A Primer on the Global Carbon Markets

A Primer on the Global Carbon Markets
April 9, 2009 Norman Bernstein
global carbon markets

In December 1997, members of the United Nations Framework Convention on Climate Change (UNFCCC) negotiated the Kyoto Protocol that established emissions reductions for the developed and developing nations that ratified the Protocol.  The Protocol went into force in February 2005 after Russia ratified it in November 2004. The U.S. did not ratify the Protocol because it set no emission limits for China or India.

The Kyoto Protocol covers the six main greenhouse gases.   Today’s global carbon markets include compliance markets based on a “cap-and-trade” system whereby emissions are “capped” and then emission rights are freely “traded”, a related but separate emission credit creation system (sometimes called a “baseline-and-credit system”) whereby reductions achieved in third-world countries are available for sale under the EU “cap-and-trade” system, and a much smaller voluntary system.  The principal example of the cap-and-trade system is the European Union Emissions Trading Scheme (EU-ETS).  The principal examples of the baseline-and-credit system are the Clean Development Mechanism (CDM) used for voluntary projects in China, India, and Africa, and the Joint Implementation (JI) system, used primarily in Eastern Europe and the countries of the former Soviet Union.  According to the research group New Carbon Finance, in 2008 the global carbon markets reached $118 billion, an 84% increase from 2007 levels.

In the United States, President Obama has indicated that he favors a cap-and-trade carbon emission system.   On June 26, 2009, the House of Representatives passed the Waxman-Markey climate bill by a vote of 219-212.  That bill includes a cap-and-trade section as well as other provisions for clean energy and energy efficiency.  On September 30, 2009, a draft of the Kerry-Boxer climate bill was introduced in the Senate and then referred to the Committee on Environment and Public Works.  It is modeled after the Waxman-Markey bill and therefore is quite similar.  However, it does have some key differences and leaves out the details for some programs in order to allow for further tailoring of the bill in Senate committees.

The basics of a “cap-and-trade” and a “baseline-and-credit” system are summarized below. Those summaries are followed by descriptions of the EU-ETS, the CDM, and the structure of the Waxman-Markey bill.  A glossary of terms is at the back of this memorandum.

An Overview of How the Carbon Markets Work

Cap-and-Trade

Under a cap-and-trade system, an overall cap is set on carbon dioxide emissions and a finite amount of emission allowances are either auctioned off or handed out by governments starting from an agreed base.  Each year fewer allowances are available and thus over time carbon emissions are reduced.  As discussed in more detail below, the goal of the EU-ETS is a 20% reduction by 2020 from 1990 levels, and the goal of the Waxman-Markey bill is a 20% reduction by 2020 from a base year of 2005, and an 83% reduction by 2050 from 2005.

In such a system, carbon emission allowances are freely tradable until they are turned over by a company to the government to cover the company’s carbon emissions for a given year.  Companies not achieving sufficient emission reductions in any one year (i.e., needing credits) can buy emission credits from companies that exceed required reductions or from brokers or others on the open market. Conversely, companies exceeding emission reduction targets can sell the credits directly to those needing them or to brokers or others on the open market.  The largest such market presently is London’s European Climate Exchange (ECX).

Baseline-and-Credit

Under the baseline-and-credit system, credits are generated by new construction or carbon emission control project in a developing country that achieves an emissions reduction that would not have happened otherwise.  This reduction is known as additionality.  The host country in which the project is carried out must support the claim and an independent third party must verify the additionality of the emission reduction.  The reduction is then certified by a U.N. body.

The baseline-and-credit system can be used in connection with a cap-and-trade system.  For example, the CDM mechanism which was established under the Kyoto Protocol allows companies to implement projects in developing countries (e.g., China, India, etc.) that emit less than would otherwise be the case under local law.  The sponsor must also show that the project would not have been built “but for” the credits.  When the additionality has been certified to, the sponsor (or any buyer of the credits) may sell the carbon credits in the EU-ETS.  The CDM mechanism is discussed in more detail below.

The idea behind the CDM is that emission reductions achieved in China and India benefit the global environment as much as emission reductions in Europe and may be cheaper to implement.  As also discussed below, there are significant risks associated with these projects, and at present the EU-ETS limits certified emission credits to 14% of the total.

The EU-ETS – Presently the Leading Cap-and-Trade Compliance Market

The International Emission Trading Association (IETA) estimates that the EU-ETS comprises two-thirds of the volume of global emissions trading and three-quarters of the financial value. According to the research group New Carbon Finance, in 2008, carbon trading in the EU-ETSreached $94 billion. Under the EU-ETS, the European Union (EU) is committed to achieving a reduction in greenhouse gas (GHG) emissions of 20% relative to 1990 levels by 2020 as well as achieving a 20% improvement in energy efficiency and consuming 20% of all primary energy in 2020 from renewable resources.

The EU-ETS is divided into three allocation phases: Phase I began in 2005 and ended in 2007, Phase II started January 1, 2008 and continues through 2012, and Phase III begins in 2013 and continues through 2020.  According to the European Commission, approximately 10,000 installations are covered by the EU-ETS and account for approximately half of the EU’s carbon dioxide emissions. They include power generation plants using fossil fuels, oil refineries, coke ovens, iron and steel plants, and factories making cement, glass, lime, brick, ceramics and pulp and paper.  Over the next several years (2012 and beyond), several new sectors are expected to be covered by the EU-ETS.  These may include emissions from aircraft and from maritime transit.

Trade is done in carbon dioxide emissions EU allowances (EUAs) and also in Certified Emission Reductions (CERs) from CDM projects and Emission Reduction Units (ERUs) from JI projects.  The price of EUAs traded on the ECX has varied over time.  (Below is a graph tracking prices for the first trading day of each month from January 2008 to October 2009.)  EUAs traded at $27 per metric ton of carbon dioxide in April of 2007.   In May of 2008, EUAs traded at $40.50 per metric ton of carbon dioxide. In June of 2009, the price of EUAs dropped to $18.78 per metric ton of carbon dioxide.  Because of the economic slowdown, there has been less demand for the carbon credits.  It is likely that as economic activity in the EU increases, demand will increase.  There will also be fewer EAUs available.  Thus, over time, it is likely that carbon prices will climb.

Because of the complex nature of EU governance, under the EU-ETS, each Member State establishes a National Allocation Plan (NAP) to determine the total quantity of carbon dioxide allowances for each phase. The European Commission then has to evaluate the NAPs based on criteria laid out in Annex IIIto the Emission Trading Directive. These criteria include ensuring that the proposed total quantity of allowances meets with Member States’ Kyoto targets and that Member States have assessed the potential for emissions reductions in all sectors.  After NAPs are approved by the European Commission, Member States can make final allocation decisions.

During Phase I of the EU-ETS, Member States allocated 95% of the allowances free of charge. The penalty for non-compliance in Phase I was $62 per excess ton.  In Phase II, 90% of allowances are allocated free of charge.  The remainder of allowances (i.e., 10%) may be auctioned off by theMember State.  Registries keep track of the issuance of the allowances, as well as the holding, transfer, and cancellation of allowances.  The penalty for non-compliance in Phase II is $155 per excess ton.  Also in Phase II, companies are able to bank EUA’s for future compliance periods.

On December 17, 2008, the EU revised the Emissions Trading System.  The revised EU-ETS calls for a reduction in emissions of at least 20% in Phase III relative to 1990 emissions.   However, if other industrialized countries commit to comparable efforts post-2012, then the goal would be to reduce emissions by 30% from 1990 levels.  Also, during Phase III (2013-2020), there will be one EU-wide cap on emission allowances, instead of 27 national caps, so NAPs will no longer be needed.  This annual cap will decrease along a linear trend line of 1.74% in relation to the Phase II cap.  For example, based on current data the cap in 2013 will be set at 1.974 million tons of carbon dioxide, the cap in 2014 at 1.937 tons, the cap in 2015 at 1.901 million tons, and so on.  This linear cap will continue to apply beyond Phase III.  A portion of the allowances (apparently not yet determined) will be auctioned beginning in 2013 and the proportion will increase in subsequent years to 70% in 2020 with a view to reaching 100% by 2027.  Ten percent of auction allowances will be redistributed from the Member States with high per capita income to those with low per capita income.

On September 23, 2009, the second highest tribunal in the EU ruled that the European Commission had failed to prove that Poland and Estonia had been too generous in issuing allowances and that the European Commission had “very restricted” power to review national allocation plans (NAPs).  The court rejected the Commission’s decision to compel Poland to cut its allowances by nearly 27% and Estonia by nearly 48%.  The European Commission is considering an appeal.  The decision should not be relevant after Phase III begins in 2013 (when the European Commission has the right to decide on the allocation of carbon allowances for each industry sector across the EU).

As noted above, besides EU allowances, certified emissions credits from the baseline-and-credit systems (i.e., CERs from the CDM mechanism and ERUs from the JI mechanism) are also traded under the EU-ETS.  During Phase II, these credits are limited to 14% of aggregate allocations.  In Phase III, based on a 20% emissions reduction by 2020, it is expected that up to half of the emissions reductions required in Phase III can be achieved by their use.  This should reduce the pressure on European industry since, in effect, it will be able to buy 50% of needed credits from developing world projects. However, only credits accepted by all Member States during 2008 to 2012 can be used under this proposal.  See below for a further discussion of CERs.

The CDM Baseline-and-Credit System

The Clean Development Mechanism offers a way for companies subject to EU-ETS to earn CERs for projects implemented in developing countries.  In October 2009, CERs sold for $17.19.  There are several types of projects that can generate CERs including biological sequestration, destruction of industrial gases with high global warming potentials, methane capture, projects that increase energy efficiency, and renewable energy projects.  However, not all types of projects are accepted in each trading system.  For example, nuclear and forestry projects, as well as some hydropower projects are not eligible for EU-ETS compliance credits.  Companies that finance the projects take on risk, because approval of the projects can be denied by the UN’s CDM Executive Board, or when the project is completed it may not achieve the emissions reductions called for in the planning documents.

During the planning phase of a project a feasibility study is conducted and a methodology is established to determine a project’s baseline and additionality.  A Project Design Document is completed that describes the project in detail.  The project then must be validated by an independent UN-approved third-party auditor, called Designated Operational Entities (DOEs).  Currently, three auditors dominate the business: Det Norske Veritas, based in Norway; Tüv Süd AG, based in Germany; and SGS Group, based in Switzerland.  After a project is validated by a DOE, it must be approved by the host country as well as by the CDM Executive Board. According to the UN, there are currently 4,417 CDM projects in the pipeline.  An additional 29 projects have withdrawn from the process and 549 projects have been rejected.  After a CDM project is approved, it is implemented and monitored. Once a project is completed, verification is required to confirm that the planned carbon emissions reductions are taking place.  This verification is done by a different DOE than the one that conducted project validation.  If it is clear that emissions were reduced, then CERs are issued.

Under the CDM mechanism, there may be a failure to deliver purchased carbon credits.  The risk of failure to deliver credits is typically allocated by contract.  Some contracts relate to credits already generated, others relate to credits expected to be generated and may be either “guaranteed” (i.e., risk to the seller) or not guaranteed (i.e., some element of risk to the buyer). Although some effort is being made to develop more uniform contracting, wide variations exist in contracts as to the allocation of risk, including the risk of project failure (i.e., the project does not get built, fails once built to produce the required additionality to justify certification of the carbon credits, or it produces certifiable credits but fewer than expected) and the credit risk that the seller becomes insolvent before the date of delivery or otherwise defaults in the delivery of certified credits in the agreed quantity when due.

Generally, contracts fall into one of three categories: immediate delivery of existing credits, future delivery at a pre-determined price and time of credits from an existing project that is already producing certifiable credits, and future delivery of credits that do not yet exist that are expected to be produced from a specified project or projects that is or are to be built.  The first category of contracts are the least risky, the last the most risky.  A buyer therefore needs to examine closely the exact terms on which a specific set of CDM credits are being offered.  There are also various non-contractual ways of managing risk.  These include having a portfolio of projects, employing independent experts to oversee projects, buying more credits then are actually needed on the assumption that the delivery of some will fail, and taking out an insurance policy.  Each of these ways of managing risk involves additional cost.

Challenges Facing the EU Carbon Markets

We are advised by our European colleagues that the EU carbon markets face a number of challenges to carbon emission reductions, including those noted below.

  • The Kyoto Protocol uses 1990 as its base year from which reductions are measured.  The carbon emission reductions that the EU has thus far achieved since that base year have been largely due to deindustrialization in the countries of the former Soviet Union (including what was formerly East Germany).  As a result, further emission reductions in the EU as a whole, and in those countries in particular, will be more difficult to achieve in the future.
  • Companies seeking to determine the number of carbon emission credits they need to hold or apply for typically hire private engineering firms to quantify their emissions and make the related calculations regarding the credits they will need.  There is, however, relatively weak oversight by governmental bodies of this process.  As a result, oversight of the process needs to be strengthened to better assure the integrity of emissions computations.
  • Currently, when a purchase and sale transaction takes place, it must be reported at multiple levels, including to registries maintained at the EU and at each of the member states where the buyer and seller are located. Additionally, each cross-border transaction must be reported to a United Nations body that converts EUAs into Assigned Allowance Units (AAUs).  AAUs are the international mechanism used to track the emission balances of the respective Kyoto states.  As a result, these databases need to be better integrated in order to provide increased assurance that the transaction reporting system is running properly (for example, that the same credit is not sold more than once by an originating company).

The Waxman-Markey Bill

The Waxman-Markey bill is a very complex bill that can only be summarized here.  It not only establishes a cap-and-trade system, but also contains provisions for clean energy and energy efficiency.  The provisions outside of cap-and-trade include:

  • Creating and improving the Smart Grid;
  • Creating an electric vehicle infrastructure and providing financial assistance to existing factories for them to shift production to electric vehicles;
  • Establishing State Energy and Environment Development Accounts (SEED accounts) to serve as state level repositories for emissions allowances for renewable energy;
  • Mandating greater energy efficiency in building codes and establishing a grant program through the Department of Housing and Urban Development to support enforcement of building codes; and
  • Requiring the Secretary of Energy to set standards for industrial energy efficiency.

The stated goal of the Waxman-Markey bill is to reduce the quantity of greenhouse gas emissions in the United States by 83% from 2005 to 2050, so that greenhouse gas emissions in 2050 do not exceed 17% of the quantity of emissions in 2005.  To achieve that result the bill requires a series of steps. Greenhouse gas emissions are to be reduced by 3% from 2005 to 2012, by 20% from 2005 to 2020, and by 42% from 2005 to 2030 before reaching the overall goal of lowering emissions by 83% by 2050.  The Waxman-Markey bill phases in when entities are considered covered and will have to hold credits for their greenhouse gas emissions.  Electricity generators, liquid fuel refiners and importers, and fluorinated gas manufacturers are covered in 2012.  Industrial sources that emit more than 25,000 tons of carbon dioxide equivalents are covered in 2014.  Local distribution companies that deliver natural gas are covered in 2016.

All covered entities will be required to report their greenhouse gas emissions to a greenhouse gas registry.  Any other entity that emits a greenhouse gas, or produces, imports, manufactures, or delivers material whose use results or may result in greenhouse gas emissions of more than 10,000 tons must also report.  Additionally, if the Administrator of the EPA determines that reporting would help to achieve the goals of the bill, any vehicle fleet with emissions of more than 25,000 tons of carbon dioxide equivalent on an annual basis or any other entity that emits a greenhouse gas (without regard to quantity) may also have to report their greenhouse gas emissions.  Reporting entities are required to submit data for a base period of 2007 to 2010 no later than March 31, 2011.

Carbon allowances (each allowance being equal to the right to emit one metric ton of CO2) will be distributed by the EPA by grant or auction for each year between 2012 and 2050. The bill provides a table which lists the carbon dioxide equivalents of various greenhouse gases. The available number of emission allowances is specified for each year between 2012 and 2050.  (These emission allowances are listed in Column A of Table 1 attached to this memorandum.)  The set number of emission allowances varies between 2012 and 2016, after which it will decrease on an annual basis between 2016 and 2050.  To demonstrate compliance, a covered entity must submit a sufficient number of allowances to cover its emissions for a given year by April 1st of the following year.

Exceeding the allotted amount of emission allowances in a given year results in a loss of allowances the following year and a fine. The loss of allowances is equal to the excess emissions that were released.  Each ton of carbon dioxide for which a covered entity fails to demonstrate compliance is considered a separate violation.  The fine, called the excessive emissions penalty, is determined by the tons of carbon dioxide equivalent of greenhouse gas emissions which exceeded the allowances held multiplied by twice the fair market value of the emission allowances.  The loss of allowances and the fine for excess emissions when taken together amount to a form of treble damages.

Under the cap-and-trade system, owners and operators of facilities are able to sell or trade their emission allowances amongst other covered entities.  Emission allowances may also be banked until such time as they are needed for compliance.  Covered entities can demonstrate compliance by borrowing emission allowances without interest only in the calendar year preceding the vintage year for the allowance.  If a covered entity demonstrates compliance by borrowing emission allowances with a vintage year one to five years later than the calendar year for which they are needed, it will have to pay interest on those borrowed emission allowances. This interest amounts to an 8% loss in emission allowances each year, as the covered entity will have to retire a quantity of emission allowances equal to 0.08 multiplied by the number of years between the calendar year in which the allowance is being used and the vintage year of the allowance.  Covered entities may only fulfill up to 15% of their emission allowances by borrowing future vintage year allowances.

Companies can use both domestic and international offset credits to demonstrate compliance for up to a total of two billion tons of greenhouse gas emissions annually.  One domestic offset is interchangeable with one emission allowance and 1.25 international offsets are interchangeable with one emission allowance, except that prior to 2018 one international offset (rather than 1.25) is equal to one emission allowance.  The amount of domestic and international offsets that a company can use each year is limited and based on a percentage of the total emission allowances for the previous year. For example, in 2013, the applicable percentage is 30.18%. (See Column B of Table 1 attached to this article for the percentage of allowances which may be fulfilled through offset credits.)  No more than half of the allowed percentage of offset credits may be used by holding domestic offset credits alone, and no more than half may be used by holding international offset credits.  Regulations establishing a program for the issuance of offset credits are to be promulgated by the Administrator of the EPA within two years of the date of the bill’s enactment.  The bill does not spell out what types of offsets projects will be eligible for the credits.  These will be specified in the regulations set forth by the Administrator of the EPA.

Finally, the bill contains opportunities to receive additional allowances for early action.  There is no comparable provision in the EU-ETS system.  Waxman-Markey treats early offset credits like other offset credits, thus they are subject to the applicable percentages mentioned above and listed inColumn B of Table 1 attached to this article. Waxman-Markey allows early offset credits for projects established under State or Tribal law or regulation started after January 1, 2001.  Early offset credits may only be used for the reduction or avoidance of emissions that take place after January 1, 2009. As with regular offset credits, the Administrator will determine what projects qualify.  Also, the Administrator has the authority to grant applications from entities whose offset programs were not established under State or Tribal law or regulation, but do meet the other necessary criteria.  Early offsets may only be issued during the three years following the date of the bill’s enactment or until the date EPA promulgates regulations for the offset credits program.  Those regulations are to be promulgated within two years of the date of the bill’s enactment.

Waxman-Markey also allows state-issued allowances to be exchanged for the emission allowances established by the EPA.  Such state-issued allowances are those issued before December 31, 2011 by the State of California, the Regional Greenhouse Gas Initiative, or the Western Climate initiative for an “amount that is sufficient to compensate for the cost of obtaining and holding such State allowances.”

Offset credits from domestic agricultural and forestry sources will be managed by the United States Agriculture Department, not the Environmental Protection Agency.  The Secretary of Agriculture (“Sec. Ag.”) will be responsible for establishing the offset credit program no more than one year after the enactment of the Waxman-Markey bill.  The duties of the Sec. Ag. are similar to those of the Administrator of the EPA with regards to the creation of the offsets program and establishment of regulations.  The Sec. Ag. will prepare and publish a list of domestic agricultural and forestry practice types eligible to generate offset credits because they avoid or reduce greenhouse gas emissions.  The Sec. Ag. must also establish methodologies for domestic agricultural and forestry practices and methodologies to determine additionality.  (Additionality under the bill means the extent to which reductions or avoidance of greenhouse gas emissions would not have occurred anyway.)  The Sec. Ag. must work with the USDA Greenhouse Gas Emission Reduction and Sequestration Advisory Committee, which is to be established no later than 30 days after the enactment of the bill.

The Waxman-Markey bill establishes a Strategic Reserve auction, which essentially functions as a safety net for covered entities that must meet certain emission allowance requirements.  Auctions are to be conducted quarterly and sales are restricted to covered entities.  Purchases of allowances from the strategic reserves may not exceed 20% of a covered entity’s emissions during the most recent year in which allowances/credits were retired.  The bill sets an initial minimum price of $28 per metric ton CO2 equivalent for auctions held in 2012.  In each of 2013 and 2014, the price will increase by 5% plus the rate of inflation.  For 2015 and thereafter, the minimum price will be 㦨% above a rolling 36-month average of the daily closing price for that year’s emission allowance vintage as reported on carbon trading facilities” (calculated using constant dollars).

The emission allowances placed in the strategic reserve account from 2012 to 2019 will be 1% of the total emission allowances established for those years.  From 2020 to 2029, the amount will be 2% of the total yearly emission allowances and from 2030 to 2050, the amount will be 3% of the yearly emission allowances.  Thus, as emission allowances become tighter, there will be a higher proportion available in the strategic reserve for auction to covered entities if they are needed to limit excess prices in the market.  The Administrator of the EPA will transfer unsold emissions allowances from other auctions to the strategic reserve at the end of each year.

There are limitations on the percentage of emission allowances that may be released for auction from the strategic reserve.  From 2012-2016, that percentage will be 5% of the overall emission allowances established for that year.  For 2017 and after, the annual limit will be 10% of the emission allowances established for that year.  (These limits will not apply to certain international offset credits.)  One-fourth of each year’s limit will be made available for each quarterly auction.  Allowances not sold will be rolled over to the next quarter.  Any allowances not sold after the fourth quarter will not be rolled over to the next year, but placed back into the strategic reserve account.

Apart from the Strategic Reserve, emission allowances are set aside for distribution or auction by the EPA. The percentage of emission allowances to be auctioned (never less than fifteen percent) varies from year to year.  The basic structure is that specified percentages of allowances are set aside for either direct distribution or auction for the benefit of specific groups, industries or programs, and any remaining allowances are also to be auctioned.  For the years 2012-2025, the extra allowances that are auctioned will be deposited into the Treasury for the purposes of reducing the deficit.  For the years 2026-2050, these same auctioned allowances will be deposited into the Climate Change Consumer Refund Account (a tax refund).

Distribution to specific groups, industries, and programs varies each year.  In 2012, for example, 43.75% of allowances will be distributed for the benefit of electricity consumers and 1.875% will be distributed for the benefit of home heating oil and propane consumers.  Trade-vulnerable industries (i.e., energy intensive, trade-exposed industries susceptible to financial setbacks as a result of these new regulations) will receive up to 2% of allowances (See Table 3 attached to this article). About 12.5% is scattered among a number of energy efficiency programs, with the bulk of it being distributed to the State Energy and Environment Development (SEED) account.  Another 1.25% is set aside for auction for the benefit of workers and worker training.  Fifteen percent will be set aside to be auctioned off for the benefit of low-income consumers.

Overall in 2012, about 72% of the allowances are distributed to specific groups, industries or programs, and 18% are set aside for auction for similar categories of beneficiaries.  The remaining 10% of allowances will be auctioned off with the proceeds deposited into the Treasury.  Therefore, the total amount auctioned in 2012 would be about 28%.  (Please see Table 2 and Table 3 attached to this memorandum for a detailed list of percentages of distributed emission allowances for 2012-2050.)

Emission allowances to benefit natural gas consumers will not be distributed until 2016, at which point the industry will receive 9% of allowances until 2025.  Starting in 2025, the proportion of allowances allocated to electricity, natural gas, and home heating oil and propane will decrease on an annual basis, ending completely after 2029.  This will leave a greater percentage of allowances available to be auctioned off for a consumer tax refund.  The allowances allocated to trade-vulnerable industries will also decrease over time, phasing out completely by 2050.

The Waxman-Markey bill also contains provisions that attempt to protect domestic industry if other countries, over time, do not adopt comparable programs to lower greenhouse gas emissions. The United States’ policy will be to work proactively under the UNFCCC (or other appropriate mediums) to create binding agreements with other nations to reduce global greenhouse gas emissions.  If, however, a multilateral agreement to lower greenhouse gas emissions has not been reached by January 1, 2018, an international reserve allowance program will be established for eligible industrial sectors. This program can only be avoided if the President determines and certifies to Congress that the program would be contrary to national economic or environmental interests and a joint resolution confirming that decision is enacted into law within 90 days.  Assuming no such determination and enactment takes place, the U.S. will notify foreign countries that, starting January 1, 2020, international reserve allowance requirements may apply to any covered goods coming in to the U.S.

The EPA will issue regulations implementing the program with the concurrence of the Commissioner responsible for U.S. Customs and Border Protection.  This program will require the submission of the appropriate amount of allowances for covered goods imported into the United States. Products may be exempt from such requirements if they come from a country that is responsible for less than 0.5% of global greenhouse gas emissions and less than 5% of the U.S. imports of covered goods for that industrial sector or if the country has been identified by the U.N. as among the least developed of developing countries. Other exemptions will be granted to eligible industrial sectors importing more than 85% of covered goods from countries that: are party to an international agreement to which the U.S. is a party that includes a national greenhouse gas emissions reduction commitment as stringent as that in the U.S., are party to a multilateral or bilateral emission reduction agreement for that sector to which the U.S. is a party, or have an annual energy or greenhouse gas intensity less than or equal to the energy or greenhouse gas intensity of that industrial sector in the U.S. The procedures that U.S. Customs and Border Patrol must use for the declaration and entry of covered goods must also be established by the Administrator with the concurrence of the Commissioner of U.S. Customs and Border Protection.

It should be noted that there are various areas where the Administrator of the EPA is given the authority to set or alter guidelines for programs and provisions outlined in the bill.  For example, there are some requirements for how auctions are to be conducted; however, the Administrator of the EPA is directed to promulgate the initial regulations in consultation with other agencies for auctioning allowances.  The Administrator also has the authority to change those initial regulations for auction procedures should it be determined (once again, in consultation with other agencies) that different methods would be more effective and fair.  As mentioned earlier, the Administrator also has influence over the offset credits program – in addition to determining regulations for the program and deciding what types of projects will qualify for offset credits, the Administrator can consider applications for offset programs not established under State or Tribal law on a case by case basis.  These provisions are intended to allow the EPA to adjust regulations in response to unforeseen circumstances and new scientific information. However, they also open the door to intense lobbying and potential litigation as the EPA exercises its discretion.

The Future

The Kyoto Protocol by its terms ends in 2012.  A plan adopted at the Bali conference lays out the procedures to be implemented to achieve a post-Kyoto agreement.  The plan anticipates a new agreement being reached in Copenhagen in December 2009.  Given the EU planning for Phase III (2013 to 2020), the commitment of President Obama to a carbon cap-and-trade system in the U.S., and the enormous sums already invested in the carbon markets, it appears likely that the carbon markets will continue to evolve, expand and provide investment opportunities while reducing global carbon emissions over time.

Mr. Bernstein, currently with N.W. Bernstein & Associates, LLC , has practiced law for more than forty years and has specialized in environmental law and environmental litigation for the last twenty years. For nine years, he was responsible for the environmental litigation of one of the nation’s largest automotive companies.

 

Contact him at nwbernstein@nwbllc.com.

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