How are you thinking about the Biden Administration’s use of regulatory power so far and going forward?

The Biden administration’s goal for this first year has been to show the world “the U.S. is back” when it comes to climate leadership, and one of President Biden’s first acts as president was to cancel the Keystone XL pipeline. Other early actions included restoring the social cost of carbon, halting new lease sales for oil & gas and outlining a whole-of-government regulatory approach toward climate.

While the back half of the year had additional announcements, tangible administrative actions on climate have been limited, for several reasons:

  1. It takes time to write and implement regulations. To put new regulations in place, regulatory agencies must propose the rules, go through the commenting and review processes, write final rules and provide time for implementation. This process can take years.
  2. The administration has been focused on legislative action. Democratic leadership and the White House have been focused on passing President Biden’s Build Back Better plan. Now that it has become clearer what will and will not be part of Democrats’ legislative package, the White House and regulators will craft regulatory measures that will fill in legislative gaps.
  3. The courts can serve as obstacles. The administration has already faced obstacles with the courts after Biden’s moratorium on new federal leases was overturned. Court challenges occurred under past administrations related to environmental regulatory changes, and the Biden administration will face similar limitations.
  4. Personnel is policy. The administration needed to get its people installed at regulatory agencies before it could implement regulatory policy. Financial regulation is a good example of this: While the administration had chosen to retain Jerome Powell as Fed Chair, it is installing Lael Brainard, who is more aggressive on climate, as Vice Chair.

We expect that if Democrats lose either the House or the Senate in the 2022 midterm elections, the Biden administration will have no other path to achieve its climate goals than through regulatory and executive powers. In such a scenario, we would expect a more aggressive and expansive application and interpretation of powers.

How can the administration utilize regulatory powers in the financial sector to achieve climate goals?

The Biden administration has indicated this is an area it wants to be quite aggressive on, marking the biggest shift this administration has taken on climate relative to previous Democratic administrations.

In May 2021, President Biden signed an executive order on climate-related financial risk that called for, among other measures:

  1. Greater climate risk disclosures
  2. The Treasury and other agencies to develop risk assessment and mitigation plans
  3. The Treasury and Financial Stability Oversight Council to analyze and make recommendations regarding climate-related risk to the country’s financial stability
  4. Updates to the Employee Retirement Income Security Act to include provisions to mitigate climate risks to federal employees’ retirements and pensions
  5. The Secretaries of Agriculture and Housing and Urban Development to explore integrating climate risk into financial underwriting

The executive order has already prompted action. Earlier this year, the SEC asked the public for comment on climate disclosures for public companies, and more recently asked public companies to provide investors with additional information on how climate change might impact their businesses. In late October, the Department of Labor issued a proposed rulemaking notice that would adjust how ERISA fiduciaries should evaluate climate and other ESG-related financial risks.

Much attention has been paid to Chair Powell’s renomination at the Federal Reserve as well as the nomination of Lael Brainard as Vice-Chair and additional vacancies. While inflation, tapering and tightening ramifications have dominated the discussion, the White House is also looking to create a package of nominees to the Fed that appeases both progressive and moderate Democrats. The requirement for 51 votes in the Senate will likely prevent the administration from nominating anyone too leftward on climate, but for the open Vice Chair for Supervision post, we anticipate the White House will appoint someone who sees a role for the Fed regulating banks on climate, and climate stress tests are already part of the dialogue. The New York Fed released a climate stress test procedure in September that could provide the Federal Reserve with a framework to implement climate stress tests.

A more climate-focused Fed could also require that future asset purchase programs include the consideration of climate risk that debt purchases could carry. That could preclude the Fed from purchasing certain municipal or corporate debt in the future that do not meet climate risk requirements.

The goal of applying such climate-related financial regulation is two-fold:

  1. To make it more expensive for banks to finance fossil fuel- and emissions-heavy projects, potentially by requiring greater leverage
  2. To make emissions and climate-risky businesses less attractive to investors by having companies spell out any physical risk from climate change (e.g., flooding) and transitional risk from changing consumer preferences and stranded assets.

Are there any concerns from among Democrats about the administration’s approach toward climate?

In the current environment of sticky inflation and rising commodity prices, there are definite political concerns. There’s a well-known inverse correlation between rising gasoline prices and a president’s approval rating – consumers are sensitive to the price they pay at the pump. That’s part of the reason why the administration, while pushing climate change mitigation, is also looking for ways to slow the rise in U.S. gasoline prices. Recent administration actions include announcing the U.S. would release 50 million barrels of crude from the Strategic Petroleum Reserve, asking OPEC to increase production and directing the FTC to investigate if oil & gas companies are colluding to keep gas prices high.

There is also a question of timing regarding the Democrats’ approach toward higher-priced fossil fuels and lower-priced renewables. How long will it take to build out an electric vehicle charging network? And with a more onerous fossil fuel environment, would that mean consumers would pay more for gas in the meantime? The same question applies to power generation – even with sizable tax credits, the U.S. electrical grid cannot transform overnight. Making natural gas more expensive via methane fees or higher royalty fees could translate into higher consumer and commercial electricity prices in the interim.

Consumer sensitivity to rising energy prices, on top of the record political volatility we’ve seen, also leads to questions around how likely the administration’s legislative and regulatory mechanisms will remain in place. Many of these measures are quite partisan, and we have seen how quickly a change in party can create a change in policy.

How long will it take to build out an electric vehicle charging network? And with a more onerous fossil fuel environment, would that mean consumers would pay more for gas in the meantime?

Are there any surprise winners you see from the Democrats’ climate goals?

One of our most out-of-consensus calls during the 2020 election was that large integrated oil companies might benefit from a more onerous policy environment for fossil fuels. We based this off what happened in 2009, when the big tobacco companies were in favor of greater regulation because it made it difficult for smaller companies to compete and shored up market share. By the same token, and based off smaller producers’ own admissions, a more onerous tax and regulatory environment would endanger their ability to compete with larger companies. This would give large companies the opportunity to take market share as well as benefit from lower supply and less competition, likely leading to higher profits.

There could also be a greater role for private companies in this environment. If the SEC moves forward with climate disclosure requirements on public companies, those companies may choose to spin-off fossil fuel-intensive segments, and others may choose to go – or remain – private. Similarly, if the Fed moves forward with climate stress tests on banks, private equity may fill that void for fossil fuel-intensive companies in need of financing.

Should the Democrats lose the House of Representatives in the midterm elections, what actions could they take outside of Congress to advance their climate agenda?

Without control of both the House and Senate, there will be virtually no pathway for Democrats to pass climate-related legislation. Regulatory and executive powers will be the only real power that Democrats can levy, though the long lead time for regulation, as well as the courts, would remain obstacles. More onerous regulations around power plant emissions and power sourcing and fossil fuel production, transportation and export – such as the EPA’s proposed methane rule – would all be on the table.

In February 2021, President Biden reinstated inflation-adjusted Obama-era numbers for the social cost of carbon – $51/ton, markedly higher than the $8/ton under the Trump administration – as well as for methane and nitrous oxide emissions. A working group is scheduled to evaluate and likely raise new numbers by January 2022. These values are used by regulatory agencies in cost-benefit regulatory analysis, so by reinstating – and possibly raising – these levels, it will be easier for the Biden administration to write climate-focused regulations with a favorable cost-benefit analysis.

Financial regulations will be important to watch regardless of what happens in the midterms. The Fed, Treasury, SEC and other regulators are expected to continue laying the groundwork for climate as a material financial risk requiring greater disclosures, risk mitigation and action from public companies and financial institutions. And while having the FTC review anti-consumer behavior by oil & gas companies might be a response to higher gas prices, it would not be surprising if antitrust and trade regulators serve a longer purpose, particularly regarding future M&A efforts.

What are some of the underdiscussed long-term trends in the renewable energy space from a policy perspective?

Policy permanency in the renewable energy, climate and overall energy space has long been a concern. The last three administrations have highlighted just how much policy can change with the party in power.

We’ll be watching to see how the industry engages in lobbying in the future and following a potential change of parties in power. Looking at the industry today, we see strong lobbying efforts from green energy companies for energy storage, electric vehicles with charging and alternative fuels, and to a lesser extent wind and solar. It will be interesting to see if those lobbying efforts grow or shrink, as engagement will be important to ensure policy certainty in a volatile Washington.

In addition, it’s important to keep in mind political factors unrelated to climate regarding green technology. Semiconductors and rare earth minerals are integral parts of green energy technology that have been swept up in the current geopolitical environment. Measures that impact these areas – like the U.S. Innovation and Competition Act (USICA), which would provide more than $50 billion in funding for U.S. semiconductor production – are important to monitor along with geopolitical events. Human rights issues with China could also impact green energy, as seen by the administration’s ban on solar imports from certain Chinese companies with links to Uyghur labor.

We would also emphasize that when looking at green energy investments, the companies that are often in ETFs and larger funds are not necessarily the ones that benefit from U.S. policy. That’s not to say these companies might not benefit from initiatives overseas, given the global climate push at play, but if investors are making decisions based off what they see in the U.S., there is some mismatch in terms of country domicile, labor usage and other factors they should be aware of.

What is the outlook for federal drilling permits and fracking in the current environment?

There was a lot of attention paid to the suspension of new oil & gas leases at the beginning of the year, an action the administration defended as keeping with its climate commitments. This suspension has run into issues with the courts, and though the administration is appealing the court ruling, it has proceeded with auctions on new lease sales. In fact, just days after COP26, the Interior Department put 80 million acres of the Gulf of Mexico to auction for new oil & gas leases, though less than 2 million acres were actually leased. New drilling permits on existing leases continued throughout the moratorium on new leases. We’ll have to see how the court case plays out: If the administration were to win its appeal, then a continued block on new leases is likely, though given the attention to higher gasoline prices heading into the midterms, drilling permits on existing leases will likely continue.

We do not expect any action to be taken on fracking on federal land at this time. Banning fracking entirely in the U.S. would require an act of Congress, an idea that did not have support even when oil prices were low.

How likely is it that the incumbent energy companies can evolve with the conversion to green energy – or are they destined to follow in the path of the coal industry?

The current global state of energy shortages and rising commodity prices is a good reminder that there is a long way to go before the U.S. or the world can move off fossil fuels. The Energy Information Administration predicts that U.S. consumption of petroleum and natural gas will increase through 2050 and remain the dominant sources of fuel generation. The trend toward renewable energy may be set, but traditional energy companies will have decades to evolve or develop new technologies. We are seeing deals within the space that indicate oil & gas companies are working to integrate emissions reduction technology and add renewables to their portfolio.

Be sure to also check out Part 1 of our conversation with Strategas on current Democratic legislation and its potential impact on the Energy sector