a laboratory of environmental innovation: states respond to Clean Air Interstate Rule

Peggy Duxbury, Calpine Corp.

The Clean Air Interstate Rule (CAIR) promises improvements to air quality and public health by requiring electric power generators to make further reductions in sulfur dioxide (SO2) and nitrogen oxides (NOx) within the eastern United States. The new regulations mean affected states must revise their existing state implementation plans (SIPs) and other rules in various ways, depending upon each state’s ambient air quality conditions. (See the map on page 56 for a state-by-state breakdown of these conditions.) One of the key options available to states is to achieve their reductions by participating in regional cap and trade programs. Through stricter caps and more robust trading, the Environmental Protection Agency’s (EPA) goal is to reduce emissions in the most cost-effective manner to society. The basic provisions of the CAIR were summarized in an earlier article. (See EL&P July/August 2005.)

States that choose to participate in the regional trading program must adopt new rules to regulate trading, most notably rules associated with allocation of NOx emission allowances to individual electric power generators. They have until Sept. 11, 2006, to submit their plans to EPA for review and approval. States will face some key challenges in the coming year regarding the design of the NOx allocation rules.

Unlike SO2 trading, where allocation methods are established through federal statute under the 1990 Clean Air Act, CAIR grants states tremendous flexibility in designing NOx emission allocation plans. This means EPA has given states a powerful policy option to ensure that their allocation design will complement other local energy and environmental goals.

Allocation methodology can be a brain numbing and complex policy challenge. Yet no design structure, except the emission cap, is more critical to the success of a cap and trade program than the design of allocation rules. Different allocation methods will not change the overall cap or the level of emission reductions achieved in a trading program, but its design structure will affect most-if not all-of the underlying energy or environmental goals of any emission-trading program. Certain allocation approaches can encourage energy efficiency and conservation, reward technology innovation, develop more renewable power or strengthen competitive wholesale power markets. Allocation decisions will also have a tremendous impact on individual companies and competitive positions among companies. This means that as state regulators begin to design their own rules, they will face many contentious and challenging policy choices.

States have two key resources as they develop specific rules. First, the EPA provided a model allocation option as one possible approach. (See Sections 96.142 and 96.345 of the CAIR rule.) Second, a menu of alternative options was developed by the State and Territorial Air Pollution Program Administrators and the Association of Local Air Pollution Control Officials (STAPPA/ALAPCO)-the two national associations of air pollution control agencies in the United States. (See STAPPA’s options, titled “Alternative NOx Allowance Allocation Language for the Clean Air Interstate Rule” at http://www.4cleanair.org/.)

EPA’s model option reflects the allocation approach that was proposed in the Bush administration’s Clear Skies legislation. In most cases, it allocates allowances based upon a generating unit’s historic heat input. That is, for all pre-2001 generation, if a unit accounts for 5 percent of the baseline heat input, it receives 5 percent of the allowances. When finalizing the CAIR, EPA added fuel weighting to the model formula, which essentially allows coal units more allowances over competing fuel sources such as oil or natural gas.

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For post-2001 units, the EPA model rule uses a modified fuel output-based approach and also allows for a modified baseline formulation for new combined heat and power (CHP) facilities. Also, there is a small new source set-aside that provides allowances for new units, starting at 5 percent per year for 2009, dropping to 3 percent in 2015. Finally, the baseline period for each facility is frozen, in perpetuity, regardless of plant retirements or other market changes.

In September, STAPPA released alternative NOx allowance approaches for states to consider. Its goal was “to present states with different options for allocating NOx allowances under the CAIR in order to help states and localities that wish to encourage the use of clean technologies by promoting generation and end-use efficiency, renewables and lower emitting technologies.” It also developed sample regulatory language and policy rational for its options. Among the key issues included in STAPPA’s list of options were fuel-neutral allocation, periodic updating of the baseline, broader use of output-based allocation and a larger new source set-aside.

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Most states are just starting to hold hearings and workshops on this issue as they prepare to meet next September’s deadline. One exception is Texas, where the state legislature acted soon after the CAIR was finalized, quickly adopting a new law that varies significantly from the EPA option. Under its new allocation law, Texas expanded the set-aside for new sources, allowed for periodic updating of allowance baseline and reduced the fuel weighting advantage for existing coal-fired units. Of these changes, the most notable was updating of the baseline. This means when old, higher-emitting units are shut down or otherwise go off line, they will not be granted allowances long after they’ve stopped operating. Texas’ departures from the EPA’s option reflects the state’s desire to further its competitive power markets, which have seen an addition of 25,000 MW of new generation in recent years.

Once implemented, there will be a hybrid of different NOx allocation approaches across the affected states. While such differences will not impact the key environmental goals established through CAIR, states will have the ability to customize their rules in ways that conform to their own unique priorities and market conditions. One of the more exciting outcomes from such diversity is that regulators, affected companies and other stakeholders will have a new laboratory of environmental innovation that will help everyone understand how emission cap and trade programs can be better refined to help further improve our nation’s air quality and public health.

Peggy Duxbury is vice president of Government & Environmental Affairs for Calpine Corporation. She can be reached at pduxbury@calpine.com.

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