same time, carbon dioxide emissions from 
energy will have to fall substantially to mitigate climate 
change.
    Shell is working on many fronts to help meet these 
challenges. We are adopting our production processes and our 
products to existing and anticipated emission constraints, and 
building new technological capabilities in biofuel and carbon 
dioxide capture and storage. We're also providing input to help 
government policy development, including building support 
within industry for effective climate change policy.
    My focus today is on industrial competitiveness under the 
EU ETS, which is a particular concern for phase three of the 
scheme that will run from 2013 to 2020.
    In the first two phases of the system, most of the emission 
allowances were allocated initially to producers for free, but 
in the third phase there will be a transition toward auctioning 
of emission allowances in those sectors and subsectors that are 
not at serious risk of carbon leakage.
    We analyzed this issue in the industrial sectors where 
Shell operates in Europe--upstream crude oil and natural gas 
production, crude oil refining, and petrochemicals. Our 
analysis led us to conclude that potential impacts on 
competitiveness, job losses, and carbon leakage are real. But, 
Shell has also concluded that the potential impacts can be 
managed through well-designed policies, such as those being 
implemented for phase three of the EU ETS.
    In the long run, Shell believes that the problem of job 
loss and carbon leakage can be addressed through a strong 
multilateral framework that requires all major economies to 
contribute fairly to the global climate effort. However, there 
will be a transition period during which the global competitive 
landscape will be uneven, due, in part, to the principle of the 
U.N. Framework Convention on Climate Change of common, but 
differentiated, responsibilities. Managing this transition 
effectively to an even global competitive playing field is a 
key to advancing climate reforms.
    Let me speak briefly to the risks identified in each of the 
three sectors that we analyzed from our own operating 
perspective.
    EU refining could face a significant loss of 
competitiveness and a high rate of emission leakage in its 
export markets in the absence of a similar emission constraint 
in other countries. Ongoing and planned refining capability 
expansion in South Asia and in the Middle East, which would, we 
anticipate, remain outside the climate policy framework in the 
medium term, poses significant competitiveness concern in EU 
markets for refined products over the medium term.
    In petrochemicals, market structures and trade exposure 
vary widely across subsectors. Some are globally traded 
commodity products in which EU competitiveness impacts and 
emission leakage could be quite high. In other sectors, they 
are more regionally segmented, but with a significant 
proportion of EU demand met from non-EU supplies. In these 
subsectors, the impacts in EU competitiveness could be less 
pronounced, but still significant, in our view.
    EU crude oil production is sold into globally competitive 
markets, while the market for EU natural gas is more regionally 
segmented. In many fields, oil and natural gas are jointly 
produced in largely fixed proportions. These characteristics of 
EU upstream production point to the potential for significant 
competitiveness impacts and leakage rates.
    While several potential policy instruments could be used to 
address competitiveness and leakage issues, Shell advocates the 
free allocation of allowances in sectors that are at risk of 
significant carbon leakage. These allowances should be linked 
to the volume of production in an allocation formula that 
recognizes process complexities. We think this approach is 
pragmatic and effective. We do not advocate the use of import 
protection in those countries that implement cap-and-trade 
systems, because of the risks of trade retaliation.
    Key features of our preferred free-allocation approach are 
the criteria for selecting industries that are eligible for 
free allowance allocations and the use of emission intensity 
benchmarking to calibrate these allowance allocations.
    The EC directive for phase three, in Shell's view, sets out 
a workable and pragmatic approach. It identifies both 
quantitative and qualitative criteria for judging whether a 
sector or subsector is a significant risk of emission leakage. 
The two quantitative criteria include the increase in direct 
and indirect production costs in the sector due to the 
directive that exceed 5 percent of gross value added, and the 
total value of its imports and exports exceed 10 percent of the 
value of its turnover and imports. Additional thresholds are 
the increase in production costs that exceeds the 30 percent of 
gross value added or the sector's imports and exports exceed 30 
percent of its turnover and imports.
    For sectors identified as being at risk using these 
criteria, the phase-three directive provides for sector 
assistance rates of 100 percent of free allowance allocation, 
to the extent that installations use the most efficient 
technologies.
    The directive calls for the initial evaluation of sector 
exposures to be completed by the end of 2009, and then reviewed 
every 5 years thereafter. There is also the potential to change 
the amount of, and form of, existence of support for these 
sectors by June 2010, depending on the outcome of the 
Copenhagen negotiations.
    While this introduces an element of policy uncertainty for 
the framework from 2013 to 2020, it does provide for feedback 
from experience with the scheme and allows for flexibility if 
international circumstances change.
    To conclude, I would like to emphasize two key points that 
emerge from the experience with European competitiveness under 
climate policies. First, concerns regarding competitiveness, 
potential job loss and carbon leakage are real. But, second, 
these concerns can be addressed through the judicious use of 
free allowance allocations. This is a pragmatic and effective 
approach during the transition period in which the global 
competitive playing field will be uneven.
    Shell believes it will be also necessary for the United 
States to take similar steps to protect business investment and 
jobs. For example, U.S. refineries are energy intensive and 
exposed to international trade. According to EI--Energy 
Information Agency's statistics--U.S. reliance on gasoline 
imports is growing. For the last 5 years, the United States has 
imported between 5-15 and 17 percent of its gasoline from 
overseas. Ten years ago, that number was 10 percent.
    In Shell's view, the United States should allocate free 
allowances to its emission-intensive trade-exposed sectors, and 
the EU approach illustrates how this can be done in practice.
    The bill the Senate is receiving from the House is a strong 
start toward a workable cap-and-trade program. In regard to 
protecting at-risk industries, there is more work to be done. 
Shell is, in particular, concerned with the current allowance 
value allocated to the U.S. refining sector in the Waxman-
Markey bill, as it does not cover direct missions as fully as 
other sectors are covered.
    Shell is committed to helping the 111th Congress enact a 
fair and effective cap-and-trade program at the lowest possible 
cost to the economy.
    Thank you. I would be happy to answer your questions.
    [The prepared statement of Dr. Fries follows:]

Prepared Statement of Dr. Steven Fries, Chief Economist for Royal Dutch 
                     Shell, The Hague, Netherlands

    Chairwoman Shaheen and members of the subcommittee, thank you for 
this opportunity to testify on the topic of European experience with 
industrial competitiveness under climate policies. I am Steven Fries, 
chief economist for Royal Dutch Shell.
    Shell is a global group of energy and petrochemical companies. With 
approximately 102,000 employees and operations in more than 100 
countries and territories, Shell helps to meet the world's growing 
demand for energy in economically, environmentally, and socially 
responsible ways. Shell's presence in the United States dates back 
nearly 100 years, and today we employ more than 20,000 people here and 
operate in all 50 States.
    Looking forward, the energy and climate challenges facing the world 
are formidable. Much more energy will be needed to support rising 
living standards, particularly in emerging markets and developing 
countries. At the same time, carbon dioxide emissions from energy will 
have to fall substantially to mitigate climate change.
    Shell is working on many fronts to help meet these challenges. 
First, we are controlling emissions from our operations and helping our 
customers manage their emissions by offering advanced fuels and 
lubricants. Shell is searching for better biofuels and building a 
capacity for carbon capture and storage, a critical technology for 
managing emissions from fossil fuel use.
    We also provide input into the shaping of government policy, 
including building support within industry for an effective climate 
policy. In the United States, Shell is a member of the U.S. Climate 
Action Partnership and supports the introduction of a cap-and-trade 
system. In Europe, Shell is an active member of Prince of Wales' U.K. 
Corporate Leaders Group on Climate Change. Shell also works within the 
oil and gas and chemical industries and with governments and the 
European Commission to promote effective climate policies.
    Key priorities for Shell in its European climate policy advocacy 
are measures to address competitiveness and emission leakage issues in 
Phase III of the EU Emission Trading System (ETS) and funding to 
support a series of demonstration projects for carbon dioxide capture 
and storage so that the technology could be deployed at scale by around 
2020 if proved effective.
    I will focus today on the competitiveness issue, which is a 
particular concern for Phase III of the EU ETS that will run from 2013 
to 2020. While in the first two phases of the system most emission 
allowances were allocated initially to producers for free, in the third 
phase there will be a transition toward auctioning of emission 
allowances in those sectors and subsectors that are not at serious risk 
of emission leakage.
    Our analysis of this issue in industrial sectors where Shell 
operates in Europe--upstream crude oil and natural gas production, 
crude oil refining and petrochemicals--leads us to conclude that the 
potential impacts are significant, but that they can be managed through 
well-designed policies such as those being implemented for Phase III of 
the EU ETS.
      competitiveness and emission leakage under climate policies
    The impact of climate policy on competitiveness is potentially most 
pronounced for those industries that are energy intensive and whose 
products are traded in global markets (trade exposed). These industries 
will face higher costs with the implementation of a cap. However, their 
product prices are set in international markets and their ability to 
pass on higher costs from the cap into product prices will be limited 
if foreign producers do not face similar emission constraints.
    These costs, can be much higher than just the direct cost of 
purchasing and using allowances to cover emissions. Industries also 
face a host of indirect costs such as higher fuel prices and higher 
electricity prices. There are also costs associated with abatement, 
including the purchase of new technology and the cost of process 
changes needed to cut emissions.
    These higher costs could ultimately drive investments and 
production capacity to countries with no climate policies. That means 
driving jobs offshore. Unless you have a well-crafted climate policy, 
the potential for job loss can be substantial. Carbon leakage from the 
movement of industry to countries that do not have climate policies 
also reduces the cost-effectiveness of the cap.
    In the long run, Shell believes the potential problems of job loss 
and carbon leakage can be addressed through a strong multilateral 
framework that requires all major economies to contribute fairly to the 
global climate effort. However, the principle of the United Nations 
Framework Convention on Climate Change of ``common but differentiated 
responsibilities'' means that there will be a transition period during 
which the global competitive landscape will be uneven. Managing this 
transition effectively is a key to advancing climate reforms.
   shell assessment of european competitiveness and emission leakage 
                                 issues
    Shell has analyzed the competitiveness impact of Phase III (auction 
phase) of the EU ETS for the three previously mentioned Shell 
industries that operate in Europe. Shell concluded that the potential 
for carbon leakage and an impact on competitiveness are a serious 
concern for Shell's energy-intensive sectors open to international 
trade.
    (1) EU refining could face a significant loss of competitiveness 
and a high rate of emission leakage in its export markets (primarily 
the United States) in the absence of similar emission constraints on 
the United States and other producers. Ongoing and planned refinery 
capacity expansion in south Asia and the Middle East pose a significant 
medium-term competitiveness concern in EU markets for refined products.
    (2) In petrochemicals, market structures and trade exposure vary 
widely across subsectors. Some are globally traded commodity products, 
such as monoethylene glycol and styrene monomers, in which EU 
competitiveness impacts and emission leakage could be quite high. Other 
subsectors, such as polyolefins, are more regionally segmented but with 
a significant proportion of EU demand met from non-EU suppliers. In 
these subsectors, the impacts on EU competitiveness and emission 
leakage could be less pronounced but still significant.
    (3) EU crude oil production is sold into a globally competitive 
market, while the market for EU natural gas is more regionally 
segmented. In many fields, oil and natural gas are jointly produced in 
largely fixed proportions. These characteristics of EU upstream 
production point to potentially significant competitiveness impacts and 
correspondingly high rates of carbon leakage.
    Shell remains concerned about the loss of jobs and competitiveness 
and the potential for carbon leakage under Phase III of the EU ETS. But 
we also believe that these concerns can be effectively addressed with 
effective implementation of Phase III as it is currently designed.
 addressing competitiveness and emission leakage under eu ets phase iii
    While several potential policy instruments could be used to address 
competitiveness and leakage issues, Shell advocates the free allocation 
of allowances in sectors that are at risk of significant carbon 
leakage. These allowances should be linked to the volume of production 
with an allocation formula that recognizes process complexities. We 
think this approach is pragmatic and effective. We do not advocate use 
of import protection in countries that implement cap-and-trade systems 
due to trade retaliation risks.
    Key features of our preferred, free allocation approach are (1) the 
criteria for selecting industrial sectors that are eligible for free 
allowance allocations and (2) the use of emission intensity 
benchmarking to calibrate these allowance allocations.
    The EC directive for Phase III, in Shell's view, sets out a 
workable approach. It identifies two quantitative and three qualitative 
criteria for judging whether a sector or subsector is at significant 
risk of emission leakage. The two quantitative criteria are:

   The increase in direct and indirect production costs in the 
        sector due to the directive exceeds 5 percent of gross value 
        added and the total value of its exports and imports exceeds 10 
        percent of value of its turnover and imports.
   Alternatively, the increase in production costs exceeds 30 
        percent of gross value added or its import and exports exceed 
        30 percent of its turnover and imports.

    The three qualitative criteria are:

   The extent to which it is possible for individual 
        installations in the sector or subsector to reduce emission 
        levels or electricity consumption, including the increase in 
        production costs related to the investment that this may 
        entail.
   The current and projected market characteristics, including 
        when trade exposure of production cost increases are close to 
        the above thresholds.
   Profit margins as a potential indicator of long-run 
        investment and/or production relocation decisions.

    For sectors judged to be at significant risk of emission leakage 
using the above criteria, the Phase III directive provides for sector 
assistance at the rate of 100-percent-free allowances to the extent 
that installations use the most efficient technologies.
    The total of potentially available free allowances to a sector in a 
given year is based on its average share of total emissions from 
industries covered by the EU ETS for the baseline years 2005-07 and the 
overall cap in that year. For example, if a sector's emission accounted 
for 15 percent of the total emissions covered by the EU ETS in 2005-07, 
the total allowances potentially available to the sector in 2013 would 
be 15 percent of the 2013 cap.
    The directive calls for the initial evaluation of sector exposures 
to emissions leakage, to be completed by end 2009 and then every 5 
years thereafter. There is also the potential to change the amount or 
form of support for these sectors by June 2010, depending on the 
outcome of the Copenhagen negotiations. While this introduces elements 
of uncertainty into the policy framework for 2013-20, it provides 
feedback from experience with the scheme and allows flexibility if 
international circumstances change.
                               conclusion
    To conclude I would like to emphasis two key points that emerge 
from the European experience of competitiveness under climate policies 
from a Shell perspective. First, the concerns regarding competitiveness 
losses and emission leakage under cap-and-trade systems are real. 
Second, these concerns can be addressed through the use of free 
allowances. This is a pragmatic and effective approach during the 
transition period in which the global competitive playing field will be 
uneven.
    Shell believes the pragmatic approach being followed in Phase III 
of the EU ETS will keep jobs and business investments in-country and 
prevent carbon leakage. Shell also believes it will also be necessary 
for the United States to take similar steps to protect business 
investments and jobs. Our U.S. chemical plants and refineries are 
energy intensive and exposed to international trade. According to EIA 
statistics, the U.S. reliance on gasoline imports is growing. For the 
last 5 years, the United States has imported between 15 to 17 percent 
of its gasoline from overseas. Ten years ago, that number was 
approximately 10 percent.
    The United States should allocate free allowances to its emission-
intensive, trade-exposed industries. The EU approach illustrates how 
this can be implemented in practice. The bill the Senate is receiving 
from the House is a strong start toward a workable cap-and-trade 
program. In regard to protecting at-risk industries, there is more work 
to be done. Shell is particularly concerned that the current allowance 
value allocated to the U.S. refining sector in the Waxman-Markey bill 
does not cover direct emissions as fully as other sectors are covered.
    Shell is committed to helping the 111th Congress enact a fair and 
effective cap-and-trade program at the lowest possible cost to 
consumers and the economy. We recognize the value of such legislation 
in spurring investment and positioning the United States as a leader in 
the coming international climate negotiations. We will continue our 
efforts to improve this legislation as it moves to the Senate.

    Senator Shaheen. Thank you very much, Dr. Fries.
    Dr. Weber.

STATEMENT OF WOLFGANG WEBER, HEAD OF ENERGY AND CLIMATE POLICY, 
               BASF GROUP, LUDWIGSHAFEN, GERMANY

    Dr. Weber. Thank you very much. Good afternoon, Senator 
Shaheen. My name is Wolfgang Weber, and I'm pleased to be 
invited to testify here before the subcommittee to talk about 
our experiences with the EU climate and energy legislation.
    Please allow me that I would start with making a few 
remarks about BASF. BASF is the world's largest chemical 
company, with close to 100,000 employees and an annual turnover 
of more than 60 billion euros. It's active all over the world, 
with production sites and sales activities.
    We do support a good greenhouse gas control regime. We 
believe that this is necessary. And I will also tell you why we 
believe that this is something that would not be to the 
detriment of our industry. We have analyzed a corporate carbon 
footprint, where we compared all the emissions that we cause, 
directly and indirectly, when we make our products, including 
the supply chain, including disposal, with the greenhouse gas 
savings that our products enable when you use them. For 
example, insulation to insulate homes. And the result is that 
this ratio is 3 to 1. So, our products help to save three times 
more greenhouse gas emissions than we cause when we produce 
chemicals. And actually, if I may say, the Institute of Felix 
Matthes validated this data and confirmed that this was right.
    Now, in order to make this ratio work, you have to have a 
real global greenhouse gas regime so that, first of all, the 
competitiveness of the chemical industry is secured, but also a 
regime which takes into account all sectors. Because only if 
the homeowners get credits for insulating their homes, that 
equation is solved and our industry can fully deliver. So, that 
is why we really support this global greenhouse gas regime.
    If I may add, we have reduced our own greenhouse gas 
emissions by more than 60 percent since 1990. We achieved this 
by integrating our production activities and by investing 
hugely in CHP. We have more than 20 CHP installations worldwide 
supplying our energy needs at our production sites. And all 
together those savings are more than the residential energy 
consumption in New Hampshire, if I may say that.
    Turning to the lessons learned from the EU ETS, I would 
have four. I will also briefly say for each of them what you 
should learn and what you should not learn from the EU, or what 
you should do differently.
    First of all, the whole issue is very complex. It's not a 
black-and-white issue and you have to get it right. And I think 
this is something that the EU did not really do properly. There 
was too much wish to do it quick and dirty, if I may say that. 
The result was that many of the very important decisions were 
postponed and delegated to sublegislation activities. I would 
pledge--or, I would ask you--not to do the same in the United 
States, but take your job seriously, as legislators, and decide 
on who is actually, in the end, paying the bill, because there 
may be a huge impact.
    Second--and this is something that you should copy from the 
EU--second, the EU realized that, in the end, the system is 
about having a cap, and it's not about earning revenues for the 
budget. So, this was recognized by the EU. So, like the EU, 
don't make it a production tax through auctioning the CO2 
allowances, but rather base the allocation on free allowances 
based on benchmarks. I will say a few words about that later. 
Because, in the end, companies need the money to actually 
invest in greenhouse gas mitigation, so don't take the money 
from the companies that they need to actually do the job.
    Third--and this is, again, rather a bad experience from the 
EU, the definition of ``exposed sectors.'' While there has been 
some effort to try to get this quantitatively assessed in terms 
of trade intensity and CO2 intensity, we have realized--and 
this is backed by preliminary findings from the EU Commission 
which were just presented last week--that this purely 
quantitative approach runs too short of the real world. If I 
may say, in the chemical industry, we have a rather complex 
production integration. We have rather CO2-intensive products 
at the very beginning of our value chains, but then, at the 
same site, we produce more downstream products, and those are 
trade-exposed. So, only if you look at the whole industry as 
such, you would have a real good picture of the real exposure 
to CO2 costs and global trade. And indeed, the chemical 
industry was recognized by the Commission as being exposed, 
taking into account also qualitative arguments. Only doing it 
at a quantitative level, is our experience from the EU, would 
not work. So, you should identify exposed sectors differently, 
as well.
    And then, finally, two remarks about the allocation 
formula. First, as I said earlier, we suggest that you should 
base the free allocations on benchmarks. So, what does that 
mean? That means that if you produce a given chemical, then, of 
course, you would find some installation which does it best, 
most efficiently. So, that installation should get the 
allowances for free, because you cannot get any better. But, if 
you are worse than that, you should pay for the difference. And 
you can show, mathematically, that the incentive to actually 
mitigate greenhouse gas emissions is exactly the same in this 
benchmark-based approach as in the full auctioning approach, 
while, at the same time, you avoid the incentive to relocate.
    The second issue about the allocation is the base year for 
the production. It probably will be that, in the EU ETS, the 
production base will be one base year ex-ante. And this will 
be, then, the same base for the next 10 years to come. The 
problem with that fixed base year is that, even if you are the 
most efficient company, and you want to grow with your 
efficient installations, you will be penalized. While, at the 
same time, a company that is not efficient, but reduces 
production, would be rewarded. So, you must make sure that the 
base year--that is the base for the allowance allocation--is 
readjusted every few years.
    So, if I may sum up again, we do support a good greenhouse 
gas regime. Make it right. It's very complex. And so, learn 
from the EU that, indeed, it's about the cap, it's not about 
earning money for the budget. However, find a better way to 
define ``exposed sectors.'' And don't be afraid to just decide 
that industry as a whole, in a learning phase, should be 
considered as exposed. And finally, for the benchmarks, make it 
a very simple system and base the allocation on a rolling 
average base year.
    Thank you very much.
    [The prepared statement of Dr. Weber follows:]

 Prepared Statement of Dr. Wolfgang Weber, Head of Energy and Climate 
               Policy, BASF Group, Ludwigshafen, Germany

                              introduction
    Good afternoon, Senator Shaheen and members of the subcommittee. I 
am pleased to be here today to represent BASF Group. Thank you for the 
invitation to testify.
    My name is Wolfgang Weber. I am the head of energy and climate 
policy for BASF Group. In this capacity, I am responsible for policy 
development and communication of BASF's position on energy and climate 
matters before the European Union and the governments of Member States. 
In addition, I consult with my BASF counterparts in other countries, 
including here in the United States, on matters relevant to my 
portfolio that impact our company.
    My testimony below explains BASF's work in the area of 
sustainability and talks about our experiences under the European 
emissions trading system (ETS). If I could sum up our views briefly at 
the outset on how an ETS impacts the business of chemistry, it would be 
as follows:

   Chemistry is one of the keys to the sustainable future to 
        our planet, as evidenced by BASF's own 3:1 carbon ratio (see 
        below), which was confirmed industrywide in a recent study by 
        McKinsey and Company \1\;
---------------------------------------------------------------------------
    \1\ The McKinsey study was commissioned by the International 
Council of Chemical Associations. The study found that the products of 
the chemical industry enable greenhouse gas (GHG) savings 2-3 times 
greater than their emissions report summary at http://www.icca-
chem.org/ICCADocs/LCA-executive-summary-english.pdf. The Oko Institut 
reviewed the report's calculations.
---------------------------------------------------------------------------
   But chemistry is an energy-intensive, globally competitive 
        business, one in which regionally unilateral costs from climate 
        and energy legislation cannot be offset by passing them through 
        to customers;
   And every payment made by the chemical industry for CO2 
        allowances, or CO2 taxes or renewable levies would be 
        equivalent to a production tax and would jeopardize--in the 
        absence of a truly global GHG regime--the existence of entire 
        value chains and put the entire chemical production system in 
        that region at risk;
   Therefore, 100-percent-free baseline allowances for 
        chemistry in any trading system based on benchmarks are 
        critical for not only our survival as a business through the 
        prevention of carbon leakage,\2\ but the long-term success of 
        any climate protection scheme that involves energy-efficiency 
        and reduced GHG emissions.
---------------------------------------------------------------------------
    \2\ The term ``carbon leakage'' refers to the loss of jobs to 
locations without a similar climate control scheme.

    And, if I may add one further point before going on, one that is 
particularly relevant to this subcommittee's jurisdiction: Climate 
protection is a global challenge that requires a multinational 
solution. No matter the course selected here, or in Europe, or China or 
India, we must all end at one point--a global accord on climate 
protection. Then and only then we will seize all the greenhouse gas 
(GHG) efficiency potentials across all sectors and avoid distortions of 
global competition.
            about basf and our commitment to sustainability
    BASF is the world's leading chemical company: The Chemical Company. 
We are headquartered in Ludwigshafen, Germany. Our portfolio includes 
chemicals, plastics, and performance products to agricultural products 
and fine chemicals, as well as oil and gas. As a reliable partner, BASF 
helps its customers in virtually all industries to be more successful. 
With our high-value products and intelligent solutions, BASF plays an 
important role in finding answers to global challenges such as climate 
protection, energy efficiency, nutrition and mobility. BASF has 
approximately 97,000 employees and operates 330 facilities on five 
continents. In the United States, we employ approximately 15,000 people 
and have facilities in more than half of the States.\3\
---------------------------------------------------------------------------
    \3\ Further information on BASF is available on the Internet at 
www.basf.com.
---------------------------------------------------------------------------
    To underscore our commitment to sustainability, I invite the 
subcommittee's attention to the following:

   BASF has been successful in significantly reducing emissions 
        of greenhouse gases through numerous measures in recent yeers. 
        Since 1990 we have reduced our absolute GHG emissions by 38 
        percent and our specific GHG emissions per ton of sales product 
        by 61 percent.
   We have developed a widely recognized Verbund system, where 
        we link production plants intelligently to save resources and 
        energy. For example, heat from production processes is not 
        discharged to the environment but instead captured to power 
        other production plants. In 2008, our energy Verbund helped us 
        to save 1.6 million metric tons of oil equivalents globally. We 
        have six Verbund sites globally, with two in the United States.
   To supply our production sites with steam and electricity, 
        we operate combined heat and powerplants, which allows us to 
        achieve an overall efficiency of almost 90 percent.
   BASF spends some =400 million per year in energy efficiency 
        and climate-related R&D.
   Globally our products save three times more CO2 than is 
        produced by the manufacture and disposal of all of these same 
        products. When our customers use our products, it results in a 
        decrease in 252 million tons of CO2-e over their use phase. 
        (See diagram below.) The results demonstrating the emission 
        reduction reality of our products were confirmed by the Oko-
        Institut, a leading European research and consultancy 
        institution working for a sustainable future.\4\
---------------------------------------------------------------------------
    \4\ Visit http://www.oeko.de/home/dok/546.php.
    
    
    Returning to one of the points I made at the outset of my testimony 
about chemistry being a key to our sustainable future, part of the 
major GHG emission savings achieved by our customers through BASF 
---------------------------------------------------------------------------
materials take place in the following areas:

   Housing with savings of 140 million tons of CO2-e per year 
        (e.g., through insulating materials);
   Mobility with savings of 30 million tons of CO2-e per year 
        (e.g., through plastics that make cars lighter or fuel 
        additives);
   Industry with savings of 48 million tons of CO2-e per year 
        (e.g., through industrial catalysts, processes); and
   Others with savings of additional 34 million tons of CO2-e 
        per year.\5\
---------------------------------------------------------------------------
    \5\ For more information on BASF products that increase energy 
efficiency and help to reduce GHGs, please see Testimony of Armstrong, 
BASF Corporation, U.S. Senate Committee on Environment & Public Works, 
Business Opportunities and Climate Protection, May 2009, at http://
epw.senate.gov/public/
index,cfm?FuseAction=Hearings.Hearing&Hearing_ID=37159346-802a-23ad-
4ea2-afa619aa8c43.

    Moving forward, BASF has dedicated itself to reduce specific GHG 
emissions by 25 percent by 2020 compared with 2002 and increase energy 
efficiency in production by 25 percent by 2020 compared with 2002.
                     the impact of the european ets
    To begin a discussion on the European ETS and its impact on BASF, 
we should first note that Europe is required to take these steps in 
light of its adherence to the Kyoto Protocol \6\; that the system is 
being implemented in three stages; and no matter what safeguards are in 
place; until a global system is achieved, carbon leakage will remain an 
issue.
---------------------------------------------------------------------------
    \6\ ``The Kyoto Protocol is an international agreement linked to 
the United Nations Framework Convention on Climate Change. The major 
feature of the Kyoto Prototol is that it sets binding targets for 37 
industrialized countries and the European community for reducing 
greenhouse gas (GHG) emissions.'' http://unfccc.int/kyoto_protocol/
items/2830.php.
---------------------------------------------------------------------------
    Stage I took place 2005-2007, was limited in scope, and was 
considered a learning phase and did not result in added costs for BASF. 
Stage II takes place from 2008-2012 and covers more installations.
    Stage III will take place from 2013-2020, and negotiations among 
Member States of the EU regarding this phase were concluded in December 
2008. It is this stage that one may consider analogous to what is being 
considered here in the United States. The European system will rest on 
auctioning, as well as allocations of baseline credits based 
benchmarks.\7\
---------------------------------------------------------------------------
    \7\ ``Benchmarking'' in the context of climate discussions refers 
to a process whereby, ``Homogenous emitters are benchmarked, rated by 
an independent auditor. From that rating, a performance reference of 
CO2 emissions per unit of production is derived. If a company wants to 
compete without additional costs, without then paying CO2 rights, it 
has to manufacture its products according to processes meeting this 
performance reference.'' European Chemical Industry Council, at http://
www.cefic.be/templates/shwNewsFull.asp?HID=l&NSID=704&NID=1. Under the 
scheme approved in December 2008, the starting point for benchmarks in 
the European ETS shall be ``the average performance of the 10-percent 
most efficient installations in a sector or subsector in the Community 
in the years 2007-2008. The European Commission shall consult the 
relevant stakeholders, including the sectors concerned.'' European 
Commission, at http://ec.europa.eu/environment/climat/emission/
benchmarking_en.htm.
---------------------------------------------------------------------------
    There is still work to be done in addressing a number of details 
regarding Stage III, and we cannot provide any concrete numbers. This 
is because the EU heads of state postponed and delegated quite 
important decisions to the so-called comitology procedure over the 
years 2009 until 2011. But, what we can draw from our rough 
calculations of the projected costs associated with this last stage and 
our experience with the first two stages is that for chemistry to grow, 
to prevent contractions, and continue to provide solutions to reducing 
GHGs, the industry must be listed as an exposed sector and qualify for 
100 percent free baseline allocations. Baseline allocations based on 
benchmarks is the best way to help minimize carbon leakage for large 
and homogeneous products. Without these free baseline allocations, the 
price for BASF could be as high as =400 million per year.
              lessons learned from the european experience
    The lessons that we have drawn from our experience with the 
European ETS are as follows:
    (1) Carbon Leakage and Exposed Sectors. A measure for reducing GHGs 
must include an early and unambiguous statement that the chemical 
industry and other energy-intensive sectors qualify for continued free 
allocation of baseline allowances based on benchmarks. (Note: As 
explained earlier, the chemical industry has substantial potential to 
help the world reduce further emissions both through GHG emissions 
savings in its own production and through its products. If steps are 
taken to facilitate emissions reductions and fully utilize chemical 
products, the ratio of emissions savings to emissions could increase to 
more than ``4 to 1'' by 2030.\8\) The difficulty is defining an 
``exposed sector.'' Today's economy, and in particular the chemical 
industry, is extremely interlinked and complex. The methodology used in 
the European Union ETS directive to define exposed sectors \9\ has 
proven difficult to implement. Thankfully, the European Commission 
applied additional qualitative and quantitative analyses, which 
resulted in a preliminary finding that chemistry is an exposed sector, 
which would make it eligible for free baseline allowances.\10\
---------------------------------------------------------------------------
    \8\ Supra note 2.
    \9\ Exposed sectors have a high CO2 cost share of gross value added 
and/or high trade intensities. Specifically, ``the extent to which the 
sum of direct and indirect additional costs induced by the 
implementation of this directive would lead to a substantial increase 
of production cost, calculated as a proportion of the Gross Value 
Added, of at least 5 percent; and the Non-EU Trade intensity defined as 
the ratio between total of value of exports to non-EU + value of 
imports from non-EU and the total market size for the Community (annual 
turnover plus total imports) is above 10 percent.'' European 
Commission, at http://ec.europa.eu/environment/climat/emission/
carbon_en.htm.
    \10\ Id.
---------------------------------------------------------------------------
    (2) Electricity and Combined Heat and Power (CHP). Electricity 
production from industrial CHP installations should be subject to free 
allocations. Industrial energy uses should be free from CO2 costs to 
avoid an unequal footing of electricity and heat-based industrial 
activities.
    (3) Coverage. The designers of an ETS should clearly limit 
installation definitions to cover only the large emitters to keep the 
administrative burden and bureaucracy at an acceptable level.\11\ The 
installation definitions under the European ETS are sometimes unclear; 
e.g., combustion versus chemical installations.
---------------------------------------------------------------------------
    \11\ More than 80 percent of chemical emissions are covered by less 
than 10 installation types.
---------------------------------------------------------------------------
    (4) Benchmarks. While we support the benchmarking concept, the 
benchmarks set under the European directive are somewhat ambiguous. The 
legislative text to establish an ETS should be very specific with 
respect to benchmarks and the benchmarks should be simple, as opposed 
to defining hundreds of benchmarks for the many different heat uses. 
One benchmark should be defined for the production of heat. We also 
believe that benchmarks should be feedstock-specific in some cases to 
allow for a continued broad energy mix and increased security of 
supply. Otherwise the natural gas supply will suffer.
    (5) Allocations. We have learned through our experience that the 
manner in which allocations are set out should be clearly stated in the 
legislation. This is not always the case in the European system. 
Because of this lack of clarity, it is likely that allocations will be 
ex ante, based on historic production in a given installation. This 
hampers growing companies and awards declining production. We suggest a 
regular adjustment of the production base.
    (6) Border Control Measures, e.g., Tariffs. We believe that the 
European Union has taken the correct approach by not implementing 
border control measures. First, we believe it likely that targeted 
countries would export their ``clean'' products and keep their 
``dirty'' products for domestic use. Second, to comply with 
international law, they could be targeted to only against countries 
which have committed to GHG reductions under a post Kyoto agreement and 
do not live up to their commitments Third, border mechanisms are 
unlikely to be compliant with standards established by the World Trade 
Organization and would lead to protectionism and retaliation 
measures.\12\ We note, for example, the existence of Article III of the 
General Agreement on Tariffs and Trade, which contains fundamental 
principle of nondiscrimination; i.e., the EU cannot discriminate 
against foreign products. The United States is also a member of WTO. 
Fourth, they would be almost ineffective for the chemical sector due to 
our huge range of (mostly upstream) products.
---------------------------------------------------------------------------
    \12\ We are aware of the recent WTO/UNEP report titled ``Trade and 
Climate Change,'' which the press has said backs tariffs as part of a 
climate protection mechanism, at http://www.wto.int/english/res_e/
booksp_e/trade_climate_change_e.pdf. However, the press's 
interpretation and even the statements in the report are not held 
unilaterally, and there are differing views, among academia the 
business community, and even elected officials, including the President 
of the United States, which should be examined by this subcommittee.
---------------------------------------------------------------------------
                               conclusion
    Thank you, Senator Shaheen and members of the subcommittee. BASF 
looks forward to sharing our expertise and experience in the area of 
climate protection. I would be pleased to answer your questions.

    Senator Shaheen. Thank you, Dr. Weber.
    Mr. Lieberman.

 STATEMENT OF BEN LIEBERMAN, SENIOR POLICY ANALYST FOR ENERGY 
 AND ENVIRONMENT, THOMAS A. ROE INSTITUTE FOR ECONOMIC POLICY 
          STUDIES, HERITAGE FOUNDATION, WASHINGTON, DC

    Mr. Lieberman. Thank you, Chairwoman Shaheen.
    My name is Ben Lieberman. I'm the senior policy analyst for 
energy and environment at the Heritage Foundation. I'd like to 
thank the Subcommittee for European Affairs for inviting me to 
testify.
    What the subcommittee is doing today is very important, but 
it's what was largely missing from the House global warming 
debate, and that is taking a look at the real-world experience 
in Europe with the Kyoto Protocol and the cap-and-trade 
approach to reducing emissions of carbon dioxide and other 
greenhouse gases. Notwithstanding questions about the 
seriousness of man-made global warming, the Heritage Foundation 
is very concerned about the cost of this approach which was 
embodied in the Waxman-Markey bill. Our analysis of the bill 
estimates higher energy costs and other costs for household of 
four, averaging nearly $3,000 annually, and an overall lost GDP 
of $393 billion annually and $9.4 trillion cumulatively by 
2035. We also estimate over a million lost jobs.
    And even if it is--even if--assuming it works to reduce 
emissions, Waxman-Markey has been estimated by climate 
scientist Chip Knappenberger to reduce the Earth's future 
temperature by no more than 0.2 degrees Celsius by 2100.
    But, will it even work? Will it even reduce emissions 
enough to accomplish that 0.2 degrees? The European experience 
with cap-and-trade strongly urges caution. The Washington Post 
recently described it as Exhibit A of what not to do on 
climate, and for good reason. The Senate would be wise to take 
a close look at Europe's track record with the 1997 Kyoto 
Protocol and the emissions trading scheme adopted in 2005.
    Most Western European nations are currently learning, the 
hard way, that ratcheting down carbon dioxide emissions in this 
manner is difficult and expensive. In fact, most of these 
nations, not to mention other Kyoto Protocol signatories, like 
Canada and Japan, have not been reducing their emissions over 
the last several years, though it should be noted that they are 
doing so now, but only as a result of the recent recession. 
Indeed, several were seeing faster increases since 2000 than 
those in the United States, which has not been subject to such 
a scheme.
    And despite lofty rhetoric from some about setting even 
more stringent future standards, we also see signs of 
fracturing in the cap-and-trade coalition, from German 
automakers to Italian steelmakers to nations that still rely on 
coal for a substantial percentage of electricity generation. 
Discussions about exclusions and delays and handouts are now 
very much a part of the debate on climate in Europe. The 
Russian cutoff of natural gas to Europe was also a reminder of 
the geopolitical risk of discouraging domestic coal under cap 
and trade.
    We have also seen examples of fraud and unfairness in the 
process, and, given the similar politics here, where big 
businesses have lobbied for free allocations much more 
effectively than the little guys--consumers, homeowners, small-
business owners, farmers--it's quite likely that the inequities 
would appear here, as well. And the reason for the failure of 
carbon cap and trade is simple: Reducing carbon dioxide from 
the existing installed base of energy-producing and energy-
using equipment and vehicles is prohibitively expensive, and 
that isn't likely to change anytime soon. Many nations 
committed to emissions reductions under the Kyoto Protocol are 
going to miss the targets unless the recession lingers, and any 
talk of tougher targets is empty rhetoric.
    The record in Europe suggests that the Heritage Foundation 
and others predicting high costs for Waxman-Markey are right, 
while those predicting postage-stamp-per-day costs are wrong. 
If it really were postage-stamp cheap, Europe's emission 
reduction record would be much better by this point and there 
would be no need to make excuses for it.
    Further, a study by the Taxpayers Alliance in the U.K. 
estimates that the cost of various green taxes in the U.K. is 
up to $1,200 per household per year, and that's to achieve only 
a fraction of what Waxman-Markey requires. Again, this points 
to high household costs for Waxman-Markey.
    To the limited extent that European nations have reduced 
emissions below business-as-usual levels, it has hurt their 
economies. Almost every Western European nation has had higher 
unemployment and energy costs than America, and a weaker 
overall economy, even as emissions were still rising. Far from 
seeing evidence of the bright, new green economy some are now 
promising, we're seeing that cap and trade has contributed to 
the harm. For example, Spain has been cited repeatedly as the 
example of a successful clean energy economy and source of 
green jobs, but it's rarely mentioned that Spain currently has 
18-percent unemployment.
    There are reasons that may explain this seemingly 
counterintuitive result that cap and trade is not only the 
wrong approach for the economy, but is also the wrong approach 
for reducing greenhouse gas emissions. Any sensible approach to 
global warming has to center on technological innovation as it 
applies to energy production and use. Breakthroughs, such as 
ways to produce energy economically with low or no carbon 
dioxide emission or improvements in energy efficiency, these 
make good sense, irrespective of global warming. Innovation is 
what we really want, and we know, from long experience, that 
free economies innovate better than centrally planned ones. 
But, cap and trade introduces a significant element of central 
planning, and thus, stifles innovation.
    We also know that strong economies innovate better than 
weak ones, but cap and trade weakens economies. Perhaps most 
importantly, stable economies innovate better than unstable 
ones, especially for something like energy, where the 
investments often run into the billions of dollars and the 
payoffs play out over decades. But, cap and trade adds a 
significant element of instability, which we have seen in 
Europe, with wild swings in the price of carbon allowances, and 
energy companies less interested in long-term investment and 
more interested in short-term gaming of the system.
    In conclusion, the economic realities of cap and trade are 
becoming clear in Europe. If we adopt a similar approach here, 
we can expect considerable economic pain for questionable 
environmental gain.
    Thank you.
    [The prepared statement of Mr. Lieberman follows:]

Prepared Statement of Ben Lieberman, Senior Policy Analyst, Energy and 
 Environment, Thomas A. Roe Institute for Economic Policy Studies, The 
                  Heritage Foundation, Washington, DC

    My name is Ben Lieberman, and I am the senior policy analyst for 
energy and environment in the Thomas A. Roe Institute for Economic 
Policy Studies at the Heritage Foundation. The views I express in this 
testimony are my own, and should not be construed as representing any 
official position of the Heritage Foundation.
    I would like to thank the Subcommittee for European Affairs for 
inviting me to testify. What the subcommittee is doing today is very 
important but was largely missing from the House global warming debate, 
and that is taking a look at the real world experience in Europe with 
the Kyoto Protocol and the cap-and-trade approach to reducing emissions 
of carbon dioxide and other greenhouse gases. Notwithstanding questions 
about the seriousness of man-made global warming, the Heritage 
Foundation is very concerned about the costs of this approach, which 
was embodied in the Waxman-Markey bill. Our analysis of that bill 
estimates higher energy and other costs for a household of four 
averaging nearly $3,000 annually and overall lost gross domestic 
product of $393 billion annually and $9.4 trillion cumulatively by 
2035.\1\ We also estimate over a million lost jobs. And even assuming 
it works to reduce emissions, Waxman-Markey has been estimated by 
climate scientist Chip Knappenberger to reduce the earth's future 
temperature by no more than 0.2 C by 2100.\2\
---------------------------------------------------------------------------
    \1\ William W. Beach, et al., ``Son of Waxman-Markey: More Politics 
Makes for a More Costly Bill,'' Heritage Foundation Web Memorandum No. 
2450, June 16, 2009, at http://www.heri-
tage.org/Research/EnergyandEnvironment/wm2450.cfm.
    \2\ Chip Knappenberger, ``Why Waxman-Markey Is Not A Climate 
Bill,'' June 29, 2009, at http://masterresource.org/?p=3507#more-3507.
---------------------------------------------------------------------------
    But will it even work? Will it even reduce emissions enough to 
accomplish that 0.2 degrees? The European experience with cap and trade 
strongly urges caution. The Washington Post recently described it as 
``Exhibit A'' of what not to do on climate, and for good reason.\3\ The 
Senate would be wise to take a close look at Europe's track record with 
the 1997 Kyoto Protocol and the Emissions Trading Scheme adopted in 
2005.
---------------------------------------------------------------------------
    \3\ ``Climate Change Solutions Sen. Boxer Is Open To Everything--
Except What Might Work Best,'' the Washington Post, February 16, 2009, 
at http://www.washingtonpost.com/wp-dyn/content/article/2009/02/15/
AR2009021501425.html.
---------------------------------------------------------------------------
    Most western European nations are currently learning, the hard way, 
that ratcheting down carbon dioxide emissions in this manner is very 
difficult and expensive. In fact, most of these nations (not to mention 
other Kyoto Protocol signatories like Canada and Japan) have not been 
reducing their emissions over the past several years, though it should 
be noted that they are doing so now but only as a result of the recent 
recession.\4\ Indeed, several were seeing faster increases since 2000 
than those in the United States, which has not been subject to such a 
scheme.\5\
---------------------------------------------------------------------------
    \4\ Press Release, ``UNFCC: Rising Industrialized Countries 
Emissions Underscores Urgent Need for Political Action on Climate 
Change,'' United Nations, November 16, 2008, at http://unfccc.int/
files/press/news_room/press_releases_and_advisories/application/pdf/
081117_ghg
_press_release.pdf.
    \5\ Energy Information Administration, ``International Energy 
Annual 2006,'' Table H.1co2: World Carbon Dioxide Emissions from the 
Consumption and Flaring of Fossil Fuels, 1980-2006, at http://
www.eia.doe.gov/pub/international/iealf/tableh1co2.xls (December 11, 
2008).
---------------------------------------------------------------------------
    And despite lofty rhetoric from many European nations about setting 
even more stringent future standards, we also see signs of fracturing 
in their cap-and-trade coalition. From German automakers to Italian 
steelmakers to nations that still rely upon coal for a substantial 
percentage of electric generation, discussions about exclusions and 
delays and handouts are now very much a part of the debate in every 
European Union meeting on climate. The Russian cutoff of natural gas to 
Europe was also a reminder of the geopolitical risks of discouraging 
domestic coal under cap and trade.
    We have also seen examples of fraud and unfairness in the 
process.\6\ Given the similar politics here, where big businesses have 
lobbied for free allocations much more effectively than the little 
guys--consumers, homeowners, small business owners, farmers--it is 
quite likely that the inequities would appear here as well.
---------------------------------------------------------------------------
    \6\ Open Europe, ``Europe's Dirty Secret: Why the EU Emissions 
Trading Scheme Isn't Working,'' August 2007, at http://
www.openeurope.org.uk/research/etsp2.pdf.
---------------------------------------------------------------------------
    The reason for the failure of carbon cap and trade is simple--
reducing carbon dioxide from the existing installed base of energy 
producing and using equipment and vehicles is prohibitively expensive, 
and that isn't likely to change any time soon. Many nations committed 
to emissions reductions under the Kyoto Protocol are going to miss the 
targets (unless the recession lingers) and any talk of tougher targets 
is empty rhetoric.
    The record in Europe suggests that the Heritage Foundation and 
others predicting high costs for Waxman-Markey are right, while those 
predicting postage stamp per day costs are wrong. If it really were 
postage stamp cheap, Europe's emissions reduction record would be much 
better, and there would be no need to make excuses for it.
    Further, a study by the Taxpayers Alliance estimates the cost of 
various green taxes in the U.K. is up to $1,200 per household per year, 
and that to achieve only a fraction of what Waxman-Markey requires.\7\ 
Again, this points to very high household costs for Waxman-Markey.
---------------------------------------------------------------------------
    \7\ Mathew Sinclair, ``The Burden of Green Taxes,'' Taxpayers 
Alliance, August 2008, at http://tpa.typepad.com/home/files/
the_burden_of_green_taxes.pdf.
---------------------------------------------------------------------------
    To the limited extent European nations have reduced emissions below 
business-as-usual levels, it has hurt their economies. Almost every 
western European nation has had higher unemployment and energy costs 
than America, and a weaker overall economy, even as emissions were 
still rising. Far from seeing evidence of the bright new green economy 
some are now promising, we are seeing that cap and trade has 
contributed to the harm. For example, Spain has been cited repeatedly 
as the example of a successful clean energy economy and source of green 
jobs, but it is rarely mentioned that Spain currently has 18 percent 
unemployment.
    There are reasons that may explain this seemingly counterintuitive 
result that cap and trade is not only the wrong approach for the 
economy but is also the wrong approach for reducing greenhouse gas 
emissions. Any sensible approach to global warming has to center on 
technological innovation as it applies to energy production and use. 
Breakthroughs such as ways to produce energy economically with low or 
no carbon dioxide emissions or improvements in energy efficiency--these 
make good sense irrespective of global warming.\8\
---------------------------------------------------------------------------
    \8\ Iain Murray and H. Sterling Burnett, ``10 Cool Global Warming 
Policies,'' National Center for Policy Analysis, June 2009, pp. 20-22, 
at http://www.ncpa.org/pdfs/st321.pdf.
---------------------------------------------------------------------------
    Innovation is really what we really want. And we know from long 
experience that free economies innovate better than centrally planned 
ones. But cap and trade introduces a significant element of central 
planning and thus stifles innovation. We also know that strong 
economies innovate better than weak ones, but cap and trade weakens 
economies. Perhaps most importantly, stable economies innovate better 
than unstable ones, especially for something like energy where the 
investments often run into the billions of dollars and the payoffs play 
out over decades. But cap and trade adds a significant element of 
instability, which we have seen in Europe with wild swings in the price 
of carbon allowances, and energy companies less interested in long-term 
investment and more interested in short-term gaming of the system.
    In conclusion, the economic realities of cap and trade are becoming 
clear in Europe. If we adopt a similar approach here, expect 
considerable economic pain for minimal environmental gain.

    Senator Shaheen. Thank you very much, Mr. Lieberman.
    Obviously, there are different perspectives represented in 
this testimony. And I'd like to pursue some of the comments 
made by panelists, and see if we can get a little more detail 
on some of what you're suggesting.
    Dr. Matthes, in your testimony you talked about an in-depth 
analysis of trade flows for the EU in the last few years that 
indicated that there have been no significant changes as the 
result of the Emissions Trading System. Could you elaborate on 
that a little bit? And I think you specifically talked about 
phase one. So, is the same true of phase two? And can you 
project out what might happen under phase three of the system?
    Dr. Matthes. Yes, thank you for the question. First is, we 
have evidence from the data which are available from the years 
since the turn of the century and including the year 2007. That 
means we have a couple of years without any price on carbon, we 
have 1\1/2\ years with a pretty high price on carbon, we have 
the year 2007 without any price, because the bloody lesson 
learned that you never should introduce an instrument of 
quantity controls if you don't have a very clear imagination on 
the quantities, but that has changed--that has changed for the 
second phase. And for the years prior to year 2007, we see no 
outlay or no differentiation. It's a short term. But, on the 
other hand, if you look on investment streams, et cetera, et 
cetera, and if you take into account that, for the year 2008, 
the cap was tightened and the future prices for allowances 
which we have at the moment, by the year 2015, are pretty 
significant, we can't see any significant reallocation of 
investment. Even in industries like the iron and steel 
industry, which is heavily exposed to carbon prices, we see 
ongoing investments there. And therefore, at the moment, we 
don't see this.
    And the key lesson learned from this is that--and that I 
tried to at this point, I tried to make in the end of my 
presentation--that the major problem is probably not the 
reallocation of production from existing facilities, but the 
reallocation of investments, because there you need a vision on 
future prices, et cetera, et cetera. And probably because the 
most of the potentially affected industries are capital-
intensive industries. It's the reallocation of investments to 
more important challenge for the economy. That is, at the 
moment, solved by free allocation, because the net present 
value of free allocation is an investment subsidy. But, there 
are also other ways to do this with direct subsidies, et 
cetera, et cetera.
    And summarizing, even in the statistical analysis, the 
heavy or the carbon-intensive productions, which are there in 
Germany or in the U.K., are mostly there because of links to 
customers, et cetera, et cetera. And it is not that easy to 
reallocation reductions. And if you see the bad example, then 
you should look to the Brazilian adventure of a big German 
steel company who tried to make it cheaper there, and there it 
became more expensive, at the end.
    Senator Shaheen. Thank you.
    Do any of the other panelists want to address that question 
before we move on?
    Yes, Dr. Weber.
    Dr. Weber. Well, thank you. So, perhaps one should just 
bring back to your attention that, of course, in phase one and 
two, and we don't know yet for phase three, there is no 
auctioning. Now, I'd say, of course, that that explains why 
there is no major change of trade flows. EU politics, so far, 
has recognized that it must do something--to avoid carbon 
leakage; i.e., allocating allowances for free. And in terms of 
investments and productions, if I might just say, that--of 
course, that depends very much on the very issue. I could tell 
you that if we had to fully auction allowances, also some 
production activities would be closed. So, it's not only 
about----
    Senator Shaheen. I'm sorry, say that again.
    Dr. Weber. So, if there was full auctioning for some of our 
production facilities, very, very likely those production 
facilities would be closed, they would not continue to produce. 
So, it's not only about investment, it's also about 
continuation of production.
    Senator Shaheen. Yes, Dr. Fries.
    Dr. Fries. Yes, I will just to follow up on the two 
previous sets of comments. I think it's important to realize 
that the timescale over which investment decisions are made in 
capital-intensive industries and energy intensive industries is 
quite long. I think it would be unrealistic to expect to see 
already signs of competitiveness problems from the EU ETS given 
the long lead times that are required for forming investment 
decisions and actually implementing them. The second important 
point is that the allocation of emission allowances under the 
EU ETS has so far been largely for free and that their partial 
auctioning will only begin in 2013. Both points suggest that it 
would be premature to try to gauge the impacts on 
competitiveness from what we've observed so far.
    Senator Shaheen. But, you must be thinking, both at Shell 
and BASF, about your investment decisions for the future, and 
factoring into that what's required under the phase three of 
the system. So, are you looking at impacts on your 
competitiveness under phase three? And are you--you said, Mr. 
Weber, that if the credits were auctioned and you had to pay 
for them, that there would be facilities that closed. So, as 
you're looking at the future, how are you factoring in those 
kinds of decisions under phase three? Either one of you.
    Dr. Weber. So, of course, this is taken into account, and--
as Steven Fries said, yes, indeed, investments take some time 
to be planned, and then also to be implemented. In an industry 
like the chemicals, the discounting would not take place over 
the next 20 or 30 years. I mention this because often people 
say, ``Well, in 20, 30 years, there will be a carbon price in 
many parts of the world, so why do you bother?'' But we need to 
discount our investments much sooner than that, because we 
don't know yet what the world would look like in 20 or 30 years 
from now.
    So, an investment in 2019, when we know that from 2021 
there will be full auctioning, will, of course, be differently 
viewed than an investment that we think about today, because 
then much of the discounting would have taken place by 2020. 
So, it's indeed much about timeframes and somewhat longer 
planning certainty. So, to sum up, these things are taken into 
account, yes.
    Senator Shaheen. Yes?
    Dr. Fries. Yes. On this point, we have systematically gone 
through our energy-intensive and trade-exposed sectors to 
assess the potential impacts from phase three of the EU ETS. We 
began with what you might expect from, say, fairly standard 
textbook economics, be it how the markets in these various 
sectors would adjust under very competitive conditions and 
uniform regulation, and then moved toward more imperfectly 
competitive market structures with very uneven regulation. This 
provided a baseline from what you might expect economic first 
principles.
    We then worked very closely with our specialists in each of 
these industries, who actively participate in these markets and 
understand the institutional norms, the pricing norms, and the 
sector dynamics, to understand better how the adjustment 
process to phase three of the EU ETS is likely to play out.
    So, what we've done is to take a fairly rigorous and 
analytically driven approach to anticipating and understanding 
these impacts, and then to feed that analysis back into our own 
strategic thinking. We have combined basic economic analysis 
with our market knowledge to shape our long-run investment 
responses to these policy developments.
    Senator Shaheen. Thank you.
    Did either of the other panelists want to address that at 
all?
    Dr. Matthes.
    Dr. Matthes. Yes. I think it is worth to have a look on the 
trade-flow patterns, because the trade flow--the existing 
trade-flow patterns somehow reflect the problems which might 
result from leakage problems.
    And I would highlight one interesting issue, that is the 
inclusion of Norway into the European Union emissions trading 
scheme. Norway is the trading partner No. 1 for aluminum, it's 
for fertilizers and others, and the inclusion of Norway--that 
means one of the target countries of potential leakage or 
reallocation has at least removed these very near-term leakage 
effects. And I think--I would highlight this.
    And we have, also, for some of the key products for those 
products which are, without any doubt, carbon intensive, the 
United States, for example, is a key trading partner. And I 
think that must be reflected.
    And the last remark is, we had a lot of studies when--
before we started the pilot phase, which made projections on 
the immediate reallocation of cement, et cetera, et cetera. And 
there, we see the evidence, it didn't happen.
    Senator Shaheen. Thank you.
    Mr. Lieberman, did you have anything you wanted to add?
    Mr. Lieberman. Oh, I would just add that probably the 
biggest fear of leakage is to fast-developing nations, namely 
China and India, who have repeatedly--I don't know how many 
times they have to say no--they don't want to go along with 
anything like this, and it is unlikely that they will. So, that 
is something that needs to be kept in mind, as well.
    Senator Shaheen. Well, clearly that is one of the biggest 
concerns that, I think, many have in Congress as we look at 
what would be the impacts of putting in place a policy to 
address climate change. And new energy technologies is the 
potential shift of jobs overseas to India and China, and--do 
any of you want to address what you're seeing as part of the 
European experience with respect to India and China?
    Dr. Matthes.
    Dr. Matthes. Yes, I think it's one of the usual suspects, 
India and China. But, if you really look to the trade patterns 
and to the import and export streams, at least empirical 
evidence from the last years--and China is not only cheaper in 
terms of carbon, it's cheaper in terms of labor force, et 
cetera, et cetera, and some productions are heavily 
subsidized--if you look to the--if you have a look on the total 
export-import streams, at least for the European Union, it 
must--not true for every product, but for the total of the 
European Union--India is negligible, and China, there is a 
problem limited to a few sectors, to a few sectors. And I think 
the suspicion everybody has that that is the major source, that 
is at least not proved by the evidence we have from the data 
for the last years.
    Senator Shaheen. Dr. Fries, I'm going to ask you for your 
comments, but I just want to explore that a little bit more, if 
I can. You said ``China, except for a few sectors.'' Can you 
identify the sectors that you've seen?
    Dr. Matthes. Yes. What we see from the data is iron and 
steel is a challenge. The--but, the major challenge comes from 
China, and we have inorganic chemicals--yes, inorganic 
chemicals, basic iron and steel, and might be, in the future, 
some organic chemicals. But, we have a wide range of other 
products. Aluminum is no problem. Fertilizers is no problem, et 
cetera, et cetera. And so, it is limited to some product 
streams, and, at least if you have a closer look to the iron 
and steel sector, we get, more or less, the, let's say, less 
quality steel products from there, and there is a limited 
demand. And the low-quality steel production from Germany has 
left, 15 years ago.
    Senator Shaheen. And so, has there--well, it might be like 
comparing apples and oranges, but has there been an effort to 
respond to any of the loss of competitiveness in those sectors 
by the system--the EU system?
    Dr. Matthes. Yes, we have free allocation, at the moment. 
It----
    Senator Shaheen. OK, so that has responded----
    Dr. Matthes. That has responded, but you have to take into 
account, from--at least from economic theory, opportunity costs 
are costs. And at least--even in a world with free allocation, 
there are some incentives to reallocation productions if you 
don't introduce complementary measures, like plant closure 
provisions, et cetera, et cetera, and preferably base this on 
benchmarking. But, at least the free allocation which was 
introduced at the moment, has compensated for this; but, 
without this complementary measures on the long run, even free 
allocation would not avoid leakage.
    Senator Shaheen. Thank you.
    Dr. Fries, and then Dr. Weber.
    Dr. Fries. I was simply going to reinforce the point that 
you need to avoid making sweeping generalizations about the 
nature of the competitive threats and where the unevenness in 
the global competitive playing field will arise. And I think 
you need to look at it, as has just been illustrated, on a 
sector-by-sector approach. We have done that, and we understand 
the competitiveness issues from our own perspective and they 
are necessarily from India and China--they can also emerge from 
other developing countries.
    Senator Shaheen. Thank you.
    Dr. Weber.
    Dr. Weber. Yes, thank you. Well, again, the reason why we 
don't face major changes is because we have that free 
allocation. And again, let me make the point that the whole 
idea behind the ETS is the cap, about doing something to 
mitigate greenhouse gas emissions, and not about earning money 
for the budget. So, we have, I think, heard, today, quite a few 
good reasons why not to go to that auctioning.
    If I may, I would like to briefly touch upon the issue of 
specific relocation--India, China--and fertilizers was the 
given example. So, fertilizers is something which is highly CO2 
and energy intense. So, of course, it's other issues also which 
are relevant for the production decisions, not only CO2, and 
this is the gas price. So, already now much pressure on the 
fertilizer production in the United States comes from Trinidad 
and Tobago because of the high gas price.
    And now, the question is, that I would like to ask you--
it's a rhetorical question, if you'll allow--Do you want to 
accelerate that by adding another cost component on top of 
that? In Europe, we still have some ammonia production. We, as 
a company, produce that. But, of course, the same challenge 
that we face in Europe, as you have it with Trinidad and 
Tobago, is--for us, is the Middle East, which also has much 
cheaper gas price. And the question, again, is, Do you want to 
accelerate that?
    Ammonia is definitely one of the very highly CO2-intense--
sensitive production. But, to make that point further, it's not 
only about ammonia, but ammonia is the starting point of a long 
value chain that we produce also in our sites. So, for example, 
resins for making tables and surfaces are based on ammonia. 
And, of course, at some point, if you don't produce ammonia 
anymore, in the long run you would then also not produce the 
more downstream processes.
    So, there is an issue, and you really have to look at the 
industry as a rather complex system.
    Senator Shaheen. Well, clearly that's why we've asked you 
here, so that we can try and learn from your experience so that 
we don't affect the competitiveness of those industries in a 
way that loses them to the United States.
    Dr. Matthes, you talked about the phase one of the system 
leading to windfall profits, particularly in the electricity 
sector. What steps have been taken to address those windfall 
profits? And how quickly did people recognize that that was an 
issue? And how do you need to adjust for that in the future?
    Dr. Matthes. Yes, that's a very easy answer. That's--all 
free allocation to power generation was removed from the third 
phase, because we saw that very clear--in the first phase, 
about 90 percent of the allowances were given for free for the 
power sector, and the second phase, in Germany, it is between 
50 and 60 percent. They have passed-through the full cost of 
carbon. That was clear from the beginning. That was very 
difficult to communicate in the political process during the 
legislation. Now we have made this experience, with these huge 
amounts of money, and now it's removed. And we see it as--we 
also saw some windfall profits in the cement industry, et 
cetera, et cetera.
    But, I think--and that is the core of the problem. If the 
carbon price signal only generates windfall profits, then for 
those sectors, free allocation is no option. Because there is a 
huge potential for perversion, the free-allocation approach to 
the power industry in Germany has introduced incentives for 
building coal-fired powerplants, compared to gas-fired 
powerplants. Because allocation does measure--does measure 
allocation changes the investment approaches, et cetera, et 
cetera. And therefore, the--for those sectors which are not 
facing serious leakage concerns, full auctioning is the option 
of choice. And for those sectors where you have a leakage 
problem, then you have to decide would you address operations 
or investments. And the EU has decided to go for free 
allocation, for the time being, but they--if we would start 
from scratch, there would also be other options, especially to 
address the investment issue. And climate change is about 
future, and future is about new installation, and new 
installations is about investments. And therefore, the 
investment issue must be addressed more than a very broad free 
and--undifferentiated free-allocation approach.
    Senator Shaheen. Well, relative to the investment issue and 
the cost, I think, Mr. Lieberman, that you, in your testimony, 
said that, according to a study that Taxpayers Alliance has 
done, that the cost to the U.K. is about $1,200 per household 
per year. Am I correct?
    Is that the analysis that you have also seen, Dr. Matthes? 
Or, have you done that kind of an analysis to look at the 
potential cost per household of----
    Dr. Matthes. No. No.
    Senator Shaheen. [continuing]. The system?
    Dr. Matthes. That's far from every relevance, I think. You 
can see we have the major part of the cost for the private 
households come from the electricity consumption, which is 
covered by the EU ETS, and we have coal-fired powerplants at 
the margin, which set the price. That means every--the 
allowance prices going--it's going one-to-one to the power 
prices. We have, in Germany, after taxes and power price, of 
about 30 cents per kilowatt hour, and in the times--very high 
carbon price--the carbon price was 30 euro; that means 3 cents 
out of 30; that means 10 percent, and that is one order of 
magnitude, at least--probably two orders of magnitudes--less 
than the number which was demonstrated here. And I think that 
must be made very clear, that these cost estimates are not 
based on the reality we have at the moment in the EU ETS.
    One comment, perhaps on the volatility of the price. You 
can see the volatility of the price as a demerit, but, on the 
other side, you could also see that as a merit. If you would 
have the alternative, which is a carbon tax, whatever else, 
this carbon was--would never have--it would have never been 
possible to adjust the carbon tax in the economic recession at 
the moment. The allowance price adjusts automatically on a 
different framing, on energy prices, on recession, et cetera, 
et cetera. And therefore, I would see this flexibility in the 
carbon price more a merit than a demerit. And we have seen 
significant innovation and significant emissions abatement 
triggered by the carbon price. Without the emissions trading 
scheme in the European Union, we would not have this major 
effort on CCS. We see an increasing interest in blending of 
cement. We see an impressive increase of coal-firing of 
biomass. That was triggered by the carbon price, even if it was 
volatile.
    Senator Shaheen. I don't know if either of you have any 
statistics relative to the cost of the system.
    Dr. Weber.
    Dr. Weber. Well, I would rather say it's not that 
difficult. I mean, Felix Matthes, earlier testified what the 
windfall profits are for the electricity producers. Well, of 
course, you simply can use that number, divide by the 
electricity consumption of each household, and then you have 
the number by how much the costs have increased. That is a 
rather easy thing to do.
    But, perhaps, if I may, I would add two things here. One 
is, as just Felix Matthes rightly has said. Yes, we do have 
price signal now, without auctioning, that does deliver. 
Without auctioning, and it does incentivize investments in the 
right direction. That is exactly the point that I tried to make 
earlier. So, I'm happy that--well, yes, this seems to be a 
common understanding here.
    And, in terms of the windfall profits for the electricity 
producers, of course one way to avoid them is to go to 
auctioning. But then we have the problem that electricity also 
goes into chemicals production, iron and steel, and so on, and 
then you have to introduce rather complicated measures to 
compensate that for those exposed industries. So, there's an 
even better--easier way to avoid windfall profits, and that 
just goes back to what I suggested, to adjust the base for the 
allocation with the given production. So, if you do that, you 
could show that windfall profits do not really occur. I mean, 
also Felix Matthes said that, you must make sure that, in a 
system without auctioning, you must avoid to award companies 
who decrease their production. And how do you do that? By 
adjusting the production base. And the more detailed you do 
it--in the extreme case, year by year--well, then you'd also 
take away all the incentives to reduce production, and then you 
also reduce the chance to generate windfall profits. So, that 
would be an easier--even better way to avoid windfall profits.
    Thanks.
    Senator Shaheen. Yes, Dr. Matthes, you want to respond to 
that?
    Dr. Matthes. I made a calculation, only to make sure. The 
average German household has an annual electricity consumption 
of 3,000 kilowatt hours, which is 3 megawatt hours. In the 
times of the highest allowance prices, which was in the 
beginning of 2006, and last year--in summer of last year--we 
had a carbon price of 30 euro. That means every household, in 
the highest case, had the burden of 90 euro per year, at--and 
at the recent carbon price, the annual burden per household is 
45 euro annually. That is--compared to a good German beer, it's 
between 9 and 18 beers a year. [Laughter.]
    Senator Shaheen. I like quantifying it in that way. That's 
very good.
    So, you all have come to different conclusions about the 
costs than Mr. Lieberman has, in your analysis. Can I also ask 
you to respond to Mr. Lieberman's testimony that there has not 
been a reduction in emissions as the result of the system? I 
think I did understand you to say that the analysis that you 
all have done at the Heritage Foundation has not indicated that 
there has been an emissions reduction. Is that correct?
    Mr. Lieberman. For covered entities, up until the current 
recession.
    Senator Shaheen. Is that your analysis, also, Dr. Matthes?
    Dr. Matthes. Definitely not. We have a lot of modeling, and 
we worked with a big group of analysts from MIT, from U.K., 
from France, from Germany, and we--there will--a book come out 
in a couple of weeks, in Cambridge University Press, where we 
have compiled all the evidence. And you can do this very easy. 
The problem is to--which is the counterfactual development. 
Even if you focus the electricity sector--we have huge 
electricity-market models which explain the price at the 
electricity exchanges, and you can make, in very easily, 
modeling exercise, you can remove the carbon price signal from 
these models, which explain the reality very good. And then you 
have the difference, in terms of CO2 emissions.
    And even for the pilot phase, for the 16 months where we 
had a significant carbon price, this emission abatement 
amounted, alone for Germany for the power sector, to an order 
of 10 million tons annually, only by changing the merit order. 
Without any investment, without other issues. And, as I said, 
we have also seen, empirically, in there, that is very clear--
we have seen an interest--increased interest of blending in 
cement, to lower the cement clinker content, which is a very 
cheap, very easy option to decrease carbon emissions. And we 
have seen that very well, and we see this development also for 
the year 2008, where we had be--where we had significant carbon 
prices before we faced the recession in the last 2 months.
    And I think we see very clear--in a couple of sectors, very 
clear indication, and we can measure this emission abatement, 
because the yardstick or the reference is the business-as-usual 
emissions. And without the EU ETS carbon emissions last year, 
where the gas prices rocketed and the ratio between gas prices 
and coal prices went very much in favor of coal-power 
production, we would have seen skyrocketing CO2 emissions even 
from the power sector, and we have seen--not. And that was 
because the carbon price reacted to the differential between 
gas and coal prices. And so, we can see very clear, we can 
prove this abatement.
    Senator Shaheen. Thank you.
    Dr. Fries, did you want to add?
    Dr. Fries. Yes, it's important to also gauge the impact of 
the current policy framework on investment behavior and to 
identify, as Dr. Matthes has done, how it's influencing 
investment decisions. At Shell we're taking very substantial 
investment decisions based on the expectation of future CO2 
prices that will be delivered by the EU ETS. These investments 
are focused in particular on carbon dioxide capture and storage 
capabilities and also on advanced biofuel that has a very low 
CO2 footprint when measured comprehensively.
    So, private investors are responding to the policy 
framework to deliver the solutions that are required.
    Senator Shaheen. Yes. In fact, I was very--I'm looking for 
the numbers now, but I was very impressed with the difference 
in investment in clean energy in the EU compared to the United 
States, so that--the numbers I have are that, since 2005, 
investments in clean energy in Europe increased from $17.7 
billion to $49.7 billion, or a net increase of $32 billion. At 
the same time in North America, our investments increased only 
about $19 billion, so from $10.3 billion to $30.1 billion. So, 
clearly there's something going on.
    Dr. Weber.
    Dr. Weber. Yes, thank you, Senator Shaheen.
    If those numbers are from 2005, probably the ETS impact 
cannot be that high, and you should recognize that in Europe--
in particular, in Germany--we have a huge subsidizing promotion 
scheme for renewables, which is still there today, on top of 
the EU ETS. So far, we did not touch much about the promotion 
of renewables. And while we support that, and, if I may say, 
we--at BASF, we contribute toward the wind blades, to 
photovoltaic, and other renewables, so we believe in the 
technology for the future times, we would question if the 
promotion scheme now in Europe and many European countries is 
the right thing. And again, you can see that the CO2 price 
signal--and again, we have all agreed that it is there--is not 
high enough to bring CCS or renewables really into deployment. 
This is basically because they are still too expensive, and 
that--in the market, you would find many other abatement 
opportunities which are there for lower CO2 prices.
    And I believe that, indeed, you should make it a market-
based approach, which means you should deploy those 
technologies which you get for the lowest price--and that is 
more energy efficiency, that is more on insulating homes, 
having more efficient vehicles, and many other efficiency 
issues--rather than to invest heavily into renewable deployment 
today. We must invest heavily in R&D. We must make sure that 
they will be ready soon, at an economic level. But, some 
technologies are not there yet, where we should really bring 
them into mass deployment.
    Senator Shaheen. I think we would agree that energy 
efficiency is the cheapest, fastest way to deal with our energy 
needs.
    I have a final question that I guess is for all of you, 
although those of you who have been dealing with this system 
can probably answer it most effectively, and that is--what 
we're talking about is a very complicated system, and, as we 
have been talking about it in the United States, one of the 
challenges has been trying to describe what we want to do, in a 
way that is easy for the average person out there to 
understand.
    Can you give us any advice or any--tell us what your 
experiences were and how--how were you able to get people to 
buy into a system that is complicated and not always easy for 
people to understand?
    Dr. Matthes. Yes, because that is a--one of the nasty 
experiences of the last 10 years. But, one of the clear message 
is that you have to present benefits to the people. And the 
benefits are there if people are interested in clean energy, et 
cetera, and--at least in my country, or in Europe, there is an 
awareness on this. You have to present the benefits in terms of 
environmental issues.
    And on the other hand, you have to avoid very complex 
schemes which necessarily lead to perverse effects. And, I 
think, to give you an example, there are many, many good 
economic reasons for not giving any free allowances to the 
power sector. There are many, many good economic reasons.
    The only argument which worked also in the public was that 
it created windfall profits. And therefore, that was--the 
introduction of full auctioning for the power sector was one of 
the parts under revision which were very much supported because 
the public wasn't accepting perverse incentives. And channeling 
new additional profits isn't perverse incentive. And the other 
perverse incentive was, it is not possible to present a scheme 
which, by accident, in an overcomplex scheme, has provided more 
benefits for coal-fired powerplants than for gas-fired 
powerplants. It was impossible to explain this. And the only 
lesson learned from this, to hold to system as simple, as 
robust, and as clear as possible. It is getting complex.
    And if I was heavily involved in two national allocation 
plans, and I can--right behind every paragraph, the company 
which has pushed through this paragraph. But, if you have too 
much of these very complex regulations, the problem of perverse 
incentives arises, and that leads to the lose of public 
acceptance. And I think the auctioning issue is in very--it's a 
very important--it's a very important issue. And from the point 
of political communication, might be that works in Europe 
better than in your country, but the prices must tell the 
ecological truth--was quite an impressive and convincing 
argument for the political communication.
    Senator Shaheen. Thank you.
    Dr. Fries.
    Dr. Fries. Yes. I think that it would be ideal to try to 
simplify the system, but I do think it's inherently complex. 
And trying to make something that is inevitably complex more 
simple is perhaps not the right way to go.
    I think that there are two dimensions that are important to 
emphasize. One is the effectiveness of the system--that it 
actually delivers real change and real environmental benefits 
for the long run--and to demonstrate the system is actually 
delivering the change that's required to meet the challenges. 
Second, I think that the system has to be perceived as fair. 
And here, I think that the--the point that Dr. Matthes had made 
about designing the system so that it neither arbitrarily 
enriches nor arbitrarily impoverishes shareholders of existing 
companies is quite important. But to get that balance right, 
unfortunately, it's quite complicated, which is why we're all 
here today.
    But, I think finding a formula that delivers fairness--and 
that formula will include auctioning, in our view, for those 
sectors that are not trade-exposed and that can effectively 
pass through the cost of allowances into product prices. I 
think that's actually critical to achieving a fairness under 
the scheme, and then return the value of those allowances 
returned to the consumers who are paying for them in the form 
of higher products prices through some other mechanism, such as 
tax cuts.
    I think getting the balance right by making sure that it's 
perceived as fair, and also by managing the complex transition 
that arises from the inherently uneven competitive playing 
field that will arise in the transition phase of the scheme are 
two keys to its success.
    Senator Shaheen. Thank you.
    Either of you like to comment on that?
    Dr. Weber.
    Dr. Weber. Yes, thank you, Senator Shaheen.
    I mean, of course, I would agree that the scheme should be 
as simple and robust as possible, but I also would agree that 
this is very difficult to achieve. And that's why I said, 
earlier in my testimony, yes, indeed, this is very complex. And 
so, I would really ask you to go through that complex 
procedure, because I believe you have to.
    And, in terms of the windfall profits, I would agree with 
Felix Matthes's analysis, that, indeed, the public did not 
accept those windfall profits anymore. But, again, here I would 
ask you--make it better than we did in the EU. Don't start by 
avoiding the windfall profits by auctioning, but just make it 
cleverer than we did with that regular readjustment of the 
production base. I think it was good--very good PR from those 
NGOs to start explaining that windfall profits could be only 
avoided by those auctioning. And at some point, politics in the 
EU did not accept any more our ideas of those regular 
readjustments of the production base. And if you don't 
introduce that in your scheme, then, indeed, the only option is 
to go for auctioning.
    But, I think, for me, this was rather good PR and was not 
the wise and really intelligent way to approach and to solve 
the problem.
    So, if you allow, I would conclude saying, yes, it should 
be a fair system. You should be cautious not to play out one 
sector against the other; I mean, not to say, ``Well, these are 
the winners, those are the losers.'' I mean, like windmill 
producers are the winners, and steel producers are the losers. 
That, I think, probably is not the right way to get public 
acceptance, but rather to find a good, balanced, fair system. I 
think, the only good way to achieve that is a system based on 
technology-specific benchmarks, which allows a fair assessment 
of what steel can do, what renewables can do, and what 
chemicals can do to lower their respective carbon footprint. 
And, I think, then the system will be fine and gain public 
acceptance.
    Senator Shaheen. Now if we could only get the media to buy 
into ``no winners and losers,'' we'd be all set, huh?
    Dr. Weber. Excuse me?
    Senator Shaheen. If we can only get the media to buy into 
the idea of ``no winners or losers,'' then we could better 
accomplish that.
    Dr. Weber. Yes.
    Senator Shaheen. Mr. Lieberman, do you want to have any 
final comments?
    Mr. Lieberman. Well, I certainly agree that cap and trade 
is complex, but my conclusion from the European experience is 
pretty simple: Economic central planning doesn't work, and 
trying to tinker with it, which can happen endlessly--and, I 
suspect, will--will always disappoint. I think, as we look at 
the state of the economies across Europe--unemployment rates, 
energy prices--that's certainly something we don't want to 
repeat in the United States. And, to the extent--and I believe, 
to an extent--cap and trade has contributed to the economic 
weakness, that's certainly a lesson we need to take in mind 
here.
    Senator Shaheen. Dr. Matthes, I'll give you the final word 
to respond to that.
    Dr. Matthes. I grew up in a social system that was based on 
central planning. I was born in the United--on the--in the 
German Democratic Republic, and I spent my last--my first 
professional years there. And I can ensure you, a market-based 
instrument, like the emissions trading scheme, has nothing, but 
nothing, to do with central planning.
    Senator Shaheen. Thank you very much.
    Oh, Senator Boxer. Well, we were just concluding. We've had 
a very interesting discussion about competitiveness and how the 
EU system has worked to try and address those industries that 
are most at risk for competitiveness concerns for any climate 
system that we put in place. We can--we will give you any 
opportunity----
    Senator Boxer. I guess----
    Senator Shaheen. [continuing]. To----
    Senator Boxer. I just want to make a couple of comments. 
The reason I came----
    Senator Shaheen. Great.
    Senator Boxer. [continuing]. Over here--I'm working so hard 
on a climate change bill, so I didn't have a chance to come 
earlier. I really did come over to just say it's very important 
that you share your experiences with us, because clearly you're 
ahead of us on all of this. And I wanted to welcome you and 
thank you, and thank our Chair. And, you know, we will be 
calling on you and visiting you and learning from you.
    And I also wanted to say, Senator Shaheen has been a real 
partner with me as we try to do this right, because we don't 
want unintended consequences; we want to make sure that this is 
the job creator.
    So, I guess I would have a yes-or-no question, if I could. 
One. And that is to ask each of you if you feel, if done right, 
that a climate change bill can create really good jobs and 
boost up the economy.
    If we could go from one to the next, that would be great.
    Senator Shaheen. Mr. Lieberman, do you want to begin?
    Mr. Lieberman. I'm--oh, I'm the designated ``no.'' The 
whole point----
    Senator Boxer. That's fine. That's fine. Designated ``no'' 
is OK. Because?
    Mr. Lieberman. The whole point of cap and trade is to 
constrain the supply of energy and, therefore, drive up its 
price, and that will have adverse effects throughout the 
economy.
    Senator Boxer. Well, I totally disagree. We don't want to 
constrain the production of energy; we want to spur it on, but 
we don't want to spend all our money, you know, buying oil from 
people that don't like us very much and use the proceeds to 
support terrorism. So, I think, clearly, the aim is to create 
other sources to compete with that foreign oil and to lead to 
independence.
    What do you think, sir?
    Mr. Lieberman. Well, these other sources, if they can only 
compete because fossil energy is made artificially more 
expensive, that means these other sources----
    Senator Boxer. Well, again, I will----
    Mr. Lieberman. [continuing]. Are also expensive, as well.
    Senator Boxer. Artificially? Do you know about the coal ash 
spill that just occurred at the TVA? Do you know what it's 
going to cost to clean that up? Because we take the toxins out 
of the air, and we put them on the ground, and then they rushed 
down and destroyed a whole community. So, to say that the full 
price of oil is reflected is just not true because of what it's 
doing to the planet--do you think that's a cost? When your 
kids, you know, can't buy insurance someday because they live 
near a coast? There's lots of costs.
    So, I think the true costs of carbon have not been 
reflected. It's been an artificially low price, even with the 
manipulation that we have.
    Let me ask the rest of the panel.
    Dr. Weber. Yes, thank you, Senator Boxer.
    Well, I would agree--I'm from BASF, and I would agree that 
we need this greenhouse gas regime. But, of course, it must 
be--it has been said so often, but it's still true--it must, of 
course, be really a global system, including all sectors. I 
outlined, earlier, a carbon footprint that we made, where we 
showed that, indeed, our sector provides more greenhouse gas 
savings through our products in other sectors--insulation, in 
vehicles, and so on, than we cause. And in order to really get 
the full potential of using technology to save greenhouse gas 
emissions, we must make sure that those credits are really 
taken into account; i.e., take all sectors and all countries 
into account.
    And if I may, you mentioned the new jobs. I think we--my 
feeling is that we rather agreed, here, that we should not play 
out one sector against the other. Of course, there will be 
winners and losers. I think you will have the difficult task 
ahead of you to make sure, in order also to win the public 
acceptance, that you really create a very fair system----
    Senator Boxer. Yes.
    Dr. Weber. [continuing]. That allows a fair transition and 
that you keep jobs in those efficient industries, efficient 
companies, even if they emit greenhouse gas emissions, while, 
at the same time, also get the right credits to create new jobs 
in new areas.
    Senator Boxer. I was just going to say, sir, in my State--
and I think Senator Shaheen would be interested--we've been 
very hit--hit very, very hard by a recession. And the only 
bright spot in California, according to the Pew Charitable 
Trust, is that, over the past 10 years, we've seen, you know, 
really about 1,000 new alternative-energy companies spring up, 
and 125,000 new jobs. Were it not for that, I don't know, 
really, where we'd be, because the housing industry collapsed, 
and the--you know, the financial sector's in trouble, and new 
construction. So, for me, from our experience--because we are 
ahead--you know, California would be the fifth-largest nation. 
And, because of its getting ahead of the game, we have at least 
had this one area--one area that's had the growth rate. And so, 
I think this is very important. And the doom and gloom that I 
hear sometimes from folks is just not playing out in my State.
    Mr. Lieberman. If I could just make one----
    Senator Boxer. Could we quickly just go--I don't think we 
have time--could we just hear from the other two? And then I'm 
done.
    Dr. Fries. I'm Steven Fries, from Royal Dutch Shell, and I 
think the answer to your question is yes. Yes, you can both 
change the way in which we produce and consume energy, 
fundamentally, and grow, at the same time.
    I think that that transition, though, has to be handled 
very carefully. And what is key is starting early and starting 
with a credible policy framework that delivers the kinds of 
investments that you were emphasizing, and the kinds of changes 
of behavior toward more energy--greater energy efficiency, that 
will allow for a smooth and effective transition.
    Senator Boxer. Thank you.
    Dr. Matthes. Unfortunately, I have four answers.
    Senator Boxer. Yes? OK.
    Dr. Matthes. And I think it is about the policy mix. 
Because climate policy is a complicated issue.
    The first is, What is the alternative? If the alternative 
is ``nothing'' to--doing nothing, then we will have to pay a 
bill, and all will have to pay a bill of--in the beginning, far 
from our countries, but increasingly close to our countries. 
And therefore, the issue to make--to implement the necessary 
policies as efficient as possible. And I strongly believe this 
emissions trading allows the implementation of emission 
mitigation for the lowest cost. That means at the lowest 
burden. And therefore, the--I think this--that's the first one.
    The second is that we--after the year 2008, we have to 
think about--differently, from my point of view, in terms of 
burden and in terms of vulnerability. What we have seen last 
year is that our--that the energy consumers and the economies 
are more vulnerable to volatile energy prices than to higher 
energy prices. The pain at the pump in Europe was significantly 
different than in the United States. I stayed at the MIT at 
this time, and the vulnerability of consumers was different. 
And I think we have to think about vulnerability more, instead 
of costs, et cetera. And vulnerability is an issue.
    These were the two--let's see past--the two issues which 
are important to the conventional wisdom.
    And the two other issues is that we will next backstop 
technologies. We will implement emissions trading, which is a 
baseload, which enables the market penetration of those 
technologies which are matured and close to market. But, we 
will need special investments in backstop technologies. These 
are those technologies which we need--which you don't need for 
the next 10, 15 years. We don't need wind for the next 15 
years. We need wind for the longer term--and if it now--and 
that's the experience of my country--the investment we do now 
in--at the moment, for a bit more expensive technologies, is at 
least not buying megawatts, it is buying the future costs down. 
I think that is the issue. And that is about the future 
vulnerability of consumers, economies, voters, whatever.
    Senator Boxer. In other words, your point is that, down the 
line, we need these energies to be there, these----
    Dr. Matthes. Yes.
    Senator Boxer. [continuing]. These new energies; otherwise, 
what Mr. Lieberman says is true.
    Dr. Matthes. Yes.
    Senator Boxer. But, if we do the right thing, then what he 
says is not true. And I think that's the whole goal, is to get 
these new energies out there.
    And I would say, in terms of vulnerability, you're 
absolutely right. And vulnerability, in our country, it--we 
don't want our consumers to have to feel a lot of pain when 
they pay an electricity bill. And that's why a lot of the work 
we're doing, the chairman and I, right now, is trying to make 
sure that our consumers--that a lot of the proceeds of our bill 
go to keep the consumers whole during this period of 
transition, while we're waiting for those new technologies to 
come online, down the road.
    Dr. Matthes. Yes. My fourth point was, it's about lead 
markets. They're----
    Senator Boxer. Lead?
    Dr. Matthes. Lead markets. There are special benefits for 
those who are the frontrunners. German companies cover, at the 
moment, 50 percent of the world market on energy efficiency. We 
want to maintain this. That is in future competition, but 
competition decreases prices, and therefore, it is important. 
But, there are, in terms of the lead-market benefits for 
industries, et cetera, only benefits for the frontrunners. And 
these benefits will only be achievable if you really go to the 
cutting edge of these issues. And there are limits of 
solidarity in between the OECD, but that is an important issue.
    The wind-power energy efficiency, et cetera, gains in the 
industry and the employment in this industry, 500,000 employees 
in the renewable energy industry in Germany, is because this 
country has decided to be a lead market, to develop the 
production facilities which have a competitive advantage for 
the future.
    Senator Boxer. Oh, I have a last question.
    Senator Shaheen. Go ahead, Senator Boxer.
    Senator Boxer. How many parts go into a windmill? How many 
parts go into making a windmill?
    Senator Shaheen. Is this a trick question?
    Senator Boxer. No. [Laughter.]
    No. Because my understanding is, it's a lot of work, and 
it's a lot of good jobs, and that's what I'm trying to 
ascertain here.
    Senator Shaheen. I think we'll all agree with that.
    Senator Boxer. Do you know, sir?
    Dr. Weber. I don't know a precise number, I just know that 
we, as a chemical producer, we also produce chemicals that go 
into the windmills. What is so important is that you don't play 
out the sectors against each other. We want to have the right 
balance so that--for example, for you in the United States, 
that you would be able to produce both, windmills and the high-
efficient chemicals you need for them, both in the United 
States and not abroad. I think you must make sure to combine 
the best from each sector's capabilities. That is best achieved 
with a good cap-and-trade system with free allocations.
    Senator Boxer. Thank you.
    Senator Shaheen. Thank you very much, Senator Boxer, for 
your leadership.
    And to all of our panelists, thank you very much for your 
time and for coming such a long way.
    Hearing is closed.
    [Whereupon, at 4:20 p.m., the hearing was adjourned.]

                                  
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