During the past decade, climate change steadily has moved up the political agenda. Now, with a new administration in Washington, D.C., that has demonstrated a clear commitment to action, comprehensive climate-change legislation appears ripe for passage within the next couple of years. As a result, many industries are appropriately wondering what the new regulatory environment will mean for their businesses.

First, it is important to note that reducing greenhouse-gas emissions to levels science projects is necessary will impose a cost to society, though that cost is likely to be small and manageable within the context of the overall economy. Most economic models project a slight decline in the rate of growth of the U.S. economy as a direct result of climate legislation but never an absolute reduction in gross domestic product. Further, these costs are small when compared to the economic consequences of doing nothing and allowing severe climate change to take place. Still, there likely will be distributional impacts as the U.S. transitions to a low-carbon economy. Carbon-intensive industries, such as cement production, coal-heavy electric utilities and energy-intensive manufacturers, may require greater government assistance to manage that transition while businesses offering low-carbon goods and services are set to thrive.

The green-building industry widely is expected to be a major beneficiary of public policies to improve energy efficiency and reduce greenhouse-gas emissions because policy makers recognize two related facts. First, the country’s existing buildings are major contributors to climate change, accounting for about 43 percent of U.S. greenhouse-gas emissions. Second, a number of low-cost mitigation options available involve improving the efficiency of existing buildings and constructing new buildings in the most sustainable manner possible.

Additionally, as the nation is mired in a serious economic downturn, policy makers increasingly view the development of low-carbon technologies as a major opportunity to jumpstart the economic recovery and put the country on a path to long-term sustainable growth. Green build- ings—new construction and retrofit of existing buildings—are expected to be a major source of new jobs in the coming years. Many important short-term measures in the federal stimulus package, including weatherization assistance for low-income households; grants for states to improve the efficiency of residential, commercial and government buildings; and tax credits for improvements to make existing homes more energy efficient, are likely to boost the green- building industry.

CAP AND TRADE

With the American Recovery and Reinvestment Act of 2009 enacted, policy makers are expected to turn their attention to legislation establishing a cap-and-trade system for greenhouse-gas emissions in the coming months. Although details have yet to be worked out, successful cap-and-trade legislation likely will call for aggressive emissions- reduction requirements with a long-term target of achieving a point 80 percent below 2005 emissions levels by 2050.

This policy change requires a broad-scale transformation of the U.S. energy economy in a little more than four decades. Although this presents a great challenge, cap and trade is a regulatory system designed to stimulate technological innovation and achieve emissions reductions at the lowest possible cost. Evidence of the transformative power of cap and trade can be seen in the Washington-based U.S. Environmental Protection Agency’s acid-rain program, which established a sulfur-dioxide trading program. This program achieved its pollution-reduction goals at approximately half the cost of traditional regulation and did so in part by stimulating efficiency improvements and cost reductions in scrubber technology.

How does a cap-and-trade program work? The government sets an annual cap on allowable emissions, and that cap declines over time. The government then distributes allowances—free of charge, through an auction or a combination of the two—to entities included in the program, which typically are major emitters, like power plants and large manufacturing facilities. Under most regulatory proposals, one allowance is equal to 1 ton of carbon-dioxide equivalents, or CO2e, a common unit of measurement for global climate- change pollution. The total number of allowances distributed must match the total emissions allowed under the cap.

Regulated firms must hold and submit to the government one allowance for each ton of CO2e they emit. Regardless of whether they received these allowances for free or bought them at an auction, the effect is the same: A price is established on greenhouse-gas emissions. This creates an economic incentive for firms to reduce emissions and forms a market for allowances. Those that easily can cut emissions can position themselves to purchase fewer allowances and/or sell excess allowances to firms that face higher reduction costs. The allowance price drives firms to cut emissions and invest in low-carbon-emitting technologies to reduce compliance costs or free up surplus allowances that can be sold at a profit. Over time, allowance prices will rise as the government ratchets down the cap and reduces the supply of allowances to the market.

PROS AND CONS

The flexibility inherent in cap-and-trade systems allows emissions reductions to be achieved at a much lower cost compared to more traditional “command-and-control” regulations. But even a perfectly designed cap-and-trade system will result in some costs to society. Cost remains the primary point of contention in the climate-policy debate. Opponents argue that any climate policy will raise electricity prices to unacceptable levels, posing undue hardships on households and crippling American industry. Most credible economic models, however, indicate that well-designed climate policy will create only a slight drag on projected economic growth and never an absolute reduction from our current economic output. Policy makers must consider the costs of inaction, which include rising sea levels, reduced freshwater supplies, more frequent heavy-rain events, and increased threat of drought and wildfires. These costs are difficult to quantify but are widely expected to dwarf the policy costs of taking action.

Opponents also fear the distributional impacts of climate-change policies. Energy-intensive manufacturers whose goods trade globally, for example, are thought to be particularly vulnerable to the economic impacts of climate policy. These industries are more exposed to carbon-price impacts as a result of their heavy energy use and may be put at a relative disadvantage to overseas competitors that are able to operate free of carbon constraints. One concern is that these firms may move out of the U.S. to regions without greenhouse-gas regulations, resulting in a loss of domestic jobs with no emissions-reduction benefits.

Although this would be an unfortunate outcome, it is unlikely to be a widespread occurrence. To the extent that it does occur, the macroeconomic impacts are likely to be negligible while the distributional impacts will be moderate and manageable. First, it is important to remember that energy-intensive, trade-exposed industries make up only a small part of the

U.S. economy. Second, past studies have shown mixed evidence that adoption of new environmental standards have resulted in significant relocations of affected firms. When companies do relocate to other countries, they often are driven more by labor costs and access to raw materials. Finally, policy makers possess a number of tools to blunt the impact of climate regulation on vulnerable industries and ease their transition into the low-carbon economy. Under a cap-and-trade system, companies could freely be granted emissions allowances to compensate for regulatory costs or receive cash rebates or tax credits for the same purpose.

CARBON ECONOMY

In establishing a cap-and-trade system, policy makers must make a number of important decisions regarding the program’s design, including what activities or entities should be covered. No serious legislative proposal has emerged to directly regulate buildings under the cap. Rather, buildings would be affected by increases in electricity and fuel costs attributable to the price of carbon. These higher energy prices will, over time, make investments in efficiency more attractive in the buildings sector.

In the early years of the program, however, the carbon price signal likely will be insufficient to drive dramatic improvements in buildings’ efficiency. This is true for two reasons. First, the price signal generated at the outset likely will be relatively low, and, second, a number of additional market failures exist that prevent more significant improvements in buildings’ efficiency from taking root. These include informational barriers and principal-agent problems, which most commonly are observed in the economic and behavioral disconnect between building owners, who are responsible for making energy-efficiency investments, and building tenants, who are responsible for paying the energy bills.

A number of complementary policy measures currently being considered likely will have a larger immediate impact on the green-building industry. The American Recovery and Reinvestment Act of 2009 enacted in February contains billions of dollars to promote energy-efficient buildings. The spending on efficiency programs is included because of the projected job- creation benefits. An analysis prepared for the Washington-based U.S. Conference of Mayors predicts that retrofitting existing buildings to meet aggressive energy-efficiency goals could result in approximately 81,000 new jobs during the next 30 years.

NO TIME LIKE THE PRESENT

Although advocates and analysts long have called for new and stronger climate and energy policies, the prospects for aggressive government action appear better than ever. President Obama has made clear his commitment to cap-and-trade legislation and related clean-energy policies, and he has appointed an environment and energy team with tremendous expertise and commitment to action on climate-change issues. Additionally, key members of Congress have pledged fast action in moving climate-change legislation forward. House Energy and Commerce Committee Chairman Henry Waxman (D-Calif.) has set a goal of passing comprehensive climate-change legislation out of his committee by Memorial Day. House and Senate leaders also have said they would like to see floor debates about climate measures before the end of the year.

Adding to the momentum for action is a strong push from the business community. This especially is noticeable in the advocacy efforts of the U.S. Climate Action Partnership, a unique coalition of businesses and nongovernmental organizations that is calling on Congress to pass comprehensive climate legislation this year. USCAP includes 25 major companies in industries, ranging from automobile and oil to coal mining and coal-burning utilities, together with five major nongovernmental organizations. Although businesses have different reasons for supporting passage of climate-change legislation, the companies in USCAP typically cite the need for regulatory certainty as the biggest factor. Individual U.S. states and regions are moving forward with their own climate- change programs, and the EPA likely will begin addressing the issue. Companies would rather see a clear and consistent federal policy as opposed to varied and inconsistent regulations that complicate the business-planning process.

USCAP released its initial recommendations in January 2007, then followed up with a detailed “Blueprint for Legislative Action” in January of this year. The blueprint calls for a cap on U.S. emissions of 14 to 20 percent below 2005 levels by 2020, 42 percent below 2005 levels by 2030 and 80 percent below 2005 levels by 2050. It also calls for a set of measures designed to contain the costs of the program. Similar to the European Union’s plan, it includes a series of complementary measures to spur technological transformation in sectors that include buildings, carbon capture and sequestration, transportation and energy efficiency. Passage of legislation reflective of USCAP’s recommendations would put the nation on the path to achieving significant emissions reductions and position it to re-engage in the international negotiations to craft a truly global response to climate change.

The stars are aligned as never before for the U.S. to take aggressive action on climate and energy issues in the coming years. Even as the country faces a significant economic challenge, business and political leaders increasingly are vocal about their commitment to addressing climate change—not at a later date, but right now. They recognize the economic opportunities in advancing clean-energy solutions. Smart policy can leverage private-sector innovation to achieve dramatic emissions reductions with minimal impacts on economic growth. The green-building industry is uniquely positioned to ride this wave and make a major contribution in the country’s transition to a low-carbon future.

CLIMATE CHANGE 101

To learn more about the cap-and-trade system, as well other responses to climate change, visit the Arlington, Va.-based Pew Center on Global Climate Change online at www.pewclimate.org. The organization has released a series of reports titled, “Climate Change 101: Understanding and Responding to Global Climate Change,” to provide an understandable introduction to the issues and solutions surrounding global climate change. To view the reports, go to www.pewclimate.org/global-warming-basics/climate_change_101.

ANDRE DE FONTAINE is a markets and business strategy fellow at the Pew Center on Global Climate Change, Arlington, Va. He works with the center’s Business Environmental Leadership Council, a group of 44 largely Fortune 500 corporations that have partnered with the Pew Center to address issues related to climate change. He can be reached at deFontain eA@pewclimate.org or (703) 516-0623.