On July 11, 2008, the U.S. Court of Appeals for the District of Columbia Circuit issued a landmark decision in State of North Carolina v. EPA, No. 05-1244 and consolidated cases, a diverse set of challenges to U.S. EPA’s Clean Air Interstate Rule (CAIR). CAIR was a regional cap-and-trade program governing emissions of sulfur dioxide (SO2) and nitrogen oxides (NOx) from electric generating units (EGUs) in the eastern half of the country.

The court vacated CAIR in its entirety, reading the underlying provision of the Clean Air Act (CAA) in a fundamentally different way than EPA had. The court’s reading, if left standing, would limit severely EPA’s ability to approve or promulgate a regional cap-and-trade program satisfying the CAA requirement that each upwind state must prevent its sources from “contributing significantly” to nonattainment of National Ambient Air Quality Standards (NAAQS) in downwind states. The decision did not address, however, EPA’s more general power to approve or promulgate a regional cap-and-trade program as a useful or authorized measure in the drive for attainment and maintenance of NAAQS.

Background

Section 110 of the CAA, 42 U.S.C. §7410, requires each state to develop and obtain EPA approval of a “state implementation plan” (SIP) to attain and maintain air quality at or better than each NAAQS. If a state fails to do that on time, EPA is required to promulgate federal rules to fill the gap.

Section 110 lists all of the necessary components of fully approvable SIP. Section 110(a)(2)(D)(i) calls for adequate measures “prohibiting … any source or other type of emissions activity within the State from emitting any air pollutant in amounts which will … contribute significantly to nonattainment in, or interfere with maintenance by, any other state with respect to any [NAAQS]….”

In 2005-06, EPA promulgated CAIR as a measure that eastern states could adopt to satisfy their SIP-planning obligations under section 110(a)(2)(D)(i) with respect to the PM2.5 and ozone NAAQS that were in effect at that time. See, e.g., 70 Fed. Reg. 25162 (May 12, 2005). EPA had determined through modeling that sources within those states were contributing materially to nonattainment problems in downwind states. Furthermore, emboldened by the D.C. Circuit’s seemingly favorable treatment of CAIR’s forerunner (i.e., the “NOx SIP Call” cap-and-trade program) in Michigan v. EPA, 213 F.3d 663 (2000), EPA had interpreted section 110(a)(2)(D)(i) as embodying a “good neighbor” principle. The principle was that states contributing materially to nonattainment problems in other states could satisfy their section 110(a)(2)(D)(i) obligation by participating in a cap-and-trade program designed to assure the application on average of “highly cost-effective” control technology to relevant sources in applicable states.

Subsequently, EPA and eastern states treated CAIR as the cornerstone of SIP planning for the PM2.5 and ozone NAAQS, as well as the CAA’s program to abate regional haze. The Bush Administration regarded it as the centerpiece of its efforts to administer the CAA in a cost-effective manner, along with a national capand- trade program aimed at EGU mercury emissions known as the “Clean Air Mercury Rule” (CAMR), which the D.C. Circuit recently vacated on unrelated grounds. Cap-and-trade and other market-based programs are widely regarded as more cost-effective than source-by-source “command-and-control” regimes.

The Decision

The State of North Carolina petitioned the D.C. Circuit to review CAIR. In broad outline, the state saw CAIR as not sufficiently protective of air quality in the state. One argument North Carolina made was that: (i) section 110(a)(2)(D)(i) requires each upwind state to have a SIP that assures the actual elimination of any material contribution to downwind nonattainment; yet (ii) CAIR fails to assure such elimination because a source in an upwind state could purchase allowances from a non-contributing source in another state without reducing emissions at all. More concretely, according to North Carolina, CAIR made it possible for an EGU in Alabama or Georgia to continue to send PM2.5 and ozone precursors into the state, actually exacerbating existing or projected nonattainment problems, even though the EGU fully complied with CAIR by securing and retiring a sufficient number of allowances.

The three-judge panel agreed unanimously, saying:

Because CAIR is designed as a complete remedy to section 110(a)(2)(D(i) problems …, CAIR must do more than achieve something measurable; it must actually require elimination of emissions from sources that contribute significantly and interfere with maintenance in downwind nonattainment areas. … Otherwise the rule is not effectuating the statutory mandate of prohibiting emissions moving from one state to another, leaving EPA with no statutory authority for its action. (emphasis added)

Applying this test, the court found that EPA failed to connect states' emission reductions to any measure of their significant contributions to air quality in adopting CAIR. Instead, the court held, EPA based the stateby- state emission caps on "irrelevant factors" like the convenient existence of Congress' acid rain caps and EPA's own "notion of fairness." The court reasoned that these factors had nothing to do with the states' obligations to prohibit significant contributions to downwind air quality, as required by Congress. Thus, in vacating CAIR, the court found the "EPA must redo its analysis from the ground up."

This will not be an easy task. It requires good emissions and air quality data, good air quality models, and good scientific analysis, among other things. In reviewing the record of just one piece of such an analysis— the actual rather than assumed emissions from several plants in Minnesota—the court held that EPA had failed to respond to factual comments submitted by one utility and remanded that part to EPA to respond to the facts in the record. EPA would need to duplicate, broaden and multiply its Minnesota analysis by hundreds of times in order to justify a single, regional rule like CAIR under section 110(a)(2)(D)(i).

The court also held that EPA would have to find proper authority in the Clean Air Act for a regional capand- trade program rather than "tampering unlawfully" with the acid rain program. The court did not accept EPA's appeal to "logic" in building the CAIR allowances from the acid rain allowances: "Lest EPA forget, it is 'a creature of statute.'" The court emphasized that EPA has "only those authorities conferred on it by Congress." Thus, EPA has no authority to discount or eliminate acid rain allowances.

Regarding these flaws, along with others, as fatal, the court decided to vacate the entire rule. Given that the flaws were “deep,” the court opined that "no amount of tinkering" would make CAIR an acceptable rule under section 110(a)(2)(D)(i).

Observations

This is a dramatic and sweeping outcome, obliterating CAIR altogether. The court’s emphasis on actual “elimination of emissions from sources that contribute significantly … in downwind nonattainment areas” throws great doubt on whether a regional cap-and-trade program could ever satisfy section 110(a)(2)(D)(i).

But this dramatic outcome should not obscure the reality that Congress expressly authorized—indeed, required—EPA to approve a regional cap-and-trade program endorsed by states to promote attainment and maintenance of NAAQS. Section 110(a)(2)(A) calls for each SIP to include such control measures, “including economic incentives such as fees, marketable permits, and auctions of emission rights …,” as are necessary to assure attainment and maintenance and satisfy other specific requirements.

The heart of a cap-and-trade program is marketable permits. This means CAIR might have survived D.C. Circuit review if EPA had rooted it in section 110(a)(2)(A), as opposed to section 110(a)(2)(D)(i). Of course, the need under section 110(a)(2)(D)(i) for source-specific controls to eliminate “significant contribution” to downwind nonattainment might reduce the ability of a regional cap-and-trade program to yield the least possible cost for a given control level. Still, the North Carolina decision does not remove regional cap-andtrade programs entirely from the tool box of air pollution control authorities under the Clean Air Act.

Moreover, while the panel in North Carolina retrenched substantially on the import of the earlier Michigan decision, it re-embraced the holding in Michigan that costs are a factor that EPA and the states may take into account in deciding how much additional emissions control on a particular source would render its contribution insignificant. This means, at the least, that the controls required by section 110(a)(2)(D)(i) must be achievable—both technologically and economically.