Baker & McKenzie Alert Climate Brief 28 September 2015 Download Forward Contact Us Visit Our Website — The Clean Power Plan: US EPA Sets First-Ever National Power Plant Carbon Standards to Address Climate Change and Expects Nationwide Trading to Emerge The U.S. Environmental Protection Agency (EPA) recently released the highly anticipated final Clean Power Plan aimed at reducing greenhouse gas emissions from existing fossil fuel-fired electric generating units (EGUs). As the first-ever national standards to address carbon dioxide from power plants, the Clean Power Plan, once implemented, will accelerate the transformation of the electricity system in the United States. While the precise nature of the Clean Power Plan's impact will be determined by the states, which have primary authority over its implementation, the Clean Power Plan will lead to increases in renewable energy development and natural gas-fired power utilization, largely to displace existing coal-fired electricity. A notable change from the proposed version of the Clean Power Plan is the degree to which EPA expressly embraces the use of market-based mechanisms, namely, emissions trading. Emissions trading is discussed favorably throughout the final version of the Plan and is the central feature of the simultaneously-released proposed Federal Implementation Plan (FIP) to accompany the Clean Power Plan. As a result, we expect many states to implement some level of emissions trading in an attempt to reduce compliance costs in meeting the EPA-set state targets. Below we provide an overview of the Clean Power Plan, the implications for emissions trading under state plans and the status of the rule and legal challenges. This brief is the first in a series of alerts analyzing the Clean Power Plan, legal challenges and the status of state implementation plans to be released jointly by Baker & McKenzie and Center for Climate and Energy Solutions (C2ES). I. Key Highlights in the Final Clean Power Plan In Baker & McKenzie's prior Clean Power Plan brief on the proposed rule, a general overview discussion of the Clean Power Plan was provided, including how it fits under the Clean Air Act. Please refer to the brief for further background discussion on the Plan. This brief describes the final Plan and highlights some of the more significant changes from the proposed Plan. In responding to the 4.3 million comments received over two years of outreach around the Clean Power Plan, EPA has made a number of changes, some of which will impact state implementation, and by extension, the business risks and opportunities throughout the electricity sector. In regulating carbon dioxide under Section 111(d) of the Clean Air Act, EPA is required to determine for the relevant affected sources CO2 emissions performance rates that reflect "the best system of emission reduction…adequately demonstrated" (BSER). In the final rule, EPA determined BSER for two categories of affected sources: 1) coal steam and oil steam plants; and 2) natural gas plants. EPA has interpreted BSER to be broad enough to include actions by the owner/operator of a stationary source that may occur off-site and actions that a third party takes pursuant to a commercial relationship with the owner/operator, which goes beyond the fence line of the affected sources to include the broader electricity system. Whether EPA will be afforded customary discretion in interpreting the statutory definition of BSER or be deemed to have abused its discretion in defining BSER in this manner will be the central issue litigated by opponents of the Clean Power Plan, and likely to be ultimately decided by the Supreme Court.i EPA determined each state's emissions targets by reference to certain "building blocks". In the final Plan, EPA refined building blocks #1 through #3 and removed building block #4 (energy efficiency). For building block 1 (improved efficiency at power plants), EPA changed the percentage of heat rate improvement to 2.1-4.3% (depending on the region) from 6% in the proposed rule. For building block 2 (shifting generation from higher emitting coal to lower emitting natural gas power plants), EPA assumed 75% of "net summer capacity factor" for natural gas units rather than assuming natural gas units could run at 70% of "nameplate capacity". For building block 3 (shifting generation to zeroemitting renewables), EPA did not include existing or under-construction nuclear plants or existing renewables but did include more use of new renewable energy based on updated information on cost of renewable technology. EPA now projects 28% renewable energy penetration by 2030 in the final Plan, up from 22% in the proposed Plan. These changes resulted in an overall increase in the emission reduction target to 32% below 2005 levels by 2030. From these building blocks, EPA derived carbon performance rates that were applied to affected sources in each state. Based on the results of this calculation, EPA established interim and final statewide goals for fossil fuel-fired electric steam generating units and natural gas-fired combined cycle generating units in three forms: • A rate-based state goal measured in pounds per megawatt hour (lb/MWh); • A mass-based state goal measured in total short tons of carbon dioxideii; • A mass-based state goal with a new source complement measured in total short tons of carbon dioxide. States then have wide latitude to develop plans to meet the state-specific targets set by EPA. States must meet interim targets between 2022 and 2029 and final target by 2030. States can either choose an "emissions standards" plan or a "state measures" plan. The emissions standards plan focuses on affected sources and requiring them to meet the rate- or mass-based goal. The state measures plan allows the state to rely on a mixture of measures involving sources beyond the affected power plants (e.g., renewable energy programs, residential energy efficiency). State measures plans are enforceable under state law. Because these measures are not included in a federal plan, a state measures plan must also include a federal backstop provision. The backstop provision would be federally enforceable against all affected power plants and triggered if the measures directed at nonaffected sources were ineffective. As a second significant change, EPA set mass-based targets in the final Clean Power Plan, which is expected to reduce the work load of any state seeking to implement a mass-based trading system. A mass-based target essentially converts the rate-based target into a fixed amount of tons of CO2 that the state then uses as its "cap" for a cap-and-trade program. The proposed rule included only a ratebased target, and many worried that the complicated process to translate a rate-based target to a mass-based target would inhibit otherwise interested states from adopting mass-based cap-and-trade programs. For some states, multi-state trading agreements are unrealistic in the short term. To address this, the final Clean Power Plan gives the opportunity for the state to design rate- or mass-based trading programs that are "trading ready" and would allow power plants to use out-of-state reductions without the need for up-front interstate agreements. Please see below for further details on the ability to use emissions trading programs in state implementation plans. States are required to submit initial state plans by September 6, 2016 or September 6, 2018, if an extension is requested by the state and approved by EPA. EPA will evaluate the state plans through a notice-and-comment rulemaking process. A proposed rule setting forth the FIP for states that do not submit plans to meet the targets was also released at the same time as the Clean Power Plan. The FIP will be open for comment for 90 days after publication in the Federal Register. II. Emissions Trading Takes Front and Center EPA's emphasis of the use of emissions trading as a preferred means of compliance for affected sources is noteworthy in the final Plan. EPA established mass-based state targets, developed proposed model trading rules and, in general, was explicit in its support of emissions trading programs. EPA states that it "anticipates the use of emission trading in state plans, given the advantages of this approach and comments suggesting a high degree of interest on the part of the states, utilities and independent power producers in the inclusion of emission trading in state plans." Final Clean Power Plan (pre-publication version), p. 885. EPA sees the advantage of a trading program in setting short-term and long-term price signals that encourage the most efficient means of achieving the emissions standard. States establishing either a rate-based or mass-based "emissions standards" plan may incorporate the use of emissions trading. A mass-based trading program is viewed as easier for states to implement and administer as renewable energy and energy efficiency measures are much easier to account for. For states implementing a mass-based emission standard plan, EPA expects a trading program to be created "as it would maximize compliance flexibility for affected EGUs and enable the state to meet its mass goal in the most economically efficient manner possible." Final Clean Power Plan (pre-publication version), p. 892-893. Trading programs may also be instituted by states opting for the "state measures" approach. Along with a cap-and-trade program, a state measures plan may also include other options like renewable portfolio programs and utility-administered incentive programs for renewable energy and energy efficiency. Trading programs under a "state measures" plan would be along the lines of California's cap-and-trade program or the Regional Greenhouse Gas Initiative. Notably, in the proposed FIP, EPA is proposing that a rate-based or mass-based emissions trading program would be implemented. The FIP also contains elements of model trading rules that states can adopt or tailor for implementation of the Clean Power Plan on their own. States may implement the model trading rule set forth in the FIP; such a state program would be presumptively approvable by EPA. EPA "strongly encourages" states to adopt one of the model trading rules to ensure consistency between and among state programs and create a broad trading program. The model trading rules involve standard emissions trading elements--setting an emissions budget; distributing allowances; and allowing transfer, purchase and sale of allowances on the open market. The model rules for the mass-based program also contain three proposed set-asides (i.e., allowances removed from the state budget). One set-aside is for the Clean Energy Incentive Program (CEIP). To address emissions "leakage" from the future development of new NGCC units not subject to the Plan, two additional set-asides are proposed to support renewable energy projects and existing NGCC units. These set-asides are viewed as a means to approximate equivalence between BSER under the ratebased system (which does not require set-asides) and the non-mandated option to choose a massbased approach under which a state does not voluntarily cap new sources. Under the optional massbased approach, EPA is concerned that states and operating entities may focus on new NGCC construction and/or additional dispatch over existing generation to avoid coverage under the Plan. EPA intends to set up and administer a system to track emissions, allowances and credits to help implement multi-state trading programs. We expect some states to join with other states in a multistate plan and others to design a program so they are "trading ready" and able to utilize out-of-state reductions even if formal agreements are not in place between the states. States may also simply opt to adopt the federal plan as set forth in the FIP and not develop their own plan. States may also adopt the model trading rules (or a version thereof) and affected EGUs in such states could trade with affected EGUs in other states that are linked to the federal program either by adopting the FIP, adopting the model trading rules or having an approved, harmonized state plan. States implementing a "state measures" approach may incorporate by reference the model rule as a backstop to the state plan. In short, EPA has provided a virtual buffet menu of options for states to encourage emissions trading. The comment period on the FIP will be 90 days after publication in the Federal Register. EPA is intending to finalize the FIP and model trading rules by summer of 2016. EPA is taking comment, among other things, on which type of trading program (rate-based or mass-based) to implement. III. Incentive Program for Early Renewable Energy and Energy Efficiency In the final Clean Power Plan, EPA is proposing the CEIP to encourage early investment in wind and solar renewable energy and demand-side energy efficiency projects in low-income communities that commence after the submission of a state plan but prior to 2022. Participation in the CEIP is optional. In the CEIP, a state would set aside allowances from the interim plan performance period (if using a mass-based approach) or may generate bonus reduction credits (ERCs)(if using a rate-based approach) from future years and allocate these to eligible projects. EPA will match state-issued ERCs or allowances up to a total amount equal to 300 million short tons of CO2 emissions with the pool reserved for wind and solar and energy efficiency projects in low-income housing. Renewable projects would receive 1 credit for 1 MWh of generation (1/2 credit from the state and 1/2 credit from the EPA) and eligible energy efficiency projects would receive 2 credits for 1 MWh of avoided generation (one credit from the state and one from the EPA). EPA is not requiring such projects to demonstrate that they are "additional" to business-as-usual in the state. Projects would be eligible for credits for generation or electricity savings that occur in 2020 and/or 2021. Before finalizing the CEIP, EPA is planning on engaging states and stakeholders to discuss further implementation details of the program. As the CEIP progresses, renewable energy developers and energy efficiency providers should consider the implications of the program from a contractual standpoint. Any projects developed prior to 2020 (and after a final SIP) would notionally be eligible to generate credits under the program starting in 2020. Developers will want to ensure that their PPAs are clear on which entity owns the future ERCs/allowances, avoid generic "all attributes" clauses and/or seek to establish an independent value or price for such to-be-generated early action credits. Developers and offtakers will also want to seek clarity on whether such early action credits under the Clean Power Plan are separable and distinct from RECs created under existing and future state-based RPS programs, and contract accordingly. In addition, given uncertainties that may exist at the time eligible projects are developed, contracting parties may seek to create optionality in their trading agreements related to such early action credits. Parties will want to carefully consider such embedded optionality to determine whether it subjects such transactions to regulation by the CFTC. IV. Pre-Publication Clean Power Plan Already Subject to Legal Challenges The final Clean Power Plan is a pre-publication version, and while signed by EPA Administrator McCarthy, the rule has not been published in the Federal Register. iii According to the Clean Air Act, rules are not final unless published in the Federal Register and thus are not "final agency action" and subject to judicial review. Nonetheless, multiple legal challenges commenced upon the release of the rules with many more to follow upon the rule's official publication. After the release of the final Clean Power Plan in prepublication form, sixteen states filed an Emergency Petition under the All Writs Act in the D.C. Circuit seeking an order to stay the deadlines in the final Clean Power Plan due to alleged irreparable harm suffered by petitioners. Peabody Energy also renewed its previous writ filed in August challenging the authority of EPA to issue the rule, which was consolidated with the state's petition. The cases were both dismissed by D.C. Circuit on September 9, 2015. The one-paragraph order stated that the petitioners failed to satisfy the stringent standards that apply to petitions for extraordinary writs that seek to stay agency action. The D.C. Circuit also denied similar lawsuits in August 2014 (the Murray Energy and West Virginia cases), which sought judicial review of the proposed Clean Power Plan rule. Those cases were dismissed because the rule had not yet been finalized. These cases are the first of what is expected to be persistent and sustained legal attacks against the Clean Power Plan. While these recent cases suffer from jurisdictional issues, once the Clean Power Plan is published in the Federal Register, those issues are resolved. Upon publication, lawsuits will be immediately filed in the D.C. Circuit, likely alleging EPA overstepped its authority in regulating CO2 because power plants are already regulated under Section 112 of the Clean Air Act and EPA inappropriately defined BSER to encompass the entire electricity system. All of these issues will take time to be resolved by the courts. In the meantime, many states, including those that are challenging the rule, will continue to develop state implementation plans or consider the FIP to manage losing ground against the September 2016 deadline in the probable event the rule remains in place. V. Next Steps This brief is the first in a series of publications analyzing the Clean Power Plan, legal challenges and the status of state implementation plans to be released jointly by Baker & McKenzie and C2ES. Our next Clean Power Plan brief will focus on the underlying legality of the Clean Power Plan and discuss the arguments that will be put forth by opponents and proponents of the rule. _________________________ i For a discussion of the current legal posture of the Clean Power Plan, see the discussion in Section IV of this brief. ii A mass-based target essentially converts the rate-based target into a fixed amount of tons of CO2 that the state then uses as its "cap" for a cap-and-trade program. iii The final Clean Power Plan is effective 60 days after publication in the Federal Register. 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