Turning up the heat

Federal, state and regional climate change initiatives are already having an impact on private equity acquisitions, and passage of a climate change bill by the US Congress would likely have an even greater effect on the market, write Stuart Hammer and Lauren Boccardi of law firm Debevoise & Plimpton.

Despite the introduction of a number of bills and some high-profile debate in recent years, the US Congress has not passed comprehensive climate change legislation. The protracted legislative process and related uncertainties concerning the eventual regulatory landscape have created both an opportunity and a burden for private equity sponsors.

Private equity firms, particularly those contemplating acquisitions of carbon-intensive businesses, are analysing issues associated with pending climate change legislation and regulation. They are investigating the potential costs of complying with proposed federal legislation, including expenditures necessary to upgrade plant equipment (to reduce greenhouse gas emissions) or purchase emissions allowances. 

Similarly, purchasers are investigating whether target businesses are subject to the US Environmental Protection Agency’s (EPA) greenhouse gas (GHG) reporting obligations and proposed climate change regulations. Purchasers are also assessing the costs necessary to comply with state and regional climate change initiatives. Additionally, private equity firms are finding new opportunities in businesses that are well positioned to prosper if the regulatory landscape favours renewable energy sources, a price is put on GHG emissions, and a robust carbon-trading market emerges in the US.

With the US House of Representatives’ passage of a climate change and clean energy bill last summer and the Senate expected to debate a climate change bill this spring, some observers believe 2010 could be the year. In the meantime, state and regional initiatives have moved forward, and the EPA has been taking steps to regulate greenhouse gas emissions under existing laws.

Federal legislation
Beginning with the introduction of legislation in the US Senate in the fall of 2007, the adoption of some form of comprehensive federal legislation addressing climate change and regulating GHG emissions has seemed increasingly likely. Most recently, in June 2009, the US House of Representatives passed the American Clean Energy and Security Act of 2009, also known as the Waxman-Markey bill, which introduced a nationwide federal renewable energy standard and created a nationwide cap-and-trade program designed to curb emissions of carbon dioxide and other GHGs.

The Waxman-Markey bill’s renewable energy standard requires utilities to obtain a certain percentage of their electricity from renewable sources, including wind, solar and geothermal energy, biomass or landfill gas, hydropower, and marine and hydrokinetic renewable energy. The bill creates federal renewable energy credits (RECs) which could be traded in a federal REC market.

With respect to cap-and-trade, the bill caps GHG emissions by certain heavy emitters, such as facilities emitting more than 25,000 tons of GHGs annually, which collectively account for approximately 85 percent of the nation’s total GHG emissions. Total US emissions are capped at 17 percent below 2005 levels by 2020 and 83 percent below 2005 levels by 2050. To comply with the cap, covered sources could reduce actual emissions by implementing technological or other changes, or purchase emissions allowances on the open market. The bill allows companies to trade and “bank” allowances for future use, and, in certain circumstances, borrow against future allowances.

In September, a climate change bill was introduced in the US Senate by Senators Barbara Boxer (D-Calif.) and John Kerry (D-Mass.). The bill, the Clean Energy Jobs and American Power Act, is similar in many respects to the Waxman-Markey bill. The Senate bill, though, calls for deeper cuts in GHG emissions than the House bill. However, because of the Senate’s focus on healthcare reform legislation, debate on the proposed Senate legislation stalled.

Senator Kerry and Senators Joseph Lieberman (I-Conn.) and Lindsey Graham (R-S.C.) have been trying to drum up bipartisan support for a new climate change bill that will be less costly to electric utilities, manufacturers and others. Their climate change bill is expected to be introduced this spring. However, it is not clear whether they will have the 60 votes necessary for the bill’s passage. President Obama supports comprehensive climate change legislation and is expected to sign any climate change bill that Congress passes.

EPA regulation
In 2009, the EPA took several steps to regulate GHG emissions under existing laws in the absence of Congressional passage of a comprehensive climate change bill. In December, the EPA issued its “endangerment finding,” which concluded that GHG emissions endanger public health and welfare and are subject to regulation. This finding opened the door for the EPA to regulate GHG emissions under the existing federal Clean Air Act.  However, legislation has been introduced in Congress to delay or stop the EPA from regulating GHG emissions.

In addition, in September, the EPA finalised a rule requiring certain large emitters of GHGs to report their annual GHG emissions to the EPA. That rule is already effective and requires many facilities to collect data on their GHG emissions. The EPA estimates the rule will require reporting from approximately 10,000 facilities.

State and regional initiatives
In the absence of federal climate change legislation, various state and regional initiatives are regulating GHG emissions and promoting renewable energy by requiring emissions reporting, setting emissions reduction targets, implementing state renewable portfolio standards and launching energy efficiency campaigns. In November, for example, California released draft rules regulating GHG emissions from electricity generators, oil refineries and other industrial facilities and creating a statewide cap-and-trade program in 2012. The Regional Greenhouse Gas Initiative, a regional cap-and-trade system for carbon dioxide emissions from power plants involving 10 states in the northeastern US, is already up and running. Currently, more than half of the states have implemented mandatory renewable portfolio standards and a number of states have similar voluntary initiatives.

Conclusion
Over the next few months, the spotlight on climate change legislation will shine brightly as the U.S. Senate debates passage of a comprehensive climate change bill. The private equity community should monitor these developments as the proposed climate change laws could affect private equity investments. We will provide a full update on climate change legislation if the US Senate passes a climate change bill.

Stuart Hammer is counsel in Debevoise’s corporate department and environmental practice group and focuses his practice on environmental matters in mergers and acquisitions, joint ventures, financings, securities offerings and other corporate transactions. 

Lauren Boccardi is an associate in the firm’s Corporate Department.

A version of this article originally appeared in the Winter 2010 issue of the Debevoise & Plimpton Private Equity Report.