June 29 (Bloomberg) -- The climate-change bill that passed the U.S. House on June 26 would set up a “cap-and-trade” market for greenhouse gases that cushions the cost for power producers, manufacturers and farmers while limiting aid to oil companies.

Among those getting help were utilities American Electric Power Co. and Exelon Corp. Washington representatives for ConocoPhillips and Exxon Mobil Corp. said the oil companies were shortchanged.

The bill, which creates a market for carbon dioxide permits potentially worth more than $100 billion a year by 2020, regulates the way the allowances could be traded to guard against speculation with derivatives that lawmakers say might drive up the prices of electricity and gasoline.

The legislation, passed 219 to 212, largely rejected President Barack Obama’s plan to raise revenue for the federal government by selling the permits at auction and instead doled out free credits to win the support of Democrats from coal, manufacturing and farm states. Oil companies got many fewer free permits. The proposal now faces action in the Senate.

“This bill tries to help utilities and manufacturers move to a low-carbon economy without harming consumers, draw farmers into the carbon market and keep that market transparent to prevent improper profit-taking,” Tim Profeta, director of the Durham, North Carolina-based Nicholas Institute of Environmental Policy Solutions at Duke University, said in a telephone interview. “The oil industry got fewer free permits because lawmakers believe these firms can pass the relatively low cost to their consumers without affecting their bottom line.”

85% of Emissions

Under the legislation, written by Democratic Representatives Henry Waxman of California and Edward Markey of Massachusetts, the federal government would set a limit, or cap, on the sectors of the economy responsible for 85 percent of U.S. greenhouse gas emissions.

The American Clean Energy and Security Act calls for the U.S. to reduce its greenhouse-gas emissions, linked by scientists to global warming, 17 percent from 2005 levels by 2020 and 83 percent by 2050. More than 70 percent of the allowances would initially be given away.

Power plants, factories, oil refineries and natural gas distributors would be the largest polluters regulated under the program. The cap would be divided into billions of permits that each carry the right to emit the equivalent of one metric ton of carbon dioxide. The allowances could be traded among firms and investors in a market similar to an emissions trading system established in Europe in 2005.

$91.4 Billion

The carbon dioxide allowances would be worth $91.4 billion and a separate class of so-called offsets $13.3 billion by 2020, the Congressional Budget Office said in a June 19 analysis.

The power sector received 35.5 percent of the allowances, a move “designed to give utilities about 85 percent of the allowances they require” until the program phases out most free credits between 2025 and 2030, said Hugh Wynne, a New York-based senior research analyst at Sanford C. Bernstein & Co.

“There’s a clear effort to try to avoid major rate increases and major changes in operating profitability” for utilities and their customers, Wynne said in a phone interview.

The Edison Electric Institute, which represents investor- owned utilities including Columbus, Ohio-based AEP, Chicago- based Exelon and Atlanta-based Southern Co., said that while the free permits are “absolutely essential to helping reduce increases in electricity prices,” they are still not enough.

Targets ‘Very Aggressive’

The Waxman-Markey bill’s “very aggressive” emission reduction targets in the early years must be eased and a ceiling put on the price of carbon dioxide permits to prevent the program from injecting further volatility into energy markets, Tom Kuhn, the electricity trade group’s president, said in an e- mailed statement.

Oil refiners would receive 2.25 percent of the allowances for free, while having to acquire nearly 40 percent of the available permits each year to cover the emissions at refineries and the carbon dioxide produced when fuels like gasoline are burned by cars and trucks, according to data from the Environmental Protection Agency.

The power sector got a much greater share of the allowances it needed for free than oil companies because state-level regulation of retail electricity rates made it easier for lawmakers to “attach strings” to the permits so they would benefit consumers rather than boost utilities’ profits, said William Whitesell, policy director at the Washington-based Center for Clean Air Policy.

Regional Tensions

The free permits to the power sector also smoothed over regional tensions among lawmakers because they will help coal- fired power plants in the Midwest and Southeast remain competitive with nuclear and hydroelectric plants elsewhere in the country, Whitesell said. Any increase in the price of gasoline would be felt evenly across the country.

“For the oil companies, it’s really a national market,” Whitesell said. “For power companies, there are some areas in the country that are much more dependent on coal than others.”

Oil firms such as Houston-based ConocoPhillips, Irving, Texas-based Exxon Mobil Corp. and San Ramon, California-based Chevron Corp. are “clear losers” under the bill’s formula for allocating the permits, National Petrochemical and Refiners Association President Charles Drevna said by phone.

The oil companies were allocated only a small number of free permits relative to their emissions so the federal government would still have some left to sell at auction, Drevna said. Oil firms, which argue the measure could lead to capacity cuts at U.S. refineries and a 77-cent increase in the cost of a gallon of gasoline, hope “cooler heads prevail” in the Senate, Drevna said.

‘Raising Revenue’

“This bill has nothing to do with carbon dioxide and everything to do with raising revenues,” he said.

ConocoPhillips, a member of a business and environmental coalition called the U.S. Climate Action Partnership, which supports cap-and-trade, said in a statement it has “major issues” with the bill’s “treatment of transportation fuel consumers.”

The bill gives manufacturers free allowances to try to prevent cost increases that would give overseas competitors an edge. As many as 15 percent of the credits would be set aside for industries that can prove they are energy intensive and exposed to international competition.

Oil refineries have been blocked from getting any of those free allowances, Drevna said. As a further protection for U.S. industry, the legislation calls for carbon-based tariffs if countries like China and India don’t adopt their own greenhouse gas controls by 2020.

The manufacturing provisions of the Waxman-Markey bill violate U.S. obligations under the World Trade Organization and could “spark a trade war,” U.S. Chamber of Commerce Executive Vice President Bruce Josten said in a letter to lawmakers urging them to vote no.

“Such a program would invite retaliation against U.S. exporters and make U.S. companies that rely on imports less competitive,” Josten said.

Helping Manufacturers

Senator Sherrod Brown, an Ohio Democrat, said in a phone interview he wants to “tighten up” the House-passed tariff provisions “to do more in terms of protecting manufacturing.”

Some environmental groups said concessions to industry were too generous.

The Waxman-Markey bill is “a victory for coal industry lobbyists, oil industry lobbyists, agriculture industry lobbyists, steel and cement industry lobbyists, among many others,” Carroll Muffett, a Greenpeace USA deputy campaigns director, said in a e-mailed statement.

Changes to the bill to win the support of farm-state Democrats stripped the EPA of responsibility for determining when farmers could claim credit for greenhouse gas offsets and gave the task to the U.S. Department of Agriculture.

Offset Credits

The bill allows emissions reductions from some sectors left unregulated by the cap-and-trade program, such as agriculture, to be certified and traded just like allowances issued by the federal government. As many as 2 billion so-called offsets, each worth one metric ton of carbon dioxide, could be used instead of allowances.

The bill would allow at least one billion offsets to be imported into the U.S. carbon market from clean energy projects in developing countries and efforts to prevent the destruction of tropical rainforests.

Environmentalists have major concerns about whether offsets represent real emissions reductions, Clean Air Watch President Frank O’Donnell said by phone before the vote.

Putting the agricultural department rather than environmental officials in charge of a program that could earn money for farmers “is like putting the fox in charge of the henhouse,” O’Donnell said.

Farm, Forest Credits

After Waxman reached a deal with farm-state Democrats on offsets there has been “heightened interest in agriculture and forest derived credits and the underlying projects,” Josh Margolis, co-chief executive of Cantor CO2E, a unit of securities firm Cantor Fitzgerald LP, said by e-mail.

European emission traders are encouraged by the passage of the House climate-change bill because a U.S. cap-and-trade program would give a “huge boost” to the size of the international carbon market, Abyd Karmali, Global Head of Carbon Markets at Bank of America Merrill Lynch, said in an e-mail.

The bill’s proposed ban on over-the-counter, or privately negotiated, deals for futures and other derivatives based on cap-and-trade permits and offsets, is a “significant concern,” Karmali said.

During the House debate over the bill, Democrats fought back Republican attacks that the cap-and-trade market would be open to manipulation by pledging severe restrictions on carbon- based derivatives.

Derivatives Trading

The House-passed bill would force all trading of these derivatives to be conducted on exchanges at least until more sweeping financial market reforms pushed by Obama and Democrats in Congress are approved.

Emissions brokers and the firms who plan to take part in the U.S. carbon market will press for over-the-counter derivatives trading to be better regulated and not banned, Henry Derwent, president and chief executive of the Geneva-based International Emissions Trading Association said in an e-mailed statement.

“Simply banning over-the-counter trades of derivatives will impair the ability of the market to deliver the risk management tools that reduce costs for companies and consumers,” Derwent said.

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To contact the reporter on this story: Simon Lomax in Washington at slomax@bloomberg.net.

Last Updated: June 29, 2009 15:21 EDT