One recently introduced bill and another forthcoming bill evidence a growing sophistication and readiness on the part of key policy makers to tackle the climate change challenge in a long-term, transformative way. Senator Jim Jeffords (I-VT), the ranking member of the Senate Environment and Public Works Committee, introduced on July 20, 2006 the “Global Warming Pollution Reduction Act” (S.3698). Senator John Kerry (D-MA), the 2004 Democratic presidential nominee and likely hopeful in 2008, intends to introduce shortly a comprehensive climate change bill. The common feature of the two new proposals is their focus on steady, incremental reductions over the next forty years, until 2050, to make significant reductions in greenhouse gases far beyond any previously introduced legislation.

For investors in the carbon markets, as well as companies subject to the emission reduction mandates, this long-term, incremental approach is the best way to establish a durable carbon price signal that can unleash the capital necessary to achieve the transformation to the low-carbon economy without creating significant short-term economic disruptions.

The Jeffords’ bill sets the following GHG emission reduction milestones: (1) 1990 levels by 2020, starting in 2010; (2) 26.6% below 1990 levels by 2030; (3) 53.3% below 1990 levels by 2040; and (4) 80% percent below 1990 levels by 2050.

The Jeffords bill would amend the Clean Air Act and give the EPA authority to establish a market-based program to implement the reduction mandates. The bill, however, does not require an emissions trading system, and leaves much of the details of the implementation of such a system to EPA to develop, at its discretion.

Among the key guidelines for a market-based system that could be developed by EPA under the Act is the “technology indexed stop price.” The technology indexed stop price is defined as:
a price per ton of global warming pollution emissions determined annually by the Administrator that is not less than the technology-specific average cost of preventing the emission of 1 ton of global warming pollutants through commercial deployment of any available zero-carbon or low-carbon technologies.

If the price of an allowance under a declining market-based cap and trade scheme exceeds the “technology indexed stop price,” the emissions allocations under the cap will not decline until the allowance price falls below the stop price or three years, whichever is earlier.

The Jeffords’ bill is an economy wide bill and includes provisions for a national renewable portfolio standard of 20% by 2020, expands California’s energy efficiency standards nation wide and includes specific emission standards for automobiles. For electricity generators, it requires all new generation to meet the per unit GHG emissions equivalent of natural gas combined cycle generation and by 2030 all generation, including existing generation, must meet the NGCC-equivalent emissions standard.

The Kerry proposal, which Senator Kerry intends to introduce this year, contains many similar characteristics to the Jeffords bill, but offers a number of differences that could have a meaningful impact on the long-term carbon price signal. The Kerry proposal calls for a reduction of GHG emissions 65% below 2000 levels by 2050. To get there, the Kerry proposal establishes by statute an economy wide, mandatory declining cap and trade program with the following milestones:

• 1.5%/yr reduction for 2010-2019

• 2.5%/yr reduction for 2020-2029

• 3.5%/yr reduction for 2030-2050

Kerry’s proposal also would set aside a certain percentage of allowances from the overall cap to be used to assist in funding related measures. Specifically, the legislation provides allocations for: consumer protection (including worker and community transition assistance); clean technology incentives (renewables, efficiency, carbon capture and sequestration); emission reductions from agriculture, forestry, and other uncapped sectors; and industry competitiveness in the global market.

The Kerry proposal also would make the California automobile GHG standards national, and establish a federal renewable portfolio standard of 20% by 2020.

Despite the similarities with the Jeffords and Kerry proposals, there are some key differences that will impact the carbon price signal and potential investment into the low carbon economy. First, the Jeffords’ bill, while hinting that a cap and trade program could be developed by EPA, does not establish such a program. In addition, the Jeffords’ bill delegates to EPA on an annual basis the determination of a price per allowance that would halt the incremental reduction in the cap in the following year. This institutional annual uncertainty on future reductions to the overall cap would make long term investments based on carbon price more difficult.

By contrast, the Kerry proposal would create a statutory based cap and trade program. This could be significant to the carbon markets because a statutory, rather than regulatory, cap and trade program carries with it more stability and less risk of varying regulatory interpretations over time.

Under either approach, the agency delegated to administer the program (likely EPA) will have considerable influence over the carbon price signal. However, the narrower EPA’s mandate to design the program (and discretion to change it) via the regulatory process, the less policy risk there is that different EPAs operating under different administrations will take inconsistent views on critical elements of the scheme. Such policy risk creates a degree of uncertainty that could deter some risk adverse investors. On that front, the Kerry proposal would likely set a more stable long-term carbon price signal than the Jeffords bill.

For investors and affected companies alike, perhaps the most critical need in climate change policy is the need for a stable long-term carbon price signal. Both the Jeffords bill and Kerry proposal are important steps toward that end.