EPA Set to Unveil Climate Proposal

WASHINGTON—The Obama administration will next week unveil a cornerstone of its climate-change initiative with a proposed rule aimed at allowing states to use cap-and-trade systems, renewable energy and other measures to meet aggressive goals for reducing carbon emissions by existing power plants.

Energy companies and others affected by the proposal will be watching for key details, including the percentage by which companies and states must reduce carbon emissions, which is expected to be proposed in a range instead of a single number. The baseline year against which those reductions are calculated will also be closely monitored.

"A 25% reduction with a 2005 baseline might be business as usual," said Jason Grumet, president of the Bipartisan Policy Center, a policy research organization founded by former Senate leaders from both parties. "A 25% reduction with a 2015 baseline might make it impossible for some companies to operate."

But the proposal is designed to give states, which will administer the regulations, flexibility to meet the benchmarks, as opposed to placing emissions limits on individual plants, according to people familiar with the Environmental Protection Agency's work on the rule.

Central to the strategy of flexibility: the option to include a cap-and-trade component where a limit is set on emissions and companies can trade allowances or credits for emissions as a way of staying under different benchmarks the EPA sets for each state. Power-plant operators could trade emissions credits or use other offsets in the power sector, such as renewable energy or energy-efficiency programs, to meet the target.

The proposed rule is "going to enable states to move forward in a way that works best for them with the energy resources they have," said Dan Utech, special assistant to Mr. Obama for energy and climate issues.

Still, the June 2 release is likely to reverberate across the nation's political, legal and environmental policy landscape as competing interests debate the economic cost and the science of climate change. The EPA is scheduled to complete the rule by June 2015, and states must submit their implementation plans the following year, according to the timeline Mr. Obama set last summer. The likelihood of lawsuits and political opposition could upend this schedule.

This week, the U.S. Chamber of Commerce is expected to release a report estimating how much the EPA proposal could cost the U.S. economy, including its potential impact on gross domestic product and jobs.

The proposed rule would affect hundreds of power plants nationwide and is expected to be challenging for utilities with a large number of coal-fired generators, which the EPA says account for about one-third of U.S. greenhouse-gas emissions. Burning coal produces more carbon dioxide than oil and natural gas, but it is also the cheapest and most plentiful source for power, providing 40% of the nation's electricity.

Politicians from coal-producing states are likely to fight the proposal, as are power companies that burn coal and business groups that say the rule could increase costs. The proposed regulation could also create political difficulties for Democratic candidates running this year, including incumbents Rep. Nick Rahall of West Virginia, a top coal-producing state, and Sen. Kay Hagan of North Carolina, where energy already has emerged as a campaign issue.

Congressional Republicans and conservative groups have criticized cap-and-trade policies as "cap-and-tax," saying that if companies have to pay for emissions allowances, it amounts to a hidden tax on them, which could be passed to customers.

"The impact will not only be to greatly increase electricity rates, putting U.S. manufacturing at a competitive disadvantage, but [also to] jeopardize reliability of the nation's electric grid," said Hal Quinn, president and chief executive of the National Mining Association, a trade group representing coal-mining companies including Alpha Natural Resources LLC, Arch Coal Inc. and Peabody Energy Corp.

Aware of the controversy, one person familiar with the drafting of the rule said it would probably use the phrase "budget program," instead of the more politically charged "cap-and-trade," even though it will mean the same thing.

Aware of the political perils, last week 45 senators, including several Democrats up for re-election, sent a letter to EPA Administrator Gina McCarthy urging her to double the amount of time allowed for public comments, from two months to four.

In public speeches and in meetings with power-plant operators, state officials and environmental groups over the past year, Ms. McCarthy has emphasized that the rule will provide compliance flexibility for states and utilities.

Carol Browner, a former top energy and climate adviser to Mr. Obama and a former EPA administrator, said the rule would likely allow states and companies to join existing cap-and-trade systems, such as those used in California or the Northeast, or create new ones.

"For some companies and states, a trading program may make the most sense," said Ms. Browner, adding that they may choose to "create some new regional" trading systems in order to meet the carbon emissions standard set by EPA.

Some utilities supported cap-and-trade legislation that failed in Congress a few years ago because it was the most flexible way to cut emissions. The House of Representatives in 2009, controlled by Democrats at the time, passed cap-and-trade legislation but it ended up dying in the Senate in 2010 where criticism gained traction and scuttled the initiative even though Democrats were in the majority.

Nick Akins, CEO of American Electric Power Co. AEP +2.41% , whose generating capacity throughout the Midwest is roughly 60% coal, said in an interview that his company supported that bill because "it was a tradable activity that could occur that really answered the greenhouse-gas question in a cost-effective manner."

The new Obama initiative could also garner support from the company. "Any approach that includes flexibility, such as cap and trade, would be better than a prescriptive limit on unit emissions," said AEP spokeswoman Melissa McHenry. "But we'd have to see the approach before we could say whether or not we'd support it."

Experts representing coal interests and environmental groups said the regulation would likely reflect suggestions from a report by environmental advocacy group Natural Resources Defense Council. "The point of our analysis is to emphasize flexibility," said David Doniger, policy director of NRDC's climate center. "EPA sets the benchmark, but the states develop the plans."

—Alicia Mundy contributed to this article.

Write to Amy Harder at amy.harder@wsj.com