Unlearned Cap-and-Trade Lessons: EPA’s Problematic Cross-State Air Pollution Rule
On August 8, 2011, EPA published the Cross State Air Pollution Rule (CSAPR) in response to the court decision, North Carolina v. EPA, 531 F.3d 896 (D.C. Cir. 2008), which vacated the Clean Air Interstate Rule. But instead of building on the lessons learned of successful programs, the rule makes so many changes to the cap-and-trade provisions that pollution reduction is in real doubt. Moreover the changes are so extensive that reliability impacts are possible.
The rule requires 23 states to reduce annual SO2 and NOx emissions to help downwind areas attain particulate matter and ozone ambient air quality standards. This rule replaces EPA’s 2005 Clean Air Interstate Rule with three different cap programs.
A 2012 annual SO2 cap is set at 3,385,929 tons as compared to the recent (average 2008 to 2010) emissions of 5,216,931 tons. There is a 2012 annual NOx cap set at 1,245,869 tons compared to the recent emissions of 1,595,756 tons.
Finally, EPA established a 2012 Ozone Season NOx cap 495,314 tons compared to recent emissions of 566,363 tons. In all three programs there is another round of reductions in 2014.
According to EPA, Cap and Trade is a market-based policy tool for protecting human health and the environment. A cap-and-trade program first sets an aggressive cap, or maximum limit, on emissions. Sources covered by the program then receive authorizations to emit in the form of emissions allowances, with the total amount of allowances limited by the cap. Each source can design its own compliance strategy to meet the overall reduction requirement, including sale or purchase of allowances, installation of pollution controls, implementation of efficiency measures, among other options.
Individual control requirements are not specified under a cap-and-trade program, but each emissions source must surrender allowances equal to its actual emissions in order to comply. Sources must also completely and accurately measure and report all emissions in a timely manner to guarantee that the overall cap is achieved.
Unfortunately, there are significant problems with CSAPR cap and trade. EPA’s approach is completely dependent upon electrical generating system modeling analyses. The methodology used to calculate the cap is markedly different than any used previously. The stringency of the reductions proposed is more stringent than likely possible and is remarkable for the time frame required. Previous programs phased in compliance with the allowance budget whereas CSAPR does not.
The Integrated Planning Model (IPM) is used by EPA to analyze the projected impact of environmental policies on the electric power sector in the 48 contiguous states. IPM is a proprietary multi-regional, dynamic, deterministic linear programming model of the U.S. electric power sector. It provides forecasts of least-cost capacity expansion, electricity dispatch, and emission control strategies for meeting energy demand and environmental, transmission, dispatch, and reliability constraints. Because the model cannot include all real-world unit-specific constraints there are significant issues related to a general model’s predictions of unit-specific operations, controls and emissions.
CSAPR calculated the caps differently than past practice. The allowance caps in earlier cap and trade programs were calculated by determining an overall emission rate that could be achieved and calculating the allowance budgets based on historical operations. For CSAPR, EPA relied on modeling analyses that accounts for both “highly cost-effective” controls per IPM and air quality improvements necessary to limit state impacts on other states from a simple air quality impact model. EPA estimated potential direct “cost-effective” control efficiencies for all affected units, adjusted for impacts, and totaled the resulting unit emissions to get a state cap.
Because the caps were calculated based on the model projections of individual units and the model does not incorporate specific site-specific constraints, the calculated cap is likely more stringent than actually possible. As a result, this is a direct control approach masquerading as cap-and-trade.
The implementation schedule is another ramification of the new approach. EPA’s modeling presumed that sources that have control equipment installed that was not operating at the levels the generic model assumed were possible, would be able to simply operate at the more stringent levels by throwing a switch.
In addition, EPA has assumed that the sector will “take advantage of the substantial new pollution control technology that is already on the way for deployment by 2012.” In both cases, dependency on a generic model’s estimated unit-specific control implementation capabilities probably over-estimates the ability of sources to reduce emissions starting in a few months.
One of the bigger problems with the rule is that there are no provisions to ease into the program. In previous programs banking and early reduction options provided early benefits and flexibility for sources to comply with the rule and implement the control strategies necessary for long-term compliance. In the proposed rule, EPA permitted the use of allowances from previous programs for compliance. Ignoring the lessons learned from previous programs, CSAPR eliminated that provision entirely rather than including a phase-out of those allowances.
There also is a presumption that the allowance trading market will be robust and efficient. The projected margin between emissions and allowances will be tight so the market may not have many allowances available. While on one hand EPA’s rule discourages allowance trading between states, within states the unit allocations are determined by historical operations, not historical emissions.
As a result more trades will be required within states and that will increase transaction costs and also decrease allowances available. In addition, even though EPA cap and trade programs have been in place since 1995, because much of the previous trading was done within company systems and the margins were not as tight, there is not as much experience with trading as a compliance option as one might expect.
Lastly, there are also reasons while companies with surpluses might not trade, e.g., due to uncertainties in a regulated environment or future requirements. As a result the presumption that the allowance market will be robust and efficient could be a stretch.
The result is a cap and trade program that could run out of available allowances for compliance. If a source fails to have appropriate allowances in its account at the compliance date, then the penalties are severe. They must provide — for deduction by the Administrator from the source’s compliance account — one allowance as an offset, and one allowance as an excess emissions penalty, for each ton of emissions (i.e., excess emissions) in excess of the amount of allowances held. The offset and the excess emissions penalty are automatic requirements in that they must be met without any further action by EPA (e.g., any additional proceedings) regardless of the reason for the occurrence of the excess emissions.
In addition, each ton of excess emissions, as well as each day in the averaging period (i.e., the control period of one calendar year), constitute a violation of the CAA, and the maximum discretionary civil penalty is $25,000 (inflation-adjusted to $37,500 for 2010) per violation under CAA section 113. Therefore, any source that continues to operate after it exceeds the number of allowances it has on hand is taking an enormous risk. The only alternative available then is for the unit to shut down. But if enough units become unavailable, reliability issues could arise.
In summary, the CSAPR cap-and-trade program ignores the key lessons learned that EPA described as components of successful cap and trade programs. The hopes and aims (in black) must be tempered by reality (in blue):
- Because cap and trade costs less than direct control, EPA can pursue more substantial reductions than would otherwise be attainable.
The CSAPR budget allocation methodology determined maximum potential direct control emissions all the while assuming that additional reductions would occur because this is a “cap and trade” program.
- Greatest reductions have occurred where emissions are highest.
The most effective dollar per ton reduced decreases occur where emissions are highest so this should occur for CSAPR.
- Trading provides regional emissions reductions which can be augmented by local direct controls.
CSAPR allocation methodology used direct local controls to determine the regional emission reductions.
- Caps, not allocation methodology, protect the environment.
The allocation methodology established the cap.
- Accountability and transparency are keys to program success and acceptance.
Given the significant differences between the draft and final rules, one could argue that accountability and transparency have been compromised.
- “Banking” enables early emission reductions, providing early benefits and flexibility for sources and reducing costs.
There are no provisions for early emission reductions which eliminates early benefits and flexibility.
- Virtually 100% compliance is possible.
Unfortunately 100% compliance may only be possible if sources stop operating when their emissions exceed the allowances the source has on hand and can reasonably be expected to purchase in the allowance market.
- State and pace of controls is important, especially to see cost advantages.
The stringency and pace of controls in this rule significantly reduces cost advantages relative to command and control rules.
Mr. Caiazza is a meteorologist (BS and MS degrees) who has worked in the air quality field for over 35 years, first as a consultant to EPA and then with an electric utility. In the latter capacity, his time was spent about equally doing regulatory analysis of air quality regulations and initiatives and doing day-to-day compliance work for cap-and-trade programs.
He is currently Director of the Environmental Energy Alliance of New York, which supports the electric companies of New York State by addressing regulatory and industry policy issues that are most effectively approached on a statewide basis.
This analysis does not reflect the position of any of his employers either present or past nor do they reflect the position of Environmental Energy Alliance of New York member companies.