Paul Gutermann and Kenneth Markowitz presented at Carbon Expo 2008 in Cologne, Germany. Mr. Gutermann discussed the ongoing battle in the United States between state and federal authorities over climate change initiatives. Mr. Markowitz presented on the challenges associated with ensuring compliance across market-based systems.

Mr. Gutermann’s presentation explored how states like California and the members of regional initiatives in New England, the West, and the Midwest run the risk of conflicting with federal programs or entering areas of exclusive federal power. Regional cap and trade programs are most susceptible to challenges under the Commerce, Compacts, and Supremacy Clauses of the U.S. Constitution.

Under the Commerce Clause, the federal government is given the power to regulate commerce among the states and with foreign nations. Inherent in this power is an implicit restraint on state action that burden interstate commerce, which known as the “Dormant Commerce Clause.” If a regional cap-and-trade program included provisions to prevent leakage — importing electricity from outside the cap region — it could be viewed as discriminatory and burdensome, and struck down by the federal courts. Without such provisions, however, the ability to actually cap emissions within the region would be eviscerated.

The Compacts Clause is a rarely invoked provision of the Constitution, and prohibits states from entering into “any Agreement or Compact with another State, or with a foreign power.” Courts applying the Compacts Clause look at whether states are attempting to enhance their own power at the expense of the federal government, and will invalidate agreements that condition action by one state on the action of another state, and when the agreement is not freely revocable. Regional cap-and-trade programs that attempt to link with foreign programs, like the European Union Emissions Trading System, face significant peril under the Compacts Clause. It would be impossible to administer an effective program if the agreement is freely revocable, or if emissions reductions were not conditioned upon action by other participants in the program. But by making the terms of the program binding and irrevocable, it may be unconstitutional.

The Supremacy Clause provides that the Constitution is the “supreme Law of the Land” in the United States. Federal laws can preempt state laws in three basic cases. The first case is one of express preemption. This occurs when federal legislation includes explicitly provisions that state laws in the area are preempted. Two current federal cap-and-trade proposals take opposing sides on the express preemption issue. The Lieberman-Warner bill encourages states to act and create innovative programs, while Senator Voinovich’s recent proposal would expressly preempt state greenhouse gas reduction efforts.

The second case for federal preemption occurs when Congress intends federal law to “occupy the field” in a given area. Even though a proposal like Lieberman-Warner does not expressly preempt state action, there is a significant risk of courts holding that a federal cap-and-trade program occupies the field by setting a nationwide price for carbon. If separate state programs were allowed to create their own price for carbon emissions, it could lead to significant regulatory programs and widespread confusion among regulated entities.

The third case for federal preemption is a when there is a conflict between federal and state law. A regional cap-and-trade program could fall victim to this test, for example, if it regulates a different set of industries than the federal law captures. If a chemical manufacturer is required to buy allowances under a regional initiative, but is exempt under the federal program, the company would likely argue that the state efforts conflict with the federal law and are thus unconstitutional.

The take-away lesson here is that there are many challenges ahead for designing an effective greenhouse gas reduction program in the United States. States are attempting to take a leadership role, but may fall victim to constitutional limits on their power, even at a time when the federal government has not fully engaged with the issues here. At the same time, the federal government risks earning the enmity of the states by disregarding their past and present leadership on pressing environmental and social issues. (For additional background on the constitutionality issues arising from state climate protection leadership, please refer to a recent article by Robert Huffman and Jonathan Weisgall.)

Mr. Markowitz’s presentation evaluated the role of compliance in ensuring environmental integrity and market confidence across carbon trading systems, during the “Emerging Innovative Market Instruments and Approaches for the GHG Market” plenary.

For further information about this topic, please contact Akin Gump.