Key senators are weighing a request from Big Oil to levy a carbon fee on the industry rather than wrap it into a sweeping cap-and-trade system that covers most of the U.S. economy.

If accepted, the approach -- supported by ConocoPhillips, BP America and Exxon Mobil Corp. -- could rearrange the politics of the Senate climate debate and potentially open up votes that may not be there otherwise.

"It gets you a solution to the carbon problem that doesn't destroy that part of the economy," Sen. Lindsey Graham (R-S.C.), a lead co-author of the Senate legislation, said yesterday. "Once you have oil people saying, 'We can live with this, this was our idea,' then hopefully everybody else begins to look at this thing anew. That's the hope."

Sen. Mary Landrieu (D-La.) said yesterday she has been in talks for several months with Graham and Sens. John Kerry (D-Mass.) and Joe Lieberman (I-Conn.) on a proposal that sets up a "linked-carbon fee" on transportation fuels, with revenues raised going back to consumers to help them deal with higher gas prices.

The idea, Landrieu said, comes in response to refiners' complaints that the House-passed climate bill short-changed the industry of the emissions allowances they would need in deference to other, better-connected industries like coal and manufacturing.

Graham found fault in the House bill too, which forced the industry into an upstream cap-and-trade system covering both the emissions from the refining process itself and the emissions from the products it sold.

"It really increases gas prices dramatically more than consumers can bear," Graham said. "The goal is to price carbon on the transportation side in a way that'd allow alternative vehicles to become more attractive to the consumer, and to manufacturers."

Senate aides say Kerry, Graham and Lieberman have taken Big Oil's ideas and run with them. No decisions have been made, but they are considering separating the industry from a cap-and-trade plan that covers electric utilities and manufacturers.

Instead, transportation fuels would face a carbon fee, with the price linked to the compliance requirements for other industries. New revenue would be geared toward transportation projects, reducing fuel consumption and lowering domestic reliance on foreign oil. The Highway Trust Fund is also a potential recipient of the carbon tax revenue.

"The whole concept is transportation money goes back into transportation projects," said a Senate aide close to the process.

Kerry said he plans to release details in the coming days to senators and interest groups on the overall energy and climate plan -- an approach that appears to have some early support from oil-state Democrats and the party's leadership.

"The issue about equalizing the costs of people who put emissions in the air is what the game plan should be," said Sen. Mark Begich (D-Alaska).

"Maybe the sector approach is the right start," said Senate Majority Whip Dick Durbin (D-Ill.). "I'm open to anything that moves us toward pricing carbon and reducing greenhouse gas emissions."

Industry officials said they too welcome the discussions of a carbon fee as part of the Kerry-Graham-Lieberman effort.

"Clearly it softens the reaction and increases the likelihood that a number of people who've been forced to push back will be much more cooperative in the dialogue," said Jack Gerard, president of the American Petroleum Institute.

Gerard said that the carbon fee approach would yield net environmental benefits, while giving consumers the most transparent signal they can get about what the costs are from the program. Unlike the House bill's cap-and-trade system, oil companies would pass through the costs with signs at the gas pump letting people know they're paying more because of U.S. efforts to deal with climate change.

"The effect is you alter consumer behavior," Gerard said. "If consumers know they have choices between buying a more efficient car, riding a bike or buying an SUV, now they're making an informed choice."

Red Cavaney, senior vice president for government affairs at ConocoPhillips, said his company joined with BP in floating a carbon fee for the oil industry during negotiations last year with the U.S. Climate Action Partnership coalition. Their approach also would send the bulk of the revenue back to consumers, but he said opening up the bill means other pricing ideas may take hold.

"The more you get into this, the more you find out there are a lot of variations on it," Cavaney said. "Having some soak time, some education time, will probably develop some better proposals as more people look at this."

ExxonMobil also has weighed in on the carbon fee. The company proposed (pdf) it in 2008 to Western governors as they worked on a regional climate program, with the fee linked periodically to the average allowance price in the cap-and-trade system.

ExxonMobil CEO Rex Tillerson has said a carbon tax has more political backing than many analysts are willing to give it. "They say a carbon tax is too politically sensitive and that it is easier and more expedient to support a cap-and-trade approach because the public will never figure out where it's hitting them," Tillerson told the Economic Club of Washington last October. "They'll just know they hurt somewhere in their pocketbook. I disagree with this assessment. I believe the American people want climate policy to be transparent, honest and effective."

Denny Ellerman, a retired energy economist who worked at the Massachusetts Institute of Technology, said the oil industry's general interest in the carbon fee stems in large part from their distaste with buying and selling emission allocations. "Just make it a tax, and we'll pay the tax," Ellerman said. "They know it gets passed on. They know demand is inelastic. They just don't like the sound of having the allowances."

Environmental groups say they want to ensure any legislation actually leads to reductions in greenhouse gases from an industrial sector that contributes to about a third of the annual U.S. emission total.

"I think it's an interesting idea," said Dan Weiss, a senior fellow at the liberal Center for American Progress. "In general, it's a good concept. If they can get emission reductions from it, great."

"The key environmental concern is that transportation fuels need to be covered by the program and within the cap," said Daniel Lashof, deputy director of the Natural Resources Defense Council's climate center. "It doesn't mean it has to be the same [as other industries]. You can certainly tailor the approach from one sector to another. But it does need to be part of the overall program."

To maintain environmental integrity, Lashof suggested the government would purchase and then retire allowances that represent the transportation sector's emissions. "Every sector has to have a responsibility," he added.

Pitfalls

The move toward a carbon fee on transportation comes with risks.

Kerry, Graham and Lieberman are already struggling to sell their approach and avoid use of the term "cap and trade," which opponents quickly dubbed "cap and tax" during the House debate. By opting for a carbon fee, sponsors will be directly exposing senators to the argument that Congress is raising taxes.

"Clearly, there's political risk for a strategy that goes to a fee approach," said Tim Profeta, head of the Nicholas Institute for Environmental Policy Solutions at Duke University. "The key is whether this brings any new members to the table and on board. If it doesn't, it doesn't seem to have much political benefit."

Majority Whip Durbin acknowledged the political dilemma. "This is not an easy issue," he said. "It's controversial. There's even a dispute in the Senate as to whether there's such a thing as global warming."

But Durbin said climate bill proponents can make their case to the public by talking up the measure's importance to U.S. competitiveness. "I just got back from Africa," he said. "China is all over Africa. Opening up companies that are focusing on energy. And we're standing on the sidelines here locked in debate, and we've got to get beyond that or we're going to surrender opportunities for job creation."

Politics are not the only sticking point.

Sen. David Vitter (R-La.) said he doubts whether there is unanimity among the refining industry on the need for a carbon fee, specifically citing concerns from smaller producers. "Some of those larger companies have thrown up the white flag in this debate a long time ago," he said. "So this is sort of a continuation of that."

A key negotiator in the House-passed climate bill also took issue with the push for a carbon fee. Rep. Rick Boucher (D-Va.) said authors of the House bill opted not to give free allocations to petroleum refiners because they would have made windfall profits by passing off the permits' costs to consumers -- unlike the electric utilities that must work through local distribution companies.

"There's no regulator in the chamber to stop that from happening, and so rather than them get a windfall profit out of the value of the allowances, we decided to let them go buy them," Boucher said. "They're going to pass through the costs one way or another. We might as well have the money flow to people, rather than see them get it."

If the Senate adopts a carbon fee for transportation fuels, Boucher predicted the industry would face essentially the same outcome as lawmakers wrestle over where to disburse the revenue. "A tax would direct the money to the government and then the government in theory could give it out to these deserving entities," he said. "You wind up with the same result as you get with our bill."

The refining industry also has other demands.

Carbon tax or not, Charles Drevna, president of the National Petrochemical & Refining Association, said he is concerned the climate bill will still drive up costs on domestic industries without the promise of internationally consistent regulations for competitors in India, China and South America.

Drevna also said he doubted the revenue raised by a carbon tax would get back to consumers given the other parochial interests that often creep into the legislative process. "It goes back to the ways of creating winners and losers," he said. "Until such a proposal is rock-solid against that, we're very cautious about getting too excited."

Refiners also do not want to face any regulatory overlap, and they are calling on the Senate to drop any plans for a renewable fuels standard. They also want credit when it comes to the emission reduction benefits that will come with new fuel economy standards that are supposed to level off the growth in U.S. motor vehicle emissions over the next 25 years, as well as the renewable fuels mandate that significantly increases ethanol use in the country.

"In fairness, that should be part of the equation," Gerard said.

Here, refiners can expect pushback from environmentalists. Lashof said an emission performance standard for transportation fuels is "an appropriate complementary policy to including transportation sector emissions under an overall cap." NRDC, he added, would oppose any attempt to restrict existing EPA or state authority to set up such a standard.

Senators also will need to sort through competing interests as they decide what to do with the revenue. But Ellerman said this is not a bad thing. "I'm actually rather encouraged Congress is confronting this in an open debate," he said. "Do you reduce taxes? Get efficiency gains? Or earmarks toward uses that are under funded? Or for useful social purposes, like Social Security, or to repair bridges and highways.

"You name it, there are lots of public needs," Ellerman said.

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