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Post Election Update
November 9, 2012
Overview and Takeaways
Consumer Product Safety
Energy and Environment
Labor, Employment and Human Resources
Lame Duck Session, Taxes and the Fiscal Cliff
Regulatory Environment for Shale Gas Production
Trade Policy and International Commerce
The voters have now spoken in one of the most hotly contested and expensive races in American history, and the net effect of countervailing political winds was ironically to perpetuate the political status quo. For those stunned at the amount of money spent on this race, the results are in on third-party spending: $1.25 billion, of which $600 million was in the Presidential. The top three political action committees (PACs) were Governor Romney's Restore Our Future and the two PACs run by Karl Rove, American Crossroads and Crossroads GPS. Judged simply by election results, there was not a great return on money spent by these entities.
When all of the final votes are tallied, the national popular vote as a percentage will still be quite close at around 50 to 48%, but the Electoral College was not - reflecting the direction that the majority of state polls were indicating, certainly since Hurricane Sandy knocked much of the race off the nation's front pages.
Now that Obama has been declared the winner in Florida, the end electoral result is 332 to 206 - in the high end of the range of both computer models and aggregations and of some human prognosticators. The President won eight of the nine hotly contested battlegrounds, and Governor Romney only took back two states from the Democratic win in 2008 - North Carolina and Indiana, the latter enjoying a plus-eight Republican voter advantage all along.
In the race for control of the United States Senate, the story of the night was the failure of the Tea Party wing of the Republican Party to fully vet their candidates. In what should have been a pick-up year for Republicans, the newly elected Senate is currently at 54 likely Democratic caucus members to 45 Republicans - with Montana and North Dakota not called at this point but tracking in the direction of the Democratic candidates. Put another way, of all the hotly contested Senate races, all broke for the Democrats except the race in Nevada won by the incumbent Republican Senator - and that one was by the barest of margins.
House of Representatives
The sole bright spot for the GOP was the maintaining of their majority in the U.S. House of Representatives. In the current House, Republicans hold 242 seats to 190 for the Democrats, and with five vacancies. With several races still outstanding, the new House will feature at least 233 Republicans and 187 Democrats with a Democrat pickup of 9 seats. The takeaway here is that House leadership was retained for the Republicans relatively early in the evening and at a ratio that really changes nothing. Interesting notes on the House results included a split decision on two of the more polarizing GOP incumbents: Rep. Allan West (R-FL) who lost and Rep. Michelle Bachmann (R-MN) who won. Other notable incumbents who lost their races were: Rep. Betty Sutton (D-OH) and Rep. Pete Stark (R-CA). In the meantime, incumbent Rep. John Tierney (D-MA) held on to his seat by one point despite a family gambling scandal that had threatened that Democratic seat earlier in the year. Finally, on the opposite coast in the San Fernando Valley, 30-year Democratic Congressman and D.C. - favorite Howard Berman was defeated in a redrawn district by another incumbent, Rep. Brad Sherman.
So what does it all mean? Here are some questions we should be asking regarding the election:
- Is there a Presidential mandate? Looking at the popular vote, there is not a tremendous one. In terms of overcoming obstacles to reelection and executing a near-perfect targeted plan, the answer is "yes." But the question remains, a mandate for what? Despite reports of House Speaker John Boehner's intransigence in previous budget negotiations with the White House, his tweet from election night was clear: "if there is a mandate, it is for parties to work together to help the economy grow."
- What Obama Administration will show up in the next two months and in the second term? Once liberated of the constraints of reelection and therefore more activist and responsive to its base? Or, as suggested by President Obama's victory speech on election night, one emboldened by a desire for a great historical legacy to extend a bipartisan olive branch and begin discussions on tax reform, climate change and energy policy, and immigration reform. It's possible that the final answer may be a combination of both of these approaches. This could mean the continuation of an activist regulatory agenda coupled with a reversal of the first term's limited engagement with Congress. The first indication we will have is the negotiations with congressional leaders on how to avoid the year-end Fiscal Cliff. Will the President work with Congressional Democrats to pressure Republicans into giving up on extending tax cuts on higher income earners? Or will he circumvent Republican leadership in Congress and make separate deals with groups of Republicans interested in compromise? It is noteworthy that Republican Senate Minority Leader Mitch McConnell (R-KY) is up for reelection next cycle.
- Will the President tend to the economic home fires? The answer here is a resounding "yes." A President's historical legacy is paved by a strong domestic economy. Making progress on unemployment and economic growth can restore political capital for his initiatives and for congressional Democrats in the 2014 mid-terms. On a domestic legacy agenda, look for President Obama to focus on immigration reform, comprehensive tax reform, and domestic energy (both increased renewable energy as well as energy independence).
- Can the Republican Party reinvent itself and recover in 2014 and 2016? This question will be much pondered by Washington, D.C. think tanks and commentators over the coming months. What is the teaching of the race? Should Republicans have nominated more of a true conservative? Or a candidate better able to connect with more moderate voters? When one combines the crushing Senate losses, the presidential result, and the changing demographics of the electorate, it is clear that the GOP must move beyond intensity and turnout among its core of white male voters and improve its standing among the young, the Hispanic community, and females. The issue to watch for here is immigration. 1.7 million new Hispanic voters cast ballots in the 2012 election, a number expected to only grow in the future. Will any Republican leader – a la President George W. Bush – rally the party around a compelling GOP vision for immigration reform? The answer could prove key to their chances for the White House in 2016.
- What will D.C. turn its attention to now that this election is over? Washington usually allots 24 hours to digest the latest presidential election results before beginning speculation on the next election. Accordingly, there will be immediate planning for the 2014 mid-terms when control of the U.S. Senate will once again hang in the balance, and once again Democratic incumbents start at a disadvantage needing to defend two-thirds of the seats that are up. Among Democrats up in the Senate are a number that must balance business moderates, political conservatives and their Democratic base in states such as Alaska, Arkansas, Louisiana, and Montana. And, of course, immediate water cooler discussion on potential 2016 nominees for the Democrats (e.g., Secretary of State Hillary Clinton, Vice President Joe Biden, and Governor Andrew Cuomo (D-NY)) and the GOP (Rep. Paul Ryan (R-WI), Senator Marco Rubio (R-FL), Governor Chris Christie (R-NJ) and former Governor Jeb Bush). Finally, a second Obama term offers another legacy opportunity-potential nominations to the U.S. Supreme Court. There are currently four Justices in their mid-70's or older. If President Obama has the opportunity to replace either Justice Kennedy or Scalia (each 76 years old), he would be able to fundamentally alter the Court's alignment.
With the re-election of President Obama, the Consumer Product Safety Commission (CPSC) will continue to have a majority of Commissioners from the President's party. The continuation of the status quo may result in a more activist CPSC, including attempts to pass more mandatory consumer product regulations. In addition, the election results also resulted in some changes to the committees in Congress with jurisdiction over consumer product safety issues.
The Consumer Product Safety Improvement Act (CPSIA), signed into law in 2008, reaffirmed the number of CPSC Commissioners from three to five. CPSIA supporters hoped that adding two more Commissioners would add a variety of expertise to the Commission. However, the addition of two more Commissioners also contributed to the CPSC's bureaucracy, inhibiting the Commission from moving quickly.
The Commission is currently down to three members (two Democrats and one Republican) because two Commissioners' terms expired. President Obama nominated Marietta Robinson to be a CPSC Commissioner earlier this year. The Senate did not act on her nomination. The President would need to re-nominate her and also nominate a Republican to fill the vacancies. No action is expected in the immediate future and the CPSC will continue to function with three Commissioners.
Consumer Product Safety Commission
The Consumer Product Safety Act, the law that created the CPSC, is based on encouraging cooperation between the private sector and the CPSC to ensure and strengthen product safety. A vast majority of the product safety standards for products are voluntary, meaning that the industry works with all stakeholders, including the CPSC and standards-making bodies such as the American National Standards Institute, to create appropriate safety standards. In fact, only nine mandatory standards have been promulgated by the CPSC in 35 years, and these standards are traditionally meant for bad actors or industries that do not work cooperatively with the CPSC.
As the National Association of Manufacturers wrote to Congress earlier this year, in order to issue a mandatory rule, the law requires the Commission to "find that an existing or voluntary standard would not be adequate, the benefits of the rule bear a reasonable relationship to its costs and the rule is the least burdensome requirement that prevents or adequately reduces the risk of injury. To issue a mandatory standard, the Commission also must make a finding that an existing voluntary standard would not prevent or adequately reduce the risk of injury in a manner less burdensome than the proposed CPSC mandatory standard."
Despite the law, the CPSC has begun rulemaking proceedings on a variety of consumer products, including table saws and Recreational Off-Highway Vehicles. These industries, as well as some Members of Congress, are urging the Commission to return to the well-established and effective voluntary standards-setting process.
In the past year, the CPSC also filed an administrative complaint against Maxfield & Oberton, the company that produces the popular high-powered magnet "Buckyballs" to force it to stop selling their products because the agency claims the products are dangerous to children. This was the first time in 11 years that the CPSC filed an administrative complaint against a company. The CPSC also obtained agreement from 11 other magnet manufacturers from producing these products and successfully urged retailers to stop selling the product. While the case now goes to court, other industries are concerned that the CPSC's position in the case, that "warning labels don't work," sets a bad precedent given that warning labels are one of the tenets of long-established product safety practices in the U.S. and around the world.
The CPSC's Consumer Database, mandated by the CPSIA, went online in March 2011. This searchable Internet database contains reports of product defects and harm caused by consumer products. Manufacturers continue to be concerned that the database contains unsubstantiated accusations that damage the reputations of companies and their safe products. Recently a federal court ruled against the CPSC and in favor of a company that filed a suit to stop the agency from publishing a report about its product on the safetproducts.gov database. The company, which filed the suit under seal because it did not want to be identified with the report, claimed that the report wrongly connected the company's product to a consumer's injury. The court agreed that the complaint was materially inaccurate and granted summary judgment to the company, preventing CPSC from including the complaint in the database. Observers are closely watching to see if the court's decision will spur other companies to file suit against CPSC.
CPSC recently announced an impending change in the agency's interpretation of its authority that could result in the disclosure of preliminary confidential information identifying the manufacturer of consumer products "under investigation" by the Commission. The issue involves companies that self-initiate reports to the CPSC or in response to a filing under section 15(b) of the CPSA. The change would allow CPSC to inform the media and other third parties that a product is "under investigation." The business community fears that this will have a negative impact on the reputation of manufacturer and the product that could depress or even halt sales.
Congress maintains the status quo with the House retaining a Republican majority and the Senate still under control of the Democrats. Consumer product safety issues fall under the jurisdiction of the House Energy and Commerce Committee and the Senate Commerce Committee, with the day-to-day oversight falling to each Committees' respective Subcommittee.
The Committee leadership positions will largely remain unchanged with one exception: the Ranking Republican on the Senate Commerce Committee. With the retirement of Senator Kay Bailey Hutchison from the Senate, the top Republican slot will go to Senator Jim DeMint of South Carolina. In addition there could be one major leadership change at the House Subcommittee level. Currently the House Subcommittee is chaired by Rep. Mary Bono Mack. Her reelection contest remains unresolved with the Chair currently trailing her Democratic opponent by some 5,000 votes. Should she be defeated there will be a new Chairman of the House Subcommittee with direct oversight over the CPSC. Under this circumstance the leaders of the Committee may use seniority of the Energy and Commerce Committee to determine the next Subcommittee Chair. Those members who currently do not have an existing Subcommittee and are next in seniority are: Lee Terry of Nebraska, Mike Rogers of Michigan and Tim Murphy of Pennsylvania. If seniority is not used then the Chair could be given to any current member of the Energy and Commerce Committee.
Given that there will be some new leadership on these two Committees and the fact that the 112thCongress attempted to address many of the unintended consequences that resulted in the passage of the Consumer Product Safety Improvement Act in 2008, we believe that the Subcommittees will take some time through the use of oversight hearings to examine ways to provide additional relief. For example, the CPSC still has not implemented a crucial part of the reform package passed during the last Congress - namely, relief in testing protocols for small manufacturers and adoption of rules to reduce testing costs for all manufacturers.
Generally though, look for the new Congress to take some time to review recent CPSC actions and to hear from impacted manufacturers. Both Committees have an interest in increasing manufacturing jobs in the U.S. and there will be some emphasis placed on CPSC activities as the Congress looks to this priority. Efforts to legislate will begin slowly in the new Congress but could speed up should the issues we described above begin to impact manufacturers. It could be that the pending policies such as the recent announcement by CPSC to change Section 15 notifications and the recent court decision on the database will impact the activities of the oversight Committees. Finally, should the CPSC begin to promulgate a host of mandatory product safety standards without following the requirements of the Consumer Product Safety Act this too could force individual manufacturers to seek relief from the Congress.
The Department of Defense (DOD) and the Armed Services face uncertain times heading into 2013. The decisions made during the debt limit fight of 2011 led to the Budget Control Act and the ill-fated "Super Committee." In November 2011, after the Super Committee failed to create a path forward with respect to the nation's revenue and spending habits, the defense industry was introduced to the now infamous term: sequestration. Facing budget cuts of approximately $500 billion over the next 10 years, including $55 billion in FY2014, the world of defense must prepare for leaner times.
After more than a decade of expanding budgets, DOD faces some tough decisions regarding procurement and end-strength. Fortunately, the one item both parties can agree on is that sequestration would be a disaster for our national security priorities and the defense industrial base. Unfortunately, the divergence of opinions begins shortly after that at how to address sequestration.
The first term of the Obama Administration is credited with drafting a strong foreign policy based on successful withdrawals from Iraq, the death of Osama Bin Laden, a 2014 exit from Afghanistan, and supporting the overthrow of Libyan leader Muammar Gaddafi without committing U.S. troops. Furthermore, Obama has expanded the use of Unmanned Aerial Vehicles (UAV) in Pakistan, Yemen, and the Horn of Africa. The President has pledged to reduce the overall number of ground forces to pre-Bush Administration numbers while expanding the use of Special Forces and cooperation with other federal agencies. The President has also focused on streamlining acquisitions and procurement as well as reducing the overall reliance of the Department of Defense on contractors.
Additionally, during the campaign, the Obama team emphasized reprogramming Overseas Contingency Operations (OCO) funding for domestic initiatives such as infrastructure development. The major initial effort will focus on avoiding sequestration, which would impose drastic cuts across the board to the Department of Defense. Even if the Administration and congressional Republicans are able to work out a compromise, currently referred to as a "bridge," the struggle for defense dollars will be a difficult one. However, it will not be unlike others seen in post-war drawdowns in the past and the military will likely scale back large outdated programs and emphasize a leaner and more agile force.
The Republicans, as predicted, have held onto control of the House of Representatives but were unable to secure a majority in the Senate. With a 44 Member majority, a strong national defense will remain a priority. However, the defense industry will not maintain the sacred position it once held. With a stream of retirements amongst the senior members of the Armed Services and Appropriations subcommittees, a plurality of Members, led by fiscally conservative members of the Tea Party, have agreed that the continued expansion of the defense budget is unsustainable. Additionally, Members of Congress, on both sides, agree that defense cuts should be made with a scalpel and not with the axe of sequestration. A crucial aspect of the discussion will involve the interplay between budgetary cuts and constituent interests, as Members of Congress maneuver to preserve projects in their districts.
Outlook in the House
There has been significant turnover on the House Armed Services Committee, with Roscoe Bartlett (R-MD) losing his seat to challenger John Delaney (D-MD). Additionally, Todd Akin (R-MO) lost his Senate race and freshmen Bobby Schilling (R-IL) and Allen West (R-FL) lost their reelection bids. In the minority, long-time defense stalwart Silvestre Reyes (D-TX) has left the House after losing his primary bid. Additionally, Larry Kissell (D-NC), Mark Critz (D-PA), and Betty Sutton (D-OH) also lost their reelection campaigns. Martin Heinrich (D-NM) will now join the Senate after a successful run in New Mexico. The Committee will be led by Buck McKeon (R-CA) while Adam Smith (D-WA) will serve as Ranking Member.
Republicans have referred to the Obama plan as a "hollowing" of the armed services and will push back against any downsizing. The Committee will likely focus on an effort to minimize hardships related to personnel budgets of the Army and Marine Corps. Operation and maintenance budgets will also face scrutiny, specifically related to overhaul and refurbishment, and the equipment and fleet demands of the Army, the Marine Corps, and the Navy, respectively.
The one bright spot that exists seems to be in UAV procurement. The UAV-based economy has grown significantly and with an emphasis from the Administration on covert/drone driven action, we expect the UAV market to expand and receive exceptional support in Congress.
On the House Appropriations Committee, Subcommittee on Defense retirements have claimed some of the top spots on both sides of the aisle. Representatives Jerry Lewis (R-CA) and Norm Dicks (D-WA) have stepped down as well as long-time defense advocate Maurice Hinchey (D-NY). This opens the door for either Rodney Frelinghuysen (R-NJ) or Jack Kingston (R-GA) to take the helm. On the minority side, Pete Visclosky (D-IN) is in line for the Ranking Member position.
The Appropriations Committee will play a large role in the effort to avert sequestration and avoid the significant cuts to defense spending. Furthermore, there has been discussion surrounding the return of earmarks, so the Committee may return to its once sought-after status but this remains doubtful.
Outlook in the Senate
In the Senate, the Democratic Party maintained control by successfully expanding their majority to 55 seats. On the Senate Armed Services Committee, retirements by Joe Lieberman (I-CT), Daniel Akaka (D-HI), Jim Webb (D-VA), and Ben Nelson (D-NE) have claimed four top spots. There is a lot of room on the Committee for newer members but this creates uncertainty about Committee priorities. With Claire McCaskill (D-MO) defeating Todd Akin (R-MO), she will have her choice of Chairmanships with perhaps Airland being her preference. Senator Carl Levin (D-MI) is expected to retain the Chair of the full Committee. Jim Inhofe (R-OK) is in line for Ranking Member, and Senator John McCain (R-AZ) is term-limited.
The Committee will focus on sequestration and working with the Administration in an effort to head off deep cuts, but unlike the House, the Committee will work with the Administration to achieve various reductions.
On the Senate Appropriations Subcommittee on Defense, the only movements in membership were the retirements of Herb Kohl (D-WI) and Kay Bailey Hutchison (R-TX). Senator Daniel Inouye (D-HI) is expected to retain the Chair of the full Committee and the Defense Subcommittee. However, Thad Cochran (R-MS) is expected to turn over the gavel to Richard Shelby (R-AL). Unfortunately, in 2012, not one of the Senate's Appropriations bills made it to the Senate floor. This track record does not bode well for the defense industry.
Additionally, without Overseas Contingency Operations, supplemental spending, and with the impending sequestration, the fight for defense dollars requires the Appropriations Committee to work more efficiently.
Overall, the Subcommittee's priorities will fall subject to the larger budget issues that rule the day.
President Obama's re-election is a positive development for supporters of and investors in renewable energy and therefore a significant development for the transmission policies that will be required to implement clean energy. Of course, a robust transmission policy impacts all electricity generation and will benefit all consumers and regions with more reliable power, and eventually, lower overall costs. With the current challenges facing the Northeast following the recent storms, transmission infrastructure's importance becomes a more essential priority each day.
We have an aging U.S. electric transmission system in need of upgrade and expansion to meet the demands of a new economy. Investments in repairing, upgrading, and expanding the electric transmission grid creates jobs, improves electric reliability, promotes competitive markets, fuel diversity, and supports economic growth.
Some progress was made in 2005 when legislation was passed to study and develop a plan to improve transmission siting though national corridors of importance. In 2007, two National Interest Electric Transmission Corridors were designated, but they were invalidated by a federal appeals court in 2011. Since then, we have also had seven projects designated under the Administration's Interagency Rapid Response Team for advancement of transmission. Already, this process has allowed transmission developers to receive fast track treatment which has allowed new projects to move forward more efficiently and effectively. The President's re-election will help this process continue for the current and future projects.
It is important to remember that we have been looking for a way to better improve our transmission siting/development process for a long time, including even legislative efforts like the national corridors that have been ineffective though the political and legal process. The bottom line is, no matter what these efforts are or entail, they are looking for solutions to a major problem which dogs us to today: how can we more effectively build a much-needed transmission infrastructure to best accommodate our ever-growing needs.
One key issue to watch is whether FERC can be consistent in granting or denying transmission incentives. Under Chairman Wellinghoff, FERC has already issued a Notice of Inquiry to examine its transmission incentives policy and industry will watch closely to see whether a new policy emerges that is more consistent region to region. For example, since 2008, we have seen smaller ROE adders for proposed transmission projects. In New England, there has been major transmission investment and healthy ROEs (including adders) have been part of the story. The ISO-NE market has benefitted from reduced congestion. New England is in contrast to New York where there has not yet been transmission investment (for a variety of reasons) and significant congestion still remains.
As to the abandonment incentive, we are watching FERC's treatment of companies seeking recovery for prudently incurred costs for abandoned projects relying on the abandonment authority FERC granted in earlier transmission incentives proceedings. One notable case is the Potomac-Appalachian Transmission Highline (PATH) project's recent FERC filing seeking recovery of $121 million (costs plus a return). PATH expects that amount might decrease as it sells some of its existing assets - such as land acquired in anticipation of the project.
Third, as to base ROE for transmission, it is important to watch a number of complaints pending against transmission owners. The New England Transmission Owners are scheduled to have a hearing on their base ROE in 2013 and there are complaints pending against Southwestern Public Service, Florida Progress, and National Grid (Niagara Mohawk) with complainants seeking to lower the company's base transmission returns. The investment community currently views FERC's ROEs very favorably, reflecting reliance that project will be granted favorable returns (relative to those ROEs typically set by state commissions). If FERC were to lower base ROEs, counter to investors' expectations in any of these cases, it could send the wrong message to the market. There are also a number of other ROE cases in the settlement context that are not initiated by complaints and when considering these ROEs, FERC's actions could surprise the investment community or diminish investors' confidence in FERC investments in transmission.
Finally, FERC will likely continue with its efforts to implement Order No. 1000's requirements. Although a number of issues still need to be worked out, Order 1000 provides directional certainty for planning and investing in transmission projects. Its reforms should lead to more opportunities for transmission investment, especially in transmission projects designed to bring renewable energy resources onto the grid.
One last key item has gotten much-needed attention over the last two years. In order to stand up a new offshore wind energy industry in the U.S., but especially off of the Atlantic Coast, the Administration has been very aggressive at working with private companies to invest in a transmission network that can support such a massive effort.
Already, the Atlantic Wind Connection (AWC) backbone transmission project, an essential foundation to the new industry, has made strong progress toward enabling the production of thousands of megawatts of clean power with strong support from FERC, the Department of Energy, and the Department of the Interior. In May 2012, Interior's Bureau of Ocean Energy Management (BOEM), which oversees the industrial development of offshore US waters, decided to move ahead with an environmental review of a corridor in the Atlantic Ocean where the transmission line would be laid.
The Administration faces many political, technical, and policy challenges on transmission policy: from security to siting to reliability. Already, they have established strong momentum that will present the framework for continuing recent progress.
Congress will likely continue to play a strong oversight and advisory role as well. After having previous legislation designating national corridors rejected by courts, it is likely they will revisit transmission infrastructure issues, alongside an ongoing effort to beef up grid security. Additionally, House Republicans are widely expected to remain vigilant in their effort to protect reliability though a secure grid, but also though protecting sources of generation like coal, which seem to be facing significant market challenges and the Administration's regulatory crosshairs. In addition to protecting more pieces of an "all of the above" energy approach to generation and infrastructure, the Republican House has focused on making sure any federal action to support the development of transmission infrastructure should strike the appropriate balance between the various stakeholders, including preserving the proper roles of state and local governments. This approach is likely to continue to be an important part of its agenda.
Regardless of the final result, one thing is certain: the debate that took place in the 2012 election cycle over energy and environmental issues was a diametrically different debate that the one that took place just four years ago. Cap-and-trade legislation? Nowhere to be seen or heard. Climate change? See cap-and-trade. Shale gas development? A competition over who favors it more. Permits for offshore oil and gas development? A debate over who has or will get them out the door fastest. Perhaps nothing signified this stunning turn of events more than President Obama's campaign running pro-coal advertisements in Ohio that attacked Governor Romney for once saying that pollution from coal plants was dangerous to public health.
Now that the election is over and President Obama has been reelected, where does all of this rhetoric leave energy and environmental issues heading into a second Obama term? Below we examine the likely impacts on the major areas of energy and environmental policy.
Shale Gas Development
When President Obama, in his acceptance speech in Charlotte, pledged to create 600,000 new jobs related to natural gas production, it became clear that the only campaign debate over shale gas development would be over who could exploit it the most. Despite this campaign rhetoric, the Obama Administration has a number of federal regulatory actions relating to shale gas production pending before various agencies in his second term. For example, EPA has an ongoing study on the relationship between hydraulic fracturing and drinking water as well as soon-to-be-finalized guidance on the use of diesel fuel in the fracturing process. At DOI, BLM is readying the final version of its regulation on hydraulic fracturing occurring on Federal lands. Additionally, there are other regulatory actions, such as DOE's forthcoming policy on LNG exports to non-free trade agreement countries, that, while not directly controlling the drilling process, will nevertheless have a great impact on the market for future shale gas production. While it is unlikely that the Obama White House would approve any federal regulation that would drastically curtail shale gas production, many of these actions all have the potential to add significant burdens to the industry and raise the cost of production.
Offshore Oil and Gas
In the months leading up to the election, President Obama was keen to take credit for the overall increase in U.S. crude oil production that has taken place over the past few years, a talking point that proved useful in hitting back against charges that his administration had slowed the flow of offshore permit and plan approvals. Behind the scenes, however, output in federal waters of the Gulf of Mexico had dropped well below government projections of just a few years ago. The real determinants of tomorrow's offshore output boil down to whether the regulatory regime is viewed as transparent and predictable enough to invite investment, and the extent to which offshore leases are made available for potential exploration and production.
On the regulatory side, the Interior Department's permit and plan approval averages are mostly back to pre-Macondo levels, but the timing and outcome of approvals has become more clouded overall. BSEE's new enforcement arm will be beefed up and launched in earnest over the coming months, and a host of new regulations are also on the horizon, including (i) the Final Drilling Safety Rule, (ii) SEMS II, the Blowout Preventer Rule, (iii) the Production Safety Systems and Lifestyle Analysis Rule, (iv) a new Oil Spill Response Plan NTL, and (v) a total rewrite of 30 CFR 250 et. seq. As for leasing, the 2012-2017 plan failed to live up to industry expectations, sticking mostly to offerings in the Central and Western Gulf despite pleas to better exploit untapped resources along the nation's coastlines and in Alaska. The administration will write the first draft of the next five-year plan, with prospects for a bolder foray into controversial new areas slim to nil.
Not until the landfall of Hurricane Sandy, and the resulting media stories linking the storm to a more variable climate, did the issue of climate change remotely come up in the 2012 election cycle. To illustrate this point, not one question relating to climate change was even asked in any one of the three Presidential debates or in the Vice Presidential debate. With a down economy and with battleground states heavily reliant on fossil fuels, advocacy for any action to address climate change was simply a non-starter for both campaigns. Combine this with a split Congress and it appears unlikely that new comprehensive climate change legislation along the lines of the previous cap-and-trade bills will be enacted. However, it was notable that both President Obama and Senate Majority Leader Harry Reid, in their respective victory speeches, mentioned climate as a priority for them to tackle over the next four years. It is possible that there will be increasing attention paid to a potential carbon tax as part of a broad agreement on climate regulation. For that to happen, however, a carbon tax would have to be part of a climate "grand bargain" that would reduce or eliminate pending climate regulations.
On the regulatory front, you do have agency actions on climate that continue to be considered and compelled to final action by various consent decrees and court rulings. Of these regulations, the most important are the pending new source performance standards for greenhouse gas emissions from existing fossil fuel fired power plants and petroleum refineries. Both of these rules have been delayed over the past two years, largely due to the Obama Administration's fears of an election backlash. With a second term, and no reelection campaign, the Obama EPA will be free to release these rules albeit with likely significant congressional oversight by House Republicans and some Senate Democrats with coal and refinery interests in their regions.
Clean Energy Funding
Clean energy funding did get some airtime in the 2012 elections, however, it was not likely the messaging most favored by the renewables industry. Since its collapse into bankruptcy in 2011, Solyndra, the solar manufacturer that received a $535 million loan guarantee by the Obama DOE, has become a symbol of wasteful government spending, the failure of the Recovery Act to create the level of jobs expected, and the disastrous result of government picking winners and losers in the capital market. The Solyndra effect swept up not only the DOE Loan Guarantee Program but also the level of support generally given for new government programs to fund clean energy or energy efficiency technologies.
In the first Presidential debate, Governor Romney labeled such stimulus programs as "green pork" and derided the Obama Administration's record of failed investments. While President Obama did stress his continued support for the development of clean energy jobs, it was hardly full-throated and no specific new funding programs were pushed for a potential second Obama term. Instead, what we are likely to see is a focus on preserving tax incentives for renewable energy development as part of the tax reform discussions and the ongoing project management of the renewable energy projects that received funding in the first term. It is possible that the Obama White House will renew its press for a Clean Energy Standard in Congress, however, it is highly unlikely that such a plan will get through the House or even be able to get 60 votes in the Senate.
President Obama's re-election is expected to bring continued, aggressive enforcement efforts at the civil and criminal levels. To the extent that legislative initiatives on key issues like climate change, shale gas, and offshore drilling are delayed or given a lower priority, the Obama Administration may seek to allay environmentalist concerns through public efforts to hold industry accountable to existing laws and regulations. Several initiatives already underway – including EPA's National Enforcement Initiatives - are expected to intensify with efforts to expand the Agency's information request authorities, its facility inspection authorities, and its technical tools for enforcement. Additional, heightened environmental enforcement is expected via other agencies, including the DOE, DOI and the SEC. The outlook for environmental enforcement efforts at DOE and DOI are addressed in our reports on energy and offshore issues. Several specific areas of EPA's heightened enforcement efforts are discussed in this update.
EPA's National Enforcement Initiatives
EPA's Office of Enforcement and Compliance Assurance (OECA) has identified the following as its primary enforcement initiatives:
- Seek major capital improvements through New Source Review (NSR) enforcement at large industrial sources;
- Obtain compliance with National Emission Standards for Hazardous Air Pollutants at a wide variety of industrial sectors;
- Address municipal sewer collection systems, which will require cities to undertake substantial infrastructure expenditures nationwide;
- Tackle water discharges from concentrated animal feeding operations within the agricultural industry;
- Seek injunctive relief at mineral processing operations; and
- Develop and implement a multi-media national enforcement program targeted at the energy extraction (domestic oil and gas development) industry.
Leveraging these initiatives, we expect OECA to be a major force in setting the policies at EPA. OECA helps set policies by ensuring that new regulations and policies allow the agency to establish liability easily and in a strict liability fashion, where possible. OECA strives to make these policies consistent with positions taken in enforcement litigation.
In the last four years, EPA has had several very public disagreements with the states, such as Texas. Over the next four years, we would expect even more high profile challenges to Texas' and other state's environmental regulatory programs. Challenges to state practices are more likely where EPA Headquarters perceives that a state's enforcement program is not adequately performing or where state and local permitting authorities issue permits or regulations that make it difficult for EPA and citizens to bring enforcement actions.
EPA's Requests for Information
Over the past two years, EPA enforcement has issued Requests for Information (RFIs) to upstream oil and gas companies with increasing frequency and scope. We expect this effort to continue. Areas of focus have been under the Clean Air Act, Safe Drinking Water Act, Clean Water Act, solid waste and public right to know statutes and even Superfund. Through these RFIs, EPA seeks a vast amount of internal company information, which is not publicly available and is highly burdensome to collect. EPA's enforcement team then uses the information provided to develop an enforcement case against the responding company. Failure to properly respond to the RFIs may result in further enforcement action and penalties. Also, unless a responding company asserts and successfully maintains confidential business information claims on its responses, the responses are often made accessible to potential plaintiffs and their lawyers who use the information in private litigation.
Industry has contended that many RFIs and facility inspections are exceeding EPA's authority. In many instances, RFIs seek information not relating to actual compliance with permits and at times can be much broader than what a court may allow in litigation.
Using Advancements in Technology and Obtaining Super-Compliance
EPA enforcement is developing and using advanced monitoring technologies, such as infrared cameras, to support bringing new enforcement cases. Advancements in air emission monitoring technology have allowed EPA to allege violations that were never contemplated before because there was no way to detect those particular emission sources in the past. As we head to a second Obama term, it is important to note that, within the last two years, EPA has used these new techniques to gather data regarding emissions from large facilities and has used that information to assess penalties and require capital improvements at those facilities. As a result, those facilities faced significant unplanned capital improvement costs. Such unanticipated capital expenditures could upset the economic viability of many industrial sites around the country.
Enforcement officials have also continued seeking "super-compliance" with existing regulations as a condition to settlement agreements. In order to avoid costly litigation, companies have agreed to pay substantial penalties and to comply with emission or discharge requirements that are much more stringent than currently required under law. These new "super-compliance" standards often become the baseline for future settlements and regulations, thus requiring an entire sector to meet ever-increasing limits established by the enforcement office.
Greenhouse Gas Enforcement
During the first-term of the Obama Administration, EPA focused on regulating Greenhouse Gases (GHGs). In its second term, EPA is expected to shift its focus to enforcement of those new GHG regulations. To carry out this goal, we would expect EPA to develop an initiative to enforce compliance with the GHG reporting rule and to renew its focus on NSR to address GHG control technologies. This may begin at the regional level and then grow. When alleging NSR violations, EPA will likely seek to enter into new NSR settlement agreements that impose strict GHG limits and advanced monitoring requirements.
Enforcement of the renewable fuels standards is yet another area where we expect to see increased enforcement because OECA can use that enforcement action as an opportunity to issue press releases claiming credit for GHG emission reductions. In addition, EPA will likely try to reduce methane emissions from oil and gas fields by seeking NSR relief and requiring companies to install emission control technology to reduce VOCs, such as methane.
by Dee Martin
With the reelection of President Obama, a full repeal of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) appears unlikely. In the current political climate, any attempts by House Republicans to roll back the law would likely be rejected by a Democratic Senate and vetoed by the President. However, in the upcoming Congress, there may be some opportunities for minor or technical corrections to Dodd-Frank. Undoubtedly, significant Congressional oversight will continue as well.
The election did bring a change to the membership and leadership of the Congressional Committees with jurisdiction over the Act: the Senate Banking, Housing, and Urban Affairs Committee and the House Financial Services Committee. In the Senate, Tim Johnson (D-SD) will likely maintain his leadership position as Chairman of the Banking Committee. Current Ranking Member Richard Shelby (R-AL) will reach his six-year term limit, likely leaving the Committee to become Ranking Member of the Appropriations Committee. Senator Michael Crapo (R-ID) is expected to replace him as Ranking Member. In addition to new Republican leadership, the composition of the Banking Committee will change, with the retirement of two Democratic members and the election of Elizabeth Warren (D-MA), a long-time champion of Wall Street reform and consumer protection. It is widely anticipated that Senator-elect Warren will be assigned to the Committee. The House will see changes in the leadership from both parties, as Chairman Spencer Bachus (R-AL) is term limited and Ranking Member Barney Frank (D-MA) is retiring. The Financial Services Committee leadership is expected to be handed over to Jeb Hensarling (R-TX) and Maxine Waters (D-CA). The membership of the Committee will also change, with six Committee members losing their reelection bids, one being elected to the Senate, and five members retiring.
A second term for President Obama also means the political balance of the Securities and Exchange Commission (SEC) will remain in favor of the Democrats, as discussed in Paul Maco's article below. Whoever takes over the position as Chair will set the agenda for the Commission and for the pace of regulation. Of the 400 new rules and requirements mandated under Dodd-Frank, regulators have only finalized a third of the rules, while another third have not even been proposed. Completing the rulemaking will be a herculean task for the SEC. We can expect frustration over missed deadlines and rules to result in House Republicans exercising oversight over the SEC. The Senate Banking Committee may revisit Dodd-Frank to take up technical corrections, as there is a slowly emerging consensus that revisions are necessary both to confirm Congressional intent and address flaws in certain parts of Dodd-Frank. However, it is unlikely that changes will be substantial. Rather, we expect tweaks to address errors or omissions in the original legislation. Below we have identified four important areas where we expect some activity:
Dodd-Frank has now survived a mid-term election, a presidential election and Hurricane Sandy. Governor Romney repeatedly indicated on the campaign trail that if elected president he would repeal Dodd-Frank and replace it with different, more practical, and - most importantly - clear regulations. However, given President Obama's re-election, all that remains to be seen is whether Dodd-Frank will survive a pending constitutional attack brought by various states and third parties.1
Specifically, the lawsuit challenges the creation of certain agencies under Dodd-Frank as well as the orderly liquidation authority established by Title II. By way of background, Title II of Dodd-Frank authorizes the dissolution of financial institutions which have been deemed to be systemically risky and a threat to the stability of the US economy. This determination is made by the Secretary of the Treasury, following recommendations from the FDIC and the Board of Governors, after considering:
- whether the financial company is in default or is in danger of default,
- the effect that the default of the financial company would have on financial stability in the US,
- a recommendation regarding the nature and the extent of actions to be taken under this Act with respect to the financial company,
- the likelihood of a private sector alternative (presumably such as a consensual restructuring),
- whether or not a case under the Bankruptcy Code is appropriate, and
- the effects of the financial company's failure on creditors, counterparties, shareholders, and other market participants.
Following a determination to wind up the financial company, the Secretary of the Treasury will notify the financial company (such companies are then referred to as a "covered financial company"). If the board of directors of the company consents to the appointment of a receiver, then the FDIC takes over. If the board of directors does not consent, then the Secretary files a petition under seal with the U.S. District Court for the District of Columbia. The fact that the liquidation provisions of Dodd-Frank contemplate court involvement, however, provides a false sense of checks and balances on the Secretary and the other regulators – a situation that is largely the focus of the pending constitutional challenge. Specifically, the lawsuit deems these limitations on court review to be "draconian." We may be a bit biased in agreeing with the lawsuit as we expressed similar views back in 2010 shortly after Dodd-Frank was passed. See Renée Dailey & Katherine Lindsay,The Dodd-Frank Act: The New World of Systemically Risky Financial Companies and What It Means for Creditors, Bank. Law R. Vol. 22, No. 36, P. 1283-87 (Sept. 23, 2010).
In particular, the lawsuit alleges, among other things, that the following provisions of Title II violate the principles of due process:
- First, the Act does not permit review over all aspects of the Secretary's liquidation determination, but rather limits judicial review to only one of the factors: the Secretary's determination that the financial company is in default or in danger of being in default.
- Second, the standard of review of such determination is arbitrary and capricious. Arbitrary and capricious is a highly deferential standard of review and means that in order to reverse the Secretary's determination, the District Court has to conclude that the Secretary's finding that the financial company is in default or in danger of being in default has no reasonable basis.
- Third, if the District Court does not rule on the petition within 24 hours of receipt, the Secretary's petition is deemed to be granted as a matter of law and the FDIC is appointed as receiver.
- Fourth, while a financial company can appeal the decision of the District Court, no stay of the receivership pending appeal is permitted and each of the appellate courts review the lower court decision on the same arbitrary and capricious standard.
- Fifth, all of the foregoing is done on a sealed and expedited basis, without notice to creditors or other stakeholders. On such a timeline, it is difficult to imagine that the covered financial company could prepare detailed opposition papers. As an aside, secrecy of the Secretary's determination and of the pending petition is deemed so important that the Act provides for criminal penalties for recklessly disclosing the Secretary's determination or the filing of the petition with the District Court.
As a result of the lawsuit, the District Court will be called upon to determine the constitutionality of the orderly liquidation provisions of Title II and the establishment of certain agencies. While the driving goal of Dodd-Frank - the stabilization of the economy - is certainly an admirable goal, it should not come at the expense of the fundamental constitutional principle of due process. We would expect any decision by the lower court to be appealed, ultimately to the Supreme Court. Accordingly, the fate of certain provisions of Dodd-Frank will remain unsettled for quite some time.
By Paul S. Maco
Former SEC Director of the Office of Municipal Securities
The regulatory "to do" list for the Securities and Exchange Commission (SEC) and Municipal Securities Rulemaking Board (MSRB) contains many items left undone from the Dodd-Frank Act. Most of the delay has been at the SEC. The prospect of reinvigorated leadership in the wake of the re-election of President Obama may enable the SEC to expedite long overdue rulemaking as well as pursue an agenda adopted this past summer for upgrading municipal market regulation. President Obama's re-election will influence the tone of future SEC activity and the resulting effect on the municipal bond market, but without the prospect for change as great as may affect a key feature of municipal bonds – tax exemption. For an outlook on that topic, please read the thoughts of our colleague Charles Almond.
- The post-election regulatory environment for the municipal securities market is determined not only by the results of the Presidential election but the Senate and House results as well.
- With President Obama returning for a second term, the Democrats in firmer control of the Senate, and the Republicans retaining control of the House, some may see little prospect for change in the financial regulatory environment from the past few years of gridlock. A closer look indicates the possibility to move forward, at least at the regulatory level, and particularly with respect to the municipal bond market.
- President Obama will nominate the candidates to fill future openings among the five Commissioners of the SEC. Current Chair Mary Schapiro has made no public statement, but the "buzz" is she is ready to step aside. Whoever President Obama nominates to replace her will set the agenda for the Commission and for regulation of the municipal securities market along with the pace at which it is pursued.
If as many expect, Chairman Schapiro steps aside, current Commissioner Elisse Walter is a likely candidate to move up to replace her, provided she secures Senate confirmation. Walter assumed a "hands-on" approach to municipal regulation early in the first Obama administration, taking the lead in the work leading up to the Commission's recent Report on the Municipal Securities Market. The Report established a road-map for future Commission regulatory action as well as legislation the Commission could pursue in Congress. The other Democrat Commissioner Luis Aguilar (Schapiro is an Independent) was reappointed in 2011 and is likewise a possible successor to Schapiro as Chair.
Should either Commissioner Walter or Commissioner Aguilar advance to the Chairman's seat, the President may nominate a third Democrat to fill the seat (of the five Commissioners, no more than three may be from the same party). Of course the President may look beyond Walter and Aguilar for his choice as Chairman.
- Among the two Republican Commissioners, Troy Paredes's term ends in 2013 and Daniel Gallagher is newly appointed in 2011. Both have voiced concern about potentially deficient Commission rulemaking practices, particularly with regard to cost-benefit issues, a concern not easily dismissed in light of a string of successful challenges to Commission rulemaking in the U.S. Court of Appeals for the District of Columbia. Both strongly dissented to the Commission's approval earlier this year of MSRB action requiring underwriters to prepare extensive written disclosure letters to issuers of municipal securities in advance of bond underwritings. This concern is unlikely to disappear from future Commission rulemaking action without the Commission demonstrating stronger response to the Commissioners' concerns.
- Whoever is nominated to succeed Chairman Schapiro will require Senate confirmation, starting with the Senate Banking Committee. The same holds for additional Commissioners. The Democrats have expanded their majority control of the Senate. On the Banking Committee, Senator Tim Johnson will likely return as Chairman. Republican Richard Shelby, current Ranking Member of the Banking Committee, will likely leave to become Ranking Member of the Appropriations Committee and Senator Michael Crapo of Idaho may succeed him as Ranking Member of the Banking Committee. With Senators Kohl and Akaka retiring, Democratic membership of the Banking Committee will change. One possible new member is Elizabeth Warren of Massachusetts, who defeated Republican Scott Brown. How she translates her pro-consumer, anti-Wall Street perception in her role as a first term Senator will likely affect the tone of the Banking Committee as well.
Congressional action on regulation of the municipal bond market, if any, will likely center on modifications to Dodd-Frank (the Dold bill below) and actions of the legislative proposals to increase SEC authority over state and local governments issuing municipal bonds identified in the SEC's Report.
- Dodd-Frank. While a Republican House and more Democratic Senate will likely retain their divided views of the efficacy of Dodd-Frank, the success in the House in late September of the Dold bill clarifying provisions on municipal advisor regulation – 60/0 vote out of Financial Services and passage by voice vote in the House – is a good indication that regulation of municipal advisors and other Dodd-Frank provisions regulating the municipal securities markets stand apart from other Dodd-Frank elements. The Dold Bill, which could be taken up in a lame duck session, is a clear cry of Congressional frustration with the pace of SEC rulemaking. How the SEC responds will likely be determined by the factors observed above.
- SEC Legislative Proposals for Increased Municipal Market Authority. The Report identified several changes to existing securities law to expand SEC authority, among them removing exemption from registration for conduit borrowers, allowing the SEC to dictate "principles based" disclosure, and granting SEC authority over the form and content of state and local government financial statements, that the SEC could recommend to Congress. Whether or not it does so may depend upon the leadership of the SEC. A Chairman Walter would likely have these measures as a priority. Even if recommended to Congress, whether anyone emerges to champion the SEC's cause remains to be seen. Tough tasks lie ahead in any event. For example, explanation of why U.S. state and local governments would have to adhere to SEC financial reporting standards in order to enter U.S. securities markets while foreign governments and their subordinate states and provinces currently do not, will have to be made. But again, the SEC has yet to make any recommendations.
- SEC Rulemaking in the municipal market has stalled, with the Dodd-Frank mandated rulemaking on regulation of municipal advisors kicked down the road for the second time this past September. SEC staff statements indicate the rulemaking may be ready to put before the Commission as early as January. How the current Commission or a Commission of four under an Acting Chairman Walter will respond may depend on how well the proposed final rule responds to concerns of the individual Commissioners, including those of Commissioners Gallagher and Paredes noted above. Similar considerations affect Commission action on final terms of the Volcker Rule and the definition of municipal securities within the Rule, which if not revised may affect liquidity for certain municipal bonds as well as issuer costs. When the SEC does complete its municipal advisor rulemaking, it will face a flood of MSRB rulemaking proposals on municipal advisor regulation waiting in the queue.
- Rulemaking by the MSRB will likely be extensive. The MSRB has a lengthy list of rulemakings pending to regulate municipal advisors. The MSRB first proposed many of these rules to the SEC, then withdrew them after the SEC delayed its basic decision of who is and who is not a municipal advisor. Once made by the SEC, the MSRB will re-introduce rule proposals governing the basics of regulation - qualification, testing, and periodic inspection, as well as conduct and client and market protection rules, including definition of the fiduciary duty owed by a municipal advisor to its clients, limits on gifts, and pay-to-play restrictions. All will have to pass through and be approved by the SEC.
- The rulemaking process employed by the SEC in considering its own rulemaking, as well as those proposed by the MSRB, is subject to the same legal requirements highlighted by Commissioners Gallagher and Parides in their dissent earlier this year, as mentioned above. The U.S. Court of Appeals for the District of Columbia has successively ruled against the SEC in process based challenges to SEC rules in recent years. Whether the SEC's rulemaking processes survive challenge in the future is yet another factor to be considered, should any of its municipal market rulemakings be so challenged.
Financial Services - Dodd-Frank "Say on Pay"
One provision of Dodd-Frank that has flown largely under the radar since it took hold in 2011 is the "Shareholder Approval of Executive Compensation" provision, also known as "Say on Pay", meant to foster shareholder participation and promote accountability in executive pay packages. The provision was designed to give ordinary shareholders a chance to voice their approval - or disapproval - of a company's executive pay packages through non-binding votes required to occur at minimum once every three years. But the law is shaking out far differently than intended due to a number of problems.
First and foremost, institutional shareholders far outnumber individual shareholders in most companies, and generally hold hundreds or thousands of publicly traded companies in their portfolios. These hedge funds, pension funds, etc. are not about to allocate the time and resources necessary to determine whether each company they hold is shaping executive compensation appropriately. Instead, they outsource the job to "proxy advisory firms" who do the research for them, recommend how they should vote , and might even execute the voting on their behalf.
The proxy advisory industry is dominated by two companies: Institutional Shareholder Services (ISS), which controls 61 percent of market share, and Glass Lewis, which controls 37 percent. The work is highly seasonal, as most shareholder meetings are held in the spring. Yet the firms have staffs of only a few hundred full-time analysts to rapidly sort through thousands of analyses during the brief window between the time proxy statements are circulated and when votes are held.
As a result, they bolster their ranks with temporary workers, often located overseas, to process a tremendous amount of data and information in a very tight time frame. More generally, they apply uniform analytical models across thousands of companies that all but eliminate their ability to consider unique characteristics of any one company's business, regulatory or other circumstances, no matter how germane. Not surprisingly, companies have discovered a slew of errors in the analyses provided by proxy firms, yet any window to correct these errors before the recommendations become official is tiny.
In addition to promoting standardized work marked by a high occurrence of inaccuracies and flaws, the firms have an array of conflicts. Among the most egregious is a practice conducted by ISS, which also offers corporate governance consulting services – meaning that companies on the receiving end of a ‘negative' recommendation may be advised to improve their subsequent proposal by working with ISS' own compensation consultants. Beyond ISS' consulting practice, both firms are part of much larger financial entities, calling into question the quality of analyses they perform that involve other companies in which their parent organizations have direct interests or investments.
As Rep. Barney Frank himself put it in July 2009, "It's a question of empowering the shareholders to decide the appropriate level because it's their money…". Given that Say on Pay has instead provided an extraordinary windfall to a select few companies with a host of potential conflicts and questionable analytical performance records, look for reform-minded Members of Congress to take a second glance at the provision in the 113thCongress.
In this update we analyze potential federal tax legislation that could directly affect public-finance/tax-exempt bonds in the 113thCongress and a second-term Obama Administration. For a broader view of the federal tax legislative outlook see Lame Duck Session, Taxes and the Fiscal Cliff. For an outlook on other (non-tax) federal legislature/regulatory proposals that could have an effect on the public finance/municipal bond markets see Municipal Bond Market Regulation.
Two expected themes for tax legislation/tax reform will affect public finance and tax-exempt bonds. In assessing the outlook for federal tax legislation that could directly affect public finance, it is helpful to think in terms of the themes that are likely to be predominant in federal tax legislative proposals generally. We expect that a Fair Share theme and a Rate/Deficit Reduction theme will be the predominant themes for tax legislation in the 113thCongress and a second-term Obama Administration.
- The Fair Share theme (i.e., that wealthy taxpayers should pay a "little bit more" or their "fair share") has been a mantra of most Democrats in Congress for some time now, and was a familiar refrain in the President's re-election campaign.
- Many Republicans in Congress have said that they are very much in favor of tax reform that eliminates loopholes and uses the resulting revenue to reduce tax rates. During the failed "grand bargain" negotiations in the Summer of 2011, Speaker Boehner and some Republican Senators expressed some willingness to have that process also contribute to deficit reduction-which could lead to tax reform with a Rate/Deficit Reduction theme.
- Although these themes will compete with each other, they are not mutually exclusive. The big question is whether sufficient pressure will be brought to bear on Congress and the Administration by the financial markets and the nation's business leaders to forge a political compromise that merges these themes.
- Both themes-Fair Share and Rate/Deficit Reduction-could potentially have significant effects on tax-exempt bonds, whose continued existence has even been called into question by some serious proposals (e.g., Simpson-Bowles recommendations).
Fair Share proposals to cap the tax benefit to higher-rate taxpayers of tax-exempt bond ownership will get serious consideration. The Fair Share theme is almost certain to result in proposals (along the lines of an Obama administration proposal that surfaced in Summer 2011) to "cap" the tax benefits associated with higher-tax-rate investors' ownership of tax-exempt bonds (together with other deductions, credits and exemptions).
- These proposals would result in taxpayers whose marginal tax rate (e.g., 35%) is higher than some specified rate (e.g., 28%) paying a tax on their tax-exempt bond interest at a rate equal to the difference between the two rates (a 7% tax in this example).
- Enactment of this type of proposal would increase, at least to some extent, state and local governments' borrowing costs for public infrastructure, which would in turn result either in less public infrastructure investment or increases in state and local taxes and/or municipal utility rates and user fees that ultimately pay for that public infrastructure.
- If applied to tax-exempt bonds outstanding on the date of enactment, enactment of this type of proposal can be expected to reduce the value of outstanding bonds currently held by investors- by as much as 10% according to at least one analyst.
Tax-exempt bonds could also be a target for revenue if there is a move toward "1986-style" tax reform. If a Rate/Deficit Reduction theme gains prominence and moves toward something like "1986‑style" tax reform, in which almost every federal "tax break" is thoroughly reexamined as a source of revenue to achieve rate reduction and/or deficit reduction targets, tax-exempt bonds will be on the table as a revenue target.
- Tax-exempt bonds' successful century-plus history, and arguments relating to the action's public infrastructure needs, are likely to shield tax-exempt bonds for traditional government-owned public infrastructure (e.g., schools, roads, water systems, transportation facilities, and the like) from drastic reform proposals (e.g., totally eliminating the interest exemption) that go beyond the "capped benefit" proposals discussed above.
- Nonetheless, in a 1986-style reform environment, state and local borrowers' ability to issue tax-exempt "advance refunding" bonds may face reexamination based on reformers' arguments that the "advance" future of those refundings do not directly add to capital investment.
Moreover, in a 1986-style reform environment, certain categories of tax-exempt "private activity" bonds that principally benefit nongovernmental "conduit borrowers" that use those bonds to finance non-governmentally-owned property (e.g., 501(c)(3) organizations and businesses engaged in so-called "exempt activities") are likely to face proposals for further restrictions (e.g., per-beneficiary limits), and perhaps, in some cases, existential threats.
- While state and local governments are generally supportive of tax-exempt private activity bonds as useful tools for economic development, much of the heavy lifting, in terms of defending legislative threats to those bonds, falls on the shoulders of the nongovernmental conduit borrower/beneficiaries of those financings (some of whom may have other "irons in the fire" in a 1986-style tax reform environment).
There may be continued discussion of holder-credit and BABs-type direct-pay bonds as options for traditional tax-exempt interest bonds. State and local governments should also be prepared for continued discussion about whether there is a "better way" than tax-exempt bonds to deliver a federal subsidy to those governments to encourage their public infrastructure investments.
- "Holder credit" bonds (i.e., bonds whose interest is taxable but with respect to which the bondholder can claim a tax credit) have never gained much market acceptance and are unlikely to get serious consideration as an option for traditional tax-exempt bonds.
- On the other hand, if state and local government borrowers' concerns about immediate and future federal budget/Fiscal Cliff sequestration threats can be addressed satisfactorily, there might be some renewed discussion of BABs-type/direct-pay bonds (i.e., taxable bonds with respect to which the federal government makes a direct payment to the state and local borrowers to subsidize their interest costs) as an option for some types of tax-exempt bonds.
There may be potential opportunities amidst the challenges. Although a comprehensive examination of tax-exempt bonds in this fiscal and legislative environment poses serious challenges to State and local governments, it also presents potential opportunities within the context of those challenges.
- There may be opportunities to achieve some simplification and technical corrections of existing tax-exempt bond rules that remain in place.
There may be opportunities for some public-finance sectors to improve their relative positions in the "grand scheme" of the tax-exempt bond rules.
- There always seem to be opportunities for "small issuers" to get special treatment under new restrictive rules.
- Based on previous legislative proposals that have gained some support over the years, certain types of bonds-e.g., airport, seaport and water facilities of a certain type that are currently subject to some of the restrictive rules applicable to tax-exempt private activity bonds-might be able to get some private-activity bond restrictions lifted.
- There may be opportunities for some demand-side participants in public finance markets (e.g., financial institutions) to reduce or eliminate restrictions on their ability to benefit from their tax-exempt bond investments.
State and local governments face some challenges in their efforts. State and local governments face some practical challenges as they seek to make the most effective case to preserve intact the benefits they receive from their ability to issue tax-exempt bonds
Prioritization. While the need for more public infrastructure investment is something on which there seems to be genuine bipartisan agreement at all levels of government, it does not always seem to be at the top of the list of things for which state and local government or federal lawmakers are willing to "fall on their sword."
- To make their case on tax-exempt bonds most effectively, state and local governments and their elected officials may want to think about whether they want to move public infrastructure investment toward the top of their own "federal issues" priority list, and, if so, how best to do so.
- In today's political and economic environment, it would seem that the more that tax-exempt bonds and public infrastructure investment can demonstrably be tied to significant job creation, the easier it will be to move up the list of federal lawmakers' priorities.
Historically low interest rates create a risk of shortsightedness. Historically low market interest rates (which some believe will be around for a while) create a risk that the adverse effect of restrictive federal-tax proposals on state and local government infrastructure investment and borrowing costs might be minimized under a shortsighted view.
- At some point, market interest rates will return to more normal historic levels, at which time the adverse effect on borrowing costs of new tax-exempt bond restrictions will be magnified, perhaps dramatically, compared to today.
- Experience suggests that once something perceived as a "tax-break" is legislatively diminished or eliminated, it is exceedingly difficult to restore it.
Coordination and Delivery of Message.There are numerous categories of state and local government entities and officials (some elected and some unelected) with varying degrees of focus on how their ability to issue tax-exempt bonds reduces their borrowing costs. This can present challenges to the public finance community in delivering a coordinated message on tax-exempt bonds to federal lawmakers.
- Networks of different state and local organizations (such as the National Governors Association, State Treasurers Association, League of Cities, Conference of Mayors, the Government Finance Officers Association and several others) have been formed to facilitate coordination of message delivery.
- Other segments of the public finance community (e.g., state and local borrowers' bankers, lawyers and financial advisors) provide knowledgeable assistance to state and local governments in delivering the message.
- Enlisting other public infrastructure allies (e.g., engineers, architects, and players in the construction/materials industries) to assist in tying job creation arguments to tax-exempt bonds would be quite helpful to the state and local governments' cause.
- Prioritization. While the need for more public infrastructure investment is something on which there seems to be genuine bipartisan agreement at all levels of government, it does not always seem to be at the top of the list of things for which state and local government or federal lawmakers are willing to "fall on their sword."
The result of the 2012 elections almost certainly means that employers will face significant employment-related actions by federal agencies, including the National Labor Relations Board (NLRB), Equal Employment Opportunity Commission (EEOC), Occupational Safety and Health Administration (OSHA), and Office of Federal Contract Compliance Programs (OFCCP). Accordingly, employers need to consider and plan for the challenges ahead.
By the time of the inauguration, the NLRB will have only three Members, with Member Hayes' term expiring December 16, 2012 and with two "recess" appointments (Members Block and Griffin) under judicial review. The recess appointments expire on December 16, 2013. The President can again appoint new Members during the 2012 Congressional recess. Chairman Mark Pearce's term expires in August 2013. Thus, there is both an opportunity and perhaps a necessity to recompose the Board in this administration.
There promises (or threatens) more stability at the EEOC, with Chair Berrien's term expiring in July 2014 and remaining terms for Commissioners Feldblum (July 2013), Barker (July 2016) and Lipnic (July 2015). A fifth Commissioner position is vacant; with a pending nomination for Washington, D.C. employee rights advocate, Jenny Yang. The President can again appoint new Commissioners during the 2012 Congressional recess.
The other important posts are filled through presidential appointment, with some requiring Senate confirmation.
Perhaps the most significant employer issue in 2013 will be the finalization and release of implementing regulations and interpretations for the Patient Protection and Affordable Care Act ("Obamacare"). The massive health care reform legislation will be implemented in January 2014, with state exchanges in place by October 1, 2013. Although 13,000 pages of regulations have been released, there are many gaps, holes, and questions remaining as of the election. Employers, as well as insurers, employees, health care providers, and state governments, all have significant stakes in these regulations.
During the current administration, perhaps no federal agency has proved more aggressive in attempting to expand employee and labor rights than the NLRB (the Board). The Board has sometimes also proved ineffective in its efforts. Although the Board mandated the posting of a new notice of employee rights, including the right to unionize, and adopted union-friendly election rules, both have been temporarily blocked by federal courts. In line with the Administration's management by executive fiat, the Board has significantly invaded the non-union workplace by regulating employer control over social media posts and by regulating the confidentiality of internal company investigations. The Board has found policies violative of the NLRA for simply "being on the books," without any evidence of enforcement. Additionally, the agency has approved "micro-units" for bargaining, which allow small groups of employees within an organization to be represented by separate unions and thus facilitating union organization.
In this Administration, employers can expect resolution of several key issues which were not resolved by the Board prior to the election:
- The Board will address the 2007 Board decision in Register Guard allowing employers to restrict the use of company e-mails, including restrictions prohibiting union organizing and other activities protected by Section 7 of the NLRA. In a pending case, the Board has the opportunity to confirm or outlaw such restrictions.
- In twin pending cases involving NYU and the Polytechnic Institute of New York, the Board will decide whether to overturn its longstanding precedent that graduate students are barred from forming or joining unions.
- The Board will decide whether to continue to defend its election rules in the courts and/or it can draft new ones, addressing the procedural deficiencies fatal to its first attempt.
- The Board can continue to assist organized labor through its attack on work rules that require non-abusive, non-profane, and generally respectful conduct by employees. The Board's concern with these rules is based on the notion that such restrictions, even if unenforced, may sufficiently "chill" employees' exercise of their rights to engage in protected, concerted activity related to working conditions and other protected activity under Section 7 of the NLRA. The Bush-Era Board, in its Lutheran Heritage Village-Livonia line of cases, had allowed employers relatively substantial latitude in adopting and enforcing work rules that prohibited undesirable behavior such as unprofessionalism, abusive language and conduct, and dishonesty.
The EEOC has also been active during this Administration. Earlier this year, the Agency issued Guidance on employers' use of employees' and applicants' criminal histories, including convictions. The Guidance forces employers to abandon across-the-board exclusions of employees based upon generic criminal background status and instead to consider the specific criminal history based upon an individual assessment of each employee or applicant because of the adverse impact of such policies on males and racial and ethnic minorities. In addition, the EEOC applied Title VII and the ADAA to applicants or employees who experience domestic or dating violence, sexual assault or stalking, signaling the agency's broader examination of protections for off-duty events. The EEOC, along with several federal courts, concluded for the first time that gender identity (transsexual) discrimination constitutes sex discrimination in violation of Title VII.
The EEOC has announced that one of its priorities over the next four years will be to pursue litigation alleging sex discrimination and sexual harassment. Its current focus is on systemic discrimination.
Another federal agency that has been particularly aggressive over the past four years has been the OFCCP, which has jurisdiction over federal government contractors and subcontractors. The OFCCP enforces various laws that prohibit discrimination and require employers to take affirmative action in their employment decisions. The Obama OFCCP has:
- Required, through Executive Order, that covered federal contractor employers post a Notice of employee rights under the NLRA. That requirement remains in place. However, federal courts have temporarily blocked the NLRB from implementing a similar requirement that all employers who are subject to the jurisdiction of the NLRB post a similar notice.
- Increased focus and enforcement on compensation equity class issues.
- Predicted issuance of final regulatory amendments to Section 503 of the Rehabilitation Act and Section 4212 of the Vietnam Era Veterans' Readjustment Assistance Act of 1974, potentially greatly increasing the affirmative action program obligations of covered employers to include applicant recordkeeping obligations and statistical analyses, enhanced outreach for veterans, and a 7% goal for the employment of disabled individuals.
- Increased focus on disability and veteran complaints, coupled with more burdensome investigations, including more on-site investigations.
- Increased filings of administrative complaints upon failure of the conciliation process.
- Continued efforts to expand OFCCP jurisdiction in the health care industry, including potential challenges to the recent dismissal of OFCCP claims basing jurisdiction solely on TRICARE network provider agreements.
Anti-employer hallmarks of the Obama OSHA program include doubling minimum penalties for serious violations, restricting discretion in penalty assessment, initiating a Severe Violator Enforcement program, and outlawing many safety incentive programs. Several nationwide OSHA investigations have been at the behest of unions facing problems at the bargaining table or organizing employees.
These aggressive and regressive agency actions should be of particular concern to employers in light of the changing makeup of the federal judiciary during the upcoming Administration. Employers often have been able to receive relief from agency action through the typically more conservative federal courts. The appointments over the next four years will define the continued availability of such effective agency oversight.
In bracing both for the impact of what has already been wrought and for what is around the corner, employers must prepare their organizations by:
- Closely monitoring developments between November 7 and January 20.
- Examining current and proposed policies and procedures to identify, revise, and/or eliminate rules or practices that could invite or fail agency challenge under current standards.
- (Re)considering and bolstering strategies and action plans for lawfully responding to union organizing efforts. With a labor-friendly Board and other federal agencies having acted for four years on labor's behest where legislative efforts have failed, unions have appreciated and utilized this window of opportunity for organizing workplaces and threatening non-cooperative employers.
- Carefully following regulatory developments, including new rules and initiatives by federal agencies.
- Monitoring decisions from federal courts to determine whether aggressive agency actions and decisions will be enforced.
- Monitoring state legislatures and courts for new and different mandates or restrictions in the employment arena.
When Congress reconvenes on November 13, the legislature will be faced with issues they have been postponing the entire year: the so-called Fiscal Cliff. With basically a status quo election, there is a good chance that the Fiscal Cliff issues will be dealt with prior to the conclusion of the 112thCongress.
What are the issues that make up the Fiscal Cliff?
The scheduled cuts and estimated savings from those cuts by category in FY 2013 include:
- Sequestration: $109 billion (half from defense and half from other spending)
- Tax Cuts, 2001/2003 Bush Tax Cuts: $110 billion (if tax cuts are not extended, top dividend rate could increase to 39.6%, capital gains tax rate would increase from 15% to 20%)
- Tax "Extenders": $30 billion (traditional extenders that expired at the end of 2011 and 2012)
- Expiration of Payroll Tax Holiday: $85 billion (least likely to be extended although Democrats raised it as an issue in the closing days of the election)
- Expiration of Unemployment Benefits: $34 billion
- Cuts in Medicare Payments (Doc Fix): $10 billion
- Individual Alternative Minimum Tax (AMT): $104 billion (expired end of 2011)
There are several factors that will encourage Congress to address these issues. First, sequestration will have the Appropriators and the Armed Services Committees work to avoid these cuts. They will look to the tax writing committees to prevent the cuts from going into effect by finding ways to pay-for the cuts. Second, the budget hawks will want to reduce the deficit, which will lead to some type of "down payment" that will include hard cuts and revenue raisers. The amounts of revenues and cuts will need to exceed the amount called for in the first year of sequestration. In addition, Congress will be reluctant to sign onto entitlement cuts and revenue raisers unless there is a path forward on tax reform and entitlement reform. Third, the hard decisions will come from deciding what type of enforcement (trigger or backstop) mechanism to enforce the down payment agreement.
Finally, Congress will have to deal with another debt ceiling vote. While the debt ceiling will be reached in December (current debt ceiling is $16.39 trillion), there are ways that Treasury can postpone the day of reckoning until sometime in February or March 2013. There will likely be a demand to match deficit reduction amounts to the amount the debt ceiling is raised, similar to what Speaker Boehner did in 2011.
If Congress kicks some of these decisions down the road, they will probably do so by extending the dates until the end of 2013. The one item that cannot be extended is the AMT which expired at the end of 2011. Taxpayers will want to file their tax returns in February 2013 to get their tax refunds and if Congress has not acted on the AMT, many additional taxpayers will find that they are not getting a refund and will be paying additional taxes.
With the status quo election behind us, Congress will turn to tax reform in 2013. President Obama will want to raise the tax rate on upper income individuals. Here is a summary of his tax proposal:
- Reduce the corporate rate from 35% to 28% (25% for manufacturing)
- Opposes a territorial system and set a minimum tax on overseas earnings
- Allow Bush tax cuts to expire for families earning above $250,000 a year and raise rate on top bracket to 39.6%
- Limit amount of deductions high income workers can take and set a minimum tax rate for millionaires ("Buffet Rule," a 30% surtax on income over $1 million)
Tax reform is the number one priority for House Ways & Means Committee Chairman Dave Camp. In the 112thCongress, there were over 20 hearings in the Committee on tax reform. While the Committee released legislative language on an international territorial system, neither the Senate Finance Committee or House Ways & Means has released concepts or legislative language on what they will propose on corporate or individual taxes.
With the growth of pass-through entities, tax reform will include both individual and corporate taxes. Also it is unlikely that Congress will use reconciliation as the vehicle for tax reform. As we have seen with the Bush 2001 and 2003 tax cuts, reconciliation permits a tax cut to be in existence for only ten-years. Congress cannot pass comprehensive tax reform and have it snap back to existing law ten-years down the road.
One of the problems that Congress will have to deal with is the effective tax rates that some sectors of the economy are paying under current law. Those that have less than 28 percent effective tax rates will not be happy to give up their tax preferences and deductions so that other sectors of the economy can have their tax rates reduced to 28 percent. See below table.
Effective Tax Rates of the 20 Largest Industrial Sectors:
- Biotechnology: 4.46%
- Drug: 5.62%
- Internet: 5.94%
- Metals & Mining: 7.41%
- Computer / Peripherals: 8.65%
- Computer Software/Services: 10.12%
- Semiconductor: 10.85%
- Medical Supplies: 11.24%
- Petroleum (Producing): 11.27%
- Auto Parts: 12.09%
- Telecom Services: 12.80%
- Hotel/Gaming: 12.93%
- Food Processing: 17.29%
- Bank: 17.50%
- Restaurant: 19.86%
- Aerospace/Defense: 20.05%
- Oilfield Services/Equipment: 22.05%
- Trucking: 30.87%
- Petroleum (Integrated): 33.00%
- Electric Utility (East): 33.77%
Another problem Congress will have in reducing the individual rate is having individuals give up popular tax deductions. See below chart.
Largest Individual Tax Expenditures:
- Exclusion of health care contributions and premiums: $659.4 billion
- Deduction of mortgage interest: $484.1 billion
- Reduced tax rates on dividends and long-term capital gains: $402.9 billion
- Net exclusion of pension contributions and earnings: Defined benefit plans: $303.2 billion
- Earned Income Credit: $268.8 billion
- Deduction of non-business state and local government taxes: $273.3 billion
- Net exclusion of pension contributions and earnings: Defined contribution plans: $212.2 billion
- Exclusion of capital gains at death: $194.0 billion
- Deductions for charitable contributions, other than education and health: $182.4 billion
- Exclusion of untaxed social security and railroad retirement benefits: 173.0 billion
We anticipate the tax writing committees to begin work on tax reform at the beginning of the 113thCongress. Prior to marking up any legislation, we think that the Committees will release either legislative language or concepts. The feedback that the Committees receive on their proposals will impact the speed and ability of the Committees to accomplish their goals.
Manufacturing could be called the "comeback player of the year" in Washington, D.C. Both Governor Romney and President Obama stressed support for the manufacturing sector during the presidential campaign. President Obama mentioned the word "manufacturing" 16 times in his most recent State of the Union address in January 2012 compared to zero times in his first address in 2009. In the last Congress, 184 legislative bills related to manufacturing were introduced in the House and Senate.
There is a good reason why the Administration and Congress have been, and will continue to be, focused on manufacturing. U.S. manufacturers are reporting slow but steady growth as a result of an improving economy. In addition, the weak dollar and companies "reshoring" production back to the U.S. from China and other countries are also having a positive impact on the sector.
While the national unemployment rate is 7.8 percent, there are an estimated 600,000 job openings for skilled workers in the U.S. manufacturing sector. In summary, after being left for dead by many in both political parties only a few years ago, manufacturing has become a central part of the conversation when it comes to growing the U.S. economy and creating jobs.
Both large and small manufacturers have a common complaint about Washington, D.C. that hinders their recovery: uncertainty. Like other businesses, manufacturers want stability. Instead, what they have seen from Washington over the past several years is uncertainty on issues ranging from taxes to regulations.
In general, those interested in manufacturing can expect the following issues to be hotly debated in Washington during the lame duck session and in 2013:
- Sequestration - Not surprisingly, manufacturers like other sectors will closely watch to see if Congress and the President can avoid sequestration - the $1.2 trillion in automatic spending cuts over ten years that are split nearly evenly between defense and non-defense spending. The cuts will automatically take place starting January 1, 2013 unless a deal is reached. These automatic spending cuts would not only devastate manufacturers in the defense industry. The entire manufacturing sector would be devastated by cuts in defense, construction projects, infrastructure investment and job training.
- Taxes - Unless Congress acts, $5.4 trillion in tax increases will take effect on January 1, 2013. There are many tax extenders and incentives that are currently utilized by manufacturers that have expired or are set to expire. The uncertainty caused by the annual review of these extenders impacts decisions to hire more workers and make new capital investments. Eighty percent of manufacturers are pass through (S-Corporations) and pay taxes at the individual rate. Tax reform will involve eliminating tax credits and exemptions in return for lower tax rates. Congress will need to tackle the issue of lowering rates for all manufacturers, whether a C Corporation, S Corporation, Partnership or other pass through entity.
- Job Training - The manufacturing sector has an estimated 600,000 job openings for skilled workers across the U.S. today. Manufacturers cannot find enough qualified workers to fill these positions. And it is only going to get worse – approximately 2.7 million manufacturing workers are expected to retire in the next decade. The problem results from a combination of an aging workforce and the difficulty in finding younger workers with the appropriate skills to replace them. Elementary and high schools have eliminated manufacturing technology programs and high schools are judged by how many students attend college – not vocational schools. With the renewed emphasis by both political parties on manufacturing, look for Congress and the Administration to look to expand job training and recruitment programs for the manufacturing sector.
- Regulations - The federal regulatory agencies that most impact manufacturers include the Occupational Safety and Health Administration (OSHA), the Environmental Protection Agency (EPA) and the National Labor Relations Board (NLRB). Manufacturers have experienced a more activist role by all three agencies during President Obama's first term and more of the same could be in store during the next four years. Given the role that unions played in helping President Obama get reelected, renewed efforts may be made on pro-union legislation. However, with a Republican-controlled House of Representatives, it is likely that unions will continue to look to the NLRB for regulatory changes aimed at boosting union membership.
- Trade and Enforcement - As covered in our trade brief, the U.S. is expected to continue to bring cases before the WTO against China. President Obama touted his commitment to pursuing trade enforcement actions during his campaign, and one can expect to see a continuing commitment to antidumping and intellectual property actions over the coming years. However, it is not likely that legislation to punish China for currency manipulation will pass Congress anytime soon. A bill passed the Senate last year but died in the House. With President Obama's reelection, it is likely he will continue to rely on diplomatic efforts over legislation on this issue. Look for the Administration to also continue its efforts to increase exports and open markets.
President Obama describes his energy policy as an "All of the Above" approach that encourages production of traditional fossil fuels while supporting the growth of renewables. Despite an increase in overall U.S. energy production over the past four years, output in federal waters of the Gulf of Mexico has dropped well below recent government projections and onshore energy production from federal lands remains minuscule. Under a second Obama term, will federal waters and lands play a leading role in U.S. energy production, or will they continue to lag behind their potential?
How federal lands policy - and related energy policy - develops under the President's second term will reflect the dueling instincts within the Administration: the desire to push an active, even aggressive regulatory-reform program, and the desire to create a more bipartisan legacy on issues such as energy independence. We suspect we'll see elements of both as the administration continues a reformist Executive Branch regulatory agenda while exploring more common ground among Democrats and Republicans in Congress and the caucuses.
Other changes we see on the horizon:
Aside from responding to the Macondo blowout, delaying the decision on the Keystone pipeline and dealing with the fallout from the bankruptcy of Solyndra, energy issues have rarely appeared at the forefront of the Administration's political agenda. Low-key leaders such as Interior Secretary Ken Salazar and Energy Secretary Steven Chu have contributed to the backseat posture of the Administration's energy policy. In a next term, look for the following changes:
- DOI Secretary Salazar likely to be replaced by someone with environmental and public-lands credibility (a la David Hayes);
- DOE Secretary Chu likely to be replaced: look for someone with technology credibility, like Secretary Chu, but with more experience dealing with the energy industry and Congress.
Future production begins with leases to develop. During each of the past four years, scheduled offshore lease sales steadily diminished. The Administration's 2012-2017 oil and gas leasing plan fell short of industry expectations, failing to open up new tracts in the Eastern Gulf and along the U.S. East and West coasts, while providing limited offerings in the Alaskan OCS. In the next term, look for the Administration to:
- Stay the course on the current Five-Year Program;
- Hold tight on the development of offshore Alaska pending more science on impacts, sensitive receptors, and technology;
- Push out consideration of mid-Atlantic O&G development until more offshore renewable energy projects get under way;
- Develop the next Five-Year Program shaped strongly by the latest scientific impact studies; since the next Program will be developed during Obama's second term but implemented during the succeeding administration, it's a chance for Obama to leave a ten-year legacy of offshore leasing.
Offshore Exploration and Permitting
In the wake of Macondo, exploration plan approvals and permits to drill dropped to low levels while rules for offshore development were hastily revamped. Over the past six months, the flow of permits and approvals has moved toward pre-Macondo levels, albeit amidst markedly more regulation and less certainty of approval timing and outcome. Look for the following developments during the next four years:
- Promulgate additional regulations governing offshore equipment (e.g., BOPs), offshore safety management systems (e.g., SEMS), and leading/lagging performance indicators of process safety;
- "Set" the current permitting regime as the new normal;
- Initiate possible major initiatives around claims for natural resource damages (NRDs) from Macondo;
- Migrate regulatory concepts from onshore to offshore, and vice versa (e.g., disclosure, safety-case);
- Move increasingly toward performance standards, while also ratcheting up existing prescriptive standards;
- Continue to advance ocean zoning as a new gating function.
Offshore Enforcement and Liability
Part and parcel of ramping up production in the Gulf following Macondo has been the Administration's emphasis on toughened enforcement of offshore regulations, marking a deliberate departure from the tarnished oversight reputation of the former Minerals and Management Service. In continuing to pursue this aim, look for the Administration to:
- Complete the development of the Investigations and Review Unit (IRU), the enforcement arm of the Interior Department's Bureau of Safety and Environmental Enforcement;
- Continue to back-fill justifications for the current position on contractor liability;
- Seek expanded Congressional authority for offshore penalties;
- Spotlight the Macondo litigation.
Onshore Federal Lands Development
The Administration will continue to feel pressure to increase energy production on federal lands, particularly to exploit the considerable shale gas reserves on BLM land. Yet the Administration is on a go-slow strategy with federal shale gas development and is busy pursuing solar and wind opportunities. In the days ahead, look for the Administration to:
- Approve new, large renewable energy projects on federal lands;
- Finalize BLM's rules governing hydraulic fracturing on federal and Indian lands, followed by progress in shale gas development premised on increased regulatory requirements;
- Explore ways to streamline opportunities for energy corridors (transmission lines, pipelines) across federal lands.
In a President's final term, leaving a legacy becomes a high priority. Look for the Administration to:
- Create new National Monuments under the Antiquities Act;
- Complete the President's Great Outdoors initiative with a flagship effort of conservation or public access to the nation's natural heritage.
The extraordinary increase in the production of natural gas from shale formations in the U.S. played a central role in the 2012 elections. As President Obama and Governor Romney campaigned throughout the battleground states of Ohio, Pennsylvania, Virginia, Colorado and elsewhere, the campaign often seemed to be a contest as to who could praise the positive impacts of domestic shale gas production more. Indeed, despite the lingering industry angst about the number of federal agencies in Obama's Administration actively exploring new regulations on shale gas development, President Obama pledged to create 600,000 new jobs connected to natural gas by the end of the decade in his acceptance speech at the Democratic convention. This pledge, combined with a desire to ensure a solid economic legacy, will likely caution President Obama against actions in his second term that could radically reduce the level of domestic shale gas production.
Despite this, important regulatory processes will continue to impact domestic shale gas production in the U.S. at both the federal and state levels. Additionally, both the Democrat-controlled Senate and the Republican-controlled House will have renewed interest in all aspects of shale gas development, including oversight over major regulatory decisions taking place in the Executive Branch.
While there are any number of federal regulatory processes under way in the Executive Branch, in general, we expect the following regulatory actions and decisions to be the subject of intense scrutiny for the Obama Administration in their second term and in the 113thCongress:
EPA Hydraulic Fracturing Study
The primary federal study on the impact of hydraulic fracturing on drinking water resources is in the process of being conducted at multiple study sites throughout the country. EPA continues to plan on releasing a first progress report by the end of 2012 and have the final draft report submitted for peer review in 2014. If early data in 2012 and/or the final report contradicts scientific evidence refuting allegations of water contamination from hydraulic fracturing operations, the Obama Administration will be under increased pressure from outside groups and Members of Congress to take regulatory action to protect the environment and/or public health.
EPA Guidance on Hydraulic Fracturing Operations Using "Diesel" Fuel
The Safe Drinking Water Act exempts hydraulic fracturing activities except in cases where "diesel" fuel is used in the operation. EPA is developing permitting guidance for issuance on the use of diesel fuel as an additive in fracturing fluids. There is significant concern in industry and on Capitol Hill that the final guidance will be expanded to include a broader definition of "diesel fuel" that triggers a new permitting requirement for hydraulic fracturing activities involving the constituents of diesel.
BLM Regulation of Hydraulic Fracturing on Public Lands
BLM has proposed revised regulations for hydraulic fracturing on public lands. The regulations include requirements for the disclosure of chemicals used in fracturing activities, well integrity standards, and water management requirements. President Obama had a sharp exchange with Governor Romney in the second Presidential debate regarding production on federal lands. Congress and industry will watch closely when the BLM final rule is issued to see if President Obama will greatly increase the burdens for producers on federal lands. Anticipated changes in leadership at DOI could impact the timing and details of the final result.
DOE Policy on LNG Exports to Non-Free Trade Agreement Countries
The Natural Gas Act provides that for applications to export LNG to non-FTA countries (e.g., Japan), DOE must make a case-by-case determination that such licenses are "consistent with the public interest." How DOE interprets this phrase and, accordingly, how it treats the approximately 27 billions of cubic feet (bcf) of liquid natural gas (LNG) export applications currently in line is the crux of the issue that has everyone from industry to unions to NGOs to Capitol Hill on edge. DOE solicited two studies on the impact of increased exports of LNG on domestic natural gas prices. The first study, completed by the Energy Information Administration (EIA) and released on January 19th, 2012, showed varying degrees of increases in domestic natural gas prices as a result of increased LNG exports. The second study, performed by an outside consultant, was to be released in April 2012, then by the end of the Summer, and now, most recently, by the end of the year. It is widely expected that this second study will also show some level of increase in U.S. natural gas prices at various levels of LNG exports.
Based on these studies, in President Obama's second term, we expect DOE to propose a de-facto cap on LNG exports for anywhere from 6 - 10 bcf/day. Furthermore, we expect DOE to propose criteria under which the pending applications will be evaluated. In our view, it is likely that such criteria will focus on the viability and geographic diversity of the projects as opposed to the date on which the particular application was filed with DOE.
EPA Enforcement Initiative
EPA's Office of Enforcement and Compliance Assurance (OECA) has rolled out a national enforcement initiative (NEI) for the 2011-2013 enforcement cycle. NEIs are concentrated enforcement initiatives led by national and regional enforcement teams that emphasize compliance with existing federal requirements to address complex pollution problems within a particular sector or source type. If history is any guide, EPA will also seize the "energy extraction" NEI as an opportunity to compel additional controls not currently required under existing federal statutes and regulations. EPA Regions 3 and 6 have already begun issuing information requests to targeted companies and inviting certain companies in to discuss settlement options. In President Obama's second term, we expect continued emphasis on this initiative and OECA to push industry beyond its regulatory compliance obligations.
The effort to grow the U.S. economy has led to predictable stalemates on trade policy and international commerce over the past couple of years. As a result of disputes involving environmental, labor, and competiveness concerns, most free trade initiatives stalled in Congress or during international negotiations over the past two years. However, the 2012 elections made trade issues more visible. Both President Obama and Governor Romney promised to use international trade as a means to reinvigorate the U.S. economy, and promised to more harshly punish trading partners that they accuse of being "cheaters."
While it is not possible to predict specific outcomes on trade policy, the reelection of President Obama and a new Congress that looks nearly identical to the last Congress in terms of partisan makeup brings both risks and opportunities in the areas of international trade and commerce.
In general, those interested in trade policy and international commerce can expect that the following issues will be hotly debated in Washington during 2013:
- Foreign Investment Issues - Foreign investment in the U.S. economy in the form of acquisitions, partnerships, and passive investment is increasingly important. However, foreign investment also has a history of serving as a political flashpoint, especially when the investment comes from countries that politicians benefit from criticizing. For example, investment from China has been subjected to a growing amount of scrutiny by the Committee on Foreign Investment in the United States (CFIUS), and Members of Congress have been increasingly willing to identify such investment as a threat to U.S. national security. Over the next year, these types of controversies are likely to grow in number and frequency as U.S. and Chinese entities endeavor to find ways to partner with each other in a complicated political environment. These controversies will require careful maneuvering of the legal, communications, and political aspects of foreign investment in order to avoid having transactions derailed and the overall trade relationship imperiled. And while the reelection of President Obama makes it less likely that action will be taken on issues such as alleged currency manipulation, the Obama Administration has promised to strongly enforce laws related to CFIUS, dumping, and intellectual property rights.
- Energy Exports - The U.S. has enormous domestic coal and natural gas resources, and the ability sell to foreign markets will be flashpoint for controversy in the coming years. Energy exports could provide thousands of U.S. jobs and allow the U.S. to become a net energy exporter. However, they will also engender political battles as a result of accusations that the production and transportation of coal and natural gas risks environmental harm and increased domestic energy prices. While President Obama has signaled support for natural gas development, he has not committed to ensuring free trade in energy products. As this dispute moves forward, companies seeking to export domestic energy resources should expect a variety of efforts to limit these opportunities through regulation and legislation at the local and national level, and it will be necessary to directly engage in this fight.
- Free Trade Agreements - The three free trade agreements approved by Congress in 2011 – South Korea, Columbia and Panama – went into force in 2012 and it could be a while before others are even brought to Congress for consideration. The focus of the Obama Administration has been on the Trans-Pacific Partnership (TPP), potentially the largest free trade agreement in the world that would include Australia, Brunei Darussalam, Canada, Chile, Malaysia, Mexico, New Zealand, Peru, Singapore, Vietnam, and the U.S.. TPP will address industrial goods, agriculture, and textiles, intellectual property, technical barriers to trade, labor, and the environment. Analysts believe that a final deal could take another year or longer as many tough issues are still to be decided. While the reelection of President Obama ensures that the negotiations will likely continue on the same path as they have in the recent past, it remains unclear how the structural and substantive problems related to the TPP will be resolved, or how it will be possible to overcome likely opposition from labor and environmental groups in the U.S. if and when the Senate takes up the TPP.
- European and World Trade Organization Issues - An immediate issue facing Congress is approval of Permanent Normal Trade Relations (PNTR) with Russia. Russia became the 156th member of the WTO in August 2012 and WTO rules require the U.S. and other countries to grant PNTR to apply the WTO-negotiated rules to trade with Russia. Congress needs to terminate the Jackson-Vanik amendment to the Trade Act of 1974 to Russia. The amendment requires annual reviews of Russia originally for emigration of Jews from the Soviet Union. Human rights and other interest groups continue to lobby against granting Russia PNTR and/or attaching conditions focused on human rights concerns. A vote may come during the lame duck session of Congress.
- WTO Issues and China - The U.S. is expected to continue to bring cases before the WTO against China, and recently the U.S. filed a WTO trade case against China on cars and auto parts on subsidies. In early October, the U.S. won a victory when the WTO ruled that China cannot impose duties on certain U.S. steel exports. Another important case against China and brought by the U.S., joined by the European Union and Japan, is on rare earth materials. The case concerns the 17 rare earth metals used in advanced technologies for products ranging from iPhones to wind turbines. China has 97 percent of world output of these metals and is accused of holding down prices for its domestic manufacturers, placing non-Chinese manufacturers at a disadvantage. President Obama touted his commitment to pursuing these actions during his campaign, and one can expect to see a continuing commitment to antidumping and intellectual property actions over the coming years.
- Latin American Trade - Outside of some brief mention of Latin America by Governor Romney, the absence of significant election discussion of Latin American policy is remarkable, in the face of the significance of the Hispanic vote. However, the coming years should see a growing focus on Latin American issues ranging from increased violence in the region, immigration reform, potential changes in Cuban sanctions, and potential export markets for the U.S. How Congress and the Obama Administration will navigate these difficult issues remains to be seen, but given the conventional wisdom about the changing demographics of U.S. voters, these debates will be time-consuming, complicated, and unavoidable.