Beyond CAIR: EPA Proposes Tough New Transport Rules

August 3, 2010

On Aug. 2, 2010, EPA published in the Federal Register (75 Fed. Reg. 45209) its proposed rule to reduce the interstate transport of nitrous oxides (NOx) and sulfur oxides (SOx) from electric generating units (EGUs) in order to eliminate the “significant contribution to” nonattainment and maintenance of small particles and ground level ozone ambient air quality standards in downwind states. EPA’s proposal, dubbed the “Transport Rule,” is intended to replace is prior transport rule, the Clean Air Interstate Rules (CAIR), key elements of which were struck down by the D.C. Circuit Court of Appeals in North Carolina v. EPA, 550 F. 3d 1176 (D.C. Cir 2008).

Like CAIR, the Transport Rule generally provides for significant reduction in emissions of NOx and SOx from EGUs generally in states east of the Mississippi. Unlike CAIR, it largely eliminates interstate emissions trading, but attempts to replicate the economics that interstate trading would have provided by using dollars per ton cost levels to allocate allowances at the unit level.

In overall structure, the Transport Rule is similar to EPA’s NOx SIP call rules and CAIR. EPA sets budgets which limit NOx and SOx emissions from each of the target states. To implement these budgets, EPA will issue allowances which authorize facilities to emit specific amounts of NOx and SOx in a given year. At the end of the year, the facilities must document that they possessed sufficient allowances to cover their actual emissions or face penalties if their allowances do not match their emissions.

In its details, however, the Transport Rule is far different. First, instead of directing the states to prepare State Implementation Plans (SIPs) to document how the states will implement the program, EPA will issue Federal Implementation Plans (FIPs) to each of the states to establish that state’s emission control program. Second, instead of having the state allocate allowances among the units within the state, EPA’s proposal describes how EPA will allocate allowances directly to individual units. Because the initial compliance date is in 2012, EPA’s allocation will remain in effect unless a state opts to reopen the issue and propose a different allocation through a SIP.

In general, the Transport Rule’s emissions levels are somewhat more stringent than CAIR’s. EPA will issue four sets of allowances for each of the EGUs in the state: (1) SOx allowances for the 13 states which require aggressive SOx reductions (Group 1 states); (2) SOx allowances for the remaining non-Group 1 states (Group 2 states) with less aggressive SO2 reductions; (3) annual NOx allowances; and (4) seasonal NOx allowances.

The compliance date for the four caps associated with the above allowances is 2012, except that Group 1 states will have a second and tighter cap for SO2 that comes into place in 2014. Unlike CAIR, there is only a single NOx compliance date (2012), although EPA acknowledges that it must complete additional modeling to determine if some states will require a second NOx cap to eliminate their significant contribution to downwind nonattainment or maintenance.

EPA’s proposal is both complex and lengthy as EPA strives to address the primary issues raised by the D.C. Circuit’s opinion in North Carolina. To address the court’s concerns that the Clean Air Act (CAA) requires EPA to eliminate all upwind states’ “significant contribution” to downwind states’ nonattainment and maintenance issues, EPA developed a new rationale for creating state emissions budgets. EPA did so by tying the amount and timing of emissions reductions more closely to the levels necessary for downwind states to achieve attainment in ways that combined economics and air quality considerations.

EPA uses air quality modeling combined with an economic evaluation of available cost per ton reductions in NOx and SOx to identify the significant contributions by individual upwind states to downwind non-compliance and the size of the reduction in emissions necessary to address that contribution. Armed with this information, EPA establishes a state-by-state budget for each of the air quality standards.

To address the court’s concern with emissions trading, EPA adopts a very conservative approach that severely restricts interstate trading and proposes two even more conservative alternatives. EPA’s proposal limits interstate trading from sources within a given state to 10% of that state’s annual emissions budget on a yearly basis, and about 6% of that state’s emissions budget on a three-year rolling average basis. EPA argues that “emissions variability” (i.e., the normal variability of state emissions from year to year) allows sources to trade allowances roughly equal to variability and still meet required statewide emissions reductions.

To implement the trading approach, EPA includes “assurance provisions” to ensure that if state budgets are exceeded, EPA can force individual EGUs responsible for the exceedence to surrender double allowances as a sanction. Notably, EPA will not implement the assurance provisions until 2014, thereby allowing unfettered trading in 2012 and 2013. EPA states that it expects very limited trading during these years due to the unit level allocations.

EPA’s trading restrictions effectively eliminate trading as a compliance option for sources. Since interstate trading can provide no assurances that sufficient allowances will be available from year to year, it cannot be relied upon as a compliance strategy. Trading will be used, and useful, for sources that need some allowances to “trim” their compliance strategy. While intrastate trading is allowed without restriction, it is doubtful that there will be a real intrastate trading market of any consequence.

The aspect of the Transport Rule that is the least discussed by EPA is also its most important: EPA’s methodology for developing unit level allocations. EPA opted to “push down” to the unit allowance allocation level the basis for developing the state budgets. Since EPA developed the state budgets largely using cost curves, EPA’s unit allocations are also based roughly on levels of reductions that can be achieved at certain dollar per ton levels. Using such cost metrics, EPA’s unit allocations provide a level of allowances for currently controlled (or planned to be controlled) units that reflect the units emissions if the emission controls were operating.

In turn, for units that have no planned controls, the allowance allocations will tend to reflect something like actual 2009 emissions. EPA’s assumptions about which units are or will be controlled in 2012 include units with controls for CAIR, units with announced plans for controls, as well as units expected to install controls under state regimes or NSR settlements. EPA similarly applies a higher dollar per ton threshold to develop the 2014 SO2 unit level allocations for Group 1 states, which results in 14 GW of additional FGD added, presumably to the most “cost effective” remaining uncontrolled units. This approach contrasts sharply with EPA’s traditional approach of allocating emission reduction requirements among units on a rough “per share” basis using different metrics.

In this fashion, EPA has roughly duplicated cap and trade economics on an industry-wide basis. Notably, this allocation methodology will ensure a very limited in-state trading program, since units with FGD or SCR systems which would typically be “over controlled” relative to allowance allocations under CAIR are no longer over controlled and have few or no excess allowances to sell.

In general, this is a good result for industry as a whole, and protective of small and older coal units. Yet, there will be individual winners and losers under this approach, such that the power sector might split on whether it finds the proposal acceptable. Similarly, environmental groups, which were counting on a restricted trading regime to force the shut down of older and smaller coal plants, will be disappointed and may challenge EPA’s unit allocation methodology.

EPA plans to hold three hearings on the proposal before the comment period ends Oct. 1, 2010.

For additional information, please contact the authors or see our Clean Air Practice.