Launching A Climate Change Practice - A Portent Of Things To Come

Thursday, November 1, 2007 - 01:00

Editor: What were the factors that led the firm to set up a special practice group to serve clients who have a known or potential liability for GHG emissions or other possible violations of environmental, social and ethical obligations?

Our climate change practice developed organically as our clients increasingly sought our help in understanding the implications of a carbon-constrained world for their operations, investments, risks and opportunities. To provide better, more efficient client service we organized a practice group for coordinating the different disciplines practicing in this arena. We have found that the scope of the unknowns and uncertainties underlies many of the questions our clients currently have. For example, the investment community needs to be able to understand and analyze risk, project developers need to assess the standards and criteria for emission offsets, and every sector needs timely and reliable information concerning the regulatory structure Congress is considering, as well as the continuing advance of international systems.

Editor: What practice groups will be involved with this team?

Our practice group is multi-disciplinary. We developed the practice around our transactional lawyers from our project finance, private equity and investment funds, and emerging markets groups, as well as our public law and policy lawyers, environmental lawyers and energy litigation lawyers.

Editor: What are the major areas of risk for which corporations may be held responsible in terms of climate change?

Every change brings risks. For the changes likely to result from the development of regulatory systems to control GHG emissions across all sectors of the economy, the legal and financial risks are enormous. But, it would be a grave mistake to focus solely on those risks and ignore the opportunities created by these changes. The major categories of risk include physical risks, financial risks and legal proceedings. Physical risks include risks to personnel, physical assets, and supply and distribution chains. They can result from changes in weather patterns, rising sea levels, loss of permafrost, the unavailability of clean water, etc. Financial risks apply both to emitters of greenhouse gases likely to be impacted directly by new regulations and to other entities facing indirect impacts, such as when regulation increases the costs or decreases the supply of a service on which a business depends, or decreases the demand for a business's own products or services. Finally, numerous climate change lawsuits have already been filed alleging, for example, personal injury and property damage from emission of greenhouse gases or the failure of regulatory agencies to consider greenhouse gas impacts of projects ranging from shopping centers to new power plants.

Editor: What do you see as the role of emissions trading systems as a market-based mechanism to regulate carbon emissions from refineries, utilities and other energy-intensive industries? What is involved in trading emissions credits?

Momentum continues to build for a multi-sector, federal emissions trading program for carbon dioxide (CO2) in the United States. Market-based cap and trade programs are designed to lower compliance costs and promote new technologies while reducing emissions. Compliance is critical to delivering environmental benefits and building market confidence.

Under a carbon cap and trade program, a governmental body allocates or auctions certificates totaling the maximum amount of CO2 that the collective regulated community may emit into the atmosphere. A market is created for facilities that meet energy demands more efficiently to sell surplus allowances to emitters that are unable to reduce their emissions sufficiently or for whom the purchase of credits is a more cost-effective alternative. Another important group of market participants are investment banks or hedge funds, holding and trading carbon credits as a commodity. Many investors and potential members of the regulated community are advocating for the development of "robust, well-functioning global emissions markets" through "accurate and rigorous caps" and "long-term regulatory frameworks" that work to effectively reduce GHG emissions.

Based on legislation currently before Congress, industries likely covered by a federal cap and trade system include the "electric power sector" and energy-intensive industries such as steel and cement. State and regional programs in the Northeast, initially only capping CO2 emissions from power plants, and in the West, led by California, are already in the initial implementation stages.

Editor: What modifications to the Clean Air Act are needed?

The focus of the legislative efforts will not be on the Clean Air Act, per se. The Supreme Court's ruling in the Massachusetts case confirms EPA's authority under the Clean Air Act to regulate carbon as a pollutant. The fallout from that decision, along with the lawsuits in various states to allow tighter emissions standards on mobile sources, will likely draw most of EPA's attention for the immediate future. Legislation regulating carbon is going to arise as free-standing legislation that may include some amendments to the Clean Air Act, but that otherwise will be establishing an entirely new regulatory structure. Among the issues that will have to be resolved are the precise scope and nature of EPA's responsibilities under a comprehensive climate change system.

Editor: What do you see as the role of technology, including renewable energy sources, in managing greenhouse gas emissions and offering investment opportunities?

There is universal agreement that rapidly advancing the development and trade of new technologies that reduce, replace or capture greenhouse gas emissions is critical to mitigation of climate change. Renewable energy technologies are at the forefront of this debate, not only yielding environmental and economic benefits, but also providing energy independence and serving an important national security function.

Renewable energy schemes complement and, at times, overlap regulatory approaches specifically designed to reduce greenhouse gas emissions, such as trading systems and carbon offset programs created through voluntary markets. Governments are designing laws and policies to reduce risks, commercialize innovative renewable energy technologies and sustain robust renewable electricity markets.

In the U.S., many states have set very ambitious renewable portfolio standards (RPS) of 20% or more of the total electricity portfolio, phased in over the next two decades. These initiatives are contributing significantly to the strong growth and promising future of the renewable energy industry, where investment is expected to exceed $120 billion globally in 2007. During the next decade, the RPS, along with the rapidly expanding voluntary carbon markets, will continue to drive tremendous demand for high-quality renewable energy projects and technology.

Editor: How can a company promote its commitment to social responsibility to its stakeholders through the use of energy efficiency, waste minimization and water conservation? Can demonstrating such commitment shield the company from future dissent by "green investors" or from government action?

Great companies lead by example. It is no different with environmental performance. Companies that have adopted energy-efficient processes, waste-reduction practices or water conservation often have strong bottom lines. These companies respond to new market opportunities and stay ahead of regulatory mandates. To date, many of these practices may have been voluntary, as the business case for using energy more efficiently and reducing consumption of natural resources has led to increased profits through lower costs. This is in addition to marketing advantage realized from "green practices," which leads to improved relationships with customers and shareholders who are beginning to demand such practices.

Currently, we are observing a pervasive trend toward new laws requiring energy-efficient building operations and manufacturing requirements in federal, state and local laws and ordinances. While early adopters of "green practices" may gain some goodwill from regulators in the form of reduced sanctions, they will not be shielded from enforcement for violations of these or other environmental requirements.

Editor: How would you advise a new client who is looking for guidance on bringing its business into the second decade of the 21st Century on the regulatory structure for managing climate change?

"The shift away from a carbon-based economy is a mega trend," as Deutsche Bank recently observed. The large-scale changes present huge opportunities for innovators and entrepreneurs, but managing this "mega trend" requires broad reaching but smartly designed and consistently applied regulation that involves all sectors that contribute significantly to GHG emissions. No business will be immune from potential carbon legislation, but sectors will be treated differently. Our multi-disciplinary climate change team has the individualized expertise required to analyze the unique risks and vulnerabilities of each individual client and to assess sector-specific needs.

Our climate lawyers assist clients in the development of comprehensive strategic and tactical plans to respond to new and emerging processes at the U.S. and international levels. We utilize tools such as direct advocacy with government decision makers, formation and coordination of professional teams to advance client objectives, and provide intelligence on the regulatory drivers of investment in greenhouse gas intensity-reduction technologies.

Editor: What is the likelihood that public companies will be required to disclose in their MD&A filings the future possibility of the need to meet stricter codes of performance entailing sizable expenditure?

We have been advising public companies to include discussions of climate change risks and opportunities for awhile now. Disclosure of climate change risks is an issue attracting significant attention. A consortium of state and municipal officials, environmental groups and institutional investors recently petitioned the SEC to issue guidance requiring greater disclosure of climate change risks and requested that the SEC examine the adequacy of climate change-related disclosures. These groups are pointing primarily to SEC Regulation S-K, which contains several provisions that can be interpreted as requiring disclosure.

Editor: What guidelines can be used to estimate future costs and thereby impact on a company's financial future for making such disclosures?

This is the interesting question because, in most cases, providing a reliable quantitative estimate may not be possible. The SEC requires publicly traded companies to disclose on a periodic basis certain information about the company's financial condition and business practices to ensure that investors have access to basic and relevant information prior to trading. While the groups that petitioned the SEC for additional guidance assert broadly that estimation of future costs should not be difficult, because there is no national or international regulatory structure applicable to domestic enterprises, most companies can only hypothesize as to the effect that future regulatory compliance costs will have on capital expenditures and competitive position.

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