Winter 2007 Fueling the Future The U.S. once ran entirely on coal and oil. But that is changing. New sources of energy that can power the economy are rapidly going online. The energy choices have expanded to include biodiesel, ethanol and synfuels. And we are learning to conserve by building more efficiently and using other choices, such as wind or solar. Synthetic fuels worked in the past. They may have a place now. p. 8 The economics of ethanol can work. And we don’t need corn to make it. p. 12 Greenhouse gas is a legal issue. Thank the polar bear. p. 21 Energy demand projected to 2030. Scenarios for what might be ahead. p. 19 Also Inside: Coal Bed Methane • Financing Alternatives • Efficient Buildings “Alternative” Investments • Global Warming CLIMATE Reprinted from the 2007 Winter issue of Energy Magazine Coping with Carbon Dioxide Greenhouse emissions are an issue in court rooms and board rooms. By John F. Spinello, Jr., Craig P. Wilson, Sandra Y. Snyder T he year just-ended, 2006, brought significant legal developments concerning global climate change (the trends observed in the warming of the earth’s surface temperature) that affect the energy sector in the United States and worldwide. This trend of increasing legal activity and policy debate surrounding the issue of climate change is a reflection of the ever-increasing attention focused on the issue by scientists, economists, advocacy and independent research groups, and policy makers here and abroad. The New Year now upon us promises even more significant developments in this area. Emissions of carbon dioxide (CO2), the most pervasive anthropologic greenhouse gas (GHG) in the atmosphere, represent about 84 percent of total GHG emitted in the United States. Most CO2 (98 percent) is emitted as a result of the combustion of fossil fuels such as coal, oil, and natural gas. Consequently, CO2 emissions and energy use are highly correlated. CO2 has a lifetime or residence time of roughly 50 to 200 years, and is mixed throughout the lower stratosphere in relatively homogeneous concentrations everywhere along the surface of the earth. The legal and policy debate regarding the management of GHG emissions is playing out vibrantly in boardrooms, courtrooms, and statehouses across the country. For example, investors have been demanding greater disclosure of GHG emissions and analysis of the associated risks and opportunities; States and environmental advocacy groups Winter 2007 have filed lawsuits to compel the United States Environmental Protection Agency (USEPA) to regulate the emission of carbon dioxide under the Clean Air Act (CAA); States have banded together to establish regional regulatory programs to mandate GHG reductions from the energy sector; State Attorneys General have sued energy companies claiming GHG emissions are a common law nuisance causing millions of dollars in damages; and private litigants have sought to fix responsibility for damages caused by severe weather on GHG emitters in the energy sector. These are just a few examples of the growing trend of legal action in this area that will continue to unfold in 2007, in addition to a widely expected increase in congressional attention to climate change in the 110th Congress—all of which raise significant legal issues for energy companies and their counsel. The proposal to list the polar bear cites receding sea ice as the only significant threat to the species, and rules out other potential factors, such as oil and gas development and subsistence hunting by Native Alaskans. Most of a polar bear’s life is spent on sea ice hunting for seals and other prey, and according to scientific observations, sea ice has been receding since 1978 in some areas of the Arctic Sea by nearly 10 percent per decade. The potential listing is significant because the ESA prohibits federal actions that are likely to harm a listed species or its habitat. Specifically, Section 7 of the ESA requires all federal agencies to consult with the FWS and insure that any action the federal agency takes, “is not likely to jeopardize the continued existence of any endangered species or threatened species or result in the destruction or adverse modification of The Polar Bear About the Authors On December 27, 2006, the U.S. Fish and Wildlife Service proposed listJohn Spinello is a(FWS) Partner in the Newark, NJ office of K&L Gates. His practice on bear regulatory counseling, ingfocuses the polar as threatened under environmental litigation, and legislative and regulatorySpecies advocacy clients the Endangered Act for (ESA), due that include power plants and chemical may bebyreached tomanufacturers. melting sea iceHecaused climatejohn.spinello@klgates.com. change. Interior Secretary Dirk KempCraigsaid, Wilson is aconcerned Partner in Harrisburg, Pa. office of K&L Gates. His thorne, “we are thethe polar practice is concentrated in the areas of environmental compliance counseling bears’ habitat may literally be melting.” and transactional advice, environmental permitting, zoning and land The listing proposal follows a petition development He may be reached at craig.wilson@klgates.com. filed by the Natural Resources Defense Council (NRDC) andisother environmental Sandra Snyder an Associate in the Newark, NJ office of K&L Gates. Ms. groups asserting GHG emissions must Snyder concentrates her practice in environmental and natural resources law beand reduced to litigation. prevent the elimination related Prior to joining K&L Gates, Ms. Snyder worked as a engineer forthe ExxonMobil. ofchemical polar bear habitat by end of the She may be reached at Sandra.snyder@ klgates.com. century. energy 21 habitat of such species…” Listing the polar bear as a threatened species because of global warming could provide a platform for third parties to challenge federal agency actions that would directly or indirectly impact the polar bear or its habitat. For example, decisions allowing the burning of fossil fuel and the resulting release of GHGs to the atmosphere, such as clean air permits issued by the USEPA or Federal Energy Regulatory Commission (FERC) decisions relating to new fossil fuel plants, could be challenged. Secretary Kempthorne suggests that climate change policy would play out in other forums, but the NRDC believes that a positive listing decision will force action to reduce GHGs. The FWS will spend most of 2007 gathering information and completing additional analysis on the status of the U.S. polar bear population, approximately 4,700 bears in Alaska, before making a final listing decision. An affirmative decision would likely prompt more litigation under Section 7 of the ESA, and the focused attention in 2007 on the fate of the polar bear may affect future climate law and policy, whether or not the species is listed as threatened. Supreme Court Showdown In 2003, the USEPA denied a petition by the International Center for Technology Assessment (ICTA), seeking the regulation of GHG emissions from new motor vehicle engines pursuant to the Section 202(a)(1) of the CAA. The USEPA cited several bases for its decision, including its determination that Congress had not delegated to it the authority to regulate GHG emissions under the CAA for the purpose of addressing global climate change. When the ICTA appealed the Agency’s decision, a divided panel of the D.C. Circuit Court of Appeals upheld the Agency’s decision, though each of the two Judges supporting the judgment expressed vastly different reasons for their decision and one judge dissented. The Supreme Court granted certiorari and oral argument was held in November 2006. Based upon the focus of the Court’s questions during oral argument, it is possible that the Court’s decision will 22 energy turn on whether the plaintiffs had standing to bring the action at all, in which case the Court may not reach the merits of the case (questioning at oral argument by Justice Kennedy, considered a key swing vote, however, suggests that he might be leaning towards recognizing standing). If Plight of the polar bear opened the way to greenhouse litigation. the Court does reach the merits of the argument and proceeds to define Regulations S-K Item 101 and Item 303 the limits of USEPA’s authority to adare especially relevant to the disclosure dress GHG emissions and climate change of GHG emissions or risks associated under the CAA, the decision will have far with climate change. Item 101 requires reaching implications. disclosure of material effects that compli Most directly, if the Court finds auance with environmental law may have thority under the CAA for USEPA to on capital expenditures, earnings, and regulate GHG emissions, the agency competitive position, including continand states undoubtedly would be presgent effects. Item 303 requires discussion sured to develop regulatory programs and analysis of currently known trends, addressing GHG emissions from motor events or uncertainties that are reasonvehicles and other sources. Moreover, if ably expected to have a material impact GHG emissions are found to be subject to on liquidity, capital, sales, revenue or regulation under the CAA, many public income. Some companies have included companies might need to reconsider how a discussion of climate related risks in S-K they treat such emissions for purposes Item 303 filings, sometimes at the behest of environmental disclosure under SEC of shareholders, though the SEC has reporting requirements, GHG emissions never expressly required this for climate might need to be considered in corporate related risks. transactional due diligence investigations, Since at least as far back as the Exxon and the plaintiff’s bar would be further Valdez oil spill in Alaska on March 24, emboldened to raise nuisance and other 1989, environmental advocacy groups claims stemming from alleged damages have rallied institutional investors to decaused by climate change. mand greater attention to environmental stewardship, and advanced principles for Corporate Disclosure corporate governance intended to add a Federal securities laws require public measure of transparency and accountcompanies to ensure investors have acability to the way environmental obligacess to information about their financial tions are managed. Following the Valdez condition, including contingent liabilities, incident, a group that became known as by filing reports with the Securities and the Coalition for Environmentally ReExchange Commission (SEC). Generally, sponsible Economies (CERES) advanced the SEC requires disclosure of informathe “Valdez Principles,” which over time tion that is material to a company’s finanevolved into the CERES Principles. Since cial position. Materiality is determined by the early 1990s, CERES and similar a “reasonable person” standard with no organizations have grown in number concrete thresholds set by the SEC. SEC and sophistication and become deeply Winter 2007 involved in the public debate over the appropriate response to climate change. For example, the Carbon Disclosure Project (CDP) and the Investor Network on Climate Risk (INCR) are networks of institutional investors and financial institutions dedicated to promoting better understanding of the financial risks and investment opportunities posed by climate change. The CDP is an international coalition of institutional investors with $31 trillion in assets under management. INCR, organized by CERES, is comprised of 50 large public pension funds and financial institutions with over $3 trillion in assets under management. In addition, the Interfaith Center on Corporate Responsibility (ICCR) focuses on climate change and wide range of social issues, and is comprised of 275 faith based institutions with collective assets over $110 billion. In October 2006, CERES, INCR, CDP, and other investor groups released the Global Framework for Climate Risk Disclosure: A Statement of Investor Expectations for Comprehensive Corporate Disclosure. The Framework is intended to encourage standardized disclosure of risks associated with climate change, and establish a benchmark for successful, voluntary, corporate climate disclosure. The Framework provides for the disclosure and analysis of the following elements: • Historic and current GHG emissions • Strategic analysis of climate risk and emissions management • Assessment of physical risks from climate change • Analysis of risk related to the regulation of GHG emissions According to the Framework, the information provided is necessary for investors to analyze companies’ business risks and opportunities resulting from climate change, as well as the companies’ efforts to address those risks and opportunities, and should be disclosed through SEC filings and/or other existing reporting mechanisms. The Framework guide favorably cites AEP’s disclosure documents as examples of reporting. CERES also issued a report this year purporting to provide the first comprehensive examination of how the world’s largest corporations in carbon-intensive Winter 2007 sectors are positioning themselves to address the risks of climate change. The report scores and ranks ten industry sectors and the major companies within those sectors according to a point system that considers issues of board oversight, management execution, public disclosure, emissions accounting and emissions management and strategic opportunities in the area of climate change. The development of this report, like the CERES Principles and the Framework, highlights the ever-increasing attention being paid by investor networks to the issue of corporate disclosure and governance on the topic of climate change. The attention of these investor networks, of course, is sometimes unwelcome. For example, in December 2006, institutional investors—five New York pension funds and the Connecticut State Treasurer’s Office - filed two “shareholders resolutions with the TXU Corp. regarding the company’s plan to build 11 new pulverized coal-burning power plants in Texas at an estimated cost of $10 billion.” The shareholder resolutions note that the new coal plants cause the company’s CO2 emissions to more than double, so the resolutions “request reports on how TXU is responding to rising regulatory pressure to significantly reduce carbon dioxide emissions from power plants and how enhanced energy efficiency programs in Texas could impact the company’s ability to sell its new power.” The Benedictine Sisters of Boerne, Texas filed a third resolution, requesting that TXU’s board of directors “adopt specific goals to reduce its CO2 emissions below 2004 levels and reduce mercury emissions to levels that are achievable using best available control technologies.” A (Growing) Band of States In September 2003, the Governors of nine New England and Northeast States—Connecticut, Delaware, Maine, Massachusetts, New Hampshire, New York, New Jersey, Rhode Island, and Vermont - announced the establishment of the Regional Greenhouse Gas Initiative (RGGI) and their plans to develop a regional “cap and trade” program to reduce CO2 emissions from power plants located in the participating States. On December 20, 2005, seven Governors signed a Memorandum of Understanding (MOU) setting forth in detail how RGGI is designed to work. In addition, the District of Columbia, Massachusetts, Pennsylvania, Rhode Island, the Eastern Canadian Provinces, and New Brunswick are observers in the process. Under the MOU, each state is allocated a certain number of allowances, which total just over 121 million short tons of CO2 for the region. Generally, an allowance equals a ton of CO2. The program applies to each fossil-fuel fired electric generating unit with a rated capacity of 25 or more megawatts, and launches on January 1, 2009, prior to which each State is to issue allowances to power producers. States participating in RGGI are discussing allocating allowances through an auction. States are also required by the MOU to allocate at least 25 percent of its allowances for consumer benefit or strategic energy purposes. The first three-year compliance period would conclude on December 31, 2011, when there would be a “true-up”: power plants that do not have enough allowances to match the amount of CO2 emitted during the three-year period would need to purchase allowances from other power plants in the RGGI system; power plants that have more allowances than needed to cover CO2 emissions for the compliance period may sell them. The MOU also identifies limited opportunities to use off-set allowances—i.e., credit for CO2 emissions reductions achieved through actions taken in States outside of RGGI and within the United States. Then, beginning in 2015, each State’s CO2 emission budget would decrease by 2.5% per year, through 2018 when each State’s budget would be 10 percent below its starting budget. RGGI staff published a draft model rule for the cap and trade program in March 2006, and finalized the model rule in August 15, 2006. Participating States must still adopt regulations, consistent with the model rule, to implement the RGGI cap and trade program in their respective States. New York was the first to issue a pre-proposal of its regulations in December 2006. energy 23 On the west coast, in September 2006, the California Legislature passed Assembly Bill 32, the California Global Warming Solutions Act of 2006, which requires the California Air Resources Board (CARB) to develop regulations and market mechanisms (e.g., a cap and trade program) to reduce California’s GHG emissions by 25 percent by 2020. In 2012, mandatory caps will begin to apply for significant sources, ratcheting emissions down to meet the 2020 goals. In October 2006, California Governor Schwarzenegger met in New York with then Governor Pataki and discussed California’s participation in the RGGI program. Governor Schwarzenegger later signed an executive order directing CARB to link the California program with RGGI, and possibly other state and regional cap and trade programs. The creation of regulatory programs by individual states to reduce GHG emissions in their respective states raises relatively few legal issues, save for the question of whether the applicable state law permits the regulation of such emissions (CO2 may not be regarded as a pollutant or air contaminant in a traditional sense and prevention of climate change may not be an appropriate subject of regulation under some state statutes). Far more significant legal issues arise, however, when states act together in support of a common regional approach. Such collective actions may implicate the Compact Clause of the United States Constitution, which provides, “No State shall enter into any Treaty, Alliance or Confederation… No State shall, without the Consent of Congress, lay down any duty of Tonnage, keep Troops, or Ships of War in Peace time, enter into any Agreement or Compact with another State or with a Foreign power, or engage in War, unless actually invaded, or in such imminent Danger as will not admit of delay.” Not every agreement between states is a compact requiring congressional consent. The United States Supreme Court has held that the Compact Clause is limited to agreements that are “directed to the formation of any combination tending to the increase of political power in the states, which may encroach upon or interfere with the just supremacy of the 24 energy United States.” The Supreme Court has further held it does not matter whether an agreement is formal or informal, and it is sufficient to require congressional consent if there is the potential for the agreement to threaten federal supremacy. The potential for RGGI to encroach upon federal supremacy may arise in several contexts, but none so clear as the President’s exclusive authority to direct foreign policy. The President’s prerogative to direct foreign policy without interference by States was underscored in the Supreme Court’s decision in American Insurance Association v. Garamendi, holding a California statute requiring disclosure of information about Holocaust-era insurance policies to be preempted as in conflict with agreements negotiated by the United States and thus an impermissible interference in the President’s prerogative to conduct foreign policy. In reaching this result, the Court observed that “our thoughts on the efficacy of one approach versus the other are beside the point, since our business is not to judge the wisdom of the National Government’s policy; dissatisfaction should be addressed to the President, or, perhaps, Congress. The question relevant to preemption in this case is conflict, and the evidence here is ‘more than sufficient to demonstrate that the state Act stands in the way of [the President’s] diplomatic objectives.’” USEPA has noted the consistent concentration of GHGs around the earth’s surface means reducing the emission of GHGs in one part of the world (or part of a country) will have no effect on climate, unless the entire world emits fewer GHGs; and the President, of course, is the only official properly posititioned to represent the United States in international negotiations for a global approach to climate change. Taking It to Court Given the President’s current approach to the issue internationally, it seems likely that the growing regional regulatory approaches being adopted by groups of states will be challenged as violative of the Compact Clause and in conflict with the power of the President to conduct foreign policy. In 2005, several State Attorneys General and environmental advocacy groups sued American Electric Power (AEP) and several other power companies alleging the GHGs their plants emitted are a common law nuisance, contributing to global climate change and causing millions of dollars in damages to their respective states. The U.S. District for the Southern District of New York ruled that the causes and regulation of greenhouse gas emissions are “political questions” beyond the court’s jurisdiction. The plaintiffs’ appeal of the decision is currently pending in the U.S. Court of Appeals for the Second Circuit and is likely to be decided in 2007. Similarly, in September 2005, several individuals and a putative class who sustained property and other damages as a result of Hurricane Katrina, have sued their insurance carriers for denial of coverage, and, in the same action, also sued a host of energy companies for allegedly emitting the GHGs that caused the severe weather and the damages they sustained. Companies sued include Murphy Oil, U.S.A.; Chevron/Texaco Corporation; and ExxonMobil Corporation. This matter is pending in the U.S. District Court for the Southern District of Mississippi. Congressional Focus In the 109th Congress, Senators Lieberman and McCain introduced, Senate Bill No. 139, the Climate Stewardship and Innovation Act of 2005, that would establish a national cap and trade program for GHG emissions. Efforts to move this bill were defeated last year by the Republican-controlled Senate. Senators Lieberman and McCain are likely to reintroduce this bill in the 110th Congress, which will be led by the Democrats’ Senate Majority Leader Harry Reid and Speaker Nancy Pelosi. Senator Barbara Boxer (D-Calif.), will chair the Senate Environment and Public Works Committee in the 110th Congress; Senator Jeff Bingaman of New Mexico will Chair the Energy and Natural Resources Committee. Both of these senators plan to introduce legislation concerning climate change. Senator Boxer has said she will press for legislation like that enacted in California in September 2006. Boxer Winter 2007 also promises to conduct “intensive hearings on global warming.” In the House, Rep. Henry Waxman (D-Calif.), the incoming chairman of the House Government Reform Committee, introduced a bill in the 109th Congress to freeze total U.S. greenhouse gas emissions at 2009 levels beginning in 2010, followed by 2 percent annual reductions through 2020. However, Rep. John Dingell (D-Mich.), who will chair the Energy and Commerce Committee in the 110th Congress, said the committee will “have a look at” legislation that would set mandatory cuts in greenhouse emissions. Conclusion The year ahead will be an active and per- Winter 2007 haps pivotal one in the evolution of climate change law and policy in the United States. Our scientific understanding of GHGs and other influences on climate will further develop with the release of assessments undertaken through the Climate Change Research Initiative, Congress will hold hearings and focus attention on national climate change policy, and the Supreme Court may define the outer limits of federal authority to regulate GHG emissions. In addition, States are likely to face legal challenges as they launch regional regulatory programs that clash with national foreign policy, and investor networks will continue to press the SEC and individual companies for greater disclosure and analysis of climate risks, and private litigants will continue to target GHG intensive industries for “damages” allegedly caused by GHG emissions. At the same time, it is unlikely Congress will enact a major new regulatory regime for GHG emissions in 2007, even less likely the President will alter his position, and the Supreme Court may not decide the merits of the case before it and dismiss the matter on procedural grounds. In this respect, the year ahead may presage more significant developments in 2008 and beyond. Nevertheless, even if 2007 ends without major breakthrough developments, the substantial activity expected to take place in courthouses, statehouses and boardrooms across the country will inalterably shape and define future climate law and policy in the United States. energy 25 BCC Publications Samples available at www.bccresearch.com FUEL CELL TECHNOLOGY NEWS The advent of the fuel cell will transform the energy industry. From major automakers to huge utilities, planners are already integrating the fuel cell into their long-range strategies and some market analysts predict that fuel cells will become a billion dollar market in the next decade. This new BCC monthly newsletter covers the latest news in fuel cell development and manufacturing, major types of fuel cells (alkaline, molten carbonate, phosphoric acid, solid oxide, and proton exchange membrane), tracks new applications by industry and follows major players. 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