The comprehensive clean energy and climate legislation, which is expected to move through the House Energy and Commerce Committee next week, establishes a limited number of carbon emission permits (aka "allowances") as the means to enforce a declining cap on the pollution that causes global warming. These allowances are a valuable public asset and how they are distributed is one of the critical questions Congress must decide in crafting legislation. The discussion draft of the American Clean Energy and Security Act, released on March 31st intentionally did not address this issue, saying that the allocation issue would be resolved through discussions among Committee members. This afternoon Chairman Waxman and Chairman Markey released their revised proposal (H.R.2454, the Chairman's mark for next weeks Committee meetings) which includes the allocation proposal that emerged from these discussions. Here's a first look.

The allocation proposal focuses on four main goals: (1) protecting consumers, (2) avoiding outsourcing of jobs and emissions in energy intensive industries, (3) promoting energy efficiency and advanced technology deployment, and (4) reducing deforestation and facilitating adaptation to the impacts of global warming that can no longer be avoided. As with other aspects of the bill, Waxman and Markey had to make significant compromises to develop a proposal that can pass out of the Energy and Commerce Committee, given that they can't rely on any Republican votes and many Democrats on the Committee come from districts where coal and oil interests have enormous political sway. Nonetheless, the proposal solves the allowance puzzle in a way that avoids large windfalls, protects low- and moderate-income consumers, and builds political support.

As I discussed in a previous post, there are many strongly held views about the "right" way to allocate emission allowances and undoubtedly everyone, including NRDC, will find fault with some aspects of this proposal. As the debate unfolds, it's important to remember that without a cap there is no guarantee of emission reductions and no allowance value to divide up.

More detail on the four main slices of the allowance pie follow:

1. Protecting consumers

The mark allocates 30% of the allowance pie to electricity retailers and 9% to natural gas retailers. These local distribution companies (LDCs) are regulated by state agencies and are required to use the value of the allowances they receive for the benefit of their customers. This approach avoids the risk of large windfall profits seen in Europe when competitive electricity generators were given allowances for free but raised their (unregulated) prices anyway, reflecting the market value of the allowances they have to use to compensate for their emissions. Consumers will see the greatest benefit from these allocations if utility companies use a portion of their value to invest in all cost effective energy efficiency improvements. The mark requires natural gas distributors to use at least one-third of the value of the allowances they receive to invest in cost-effective energy efficiency measures; inexplicably no similar requirement applies to electricity distributors.

Low- and Moderate-income households will be further protected from the indirect costs of the program by auctioning 15% of the allowances and returning the revenue to them through tax credits and other benefits.

2. Preventing outsourcing of energy intensive industries

Steel, cement, and other energy-intensive manufacturers argued that the energy price increases created by capping carbon emissions could cause them to shift production to countries without similar programs, outsourcing both jobs and emissions. The allocation proposal addresses this issue by adopting an approach introduced by Congressmen Inslee (D-WA) and Doyle (D-PA), which would allocate allowances to energy-intensive trade-exposed firms based on how much output they produce in the United States. This means that if a firm reduces its output or shifts production overseas it receives fewer allowances, creating an incentive to invest in improving the efficiency of domestic production instead. The proposal sets aside 15% of allowances for this purpose and would initially allocate to each firm an amount based on 100% of average emissions per unit of output for each sector.

This is more generous than necessary. The original Inslee-Doyle proposal called for allocating based on 85% of average emissions. The principle should be to allocate enough to level the playing field between domestic and international producers. This may require much less than 100% of average emissions as firms can pass some of their increased costs along to their customers and as more countries adopt comparable programs. This is particularly true for oil refiners, who are likely to pass most if not all of their costs on to consumers. Nonetheless, they receive 2% of the allowances, which would cover about two-thirds of their emissions.

3. Promoting energy efficiency and advanced technology deployment

States would receive 5-10 percent of the allowances (depending on the year) to promote investments in energy efficiency and renewable energy production. This includes funding for building code enforcement and for building retrofit programs which have the potential to substantially reduce consumer energy bills and the overall cost of complying with the emission reduction targets. Unfortunately the funding levels are much less than what is needed to capture all of the cost-effective energy efficiency potential.

Additional allowance value is set aside for promoting carbon capture and disposal, advanced vehicle deployment, clean energy job training, and university-based energy research.

4. Reducing deforestation and facilitating adaptation

The mark provides 5 percent of the allowance value for activities to reduce tropical deforestation with the goal of achieving emission reductions equal to at least 10 percent of U.S. emissions in 2005. By funding these activities through allowance value, in addition to the offset market, this program will produce emission reductions over and above those generated by the cap itself.

The mark also provides emission allowance value to facilitate adaptation and clean technology transfer. Funding for domestic adaptation comes from 2 percent of the allowances for the first 10 years of the program and then increases to 4 percent in 2022 and 8 percent in 2027. These resources are split evenly between natural resource adaptation and helping vulnerable communities, including through public health preparedness. Funding for international adaptation and clean technology transfer similarly ramps up from 2 percent of the allowance value to 4 percent in 2022 and 8 percent in 2027.