Cap and trade may play a major role in the U.S. Environmental Protection Agency’s (EPA) recent proposal to cut carbon dioxide emissions from existing fossil-fueled electric generating facilities. On June 2, 2014, EPA issued a proposed rule under section 111(d) of the Clean Air Act that would establish state-by-state carbon dioxide emission-reduction targets for existing electric generating units (EGUs). Under the proposal, EPA establishes both an interim compliance period from 2020 through 2029, as well as a final performance level that must be met by 2030 and maintained thereafter. EPA projects that once all states meet their emission goals, the cumulative reductions will equal a 26 percent to 30 percent reduction from 2005 emission levels for the power sector by 2030.

To achieve each state’s reduction targets, EPA’s rule is encouraging states to develop or join existing regional carbon trading systems. This Reed Smith Client Alert provides background information on section 111(d), the state-by-state emission targets, and implications of the rule on cap-and-trade programs.

State Emission Targets

EPA proposes to allow states to achieve their emissions targets through a range of compliance options that include initiatives both “inside” and “outside-the-fence line,” i.e., initiatives beyond those directly affecting the power plant unit. In the draft rule, EPA established each proposed state goal by determining the “best system of emission reduction” for the state and utilities. In particular, EPA identifies four main “building blocks” or measures states can apply to achieve carbon dioxide emission reductions. The interesting thing about these building blocks is that only one “block” actually focuses on reducing stack emissions; the other three building blocks emphasize measures that reduce the demand for fossil fuels and measures that increase the efficiency of fossil fuel. Thus, it can be said there is an emphasis in the EPA proposal on renewable energy and energy-efficient improvements.

EPA Offers Flexibility to States

EPA provides the states with flexibility to achieve the targets. In the 645-page rule, EPA indicates that states may develop a compliance plan that includes a number of options. For example, proposed section 111(d) regulations set targets that are initially rate-based but allow for conversion of these rate-based targets to mass-based systems (the significance here being that only mass-based targets can be the cornerstone to a cap-and-trade system). EPA specifically highlights the Regional Greenhouse Gas Initiative (RGGI) and allows states to partner with each other and submit multi-state plans to reduce carbon dioxide emissions from the power sector.

Should Pennsylvania Join RGGI to Comply?

The existing northeast trading system is called the Regional Greenhouse Gas Initiative, or RGGI. RGGI bills itself as a “cap and invest” (as opposed to “cap and trade”) program. In so doing, it highlights the facts that RGGI states have chosen to auction the vast majority of CO2 allowances, and that states have by-and-large used the resulting proceeds to fund energy efficiency and renewable energy programs. RGGI credits this targeted investment of auction proceeds for much of its success in stimulating economic growth at the same time as it caps carbon emissions.

Under the proposed emissions rule, would there be an incentive for a state to join market-based trading programs such as RGGI? Put another way, is joining a trading regime the most cost-effective way for a state to comply with the emissions rule? Consider the case of Pennsylvania and RGGI. There are several reasons for Pennsylvania to consider joining RGGI:

(1) The scope of RGGI is “right.”

  • It covers just the electric utility sector, unlike AB 32 in California – which covers more than just the utility sector and could be complicated regarding section 111(d) compliance.
  • RGGI aims to reduce emissions through two channels: (1) measures that reduce the demand for fossil fuels, like energy efficiency and renewable energy investments; and (2) measures that increase the efficiency of fossil fuel generation, including retrofitting and switching more to natural gas. As discussed above, EPA is proposing to pursue a section 111(d) program that includes both of these channels.
  • Proposed section 111(d) regulations recommend targets that are either mass-based or rate-based. As a mass-based system itself, RGGI fits into those options as long as EPA allows mass-based approaches to comply with section 111(d).

(2) RGGI may offer cost-effective compliance for EGUs. Joining regional networks may be the easiest way to comply because, under these types of programs, utilities buy and sell emissions credits to meet targets for cutting emissions. As the pool of permits shrinks over time, emissions are reduced. At the same time, the utilities benefit from flexible “outside the fence line” compliance. Further, a regional compliance approach allows for regional averaging rather than requiring states (or each utility) to meet assigned limits individually.

(3) RGGI may offer incentive for renewables. RGGI has raised $1.6 billion to help pay for energy conservation and clean energy programs in its member states, mainly through auction of allowances. Structured properly, this revenue could benefit the renewable sector.

(4) RGGI may offer cost-effective SIP revision and program administration. Once this rule is finalized, states will have to develop State Implementation Plans (SIPs) that establish standards of performance for existing sources, and provide for their implementation and enforcement based on the emission guidelines. EPA then would approve or deny each SIP based on criteria set forth in the guideline document. If Pennsylvania joins RGGI – an existing system – it does not have to start from scratch for its SIP because the regulatory framework is, in effect, written. It would also get an extra year to submit its SIP. Further, if EPA would deny Pennsylvania’s SIP, it would not be alone in a challenge to EPA as other RGGI member states would have a strong interest in Pennsylvania’s SIP approval. Moreover, expanding RGGI could lead to efficiencies and a lesser burden on each state that is in the initiative. Also, similar to any cap-and-trade, mass-based system, RGGI’s “cap and invest” system has the advantage of simplicity of enforcement in that compliance can be measured through the overall number of allowances a source has, as compared with their reported emissions.

(5) Grid-wide compliance may make sense (and cents). Pennsylvania utilities are part of PJM, a regional transmission organization that primarily coordinates the movement of wholesale electricity (secondary responsibility of dispatching generating capacity on a lowest cost basis) in all or parts of 13 states and the District of Columbia, as are some other RGGI states (Maryland and until recently, New Jersey). If Pennsylvania utilities are producing/selling electricity across state lines in the PJM and other grids (and Pennsylvania is; Pennsylvania is the second-largest power producer in the nation (only Texas makes more electricity)), it makes sense that compliance is across state lines, allowing efficiencies to be gained by allowing a region to collectively achieve targets by locating cleaner generation where it is most cost-effective, and investing in energy efficiency anywhere within the region. Further, some experts suggest that 111(d) is a harbinger of a national network to come. If so, Pennsylvania utilities can “learn” early and be experts re compliance (and revenue stream maximization) if this system turns national.

However, there are several large reasons against joining:

(1) Is RGGI’s “cap” too tight? RGGI is on track to achieve regional emissions reductions of 50 percent below 2005 levels by 2020 (an achievement aided in part by the recession and low natural gas prices). This is more stringent than the proposed targets under 111(d): EPA projects that once all states meet their emission goals, the cumulative reductions will equal a 26 percent to 30 percent reduction from 2005 emission levels for the power sector by 2030. It is not clear if there is any advantage to overregulating the utility sector. Of course, a cap can be adjusted.

(2) Is cap and trade effective? Analysts say it is too soon to judge how well any U.S. trading programs are working. Emissions have dropped in general in the United States, in part because energy use declined in the economic slowdown and cleaner-burning natural gas has displaced some coal as an electricity source. Prices for the carbon credits have traded near the low price set up by administrators, an indication that the overall caps have been set too high to change behavior.

(3) Political hurdles? “Cap and trade” is such political anathema that it is the “compliance mechanism that shall not be named.” Gina McCarthy, the administrator of the EPA, said in announcing the proposed 111(d) rules that there are several options to reduce carbon emissions, but she didn’t use the term cap-and-trade – instead describing the idea as “multi-state market-based programs.” The interesting thing about cap and trade is that Republicans championed the approach decades ago then rejected it when President Barack Obama pushed it in 2009. True fact: A majority of governors who set up RGGI were Republicans. However, Republican opposition to the idea of cap and trade to comply with 111(d) is already becoming a theme in criticism by Republicans, who are reviving complaints that Obama’s plan is a “cap and tax” approach that would send electricity bills higher and hurt the economy. In a press statement, Gov. Tom Corbett expressed concern re loss of jobs under EPA’s proposal: "In Pennsylvania, nearly 63,000 men and women, including 8,100 miners, work in jobs supported by the coal industry… Anything that seeks to or has the effect of shutting down coal-fired power plants is an assault on Pennsylvania jobs, consumers, and those citizens who rely upon affordable, abundant domestic energy,"1 However, his position could change in light of recent polls that found that 72 percent of Pennsylvania voters favor EPA’s proposed limits on greenhouse gas emissions from coal-fired power plants.2 In fact, in April 2014, the Pennsylvania Department of Environmental Protection (DEP) submitted a white paper to the EPA, urging federal officials to consider state differences and needed-flexibility when developing 111(d) programs. In the white paper, DEP endorses regional programs, stating, “States must be allowed to join with other states in multi-state or regional programs.” Further, DEP gives a nod of approval to an emission allowance-based program at a state’s discretion as long as the allowance-based system has consistent quantification of emissions (to read the white paper, the Pennsylvania Department of Environmental Protection, and click on “Air,” then “Bureau of Air Quality.”).

(4) Does Pennsylvania need additional reductions? Even though about 40 percent of Pennsylvania’s electricity comes from coal-fired power plants, and the state is also the fourth-leading producer of coal in the nation, Pennsylvania carbon emissions in 2016 are expected to be 20 percent to 25 percent lower than 2005 levels in the electric generation sector as a result of plant retirements, reduced use of coal-fired generation, and more build-out of natural gas-fired plants, according to Vince Brisini, deputy secretary for the state Department of Environmental Protection’s office of waste, air, radiation and remediation.3 If such reductions bear out and all “count” in final 111(d) framework, Pennsylvania could meet the near-term 111(d) goals without doing much further.

(5) Higher cost to consumer? One of the strategies EPA describes in the proposed rule is the adoption of programs that “enhance the dispatch priority of … low emitting and renewable power.” This is an approach that that will no doubt result in increased energy costs since most low-emitting and renewable power options cost more per kilowatt hour. However, David Cash, commissioner of the Massachusetts Department of Environmental Protection, said the experience in the northeast shows that trading systems can help governments trim emissions without raising costs. Estimates predicted the carbon caps under RGGI would lead to a modest increase in electricity prices; instead bills have fallen by 8 percent. The enhanced dispatch authority provisions of the proposed 111(d) could eviscerate any savings for power produced in Pennsylvania under RGGI.

Legal Risks

It is too early in the rule-making process to say what a utility’s plan should be to comply with any regulations. However, what is clear is that each utility's actions will be dictated by the state's individual SIPs and the scope of each SIP is dependent on the 111(d) final rule. All potentially affected entities should review the proposed 111(d) guidelines in detail, comment where necessary, and have a clear view of how they want EPA’s final rule under 111(d) to provide for compliance flexibility.

Comment and Public Hearings. Comments must be received within 120 days of the proposed rule’s publication to the Federal Register. The deadline is unknown but likely to be in October 2014. EPA has also scheduled four public hearings to discuss the proposed rule, including a hearing in Pittsburgh July 31.

Submission of State Plans. EPA expects to issue the final rule in June 2015. States would then have until June 30, 2016 to develop plans for EPA approval. States that need more time to develop a complete plan and that meet particular criteria can submit an initial plan for EPA approval June 30, 2016, and request an extension until June 30, 2017 for a final plan. States joining together to develop multi-state plans can request an extension until June 30, 2018. Of course, legal challenges to the rule and state plans are likely and may result in an extension of this proposed schedule.