- The Supreme Court ruled the EPA does not have authority to enforce “generation shifting” from high emission power sources to lower emission sources
- The ruling reduces regulatory pressure to reduce GHGs and jeopardizes proposed SEC climate rules
- However, pressure for businesses to reduce emissions will persist in the form of market forces, industry trends, customer preferences and requirements, and incentives from the Inflation Reduction Act
In June of this year, the Supreme Court ruled in West Virginia v. Environmental Protection Agency that the U.S. Environmental Protection Agency (EPA) did not have authority under the Clean Air Act to regulate greenhouse gas (GHG) emissions from power plants through “generation shifting.” By definition, generation shifting requires energy producers to shift electricity generation from fuels associated with high emissions (e.g., coal) to lower-emission energy sources such as natural gas, wind, and solar.
The Court held that the EPA did not have authority to enforce generation shifting under the Major Questions Doctrine. The doctrine asserts that when an executive agency seeks to decide an issue of “major national significance,” it must have clear statutory authority; in other words, its power to perform the action must be explicitly granted by Congress. Moreover, Section 111d of the Clean Air Act provides the EPA with the authority to regulate “air pollution”, and in the 2007 case Massachusetts v. EPA the Court recognized GHGs as air pollutants. However, in West Virginia the conservative Court, voting in a 6-3 decision along partisan lines, ruled that despite this authority and judicial precedent the EPA did not have the authority to regulate GHGs through generation shifting, which is not explicitly noted in the Clean Air Act. By limiting the EPA’s ability to dictate power generation sources, the ruling curbs the U.S. federal government’s ability to regulate GHGs.
Climate Regulation in the U.S.
The ruling does more than remove an arrow in the EPA’s quiver to fight climate change: it hurts the U.S.’s ability to meet its climate commitments and goals via regulatory action. The Biden administration committed the U.S. to ambitious GHG reduction targets: 50% reduction (as compared to 2005 emissions) by 2030, and net-zero emissions by 2050. These targets are necessary for the U.S. to align with the goals outlined in the Paris Agreement and to avoid the worst outcomes of climate change.
West Virginia may also impact other proposed climate regulation. Most notably, the ruling could jeopardize the SEC’s recently proposed mandatory climate disclosure rules. The proposed rules would require registrants to include climate-related information in their disclosures, such as climate-related risks as well as Scope 1, Scope 2, and in some cases Scope 3 emissions. The SEC has congressional authority to regulate the flow of “material” information, defined as information that a “reasonable person would consider important,” from public companies to investors. Though Malk would consider climate-related disclosures to be increasingly “material” to the average investor, the conservative Court may not agree. If a challenge to the SEC disclosure rule were made under the Major Questions Doctrine, the Court could find the rule to be one of “major national significance.” Rules of “major national significance” can only be enforced by executive agencies, such as the SEC, when given explicit statutory authority by Congress. The Court may decide the SEC is seeking to establish regulation through powers not granted to it; further, Congress has failed multiple times to pass climate-related disclosures for public entities.
That said, the U.S. is not entirely without climate change regulation. Most notably, the EPA has unchallenged levers to regulate non-carbon dioxide GHGs, such as methane and hydrofluorocarbons (HFCs). Various state legislatures have also rolled out climate change regulation, highlighted by the Northeast’s cap and trade program, Regional Greenhouse Gas Initiative (RGGI).
Adding further nuance is the Inflation Reduction Act (“the Act”), a surprise deal between Senate Democrats to advance President Biden’s agenda through healthcare, tax, and climate spending provisions. The legislation will not replace the regulatory lever of GHG reduction via generation shifting, struck down in West Virginia. It instead will provide incentives for power generators and manufacturers to reduce emissions, placing federal climate change action less in the stick and more in the carrot. Sources estimate that the spending could lead to the U.S. reducing carbon emissions by 40% relative to 2005 levels by 2030. Further, though the Act primarily addresses budgetary allocations, it also amends language in the Clean Air Act to explicitly define carbon dioxide produced by the combustion of fossil fuels as an “air pollutant.” Though the added language is unlikely to affect U.S. climate regulation in the short-term, the classification could provide justification for future EPA enforcement.
Despite the increased resources dedicated to decarbonization through the Inflation Reduction Act, West Virginia leaves the U.S. federal government without an effective regulatory tool to reduce carbon dioxide emissions at a national level.
Under West Virginia, regulatory pressure for power generating companies may dissipate as the EPA loses authority to regulate GHGs through generation shifting. However, the absence of regulatory pressure does not remove external pressure and incentives to lower emissions. Market forces already encourage power generators to abandon high-emission fuels. Coal-fired power plants, which are the highest emitting power generators on average, are becoming increasingly unviable investments as natural gas and renewables become cheaper and coal prices increase. Indeed, 45% of U.S. coal power by generation capacity is scheduled to be retired by the end of the decade, and largely for economic reasons. Further, power generators are likely to face increasing competitive pressure to reduce emissions from industry peers. Nine of the ten largest utility companies in the U.S. by generation capacity have emissions reduction goals; eight have net-zero goals by 2050. This trend extends to powerful industry groups. Industry associations, such as the Edison Electric Institute, have historically dragged their feet on GHG reductions and contributed to climate misinformation. Illustrating the increased attention paid by power generators to GHG emissions, such groups are changing their tune. They are advocating for U.S. participation in international climate agreements, EPA regulation of methane emissions, and investment into cleaner energy technologies.
Companies and investors in power-generation markets will also need to consider the opportunities of decarbonization, most notably those generated by the Inflation Reduction Act; the Act provides significant resources, including tax credits, grants, and loans, for electric utilities to accelerate the transition to clean electricity. Opting for the carrot rather than the stick, the Act will pressure power generators to reduce emissions through these resources, or risk leaving money on the table and failing to keep up with industry trends. Power-generating firms that heed these trends and take advantage of these incentives are likely to gain a competitive advantage over laggard firms, as market forces and potential future regulation decrease the viability of high emitting, fossil-based generation.
Further, the EPA’s ability to regulate other pollutants remains unchanged, with important implications for GHG emissions from coal plants. The EPA’s statutory authorization to regulate pollutant byproducts of fossil fuel energy generation, such as nitrogen and sulfur oxides, is unlikely to face similar challenges as those in West Virginia. The Clean Air Act explicitly gives the agency authority to regulate such pollutants; further, this authority is likely to result in reduced GHG emissions from coal-burning power plants through recently changed effluent guidelines. The EPA’s strengthened wastewater rule requires power plants to clean coal ash and toxic heavy metals from effluent prior to disposal, and is expected to result in numerous coal plant closures or transitions to natural gas by 2028, as the cost of retrofitting coal plants to meet the wastewater requirements is too high to justify continued operations.
Ultimately, power generators and their investors would be ill-advised to interpret the West Virginia ruling as reducing their obligations to comply with existing environmental regulations. Failure to align with existing regulations could lead to steep fines, public scrutiny, and loss of customers. For instance, American Electric Power’s violations of the Clean Air Act resulted in $15M in penalties, $60M in remediation costs, and $4.6B in upgrades to avoid future fines. In sum, despite the removal of generation shifting as a regulatory tool, power generating firms are still exposed to existing environmental obligations, market forces, and competitive pressures.
Persisting Pressures to Decarbonize
Though West Virginia will likely reduce federal regulatory pressure on power generators to decarbonize, pressure on businesses to decarbonize will persist from external sources. Companies serving both consumer and enterprise customers are likely to face increasing climate-related pressure from their customers. Further, limited partners’ growing commitments to GHG reduction across their portfolios will encourage their private equity partners to follow suit. Moreover, some general partner firms maintain their own independent climate goals, which flow down to their portfolio companies.
Customer Pressure and Funding Opportunities
Consumer-facing companies must account for a consumer and enterprise market that is increasingly concerned with sustainability and carbon emissions. Recent studies have found that 79% of consumers have changed their purchase preferences based on sustainability, and 50% rank sustainability as a top five value driver. Subsequently, sustainable approaches can increase customer loyalty and thus revenue, incentivizing GHG reporting and monitoring from private companies, even if not required by regulation. Enterprise-facing companies may face even greater pressure as their business partners and customers pursue concrete GHG goals in response to consumer demands. Notably, large tech companies like Apple, Salesforce, and Microsoft have launched ambitious supplier GHG programs, requiring their extensive networks of suppliers to report and reduce their GHG emissions and thus incentivizing private investors in those companies to monitor and reduce emissions or risk losing key customers. This ambition is not limited to the tech space; food and beverage players like Coca Cola and large manufacturers such as GM have made ambitious GHG reduction commitments that include Scope 3 emissions, and thus apply to their suppliers, illustrating how B2B relationships will drive decarbonization from all facets of value chains.
Finally, companies in certain sectors may have the opportunity to take advantage of government funding through the Inflation Reduction Act. The Act encourages manufacturers downstream of electricity generation to reduce emissions by providing grants and tax credits for industrial decarbonization; historically large polluters such as chemical, steel, and cement manufacturers will be eligible for $6B in funds from the Act’s Advanced Industrial Facilities Deployment Program.
SEC Climate Disclosures
The proposed SEC climate disclosure rule would apply to publicly registered companies; however, the rule could also impact private companies. Under the proposed rule, certain public registrants would be required to disclose Scope 3 emissions, which include all upstream and downstream emissions of a company’s operations. As a result, privately held companies included in a public company’s Scope 3 emissions profile would need to report emissions to their public partners. Should the rule be accepted, in-scope companies will be required to report GHG emissions; the ruling will not compel them to reduce their carbon footprint. Instead, that reduction pressure will come from non-regulatory sources, such as customers and investors.
If the rule is struck down by the courts, public companies may still impose these requirements onto their privately held partners. A large number of public companies (e.g. Siemens, Ford, Coca Cola) have already pledged to reach net zero in the next 20 to 30 years. As a result, companies with net zero commitments will still impose climate tracking/reduction requirements onto their partners, independent of SEC requirements.
Private Equity in Power Generation
While West Virginia and the potential nullification of proposed SEC climate disclosure rules may reduce regulatory pressure to report and decrease GHG emissions, such pressure will persist as private investors continue to take action against climate change. Private equity firms own 13% of U.S. power generation; of their collective power generation, 80% is fossil fuel-based (natural gas, coal, and oil). Prior to West Virginia, proactive asset managers were incentivized to push their power generation investments towards lower-emitting sources by generation shifting. But while the regulatory pressure for privately held generation companies to decarbonize decreased with West Virginia, directionally aligned external forces remain. In some cases, their direct managers have made ambitious climate goals. For instance, Carlyle, owner of 22 natural gas plants, is committed to net zero emissions across investments by 2050. Further, private equity firms themselves face increasing scrutiny from their LP investors to reduce emissions, as illustrated by growing commitments from LPs to achieve significant carbon reductions across their portfolios. Most notably, the Net Zero Asset Managers initiative has 273 signatories committed to net zero carbon emissions across investments by 2050; these members collectively oversee $61.3 trillion in AUM.
West Virginia was a step backwards for those in favor of ambitious climate action in the U.S. The Supreme Court’s rejection of the EPA enforcing generation shifting under the major questions doctrine blocked a key lever for GHG enforcement and placed the SEC’s proposed climate disclosure rule in jeopardy. However, savvy private investors should take stock of other factors encouraging GHG reductions, most notably market forces including consumer preferences, competitor trends, and enterprise requirements, as well as climate “carrots” arising from the Inflation Reduction Act. Indeed, as climate risks become increasingly salient through extreme weather events, private markets can and should lead the way with regard to GHG reductions; the alternative is dissatisfied consumers, unhappy enterprise customers, and money left on the table.
Malk Partners does not make any express or implied representation or warranty on any future realization, outcome or risk associated with the content contained in this material. All recommendations contained herein are made as of the date of circulation and based on current ESG standards. Malk is an ESG advisory firm, and nothing in this material should be construed as, nor a substitute for, legal, technical, scientific, risk management, accounting, financial, or any other type of business advice, as the case may be.