FEDERAL LEGISLATIVE UPDATE ON 110TH CONGRESSRE: ENERGY AND ENVIRONMENT ISSUES

GLOBAL ENERGY MANAGEMENT INSTITUTE’S ENERGY TRADING CONFERENCE

JANUARY 25, 2007

PRESENTED BY: GEORGE D. BAKERPRINCIPALWILLIAMS & JENSEN PLLCSUITE 3001155 21ST STREET, NWWASHINGTON, DC 20036202-659-8201gdbaker@wms-jen.com

For those who have been in a cave for the past several months here is the big political news:

Democrats Take Control onCapital Hill!

So what does the Democratic takeover of Congress mean?

Energy and environment are at the very top of the new Democratic-controlled Congress

So how should you feel about that?Depends on who you are.

If you are a Democrat, or are in the environmental, ethanol, renewable fuels community, you may feel like this kid:

If you are a Republican, or in the coal, utility, or oil and gas community, (or pharmaceutical, tobacco, or health care) you might feel like this kid:

Neither perception is completely accurate, and outcomes of the 2007 energy and environment debate on the Hill remain subject to a range of uncertainties.

But several overarching realities will influence the outcome:

1.House Democrats are empowered by the traditional House rules that allow the majority to largely control what gets to the floor and how it is considered.

You can pass a ham sandwich in the House!!

Speaker Pelosi wants to have energy and global climate legislation through the House Committees by June and on the House floor by July 4: “Energy Independence Day.”

2. Senate rules still empower the minority to block and obstruct action of the majority, which gives them leverage and political relevance.

Under Constitution, Senate is the place where the “hot tea of the House of Representatives cools”

To break a filibuster/invoke cloture, 60 votes needed to move anything

controversial

Democrats have narrow majority (51-49)

3.Although his popularity is low and he may increasingly be viewed as a “Lame Duck,” the President still is very relevant with his veto power

Congress needs two-thirds vote of each body to override vetoes

Bush will also make his compromises

- Has already said some oil & gas subsidies are unnecessary.

- Speculation about a compromise on global warming? (Bodman, Paulson)

4. Stabilization of energy prices vs 2006 allows Congress to consider whatever it may do in a calmer atmosphere than during crisis of 2005-2006 price spikes.

Traditionally, you need either a consensus or a crisis to move energy legislation.

In energy, consensus is difficult without a crisis and legislative response in a crisis too often is premised on perpetual continuation of the crisis itself rather than a return to “normal” supply/demand equilibrium.

Fuel Use Act, SynFuels Corporations, Oil and Gas Price Controls.

5. However, there is a sense that nation’s political perceptions on energy and environment may have changed based on several factors including:

Democrats certainly believe they are correct in elevating the priority of energy and environment.

Domestic manufacturing hit hard by sustained high energy costs

Domestic job flight overseas

Iraq War

Note: passage of Gulf of Mexico OCS bill in ‘06

Wider acceptance of Global Warming threat

Listing of polar bears as endangered species

Melting ice caps

Greater acceptance of nuclear power

Farm belt advocacy of domestically grown agri-fuels

So what should you expect from the 110th Congress?

Let’s start with what NOT to expect:

ANWR

More favorable tax benefits for major oil and gas companies

The repeal of oil and gas tax provisions has already begun

Expansive OCS drilling on Atlantic and Pacific coasts

House Democrats’ Energy and Environment priorities/themes:

Energy Taxes

Energy Oversight

Renewable Energy Development

Price Gouging/Anti-Manipulation

Global Climate

I. Repeal Oil and Gas Industry Tax Benefits

One of the top Democratic priorities already passed by the House was energy related:

The “Creating Long-term Energy Alternatives for the Nation (CLEAN) Act” (HR 6)

- Gulf of Mexico OCS Royalty reform

- Rollback “G&G” depreciation from 5 to 7 years for Majors

- Section 199 repeal

- Creation of new $8 billion “Strategic Energy Efficiency and Renewables

Reserve”

Note: HR 6 could have been a lot worse for the Oil and Gas Industry. Thanks to the “Oil Patch” Blue Dog Democrats the bill was significantly modified to EXCLUDE various big ticket items such as:

Repeal of last-in-first-out (LIFO) accounting

Repeal of expensing of intangible drilling costs

Repeal of accelerated depreciation for natural gas distribution lines

Repeal of refinery expansion expensing

Repeal of foreign tax credit

Imposition of a windfall profit tax

Note: ALL OF THESE TAX ITEMS, AND MORE, REMAIN AT RISK FOR

FUTURE ENERGY TAX BILLS!

Oil and Gas Industry hopes that HR 6 is its only tax hit in 110th Congress

Wishful thinking?

Note: Senate will likely not consider HR 6 immediately

But expect a broader energy tax package in Senate and in House which will create exposure for all energy sectors

- Significant “Pay-Go” Risk

II. Heavy Dose of Oversight:

- Both Chairman John Dingell at Energy and Commerce and Chairman Henry Waxman of Government Oversight will conduct substantial oversight of Bush Administration’senergy policy:

Stupak Subcommittee hearings on

energy market manipulation and price gauging.

- Senate Energy and Senate Homeland Security/Government Affairs

Oversight

III. Renewable Energy Development:

HR 6 provided for a new Renewable Energy Fund ($8 billion) that can pay for renewables.

More ethanol, bio-fuel subsidies?

25% in 2025 goal?

Farm Bill in ‘07

Renewable Portfolio Standard for electric utilities?

- Senate likely has majority in favor

- Previous Republican Majority prevented this from coming to House floor in Energy Policy Act of 2005

- New Democratic House majority might favor an RPS

IV. Price Gouging/Anti-Manipulation

Senate: Cantwell and Stevens Bill

- Empower FTC to monitor for “unconscionable” price increases for gasoline or petroleum distillates.

- “Unconscionable” means substantially exceeds the supplier’s average price

during prior 30 days and supplier’s competitors’ average prices, and

cannot be justified by increased costs of the sold product, operational costs or local,

regional, national, or international market conditions.

House: Stupak Bill (H.R. 594):

- Gives CFTC regulatory authority to investigate OTC energy contract trading subjects OTC energy trading to CFTC’s anti-fraud and anti-manipulation, reporting, and recordkeeping provisions and penalties.

V. Energy Tax Risks:

Repeal of last-in-first-out (LIFO) accounting

Repeal of expensing of intangible drilling costs

Repeal of accelerated depreciation for natural gas distribution lines

Repeal of refinery expansion expensing

Repeal of foreign tax credit

Imposition of a windfall profit tax

Reimpose long-expired Superfund taxes?

VI. Global Climate: “RED HOT” issue

House: Speaker Pelosi appointed “Select Committee on Energy Independence and Global Warming”:

Select Committee lacks legislative authority but is designed to develop research and inform public on the issues

Chaired by Representative Ed Markey of Massachusetts

Underscores priority Democratic leadership gives issue

Dingell: “These select committees are as useful as feathers on a fish.”

Viewed as strong signal to more cautious/deliberate Energy Committee Chairman Dingell

Dingell vowed to hold hearings and “carefully consider” all views to create a consensus

Dingell’s concern for constituent auto industry

Energy and Environment Subcommittee Leadership:

Democratic: Chairman Boucher of Virginia

Republican: former Speaker Denny Hastert of Illinois

Senate: Senate Environment and Public Works: Boxer vs. Inhofe

Generally: Major change in philosophy here.

Boxer to conduct aggressive oversight into EPA clean air, clean water, global climate, children's health, chemical safety issues

Global Climate: Major difference between Boxer and Inhofe:

Boxer Views California’s new global climate regime as “gold standard”

California provisions: Rollback GHG emissions to 2000 levels by 2010; to 1990 levels by 2020, and 80% below 1990 levels by 2050.

Inhofe: “Global warming is the greatest hoax ever perpetrated on the American people.”

A Range of Global Climate proposal to consider:

Boxer will start hearings on January 30 to hear from sponsors of competing proposals

McCain, Lieberman, Obama

- Reduce GHG by 2% per year after 2012 until one-third below current

levels by 2050.

- Embraces nuclear power as a solution.

- Earlier version defeated in 2005 (36-60).

Leahy Sanders

Feinstein Carper

Bingaman: Viewed as more moderate proposal, designed to garner industry support as a compromise

- Goal: Reduce emissions 14% by 2030.

- Contains offsets and safety valves.

These proposals vary in terms of aggressiveness of emissions reductions targets, timetables, scope of industries affected, conceptual approaches.

But all allow some form of emissions trading.

They all would affect US industry sectors substantially.

Query: Is America ready to accept the changes required by any of the global climate bills?

- Democrats believe “yes” and believe they will be credited for their leadership.

Note: McCain, Lieberman, Obama:

Presidential Politics anyone?

Note criticism of Obama from enviros for supporting coal to oil program

Note: Global Climate solution may mean increased nuclear power

VII. Renewable Energy: Another Huge priority

Agriculture Committees:

Farm Bill will dominate agenda of two Congressional Ag Committees

Increased ethanol and other bio-fuel production will drive the Farm Bill

Chairman Harkin: Targets getting “Food, Fiber and Fuel” bill through Senate Ag Committee before July

Chairman Peterson: Targets getting bill to President by September 30.

Expect significant increase in current 12 billion gallons of ethanol

Perhaps new production target in 30-60 billion gallons?

Concerns: Impact on cost of corn for animal feed and for human consumption

Cellulosic bio-fuels supports?

Other Energy Issues:

- Increase in CAFÉ standards?

- Coal to liquids; coal gasification

- Renewable Portfolio Standard (RPS) for electric utilities

Expect Chairman Bingaman to move a Renewable Portfolio Standard mandate for electric utilities

Bingaman RPS passed the Senate in prior Congresses;

Start at 3% and graduate percentage to 15% in 2020

Query: Greater support now with Democratic majority in Senate?

Query: Will Democratic House support an RPS?

Other Legislative Policy Issues of Interest to Energy Trading:

CFTC Reauthorization

Hedge Fund oversight/regulation

Capital Markets Reform

VIII. Commodity Futures Trading Commission (CFTC) Reauthorization:

Congress failed to complete reauthorization in 109th Congress

House passed its version (HR 4473)

Senate negotiated floor consideration but failed to get bill on the floor

- Opposition from OTC and Energy Sectors over various concerns

from perceived expansion of CFTC’s jurisdiction.

Bills in House and Senate were largely similar; increasing fines and penalties for violations, especially manipulation; clarifying CFTC jurisdiction over fraud and retail FX abuse.

But controversy arose energy related issues:

House-passed bill contained a compromise requiring CFTC to create rules compelling any entity with an interest in natural gas futures to maintain records for 5 years regarding its natural gas futures position and any related contract in natural gas to which that entity is a party.

Senate leaders prepared for fight over four amendments:

Conrad: would create a rebuttable presumption that CFTC has anti-fraud

jurisdiction over any contract with a retail customer that is leveraged or margined if that customer lacks a commercial use for the underlying commodity or lacks the financial and physical capacity to take/make delivery or to effect a cash settlement

- Would apply to any commodity: Fx, energy, ag.

Cantwell and Stevens: Gasoline and distillates price gouging

Feinstein: Expand CFTC jurisdiction to require record keeping and reporting of OTC energy trading in any energy commodity

Broader than just natural gas (includes electricity, coal, oil, petroleum and natural gas products)

Covers trading of any energy commodity contract on any

domestic electronic trading facility OR any contract involving an underlying energy commodity that has a physical delivery point in the US and is

executed through any US terminal of a foreign board of trade

These Senate amendments may appear again if and when CFTC bill is taken up in Senate.

Additional amendments possible?

Query: will Senate Democrats hold upper-hand on their amendments?

Query: will House Democrats entertain the Conrad, Feinstein, Cantwell amendments as well?

Complications and Prospects in ’07:

- CFTC bill is within Ag Committees’ jurisdiction

- House and Senate Ag Committees top priority is the Farm Bill

- Big incentive to avoid political controversy that will demand time, resources and political capital and divert attention from Farm Bill.

House: Chairman might report out ’06 bill

Senate: Feinstein, Conrad, Cantwell might want their amendments adopted

in Ag Committee.

OTC Energy industry would prefer to avoid fight over Feinstein and Cantwell/Stevens amendments, or having to deal with House natural gas provision.

Cantwell/Stevens gouging amendments could be re-directed to any Senate Energy bill

OTC would prefer to avoid fight over Conrad amendment

IX. Capital Markets Reform:

Substantial concerns raised that US financial market competitiveness is at risk due to heavy or antiquated US regulatory scheme

Sarbanes Oxley

Multiple regulators at federal and state levels for banking, securities, insurance industries

Calls for federal preemption of aggressive state regulation

Principle-based (FSA) regulation vs. proscriptive/detailed/micromanaged regulation

SEC enforcement first culture/antagonistic relationship to industry mentality

Some calls for reform have already brought change:

Merger of NYSE and NASD regulatory apparatus.

Sarbanes Oxley issues being reconsidered

Rest of US financial services industry seems to want what the futures industry has under the Commodity Futures Modernization Act of 2005:

Principle Based Regulation

Cooperative regulator/industry relationships

Regulatory incentive to innovate to meet global competition

Watch for Secretary Paulson’s financial industry conference in Spring ’07 for discussion of the range of suggestions for changes.

No merger of CFTC and SEC likely any time soon:

Congressional Ag Committees have done a great job and appreciate their jurisdiction over futures industry with CFMA

Until and unless there is serious reform of equities regulation, don’t expect futures industry to be interested in discussing a merger of agencies

X. Hedge Funds:

Have come under increasing scrutiny by regulators and lawmakers on both sides of the aisle. Factors contributing to this interest:

Recent rapid growth of hedge funds and especially the increased pension fund investment in hedge funds.

Constant media attention of hedge funds and activities, including references to the “lightly regulated” and “secretive” nature of the industry.

Lack of knowledge about hedge funds and the nature of their activities and their regulation.

High-profile failures of several hedge funds, including Amaranth, Bayou, and the poster-child Long Term Capital Management (systemic risk concerns). Note that several pension funds lost money in the Amaranth collapse, although it does not appear to have caused funding or other problems with those pension funds.

Congressional Concerns:

Degree of regulation vs. size/scope of funds in market

Systemic risk?

Impact on pension funds?

Impact on energy trading markets?

Coleman/Levin Oversight Report in ‘06

Query: Is there a “hedging or speculative premium” in markets?

Query: Who are appropriate market participants?

Will Congress Increase Regulation of Hedge Funds?

The new Democratic leadership is not calling for increased regulation of hedge funds, but they do expect to hold hearings, with one focus to revolve around pension fund investments in hedge funds.

House Financial Services Committee Chairman Barney Frank:

December 19, 2006, Frank’s spokesman said, “His view is that if rich people are losing a lot of money, there is not a lot government should do about it.”

But, when it comes to the investment of pension fund money into hedge funds, Frank’s committee will hold hearings to examine whether there may be any concerns to such investments.

Administrative Activity Re: Hedge funds

The Treasury Department has been conducting a review of hedge funds and their activities. The review is not expected to result in the production of a written report, but it has been part of a process of determining if there are concerns with the existing regulatory framework over hedge funds.

The SEC recently published its proposal to increase the “accredited investor” standard (Regulation D) for certain hedge funds (3(c)(1) hedge funds). Currently, the term “accredited investor” includes those with net worth exceeding $1 million or whose individual income exceeds $200,000 ($300,000 joint income with spouse) for 3(c)(1) funds.[1] The proposal would create a new standard: (a) the investor must meet the $1 million net worth and income test as described above; and (b) the investor must own at least $2.5 million in investments (excluding the value of their house).

[1] Investors must own $5 million in investments at the time of their investment in a 3(c)(7) hedge fund. The proposed rule does not change the investment threshold standard for 3(c)(7) funds, since it is a higher investment threshold and such funds must limit the sale of their securities to qualified purchasers who also meet the definition of accredited investor.

The SEC’s action seems to have blunted calls by some advocates for registration of hedge fund advisers (in Goldstein decision, the courts struck down the SEC’s rule to require hedge fund advisers to register with the SEC).

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