How Environmental Laws Work:\
An Analysis of the Utility Sector's Response to Regulation of Nitrogen
Oxides and Sulfur Dioxide Under the Clean Air Act

Published at 14 Tulane Environmental Law Journal 309 (Summer 2001)

Byron Swift

Environmental Law Institute[^1]

[I. Introduction 312](#i.-introduction)

[A. Methodology 313](#a.-methodology)

[B. Background of Title IV 314](#b.-background-of-title-iv)

[II. Regulatory Program for Sulfur Dioxide (SO~2~)
315](#ii.-regulatory-program-for-sulfur-dioxide-so2)

[A. Background and History of SO~2~ Regulation: Traditional Rate-Based
Standards
316](#a.-background-and-history-of-so2-regulation-traditional-rate-based-standards)

[B. Title IV 319](#b.-title-iv)

[C. Industry Response 322](#c.-industry-response)

[1. Price Signals, Coupled with the Flexibility of Title IV, Drove Major
Shifts in Businesses' Compliance Strategy
323](#price-signals-coupled-with-the-flexibility-of-title-iv-drove-major-shifts-in-businesses-compliance-strategy)

[2. Over-Compliance and Banking 325](#over-compliance-and-banking)

[3. Autarkic Compliance 327](#autarkic-compliance)

[4. Strategies for Compliance 328](#strategies-for-compliance)

[5. The Scrubbing Story: Fewer Scrubbers than Expected but Lower Costs
Due to Economics, Innovation, and Regulatory Design
330](#the-scrubbing-story-fewer-scrubbers-than-expected-but-lower-costs-due-to-economics-innovation-and-regulatory-design)

[6. The Low-Sulfur Coal Story---Regulatory Design and Economic Choices
335](#the-low-sulfur-coal-storyregulatory-design-and-economic-choices)

[7. Retirement 339](#retirement)

[8. Substitution Units 340](#substitution-units)

[9. Trading 341](#trading)

[10. Phased Structure Caused Problems
349](#phased-structure-caused-problems)

[11. Environmental Effects or "Hot Spots" from Trading
350](#environmental-effects-or-hot-spots-from-trading)

[III. Regulatory Programs for NO~X~
351](#iii.-regulatory-programs-for-nox)

[A. Background 353](#a.-background)

[B. Title IV NO~X~ Standard and Its Legislative History
354](#b.-title-iv-nox-standard-and-its-legislative-history)

[C. Results of Title IV 357](#c.-results-of-title-iv)

[1. Initial Litigation and Delay 357](#initial-litigation-and-delay)

[2. Implementation 358](#implementation)

[D. Business Behavior and Title IV
360](#d.-business-behavior-and-title-iv)

[1. Rate Standards Led to One-Time Compliance Using the Expected
Technology
360](#rate-standards-led-to-one-time-compliance-using-the-expected-technology)

[2. In Making Pollutant Reductions, Firms Sought First to Optimize Their
Process Efficiency, as Regulations Were Sufficiently Flexible to Create
Benefits Through Doing So
360](#in-making-pollutant-reductions-firms-sought-first-to-optimize-their-process-efficiency-as-regulations-were-sufficiently-flexible-to-create-benefits-through-doing-so)

[3. Firms Heavily Used Flexibility Mechanisms with Low Transaction
Costs, Such as Averaging
361](#firms-heavily-used-flexibility-mechanisms-with-low-transaction-costs-such-as-averaging)

[[4.]{.smallcaps} Businesses Faced with Rate Standards Can Be Expected
to Over-Comply by 10%
365](#businesses-faced-with-rate-standards-can-be-expected-to-over-comply-by-10)

[5. Innovation under Title IV's Moderate Rate Standards Was Limited in
Scope and Extent
366](#innovation-under-title-ivs-moderate-rate-standards-was-limited-in-scope-and-extent)

[E. Other NO~X~ Regulation in the 1990s
370](#e.-other-nox-regulation-in-the-1990s)

[1. OTC Cap-and-Trade in 1999 Forced Further Reductions at Existing
Plants
371](#otc-cap-and-trade-in-1999-forced-further-reductions-at-existing-plants)

[2. New Source Standards 374](#new-source-standards)

[3. Technology-Based Rate Standards for NO~X~ in the 1990s Created an
Uneven Regulatory Framework and Varied Economic Signals for Most
Business Units
376](#technology-based-rate-standards-for-nox-in-the-1990s-created-an-uneven-regulatory-framework-and-varied-economic-signals-for-most-business-units)

[IV. General Findings 377](#iv.-general-findings)

[A. Environmental Standards Have Been Essential to Drive Businesses to
Reduce NO~X~ and SO~2~ Emissions
377](#a.-environmental-standards-have-been-essential-to-drive-businesses-to-reduce-nox-and-so2-emissions)

[B. It Has Proven Difficult to Set Standards That Properly Align Private
with Social Costs, and Both NO~X~ and SO~2~ Standards Were in Retrospect
Too Lenient
378](#b.-it-has-proven-difficult-to-set-standards-that-properly-align-private-with-social-costs-and-both-nox-and-so2-standards-were-in-retrospect-too-lenient)

[C. Standards Based on Rates or an Old Source/New Source Distinction May
Create Conflict Rather Than Alignment Between Regulatory and Economic
Drivers for Environmental Quality
380](#c.-standards-based-on-rates-or-an-old-sourcenew-source-distinction-may-create-conflict-rather-than-alignment-between-regulatory-and-economic-drivers-for-environmental-quality)

[D. Different Regulatory Designs Greatly Affect the Cost of Compliance
for Achieving Equivalent Environmental Results
382](#d.-different-regulatory-designs-greatly-affect-the-cost-of-compliance-for-achieving-equivalent-environmental-results)

[E. Rate Standards Were Inflexible, Limiting Businesses' Ability to
Develop and Implement Compliance Methods and Technologies
384](#e.-rate-standards-were-inflexible-limiting-businesses-ability-to-develop-and-implement-compliance-methods-and-technologies)

[1. Emissions Rate Standards Limited Technology Choice
385](#emissions-rate-standards-limited-technology-choice)

[2. Emissions Rate Standards Did Not Force a Move Toward Cleaner
Technologies
388](#emissions-rate-standards-did-not-force-a-move-toward-cleaner-technologies)

[3. Rate Standards Promote One-Time Compliance Without Incentives for
Further Progress
388](#rate-standards-promote-one-time-compliance-without-incentives-for-further-progress)

[4. Rate Standards Created High Transaction Costs
389](#rate-standards-created-high-transaction-costs)

[5. The Design of Rate-Based Standards Can Be Marginally Improved
389](#the-design-of-rate-based-standards-can-be-marginally-improved)

[F. Emissions Cap and Allowance-Trading Programs Allow Greater
Integration of Environmental Issues into Business Decision-Making
Processes, Providing Greater Flexibility and Lowering Costs Without
Sacrificing Environmental Integrity
391](#f.-emissions-cap-and-allowance-trading-programs-allow-greater-integration-of-environmental-issues-into-business-decision-making-processes-providing-greater-flexibility-and-lowering-costs-without-sacrificing-environmental-integrity)

[G. Innovation, Investment, and Cleaner Production
393](#g.-innovation-investment-and-cleaner-production)

[1. Cap-and-Trade Programs Promote Broader Technology Use and Innovation
394](#cap-and-trade-programs-promote-broader-technology-use-and-innovation)

[2. Rate-Based Systems Were Unfriendly to Innovation
395](#rate-based-systems-were-unfriendly-to-innovation)

[3. While Innovation Can Be Expected to Occur Broadly, It Is Not
Guaranteed for Any Specific Technology
395](#while-innovation-can-be-expected-to-occur-broadly-it-is-not-guaranteed-for-any-specific-technology)

[4. Traditional Regulatory Approaches Have Discouraged and Distorted
Private Investment in Research and Development, and Capital Markets for
Innovation
396](#traditional-regulatory-approaches-have-discouraged-and-distorted-private-investment-in-research-and-development-and-capital-markets-for-innovation)

[H. Imposing Stricter Standards on New Sources Has Proven Ineffective in
the Power Sector, and Has Led to Neither Cheaper Compliance Nor Better
Environmental Results
397](#h.-imposing-stricter-standards-on-new-sources-has-proven-ineffective-in-the-power-sector-and-has-led-to-neither-cheaper-compliance-nor-better-environmental-results)

[1. New Source Standards Have Not Effectively Reduced Ambient Pollution
Levels
398](#new-source-standards-have-not-effectively-reduced-ambient-pollution-levels)

[2. New Source Standards Force Only Limited Kinds of Innovation
398](#new-source-standards-force-only-limited-kinds-of-innovation)

[3. NSR Rate Standards Create Few Net Benefits When Combined with
Offsets or in Conjunction with an Emissions Cap
399](#nsr-rate-standards-create-few-net-benefits-when-combined-with-offsets-or-in-conjunction-with-an-emissions-cap)

[I. Transaction Costs in Cap-and-Trade and Rate-Based Programs
400](#i.-transaction-costs-in-cap-and-trade-and-rate-based-programs)

[1. Transaction Costs in Establishing Legislation
400](#transaction-costs-in-establishing-legislation)

[2. Transaction Costs in Establishing Regulations
402](#transaction-costs-in-establishing-regulations)

[3. Transaction Costs in Implementing the Programs
403](#transaction-costs-in-implementing-the-programs)

[4. Transaction Costs in Incrementally Lowering Standards
404](#transaction-costs-in-incrementally-lowering-standards)

[J. Monitoring and Compliance 405](#j.-monitoring-and-compliance)

[1. Strict Monitoring and High Penalties
405](#strict-monitoring-and-high-penalties)

[2. Design of Cap-and-Trade Programs
405](#design-of-cap-and-trade-programs)

[3. Inclusiveness of Cap-and-Trade Programs
406](#inclusiveness-of-cap-and-trade-programs)

[K. Over-Compliance and Other Conservative Compliance Strategies by
Firms
406](#k.-over-compliance-and-other-conservative-compliance-strategies-by-firms)

[L. Flexibility Mechanisms with Low Transaction Costs Were Widely Used
407](#l.-flexibility-mechanisms-with-low-transaction-costs-were-widely-used)

[M. Retirement and/or Switching to Cleaner Power Sources
408](#m.-retirement-andor-switching-to-cleaner-power-sources)

[V. Conclusion 409](#v.-conclusion)

[A. Stringency 409](#a.-stringency)

[B. Regulatory Design 409](#b.-regulatory-design)

# I. Introduction

Many people have voiced concerns about our environmental regulatory
system. Businesses express concern about the cost and complexity of
regulation and slow governmental approvals. These concerns have added to
industry resistance to efforts to tighten environmental standards or to
address new problems such as global climate change. Environmental
advocates are concerned about the effectiveness of regulations, their
enforcement, and the need to tighten standards to increase social
benefits. Policy analysts have drawn attention to the lack of common
sense results and the inflexibility in many current regulatory systems,
together with the lack of appropriate incentives for continuous
improvement and innovation.

This study is designed to examine the actual performance of
environmental regulations and the compliance behavior of regulated
businesses in a real-world setting. It focuses on business compliance
with regulatory standards for nitrogen oxides (NO~X~) and sulfur dioxide
(SO~2~) in the electric power industry from 1995 through 1999. The
selected time period permits evaluation of Phase I of Title IV of the
federal Clean Air Act (CAA), enacted in 1990 to regulate utility
emissions of SO~2~ and NO~X~. This allows comparison of the two
contrasting regulatory approaches Title IV imposed on
electricity-generating facilities: an emissions cap and allowance
trading program for SO~2~, the most ambitious such program operating in
the United States, and a more traditional technology-based emission rate
standard to control NO~X~ emissions. The study also compares these
standards to the new source standards for NO~X~ and SO~2~ in effect
during the 1995-1999 period, providing findings about business behavior
in the face of varied regulatory standards.

## A. Methodology

A principal methodological approach of the study was the analysis of
applicable environmental laws and polices, together with the extensive
data compiled by governmental and private sources on the power
generation industry. Particular use was made of the emissions and
generation data compiled by the United States Environmental Protection
Agency (EPA) and the Department of Energy's Energy Information
Administration (EIA),[^2] together with private sources such as the
Center for Energy and Environmental Policy Research of the Massachusetts
Institute of Technology (MIT) and Resources for the Future.

A second major methodological approach of the study was to conduct
confidential interviews with representatives of power-generating firms,
federal and state regulators, public interest and citizen organizations,
and technology manufacturers and consulting organizations providing
equipment and advice to the electricity generating industry. This
included detailed, often on-site interviews with environmental program
managers for most of the electricity-generating firms affected under
Phase I.[^3]

## B. Background of Title IV

Acid precipitation, which forms as a result of SO~2~ emissions and to a
lesser extent NO~X~ emissions, emerged as a significant environmental
and political issue in the late 1970s. The problem was caused primarily
by electricity-generating plants in the east-central part of the United
States, extending from Missouri east to West Virginia and south to
Georgia, which burned the high-sulfur coal from this region.[^4] The
issue pitted these midwestern states and coal interests against
environmentalists and the downwind northeastern states, and the
acrimonious debate produced a ten-year stalemate in Congress during the
1980s.[^5] Title IV of the Clean Air Act Amendments of 1990, which
enacted the Acid Rain Program to address both SO~2~ and NO~X~ emissions,
ultimately broke this stalemate.[^6]

Title IV's emissions cap and allowance trading system for SO~2~ was
designed to reduce 1980 SO~2~ emission levels by 10 million tons, while
promising lower costs than typically associated with traditional
rate-based standards.[^7] The law also imposed rate-based standards
designed to lower NO~X~ emissions by about 2 million tons from baseline
levels.[^8] Both programs required significant reductions from the
larger, dirtier utility units during Phase I, which lasted from 1995
until 1999.[^9] Phase II commenced in 2000, and imposed stricter
standards on virtually all utility units.[^10]

# II. Regulatory Program for Sulfur Dioxide (SO~2~)

The centerpiece of Title IV was the emissions cap and allowance trading
program for SO~2~, designed to reduce utility emissions by 10 million
tons, or roughly 50% from 1980 levels. The program's record of
over-achieving this goal at very low compliance cost has prompted many
to regard it as one of the most successful environmental regulatory
programs.[^11]

The emissions cap sets a mass performance standard very unlike
traditional rate standards. The cap is the most important element of
Title IV because it establishes the program's environmental integrity
and much of its economic efficiency by allowing regulated firms to
choose any effective compliance method, leading to significant cost
savings.[^12] The emissions trading system also helped to lower
compliance costs by allowing firms to reduce emissions at the generating
units where their costs were lowest, and resulted in establishing a
market price per ton of emission reductions.

The combination of a cap-and-trade system makes every ton of reductions
count and exerts continuous economic pressure on firms to improve
performance, transforming business compliance behavior as compared to a
traditional rate-based approach.[^13] Overall, this unique regulatory
design resulted in major emissions reductions, industry compliance costs
below the lowest predictions, significant and unexpected innovation,
relatively little litigation during program implementation, very low
ongoing transaction costs, and 100% compliance.

The environmental effects of the sulfur reductions have also been
significant. Compliance with Title IV has already reduced acid
deposition in northeastern states.[^14] The EPA has also estimated the
health benefits from reduced SO~2~ emissions at over \$10 billion.[^15]

## A. Background and History of SO~2~ Regulation: Traditional Rate-Based Standards

Prior to Title IV, existing power plants were primarily affected by
state-based legislation aimed at attaining national ambient
environmental standards.[^16] The federal Clean Air Act of 1970
established the first national ambient air standards for SO~2~, designed
to protect health and welfare,[^17] and required states to develop
"state implementation plans" (SIPs) to achieve these standards.[^18] The
primary standard for SO~2~ was set at 0.030 parts per million (ppm), to
be achieved on a calendar-year basis, and the secondary standard was 0.5
ppm, set on a three-hour basis.[^19] An unintended consequence of these
new ambient standards was the dispersion of SO~2~ through tall stacks.
The EPA permitted over a dozen states to adopt SIPs allowing sources to
meet the new standard by building tall stacks to disperse the SO~2~
instead of reducing emissions.[^20] This practice injected SO~2~ into
the higher atmosphere where it remained longer, facilitating the
chemical reactions that produce sulfuric acid and aggravating acid
precipitation. In the 1977 CAA Amendments Congress subsequently
prohibited the use of tall stacks to achieve ambient standards.[^21] It
is important to note that these ambient standards still exist and
protect against plants emitting SO~2~ at levels that would exceed local
health-based limits.

In contrast to the lenient standards and relative lack of regulation of
existing plants, the CAA established stringent standards for new sources
or major modifications of existing sources, based on "new source
performance standards" (NSPS).[^22] The first NSPS established in 1971
limited emission rates to 1.2 pounds of SO~2~ per million BTU of fuel
burned (lb/mmBtu) for coal-fired plants.[^23] To meet this standard, new
sources either had to use scrubbers to reduce emissions or use so-called
"compliance coal" with a sulfur content equivalent to the NSPS rate. The
effect on the industry was dramatic because emission rates from existing
sources were far higher. Because of the disparity between standards for
existing and new plants, electric utilities began to focus their
research and operational efforts on extending the operating life of the
older, "grandfathered" facilities.[^24]

In the Clean Air Act Amendments of 1977, Congress created the New Source
Review process and a stricter new source performance standard that
retained the former 1.2 lb/mmBtu standard but also required new sources
to reduce potential stack SO~2~ emissions by 70% or 90%, depending on
the coal quality.[^25] This standard required utilities to install
scrubbers at all new generating units, removing much of the incentive to
use low-sulfur coal and favoring powerful eastern high-sulfur coal
interests.[^26] By thus increasing the cost of new coal-fired plants,
the scrubbing requirement added incentives to extend the life of the
older, dirtier plants.

Both the ambient and new source SO~2~ standards were based principally
on human health concerns, and proved inadequate to address the broader
regional effects of acid deposition on ecosystems. By the late 1970s,
Canada, several states, and national and state environmental
organizations were raising serious concerns about acid precipitation. In
1980, Congress created the National Acid Precipitation Assessment
Program to address disagreements over the cause of acid
precipitation.[^27]

Throughout the 1980s, legislators introduced bills in Congress to reduce
acid precipitation.[^28] These typically focused on requiring the older,
dirtier coal plants to meet the 1.2 lb/mmBtu standard used for new
sources since 1970, or to require scrubbing, with annual costs estimated
at \$4 to \$7 billion.[^29] Eastern coal interests and electric
utilities blocked these efforts, arguing that they were too costly and
would cause dramatic increases in electricity rates in many states.[^30]

In mid-1989, the Bush Administration broke the deadlock on acid
precipitation with a proposal to cap emissions at a level 10 million
tons below 1980 levels and to allow emissions trading under the
cap.[^31] This proposal, which became Title IV, was designed to achieve
significant emissions reductions at substantially lower cost than
earlier proposals.

## B. Title IV

Title IV was passed in 1990 to substantially reduce the SO~2~ emissions
of electric utilities, which were then responsible for 70% of national
emissions.[^32] Title IV is unlike traditional regulations that impose
source-specific rate limits, and instead implements an industry-wide
mass standard---a permanent cap on utility SO~2~ emissions at 8.95
million tons per year, or roughly half their 1980 baseline
emissions.[^33] Phase I of the program began in 1995, and required the
263 dirtiest coal-fired electricity-generating units (referred to as
"Table A" units) to reduce their SO~2~ emissions to a base level of 5.7
million tons per year.[^34] Phase II commenced in 2000, and requires all
generating units larger than 25 megawatts to reduce their emissions to
reach the final cap amount of 8.95 million tons.[^35]

To implement the cap, the law assigned allowances, each equivalent to
one ton of SO~2~ emissions, to each affected generating unit based on
its historic base period (1985-1987) generation rates, but scaled down
so that the aggregate emissions equaled the target emissions cap.[^36]
Title IV therefore effectively implements a new source standard of zero
because any new generating source must purchase all its needed
allowances from other sources, and total emissions do not grow.[^37]

In addition to these baseline allowance allocations, Title IV provided
almost 4 million bonus allowances over the first years of the program,
primarily to encourage the use of scrubbers;[^38] together with a small
number for renewable energy and small diesel refineries producing
desulfurized fuel.[^39] Both the annual allowances and the bonus
allowances were allocated without charge to existing sources. Finally,
to help establish a market and to counter fears of allowance hoarding,
the law requires the EPA to hold back and auction roughly 3% of the
allowances allocated to units each year, and to make available a limited
amount of allowances at \$1500 through a Direct Sales Reserve.[^40]

In another departure from traditional regulation, Title IV allows
individual sources to trade their unused allowances to other sources, or
bank them for future use.[^41] The design of Title IV therefore creates
several compliance options for a generating source:

-   emit *at* the unit's annual baseline tonnage limit;

-   emit *below* the limit and generate unused allowances that can be
    banked for later use, used by other units within the company, or
    sold or traded to other firms; or

-   emit *above* the limit and obtain allowances to cover the additional
    emissions.[^42]

In order to guard against the transfer of generation from Phase I units
to noncovered Phase II units, Title IV required firms to maintain their
average heat input from their baseline period, or suffer the loss of
allowances.[^43] However, another flexibility mechanism allowed them to
designate non-Table A units that would otherwise not be covered until
Phase II as "substitution units" during Phase I.[^44] Once a firm
elected to do so, the EPA determined a baseline for the units and
provided them with allowances just like Table A units, allowing firms to
use the emissions reductions (or exceedances) from these plants as part
of their overall compliance strategy.[^45]

Finally, Title IV incorporates an extremely strict monitoring and
compliance system. Continuous Emissions Monitoring Devices (CEMS) must
record data every fifteen minutes and regularly report consolidated data
to the EPA, including data that indicates that the monitor is
functioning properly.[^46] The CEMS cost almost \$1 million per
stack.[^47] At year end, following a two-month period for "true-up,"
each company must show that it has sufficient allowances to cover all
emissions for that year.[^48] If not, firms automatically receive a
\$2000 fine per ton of exceedances, and must restore each excess ton
plus a penalty ton that is deducted from the firm's allotment for the
following year.[^49] This system has resulted in 100% compliance over
the five years of the Phase I program.[^50]

This cap-and-trade system is both more rigid and more flexible than
traditional regulation. The emissions cap is more rigid because it
creates zero growth of emissions, which benefits the environment. The
monitoring rules and compliance system are also extremely strict, with
severe and automatic penalties. However, the system provides great
flexibility to firms in choosing compliance options. Due to the true
performance standard established by the emissions cap, together with
trading, a utility is free to choose among competing compliance
approaches, including scrubbing, switching to lower sulfur coal,
blending coals with different sulfur contents, and shifting load to
units that emit less sulfur. In addition, government regulators are not
involved in decisions about technology choice, as they are in
application of technology-based standards like BACT, RACT, and
LAER.[^51] The government role is that of strict compliance monitoring,
not supervising the choice of technology, which greatly lowers
transaction costs and allows firms to rapidly change their compliance
approaches.

## C. Industry Response

The electric industry's response to Title IV can be characterized in
three overlapping stages. In the earliest years of the program, firms
significantly over-invested in compliance, including constructing
scrubbers for twenty-seven Phase I units.[^52] These actions were driven
by predictions of relatively high allowance prices in the \$300 to
\$1000 range, and uncertainty as to whether additional allowances would
be available on the market.[^53] In the second stage, firms began to
recognize and react to the lower cost of compliance represented by lower
allowance prices in the \$150 range, which first became evident in the
period from 1992 to 1993.[^54] These price signals led some firms to
cancel scrubber contracts, and led to a growing use of low-sulfur coal
to reach compliance.[^55] In this stage, and continuing throughout Phase
I, the trading provisions were used by many firms to bank allowances for
future use and for intra-firm averaging among different units, with only
a handful of firms using inter-firm trading as a compliance
strategy.[^56]

A third stage became evident toward the end of Phase I, in which many
firms increased their participation in the allowance market, trading
directly with other firms and increasing trading for arbitrage or
profit-making purposes.[^57] However, this third stage did not represent
any change in compliance strategies. Virtually all firms continued
essentially autarkic or self-reliant compliance strategies throughout
Phase I, emitting well below their limits and banking allowances for
future use.[^58]

The following sections describe firms' observed compliance behavior, and
assess how the legal provisions or other aspects of Title IV have acted
to influence this behavior.

### 1. Price Signals, Coupled with the Flexibility of Title IV, Drove Major Shifts in Businesses' Compliance Strategy

One of the most interesting aspects of the early years of Title IV was
firms' relatively rapid response to price signals generated by the
allowance market that reflected the underlying cost of compliance.
Initial industry expectations in 1991 were for prices between \$300 and
\$1000 per allowance.[^59] In 1992 and 1993, the earliest signals began
to reveal that prices would be substantially lower. The first trades
took place in 1992 at \$265 and \$300,[^60] and the EPA's first auction
of allowances in March of 1993 revealed prices at \$131.[^61] As shown
below, private transactions continued for almost a year to be somewhat
above the price set by the 1993 auction, but by mid-1994 they fell to
the \$150 level set by the EPA auction in March of 1994, and continued
in the \$100 range through Phase I, until they began to climb towards
\$200 as Phase II approached.[^62]

###### *See* Figure 2-1: SO~2~ Allowance Prices[^63]

Since allowance prices are closely tied to the cost of compliance, the
low allowance prices reflect a very positive development: a low cost of
compliance.[^64] The major drivers of the lower costs in Phase I were
innovation and investment relating to low-sulfur coal, as well as
increased scrubbing efficiency.[^65] These responses were prompted in
large part by the design of Title IV, although unrelated market forces,
such as increased rail competition, also contributed.[^66]

The ability of firms to shift compliance strategies in response to the
changing costs of different compliance options is directly related to
the cap-and-trade standard. Title IV allowed firms to respond to the
unexpectedly low price of low-sulfur coals; several firms cancelled
scrubber contracts and many switched to low-sulfur coal. Altogether,
scrubbers were built for only twenty-seven Phase I units, significantly
fewer than were anticipated at the time the 1990 CAA Amendments were
adopted.[^67] Title IV is therefore unlike the previous rate-based NSPS
standards that limited compliance technologies to scrubbing or the use
of "compliance coal."[^68] It also differs markedly from traditional
regulation by not requiring regulatory approval of changes in compliance
choices, thus avoiding delay and transaction costs.

### 2. Over-Compliance and Banking

Title IV required firms to reduce emissions at Phase I units to a base
level of approximately 6.7 million tons per year (including both Table A
and substitution units),[^69] but the addition of bonus allowances
distributed primarily in the first years of the program meant that the
annual cap was between 8.7 and 7 million tons during Phase I, as shown
in Figure 2-2.

###### *See* Figure 2-2: Phase I Sulfur Dioxide Emissions and Allowance Cap (1990-1999)[^70]

Utilities responded to the Title IV program by over-complying and
reducing SO~2~ emissions to 5.2 million tons, or approximately 30% below
the cap.[^71] This over-compliance in part reflects a conservative
business tendency to leave a margin of safety when complying with
environmental regulations. However, two aspects of Title IV provided
firms additional impetus to over-comply. The first was the significant
allocation of almost 4 million bonus allowances in Phase I, mostly for
construction of scrubbers as a concession to coal mining interests.[^72]
Second, the ability to bank allowances under Title IV added value to
early reductions because allowances would become more valuable in Phase
II when allocations to Table A units would be reduced and all other
units would enter the program.[^73] Together these factors created
significant motivation towards over-compliance in Phase I.[^74]

The net result in Phase I was that 38.1 million allowances were issued
over all five years and net emissions were only 26.5 million tons. This
created a bank of 11.6 million allowances saved for use in Phase II that
is not expected to be depleted until 2010.[^75] Overall, a principal
effect of banking may simply be to smooth the transition between Phases
I and II, as it promotes a more gradual decline in emissions. The
banking behavior also has minor positive environmental significance
because it achieved early reductions during Phase I, although the saved
tons may be expected to be emitted in later years.[^76]

Banking may be considered a form of trading, as it shifts the use of
allowances from one year to another. If so, the extensive banking
behavior becomes the principal use of Title IV's trading mechanisms.
Overall, 14,031,943 tons of emission reductions were created by units
that emitted below their allowance allocations. Of this amount,
10,518,211, or fully 75%, were banked for later use, and only 3,541,045
were "traded" in the more traditional sense to offset emissions of other
units during Phase I.[^77]

### 3. Autarkic Compliance

Compliance responses in Phase I revealed a strong tendency for firms to
adopt an autarkic or "comply on your own" strategy. Most of the
fifty-one affected firms made extensive use of the flexibility
mechanisms to achieve emission reductions within their own firm, but as
shown in Figures 2-3, A and B, only three firms (Illinois Power, Tampa
Electric, and Duquesne Power) used inter-firm trading as a compliance
option over the full period of Phase I. All other firms achieved
compliance through actions taken within the firms themselves.

###### *See* Figure 2-3A: SO~2~ Allowances and Emissions of Top 10 Phase I Utilities by Total Allowances Allocated (1995-1999) and Figure 2-3B: SO~2~ Allowances and Emissions, Phase I Utilities (except 10 largest) (1995-1999)[^78]

This finding of minimal inter-firm allowance trading is significant
because most economic analyses reveal substantial differences in
compliance costs among the Phase I units. Those differences should have
driven greater use of the inter-firm trading option.[^79] The discussion
in Part II(C)(9) provides some reasons why firms did not use inter-firm
trading to the full extent that it may have been economically justified.

Another aspect of autarkic compliance is the unequal burden placed on
smaller firms with few units. When firms primarily use the trading
provisions for intra-firm averaging, large firms are able to lower their
cost of compliance due to the variability among their own multiple units
and may be little affected by the lack of inter-firm trading. On the
other hand, absent the ability to trade with other firms, a firm with
only one or two units would be limited to compliance options that could
achieve the needed reductions at those particular units. Indeed, a few
of these smaller firms chose to install scrubbers, a relatively
expensive compliance option for a small plant.[^80]

### 4. Strategies for Compliance

As noted above, Title IV provides firms with a very wide scope of
compliance options that include:

1\. scrubbing;

2\. fuel switching to lower-sulfur coals;

3\. shifting to natural gas or renewable energy;

4\. optimization, or increasing the efficiency of the unit;

5\. load shifting to lower-emitting units;

6\. use of substitution provisions;

7\. allowance trading;

8\. allowance banking;

9\. demand-side management;[^81] and

10\. retirement.[^82]

The emissions cap (as opposed to the trading provisions) is the primary
aspect of Title IV that allows firms the flexibility to choose among the
first four compliance options. Traditional emissions rate standards
would be more restrictive because they tend to reward technologies that
reduce end-of-pipe emission rates, which may not allow firms to achieve
pollutant reductions through cleaner processes, increased efficiency, or
reduced demand.[^83] The greater flexibility afforded by the emissions
cap approach is supplemented by the trading and substitution mechanisms
in Title IV that allow firms added flexibility in the locus of emissions
reductions. The trading provisions allow intra-firm averaging, trading
with other firms, and banking allowances, and the substitution
provisions allow for greater inclusiveness of units.

The table below shows that firms achieved the major share of SO~2~
reductions by two methods. Scrubbing, an end-of-pipe control technology
that reduces SO~2~ to a solid waste,[^84] contributed 35% of the total
emission reductions made during Phase I (not counting bonus allowances).
Fuel switching by firms that blended or switched to low-sulfur or
medium-sulfur coal contributed 59% of reductions. Retiring units
contributed another 6% of reductions although their output was generally
made up at other units.

###### Figure 2-4. Source of Reduction for Plants that Reduced Emissions Below Allocations (Total Reductions Made in Phase I, 1995-1999)[^85]Number range CHAPTER

+-----------+------------+----+-------------+----+--------------+----+
|           |            | u  | Reductions  | \% | Reductions   | \% |
|           |            | ni | with Bonus  |    | w/o Bonus    |    |
|           |            | ts |             |    |              |    |
+-----------+------------+----+-------------+----+--------------+----+
| Table A   | scrubbing  | 26 | 5,856,376   | 42 | 3,665,433    | 32 |
| Units     | total      |    |             |    |              |    |
+-----------+------------+----+-------------+----+--------------+----+
|           | switching  | 1  | 5,526,657   | 39 | 5,178,540    | 45 |
|           | total      | 26 |             |    |              |    |
+-----------+------------+----+-------------+----+--------------+----+
|           | r          | 7  | 283,905     | 2  | 283,905      | 2  |
|           | etired/not |    |             |    |              |    |
|           | util.      |    |             |    |              |    |
+-----------+------------+----+-------------+----+--------------+----+
| Sub       | scrubbed   | 16 | 292,469     | 2  | 292,469      | 3  |
| stitution |            |    |             |    |              |    |
|           |            |    |             |    |              |    |
| Units     |            |    |             |    |              |    |
+-----------+------------+----+-------------+----+--------------+----+
|           | unscrubbed | 1  | 1,712,075   | 12 | 1,712,075    | 15 |
|           |            | 13 |             |    |              |    |
+-----------+------------+----+-------------+----+--------------+----+
|           | r          | 44 | 360,461     | 3  | 360,461      | 3  |
|           | etired/not |    |             |    |              |    |
|           | util.      |    |             |    |              |    |
+-----------+------------+----+-------------+----+--------------+----+
| Total     |            |    | 14,031,943  | 1  | 11,492,883   | 1  |
|           |            |    |             | 00 |              | 00 |
+-----------+------------+----+-------------+----+--------------+----+

Figure 2-5 reveals individual firms' compliance strategies. The first
column shows firms' net allowance savings or withdrawals during Phase I.
The second column shows the allowance savings made by unscrubbed Table A
firms that emitted below their allowance allocation. The third shows the
allowance withdrawals used by units that emitted above their
allocations. Subsequent columns show the reductions achieved through
scrubbed, retired, or substitution units. Bonus allowances allocated to
firms are shown for information purposes, but these allowances are also
included in the other columns since they formed part of firms'
compliance strategies.

###### *See* Figure 2-5. Compliance Methods of Fifty-One Companies in Phase I (1995-1999)[^86]

Several compliance strategies are evident:

\(a\) Sixteen utilities scrubbed at one plant and used the excess
allowances for all or a substantial part of their allowance needs at
their other units. Firms such as American Electric Power, TVA, and
Allegheny Power scrubbed a single large plant to create over a million
excess allowances in each case.

\(b\) Thirty-four firms adopted a primary strategy of switching to
lower-sulfur coals at some units to create excess allowances for all or
a substantial part of their needs at their other units. The large
Southern Company achieved net reductions at all of its forty-nine units
primarily by switching to lower-sulfur coal.

\(c\) Only one firm, Illinois Power, purchased allowances as its
principal compliance strategy.

### 5. The Scrubbing Story: Fewer Scrubbers than Expected but Lower Costs Due to Economics, Innovation, and Regulatory Design

Scrubbing, or flue gas desulfurization,[^87] was the principal
compliance strategy for sixteen utilities, and scrubbed plants achieved
35% of all emissions reductions.[^88] Scrubbing was clearly the central
compliance strategy of major firms such as American Electric Power, the
TVA, and Allegheny Power. These firms' scrubbing strategies not only
offset excess emissions at other units, but allowed each firm to build
up a banked supply of over 1 million allowances for Phase II.[^89] In
addition to these larger firms, some small firms, such as municipally
owned entities, chose scrubbing despite the relatively high per-ton
compliance costs to install scrubbers at smaller units. These firms did
so because it was an available compliance option that allowed each firm
to comply on its own.[^90]

Contrary to initial expectations, scrubbing turned out to be the more
expensive of the two principal compliance methods, and the actual number
of scrubbers built was substantially less than expected, as firms turned
to low-sulfur coals as a cheaper compliance option. A 1994 Government
Accounting Office report found that scrubber vendors expected to
complete thirty-five or forty contracts in Phase I, though some vendors
claim that they expected a need for as much as 100,000 MW of installed
or retrofit scrubber capacity.[^91] Ultimately, only twenty-seven
scrubbers were installed for Table A plants, with a capacity of 16,167
MW.[^92] Most utilities that installed scrubbers did so in part due to
the need for early implementation of compliance options. A retrofit
scrubber requires from eighteen to thirty months of advance planning, so
commitments to scrubbing vendors had to be made as early as 1992, when
estimates of the cost of compliance and of allowances still ranged from
\$300 to \$700.[^93] Had these early projections of compliance costs
proven to be accurate, scrubbing, especially at larger plants, would
have been a cost-effective compliance strategy.[^94] However, economic
analysis shows that in retrospect, few or none of these scrubbers would
now be considered to have been an economic investment.[^95]

The bonus allowance provisions in Title IV also contributed to the early
over-investment in scrubbers. As a concession to high-sulfur coal mining
interests, Congress allocated about 2.1 million of the 3.5 million
extension allowances awarded during Phase I to utilities that committed
to install scrubbers.[^96] These bonus allowances provided subsidies
regarded as worth \$200 to \$400 million based on the value of
allowances, and were a significant factor that motivated several
utilities to install Phase I scrubbers at an estimated five or six
units.[^97]

###### *See* Figure 2-6. Scrubbers Installed by Year and Type[^98]

One of the significant stories of Phase I was the declining cost of
scrubbing over the course of Phase I. ICF Resources projected in 1990
that scrubber costs for Phase I units would amount to \$455 per ton of
SO~2~ removed.[^99] Actual costs calculated by MIT were \$282 per ton,
caused not by a decline capital costs, but major reductions in operating
costs, as shown in Figure 2-7. By 2000, scrubbing costs had declined yet
again, this time due to a precipitous drop in capital costs to the
\$100/kW level, less than half the \$249/kW cost in 1995.[^100]

###### Figure 2-7. Phase I Scrubber Cost Components (in 1994 dollars)[^101]

+---------------------------+--------------------+--------------------+
|                           | Predicted 1995     | Actual 1995        |
|                           |                    |                    |
|                           | (ICF Resources,    | (MIT, 2000)        |
|                           | 1990)              |                    |
+---------------------------+--------------------+--------------------+
| Initial Capital cost      | \$249              | \$249              |
| (\$/KW)                   |                    |                    |
+---------------------------+--------------------+--------------------+
| Fixed O&M (\$/KW-yr)      | \$6.55             | \$2.00             |
+---------------------------+--------------------+--------------------+
| Variable O&M (per kWh)    | 1.81 mills         | 1.26 mills         |
+---------------------------+--------------------+--------------------+
| Removal efficiency        | 90%                | 95%                |
+---------------------------+--------------------+--------------------+
| Utilization               | 65%                | 82%                |
+---------------------------+--------------------+--------------------+
| Cost per ton SO2:         | \$455              | \$282              |
+---------------------------+--------------------+--------------------+
| Capital charge (@11.33%)  | \$285              | \$206              |
+---------------------------+--------------------+--------------------+
| Fixed Overhead and        | \$66               | \$15               |
| Maintenance               |                    |                    |
+---------------------------+--------------------+--------------------+
| Variable Overhead and     | \$104              | \$65               |
| Maintenance               |                    |                    |
+---------------------------+--------------------+--------------------+

These major cost reductions were due to several factors: technological
innovation in scrubber design, economic factors that led firms to
increase utilization at scrubbed plants in Phase I, and Title IV's
flexible design that allowed more efficient scrubbers to be built. The
innovation and rapid decline in scrubber costs during Phase I stand in
marked contrast to the previous two decades, during which scrubbing
vendors enjoyed a monopoly in SO~2~ compliance technology for new firms.
During that time relatively little innovation in scrubber design had
taken place.[^102]

#### a. Increased Scrubber Utilization

One factor that led to decreased per-ton costs of scrubbing was the
unexpectedly high utilization rate of scrubbed units during Phase I,
which spread the capital costs over a larger number of tons. The
increased utilization can be explained by the relatively low variable
costs of scrubbing, at about \$65 per ton of SO~2~, once the significant
capital investment is made.[^103] Operating an existing scrubber was
therefore profitable as long as the variable cost was lower than the
price of allowances. This cost savings created an impetus for firms to
shift power generation, or "load," away from Phase I unscrubbed units to
scrubbed units.[^104]

#### b. Innovation in Scrubber Design

Design improvements also lowered scrubbing costs. Interviews with
scrubber manufacturers revealed that significant innovation in scrubbers
has occurred since the first Phase I scrubbers were installed in
1995.[^105] The major advance that led to price reductions was
eliminating redundancy. Modern scrubbers typically have a single vessel
that serves multiple units, greatly reducing costs. Redundancy has been
reduced in other components as well. Another advance has been
higher-speed flue gas streams that increase the rate at which the
reaction between flue gas and the reagent slurry occurs.[^106] Other
advances include using less expensive ceramic materials in scrubbing
vessels and sourcing materials worldwide.

In addition to these design improvements, innovation has taken place in
waste disposal practices. Since the solid wastes from a scrubber may
cover 1000 acres over the life of a large plant, waste disposal is a
significant part of scrubbing cost.[^107] Utilities have worked to
enhance cost-effective ways to recover saleable, commercial-quality
gypsum from scrubbing waste by using a different reagent, or by further
processing.[^108]

#### c. Title IV's Design

A third factor in reducing scrubbing expense is that Title IV's design
allowed more efficient scrubbers to be built. Until 1992, most utilities
installed scrubbers to meet New Source Performance Standards, although a
few utilities had installed scrubbers to meet state SO~2~ emission or
ambient standards.[^109] Under NSPS, sources had to achieve a 90% or 70%
reduction on a continuous basis.[^110] NSPS scrubbers therefore had to
be very reliable to ensure strict compliance with this rate limit, as
any deviation would lead to a violation and potentially require shutting
down the plant while the scrubber was repaired. As a consequence, the
scrubber built for NSPS required significant redundancy and typically an
entire backup scrubber module in case the first one failed, causing
costs to be far higher than needed to reduce sulfur emissions
efficiently. Title IV adopted a mass limit with an annual averaging
period, allowing a utility to average its emissions over a year and even
to purchase allowances if needed to compensate for scrubber down time.
As a result, scrubbers built to comply with Title IV do not have to be
over-built, nor include backup modules, significantly lowering their
capital and operating costs.[^111]

Another aspect of Title IV's design that promoted innovation was its
flexibility, which introduced competition into the SO~2~ reduction
field. For the first time scrubbers had to compete with other compliance
methods, thus spurring innovation. A second factor of Title IV's design
is that every ton of reductions counts, creating incentives for
businesses to raise scrubber efficiencies. The NSPS rate standard, on
the other hand, created no incentives for achieving removal efficiency
greater than the established rate limits.[^112]

### 6. The Low-Sulfur Coal Story---Regulatory Design and Economic Choices

The widespread use of low-sulfur coal has been a major compliance
strategy during Phase I, accounting for 59% of actual reductions.[^113]
Firms such as the Southern Company switched to lower-sulfur coals as the
centerpiece of their compliance strategies, characterized by the company
as "BUBA," or "Bank, Use and Buy Allowances." All forty-nine of
Southern's units emitted below their allowance allocation, allowing the
company to build a 1 million ton bank of allowances for Phase II.[^114]
Many other firms were also able to switch to low-sulfur coal at
relatively low cost, although geographic location in relation to
low-sulfur coal fields, and the availability of low-cost transportation
from these fields, were important factors.[^115]

The use of low-sulfur coal was catalyzed by the flexibility afforded by
Title IV, which unlike any of the NSPS standards did not place
constraints on the use of low-sulfur coal for compliance.[^116] This led
to experimentation and innovation in fuel blending techniques that
facilitated greater use of low-sulfur western coals, and provided
incentives to use eastern low- and medium-sulfur coals, as described
below. These innovations, together with investment prompted by Title IV,
lowered the expected cost premium for low-sulfur coals and increased
their use.[^117]

#### a. Low-Sulfur Western Coal

Coal from the Powder River Basin (PRB) in Wyoming and Montana has a very
low sulfur content at or below 0.6 lb/mmBtu.[^118] The market for
western coal was growing even before Title IV was enacted because of its
low cost to mine, lower shipping prices produced by rail deregulation,
and state acid precipitation regulatory programs in states such as
Minnesota and Wisconsin.[^119] Following the enactment of Title IV
several utilities, especially those within 1000 miles of the PRB, moved
rapidly to adapt their coal handling and milling equipment to
accommodate PRB coal.[^120] Use of PRB coal has now penetrated east to
West Virginia and south to Georgia.[^121]

Despite its low sulfur content, the use of PRB coal presents problems:
it is subbituminous, and has both higher ash content and lower heat
value than harder eastern bituminous coals, which can cause derating (or
loss of generating capacity) and interfere with boiler operation.[^122]
Prior to the enactment of Title IV, many utilities believed that western
coals would not perform well in their generating units, especially the
large cyclone boilers in the midwest built to handle eastern
coals.[^123] Available options therefore were believed to be scrubbing
or switching to relatively expensive eastern low-sulfur coals.

In response to the impetus provided by Title IV's design, which credits
any emission reductions, utilities began experimenting with blending
inexpensive low-sulfur PRB coal with traditionally higher-sulfur
midwestern coal to reduce total SO~2~ emissions.[^124] Early on, typical
blends were 40% low-sulfur PRB coal and 60% higher-sulfur bituminous
coal, a combination firms believed would prevent or minimize the
operational and derating problems. Experimentation allowed utilities to
steadily increase the percentage of PRB coal through reengineering their
plants.[^125] Today, blends of up to 80% PRB coal are not uncommon, and
a number of plants have been modified in ways that permit using 100% PRB
coal.[^126]

PRB-related innovation is closely tied to Title IV's mass standard
because firms initially did not think they could blend PRB coal to reach
rate values such as 1.2 lb/mmBtu.[^127] Because, unlike a rate standard,
Title IV rewarded any reduction, such as moving from high emissions to
medium emissions, firms began to experiment with blending PRB, with the
positive results outlined above.

#### b. Low- and Medium-Sulfur Eastern Coals

As Phase I continued, eastern low- and medium-sulfur coals also began to
compete with western coal for new market share. The greater distance
from western coal fields and the operating issues with PRB coal
increased the attractiveness of Appalachian low-sulfur coal, with sulfur
content at about 1.2 lb/mmBtu. A study by MIT of the early years of
Phase I showed this coal was able to capture a significant part of the
market, accounting for 44% of SO~2~ reductions from fuel switching, with
the medium sulfur coal accounting for another 35% of reductions from
fuel switching.[^128]

#### c. Economic Considerations in Switching to Low-Sulfur Coals

In considering switching from higher-sulfur to low-sulfur coals, firms
considered three primary cost elements: mine-mouth cost, transportation
cost, and the premium paid for the lower sulfur content of the
coal.[^129] All three costs can vary considerably between coals.[^130]
For example, PRB coal from large open-pit mines costs only \$0.20 per
mmBtu to mine, or one quarter of the cost of mining eastern coals, but
transportation costs are higher due to the greater distance to eastern
generating units.[^131]

A major element affecting Title IV implementation has been the lower
than expected sulfur premium, which has led to greater use of low-sulfur
coal. One factor contributing to the lower price was rail deregulation
in the 1980s, which lowered shipping cost and made PRB coal more
competitive.[^132] Title IV itself promoted major investment by
utilities. One study identified \$12 billion in added investment
associated with Title IV by mid-1995: \$6 billion for development of
low-sulfur coal fields, \$3 billion for scrubbers and modifications, \$2
billion in coal-related rail investment, and over \$1 billion in
allowance purchases.[^133] This spurred rail industry innovations in the
design of cars and infrastructure,[^134] and some utilities also
invested in transportation infrastructure, including barges and rail
cars, to ensure access to PRB coal at competitive prices.[^135] These
investments in assets and infrastructure addressed bottlenecks and
barriers to the use of low-sulfur coal, and contributed to the observed
reduction in compliance cost.

The second factor leading to greater than expected use of low-sulfur
coal was the lower than expected capital cost of retrofitting boilers so
they could use low-sulfur coal, which included the cost of boiler
modifications, coal-handling equipment, and particulate controls.[^136]
Here, there is an important distinction between eastern and western
coals. Most boilers built for the bituminous coal prevalent in the
eastern part of the country can switch to low-sulfur bituminous coal at
low capital expense, around \$5 to \$10 per kW of capacity for most
units.[^137] It costs more to retrofit these boilers to burn
sub-bituminous coals from the western United States, which have higher
ash and moisture content, and hence different combustion
characteristics. The magnitude of this expenditure depends on the plant,
but typically is in the range of \$50 to \$75 per kW.[^138] Although
significant, these costs are far less than the \$249/kW in capital costs
to install scrubbers.

A third factor related to the use of low-sulfur coal was the concern
about the use of PRB coal potentially resulting in derating and
operational problems. These concerns failed to materialize.

#### d. Effect of Title IV on Coal Pricing

Title IV significantly changed coal prices. Prior to Title IV, the
principle added value was for coal with a sulfur content of 1.2 pounds
or less of sulfur per million Btu of heat content. Often referred to as
"compliance coal," it allowed firms built between 1971 and 1978 to meet
the New Source Performance Standard in effect at that time, or similar
state standards.[^139] The sulfur content of coal made little difference
to other plants: plants built before 1971 were essentially unregulated,
and plants subject to the new source standard imposed after 1978 were
required to scrub, making them apt to buy the cheapest coal regardless
of its sulfur content.[^140] Title IV dramatically changed this
situation by making any reduction in SO~2~ valuable. This introduced
more price competition among fuels and created a uniform gradient in the
price of coals based on sulfur content.

### 7. Retirement

Normally, retirement of a unit would be an effective compliance strategy
under a cap-and-trade program, as it would result in allowance savings.
However, the phased nature of Title IV required that firms maintain
their baseline utilization during Phase I, although they could average
the utilization of all their units.[^141] For the most part, this
precluded retirement as an independent compliance strategy in Phase I,
since the reduced utilization would need to be made up at other units.
Overall, only seven Table A units (1343 MW) in the midwest with short
remaining lives were shut down, with lost generation made up at other
units.[^142] Approximately forty substitution units, or more than 3000
MW, also were retired, reducing the emissions of these units by 383,587
tons, but again with offsetting generation at other units.[^143]

### 8. Substitution Units

Firms made significant use of substitution units, confirming their
readiness to make use of a flexibility mechanism with low transaction
costs. Almost three-quarters of all firms, thirty-six in all, designated
substitution units, and substitution was a significant method of
compliance for a dozen firms.[^144] Overall, 195 units were included as
substitution units for at least one year, and net reductions from
substitution units were 2,365,005 tons, about 20% of the total
reductions achieved during Phase I.[^145]

The substitution provisions were intended to allow greater flexibility
in meeting the reduction requirements, as firms found it cheaper to
achieve the needed reductions at another of their units rather than the
ones designated under Table A. For example, it might make more economic
sense to scrub a newer Phase II unit, or switch to low-sulfur coal at a
Phase II unit that was located nearer to a transportation route such as
a river or railway. However, analysis conducted at MIT shows that
allowing firms to voluntarily choose which units to include led in part
to "gaming," with firms choosing to include units that would have
decreased their emissions anyway.[^146] Again, this is a problem with
the phased structure of Title IV, and will not be an issue once all
firms are included in Phase II.

The use of the substitution provision could have been even greater had
not the environmental community and certain elements of the industry
litigated in response to initial rules promulgated by the EPA that would
have allowed firms to count the reductions made at substitution units
that installed scrubbers between 1985 and 1990.[^147] Although advocates
of this approach argued that the scrubbers were installed in
anticipation of the legislation, and thus that their reductions should
be counted, the plaintiffs argued against retroactively counting any
reductions achieved before 1990. The EPA settled the case by agreeing
with the plaintiffs, and providing that baseline emissions would be the
lower of 1985 or 1990 levels.[^148] These events left a searing memory
in many of the firms interviewed, who view the lesson learned as "early
compliers lose." They also partly attribute industry's reluctance to
voluntarily reduce CO~2~ emissions before passage of final legislation
to these earlier events.[^149]

### 9. Trading

The trading mechanisms under Title IV represent the most significant use
of emissions trading in our environmental laws, and so have received a
great deal of attention. Although not as critical as the emissions cap,
trading is an important element of Title IV, as it contributed to cost
reductions by allowing firms to bank allowances, shift load between
their units as a compliance strategy, and to benefit from inter-firm
trading.

Allowance trading climbed steadily throughout Phase I as firms became
more accustomed to its use, and as movement toward a deregulated energy
policy placed greater emphasis on marketing and trading in general. EPA
data from the Allowance Tracking System shows that at least 81.5 million
allowances were traded during Phase I.[^150] However, most of these
consisted simply of internal reallocation within a firm, and the extent
of trading is better reflected in the 30.8 million allowances traded
between economically unrelated entities, as shown in Figure 2-8.[^151]

###### *See* Figure 2-8. Allowance Transactions Between Unrelated Entities (1995-2000)[^152]

The experience of Phase I reveals a number of interesting contrasts and
findings regarding trading. One was its increased importance and use for
arbitrage and profit-making purposes, contrasting with firms'
conservative use of trading for compliance. Aside from banking, only 3.5
million of the traded allowances, or 13% of total emissions, were used
for compliance purposes during Phase I.[^153] Most of these were used
internally by firms to average the emissions of their own units, and
inter-firm trading for compliance comprised only 577,583 allowances, or
2% of total emissions.[^154] Another was that early fears about market
power in trading, or the creation of emissions hot spots, never
materialized. Finally, the effect of trading in creating a price for a
ton of emissions reduction allowed the greater integration of an
environmental parameter into the economic decision-making of firms.

Before examining the use of trading in Phase I, it is important to note
the relationship of trading to the emissions cap. The cap is arguably
the more important element of Title IV, as it creates the environmental
integrity and much of the economic efficiency in the program. The cap
also creates the context in which trading can take place through
allowances, which combine far greater opportunity for trading, lower
transaction costs, and greater environmental integrity than the previous
forms of credit trading. This commodity-like nature of allowances allows
trades to be made without government presence, and creates some of the
important environmental and economic benefits of allowance trading.

#### a. Establishment of the Trading System

The growth of trading has been influenced by the annual EPA auction of
allowances and the role of an independent community of allowance brokers
who facilitate allowance transactions. The initial 1993-1994 period of
trading was marked by relatively little trading and uncertainty in the
market.[^155] Roughly 50% of allowance transactions were made through
the official EPA auctions, which provided an early signal of the
unexpectedly low price of compliance. Allowance prices, however, varied
between the auction and private deals, indicating an immature
market.[^156] Confirming firms' lack of familiarity with the market,
most trades were made through brokers, and different brokers charged
commissions of \$3.50 to \$10 per allowance in this period.[^157]

Today, about 6 to 10 million allowances are traded annually between
separate entities, largely through private transactions. Only 2% of
transactions take place through the EPA auction.[^158] However, the EPA
helps establish a secure market through its Allowance Tracking System,
which records allowance transactions, typically within twenty-four
hours.[^159] Prices are transparently quoted in several privately
maintained indexes, and the consistency of prices is high.[^160] One
aspect of firms' increased familiarity with trading is the decreased
fraction of trades made through brokers today. Direct trades made by
utilities have climbed from a negligible amount in 1994-1997 to an
amount equal to the total made through brokers. This trend is also
reflected in the commission charged by brokers, which has steadily
declined to \$1 per ton in 1995, \$0.50 per ton in 1997, and \$0.20 per
ton in 1999.[^161]

One of the early concerns during the creation of Title IV was that
allowances simply would not be available, due to hoarding or other
market power problems. This concern led to inclusion of the provisions
for an allowance auction and a guaranteed reserve of allowances priced
at \$1500.[^162] However, there has been widespread liquidity throughout
Phase I, assisted by the independent community of emissions
brokers.[^163]

#### b. Use of Trading

Allowance trading encouraged utilities to seek out "least-cost"
compliance options among their plants in order to minimize the cost of
compliance. Such strategies can be clearly seen in firms' decisions to
install scrubbers on the largest plants, where the cost per ton of
emission reductions would be the lowest; or to switch those plants
closest to existing rail or water transportation to low-sulfur coal,
thereby minimizing the cost of the transported coal.[^164] The benefits
of trading have the potential to be significant, as most studies have
shown great variability in the cost per ton of emissions reductions at
various plants.[^165]

The extent of trading depends greatly on the definition of trading. As
shown in Figure 2-8, over 30 million allowances were traded between
discrete entities, but in contrast only 3.5 million allowances were used
for compliance purposes by units to emit above their allowance
allocation.[^166] Almost all of this use was for averaging, or trading
between units owned by the same firm, and only 708,372 allowances were
used over all of Phase I to allow firms to exceed their allowance
allocation in any one year.[^167]

The use of the trading provisions at the unit level is shown by Figure
2-9, which compares actual emissions of the 372 units in the program all
five years with their allowance allocations. The figure shows that a
majority, or 244 units, emitted lower than their allocated level and
banked allowances, while 128 units emitted over their allocated level
and used excess allowances generated by other units for compliance.

###### *See* Figure 2-9: Difference Between SO~2~ Emissions and Allowances, Phase I Units (1995-1999)[^168]

#### c. Compliance Trading

Notwithstanding the greatly increased use of trading, firms' use of
trading for compliance purposes was relatively unchanged throughout
Phase I, and remained conservative. Firms made major use of only two
potential compliance uses of trading, those of banking and intrafirm
averaging, and made less use of interfirm trading than may have been
dictated by purely economic factors.

##### i. Banking

The most extensive use of the trading provisions in Title IV was
inter-temporal trading or banking, described earlier. Banking, or saving
allowances, accounted for almost 75%, or 10,518,211, of the 14,031,943
allowances created by the 244 units that emitted below their allowance
allocations.[^169]

##### ii. Averaging

Firms made considerable use of the opportunity to trade allowances
between different units for the purpose of intra-firm averaging. Almost
60%, or thirty of the fifty-one firms, used averaging to achieve
compliance over the five years of the program, and even more used
averaging to allow a unit to emit over its allowance total for at least
one year.[^170] For instance, all of the forty-nine units owned by the
Southern Company emitted below their allocations over the five year
period, but a few required allowances to meet their compliance
obligations in one or more years.[^171]

##### iii. Inter-firm Trading for Compliance

Inter-firm trading of allowances for compliance purposes totaled only
708,372 allowances during Phase I, or less than 3% of total
emissions.[^172] Despite the growing level of trading, only one utility,
Illinois Power, relied extensively on allowances to meet its compliance
obligations in Phase I, emitting 44% over its allocation.[^173] Only two
other firms made net allowance purchases during Phase I: Tampa Electric
emitted 14% over its allocation, and Duquesne Power emitted 4%
over.[^174] An additional twelve firms used inter-firm trading to emit
more than their allowances in a given year, but in all cases only did so
for one or two years, and emitted below their allocation for Phase I as
a whole.[^175]

In large part, the limited interutility trading reveals a bias towards
autarkic behavior by firms in their environmental strategies. However,
several specific problems discouraged such trading. The most important
involved state public utility regulations, which typically required that
gains or losses generated by trading be refunded to ratepayers as an
element of fuel cost.[^176] A second disincentive is the tax treatment
of allowances. The Internal Revenue Service considers allowances to have
a zero cost basis, since they are allocated for free.[^177] This imposes
a large tax on the first seller of an allowance, creating a significant
disincentive. Discussions with several utilities showed that this was a
serious constraint for some firms, but not for others that had
offsetting tax credits or other special situations that avoided tax
consequences.[^178] Thirdly, public opposition to trading in the early
years of the program led some utilities, such as TVA, to limit buying or
selling allowances for compliance.[^179]

#### d. New Paradigm of Trading and Arbitrage Trading

Trading of energy-related commodities such as power, fuels, and
emissions has been at the center of the revolution in the power sector
as many states have initiated deregulation to a market-based system for
the generation and marketing of power.[^180] In this new, competitive
era, firms' use of trading has also evolved, with many firms commencing
to trade for arbitrage or profit-making purposes as well as
compliance.[^181] The increased emphasis on marketing and trading in
many firms has led to a major realignment in which the generation
division within a firm may no longer dictate terms to the traders, but
vice-versa.[^182]

Arbitrage trading by some firms has become significant, with allowances
regarded as an asset that can lead to profits through trading,
especially if combined with fuel and energy trading.[^183] This new
attitude toward trading has been assisted by practices such as six-month
tax-free loans of allowances between utilities and brokers that the
broker uses for trading, and then repays to the utility with additional
allowances as interest.[^184] Such arbitrage trading is neutral in terms
of the environment, and helps to explain the difference between the 30.8
million allowances traded between distinct entities in Phase I, and the
only 3.5 million traded for actual compliance purposes.

The enormous importance of trading to some firms is reflected in the
placement of emissions trading authority in the corporate structure. The
allowance trading function was traditionally located in the company's
environmental department, after which it was shifted in some firms to
the fuel-purchasing department where allowances are bought and sold
along with other commodities like coal. Today, many
electricity-generating companies have established a division or separate
corporate entity for trading energy-related commodities.[^185] Some
smaller firms with particularly active programs may generate as much
gross revenue from such trading as they do selling electricity.[^186]

#### e. Trading Helped to Integrate Environmental and Economic Issues

A potentially profound influence of trading on compliance behavior is
its effect in establishing a market price for a ton of reductions. This
has allowed a greater integration of environmental and certain economic
aspects of the industry and, some claim, allowed far greater integration
of environmental considerations into overall business
decision-making.[^187]

The most evident example of this integration is that allowance prices
are today fully integrated into the price of coal: the sulfur premium
for coal tracks the allowance price, and coal suppliers now bundle
allowances with their coal.[^188] This integrates the environmental
effects of coal into its price, and hence into all firm decisions about
fuel cost and efficiency. It also creates an even cline in the sulfur
premium that contributes to a competitive coal market. A second example
is that allowance prices are regularly updated in the dispatch models
that dictate which of a firm's plants will operate at any time.[^189]
Again, this fully integrates an environmental parameter into one of a
firm's key ongoing economic decisions. Neither of these integrations
would be possible under rate standards, and both show how cap-and-trade
systems continue to exert dynamic effects on a continuing basis long
after the effective date of the regulations.

Some argue further that creating a price for pollution causes a
revolution in compliance behavior because it broadly moves consideration
of pollution effects into mainstream company decisions.[^190] By
allowing companies to profit from trading allowances, they argue that
firms begin to view environmental compliance as another arena for
competition, lowering resistance to regulation by firms that perceive
they may out-compete other firms in this arena. Achieving these positive
effects is assisted if the company's accounts reflect the market value
of allowances, instead of carrying them at zero basis if they are
allocated for free. Once the cost of allowances is reflected in the
accounts, the pollution consequences of actions may affect all economic
decisions made by a firm.

One regulatory factor that appears to be critical in achieving this
integration is the ability to freely trade allowances with minimal
transaction costs or delay. This creates a market price through a
competitive and transparent trading market that is national in scope
with no restrictions or limits on trades. Because of the cap-and-trade
system, this can be done while maintaining very high environmental
integrity.[^191]

### 10. Phased Structure Caused Problems

Title IV created a two-phased structure that regulated only certain
generating units in Phase I. However, because of the interconnected
nature of the electricity grid, this created the potential for these
units to transfer generation and therefore emissions to other units not
included in Phase I.[^192] Title IV's rules partially prevent this
practice by requiring firms to utilize their Phase I plants at least to
the level at which they were operated during the baseline period.[^193]
However, they did not prevent firms from meeting the increased demand
for energy that occurred during Phase I by increasing the use of Phase
II generating units proportionally more than Phase I units.

The MIT Center for Energy and Environmental Policy Research analyzed
utilization levels in the years 1995-1997, and concluded that firms did
indeed shift some utilization due to growth from Phase I to Phase II
units, leading to greater SO~2~ emissions over time.[^194] These actions
actually reduced Phase I emissions by a total of 427,590 tons, as the
Phase II units were generally cleaner~.~[^195] However, it allowed the
Phase I units to bank an additional 1,159,995 allowances, potentially
creating a net difference of 732,404 additional tons of emissions over
time.[^196] These problems indicate that phasing of power plants in a
regulatory system is difficult at best, and if done again, more
sophisticated rules need to be developed.

### 11. Environmental Effects or "Hot Spots" from Trading

Concern has been expressed that Title IV's allowance trading system
could result in "hot spots," or areas of localized high pollution
levels, by allowing heavily emitting units simply to buy allowances
instead of reducing emissions.[^197] The results of Phase I reveal that
allowance trading had a relatively small effect in shifting emissions,
with a slight tendency towards cooling hot spots, not creating
them.[^198] Since local pollutant levels depend primarily on the overall
stringency of regulation, together with economic factors such as plant
siting, size, and utilization, it appears that rate-based systems may
allow greater hot spots than cap-and-trade systems.

Before examining the results of trading in Phase I, it is important to
note that Title IV requires reductions in addition to the existing
ambient standards for SO~2~ that are designed to protect public health
in the vicinity of a plant.[^199] As noted before, many plants met these
ambient standards through tall stacks and not emissions reduction, but
these ambient standards still exist and serve as a check against SO~2~
trading ever causing significant hot spots.[^200]

Phase I data indicates there has been relatively little shifting of
emissions due to trading. First, as shown in the figure below, emissions
were fairly evenly below authorized allocations in virtually all states.

###### *See* Figure 2-10: SO~2~ Allowances Allocated and Emissions by State (1995-1999)[^201]

A second indication of the lack of effect of trading in causing hot
spots during Phase I is an EPA analysis of the origin of all allowances
actually used at units to offset emissions in the years 1995-1998.[^202]
This study revealed that 81% of allowances actually used originated in
the same state as the source, and that net inter-regional trading only
constituted 3% of all allowances used.[^203]

A third way to look at the effects of trading is to review the
reductions made at individual plants during Phase I. The data confirms a
general prediction made about cap-and-trade programs that they will tend
to create incentives for the dirtiest plants to clean up the most, as
the per-ton cost of emissions reductions should be lowest where the
capital costs of control are spread over the largest number of tons.
Figure 2-11 reveals that the largest emitters have reduced emissions the
most, with the result of cooling hot spots rather than creating them.

###### *See* Figure 2-11: Allowances vs. Emissions of the Twenty Largest Phase I Plants[^204]

Overall, it appears that localized levels of pollution are determined
overwhelmingly by economic factors, notably plant location, size, and
utilization. To the extent that regulation has any effect on localized
levels of pollution, it is the overall stringency of the regulation that
matters, not whether it is achieved by a rate or cap-and-trade system.

# III. Regulatory Programs for NO~X~

This Part discusses the standard for nitrogen oxides (NO~X~) established
under Title IV, with reference to other NO~X~ regulations applicable to
sources in northeastern states and to new sources. Title IV's Phase I
NO~X~ program has succeeded in many respects. Although litigation
delayed the program one year, firms achieved 100% compliance with the
standards in every year thereafter.[^205] In other ways, however, the
program failed to achieve noteworthy results. The standards were
relatively weak, and exempted major groups of boilers from coverage. As
contemplated by Congress, the standards led firms to do little more than
install retrofits of low-NO~X~ burners on most boilers, limiting
innovation to one point in time and to methods that reduced the cost of
making the retrofits.

Title IV established the first regulation of NO~X~ faced by many
existing power plants. Most coal-fired power plants were built before
the Clean Air Act of 1970, and so faced few restrictions on NO~X~
emissions, as Clean Air Act regulation focused on new sources.[^206]
Although states were authorized to regulate existing sources in areas
that had not attained the national ambient standards, these tended to be
large urban centers; since most coal plants were located outside such
areas, few states imposed significant restrictions.[^207] Major
state-level regulatory activity on NO~X~ did not commence until the
1990s, when scientists began to emphasize the role of NO~X~ in the
formation of urban ozone.[^208]

During the period studied, incentives to firms to make added NO~X~
reductions came primarily from the Ozone Transport Commission (OTC)
cap-and-trade program established in 1999,[^209] and from new source
NO~X~ standards that apply primarily to gas-fired turbines.[^210] The
OTC program led firms to use a variety of additional technologies to
make further NO~X~ reductions, but innovation under the new source
standards has focused primarily on end-of-pipe control
technologies.[^211] The regulatory system for NO~X~ therefore creates a
fragmented set of rate standards that impose different limits and
compliance burdens on different technologies and far more lenient
standards on old versus new sources. This is very unlike the SO~2~
program in which all sources faced the uniform emissions cap and
allowance-trading system.[^212]

## A. Background

Nitrogen oxide (NO~X~) is a criteria pollutant regulated under the Clean
Air Act,[^213] and plays a major role in a variety of environmental
problems, including acid precipitation, the formation of particulates
and ozone dangerous to human health, and damage to plants and
agricultural productivity.[^214] Electricity-generating facilities
emitted 6.1 million tons of NO~X~ in 1998, 25% of national emissions,
with 88% of these emissions from coal-fired generation.[^215]

The combustion process produces NO~X~ in two principal ways. Fuel NO~X~
is created through oxidization of nitrogen in the fuel, with combustion
conditions determining the extent of NO~X~ formation. Thermal NO~X~ is
created by the reaction of molecular nitrogen and oxygen in the
combustion air, and increases with combustion temperature and oxygen
content. Fuel NO~X~ can be controlled to a small degree by burning coal
with lower nitrogen content, but thermal NO~X~ must be controlled by
lowering flame temperature and creating oxygen-lean conditions in the
combustion process to reduce NO~X~ formation.

Low-NO~X~ burners control fuel and air mixing to reduce peak flame
temperatures, and are an economical way to limit the formation of NO~X~
in electricity-generating units.[^216] Installing low-NO~X~ burners,
however, is more difficult in some boiler types than others, and
achieves different levels of emissions reductions in different
boilers.[^217] Because low-NO~X~ burners may increase unburned carbon
levels, they typically lower boiler efficiency by a few percentage
points.[^218] In addition to these "combustion controls" that limit
NO~X~ formation, NO~X~ emissions can be destroyed after formation by
control technologies.

Our research found that utilities struggled with the alternatives
available for reducing NO~X~ emissions. Most had limited experience with
most of the later generation low-NO~X~ burner technology, and there were
major concerns over detrimental impacts of low-NO~X~ burners on boiler
tubes and overall efficiency. Control technologies like Selective
Catalytic Reduction (SCR) and Selective Non-Catalytic Reduction (SNCR)
at the time were not well proven on a commercial scale nor for large
coal-fired units. Also, deregulation was on the horizon and some
companies were hesitant to invest capital with a lengthy recovery
period. Changing to lower emitting fuels could possibly trigger New
Source Review (NSR) requirements and could adversely affect unit
efficiency, driving up production cost and making the unit less
competitive. These uncertainties caused firms to delay and minimize
expenditures to the extent possible while maintaining their obligation
to serve load.[^219]

## B. Title IV NO~X~ Standard and Its Legislative History

Title IV was designed to cut NO~X~ emissions from utility boilers by 2
million tons from 1980 levels by the year 2000.[^220] However, instead
of using an emissions cap and allowance-trading system as with SO~2~,
Congress established annual average emission limits for coal-fired
electric utility units based on the use of "low-NO~X~ burner
technology."[^221]

Phase I of the NO~X~ program lasted from 1996 through 1999, and applied
to the 265 wall-fired and tangentially-fired boilers[^222] included in
the Acid Rain Program as Table A units, or substitution units active on
January 1, 1995.[^223] The legislation exempts other boiler types from
Phase I because low-cost combustion controls such as low-NO~X~ burner
technology were not known to be available for these boilers at the time
of passage of the Act.[^224] Phase II of the program started in 2000,
and includes all other units affected by Title IV.[^225] Since the units
included in Phase I have already made their boiler modifications, they
are permanently grandfathered at the lower Phase I standards and not the
more stringent Phase II standards.[^226]

Figure 3-1 shows the emissions limits applicable to different boiler
types in Phase I and Phase II of the program. Phase I limits for
wall-fired and tangentially-fired boilers were 0.50 and 0.45 lb/mmBtu, a
significant reduction from their average uncontrolled emission level of
0.95 and 0.65 lb/mmBtu respectively.[^227]

###### Figure 3-1. Title IV NO~X~ Standards by Boiler Type (lb/mmBtu)[^228]

  -------------------- ------------- ------------- ------------- -------------
  Number range CHAPTER Phase I                     Phase II      

  *Boiler Type*        *\# of Units* *Standard*    *\# of Units* *Standard*

  Tangentially-fired   135           0.45          308           0.40

  Dry bottom\          130           0.50          299           0.46
  wall-fired                                                     

  Cell burners                                     36            0.63

  Cyclones\                                        55            0.86
  (\>155 MW)                                                     

  Vertically fired                                 28            0.84

  Wet-bottom\                                      26            0.84
  (\>65 MW)                                                      
  -------------------- ------------- ------------- ------------- -------------

In contrast to the intense debate on sulfur standards, there is
relatively little legislative history on the NO~X~ standard adopted in
Title IV. The NO~X~ reductions were perceived to be an adjunct to SO~2~
regulation, as the contribution of NO~X~ to acid deposition was confined
mostly to western states, and NO~X~ controls were expected to cost far
less than SO~2~ controls.[^229] Although the motives for regulating
NO~X~ included its contribution to nutrient loading in sensitive waters
and in ozone formation, at that time the role of NO~X~ in ozone
formation was not perceived to be as important as it is today.[^230]

The manner in which NO~X~ would be regulated shifted dramatically during
the legislative process. As introduced, the NO~X~ provisions required
affected units to meet an annual tonnage limit for NO~X~ and provided an
allowance trading provision, similar to the SO~2~ cap-and-trade
program.[^231] However, this was changed radically upon adoption of a
substitute provision introduced by Senator Trent Lott of Mississippi
that established emission rate standards for NO~X~ set in the
traditional manner for each boiler type.[^232] The final rate standard
was based on what could be achieved using low-NO~X~ burner technology,
with an explicit recognition by Congress that this would not lead to
major costs.[^233]

Subsequently, Congress added a number of flexibility provisions designed
to reduce the costs to affected firms. First, the rate standard is an
annual standard, which allows more flexibility in technology use than a
daily or monthly standard.[^234] Second, companies are allowed to
average their units to meet the rate standard, an important tool that
most companies would use.[^235] Third, the law allows an individual unit
to obtain an Alternate Emission Limit (AEL) if it could not meet the
standard even after installing a low-NO~X~ burner.[^236] A final
flexibility provision created through the regulations was the Early
Election Program that allowed Phase II units an exemption from Phase II
standards until 2008 if they voluntarily met Phase I standards by
1997.[^237] The end result was a rate standard with both flexibility and
a waiver provision that ensured firms would not need to do more than
install known, relatively inexpensive combustion controls on their
units.

The limitations of this mandate became apparent when the Court of
Appeals for the District of Columbia Circuit subsequently determined
that the EPA's initial regulation, which would have required both
low-NO~X~ burners and "overfire air" (a related combustion control),
exceeded the agency's authority.[^238] The court held that only
low-NO~X~ burners were required.[^239] In this sense, Title IV was
almost as much a limitation on the EPA's power to regulate NO~X~ emitted
by electricity-generating units as it was an authorization.

## C. Results of Title IV

### 1. Initial Litigation and Delay

The initial result of the Title IV NO~X~ standard was controversy over
the meaning of low-NO~X~ boiler technology. After much debate, the EPA
promulgated regulations establishing NO~X~ emission limits for Phase I
units to begin in 1995, based on the combined effect of low-NO~X~ burner
and overfire air technology.[^240] However, industry sued and the United
States Court of Appeals for the D.C. Circuit vacated the rule, holding
that low-NO~X~ burners do not incorporate the combination of low-NO~X~
burners and overfire air.[^241] Consequently, the EPA reissued a revised
final rule in April of 1995 that eliminated the incorporation of
overfire air, and delayed the effective date of Phase I by one year to
1996.[^242]

### 2. Implementation

Following the lawsuit, implementation of the NO~X~ program was
relatively straightforward, and all 265 coal-fired units affected under
Phase I met the legal requirements in each year.[^243] Most, or 175
units, met the emissions rate limits as expected through the
installation of low-NO~X~ burners.[^244]

The rate and tonnage reductions resulting from Phase I are shown
graphically in Figures 3-2 and 3-3. Overall, units lowered their average
NO~X~ emissions rates to 0.40 lb/mmBtu during Phase I, 43% below the
1990 average of 0.70 lb/mmBtu.[^245] This reduced NO~X~ emissions by
approximately 400,000 tons per year, or 32% below 1990 levels, with
overall reductions projected to rise to 2,060,000 tons per year during
Phase II, which started in 2000.[^246] There is less reduction in total
tons than in rates because economic growth led to higher utilization of
generating units. Unlike the SO~2~ program, in which emissions are
capped, the rate-based NO~X~ program will allow NO~X~ emissions to rise
with increased utilization.[^247]

###### *See* Figure 3-2. NO~X~ Rate Reductions During Phase I[^248]

###### *See* Figure 3-3. NO~X~ Tonnage Reductions During Phase I[^249]

Most of the 265 Phase I units achieved compliance in a straightforward
manner, by retrofitting low-NO~X~ burners. Overall, 175 units (66%)
installed low-NO~X~ burner technologies for compliance, with most (114)
of these units coupling the low-NO~X~ burners with overfire air.[^250]
Many firms also used the ability to average emissions among their
plants, creating twenty-two averaging plans covering 204 of the 265
units in Phase I.[^251] This allowed fifty-two uncontrolled units to
continue to emit above the limit, and comply by averaging; of the
remaining units, twenty-three already met the Phase I limits, seven were
not operating, and eight used other compliance technologies, principally
independent overfire air.[^252] Figure 3-4 shows the use of compliance
technologies according to the decade in which the plant was built.

###### *See* Figure 3-4. Phase I NO~X~ Control Technologies by Age of Plant[^253]

Overall, flexibility provisions in the law, including the annual rate
standard and the ability to average emissions among a firm's units,
allowed relatively economical compliance. Only ten received interim
Alternate Emissions Limits from the EPA when they could not meet their
rate limits even after installing low-NO~X~ burners.[^254] Overall, the
EPA estimated that the cost of the Phase I NO~X~ reduction program to
the electric power industry was \$267 million per year.[^255] Analysis
of the cost of the burner retrofits in Phase I reveal an average per-ton
reduction cost of \$412, with an average capital cost of \$19.75/kW in
1990 dollars.[^256] The two types of boilers represented in Phase I,
however, experienced markedly differing costs. Wall-fired boilers
achieved reduction at \$161/ton, whereas tangentially-fired boilers cost
\$631/ton.[^257]

## D. Business Behavior and Title IV

The following Subparts discuss business responses to Title IV's NO~X~
program and relate findings to Title IV's regulatory structure.
Subsequent sections discuss other NO~X~ regulations affecting
electricity generators in the 1990s. Finally, Part IV compares the
results of the regulatory programs for NO~X~ with those for SO~2~.

### 1. Rate Standards Led to One-Time Compliance Using the Expected Technology

As can be seen from Figure 3-4, the principal effect of the Title IV
rate standards was the one-time retrofit of a known compliance
technology. Although these standards significantly reduced NO~X~
emissions from baseline levels, thereafter firms made little effort or
progress in reducing NO~X~. This reveals one of the intransigent
problems with rate-based limits, as they do not encourage continuous
efforts by firms to reduce emissions, or provide incentives to go beyond
the standard.

### 2. In Making Pollutant Reductions, Firms Sought First to Optimize Their Process Efficiency, as Regulations Were Sufficiently Flexible to Create Benefits Through Doing So

The initial response of plant operators subject to the Phase I NO~X~
program was to optimize boilers by addressing such parameters as
air/fuel mixtures and temperatures to assure the lowest possible NO~X~
emissions prior to investing in additional control technology.[^258]
Optimization can increase efficiency, and so reduce not only NO~X~ but
all other pollutants emitted by the plant as well. Since most units had
not been subject to NO~X~ requirements before,[^259] the results of
optimization were generally positive. Plant operators report that the
optimization process achieved NO~X~ reductions of several percent,
although some reported gains of 10% to 20%.[^260] Vendors of the
services and software products involved in optimization claim greater
reductions of up to 30%, especially in plants that were previously
poorly maintained.[^261]

The availability of flexibility mechanisms in Title IV, such as
averaging and the Early Election Program, prompted widespread use of
optimization in the Phase I NO~X~ program. Regulatory design strongly
affects the use of optimization, as less flexible rate standards may
create few incentives for optimization. For example, a percentage rate
reduction standard, like the 1977 SO~2~ New Source Performance Standard,
creates no incentives for efficiency or optimization because it only
measures reductions achieved within the stack. Concentration rate
standards provide incentives to optimize only to those units that
previously exceeded the rate limit by a small amount. All others must
install control technology. However, more flexible regulatory systems,
such as those that allow averaging or trading, make optimization
important for most or all affected units, and thereby promote efficiency
as well as lower-cost compliance.

### 3. Firms Heavily Used Flexibility Mechanisms with Low Transaction Costs, Such as Averaging

Firms heavily used the two flexibility provisions in the law that
provided significant economic benefits with relatively simple
procedures. One was the averaging provision, which allowed firms to
average the emissions rates of various units under their control.[^262]
The second was the Early Election Program, which allowed firms to
include Phase II units in Phase I, giving them a seven-year grace period
from more stringent Phase II limits.[^263] Both had low transaction
costs because they could be implemented through a simple designation by
a firm.[^264] In contrast to these, the AEL exemption process was
complex and could be used only if a unit could not reach the standard
even after installing a low-NO~X~ burner; it was used for only ten
units.[^265]

#### a. Averaging and Uncontrolled Units

The Clean Air Act allowed utilities to comply with applicable rate
standards by averaging the heat-input-weighted annual emissions rate of
two or more units to meet the applicable rate standard.[^266] This
allowed large firms with many units to shift the burden of compliance
between units, providing flexibility almost equivalent to that of
trading.

Averaging was a widely used compliance strategy, and twenty-two firms
included 204, or 80%, of the 265 affected units in averaging plans in a
typical year.[^267] Averaging plans allowed larger firms to avoid
installing low-NO~X~ burner technology in some units, and helped to
lower compliance costs while maintaining the overall emissions reduction
goal. As evident in Figure 3-4, it also allowed a shift in investment to
newer facilities, as units built before 1954 were more likely to be
uncontrolled than controlled. Interviews addressed the question whether
the averaging provision may have allowed firms to extend the life of
older facilities, but respondents generally reported using averaging as
a flexibility provision, to save on costs they would have otherwise
incurred in installing low-NO~X~ burners in these plants.[^268]

Despite allowing greater flexibility, most averaging plans surprisingly
resulted in a significant level of over-compliance, with the average
emissions rates 10% or more below the applicable limits.[^269] The
results also show that some firms were overly cautious in creating
averaging plans, as nine plans, including thirty-seven units, actually
did not need to average at all since all units met the standard.[^270]
However, even for these units, inclusion in an averaging plan may have
provided firms with greater operational security during the year,
providing compliance assurance even if one unit were to fail to meet its
rate limit.

Averaging allowed fifty-two units, typically older ones, to remain
uncontrolled despite exceeding the emissions standard.[^271] With
average emissions of 0.61 lb/mmBtu, still above the statutory limits,
these units can remain uncontrolled due to the flexibility afforded by
averaging.[^272] Although they remain uncontrolled, the averaging
provisions still create an incentive for reductions, such as through
optimization, as any emissions reduction helps the overall average.
Therefore, these units have reduced their emissions rate from 0.67
lb/mmBtu in 1990, and the rates of the highest emitters have been
reduced from 1.41 lb/mmBtu in 1990 to 0.81 lb/mmBtu in 1999. An
additional twenty-three units, mostly substitution units, are relatively
clean plants that are uncontrolled because they meet the required
emissions limits anyway, totaling seventy-two uncontrolled units in all.
Because of averaging incentives, even these plants reduced their
emissions, from an average of from 0.45 lb/mmBtu in 1990 to 0.35
lb/mmBtu in 1999.[^273]

#### b. Early Election Units

Another widely used flexibility provision designed to promote early
NO~X~ reductions was the Early Election compliance option created by the
EPA.[^274] Under this regulatory program, wall- or tangentially fired
boilers that would normally not be regulated until Phase II could elect
to comply with Phase I emissions limits starting in 1997, and would not
be required to meet the more stringent Phase II limits until 2008.[^275]

Two hundred seventy-four units in thirty-six states participated in the
EPA's Early Election Program for NO~X~, almost half of the 614 eligible
units.[^276] These participating units reduced their NO~X~ emissions
rates by 20%, from an average of 0.46 lb/mmBtu in 1990 to 0.37 lb/mmBtu
in 1999.[^277] The Early Election Program resulted in environmental
results by achieving net emissions reductions of 435,790 tons, or the
difference between additional reductions of 557,491 tons achieved in
1997-1999,[^278] and the expected higher emissions of 121,701 tons
during the period 2000-2007.[^279] Another environmental benefit was the
added value in achieving earlier reductions, which helped ecosystem
recovery.

Firms also benefited economically from the Early Election Program
because it allowed operators to use less expensive compliance methods at
certain units that could meet Phase I standards at low cost, and to
avoid more costly investments, such as burner retrofits, that would be
needed to meet the more stringent Phase II limits. Typical Early
Election units had emissions rates slightly above the Phase I standard,
and could meet that standard through optimization or other compliance
methods that were low in cost, but could only achieve limited
reductions.[^280]

Another business benefit of the program was that it provided greater
regulatory certainty over a longer planning horizon for firms. Indeed,
many units appeared to have been entered into the early election program
as a precaution, as one-third, or ninety, of the early election units
were already below Phase II limits in 1990, and two-thirds, or 201,
below them in 1999.[^281]

#### c. Alternative Emissions Limits (AELs)

In contrast to the simple procedures for averaging and early election
units, a third flexibility option, Alternative Emissions Limits (AELs),
required high transaction costs and was little used. In order to qualify
for an AEL, firms had to compile a detailed justification demonstrating
that they attempted to install a low-NO~X~ burner in a unit and that it
still failed to meet the emissions rate limit.[^282] Firms filed for
AELs for ten units in Phase I. These requests have only been approved on
an interim status by the EPA, and are still involved in administrative
proceedings four years after the start of the program.[^283]

### [4.]{.smallcaps} Businesses Faced with Rate Standards Can Be Expected to Over-Comply by 10%

One of the evident characteristics of firm behavior was over-compliance
with the NO~X~ standards. For Table A units, average emissions were
0.435 lb/mmBtu during the four years of the program, 11% below the
average limitation of 0.49 lb/mmBtu.[^284] Substitution unit emissions
were even lower, averaging 0.37 lb/mmBtu, partly because many of the
substitution units were newer and were therefore already lower NO~X~
emitters.[^285]

This over-control represents several factors. Most firm representa-tives
indicated that 10% over-compliance represents a reasonable operating
margin to ensure that a particular limit is not exceeded.[^286] Since
exceeding the limit would bring about a \$2000 per ton fine and
potential criminal penalties,[^287] firms tend to design compliance
technology that would slightly surpass the limit in case the technology
does not perform quite as well as predicted, and operate the equipment
to slightly over-comply in case a malfunction reduces its efficiency
towards the year's end.[^288]

However, over-compliance is also the result of expected business
behavior in the face of regulatory uncertainty, which was exacerbated in
this case by the delay in promulgating proposed regulations, the
subsequent lawsuit, and revisions to the standard.[^289] The effects of
uncertainty are pronounced in the case of NO~X~ combustion controls, as
every low-NO~X~ burner must be designed for a specific boiler, and
eighteen to twenty-four months are needed to design and install the
burners.[^290] Therefore, during the early stages of the planning
process, when the NO~X~ rules were not final, some firms opted to
install overfire air technology (OFA) as called for by the initial
regulation, achieving slightly higher levels of emissions
reductions.[^291]

### 5. Innovation under Title IV's Moderate Rate Standards Was Limited in Scope and Extent

A retrospective view reveals that the Title IV NO~X~ standards had only
limited effects in leading firms to develop new solutions. The sections
below describe technical innovation for the three main boiler types and
for overfire air. This assessment also reveals that the Title IV rate
standards led firms to identify better or cheaper ways of compliance
only at the time the standard took effect, and did not drive continuous
improvement.

#### a. Wall-Fired Boilers

Innovation significantly reduced the costs of compliance for wall-fired
boilers. The initial assumption was that Title IV would require firms to
replace existing burners with low-NO~X~ burners, which was the basis of
the EPA's cost estimates in its regulatory analysis.[^292] However,
manufacturers and users of wall-fired boilers found that if the burners
were in good condition and of sufficient capacity, removing a line of
burners near but not at the top of the boiler would distribute air in a
way that replicates a new low-NO~X~ burner. This innovation reduced cost
to a small fraction of the cost of installing a new burner, with capital
costs on the order of only 25% to 50% of the cost of low-NO~X~ burners
for comparable NO~X~ control.[^293] Some vendors report even lower
numbers for some units, with capital cost about \$1 per kilowatt,
compared to the \$10 to \$20 per kW cost of a new low NO~X~
burner.[^294]

#### b. Tangentially Fired Boilers

Low-NO~X~ burner technology for tangentially-fired boilers differs from
that for wall-fired boilers, with overfire air playing a more integrated
role.[^295] Retrofit applications of low-NO~X~ burners significantly
reduce NO~X~ emissions from tangentially-fired boilers, with reductions
in emissions between 10% and 48% in one study, and controlled levels
ranging from 0.34 to 0.55 lb/mmBtu.[^296] However, contrary to the
findings for wall-fired and cyclone boilers, no significant innovation
reduced the costs for low-NO~X~ burner retrofits for tangentially-fired
boilers. The cost of reductions averaged \$631 per ton, and capital
costs ranged from \$6 to \$42 per kilowatt.[^297]

#### c. Cyclone Boilers

Although cyclone boilers were not included in Phase I, the reasons for
this exclusion and the circumstances of their inclusion in Phase II
present a good example of business behavior and innovation when
confronted with rate standards. Cyclone burners are quite different from
wall- and tangentially-fired boilers, firing chunk rather than
pulverized coal. Because no low-NO~X~ burner technology was known to be
applicable to cyclone boilers in 1990, they were exempted from
regulation under Phase I.[^298] The law did provide, however, that if
technology "comparable to the costs" of low-NO~X~ burner technology
became available, the EPA could issue standards for cyclones and other
boilers for Phase II starting in the year 2000.[^299]

The industry made few efforts to identify NO~X~ reduction methods for
cyclones until 1995, when the EPA indicated it would regulate them in
Phase II because the cost of downstream technologies such as reburn and
SCR had become "comparable" to the cost of low-NO~X~ burners.[^300] The
EPA promulgated regulations in 1996 permitting relatively high emissions
(0.86 lb/mmBtu), and exempting cyclones less than 155 MW altogether,
based on the cost-effectiveness of these technologies.[^301]

The industry then formed the Cyclone NO~X~ Control Interest Group
(CNCIG) under the auspices of the Electric Power Research Institute
(EPRI) in 1995 to commence research and development.[^302] This group
achieved spectacular results, and by 1997 demonstrated that applying
overfire air technology to cyclones could achieve significant NO~X~
reductions, on the order of 50%, at very low cost.[^303] This result was
unanticipated, as the attempts made in the 1980s to use overfire air
were failures, and had led to unacceptable wall wastage or carbon loss.
The R&D investment in CNCIG was relatively modest, less than \$2
million, including full scale demonstrations, and the payback saved the
industry a minimum of \$250 million in the cost of retrofitting cyclone
boilers to meet Title IV requirements.[^304] Once this group achieved
its objective in meeting the Title IV rate limits, however, the research
effort was scaled back.[^305]

Although this technology innovation is now available, it is underused
because the regulations do not require reductions beyond the rate limit
even if they are inexpensive, and they also exempt cyclone units under
155 MW, which may continue to emit NO~X~ at uncontrolled levels over 1.5
lb/mmBtu, higher than that of any other boiler type.[^306] This example
illustrates the problems with rate standards when government regulators
fail to accurately predict technology innovation, as well as the
sporadic nature of technology research they motivate.

#### d. Overfire Air

Overfire air technology can be combined with low-NO~X~ burners to divert
about 20% of combustion air at the burner level to air ports above the
burner zone, reducing the oxygen availability at the burners.[^307]
However, although overfire air decreases NO~X~ formation during
combustion, it can inadvertently promote waterwall wastage by creating
reducing conditions within the burner zone. Wastage has appeared mostly
in high-temperature supercritical boilers, and in some cases was severe
enough to instigate tube failures and forced outages.[^308] These
problems made many operators reluctant to use the technology in their
boilers. An EPRI team discovered that low-cost changes in burner
settings and operating practices appeared able to cut waterwall wastage
significantly in many boilers by reducing the area covered by damaging
iron sulfide deposits.[^309]

## E. Other NO~X~ Regulation in the 1990s

Title IV applied to both old and new power generation sources, but was
significant principally in its effects on older units, most of which had
never been subject to NO~X~ regulation. In order to evaluate firm
behavior with regard to NO~X~ regulation, ELI reviewed the other major
NO~X~ regulations affecting utility plants in the 1990s. These include
the Ozone Transportation Commission (OTC) program for summertime NO~X~
reductions in northeastern states,[^310] and the new source standards
that affect new plants or major modification of existing plants.
Additional reductions of NO~X~ emissions from power plants in eastern
states has been proposed by the EPA under its NO~X~ SIP call regulation,
but this will not take effect until 2004.[^311]

### 1. OTC Cap-and-Trade in 1999 Forced Further Reductions at Existing Plants

In the twelve northeast and mid-Atlantic states,[^312] NO~X~ emissions
from large power plants have been controlled not by Title IV, but by
more stringent state regulations to reduce summertime NO~X~ emissions
coordinated under the OTC. The OTC was created under the Clean Air Act
Amendments of 1990 to facilitate regional planning of states' efforts to
attain the National Ambient Air Quality Standard (NAAQS) for ground
level ozone.[^313] In September of 1994, all OTC states but Virginia
adopted a Memorandum of Understanding to achieve regional reductions of
NO~X~ from power generators starting in 1995.[^314]

In Phase I of the OTC program, states required sources to install
Reasonably Available Control Technology (RACT), a standard roughly
equivalent to the Title IV NO~X~ standards but applying almost one year
earlier.[^315] Pennsylvania required sources to install low-NO~X~
burners with separate overfire air, and other states such as New York
and New Jersey defined rate standards that were slightly more stringent
than the Title IV standards.[^316] Most states also allowed averaging
among a firm's facilities, creating standards slightly more stringent
but similar in nature to Title IV.[^317] The result was also similar,
with most firms adding combustion controls such as low-NO~X~ burners
and/or overfire air to most units.

For Phase II, starting in 1999, nine OTC states established a NO~X~
Budget Program creating an emissions cap and allowance-trading system
similar to the EPA's SO~2~ Acid Rain Program.[^318] The emissions cap
required 912 electricity-generating units to reduce NO~X~ emissions by
55% to 65% from their 1990 baseline of 417,444 tons.[^319] Despite the
stringency of the standard, sources over-complied, reducing emissions
20% below the cap level in 1999.[^320] Compliance levels were also very
high, with only one source failing to meet its standard by one ton,
therefore subjecting it to an automatic penalty.[^321]

Despite initial expectations that many sources would need to use
expensive end-of-pipe controls such as Selective Catalytic Reduction
(SCR) to achieve these deep reductions, the flexibility afforded by the
cap-and-trade approach led to unexpected results. One was that 126 of
the 142 affected coal-fired units achieved up to 30% NO~X~ reductions
through operational changes alone, without significant capital
additions.[^322] The cap approach allowed compliance through a number of
technologies, described in Figure 3-5, and not only SCR. As a
consequence, allowance costs, after initial volatility at the program's
start in which prices ranged from \$3000 to \$7000 per ton, have settled
down to \$500 to \$1000, significantly lower than originally
estimated.[^323]

###### Figure 3-5: Technology Options Available to Existing Coal-Fired Plants to Meet Stringent NO~x~ Standards[^324]

> **Combustion controls** are boiler modifications that minimize the
> formation of NO~x~ in the boiler. In addition to the direct burner
> modifications required for Title IV, advanced combustion controls can
> include overfire air and computer controls that enhance mixing of coal
> and air in the boiler.
>
> **Gas Reburn** technologies reduce NO~x~ by injecting natural gas
> above the coal combustion zone. Gas reburn may achieve up to 55% NO~x~
> reduction using 15% gas injection, with capital costs of \$12 to \$25
> per kW and additional operating costs for the relatively more
> expensive natural gas fuel. Enhanced forms of gas reburn can use
> reagents such as amine injection to increase NO~X~ reductions to 60%,
> although these are slightly more expensive.
>
> **Selective Non-Catalytic Reduction (SNCR)** injects a urea-based
> reagent in the upper furnace to reduce NO~X~. SNCR achieves about a
> 35% NO~X~ reduction at a capital cost of \$5 to \$20 per kW. Combining
> re-burn with SNCR can get over 70% reductions.
>
> **Selective Catalytic Reduction (SCR)** injects ammonia into the
> boiler, which catalytically reduces the NO~X~. SCR has the greatest
> NO~X~ reducing potential, achieving 70% to 90% reductions, but is also
> the most expensive, with capital costs of \$50-100 per kW. In
> addition, SCR has substantial operating costs, uses toxic catalysts
> that must be replaced, releases ammonia and entails a 0.5% efficiency
> loss.

It is interesting to view firms' response to the OTC cap, since the
affected units were previously subject to rate standards set at levels
similar to Title IV standards. Figure 3-6, developed by the Gas Research
Institute, shows emissions levels for coal-fired units subject to the
OTC cap in 1999.

###### *See* Figure 3-6: 1999 Ozone Season NO~X~ Emission Rates for OTR Coal Boilers Without Post-Combustion Controls[^325]

These results show how different units emit at different levels under a
cap-and-trade system that creates a uniform cost per ton for emissions
reductions. This is due to the "step-wise" nature of technology choice.
In other words, at a given moment in time some firms may find it
inexpensive to achieve, for example, a 56% reduction, but very expensive
to reach 57% because that would require major new equipment. Another
firm may face this "cost knee" at a higher or lower level. So at an
equal cost, firms will want to operate units to emit at slightly
different levels. However, over time, firms may find ways to
incrementally improve processes or operations to achieve greater
reductions, typically at low cost.[^326] Systems like a cap-and-trade
approach encourage such differential behavior and the seeking of
continuous reductions. A rate standard sets one limit that must be
achieved at a certain date, and so eliminates both these possibilities,
restricting firm behavior, raising costs, and eliminating incentives for
continued incremental improvements.

### 2. New Source Standards

In contrast to existing plants, new plants or significant modifications
of existing plants have been subject to NO~X~ standards since the
initiation of the Clean Air Act in 1971.[^327] Today, new sources are
subject to a stringent federal New Source Review process, which requires
at a minimum compliance with NSPS.[^328] Traditional NSPSs establish
emissions rate standards for each power-generation technology; e.g.,
coal-fired boilers are allowed to emit twice the NO~X~ as oil-fired
boilers, and three times that of gas-fired.[^329]

In 1998, the EPA established a new, fuel-neutral NSPS of 0.15 lb/mmBtu
for major modifications of existing sources, and 1.6 lb/MWh of
electricity generated for new sources, the latter an innovative
output-based standard that provides a benefit to efficient
producers.[^330] However, this fuel-neutral NSPS rarely applies, as the
standards created under the New Source Review process are more stringent
and therefore control.[^331]

New Source Review establishes an emissions rate standard set by
regulators on a case-by-case basis based on the specific plant and
power-generation technology, such that more lenient standards are
applied to dirtier technologies.[^332] Sources built after August 7,
1977, in areas that have attained the federal ambient ozone standard set
by the EPA must prevent significant deterioration of air quality, and
install the Best Available Control Technology (BACT) for the type of
plant proposed considering "energy, environmental, and economic impacts
and other costs."[^333] New plants in nonattainment areas must meet the
even more stringent Lowest Achievable Emissions Rate (LAER) standard,
which excludes considerations of cost.[^334] These strict standards are
meant to achieve ambient standards, prevent airshed deterioration, and
be used as mechanisms to spur the development and application of new
technologies.

### 3. Technology-Based Rate Standards for NO~X~ in the 1990s Created an Uneven Regulatory Framework and Varied Economic Signals for Most Business Units

As shown in Figure 3-7, power plant NO~X~ regulation in the 1990s
created a highly uneven regulatory framework that sent different
economic signals to the owners of different technologies. Because rate
standards were set at differing levels for the different base
technologies, they created a progression in which the dirtier a
power-generating technology was in terms of NO~X~ emissions, the more
lenient the rate standard. This created highly differential costs for
NO~X~ reductions for different technologies, in the hundreds of dollars
per ton of reductions for higher-emitting coal-fired units, and up to
\$10,000 per ton for clean gas turbines.

###### Figure 3-7: Differential Standards for NO~X~ Emissions and Costs from Generating Technologies (1996-1999)[^335]

  -------------- ---------- ------------ --------- ------------- --------- -----------
                 Old                               New Sources             
                 Sources                           (BACT/LAER)             
                 (Title                                                    
                 IV/RACT)                                                  

                 Cyclone    Wall-fired   T-fired   New coal      New gas   New gas
                 coal       coal         coal                    large     small

  Uncontrolled   1.50       0.95         0.65      0.50          0.05      0.10
  NO~x~                                                                    
  (lb/mmBtu)                                                               

  Legal standard none       0.50         0.45      0.15          0.02+     0.02+
  (lb/mmBtu)                                                               

  Cost per ton   none       \$161        \$631     \$565 (SCR)   \$2,500   \$10,000+
  of NO~x~                                                                 
  reduction                                                                
  -------------- ---------- ------------ --------- ------------- --------- -----------

The disparities in the regulation of NO~X~ emissions from different
technologies, as well as between old and new plants, created strong
economic incentives for the use of dirtier technologies and against the
installation of new plants. They also imposed high costs on new
technologies, despite creating few, if any, net ambient environmental
benefits. These standards create a situation in which regulation of
NO~X~ may frustrate the economic drivers leading firms to use cleaner
energy sources, and fail to capture multi-pollutant reductions created
by switching to such sources.[^336]

# IV. General Findings

The design of Title IV and other regulatory programs to reduce NO~X~ and
SO~2~ emissions in the electricity-generating sector led to dramatically
different industry responses. ELI's review of business responses to
these programs provides a foundation for looking at how regulatory
design affects environmental results, compliance decisions, and
innovation.

Key distinctions between the programs examined include the difference in
the standards (an equal effort approach using rates versus an equal cost
per ton approach using cap-and-trade); the degree of flexibility allowed
in compliance technology; the degree of governmental involvement in firm
decision-making about compliance; and whether the systems created
continuous or one-time incentives for firms to reduce their pollution
levels. The mass-based standards such as cap-and-trade systems worked
better than rate systems in these regards, as they imposed stringent
environmental standards while allowing greater integration of
environmental parameters into business decision-making.

## A. Environmental Standards Have Been Essential to Drive Businesses to Reduce NO~X~ and SO~2~ Emissions

Although economic forces may also lead firms to cleaner production,
regulatory standards have clearly been necessary in order to ensure that
firms reduced NO~X~ and SO~2~ emissions. Title IV led firms to make
major additional SO~2~ reductions by building scrubbers and increasing
their use of lower-sulfur coals.[^337] Regulation was even more
important in making firms reduce NO~X~ emissions, as NO~X~ controls for
coal-fired boilers generally involve a loss of efficiency or additional
costs. Therefore, virtually no firms reduced NO~X~ emissions at existing
boilers before the advent of regulatory standards, and exempted units
continue to emit NO~X~ at uncontrolled levels.[^338] This indicates the
importance of setting standards to regulate firm behavior.

The record also shows that economic forces have also played an important
independent role in leading firms to lower emissions of both SO~2~ and
NO~X~. Prior to the advent of Title IV's SO~2~ standard, firms near the
Powder River Basin began to switch to cheaper lower-sulfur coals for
economic reasons.[^339] An analysis by MIT shows that a portion of SO~2~
reductions in Phase I can be attributed to this economic trend.[^340]
Regarding NO~X~, economic forces have cut both ways. Although there are
few economic incentives for owners of existing coal boilers to reduce
NO~X~ emissions, the situation for new plants is completely different.
New combined cycle gas turbines, which emit no SO~2~ and about a tenth
of the NO~X~ of older plants, are more efficient and cheaper than new
coal plants, and are forecast to capture over 90% of the market for new
plants.[^341] Because economic forces also can lead to major pollutant
reductions, in some cases to a greater extent than regulatory mandates,
good environmental regulation should enhance rather than interfere with
such positive economic drivers.

## B. It Has Proven Difficult to Set Standards That Properly Align Private with Social Costs, and Both NO~X~ and SO~2~ Standards Were in Retrospect Too Lenient

While standards appear necessary, it has proven difficult to set
standards that properly align firms' private costs with social
benefits.[^342] Ideally, environmental standards should create an
economic context that makes private sources perceive costs that reflect
a broader social context of costs and benefits. In retrospect, Congress
in 1990 both overestimated the costs of compliance with Title IV,[^343]
and underestimated the harm stemming from NO~X~ and SO~2~
emissions.[^344]

For both the NO~X~ and SO~2~ programs, the cost of control has remained
well below current estimates of the social benefits of additional
reductions. For NO~X~, the cost of retrofitting boilers with low-NO~X~
burners in Phase I averaged \$412 per ton, and the results of the OTC
NO~X~ cap show that significant added reductions could be made at a cost
of around \$500 to \$1000 per ton.[^345] In comparison, the benefit of
added NO~X~ reductions in eastern states is estimated by the EPA to be
between \$1262 and \$4786 per ton.[^346] Similarly, the cost of SO~2~
allowances in Phase I averaged \$150, far below current estimates of the
social benefits of added SO~2~ reductions, which exceed \$5000 per
ton.[^347] Therefore, for both pollutants, additional reductions would
be fairly inexpensive and very beneficial, but are not forced by the
standards-based approach. This shows the indispensable nature of
establishing the overall standard at the correct level of stringency,
whether it is expressed as a cap or a rate.

Technology-based rate standards, and the new source/old source
distinction in the Clean Air Act, both cause an added disadvantage in
aligning private with social values because they impose highly
differential costs on different technologies.[^348] This creates a
hetero-geneous set of cost signals based on technologies which are not
aligned with one another. Under NO~X~ rate regulation, some of the
dirtiest technologies faced lenient or no standards even though some
could reduce emissions cheaply at prices under \$100 per ton, whereas
the cleanest technologies faced the most stringent standards and were
forced to pay thousands of dollars per ton. Clearly, the economic
drivers faced by these firms result in little consistency or rationality
when compared to each other, or to a social optimum. The cap-and-trade
programs performed better in equating private and social costs because
they created a uniform cost faced by all firms, eliminating the
inefficiency caused by multiple rate standards that create different
economic signals for different technologies.

The cap-and-trade standard is also better in its environmental result
over time, since it permanently caps emissions, whereas rate standards
can be expected to allow emissions to grow over time along with economic
growth. Therefore, while SO~2~ emissions were capped during Phase I
despite increased power generation, NO~X~ emissions grew slightly. The
cap-and-trade system is also more dynamic at the firm level, as firms
have continuing incentives to reduce pollution to meet their quota or
create additional allowances; in contrast, rate standards simply require
a firm to install technology once and then maintain it. However, the cap
is set at a fixed amount for the industry as a whole, limiting its
dynamic aspect over time.[^349] Understanding how different regulatory
systems will interact with firm behavior over time is an important
element of understanding regulatory design.

## C. Standards Based on Rates or an Old Source/New Source Distinction May Create Conflict Rather Than Alignment Between Regulatory and Economic Drivers for Environmental Quality

A central finding of this study is that traditional environmental
regulations fail to align the regulatory and economic drivers that lead
firms to improve their environmental performance. The lack of alignment
appears to be unintentional, and stems both from the new source/old
source distinction in our law, and from the inflexibility inherent in
rate-based regulatory methods. Examples of the lack of integration
created under traditional regulations follow:

*Example 1*: A firm is choosing between continuing to operate an
existing coal-fired plant, or replacing it with a new gas-fired combined
cycle plant with no SO~2~ emissions and 90% to 95% lower NO~X~
emissions. Environmental regulations place few costs or burdens on the
firm if it chooses to continue operating the older and dirtier facility,
but require the firm to undergo a lengthy New Source Review process and
may require it to install expensive controls if it chooses to build the
new and cleaner facility. The distinction between new sources and old
sources creates economic incentives to firms that strongly favor the
older, more polluting technology.

*Example 2*: A firm is deciding between two new generation technologies,
one clean, such as natural gas, and the other with far higher emissions,
such as coal. There are large social benefits if the firm chooses the
clean technology, as total pollution levels are greatly reduced. The
NO~X~ rate limits treat each technology separately, and impose
proportionately equal burdens on each, and so create no incentive for
the firm to choose the cleaner one. Firms may even face lower per-ton
environmental costs in choosing the dirtier technology.[^350]

*Example 3*: A firm is choosing between building a new single-cycle gas
turbine or a combined-cycle gas turbine that achieves greater
efficiency. Since emissions rate standards under BACT or LAER are based
on parts per million (ppm), they provide no benefit to the firm in
achieving greater efficiency or lowering overall pollution by using the
combined-cycle unit.

*Example 4*: A firm building a new coal plant must decide on what kind
of coal to use. The SO~2~ cap-and-trade program encourages it to use
cleaner, low-sulfur coal. However, the rate-based SO~2~ New Source
Performance Standard requires it to use scrubbers, regardless of how
clean the coal is. In another example, if a firm builds a new gas-fired
plant, New Source Review requirements in many states require it to
install end-of-pipe controls for NO~X~ regardless of whether or not it
uses very clean process technology. In either case, rate-based New
Source Performance Standards dictate the installation of control
technologies and preclude compliance through cleaner fuels or processes
that may cost less and create less overall pollution.

One root cause of the conflict may be that regulations are developed on
a policy basis, with paramount attention paid to broad political and
social considerations, whereas business decisions are made on an
economic basis, in which small differences in cost and regulatory design
make an enormous difference. Because businesses try to find the
lowest-cost method to comply with the precise wording of regulatory
standards, it makes a huge difference if standards require compliance
with rate limits or mass limits (cap-and-trade); whether averaging times
are hours, days, or months; whether rate standards are set by
concentration limits, inputs, or outputs; and whether regulation focuses
upstream or downstream in the process. The dramatic differences in the
ways in which the precise nature of a standard will affect businesses'
economic behavior are often paid inadequate attention when standards are
established.

## D. Different Regulatory Designs Greatly Affect the Cost of Compliance for Achieving Equivalent Environmental Results

Many types of environmental regulations fail to harness the strong
business drivers that can lower compliance. This is shown in Figure 3-7
for NO~X~, where firms are not allowed to pursue least-cost approaches
to reducing overall NO~X~ levels on an industry-wide basis, because each
technology is regulated separately. The constraints imposed by
environ-mental laws can be seen even more clearly in SO~2~ regulation,
where we can benefit from a historical analysis of different types of
SO~2~ regulations and their costs.

Figure 4-1 shows how the greater flexibility of different environmental
regulation of SO~2~ leads to significantly lowered cost in achieving a
similar environmental result. It compares cost estimates for achieving
equivalent environmental reductions via a technology pre-scription
mandating scrubbers; the 1977 NSPS that required a 70% to 90% reduction
in potential emissions; the 1971 NSPS concentration rate standard of 1.2
lb/mmBtu; and the Title IV cap-and-trade program with and without the
trading element. The Figure shows how different regulatory designs
create very different compliance costs, from \$1.2 billion and \$7
billion annually for equivalent reductions.

###### Figure 4-1: Technologies Permitted and Compliance Costs Under Different SO~2~ Regulatory Systems[^351]

+---------+---------+---------+-----------+-----------+------------+
| Reg     | Tec     | Em      | Emissions | Emissions | Emission   |
| ulatory | hnology | issions | Rate      | Cap       | Cap With   |
| Method  | Presc   | Rate (% | (Conce    | Without   | Trading    |
|         | ription | Red     | ntration) | Trading   |            |
|         |         | uction) |           |           |            |
+---------+---------+---------+-----------+-----------+------------+
| Techn   | -       | -       | -   sc    | -   more  | -   more   |
| ologies |    scru |    scru | rubbers\* |           |            |
| Pe      | bbers\* | bbers\* |           | efficient |  efficient |
| rmitted |         |         | -         |           |            |
|         |         |         |   limited | scrubbers |  scrubbers |
|         |         |         |     use   |           |            |
|         |         |         |     l     | -   major | -   major  |
|         |         |         | ow-sulfur |     use   |     use    |
|         |         |         |     coal  |     l     |            |
|         |         |         |           | ow-sulfur | low-sulfur |
|         |         |         |           |     coal  |     coal   |
|         |         |         |           |           |            |
|         |         |         |           | -   fuel  | -   fuel   |
|         |         |         |           |           |            |
|         |         |         |           |  blending |   blending |
|         |         |         |           |           |            |
|         |         |         |           | -         | -   demand |
|         |         |         |           |    demand |     side   |
|         |         |         |           |     side  |            |
|         |         |         |           |     m     | management |
|         |         |         |           | anagement |            |
|         |         |         |           |           | -   power  |
|         |         |         |           |           |            |
|         |         |         |           |           |   shifting |
|         |         |         |           |           |            |
|         |         |         |           |           | -          |
|         |         |         |           |           |    trading |
+---------+---------+---------+-----------+-----------+------------+
| Es      | \$7     | \$4.5   | --        | \$2.5     | \$1.2      |
| timated |         |         |           |           |            |
| Com     |         |         |           |           |            |
| pliance |         |         |           |           |            |
| Cost in |         |         |           |           |            |
| B       |         |         |           |           |            |
| illions |         |         |           |           |            |
| per     |         |         |           |           |            |
| Year    |         |         |           |           |            |
+---------+---------+---------+-----------+-----------+------------+

> \* In addition to limiting compliance options to scrubbing, the
> scrubber technology permitted under various standards varied. The 1977
> rate standard has short averaging periods, which required scrubbers to
> be significantly over-built with redundant modules, greatly increasing
> their cost. Title IV allowed significant innovation and gains in
> efficiency in scrubber design.

An encouraging result of this study is that the cost of compliance for
both cap-and-trade programs were greatly below estimates, and several
times lower than the cost of equivalent rate-based regulatory
approaches. In the Title IV SO~2~ program, allowances cost \$150 during
Phase I, far lower than the \$300 to \$1000 initially forecast.
Similarly, the OTC NO~X~ cap resulted in allowance prices of \$500 to
\$1000, or one third of most estimates. The cap-and-trade approach is
less expensive as it helps align economic and environmental incentives
by freeing technology choice and creating a uniform incentive for all
sources to reduce pollution.

A final observation is that firms' efforts to achieve lower costs of
compliance generally have incidental and positive environmental effects.
The reason is that lower economic costs typically reflect a lowered use
of resources and energy, which is a positive environmental result.
Often, lower costs also represent a shift towards pollution prevention
in compliance instead of the use of end-of-pipe controls. Therefore
increased flexibility under Title IV led firms to use cleaner coal
instead of scrubbing emissions, which wastes about 1.5% of plant energy
and creates high waste volumes, and helped to halve the capital cost of
scrubbing which represents significant savings in materials used.

## E. Rate Standards Were Inflexible, Limiting Businesses' Ability to Develop and Implement Compliance Methods and Technologies

One of the chief findings of this study is that rate standards such as
those used in the Title IV NO~X~ program and new source standards for
both NO~X~ and SO~2~ proved to be poor performance standards, as they
significantly restricted the range of technology choices available for
compliance and provided limited incentives for innovation and
improvement. In the past, it has been noted that traditional rate-based
standards established on a technology-by-technology basis do not
encourage shifts to cleaner technology and tend to freeze
innovation.[^352] The findings of this study reveal four characteristics
of rate standards that have limited business ability to develop and
implement effective and efficient compliance methods for NO~X~ and SO~2~
in the power sector, as described below.

### 1. Emissions Rate Standards Limited Technology Choice

As shown in this study, rate-based standards inherently limit technology
options compared to mass-based performance standards because of the very
language of the standard. By defining performance as a reduction in
rates instead of a reduction in tons, rate standards may limit or even
preclude technologies that would reduce amounts but not rates of
pollution. This included both the 1971 and 1977 NSPS for SO~2~, which
limited compliance to either a certain quality of coal or to
scrubbing.[^353] Another is the New Source Review standards for NO~X~
that are defined in "parts per million" (ppm), and so preclude
compliance by increasing efficiency or similar prevention methods.[^354]
By defining performance as rate reduction, rate standards tend to
emphasize end-of-pipe controls instead of cleaner fuels or more
efficient processes.

Figure 4-2 shows the actual use of technology under the rate standards
reviewed, compared with the technologies used by firms in the
cap-and-trade programs for NO~X~ and SO~2~. Technology solutions are
divided into the three basic means of compliance: cleaner fuels, cleaner
processes, and end-of-pipe controls. They are further characterized as
high-tech, low-tech or no-tech to emphasize that compliance responses do
not have to be high-tech to create highly effective solutions, since an
emissions reduction by any method benefits the environment equally.

The Figure shows how weak NO~X~ rate standards in this sector have
simply led to retrofits of known technologies (combustion controls and
averaging), and stringent NO~X~ rate standards promoted innovation
principally in high-tech end-of-pipe controls (SCR and SCONOX).[^355] In
contrast, cap-and-trade systems allow the use of any technology that
could reduce emissions, and so promote the application of, refinement,
and innovation in the broadest set of potential technologies.

###### Figure 4-2: Technologies Used to Meet NO~X~ Standards[^356]

+----------------+-----------------+----------------+-----------------+
|                | High-Tech       | Low-Tech       | No-Tech         |
+----------------+-----------------+----------------+-----------------+
| Cleaner Fuels  |                 |                | Shift to gas    |
|                |                 |                |                 |
|                |                 |                | Low-NO~X~ coals |
+----------------+-----------------+----------------+-----------------+
| Cleaner        | Dry Low-NO~X~   | [Combustion    | [Averagi        |
| Processes      |                 | Controls       | ng]{.underline} |
|                | Turbine         | (LNB/OFA       |                 |
|                |                 | )]{.underline} | Load shifting   |
|                |                 |                |                 |
|                |                 |                | Burners out of  |
|                |                 |                | service         |
+----------------+-----------------+----------------+-----------------+
| End-of-Pipe    | *SCR*           |                |                 |
| Controls       |                 |                |                 |
|                | *SCONOX*        |                |                 |
|                |                 |                |                 |
|                | SNCR            |                |                 |
|                |                 |                |                 |
|                | Gas Reburn      |                |                 |
+----------------+-----------------+----------------+-----------------+

Technologies used for NSPS in italics; for Title IV underlined; all used
for OTC cap-and-trade

A key distinction between new source rate standards versus a
cap-and-trade approach is in how they treat cleaner new sources.
Cap-and-trade approaches created declining costs for plants as their
pollution emissions declined and so encouraged the use of any cleaner
technology. However, New Source Review standards differentially placed
very high burdens and costs on new technologies, even if they were
relatively clean. This has proven particularly important for NO~X~, as
over the past decade, major technological advances in natural gas
turbines have reduced uncontrolled NO~X~ emissions from over 100 ppm to
the very low 9 to 15 ppm range, ten to thirty times lower than
coal-fired boilers.[^357] While this has achieved a 90% pollution
reduction, these reductions often may not count when a regulatory body
applies a standard like BACT or LAER.[^358] Some states applying these
rate standards require end-of-pipe control equipment such as SCR when
applying NSR to these very clean sources, and do not count what has been
achieved through pollution prevention or process change.[^359] The
epitome of this tendency may be SCONOX, which doubles the cost of
controls to achieve a very small additional reduction.[^360] The energy
used to run SCONOX itself creates more ancillary pollution than the
incremental reductions it achieves,[^361] but this may not be able to be
considered under a literal interpretation of the inflexible LAER rate
standard.[^362]

Figure 4-3 shows different technologies used under SO~2~ regulations.
The percentage reduction standard of the current NSPS limited technology
choice to a single method: scrubbing.[^363] In contrast, the SO~2~
cap-and-trade approach allowed maximum technology choice, and because it
did so, led to unexpected innovation in fuel blending that allowed far
greater use of low-sulfur coal for compliance, dramatically reducing the
cost of compliance. It also created competition for scrubbing that has
driven innovation and cost reductions in scrubbing.

###### Figure 4-3: Technologies Used to Meet SO~2~ Standards[^364]

+-------------------+--------------+----------------+-----------------+
|                   | High-Tech    | Low-Tech       | No-Tech         |
+-------------------+--------------+----------------+-----------------+
| Cleaner Fuels     |              | Low Sulfur     | Shift to gas    |
|                   |              | Coal:          |                 |
|                   |              | sub-bituminous | LSC: bituminous |
|                   |              |                |                 |
|                   |              | Rail           | Demand Side     |
|                   |              | Investment/    | Management      |
|                   |              | Innovation     |                 |
+-------------------+--------------+----------------+-----------------+
| Cleaner Processes |              | Trading        | Averaging       |
|                   |              |                |                 |
|                   |              |                | Load shifting   |
+-------------------+--------------+----------------+-----------------+
| End-of-pipe       | #####        |                |                 |
| Controls          | ## Scrubbing |                |                 |
+-------------------+--------------+----------------+-----------------+

Allowed under NSPS in italics

### 2. Emissions Rate Standards Did Not Force a Move Toward Cleaner Technologies

Because emissions rate standards under the CAA are individually set for
each specific production technology, they create different standards for
the kind of fuel used and the specific boiler or turbine
technology.[^365] This created no incentive for firms to move towards
cleaner technologies. The NO~X~ study shows how the use of
technology-based rate standards may create perverse results under which
the dirtiest sources receive the weakest economic signals to reduce
pollution, and clean sources the greatest. As shown in Figure 3-7, rate
standards have actually placed differentially greater burdens on cleaner
technologies, creating economic signals contrary to those needed to
promote cleaner production.[^366]

### 3. Rate Standards Promote One-Time Compliance Without Incentives for Further Progress

One of the strongest drivers firms face is the economic incentive to
reduce costs. Environmental regulations can harness these drivers by
creating economic benefits from pollutant reductions on a continuing
basis. However, fixed-rate standards created no incentives for
continuous reductions, or for compliance that goes beyond stated limits.
Therefore, once firms installed low-NO~X~ burners as required by the
Title IV rate limits, they took no further action to reduce pollution
under Title IV.[^367] This limits compliance options to capital or
process choices made at the time a plant is built or modified, and
eliminates the possibility of compliance through changes in management
practices, fuels, or any other operational decisions after a plant is
built. Many NO~X~ reduction technologies, such as gas reburn and
overfire air, are incremental, and can be adjusted to achieve various
rates of NO~X~ control depending on the cost of inputs and other
parameters.[^368]

In contrast, the first year of application of the OTC NO~X~
cap-and-trade program revealed that once a market incentive was created
to reduce NO~X~ emissions on a continuing basis, firms found ways to
lower NO~X~ by 20% to 30% at existing units without significant capital
additions.[^369] Achieving such NO~X~ reductions through operational
changes can be highly effective, and may be essential to reduce NO~X~ to
very low levels. Similarly, the Title IV SO~2~ cap-and-trade program has
encouraged continuing innovation and improvement that has significantly
increased scrubber efficiency and steadily lowered the costs of
scrubbing and of low-sulfur coal throughout Phase I.

### 4. Rate Standards Created High Transaction Costs

Rate-based standards typically require significant government
intervention in approving the compliance technology chosen by firms,
creating significant transaction costs and delay. This is particularly
true of New Source Review standards, which require a case-by-case
determination of the required technology by government regulators.[^370]
However, regulations such as cap-and-trade systems have created very
strict standards in allowing zero growth in emissions without government
review and with very low transaction cost.

### 5. The Design of Rate-Based Standards Can Be Marginally Improved

The performance of NO~X~ and SO~2~ regulations also show how the design
of rate-based standards can strongly affect business compliance
alternatives and costs. Making rate standards uniform, annual, and
output-based could improve the performance of rate standards, as
described below. However, these alternative rate-based approaches do not
resolve all of the inflexibilities of rate standards, and would not work
as well for the economy or the environment as the cap-and-trade system.

#### a. Longer Averaging Periods

Short averaging periods, such as the thirty-day average for the SO~2~
NSPS, have been shown to limit technology development and increase the
cost of compliance.[^371] On the other hand, long averaging periods,
such as the one-year period for the Title IV NO~X~ standards, increased
flexibility.[^372] Longer averaging periods should be used unless the
specific characteristics of a pollutant and the resulting health and
environmental problems require the use of shorter averaging
periods.[^373]

#### b. Uniform Rate Standards

A uniform rate standard that does not discriminate between old and new
sources, or between technologies, would address the problems identified
above that stem from the variability of rate standards between
technologies and the distinction between old and new sources. It could
also reduce transaction costs by creating a simple, objective
parameter.[^374] However, such a standard may be perceived as unfair. It
would also still suffer from the problems that rate standards experience
in restricting technology and compliance choices, not promoting
compliance above the limit, and not creating a continuous driver for
improvement and innovation.

#### c. Output-Based Rate Standards

Another important goal is to change from input-based standards such as
lb/mmBtu, or concentration standards such as ppm, to output-based
standards such as lb/MWh, to reward efficiency. A breakthrough was made
in this regard in the EPA's New Source Performance Standard for boilers
adopted in 1998, which established a uniform output-based NO~X~ standard
of 1.6 lb per MWh of electricity generated from new boilers.[^375]
Unfortunately, NSPS is no longer what determines compliance for new
sources, as New Source Review imposes a more stringent standard under
BACT or LAER.[^376] Currently those standards are based on parts per
million, which does not reward efficiency and is a very poor indicator
of the actual pollution caused by the plant.[^377]

#### d. More Frequent Updating of Rate Standards by Government

Another way of improving rate standards would be for government to more
frequently update the standards. However, there are practical
impediments to this approach in the length of time it takes to
promulgate rules.[^378] Title IV could be considered a laboratory
experiment of this approach, as it created a two-phased rate-based
rulemaking process for NO~X~, with Phase I starting in 1996 and a more
stringent Phase II in 2000. However, the Phase II process occasioned the
typical response of lawsuits, a lack of industry focus on achieving
reductions until the regulations were imminent, and lack of reductions
beyond the standards after they were promulgated. Also, in retrospect
the standards failed to predict and capture a major opportunity for
emissions reductions in cyclone boilers. Only when the OTC cap-and-trade
program started did firm behavior reveal that an additional 20% to 30%
in NO~X~ emissions reductions could be achieved through operational
changes at plants.[^379]

## F. Emissions Cap and Allowance-Trading Programs Allow Greater Integration of Environmental Issues into Business Decision-Making Processes, Providing Greater Flexibility and Lowering Costs Without Sacrificing Environmental Integrity

This study shows that technology-neutral performance standards such as
emissions cap and allowance-trading systems can rectify the problems
caused by rate standards without sacrifice to the environment, by
creating more flexible systems and eliminating governmental review of
technology choice.[^380] Both the Acid Rain Program's SO~2~ cap and the
OTC NO~X~ cap create major emissions reductions and a zero new source
standard without any lengthy permitting procedures (transactions take
less than twenty-four hours) or case-by-case conflicts between
regulators and regulated.

The major benefits of a good cap-and-trade system are that it enacts a
stringent and permanent cap on emissions, which serves society's
interest in pollution reductions, while allowing the widest possible
breadth of compliance options, hence allowing firms to reduce costs.
Cap-and-trade approaches establish a uniform standard for both old and
new plants, and so place no undue burdens on new plants that may be
cleaner and more efficient. They also are technology-neutral, helping to
move compliance away from the end-of-pipe controls promoted by rate
standards toward the use of cleaner technologies. Because any reduction
creates economic value to a firm, firms also face a continuous driver to
reduce emissions and develop innovative technologies and methods.[^381]
Cap-and-trade approaches also remove government from making case-by-case
decisions about technologies, redirecting business effort away from
contesting regulatory authority and towards competing in the
marketplace.

A more subtle change created by cap-and-trade programs is that by
establishing a price for a ton of additional pollution reduction, they
have helped to link environmental with economic decision-making within a
firm.[^382] One instance of this is that the price of an allowance is
regularly entered into firms' dispatching models that determine which
generation units are operated. In another, the allowance price has
become integrated with the quality of coal so that the price of coal now
reflects its sulfur emissions. Both of these create efficiency in
merging the environmental quality demanded by society with industry
decision-making.

Another reason that flexible systems such as cap-and-trade programs may
function effectively is that they provide shared benefits. The
environment benefits from the permanent emission reductions created by
the emissions cap, together with high levels of compliance and a zero
new source mandate. Industry benefits from the lower costs of compliance
as well as a greater ability to integrate compliance planning with
investment cycles, seek out least-cost solutions, and save or even make
money through trading. In a sense, the cap-and-trade approach allows
firms to apply their entrepreneurial skills to innovate or reduce the
costs of compliance, and retain part of the economic gains that result
from these efforts. These shared benefits may allow for more stringent
standards to be set, while allowing industry to make the most
cost-effective reductions.

## G. Innovation, Investment, and Cleaner Production

The different regulatory programs controlling NO~X~ and SO~2~ emissions
elicited dramatically different responses as to the scope, quality, and
timing of innovation. As described above, the Title IV NO~X~ rate
approach elicited only one-time and limited innovation for existing
plants, leading principally to the installation of low-NO~X~
burners.[^383] In contrast, Title IV's SO~2~ cap-and-trade program
created continuous drivers for innovation that lasted throughout Phase
I, as well as a broader effort by firms to seek pollution prevention
methods.[^384] New Source Performance Standards drove innovation, but
only for a limited set of primarily end-of-pipe control
technologies.[^385] The lesson learned is that even when applied at
moderate levels such as in Title IV, cap-and-trade programs can be
expected to create significant innovation, whereas rate-based standards
limit both the breadth and extent of innovation.[^386]

### 1. Cap-and-Trade Programs Promote Broader Technology Use and Innovation

Figures 4-2 and 4-3 show that both SO~2~ and NO~X~ cap-and-trade
programs promoted broad technology choice, and thereby increased the
opportunity for innovation. In particular, the wider breadth of
technology choice creates greater opportunity for unexpected innovation
to occur that cannot be predicted or captured in a
government-controlled, rate-setting exercise. It is also noteworthy that
despite their purpose of helping to force innovation, the new source
standards principally promoted innovation in high-tech, end-of-pipe
technologies, leaving out many potential technologies and solutions used
under the cap-and-trade programs that could achieve environmental
benefits.[^387]

Possibly the best example of how the flexibility of cap-and-trade
programs promoted innovation and breakthroughs in compliance was firms'
increased use of low-sulfur western coals under the Title IV SO~2~
program.[^388] Title IV encouraged early experimentation in blending PRB
coal precisely because it did not impose a rate-based standard.
Initially, most firms believed they could not use sufficient amounts of
low-sulfur subbituminous PRB coals in their boilers to meet a particular
rate standard such as a 1.2 lb/mmBtu.[^389] However, since a rate
standard was not involved, and all tons of reductions were rewarded,
firms began to experiment with blending coals. Unexpectedly, blending
worked far better than believed possible, and at lower cost. By the end
of Phase I, blends using as high as 80% PRB coal were common, driving
low-cost emission reductions.[^390]

### 2. Rate-Based Systems Were Unfriendly to Innovation

Another finding of this study is that rate-based systems are unfriendly
to innovation due to the same four characteristics that limit business
compliance alternatives, described in Part IV(E). By limiting the kinds
of technologies used for compliance, rate standards in turn limit the
scope for innovation. By limiting compliance to one point in time, they
create no incentives for ongoing improvements in operational
techniques.[^391] Because technology-based rate standards impose
stricter standards on cleaner technologies, they limit the incentives
for business to develop or use cleaner technologies.[^392] Finally, by
failing to create continuous drivers for improvement, they limit
research and development efforts.[^393] As described below, these
barriers have also contributed to declining funding for environmental
technology development.

### 3. While Innovation Can Be Expected to Occur Broadly, It Is Not Guaranteed for Any Specific Technology

One of the reasons that flexible programs such as cap-and-trade
approaches encourage innovation is that innovation can be expected to
occur broadly over an industry, but cannot be guaranteed to occur for
any particular base technology. For example, under the Title IV NO~X~
program, innovation led to major cost reductions for two of the three
major boiler types, wall-fired and cyclone boilers, but not
tangentially-fired boilers, where the cost of compliance exceeded
estimates.[^394] Therefore, rate standards that establish specific
limits for an individual base technology such as a boiler type must be
set conservatively, as that technology might not experience innovation.
This limits the potential benefits from unexpected innovation when using
technology-specific standards.

### 4. Traditional Regulatory Approaches Have Discouraged and Distorted Private Investment in Research and Development, and Capital Markets for Innovation

A significant negative effect of the current rate-based regulatory
system is its role in lowering and limiting industry commitment to
research and development. Since the rate standards create no continuous
driver to lower emissions, firms do not invest continuously in research
and development to enhance environmental quality, because there is no
compliance benefit in doing so. Instead, the periodic effort to lower
the rate standards becomes a political issue, with industry battling
through its lawyers to make sure the rate standard is as lenient as
possible and to use existing technologies for compliance. As
demonstrated by the cyclone boiler situation, when a rate standard is
announced, there is then a flurry of research activity on how to reach
the standard at least cost, after which the research effort subsides
again.[^395]

This has virtually eliminated private venture capital in the
environmental field, which has shrunk from a meager \$200 million in
1990 to only \$60 million in 1999, during a decade in which funding for
technology skyrocketed to a record \$35 billion.[^396] Environmental
financiers interviewed gave two reasons for this: innovative
environmental technologies could not survive the length, transaction
costs, and delay of the government regulatory approval process under
technology-based rate systems; and the permitting process for the
rate-based system fractures the national market into the hundreds of
permitting districts, vastly reducing potential markets.[^397] The
consequence of this is that there is virtually no venture capital for
environmental technology, when it could be one of the strongest drivers
of innovation and progress.

In addition to the problems caused by rate-based standards, the new
source/old source distinction in the CAA also distorts industry
investments in research and development. The power industry research
coalition, EPRI (formerly the Electric Power Research Institute), had a
1999 budget of \$364 million, of which over 90% was devoted to
improv-ing existing plants, not developing new technologies.[^398] On
the other hand, government spending is about evenly split, with half of
the DOE's energy research budget devoted to developing new
electricity-generating technologies.[^399] We see, therefore, that our
regulatory system, which imposes stringent environmental requirements on
new plants but not old plants, creates major economic pressure on
business to extend the life of old plants, causing the industry to
mis-allocate hundreds of millions of research dollars.

## H. Imposing Stricter Standards on New Sources Has Proven Ineffective in the Power Sector, and Has Led to Neither Cheaper Compliance Nor Better Environmental Results

One of the fundamental elements of our clean air legislation has been to
impose stricter standards on new sources than on existing sources, in
order to attain ambient pollution levels, help prevent the degradation
of airsheds, and to spur innovation.[^400] Originally, federal standards
applied only to new sources, on the theory that it would be cheaper to
attain ambient standards by requiring new sources to install modern
technologies or controls, and that retirement would ultimately lead to
all sources being covered under new source standards.[^401] Today the
distinction is carried forward in the relatively lenient standards
applied to existing sources under Title IV, compared to the stringent
standards applied to new sources.

### 1. New Source Standards Have Not Effectively Reduced Ambient Pollution Levels

Contrary to the initial supposition that it would be cheaper to achieve
significant reductions at new plants rather than older plants, it has
not in fact been cheaper for new sources to reduce pollution. A review
of the costs of NO~X~ reduction in Figure 3-7 shows that it is far
cheaper today for older sources to reduce NO~X~ than for cleaner modern
technologies. Because fundamental technology change in the power sector
has produced far cleaner natural gas generation technologies,[^402]
significant reductions are available principally at old plants, where
they are also far cheaper. Yet the new source standards impose very high
costs on the new gas-fired facilities to reduce small amounts of NO~X~,
while many older and dirtier sources must make only modest or even no
reductions.[^403]

The law's emphasis on reductions from new sources may derive from an
older, static view of technology in which the base technology is assumed
to not change much. However, a modern view is that fundamental
technology change may be expected in most industries, and new sources
are likely to be more efficient and less polluting than old sources. A
strategy focused on new sources will not work well when technology
change is rapid, plants are long-lived, or when fundamentally different
technologies are used for new sources than old sources. In these cases,
New Source Review can become an obstructionist policy that achieves
little pollution reduction, but imposes high transaction and compliance
costs only on the new clean technologies. These findings stress the
importance of adopting regulatory systems that create equal pressure on
both old and new sources to reduce emissions.

### 2. New Source Standards Force Only Limited Kinds of Innovation

New source standards were also adopted in part for their role in
prompting innovation, and here their role is more complex. New source
standards have led to development of new technologies, including
innovative control technologies such as SCONOX and XONON.[^404] They
have also contributed to a collaborative federal-industry effort to
develop cleaner and more efficient gas turbines, in which federal
research funds have also played a large role.[^405]

However, new source standards have also suppressed innovation and
improvement. By definition, new source standards fail to prompt
innovation in existing plants, and because they apply only at one time
they did not encourage innovation and improvement in ongoing management
and operational practices. As shown in Figures 4-2 and 4-3, new sources
standards have created only limited innovation, focused on expensive,
end-of-pipe controls. New source standards also discouraged improvement
at old plants, as firms have limited upgrades or efficiency investments
that might trigger New Source Review, which would impose major
transaction and compliance costs on the firm.[^406] Finally, new source
standards have significantly distorted the focus of industry research
efforts towards extending the life of older plants, and not developing
new technologies.[^407]

### 3. NSR Rate Standards Create Few Net Benefits When Combined with Offsets or in Conjunction with an Emissions Cap

New source standards also help to prevent the deterioration of airsheds,
but this goal is addressed more effectively by establishing an emissions
cap, especially if the cap level implements significant reductions. The
irony is that once an emissions cap is established for a pollutant,
there are no net environmental benefits from the stringent emissions
rate limits imposed by New Source Review.[^408] Despite imposing high
costs on cleaner new technologies, they create no net reduction in
emissions, which are now controlled by the cap. The same result applies
today in nonattainment areas, where the CAA requires any new source to
fully offset its emissions with matching reductions from existing
sources.[^409] In both of these circumstances, a better policy would be
to not apply NSR, as it creates few net environmental benefits and may
hinder the multi-pollutant benefits that come from the transition to
cleaner new technologies.[^410]

## I. Transaction Costs in Cap-and-Trade and Rate-Based Programs

The NO~X~ and SO~2~ cap-and-trade and rate-based programs differ greatly
in transaction costs.[^411] These include both the effort required to
establish the programs and the ongoing transaction costs in applying the
regulatory programs to new and old sources. In general, although the
creation of cap-and-trade programs may involve extensive efforts and
lobbying activity, once created they perform with very low transaction
costs.[^412] Rate-based regulations on the other hand may also be
difficult to create if they are set at stringent levels, but importantly
create high transaction costs and a culture of conflict in their
implementation phase. In doing so they may exact a heavy toll on
economic development by lengthening and creating uncertainty in the
process of siting new plants, despite creating no net environmental
benefits in comparison to a cap-and-trade approach.[^413]

### 1. Transaction Costs in Establishing Legislation

Creating legislation for either a rate-based or cap-and-trade program
involves extensive efforts and lobbying activity, which depend primarily
on the stringency of the standard. There were considerable transaction
costs in establishing the Acid Rain Program in Congress, especially with
regard to the SO~2~ standard.[^414] There was significant lobbying
activity as to the overall level of SO~2~ reductions, and an even
greater amount on specific provisions as firms jockeyed to have Congress
include special allowance allocations that benefited their particular
firm or region.[^415] Although the ten years it took to enact acid rain
legislation might be interpreted to indicate the difficulty of
establishing a cap-and-trade program, this delay had more to do with the
stringency of the program itself rather than the cap-and-trade mechanism
finally adopted in 1990.[^416] The emissions cap and allowance-trading
approach was only initiated under President Bush at the end of this
period, and is generally thought to have facilitated enactment of the
legislation by satisfying environmental concerns for a 10 million ton
reduction while allowing business greater flexibility to reduce
costs.[^417]

The Title IV NO~X~ program occasioned far less discussion or lobbying
activity in the legislative proceedings, in part because the 2 million
ton NO~X~ reduction was less than the 10 million ton SO~2~ reduction. In
addition, the expected compliance cost was considerably less, even
though the NO~X~ standard also represented a roughly 50% reduction from
prior emissions levels. The expected capital cost of a low-NO~X~ burner
was \$20/kW,[^418] far less than the \$249/kW capital cost of scrubbing
expected to meet the SO~2~ standard. This suggests that there may be
fewer transaction costs in enacting less costly standards. Indeed,
establishing other more stringent NO~X~ rate standards for power plants
such as the OTC NO~X~ reductions program,[^419] the new NO~X~
NSPS,[^420] and the new ambient limits for ozone have all involved major
transaction costs.[^421]

### 2. Transaction Costs in Establishing Regulations

Transaction costs were far lower for the Title IV SO~2~ program than the
NO~X~ program in the next phase, that of establishing regulations to
implement the program. One reason was that key sections of the SO~2~
provisions were self-executing.[^422] Another was that there was less
area for dispute in cap-and-trade programs, since the law established
both the basic standard and the allocations. Except for a lawsuit
concerning the rules for substitution units, which was settled,[^423]
the only lawsuits filed under the SO~2~ program were relatively minor
ones dealing with specific allocation disputes.[^424] In contrast, the
Title IV NO~X~ standards were the subject of an intensive
government-industry negotiation process over the meaning of "low-NO~X~
technology" that significantly delayed the proposal of
regulations.[^425] An industry lawsuit then successfully contested the
EPA's interpretation, delaying implementation of the program by a full
year.[^426]

The implementation of Phase II standards have been similar. There was
relatively little conflict in implementing the Phase II SO~2~ standard,
which simply reduced allowance amounts. In contrast the NO~X~ standards
led to considerable efforts to determine the appropriate rate standards
that fit with the statutory language, and the industry again filed
lawsuits over the proposed Phase II NO~X~ regulations.[^427] Again, the
NO~X~ standards created greater transaction costs in establishing the
regulations.

### 3. Transaction Costs in Implementing the Programs

The ongoing transaction costs under the NO~X~ and SO~2~ programs are
very different, especially for new sources. Phase I SO~2~ permits
consist simply of a sheet of paper that states the correct allowance
allocation and monitoring protocols.[^428] The principal government
roles are to operate the allowance-trading systems, monitor emissions,
and perform end-of-year reconciliations.[^429] This creates extremely
low transaction costs: the government role in recording allowance
transactions typically takes place in less than twenty-four hours.[^430]
The Phase I NO~X~ program also faced relatively few transaction costs in
requiring a one-time retrofit of a defined technology, although some
firms had to apply for an alternative emissions limit.[^431]

However, for new sources, the SO~2~ cap-and-trade program creates far
lower transaction costs than NO~X~-based regulation, even though it
implements a zero new source standard in which emissions cannot grow.
New sources are simply subject to the same allowance system as other
plants, which imposes low transaction costs and no permitting delays for
new plants. In contrast, the ongoing transaction costs for new sources
to comply with NO~X~ regulation are extremely contentious and
time-intensive, with New Source Review a major cause of conflict between
the industry and government over the past decade. The NSR process
typically takes months or even years to permit a new plant, creating
administrative costs to governments and major opportunity costs for
firms.[^432] Under this process, the law requires government regulators
to make a specific determination of what precise technology is the "best
available" or "lowest achievable."[^433] These standards pit regulators
against the applicant in a series of factual issues, and create high
transaction costs.[^434] However there may be no gain to the environment
if the plant is a modern gas plant, as NO~X~ emissions are minimal and
the plant would be expected to create multi-pollutant benefits by
displacing power from dirtier sources.

### 4. Transaction Costs in Incrementally Lowering Standards

An interesting benefit of the cap-and-trade approach was evident in the
transition from Phase I to Phase II of Title IV. Under the rate-based
approach for the NO~X~ standards, it would have been unfair to again
require Phase I units to retrofit their boilers a few years after the
beginning of Phase I in order to meet the slightly lower Phase II
standard in 2000. Therefore all Phase I units were exempted from meeting
the more stringent Phase II limits and were grandfathered at the lower
Phase I limits.[^435] In contrast, Phase II of the SO~2~ program was
able to require added reductions from all the Phase I units simply by
reducing their allowance allocations, while including all other sources
equally.[^436] This was implemented without any grandfathering problem,
transaction costs, or major lawsuits. The cap-and-trade approach
therefore allows a simple, effective, and equitable way to require firms
to reduce emissions if needed in the future.

## J. Monitoring and Compliance

Both Title IV NO~X~ and SO~2~ programs have achieved 100% compliance
with emission limitations in all years of Phase I.[^437] The factors of
regulatory design that contributed to this excellent result are
described below.

### 1. Strict Monitoring and High Penalties

Key factors in the 100% compliance rate are the strict monitoring
protocols that require continuous emissions monitors,[^438] and the high
penalties. Title IV imposes a penalty of \$2000 for each ton of NO~X~ or
SO~2~ emitted in excess of emissions limitations requirements,[^439]
forfeiture of allowances under the SO~2~ program, as well as regular
civil and criminal penalties.[^440] Since the monitoring ensures that
violators will be caught, and the high penalties are many times the cost
of compliance, both programs work well to assure compliance.

### 2. Design of Cap-and-Trade Programs

Another factor in the very high compliance levels is the design of
cap-and-trade programs.[^441] The Title IV SO~2~ program achieved 100%
compliance in emissions reductions, and there was only one violation of
one ton in the OTC NO~X~ program in 1999, which led to a swift and
automatic penalty.[^442] These compliance rates are significantly better
than the 80% compliance typical under other federal air programs.[^443]
Several factors contribute, including the factual simplicity of the
standard, which lacks any limitations or special conditions. Also, the
availability of trading coupled with the annual reconciliation period
after the end of the year, creates a "no-fault" aspect to compliance
under cap-and-trade helps firms achieve 100% compliance without
compromising environmental integrity.[^444] Finally, as demonstrated by
the one OTC violation, enforcement is also very simple under
cap-and-trade programs, with penalties immediately and automatically
assessed.

### 3. Inclusiveness of Cap-and-Trade Programs

A final benefit of cap-and-trade programs is their lack of exceptions,
which allows more sources to be included in the compliance system.
Cap-and-trade programs typically include all relevant sources, and
provide for no exceptions. In contrast, entire classes of boilers (i.e.,
the Group 2 boilers) were not placed in the Phase I NO~X~ program
because of the perceived lack of available technology.[^445] Second,
special alternative emissions limits were provided to ten units that
installed low-NO~X~ burners but could still not meet the rate
standards.[^446] Therefore, although the NO~X~ rate program achieved
100% compliance,[^447] there was limited participation and the need to
authorize exceptions for some units through the granting of alternate
emissions limit (AEL) permits.

## K. Over-Compliance and Other Conservative Compliance Strategies by Firms

Both Title IV programs led to conservative strategies by firms, leading
to self-reliance and over-compliance. Under the Title IV NO~X~ program,
Table A firms reduced emissions 11% below established rate limits to
assure a margin of safety, resulting in additional pollutant
reductions.[^448] Emissions were 30% below authorized levels in Phase I
of the Title IV SO~2~ program, but the ability of firms to bank
allowances means that these early reductions are not permanent, and the
tons are likely to be emitted in the future. The OTC NO~X~ cap-and-trade
program also surprised analysts when firms over-complied by 20% in the
first year. The banking rules for the OTC NO~X~ program may result in
future reductions of banked allowances,[^449] creating additional
environmental benefits. Thus, although both cap-and-trade programs led
to over-compliance, future environmental benefits are diluted by the
ability to bank reductions.

## L. Flexibility Mechanisms with Low Transaction Costs Were Widely Used

Firms made extensive use of all flexibility mechanisms that provided
economic benefits with low transaction costs. Under the NO~X~ program,
80% of units were included in averaging plans, and almost half of
potential units used the early election option.[^450] Under the Title IV
SO~2~ program, 30% of potential substitution units entered the program,
and most firms used both the banking and trading mechanisms.[^451] In
contrast, flexibility mechanisms with high transaction costs, such as
the AEL program, were infrequently used.

The effect of the flexibility mechanisms on firms' behavior can be seen
in Figures 4-4 and 4-5 that compare compliance results achieved under
both Title IV programs. The emissions figures for NO~X~ show most firms
emitted at or around the rate standard level, with averaging provisions
allowing some units to exceed the rate standard by a small amount. The
data for SO~2~ shows a different behavior, with unit emissions uniformly
spread over a wide range from very low levels to 140% of the standard,
indicating the importance of the flexibility provided by market
mechanisms.

###### *See* Figure 4-4.[^452] Emissions Results (by quintiles) for Unit Emissions of SO~2~ in Phase I (1995-1999)

###### *See* Figure 4-5[^453]: Emissions Results (by quintiles) for Unit Emissions of NO~X~ in Phase I (1996-1999)

The economic effect of the flexibility mechanisms was clearly positive,
as it allowed firms greater flexibility in their compliance planning,
leading to lower costs. However, they gave some slight economic
advantage to larger firms, as larger firms may make the greatest use of
provisions like averaging and internal trading, due to the greater
number of units they have to include in the programs.

The environmental effect of the flexibility mechanisms was minimal or
nonexistent. The tendency of most firms to comply autarkicly meant that
most flexibility mechanisms were used locally. Eighty percent of SO~2~
allowances used for compliance come from within the same state, and 80%
of NO~X~ averaging plans are also confined to one state.[^454] The
concern that trading could shift emissions to cause hot spots also
proved unfounded, as an analysis of the first four years of the SO~2~
cap-and-trade program showed that regional movements of allowances were
minimal (i.e., 3% of all allowances used), and that trading may even
have helped cool hot spots by encouraging emissions reductions at the
largest plants.[^455]

## M. Retirement and/or Switching to Cleaner Power Sources

Neither standard resulted in significant switching to cleaner power
sources such as natural gas or renewable sources, or the retirement of
older coal-fired facilities. In retrospect, it can be seen that neither
standard was sufficiently stringent to create an economic rationale that
would lead firms to switch from existing coal-fired plants. Since
existing coal power plants have paid off their capital costs, they
generate electricity at low cost---around 2¢ per kWh.[^456] This is
sufficiently below the cost of alternative sources of power, including
new gas generation at 3¢ to 4¢ per kWh,[^457] to lead firms to invest
heavily in these older plants before it makes economic sense to retire
them in favor of new generation. Economic analyses have shown that even
imposing New Source Performance Standards on old plants, thereby
requiring a 90% reduction in SO~2~ and attainment of a 0.15 lb/mmBtu
NO~X~ standard, would force only limited retirement.[^458] Therefore,
Title IV standards, which are far less stringent than new source
standards, would evidently not lead to significant retirement.

# V. Conclusion

## A. Stringency

A central conclusion of this study is that both the Title IV NO~X~ and
SO~2~ standards were too lenient, and failed to align the private costs
faced by firms in reducing pollution with the society-wide benefits from
pollutant reductions. In both cases, the private cost to businesses of
reducing an additional ton of pollution was far below the social health
and welfare benefits of additional reductions.[^459] In the case of
SO~2~, these costs were possibly an order of magnitude lower, indicating
major net benefits of further SO~2~ reductions. This calls for
additional action by legislation or regulation to further reduce SO~2~
and NO~X~ emissions levels.[^460]

## B. Regulatory Design

Other major findings of the study relate to regulatory design, where
dramatic differences were found in the efficiency and effectiveness of
the various regulatory programs for NO~X~ and SO~2~. Overall, the two
Title IV standards embody fundamentally different methods of
establishing objective and fair regulatory regimes, reflecting
fundamental choices in environmental law. The NO~X~ regulatory program,
like most environmental regulation today, is rate-based and embodies an
"equal effort" philosophy that accepts any base technology, but requires
firms to achieve reasonable or best controls for that given technology.
Title IV's SO~2~ and the OTC NO~X~ cap-and-trade programs are two of the
first major pieces of environmental regulation to impose an "equal cost
per ton" approach to pollution, in which all firms face a similar cost
for an additional ton of pollution.[^461]

These different approaches were found to have very different effects on
firm behavior and the functioning of the regulatory systems, as
summarized in Figure 5-1.

###### [Figure 5-1. Comparison of Performance of Rate-Based and Cap-and-Trade Systems for NO~X~ and SO~2~\*]{.smallcaps}

  ------------------------------------------------------------------------
                                                         Cap &    CAA Rate
                                                         Trade    
  ------------------------------------------------------ -------- --------
  1\. Allows business flexibility to choose different    \+       \-
  compliance approaches                                           

  2\. Applies uniform standards, creating benefits for   \+       \-
  firms that choose cleaner technologies                          

  3\. Lowers cost of compliance                          \+       \-

  4\. Creates continuous drivers for improvement and     o        \-
  innovation                                                      

  5\. Ensures effective monitoring of emissions          \+       \+

  6\. Achieves high levels or 100% compliance            \+       o

  7\. Minimizes transaction costs and conflict.          \+       \-
  ------------------------------------------------------------------------

\*Note: + is positive, o neutral, and -- negative

Overall, the rate-based or equal effort approach is shown to have a
number of key problems that distort the economic context faced by firms
in ways that prevent them from achieving lower costs or greater
environmental quality. It creates few incentives for firms to choose
cleaner base technologies, eliminating what is possibly the principal
driver towards environmental quality. Second, it creates incentives for
the business to achieve emissions reductions at only one point in time,
and not continuously. Third, rate standards are inflexible, driving up
costs and limiting compliance technologies and potential innovation.
These problems are both magnified and added to by the new source/old
source distinction in current air pollution laws. These characteristics
create conflict rather than alignment between environmental and economic
drivers that cannot be resolved without moving away from the rate
standard approach.

The cap-and-trade programs performed far better, creating significant
environmental and economic benefits by imposing a mandatory
environmental standard while allowing firms to minimize their compliance
costs. Important features of these programs were the elimination of the
distinction between new and old firms and between different
technologies, allowing greater efficiency in creating pollutant
reductions. Overall, this approach was considerably less intrusive to
businesses and dramatically lowered compliance costs, without
compromising environmental integrity.

Several overarching issues are worth mentioning. One is the difference
in the industry/government relationship under the two approaches. The
rate-based standards in place for NO~X~ and new SO~2~ sources require
government regulators to review and permit every firm action to control
pollution, imposing high transaction costs and inflexibility. Under the
cap-and-trade programs, the government role is transformed to one of
assuring high quality monitoring and compliance, and leaving the choice
of compliance technology to firm decision-making. This vastly reduces
transaction costs and delay, and also creates less friction and conflict
between regulators and the regulated, possibly making future regulatory
needs less contentious.

The second concerns innovation. In order to broadly support incentives
for efficiency, innovation, and pollution prevention, environmental
regulations must create a continuous driver for pollution reduction.
Rate standards cannot do so, as they apply only at one time and create
incentives only to attain a precise level, providing no incentives to go
beyond the limit. The cap-and-trade approach creates such continuous
incentives, both through the lack of growth in the cap and the
opportunity for trading.

Thirdly, the two approaches differ in their ability to align economic
and regulatory drivers toward cleaner production. For both NO~X~ and
SO~2~, economic forces could lead firms to make pollutant reductions,
including drivers for greater efficiency, the use of low-sulfur western
coal, and cheaper and cleaner gas turbines for new generation sources.
However, traditional regulations for NO~X~ and SO~2~ were found to
actively interfere with these economic drivers, primarily due to the
inflexibility of rate standards and the distinction between new and old
sources. The record of traditional environmental regulations in actually
frustrating environmentally positive economic forces is one of the most
troublesome aspects of current regulation. As with many problems, this
was able to be resolved in the period studied by moving towards a
performance-based approach using cap-and-trade systems to control NO~X~
and SO~2~ pollution.

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[^1]: ^\*^ \* The Environmental Law Institute gratefully acknowledges
    the support of the Andrew W. Mellon Foundation for this study. The
    research and analysis for this study benefited considerably from the
    assistance of LeRoy Paddock, together with Susan Bass, Linda
    Breggin, Shi-ling Hsu, Gary Ganoung, Beverly Grossman, Kelly Mott,
    Jay Pendergrass, and Brian Rohan. ELI also gratefully acknowledges
    the assistance of the EPA's Clean Air Markets Division, Denny
    Ellerman of MIT, and Dallas Burtraw of Resources for the Future, the
    individuals who provided comments on this Article, and the many
    individuals, firms, and organizations interviewed during the
    research. The author can be reached by e-mail at swift@eli.org.

[^2]: ^?^. Prominent among these are the annual publications [EPA, Pub.
    No. EPA-430/R-00-007, Acid Rain Program: 1999 Compliance
    Report]{.smallcaps} (2000), *available at* [http://www.epa.gov/\
    airmarkets/cmprpt/arp99](http://www.epa.gov/airmarkets/cmprpt/arp99)
    (last updated Dec. 11, 2000) \[hereinafter [EPA 1999 Compliance
    Report]{.smallcaps}\]; [EPA, Acid Rain Program: 1999 Emissions
    Scorecard]{.smallcaps} (2000), *available at*
    http://www.epa.gov/airmarkets/ emissions/score99 (last updated Dec.
    11, 2000) \[hereinafter [EPA 1999 Emissions
    Scorecard]{.smallcaps}\]; [U.S. Energy Information Administration
    (EIA), U.S. Dep't of Energy, Pub. No. DOE/EIA-0383, Annual Energy
    Outlook 2001: With Projections to 2020]{.smallcaps} (2000),
    *available at*
    [http://www.eia.doe.gov/oiaf/aeo/index.html](http://www.eia.dx.gov/oiaf/aeo/index.html)
    (last modified Jan. 30, 2001) \[hereinafter [DOE Annual Energy
    Outlook]{.smallcaps}\].

[^3]: ^?^. The interviews were confidential, and covered a wide range of
    topics about the effect of the regulations and firms' compliance
    strategies and behavior.

[^4]: ^?^. Acid precipitation occurs when sulfur dioxide and nitrogen
    oxides react in the upper atmosphere with water, oxygen, and other
    chemicals to form sulfuric acid and nitric acid. These acids adhere
    to rain drops or snow, damaging forests and acidifying lakes and
    limiting their ability to support aquatic life. Acid precipitation
    damage has been most pronounced in the northern tier and
    northeastern United States and Canada because the forests and lakes
    in these areas are more sensitive to acidic deposition. [National
    Acid Precipitation Assessment Program]{.smallcaps}, [1990 Integrated
    Assessment Report]{.smallcaps} (1991) \[hereinafter [NAPAP
    Integrated Assessment]{.smallcaps}\]; [James L. Regens & Robert
    Rycroft,]{.smallcaps} [The Acid Rain Controversy]{.smallcaps} 35-58
    (1989).

[^5]: ^?^. *See generally* [Richard Cohen,]{.smallcaps} [Washington at
    Work, Back Rooms and Clean Air]{.smallcaps} (1990) (discussing
    congressional debates); [Bruce A. Ackerman & William T.
    Hassler,]{.smallcaps} [Clean Coal and Dirty Air]{.smallcaps} (1981)
    (discussing competing interests regarding coal industry,
    environmentalists, CAA regulation, and various states).

[^6]: ^?^. Clean Air Act Amendments of 1990, Pub. L. No. 101-549, 104
    Stat. 2399 (1990) (codified at 42 U.S.C. §§ 7401-7700 (1994)).

[^7]: ^?^. Ian M. Torrens et al., *The 1990 Clean Air Act Amendments:
    Overview, Utility Industry Responses, and Strategic Implications*,
    17 [Ann. Rev. Energy & Env't 211,]{.smallcaps} 213 (1992). Today, it
    is understood that the reductions required by Title IV benefit not
    only acid deposition, but also human health in reducing the
    formation of fine particulates and of urban ozone.

[^8]: ^?^. 42 U.S.C. § 4651(b) (1994). Because the standards were
    rate-based, they never achieved the reduction from the 1980
    baseline, but did slow the growth of NO~X~ emissions to 3% between
    1990 and 1999, compared to a 28% increase in plant utilization. [EPA
    1999 Compliance Report]{.smallcaps}, *supra* note Error: Reference
    source not found, at 2.

[^9]: ^?^. Title IV only covers electric generation units that sell
    electricity, loosely termed "utility units," although in today's
    deregulated environment, independent power providers may sell power
    without being a regulated utility. *See* 42 U.S.C. § 7651a(17)
    (1994). Title IV excludes from its coverage industrial producers of
    electricity, even though in 1990 they emitted 3.6 million tons of
    SO~2~ compared to utility emissions of 15.9 million, and 3.0 million
    tons of NO[~X~]{.smallcaps} compared to utility emissions of 6.7
    million. [EPA,]{.smallcaps} [National Air Pollutant Emission
    Trends]{.smallcaps} 1900-1998, [Pub. No.]{.smallcaps}
    EPA-454/R-00-002, at 3-10, 3-12 (Mar. 2000), *available at*
    [http://www.epa.gov/ttnchie1/trends/index.html](http://www.epa.gov/hn/chief/trends/trends98/index.html)
    \[hereinafter [EPA Emissions Trends]{.smallcaps}\]. Note that
    industrial sources may voluntarily opt into the SO~2~ program. 42
    U.S.C. § 7651i(a) (1994).

[^10]: ^?^. Phase I of the program includes only larger units with
    emissions greater than 2.5 pounds per million Btu of fuel burned
    (lb/mmBtu) during the baseline period of 1985-1987 (known as "Table
    A" units, as they are listed in Table A in the statute), together
    with any substitution or compensating units that were voluntarily
    entered into Phase I. *See* 42 U.S.C. § 7651c (1994). The 265 units
    included in Phase I of the SO~2~ program as of January 1, 1995, also
    are affected by the Phase I NO[~X~]{.smallcaps} program. *See id.*
    § 7651f. All utility units larger than 25 MW in size are included in
    Phase II of the program, which began in 2000. *See id.* §§ 7651d(a),
    7651f(a).

[^11]: ^?^. *See generally* [Emissions Trading (]{.smallcaps}Richard F.
    Kosobud et al. eds., 2000) (discussing economic, environmental, and
    regulatory issues surrounding emissions trading); [A. Denny Ellerman
    et al., Markets for Clean Air: The U.S. Acid Rain Program
    (2000)]{.smallcaps} (evaluating the impact of Title IV on SO~2~
    emissions).

[^12]: ^?^. 42 U.S.C. § 7651a-c (1994).

[^13]: ^?^. Emission rate systems, especially if differentiated by
    technologies, exert few incentives to use cleaner base technologies,
    and promote an "equal effort" approach based on reasonable or best
    efforts. They also create no incentives to go beyond the standard.
    In contrast, emissions cap and allowance trading approaches,
    together with other potential market mechanisms, create an equal
    "cost per ton" approach that allows greater flexibility in
    compliance choices and exerts continuous pressure on businesses to
    reduce tons of pollution. These issues are discussed *infra* Part V.

[^14]: ^?^. James A. Lynch et al., *Changes in Sulfate Deposition in
    Eastern USA Following Implementation of Phase I of Title IV of the
    Clean Air Act Amendments of 1990*, 34 [Atmospheric
    Env't]{.smallcaps} 1665 (2000) (finding a 25% reduction by 1998).

[^15]: ^?^. [EPA, Pub. No.]{.smallcaps} EPA-430/R-95-010, [Human Health
    Benefits from Sulfate Reductions Under Title IV of the 1990 Clean
    Air Act Amendments]{.smallcaps} 6-4 (1995) (calculating annual
    benefits for sulfate aerosol reductions at \$10 billion in Phase I,
    rising to \$40 billion by 2010, with 88% of benefits from reduced
    premature mortality). The EPA also estimates the benefits of
    additional NO~X~ reductions at \$1262 to \$4786 per ton in 1999.
    EPA, [Pub. No.]{.smallcaps} EPA-452/R-98-003B, 2 [Regulatory Impact
    Analysis for the NO~x~ SIP Call, FIP, and Section 126
    Petitions]{.smallcaps} ES-6 (1998) \[hereinafter EPA 1998 RIA\];
    *see generally* [Envtl. Law Inst., Cleaner Power: The benefits and
    Costs of Moving Away from Coal to Natural Gas Power
    Generation]{.smallcaps} (Nov. 2000) (calculating NO~X~, SO~2~ and
    CO~2~ benefits from reduced coal generation) \[hereinafter [ELI
    Cleaner Power]{.smallcaps}\]; [Clean Air Task Force, Death, Disease
    & Dirty Power: Mortality and Health Damage Due to Air Pollution from
    Power Plants]{.smallcaps} 4-5 (2000) \[hereinafter [Clean Air Task
    Force]{.smallcaps}\] (calculating annual benefits of bringing power
    plants into compliance with modern pollution standards for SO~2~ and
    NO~X~ at over \$100 billion).

[^16]: ^?^. National legislation affecting SO~2~ dates back to the Clean
    Air Act of 1963, which restricted interstate air pollution. Clean
    Air Act of 1963, Pub. L. No. 88-206, 77 Stat. 392 (1963). This law
    failed to have great effect, as its cumbersome procedures required
    intergovernmental conferences to address specific instances of
    interstate pollution, as well as multiple requests for remedial
    action. Several cases did, however, result in reductions of SO~2~
    and particulate deposition. *See* [Senate Comm. on Public Works, 93d
    Cong., 2d Sess., A Legislative History of the Clean Air Act
    Amendments of 1970,]{.smallcaps} at [1346 (Comm. Print
    1974)]{.smallcaps}. The Air Quality Act of 1967 later initiated a
    system for air-quality planning based on ambient air-quality
    standards to supplement these abatement procedures, a precursor to
    the 1970 legislation. *See* Air Quality Act of 1967, Pub. L. No.
    90-148, 81 Stat. 485 (1967); Vickie L. Patton, *The New Air Quality
    Standards, Regional Haze, and Interstate Air Pollution Transport*,
    28 [Envtl. L. Rep.]{.smallcaps} 10,155 (1998).

[^17]: ^?^. Clean Air Act, 40 C.F.R. 50.2(b) (2000).

[^18]: ^?^. 42 U.S.C. § 7410 (1994).

[^19]: ^?^. Clean Air Act, 40 C.F.R. §§ 50.4, 50.5 (2000). *See*
    National Ambient Air Quality Standards for Sulfur Oxides (Sulfur
    Dioxide)---Final Decision, 66 Fed. Reg. 1665-01 (May 22, 1996).

[^20]: ^?^. *See* Patton, *supra* note Error: Reference source not
    found, at 10,162; Richard L. Revesz, *Federalism and Interstate
    Environmental Externalities*, 144 [U. Pa. L. Rev.]{.smallcaps} 2341,
    2351-52 (1996); *see generally* [Regens & Rycroft,]{.smallcaps}
    *supra* note Error: Reference source not found (discussing history
    of efforts to control acid rain).

[^21]: ^?^. The 1977 Amendments added section 123 to the Act, which
    states that the "control of any air pollutant under an applicable
    implementation plan under this title shall not be affected in any
    manner by---(1) so much of the stack height of any source as exceeds
    good engineering practice . . . or (2) any other dispersion
    technique." 42 U.S.C. § 7423 (1994).

[^22]: ^?^. *Id.* § 7411.

[^23]: ^?^. Clean Air Act, 40 C.F.R. § 60.43 (2000) (applying the
    standard to plants built between 1971 and 1978).

[^24]: ^?^. *See infra* Part III.D.3.a.

[^25]: ^?^. 42 U.S.C. § 7411; Clean Air Act, 40 C.F.R. § 60.43a (2000).

[^26]: ^?^. In *Sierra Club v. Costle*, the court held that a utility
    could not use low-sulfur coal to create equivalent reductions. 657
    F.2d 298, 320-21 (D.C. Cir. 1981). It interpreted the rate-based
    standard and held that "\[i\]n no instance, however, can a plant
    reduce emissions less than 70% of potential uncontrolled
    emissions . . . . There is no dispute that the 70% floor in the
    standard necessarily means that, given the present state of
    pollution control technology, utilities will have to employ some
    form of flue gas desulfurization ('FGD' or 'scrubbing') technology."
    *Id.* at 316 & n.38. Later, in *Wisconsin Electric Power v. Reilly*,
    the court held that use of low-sulfur coal was also not permissible
    to avoid the threshold for imposition of strict New Source
    Performance Standards. 893 F.2d 901, 919 (7th Cir. 1990).

[^27]: ^?^. 42 U.S.C. §§ 8901-8912 (1994).

[^28]: ^?^. *See generally* [Cohen]{.smallcaps}, *supra* note Error:
    Reference source not found (discussing congressional debates).

[^29]: ^?^. For instance, the Mitchell Compromise negotiated between
    Senator Mitchell, then-Chairman of the Environment Subcommittee of
    the Senate Environment and Public Works Committee, and Majority
    Leader Senator Byrd, would have initially required scrubbing at 33
    MW of "cost-effective" plants, and required all utility coal-fired
    plants not already meeting a 1.2 lb/mmBtu emissions rate standard to
    meet a 1.0 lb/mmBtu standard beginning in 2003. The annualized costs
    of fully implementing this were estimated at \$4.4 to \$6.1 billion.
    The Waxman-Sikorski bill of the 98th Congress, co-sponsored by over
    80 House members, would have mandated scrubbing on the 50 largest
    utility plants with an estimated cost of as much as \$7 billion
    annually. Paul R. Portney, *Policy Watch: Economics and the Clean
    Air Act*, 4 [J. Econ. Persp.]{.smallcaps} 173, 175 (1990); *see
    also* H.R. 3400, 98th Cong. (2d Sess.1984). *See generally* Dallas
    Burtraw, *Appraisal of the SO~2~ Cap-and-Trade Market,* *in*
    [Emissions Trading]{.smallcaps} 133 (Richard F. Kosobud et al. eds.,
    2000) (discussing costs and benefits of alternative regulatory
    methods).

[^30]: ^?^. Paul L. Joskow & Richard Schmalensee, *The Political Economy
    of Market-Based Environmental Policy: The U.S. Acid Rain Program*,
    41 [J.L. & Econ.]{.smallcaps} 37, 47 (Apr. 1998); Arnold W. Reitze,
    Jr., *The Legislative History of U.S. Air Pollution Control*, 36
    [Hous. L. Rev.]{.smallcaps} 679, 715 (1999).

[^31]: ^?^. The Bush Administration bill as originally presented on June
    15, 1989, would have created a two-pronged regulatory approach:
    power generation units that emitted over 1.2 lb/mmBtu of SO~2~ in
    the baseline year (1985) would be subject to an emissions cap of 5.1
    million tons, combined with an allowance trading system; those
    emitting less than 1.2 lb/mmBtu would be required to maintain that
    emissions rate. The latter group, known as "the class of '85," came
    to perceive inclusion in the allowance system as preferable, and the
    debate began to center on how many allowances to provide to these
    "clean" utilities and to various sub-groups within this group. The
    overall choice of a 10 million ton reduction was slightly in excess
    of the estimated reductions required by other bills recently
    proposed in Congress, and was based in part on a perceived "knee" in
    the cost of compliance curve at the 10 million ton reduction level.
    *See, e.g.*, Nancy Kete, The Politics of Markets: The Acid Rain
    Control Policy in the 1990 Clean Air Act Amendments 182-3, 251-2
    (1993) (unpublished Ph.D. dissertation, Johns Hopkins University)
    (on file with author) (outlining costs of four bills as presented to
    the Bush Administration).

[^32]: ^?^. [EPA Emissions Trends,]{.smallcaps} *supra* note Error:
    Reference source not found, § 2.2, at 3-4.

[^33]: ^?^. 42 U.S.C. § 7651c (1994); *see also* Torrens et al., *supra*
    note Error: Reference source not found, at 213.

[^34]: ^?^. 42 U.S.C. § 7651c. The level of the Phase I cap was reached
    by multiplying an emissions rate of 2.5 lb/mmBtu SO~2~ (about double
    the Phase II standard) times utilization in the baseline years.
    *Id.*; *see also* [Ellerman et al.]{.smallcaps}, *supra* note Error:
    Reference source not found, at 39-41 (detailing precise Phase I
    allocation rules).

[^35]: ^?^. The level of the Phase II cap is reached by multiplying an
    emissions rate of 1.2 lb/mmBtu SO~2~ times baseline utilization. The
    1.2 lb/mmBtu emission rate has historical significance, as it is the
    rate standard which has been required for new coal-fired power
    plants since 1970.

[^36]: ^?^. Congress was trying to achieve a reduction of 10 million
    tons from 1980 emissions, but the individual source information for
    1980 was poor, so Title IV established the baseline period based on
    emissions from 1985 through 1987, proportionately reduced to equal
    estimated 1980 emissions. 42 U.S.C. § 7651a(4) (1994).

[^37]: ^?^. *See* 42 U.S.C. § 7651b(e) (1994).

[^38]: ^?^. By far the largest quantity of bonus allowances was the 3.5
    million extension allowances, allocated primarily (2.1 million) to
    units that installed scrubbers. The origin of these 3.5 million
    bonus allowances was a shift forward of one year in the effective
    date of the Act, in moving from the Senate bill to the
    Administration bill. During Phase I, this achieved an added 3.5
    million ton reduction, redistributed as bonus allowances to firms
    choosing to install scrubbers, which was in the interest of states
    with high-sulfur coal deposits. 42 U.S.C. § 7651c(d) (1994); Torrens
    et al., *supra* note Error: Reference source not found, at 215. A
    similar advance of one year for Phase II led to the allocation of an
    additional 530,000 allowances for the years 2000 through 2009. *Id.*
    at 213 n.1.

[^39]: ^?^. Although 300,000 bonus allowances were authorized to reward
    efforts to develop alternative energy sources, only 30,377 were
    allocated during Phase I. 42 U.S.C. § 7651c(g) (1994). In addition,
    up to 35,000 allowances a year were authorized for small diesel
    refineries producing low-sulfur fuel, of which 147,820 were
    allocated in Phase I. *Id.* § 7651i(h). Allo-cation data from [EPA
    Compliance Reports]{.smallcaps}.

[^40]: ^?^. 42 U.S.C. § 7651o(b)-(d). The auction and Direct Sales
    Reserve provisions were added to Title IV to counter "fears that
    market imperfections, such as irrational hoarding of allowances by
    utilities or anti-market behavior by state public utility
    regulators, might make it impossible for new entrants to acquire
    allowances necessary to construct and operate new generating
    capacity." [Ellerman et al.]{.smallcaps}, *supra* note Error:
    Reference source not found, at 169 & n.5.

[^41]: ^?^. *See id.* § 7651b(b).

[^42]: ^?^. Such allowances can come from the allowance market or from
    other units owned by the company, whether generated
    contemporaneously or banked in previous years. *Id.*

[^43]: ^?^. *See id.* §§ 7651c, 7651g(c)(1); Clean Air Act, 40 C.F.R.
    § 72.43 (2000).

[^44]: ^?^. *Id.* § 7651c(b).

[^45]: ^?^. *Id.* § 7651c(b), (c).

[^46]: ^?^. Clean Air Act, 40 C.F.R. § 75.1 (2000). This is more
    stringent than the new source provisions, which require only two
    data points per hour. Clean Air Act, 40 C.F.R. § 60.47a(g) (2000).
    It has been noted that predictive emissions monitors are far cheaper
    and may be as accurate as CEMS, since sulfur emissions can be
    accurately predicted from fuel sulfur content and boiler
    characteristics, but these are rarely allowed. C. Foster Knight,
    *How Regulations Impact Innovative Environmental Technologies: A
    Recent Case Study*, [Total Quality Envtl. Mgmt]{.smallcaps}. 119
    (Spring 1995) (discussing predictive emissions monitoring systems).

[^47]: ^?^. [Ellerman et al.]{.smallcaps}, *supra* note Error: Reference
    source not found, at 248-50.

[^48]: ^?^. At the end of the year, utilities are granted a sixty-day
    "true-up," or grace period, during which SO~2~ allowances may be
    purchased, if necessary, to cover each unit's emissions for the
    year. At the end of the grace period, the allowances that a unit
    holds in its compliance account must equal or exceed the annual
    SO~2~ emissions recorded by the unit's monitoring system. Any
    remaining allowances may be sold or banked for use in future years.
    Clean Air Act, 40 C.F.R. § 77.3 (2000).

[^49]: ^?^. 42 U.S.C. § 7651(j) (1994); Clean Air Act, 40 C.F.R. § 77.6
    (2000).

[^50]: ^?^. [EPA 1999 Compliance Report]{.smallcaps}, *supra* note
    Error: Reference source not found, at 2.

[^51]: ^?^. 42 U.S.C. §§ 7479(3), 7501(3), 7502(c)(1) (1994).

[^52]: ^?^. *See infra* note Error: Reference source not found.

[^53]: ^?^. When the cap-and-trade system was first proposed in 1990,
    the EPA's marginal cost estimates for Phase I were between \$290 and
    \$410 per ton, and \$580 to \$815 for Phase II in constant 1995
    dollars. [ICF Resources, Inc., Comparison of the Economic Impacts of
    the Acid Rain Provisions of the Senate Bill (S.1630) and the House
    Bill (H. 1630)]{.smallcaps} (July 1990) \[hereinafter [ICF
    Resources]{.smallcaps}\]. The National Acid Precipitation Assessment
    Program (NAPAP) estimated that only modest SO~2~ reductions could be
    made at under \$200 per ton, and that the marginal cost of a 10
    million ton reduction by 2000 would be \$700 to \$900 per ton.
    [NAPAP Integrated Assessment,]{.smallcaps} *supra* note Error:
    Reference source not found, at 411[.]{.smallcaps}

[^54]: ^?^. [Ellerman et al.]{.smallcaps}, *supra* note Error: Reference
    source not found, at 231-35 (discussing estimates of Phase I costs
    prior to implementation).

[^55]: ^?^. [U.S. General Accounting Office]{.smallcaps}, [Pub. No.
    GAO/RCED-95-30, Air Pollution: Allowance Trading Offers an
    Opportunity to Reduce Emissions at Less Cost]{.smallcaps} 29 (1994)
    \[hereinafter [GAO 1994 Trading]{.smallcaps}\]; Burtraw, *supra*
    note Error: Reference source not found, at 133-67.

[^56]: ^?^. *See* Figure 2-3. *See generally* A. Denny Ellerman, *From
    Autarkic to Market-Based Compliance: Learning from Our Mistakes*,
    *in* [Emissions Trading]{.smallcaps} (Richard F. Kosobud et al.,
    eds. 2000) (discussing utility emphasis on self-reliance and Phase I
    over-compliance).

[^57]: ^?^. *See id.* at 12.

[^58]: ^?^. *See* Figures 2-3 A, B.

[^59]: ^?^. An industry poll showed widespread expectations of allowance
    prices on the order of \$300 to \$725 for Phase I and \$500 to
    \$1000 for Phase II in June-July 1991, falling to \$200 to \$550 for
    Phase I and \$300 to \$700 for Phase II by October/November 1991.
    Torrens et al., *supra* note Error: Reference source not found, at
    220. Similarly, the EPA and other economic studies predicted that
    allowances would cost \$290 to \$410 during Phase I, and \$580 to
    \$815 in Phase II. *See* [ICF Resources]{.smallcaps}, *supra* note
    Error: Reference source not found. *See generally* Burtraw, *supra*
    note Error: Reference source not found, at 152 (setting forth
    long-run cost estimates).

[^60]: ^?^. The first trade was of 10,000 allowances at \$265 per
    allowance from Wisconsin Power & Light Company to the Tennessee
    Valley Authority. Frank Edward Allen, *Tennessee Valley Authority Is
    Buying Pollution Rights From Wisconsin Power*, [Wall St.
    J]{.smallcaps}., May 11, 1992, at A12. The second was a trade of
    25,000 allowances from ALCOA to Ohio Edison for \$300 per allowance.
    Joan E. Rigdon, *Alcoa Unit Arranges \$7.5 Million Sale of Pollution
    Allowances to Ohio Edison*, [Wall St. J]{.smallcaps}., July 1, 1992,
    at A6.

[^61]: ^?^. *See* Ellerman, *supra* note Error: Reference source not
    found, fig. 1, at 6.

[^62]: ^?^. [EPA 1999 Compliance Report]{.smallcaps}, *supra* note
    Error: Reference source not found, at 10.

[^63]: ^?^. [EPA, Pub. No. EPA-430/R-00-0007, Acid Rain Program: 1999
    Compliance Report (2000)]{.smallcaps}.

[^64]: ^?^. Researchers, however, have pointed out that allowance prices
    may be lower than expected because they may reflect the marginal
    cost of compliance, and be less than the average cost due to the
    "lumpy" nature of certain investments in compliance technologies,
    such as scrubbers. *See* [Ellerman et al.]{.smallcaps}, *supra* note
    Error: Reference source not found, at 297-302; Dallas Burtraw &
    Byron Swift, *A New Standard of Performance: An Analysis of the
    Clean Air Act's Acid Rain Program*, 26 [Envtl. L. Rep.]{.smallcaps}
    10,411 (1996).

[^65]: ^?^. *See infra* Part II.C.5.a-d.

[^66]: ^?^. Richard Schmalensee et al., *An Interim Evaluation of Sulfur
    Dioxide Emissions Trading*, 12 [J. Econ. Persp.]{.smallcaps} 53, 57
    (1998).

[^67]: ^?^. [GAO 1994 Trading]{.smallcaps}, *supra* note Error:
    Reference source not found, at 29; Burtraw, *supra* note Error:
    Reference source not found, at 133-67; *see also infra* Part II.C.5.

[^68]: ^?^. The design of Title IV prompted both innovation and
    investment in low-sulfur coal, as firms actively began to experiment
    with fuel blending as a compliance strategy. *See* *infra* Parts
    II.C.4, II.C.6.a; *see also* [Ellerman et al.]{.smallcaps}, *supra*
    note Error: Reference source not found, at 244. Previous industry
    experience in reducing SO~2~ was under the New Source Performance
    Standards (NSPS), which were rate standards and strongly limited
    compliance options. *See supra* text accompanying notes Error:
    Reference source not found-Error: Reference source not found.

[^69]: ^?^. [EPA 1999 Compliance Report]{.smallcaps}, *supra* note
    Error: Reference source not found, at 7, exh. 3. Approximately 5.7
    million were allocated to Table A units, and 1 million per year to
    substitution units.

[^70]: ^?^. [EPA, Pub. No. EPA-430/R-00-0007, Acid Rain Program: 1999
    Compliance Report (2000]{.smallcaps}), at 7, 9. The 1990 emissions
    level of 9,720,466 tons is the average of the 1995-1999 units'
    emissions in 1990, and was derived from data in [EPA, Acid Rain
    Program: 1999 Emissions Scorecard (2000).]{.smallcaps}

[^71]: ^?^. *Id.* at 7, 9. If the 4 million tons of bonus allowances are
    not counted, the over-compliance falls to 22% below the cap amount.
    *See* [Environmental Defense, From Obstacle to Opportunity: How Acid
    Rain Emissions Trading Is Delivering Cleaner Air]{.smallcaps} 22
    (2000).

[^72]: ^?^. *See supra* note Error: Reference source not found.
    Interviews with government regulators and utility representatives
    indicate that the bonus allowances motivated the construction of an
    additional five to six scrubbers, generating additional reductions.

[^73]: ^?^. 42 U.S.C. § 7651d (1994).

[^74]: ^?^. Analysis by Resources for the Future shows that banking
    helped to drive over-investment in scrubbers. Dallas Burtraw & Erin
    Mansur, *The Effects of Trading and Banking in the SO~2~ Allowance
    Market*, [Discussion Paper No. 99-25]{.smallcaps}, at 19, *at*
    http://www.rff.org/\
    environment/air.htm (Mar. 1999).

    In theory, allowing for banking should decrease costs. However, we
    find that the opportunity for banking actually led compliance costs
    to be higher by \$651 million in 1995 and \$339 million in 2005 in
    our model. Banking encouraged the construction of scrubbers that
    appear *ex post* to be cost-inefficient. Given changes in fuel
    markets subsequent to the planning and construction of these
    facilities, we calculate that none of the 21 scrubbers that were
    built in Phase I would have been built if there had not been
    banking.

    *Id.*

[^75]: ^?^. The 11.6 million ton bank includes the net 10.5 million
    allowances created by over-compliance at utility units during Phase
    I, plus other allowance pools not directly allocated to those units,
    i.e., the 750,000 auctioned allowances, 339,705 allowances to
    industrial opt-in sources and the 147,820 allowances issued to small
    diesel refineries. These figures are derived from ELI analysis of
    [EPA Compliance Reports]{.smallcaps}, 1995-1999.

[^76]: ^?^. Since acid deposition creates cumulative impacts, early
    reductions are beneficial as they may prevent threshold effects for
    acid deposition that harm ecosystems. One analysis shows banking may
    also slightly improve health effects over time, primarily by
    displacing emissions out of highly populated areas in the northeast,
    but that this effect may be countered by future population growth.
    Burtraw & Mansur, *supra* note Error: Reference source not found, at
    15.

[^77]: ^?^. *See* Figure 2-5. Figures derived through ELI analysis of
    [EPA Compliance Reports]{.smallcaps}.

[^78]: ^?^. Figures derived from analysis of [EPA Compliance Reports,
    1995-1999]{.smallcaps}. *See also* figure 2-5. Data shows the sum of
    all emissions and allowance allocations to Phase I-affected units
    for each firm in the years 1995-1999.

[^79]: ^?^. [GAO 1994 Trading]{.smallcaps}, *supra* note Error:
    Reference source not found, at 72-73; Ellerman, *supra* note Error:
    Reference source not found, at 190-91; Douglas R. Bohi & Dallas
    Burtraw, *SO~2~ Allowance Trading: How Do Expectations and
    Experience Measure Up?*, 10:7 [Elec. J.]{.smallcaps} 67 (1997)
    (noting that many utilities have failed to take advantage of
    allowance trading as a method of reducing compliance costs).

[^80]: ^?^. These firms included small municipal utilities for the City
    of Owensboro, and Atlantic City. *See* Figure 2-5. *See generally*
    Todd J. Zywicki, *Environmental Externalities and Political
    Externalities: The Economy of Environmental Regulation and Reform*,
    75 [Tulane L. Rev.]{.smallcaps} 845, 864 (1999) (finding that the
    fixed cost of scrubber installation falls harder on small
    businesses).

[^81]: ^?^. Demand-side measures are those taken to improve the
    efficiency of consumer power use, or to reduce consumption. Clean
    Air Act, 40 C.F.R. § 72.2 (2000). Note that while demand-side
    management is a compliance mechanism under a cap-and-trade approach,
    the phased nature of Title IV required firms in Phase I to not
    reduce their overall utilization. Therefore, special rules were
    needed in Phase I to encourage demand-side management. *See, e.g.*,
    *id.* §§ 72.43, 73.80.

[^82]: ^?^. Again, as with demand-side management, the retirement of
    inefficient or obsolete units is a compliance mechanism generally
    under a cap-and-trade approach, but the phased nature of Title IV
    required firms in Phase I to not reduce utilization. 42 U.S.C.
    § 7651g(c)(1) (1994).

[^83]: ^?^. Rate standards limit or restrict compliance technologies. In
    the SO~2~ context, the New Source Performance Standard adopted in
    1977 only allowed scrubbing, and the 1971 NSPS standard limited
    compliance choice to scrubbing or a particular quality of coal. In
    the NO[~X~]{.smallcaps} context, standards such as BACT are
    interpreted by some states to only recognize reductions made through
    end-of-pipe control equipment, not through process change. *See
    infra* Part IV.E.1. Rate standards thus often do not recognize or
    reward reductions made upstream, such as those made through the use
    of cleaner processes or fuels.

[^84]: ^?^. *See* [Regens & Rycroft]{.smallcaps}, *supra* note Error:
    Reference source not found, at 59-74.

[^85]: ^?^. Data derived from analysis of [EPA Compliance Reports,
    1995-1999.]{.smallcaps} Note that only plants that reduced emissions
    below allocations are included.

[^86]: ^?^. Data derived from analysis of [EPA Compliance Reports,
    1995-1999.]{.smallcaps}

[^87]: ^?^. Scrubbing essentially replicates the chemical reaction that
    gives rise to acid precipitation, but is contained within the
    scrubbing vessel. This technology sprays limestone or another
    calcium source into the fuel chamber, causing a chemical reaction
    with the flue gas that turns the SO~2~ gas into a solid. The
    resulting slugs are then disposed of in landfills or, if calcium
    sulfite is used, employed in the production of wallboard. *Id.*

[^88]: ^?^. Phase I scrubbers cost \$249 per kilowatt to install, or
    \$150 million for a 600 MW plant. *See* Figure 2-7. They also use
    about 1.5% of the electric power generated by the plant to run,
    consume significant lime or limestone, and generate solid wastes
    that over the lifetime of a 300 MW plant would fill 1000 acres,
    unless alternative uses of the wastes can be found, such as for
    gypsum or landfill. Interviews with scrubber manufacturers.

[^89]: ^?^. Each of these companies generated over a million allowances
    at a single scrubbed plant, Cumberland (TVA), Harrison (Allegheny
    Power), and Gavin (AEP). *See* Figure 2-11.

[^90]: ^?^. Interviews with smaller firms show that most never seriously
    considered allowance purchases for compliance.

[^91]: ^?^. [GAO 1994 Trading]{.smallcaps}, *supra* note Error:
    Reference source not found, at 29. An MIT Center for Energy and
    Environmental Policy Research (MIT/CEEPR) survey of respondents who
    represented about half of the retrofitted scrubbing capacity also
    identified 3600 MW where scrubbing was the initial option but not
    the last. [A.D. Ellerman et al., Emissions Trading Under the U.S.
    Acid Rain Program: Evaluation of Compliance Costs and Allowance
    Market Performance]{.smallcaps} 50 (M.I.T. Center for Energy and
    Envtl. Policy Research, 1997); *cf.* [ICF Resources,]{.smallcaps}
    *supra* note Error: Reference source not found (predicting lower
    need for scrubbed capacity).

[^92]: ^?^. The scrubbers for these twenty-seven units were constructed
    in the early to mid-1990s in response to Title IV. In addition, a
    scrubber was installed at one Table A plant in 1985, which was
    therefore part of its baseline and not a compliance strategy.
    Another Table A unit, Big Bend Unit 1, installed a scrubber in
    December 1999, which was the last month of Phase I, and relevant
    only for Phase II compliance. In addition to the Table A units,
    substitution units had installed fifteen pre-1990 NSPS scrubbers,
    with a capacity of 6056 MW, making a grand total of 21,223 MW
    scrubbed capacity for units in Phase I for all five years. However,
    the reductions at substitution units made before 1990 do not count
    as Phase I reductions, but instead are part of their baseline
    emissions. *See* Clean Air Act, 40 C.F.R. § 72.41(c)(3) (2000).

[^93]: ^?^. *See* Torrens et al., *supra* note Error: Reference source
    not found, tbl.1, at 220. In a survey conducted by the MIT/CEEPR,
    75% of respondents, representing about half of the retrofitted
    scrubbing capacity, "indicated that expectations of allowance prices
    of \$300 to \$400 were 'very important' in decisions to scrub."
    [Ellerman et al.]{.smallcaps}, *supra* note Error: Reference source
    not found, at 50. The long lead time to install a retrofit scrubber
    was needed so the equipment could be installed during planned
    outages in 1994 or 1995.

[^94]: ^?^. Economic estimations are that few scrubbers would have been
    built during Phase I had firms been able to accurately predict the
    lower costs of switching. *See* Burtraw, *supra* note Error:
    Reference source not found.

[^95]: ^?^. Burtraw & Mansur, *supra* note Error: Reference source not
    found.

[^96]: ^?^. These 3.5 million allowances represent the savings made by
    moving up the effective date of the legislation one year, from 1996
    to 1995.

[^97]: ^?^. *See* Interviews with state regulatory officials and utility
    companies. States such as Illinois also attempted to protect their
    high-sulfur coal mining industries by providing subsidies for
    scrubber installation. Even these incentives were insufficient to
    tilt the balance in favor of scrubbing. One utility spent \$35
    million to begin construction of a scrubber, received approval for a
    subsidy from the state for the scrubber, but opted instead to
    achieve compliance by first purchasing allowances in Phase I, and
    subsequently by switching to low-sulfur coal in Phase II, thus
    foregoing a substantial subsidy for the scrubber installation. *See*
    American Bar Association, *New Strategies for New Market: The
    Electric Industry's Response to the Environmental Protection
    Agency's Sulfur Dioxide Emission Allowance Trading Program*, [47
    Admin. L. Rev.]{.smallcaps} 469, 480-81 (1995) (describing Illinois
    Power's decision to cancel "its plan to install scrubbers" in favor
    of purchasing allowances to comply with Phase I).

[^98]: ^?^. [U.S. Energy Information Agency, Pub. No. EIA-0348(99)12.
    Flue Gas Desulfurization (FGD) Capacity in Operation at U.S.
    Electric Utility Plants as of December 1999, 2 Elec. Power
    Annual]{.smallcaps}, tbl. 30 (October 2000). The type of scrubber
    was determined through interviews with plant managers and scrubber
    manufacturers, and also by reference to data compiled by MIT's
    Center for Energy and Environmental Policy Research.

[^99]: ^?^. *See* Figure 2-7.

[^100]: ^?^. *See* Interviews with scrubber manufacturers.

[^101]: ^?^. [ICF Resources, Inc. Comparison of the Economic Impacts of
    the Acid Rain Provisions of the Senate Bill (S.1630) and the House
    Bill (H.1630]{.smallcaps}\[sic\]) (July 1990); [A.D. Ellerman et
    al., Markets for Clean Air: The U.S. Acid Rain Program]{.smallcaps},
    tbl. 9.3, 240 (2000).

[^102]: ^?^. [Ellerman et al.]{.smallcaps}, *supra* note Error:
    Reference source not found, at 241 ("A recent study of the advances
    in scrubber technology in the United States through 1992 found 'no
    significant progress . . . in abatement technology' and attributes
    this result to the 'small incentives for innovation \[associated
    with\] the form of regulation typically used in the U.S.'"); *see
    also* Allen Bellas, *Empirical Evidence of Advances in Scrubber
    Technology*, 20 [Resources & Energy Econ.]{.smallcaps} 327 (1998);
    Paul A Ireland et al., *A Review of Phase I Retrofit FGD Cost
    Experience---New Benchmarks for the Future*, Presentation at AMWA
    Mega Symposium sponsored by EPRI-DOE-EPA (1995) (notes on file with
    author).

[^103]: ^?^. *See* Figure 2-7.

[^104]: ^?^. [Ellerman et al.]{.smallcaps}, *supra* note Error:
    Reference source not found, at 235-42.

[^105]: ^?^. In one case, scrubbers being built at two units of the
    Mount Storm plant today will cost 30% to 40% less than the scrubber
    built at an identical unit of that plant in 1995. *See* Interviews
    with industry representatives; Pollution Engineering Online,
    *Marshley Wins \$88 Million Scrubber Contract*, *at*
    http://www.pollutionengineering.com (Apr. 1999).

[^106]: ^?^. This has made it possible to achieve the same amount of
    SO~2~ emissions reduction with a smaller scrubbing vessel, thereby
    lowering capital costs and maintenance costs by 15% to 20%.

[^107]: ^?^. *See* Interviews with scrubber manufacturers.

[^108]: ^?^. An increase in the demand for gypsum has helped fuel
    research and development in refining this process, with the result
    that by-product gypsum production has become highly economical for
    some utilities. Gypsum companies are now building facilities close
    to some generating units. The use of gypsum obtained from scrubbers
    increased from 1.5 million tons to 2.5 million tons between 1996 and
    1998. [R.F. Balazik, U.S. Geological Survey, Minerals
    Information---1998: Annual Review for Gypsum]{.smallcaps} 35.1
    (1999).

[^109]: ^?^. *See* Interviews with electric utilities; [Ellerman et
    al.]{.smallcaps}, *supra* note Error: Reference source not found, at
    235-42.

[^110]: ^?^. *See supra* note Error: Reference source not found.

[^111]: ^?^. *See* Figure 2-7.

[^112]: ^?^. Some firms reported that some public utility commissions
    prohibited over-compliance with the 90% reduction new source
    standard for scrubbing, as any overcompliance was not in accordance
    with a "prudent investment" policy. This represents an extreme
    example of the limitations caused by rate-based standards.

[^113]: ^?^. *See* Figure 2-4.

[^114]: ^?^. Gary R. Hart, *Southern Company's BUBA Strategy in the
    SO~2~ Allowance Market*, *in* [Emissions Trading 204,]{.smallcaps}
    205 (Richard F. Kosobud ed., 2000) ("Our plan was to procure a
    substantial supply of this low-sulfur coal for our affected units
    during Phase I while at the same time paying little or no premium
    for this 1% coal \[emitting SO~2~ at 1.67 lb/mmBtu\] as opposed to a
    coal that emitted the 2.5 lb/mmBtu rate.").

[^115]: ^?^. *See* Jeffrey M. Hirsch, *Emission Allowance Trading Under
    the Clean Air Act: A Model for Future Environmental Regulations?*, 7
    [N.Y.U. Envtl. L.J.]{.smallcaps} 352, 381-82 (1999).

[^116]: ^?^. 42 U.S.C. § 7651b (1994).

[^117]: ^?^. *See* [Ellerman et al.,]{.smallcaps} *supra* note Error:
    Reference source not found, at 82-89; *infra* text accompanying note
    Error: Reference source not found.

[^118]: ^?^. [EIA]{.smallcaps}, [Coal Industry Annual, Pub.
    No.]{.smallcaps} DOE/EIA-0584(98) (1999).

[^119]: ^?^. Utility emissions of SO~2~ had already begun to fall before
    Phase I, with 1993 levels 7% below 1985 levels. [EPA 1999 Emissions
    Scorecard,]{.smallcaps} *supra* note Error: Reference source not
    found.

[^120]: ^?^. *See* [Ellerman et al.]{.smallcaps}, *supra* note Error:
    Reference source not found, at 82-88. "\[T\]he consequence of
    competition and productivity improvements has been the halving of
    the rail rate for long-distance shipments of coal out of the PRB."
    *Id.*

[^121]: ^?^. *See* Interviews with utility companies.

[^122]: ^?^. *See* [Ellerman et al.]{.smallcaps}, *supra* note Error:
    Reference source not found, at 244.

[^123]: ^?^. *See* Interviews with utility companies; Burtraw & Swift,
    *supra* note Error: Reference source not found.

[^124]: ^?^. [Ellerman et al.]{.smallcaps}, *supra* note Error:
    Reference source not found, at 250.

[^125]: ^?^. *Id.* at 244. "\[I\]n what must be considered a triumph of
    tinkering and continuous tinkering, it was found that subbituminous
    coal could be blended with the local bituminous coal up to a point
    without incurring significant derating." *Id.*

[^126]: ^?^. *See* Interviews with utility firm representatives. *See
    also* [Ellerman et al.]{.smallcaps}, *supra* note Error: Reference
    source not found, at 129 (noting that PRB coal accounts for about
    15% of the SO~2~ emissions reductions from fuel switching under
    Title IV and 10% of the overall SO~2~ emissions reductions under
    Title IV).

[^127]: ^?^. The rate value of 1.2 lb/mmBtu has significance as it is
    the rate standard new plants have to achieve under NSPS, and is the
    rate standard on which the Phase II cap was established. Most units
    would need to reach such a rate level by Phase II.

[^128]: ^?^. [Ellerman et al.]{.smallcaps}, *supra* note Error:
    Reference source not found, at 128-29.

[^129]: ^?^. *See* Ireland, *supra* note Error: Reference source not
    found.

[^130]: ^?^. [Ellerman et al.]{.smallcaps}, *supra* note Error:
    Reference source not found, at 129-30.

[^131]: ^?^. *Id.*

[^132]: ^?^. *See id.* at 128-30; [EIA,]{.smallcaps} [The Effects of
    Title IV of the Clean Air Act Amendments of 1990 on Electric
    Utilities: An Update]{.smallcaps}, [Pub. No.]{.smallcaps}
    DOE/EIA-0528(97), at 23-25 (1997).

[^133]: ^?^. Clean Air Capital Markets, Research (1995) (unpublished
    data, Washington, D.C.) (on file with author).

[^134]: ^?^. Burtraw & Swift, *supra* note Error: Reference source not
    found, at 10,419.

[^135]: ^?^. *See* Interviews with utility representatives.

[^136]: ^?^. *Id.*

[^137]: ^?^. *See* Ireland et al., *supra* note Error: Reference source
    not found; *see also* [Ellerman et al.]{.smallcaps}, *supra* note
    Error: Reference source not found, at 224 (switching to PRB cost
    \$15 to \$75 per kW; switching to other bituminous coals cost \$0 to
    \$15 per kW).

[^138]: ^?^. *See* Ireland et al., *supra* note Error: Reference source
    not found; *see also* [Ellerman et al.]{.smallcaps}, *supra* note
    Error: Reference source not found, at 224. Added particulate
    controls were also needed because western coal is "dustier" than
    most eastern coal, increasing explosion danger as well.

[^139]: ^?^. Clean Air Act, 40 C.F.R. § 60.43 (2000); *see also* *supra*
    text accompanying note Error: Reference source not found.

[^140]: ^?^. *See supra* text accompanying note Error: Reference source
    not found. If a utility had to install a scrubber in order to meet
    ambient air quality standards or if a plant subject to NSPS opted
    for the 90% removal standard, the principle consideration in the
    choice of coal was price, not sulfur content, since there was no
    regulatory or economic advantage to using lower sulfur coal. Many of
    the utilities in the central part of the country chose to use lower
    priced high sulfur coal mined in the region. *See* Interviews with
    utility representatives.

[^141]: ^?^. 42 U.S.C. § 7651g(c)(1) (1994).

[^142]: ^?^. Four of the units were Wisconsin Electric Power's old North
    Oak Creek plant, and the lost utilization was made up at the South
    Oak Creek plant owned by the same utility. The other retired units
    were Avon Lake 11 in Ohio, Breed 1 in Indiana and Des Moines 11 in
    Iowa. [EPA 1999 Compliance Report,]{.smallcaps} *supra* note Error:
    Reference source not found[,]{.smallcaps} app[.]{.smallcaps} B-4.
    *See generally* Ireland et al., *supra* note Error: Reference source
    not found (citing [Power Engineering Update]{.smallcaps}, Mar.
    1993).

[^143]: ^?^. [EPA 1999 Compliance Report]{.smallcaps}, *supra* note
    Error: Reference source not found, app. B-4.

[^144]: ^?^. Eleven companies with three or more units achieved roughly
    half or more of their compliance through substitution units. In
    addition, two smaller firms participated in Phase I only because
    their units were chosen as substitution units. *See* Figure 2-5.

[^145]: ^?^. *See id.*

[^146]: ^?^. [Ellerman et al.]{.smallcaps}, *supra* note Error:
    Reference source not found, at 197-220.

[^147]: ^?^. *See* Acid Rain Program: Permits, 59 Fed. Reg. 60,218 (Nov.
    22, 1994).

[^148]: ^?^. *See* Clean Air Act, 40 C.F.R. § 72.41(c)(3) (2000).

[^149]: ^?^. *See* Interviews with utility representatives.

[^150]: ^?^. [EPA 1999 Compliance Report,]{.smallcaps} *supra* note
    Error: Reference source not found[,]{.smallcaps} at 10-11. These
    figures include trades of both Phase I and Phase II allowances,
    which are not reported separately by the EPA.

[^151]: ^?^. [EPA 1999 Compliance Report]{.smallcaps}, *supra* note
    Error: Reference source not found, at 11.

[^152]: ^?^. *Id*.

[^153]: ^?^. 3.5 million was the total number of allowances needed by
    individual units to cover emissions that exceeded their allowance
    allocations. *See* Figure 2-5.

[^154]: ^?^. Only three firms emitted more allowances than they were
    allocated, requiring their use of 577,583 allowances. *See* Figure
    2-5. A slightly higher number is reached if one adds the 130,789
    allowances used by other firms that exceeded their allowance
    allocation for only one or two years. *See infra* note Error:
    Reference source not found.

[^155]: ^?^. [EPA 1999 Compliance Report]{.smallcaps}, *supra* note
    Error: Reference source not found, at 11.

[^156]: ^?^. Ellerman, *supra* note Error: Reference source not found,
    fig. 1, at 6.

[^157]: ^?^. *See* Interviews with emissions brokers. One firm charged
    \$10 per allowance in this early period, and sold a significant
    share of the early allowances, but provided considerable technical
    and strategic advice along with the allowance sale.

[^158]: ^?^. Only 150,000 allowances are traded in the EPA auction,
    which was about 2% of the 10 million allowances traded in 1999.
    *See* Figure 2-8.

[^159]: ^?^. Clean Air Act, 40 C.F.R. § 73.30 (2000). *See* Joseph A.
    Kruger et al., *A Tale of Two Revolutions: Administration of the
    SO~2~ Trading Program*, *in* [Emissions Trading]{.smallcaps} 115,
    121 (Richard F. Kosobud ed., 2000) (noting that the "EPA processes
    about 90% of allowance transactions within 24 hours of receipt,
    using just two Acid Rain staff.").

[^160]: ^?^. [EPA 1999 Compliance Report,]{.smallcaps} *supra* note
    Error: Reference source not found, at 10 (showing allowance price
    indexes of Fieldston Publications and Cantor Fitzgerald).

[^161]: ^?^. Carlton J. Bartels, *Turning Gas into Cash*, [Envtl.
    Fin.]{.smallcaps} 32 (Nov. 1999); [Ellerman et al.]{.smallcaps},
    *supra* note Error: Reference source not found, at 167 n.4.

[^162]: ^?^. Each year approximately 3% of allowances are withheld from
    units to be auctioned, and a limited reserve of allowances are
    guaranteed to be available at a price of \$1500, to ensure the
    availability of at least a small number of allowances. 42 U.S.C.
    § 7651o (1994); *see also* [Ellerman et al.]{.smallcaps}, *supra*
    note Error: Reference source not found, at 169 n.5.

[^163]: ^?^. *See* Interviews with emissions brokers; *see also*
    Bartels, *supra* note Error: Reference source not found.

[^164]: ^?^. *See* Interviews with utility representatives; *see also*
    [Ellerman et al.]{.smallcaps}, *supra* note Error: Reference source
    not found, at 129-36.

[^165]: ^?^. [GAO 1994 Trading]{.smallcaps}, *supra* note Error:
    Reference source not found.

[^166]: ^?^. *See* Figure 2-5 (showing that only 3,541,045 allowances
    were used by units to emit over their allowance allocations).

[^167]: ^?^. *See infra* note Error: Reference source not found.

[^168]: ^?^. Data derived from analysis of [EPA Compliance Reports,
    1995-1999.]{.smallcaps}

[^169]: ^?^. *See* Figure 2-4.

[^170]: ^?^. *See* Figure 2-5 (showing ELI analysis of unit data in [EPA
    1999 Compliance Report,]{.smallcaps} *supra* note Error: Reference
    source not found[).]{.smallcaps}

[^171]: ^?^. *Id.*

[^172]: ^?^. The total use of allowances by firms to emit more than
    their allowances in any one year was: Illinois Power, 503,208; Tampa
    Electric, 60,138; Duquesne 14,237, and all others 130,789. *Id.*
    These 708,372 allowances used by firms to cover their allowance
    deficit during Phase I is 2.6% of Phase I's 26.5 million tons of
    total emissions. Data from ELI analysis of [EPA Compliance Reports
    1995-1999.]{.smallcaps}

[^173]: ^?^. This situation occurred primarily due to political, and not
    economic, considerations concerning the 1900 MW Baldwin Plant,
    responsible for most of Illinois Power's emissions. The Baldwin
    plant burned local high-sulfur coal, with emissions over 5 lb/mmBtu.
    There was political opposition from coal miners and the legislature
    to closing these mines and allowing the plant to switch to
    low-sulfur coal. Illinois Power initially started to build a
    scrubber at Baldwin, although according to some sources this was
    simply to appease the local legislature and in-state coal miners.
    Ultimately, Illinois Power stopped building the scrubber, and
    instead used allowances for compliance throughout Phase I. *See*
    Interviews with government regulators and environmental groups.
    Illinois Power has now achieved a 90% reduction in SO~2~ at Baldwin
    by shifting to low-sulfur coal at the advent of Phase II. [St. Louis
    Post-Dispatch]{.smallcaps}, Nov. 13, 1998.

[^174]: ^?^. The excess emissions were: Illinois Power, 503,208; Tampa
    Electric, 60,138; Duquesne 14,237. *See* Figure 2-5.

[^175]: ^?^. *See supra* note Error: Reference source not found.

[^176]: ^?^. [Ellerman et al.]{.smallcaps}, *supra* note Error:
    Reference source not found, at 193 ("\[A\]cross all states issuing
    regulations, public utility commission regulations on
    allowance-trading activity largely require that 100% of both expense
    and revenues be returned to the ratepayers."). *See generally*
    Elizabeth M. Bailey, *Allowance Trading Activity and State
    Regulatory Rulings: Evidence from the U. S. Acid Rain Program*, *at*
    web.mit.edu/afs/Athena.mit.edu/org/c/ceepr/www/workingpapers.htm
    (Mar. 1998) (analyzing public utility trading in response to state
    regulation).

[^177]: ^?^. *See* Gary Hart, *Roadblocks to an Optimal Trading System*,
    [Envtl. Fin.]{.smallcaps} 26, 26 (May 2000), *available at*
    <http://www.emissions.org/publications/member_articles/index.html>.
    "The potential tax policy consequences coupled with the direct
    refunding of the remaining proceeds to customers . . . . have led
    many utilities to hold, or bank, allowances for future compliance
    and not participate fully in the allowance market." *Id.*

[^178]: ^?^. *Id.*; *see also* Interviews with utility representatives.
    One practice of utilities was to make a six-month loan of allowances
    to brokers or other utilities to trade, which is tax-free. The
    allowances would be repaid by the broker with interest in an
    additional amount of allowances, such as 5%. *See* Hart, *supra*
    note Error: Reference source not found, at 26. Although this was a
    way of making profits from allowances holdings, it has little
    relevance to compliance.

[^179]: ^?^. TVA's board of directors adopted a no-trading policy after
    negative publicity on its participation in one of the very first
    SO~2~ allowance trades in 1992. *See* Matthew L. Wald, *Utility Is
    Selling the Right to Pollute*, [N.Y. Times]{.smallcaps}, May 12,
    1992, at A1 (criticizing the firm's participation in the allowance
    trade).

[^180]: ^?^. *See* *Energy Survey*, [The Economist]{.smallcaps}, Feb.
    10, 2001, at 11. []{.mark}

[^181]: ^?^. *See* Interviews with emissions brokers and utility
    representatives.

[^182]: ^?^. *See* Vito Stagliano & Sarah Emerson, *Energy Trading: The
    Market's Response to Deregulation*, [Resources]{.smallcaps} 127
    (Spring 1997); *see also* Interviews with utility representatives.

[^183]: ^?^. *See* Interviews with utility representatives.

[^184]: ^?^. *Id.*; *see also* [Ellerman et al.]{.smallcaps}, *supra*
    note Error: Reference source not found, at 178 (discussing allowance
    swapping).

[^185]: ^?^. *See* Interviews with utility representatives

[^186]: ^?^. *See* Interviews with emission trading representatives of
    utility companies. Cinergy, a larger firm, reported revenues of
    \$640 million from its trading subsidiary, about 11% of its total
    1998 revenues. [Cinergy Corp., 1998 Financial Report & 1999 Proxy
    Statement C-20, C-26 (1999).]{.smallcaps}

[^187]: ^?^. *See* Interviews with emission trading representatives of
    utility companies and indepen-dent emissions brokers.

[^188]: ^?^. The allowance system allows coal suppliers to "bundle"
    allowances with their coal to meet emissions limits or utilities'
    demands. The opportunity to profit through arbitrage trading if coal
    prices are out of line with allowance prices ensures a relatively
    high degree of consistency between allowance prices and the sulfur
    premium. Coal suppliers have opened accounts in the EPA's Allowance
    Tracking System and trade allowances to bundle them with coal
    supplies. These practices tie in the price of coal with other
    compliance strategies, and so achieve economic efficiency and
    least-cost compliance. *See* [Ellerman et al.]{.smallcaps}, *supra*
    note Error: Reference source not found, at 255-57.

[^189]: ^?^. *See* Interviews with environmental compliance
    representatives of power generation firms. Many update allowance
    prices on a monthly basis.

[^190]: ^?^. The discussion in the following paragraphs is derived from
    confidential interviews with industry sources.

[^191]: ^?^. The cap assures environmental quality, while the strict
    monitoring and penalty provisions assure the integrity of trading.
    The allowance method, unlike credit trades, also means that no
    government pre-approvals are needed that would slow trades and add
    significant transaction costs.

[^192]: ^?^. While Phase I achieved early reductions, it created a
    problem due to the inter-connectedness of all electricity generating
    firms. Firms could potentially reduce emissions at Phase I units
    simply by generating more electricity at other units that would not
    be covered until Phase II. *See* [Brian McLean, EPA, Pub. No. EPA
    95-RA12004, Lessons Learned Implementing Title IV of the Clean Air
    Act]{.smallcaps} 7 (1995). Further, as described *infra* in Part
    II.C.8, the substitution provisions also likely resulted in excess
    Phase I emissions.

[^193]: ^?^. *See* 42 U.S.C. § 7651g(c)(1) (1994); Clean Air Act, 40
    C.F.R. § 72.2 (2000).

[^194]: ^?^. Susanne Schennach, *The Effect of Title IV on SO~2~
    Emission and Heat Input*, *in* [Markets for Clean Air: The U.S. Acid
    Rain Program 323]{.smallcaps} (Ellerman et al. eds.,
    [2000);]{.smallcaps} [Ellerman et al.]{.smallcaps}, *supra* note
    Error: Reference source not found, at 50; E-mail from A. Denny
    Ellerman, Executive Director, MIT Center for Energy and
    Environmental Policy Research, to Byron Swift, Environmental Law
    Institute (Dec. 29, 1999) (on file with author) (calculating that 7%
    of heat input was transferred from Phase I unscrubbed units to Phase
    II units, and the emissions transferred to Phase II less the
    emissions reductions in Phase I).

[^195]: ^?^. *See supra* note Error: Reference source not found.

[^196]: ^?^. *Id.*

[^197]: ^?^. Byron Swift, *Allowance Trading and SO~2~ Hot Spots---Good
    News from the Acid Rain Program*, 31 [Env't Rep.]{.smallcaps} 954
    (May 12, 2000), *available at* http://www.epa.gov/airmarkets/\
    articles/so2trading-hotspots_charts.pdf.

[^198]: ^?^. *Id.*

[^199]: ^?^. *See* 42 U.S.C. § 7651 (1994).

[^200]: ^?^. *See supra* text accompanying notes Error: Reference source
    not found-Error: Reference source not found.

[^201]: ^?^. Data derived from analysis of [EPA Compliance Reports,
    1995-1999.]{.smallcaps}

[^202]: ^?^. EPA, Clean Air Markets Div. (unpublished data, on file with
    author) (2000).

[^203]: ^?^. Even the 3% of interregional trading showed little
    directionality, often consisting of transfers between neighboring
    states that happened to cross a regional boundary. *See* Swift,
    *supra* note Error: Reference source not found, at 954-55, 957;
    [U.S. General Accounting Office, Pub. No. GAO/RCED-00-47 Acid Rain:
    Emissions Trends and Effects in the Eastern United
    States]{.smallcaps} (Mar. 2000), *available at*
    [http://www.gao.gov](http://www.gao.gov/)/archive/2000/re00047.pdf
    \[hereinafter [GAO 2000 Effects]{.smallcaps}\].

[^204]: ^?^. Data derived from analysis of EPA [Compliance
    Reports]{.smallcaps} 1995-1999. Emissions and allowance totals were
    calculated by summing the emissions and allocations to Phase I
    affected units within each plant.

[^205]: ^?^. [EPA 1999 Compliance Report]{.smallcaps}, *supra* note
    Error: Reference source not found, at 2; [EPA, OTC NO~x~ Budget
    Program: 1999 Compliance Report]{.smallcaps} 2 (2000), *available
    at* [http://www.epa.gov/airmarkets/\
    cmprpt/otc99/index.html](http://www.epa.gov/irmarkets/cmprpt/otc99/index.html)
    (last updated Dec. 11, 2000) \[hereinafter [EPA 1999 OTC NO~X~
    Compliance Report]{.smallcaps}\].

[^206]: ^?^. *See* Figure 3-4 for data on age of plants. The 1970 Clean
    Air Act established federal performance standards for new or
    modified sources, initially establishing New Source Performance
    Standards, followed by the more complex New Source Review process in
    the 1977 Amendments. 42 U.S.C. §§ 7411, 7503 (1994). New Source
    Performance Standards for NO~X~ for boilers and turbines are found
    at 40 C.F.R § 61 (2000). In contrast, existing power plants were not
    subject to direct federal regulation until Title IV was passed in
    1990.

[^207]: ^?^. Illinois, for example, only regulated larger existing
    plants in the Chicago or St. Louis (IL) major metropolitan areas,
    and imposed fairly lenient NO~x~ standards. These were 0.46 kg/MW/hr
    (0.3 lbs/mmBtu) for gas or liquid fossil fuels, and 1.39 kg/MW/hr
    (0.9 lbs/mmBtu) for coal. *See* Existing Emission Sources in Major
    Metropolitan Areas, [Ill. Admin. Code]{.smallcaps} tit. 35,
    § 217.141 (2001). Many other states simply did not develop any
    standards for existing power plants. *See, e.g.*, 41 [Ky. Admin.
    Regs]{.smallcaps}. 61 (1981). Compare with standards set for new
    electric utility steam generating units. 41 [Ky. Admin.
    Regs]{.smallcaps}. 59:016 (1981). States in the Ozone Transport
    Region typically did not impose NO~X~ standards on existing plants
    until March 15, 1994. *See, e.g.*, [N.Y. Comp. Codes R. &
    Regs.,]{.smallcaps} tit. 6 [§ ]{.smallcaps}227-2 (2001). Earlier
    standards for stationary sources focused on particulates and
    opacity. *See id.* § 227-1.

[^208]: ^?^. *See generally* [Nat'l Research Council, Rethinking the
    Ozone Problem in Urban and Regional Air Pollution]{.smallcaps}
    (1991) (discussing national policy on the effect of NO~x~ in urban
    areas).

[^209]: ^?^. *See infra* Part III.E.1; 42 U.S.C. § 7511c (1994).

[^210]: ^?^. *See infra* Part III.E.2.

[^211]: ^?^. *See* Figure 4-2.

[^212]: ^?^. *See infra* Part III.E.3.

[^213]: ^?^. 42 U.S.C. § 7409(c) (1994).

[^214]: ^?^. *See* [EPA, Pub. No. EPA-456/F-99-006R, Technical Bulletin,
    Nitrogen Oxides (NO~x~), Why and How They Are
    Controlled]{.smallcaps} (Nov. 1999), *available at*
    http://www.epa.gov/ttn/\
    catc/dir1/fnoxdoc/pdf.

[^215]: ^?^. [EPA Emissions Trends,]{.smallcaps} *supra* note Error:
    Reference source not found[,]{.smallcaps} at 2-2, 3-4. Vehicles
    contributed 53% of national emissions, while other fuel combustion
    contributed 17%. *Id.*

[^216]: ^?^. Normally, "\[r\]etrofitting low-NO~X~ burners in wall-fired
    boilers . . . involves removing the existing burners and providing
    more space for the installation of the low-NO~X~ burners" together
    with modifications to the waterwall and windbox. "For small
    furnaces, installation of low-NO~X~ burners may cause flames to
    impinge on the opposite wall of the furnace," causing derating of
    the unit load and corrosion of the waterwalls. EIA[,]{.smallcaps}
    *Reducing Nitrogen Oxide Emissions: 1996 Compliance with Title IV
    Limits*[, Elec. Power Monthly]{.smallcaps}, at xv (May 1998),
    *available at*
    http://www.eia.doe.gov/cneaf/electricity/nox_emissions/contents.html.

[^217]: ^?^. *Id.*

[^218]: ^?^. Low-NO~X~ burners may increase carbon monoxide and unburned
    carbon levels, contributing to imbalances in the distribution of air
    and fuel. Operating low-NO~X~ burners with systems that accurately
    regulate the fuel and air supplies can alleviate these problems.
    [State and Territorial Air Pollution Program Administrators &
    Association of Local Air Pollution Officials]{.smallcaps}
    [(STAPPA/ALAPCO)]{.smallcaps}, [Controlling Nitrogen Oxides Under
    the Clean Air Act: A Menu of Options 18]{.smallcaps} (July 1994)
    \[hereinafter [STAPPA/ALAPCO 1994]{.smallcaps}\]; Acid Rain Program;
    Nitrogen Oxides Emission Reduction Program, 57 Fed. Reg. 55,632,
    55,639 (Nov. 25, 1992).

[^219]: ^?^. *See* Interviews with utility representatives.

[^220]: ^?^. 42 U.S.C. § 7651(b) (1994).

[^221]: ^?^. *Id.* § 7651f(b).

[^222]: ^?^. Most boilers firing pulverized coal are wall-fired or
    tangentially fired. Wall-fired boilers produce discrete flames from
    burners mounted in the boiler wall, or in opposing walls.
    Tangentially-fired boilers have burners at the four corners of the
    furnace to create a single rotating fireball in the center. *See*
    STAPPA/ALAPCO 1994, *supra* note Error: Reference source not found,
    at 14.

[^223]: ^?^. 42 U.S.C. § 7651f(b) (1994).

[^224]: ^?^. These units, known as Group 2 boilers, include cell,
    cyclone, and wet-bottom boilers. *Id.* § 7651f(b)(2).

[^225]: ^?^. Phase II includes both wall- and tangentially-fired
    (Group 1) boilers not covered in Phase I and other types of boilers
    (Group 2). Congress authorized the EPA to establish a lower limit
    for these remaining Group 1 boilers "if the Administrator determines
    that more effective Low-NO~X~ burner technology is available." The
    EPA made such a finding, and in 1996 established slightly lower
    limits for Group 1 boilers in Phase II. Acid Rain Program; Nitrogen
    Oxides Emission Reduction Program---Phase II Final Rule, 61 Fed.
    Reg. 67,112, 67,113 (Dec. 19, 1996).

[^226]: ^?^. 42 U.S.C. § 7651f(b)(2) (1994).

[^227]: ^?^. EPA, [Pub. No. AP-42, Compilation of Air Pollutant Emission
    Factors]{.smallcaps} (1995); *see also* [ICF Consulting, Inc.,
    Regulatory Impact Analysis of the Proposed Intervention Level
    Program for Sulfur Dioxide: Final Report]{.smallcaps}, [Pub.
    No.]{.smallcaps} EPA-452/R-96-14 (1996) \[hereinafter ICF RIA
    1996\].

[^228]: ^?^. *See* Clean Air Act, 40 C.F.R. §§ 76.5, 76.6 (2000); Acid
    Rain Program; Nitrogen Oxides Emission Reduction Program---Phase II
    Final Rule, 61 Fed. Reg. 67,112, 67,112-18 (Dec. 19, 1996).

[^229]: ^?^. [S. Rep. No.]{.smallcaps} 101-228, at 333 (1989).

[^230]: ^?^. *See* Acid Rain Program; Nitrogen Oxides Emission Reduction
    Program---Phase I; Final Rule, 59 Fed. Reg. 13,538 (Mar. 22, 1994);
    [NAPAP Integrated Assessment]{.smallcaps}, *supra* note Error:
    Reference source not found, at 2-4.

[^231]: ^?^. S. 1630, 101st Cong. § 407 (1990).

[^232]: ^?^. Senator Lott stated that under his amendment, "utilities
    will not be forced to install unreasonably expensive equipment" and
    NO~X~ emission limits will be based on "the application of low-NO~X~
    burner technology, a much more reasonable and cost-effective method
    proven to successfully achieve significant NO~X~ reductions." 136
    Cong. Rec. 5044 (1990).

[^233]: ^?^. 42 U.S.C. § 7401(a)(4) (1990) (current version at 42 U.S.C.
    § 7401 (2000)); S. 1630 101st Cong. § 401(a)(4) (1990). Together
    with Senator Lott, Senator Lincoln Chafee asserted that the
    provisions that became section 407 would not force the installation
    of "unreasonably expensive equipment" and added that "reasonable and
    cost-effective methods have proven to be successful in achieving
    significant NO~X~ reductions." 136 Cong. Rec. 5044 (1990); *see
    also* [McLean]{.smallcaps}, *supra* note Error: Reference source not
    found, at 9. "It seems that through the legislative process, the
    goal shifted from a specific emissions reduction target to specific
    performance standards to a requirement to use 1 or more
    technologies. . . ." *Id.*

[^234]: ^?^. *See* 42 U.S.C. § 7651f (1994).

[^235]: ^?^. *See id.*

[^236]: ^?^. *Id.* § 7651f(d).

[^237]: ^?^. Clean Air Act, 40 C.F.R. § 76.8 (2000).

[^238]: ^?^. Al. Power Co. v. EPA, 40 F.3d 450, 456 (D.C. Cir. 1994).

[^239]: ^?^. *Id.*

[^240]: ^?^. Acid Rain Program; Nitrogen Oxides Emission Reduction
    Program---Phase I; Final Rule, 59 Fed. Reg. 13,538, 13,540 (Mar. 22,
    1994).

[^241]: ^?^. *Al. Power*, 40 F.3d at 451 (vacating Phase I NO~X~ final
    rule).

[^242]: ^?^. Acid Rain Program; Nitrogen Oxides Emission Reduction
    Program: Direct Final Rule, 60 Fed. Reg. 18,751, 18753, 18757 (Apr.
    13, 1995).

[^243]: ^?^. [EPA 1999 Compliance Report]{.smallcaps}, *supra* note
    Error: Reference source not found, at 2.

[^244]: ^?^. Data derived from ELI analysis of [EPA, Acid Rain Program:
    1998 Emissions Scorecard]{.smallcaps} (1999), *available at*
    http://www.epa.gov/airmarkets/emissions/score98 (last updated Dec.
    11, 2000) \[hereinafter [EPA 1998 Emissions
    Scorecard]{.smallcaps}\]. This [1998 Emissions
    Scorecard]{.smallcaps} was used because the [1999 Emissions
    Scorecard]{.smallcaps}, *supra* note Error: Reference source not
    found, was found to contain errors, notably in recording that 28
    Phase I units had switched from low-NO~X~ burners to an uncontrolled
    state, which upon investigation by ELI turned out to be inaccurate.

[^245]: ^?^. [EPA 1999 Compliance Report,]{.smallcaps} *supra* note
    Error: Reference source not found[,]{.smallcaps} app. C-2. The range
    of emissions rates for the affected boilers also has been reduced,
    from 1990 baseline emissions ranging from 0.26 to 1.41 lb/mmBtu to a
    range from 0.13 to 0.81 lb/mmBtu in 1999.

[^246]: ^?^. [EPA 1999 Compliance Report]{.smallcaps}, *supra* note
    Error: Reference source not found, at 12. These 2 million tons are a
    reduction in what would have been emitted without regulation, as the
    rate-based standard allowed overall emissions to grow with economic
    growth and increased utilization. *See id.* at 2.

[^247]: ^?^. [EPA, Acid Rain program: 1998 Compliance
    Report]{.smallcaps} 13-15 (1999), *available at*
    http://www.epa.gov/airmarkets/cmprpt/arp98 (last updated Dec. 11,
    2000). Note the slight reduction in emissions observed from 1998 to
    1999 was caused in part by the initiation of the cap-and-trade NO~X~
    budget program for sources in northeastern states. *See infra* Part
    III.E.1.

[^248]: ^?^. EPA 1999 [Compliance Report]{.smallcaps}, *supra* note
    Error: Reference source not found, exh. 9, at 14.

[^249]: ^?^. *Id.* exh. 10, at 15.

[^250]: ^?^. EPA [1998 Emissions Scorecard]{.smallcaps}, *supra* note
    Error: Reference source not found.

[^251]: ^?^. [EPA 1999 Compliance Report,]{.smallcaps} *supra* note
    Error: Reference source not found[,]{.smallcaps} exh. 8, at 13, app.
    C-1.

[^252]: ^?^. *See* [EPA 1998 Emissions Scorecard]{.smallcaps}, *supra*
    note Error: Reference source not found.

[^253]: ^?^. Data derived from analysis of [EPA]{.smallcaps} report.
    *Id.* tbl. B1.

[^254]: ^?^. *See id.*

[^255]: ^?^. EIA, *supra* note Error: Reference source not found, at 4.

[^256]: ^?^. Acid Rain Program; Nitrogen Oxides Emission Reduction
    Program, 61 Fed. Reg. 67,112, 67142-43 (Dec. 19, 1996).

[^257]: ^?^. *Id.* at 67,141-42. Of the boilers assessed, wall-fired
    boiler retrofits averaged \$161 per ton of NO~X~ reductions, with a
    high of \$382 and a low of \$37, whereas tangentially-fired boilers
    achieved average costs of \$631 with a high of \$2625 and a low of
    \$312. The unweighted average of all boilers is \$282, but a
    weighted average is \$412. *Id.*; *see also* EIA, *supra* note
    [Error: Reference source not found,]{.smallcaps} at 10 (noting that
    capital cost for twenty-one wall-fired plants varied between \$9 and
    \$44 per kilowatt).

[^258]: ^?^. Note the difference between optimization, or fine-tuning
    boiler process to achieve maximum efficiency, and compliance options
    that involve purely operational modifications. While the latter may
    not involve any additional NO~X~ controls, they represent compliance
    alternatives that reduce NO~X~ further but involve costs or a loss
    of efficiency. As the OTC cap-and-trade program shows, many firms
    discovered low-cost reductions through operational modifications
    when subject to a broad and flexible regulatory standard that made
    them "look everywhere" for reductions, but this differs from
    optimization.

[^259]: ^?^. The exceptions were plants built after 1971, and thus
    already subject to new source standards under the Clean Air Act.
    *See* 42 U.S.C. § 7411 (1994); *see also* *supra* Part III.A.

[^260]: ^?^. *See* Interviews with utility representatives; *see also*
    [Elec. Power Research Inst.]{.smallcaps}, [EPRI Plant Maintenance
    Optimization Services]{.smallcaps}, Document SO-113427 (July 1999)
    \[hereinafter [EPRI Plant Maintenance]{.smallcaps}\]; Elec. Power
    Research Inst., *Overhauling the Plant Maintenance Process*, [EPRI
    Fossil Plant News]{.smallcaps} (Winter, 1999).

[^261]: ^?^. The optimization process has been greatly assisted by the
    development of new optimization software programs that monitor and
    develop correlations between parameters, allowing operators to
    better understand the combustion process and adjust the parameters
    to yield optimal results (i.e., low levels of NO~X~ and carbon
    monoxide, together with best efficiency). The developers of one such
    program, Boiler Op, report NO~x~ reductions averaging between 20%
    and 30% at a dozen units implementing their system, with minimum
    deterioration of heat rate and other operating parameters. Carlos
    Romero et al., *Field Results from Application of Boiler Op to
    Utility Boilers*, Presentation at EPRI-DOE-EPA Mega Symposium
    (August 1999) (notes on file with author). Another program uses a
    sequential optimization process that maintains boiler performance
    while achieving reduction in NO~X~. Using this program, without any
    other add-on reduction equipment, reductions in NO~X~ of between 5%
    and 20% from historical levels were achieved at one unit. Another
    similar program, GNOCIS, an EPRI collaborative project, monitored
    twenty-five to fifty parameters and achieved about a 10% reduction
    in NO~X~. *See* [EPRI Plant Maintenance]{.smallcaps}, *supra* note
    Error: Reference source not found; Elec. Power Research Inst.,
    *supra* note Error: Reference source not found.

[^262]: ^?^. 42 U.S.C. § 7651f(e) (1994).

[^263]: ^?^. Clean Air Act, 40 C.F.R. § 76.8.

[^264]: ^?^. *Id.* §§ 76.8, 76.11.

[^265]: ^?^. [EPA 1999 Compliance Report]{.smallcaps}, *supra* note
    Error: Reference source not found, at 12.

[^266]: ^?^. 42 U.S.C. § 7651f(e).

[^267]: ^?^. [EPA 1999 Compliance Report]{.smallcaps}, *supra* note
    Error: Reference source not found, exh. 8, at 13, app. C-1. The list
    of units included in averaging plans shows that most (seventeen
    plans or 77%) involved units in only a single state.

[^268]: ^?^. TVA, for example, averaged six units of its Johnston plant
    that marginally exceeded their limit, avoiding a major capital
    outlay for a small NO~X~ reduction. [EPA 1999 Compliance
    Report,]{.smallcaps} *supra* note Error: Reference source not
    found[,]{.smallcaps} app. C-1, C-4.

[^269]: ^?^. *Id.* app. C-1.

[^270]: ^?^. *See* [EPA 1999 Compliance Report]{.smallcaps}, *supra*
    note Error: Reference source not found.

[^271]: ^?^. Fifty-two plants are listed as uncontrolled in [EPA 1998
    Emissions Scorecard,]{.smallcaps} *supra* note Error: Reference
    source not found.

[^272]: ^?^. In this paragraph, emissions rate figures are derived from
    ELI analysis of unit emissions data of these fifty-two units using
    [EPA 1999 Emissions Scorecard]{.smallcaps}, *supra* note Error:
    Reference source not found.

[^273]: ^?^. *Id.* app. C-2.

[^274]: ^?^. Clean Air Act, 40 C.F.R. § 76.8 (2000).

[^275]: ^?^. There was vigorous debate between the EPA,
    environmentalists, and industry as to the appropriate number of
    years of exemption from Phase II limits. The goal was to provide
    early election units so there would be an incentive for firms to
    join, but also guarantee net environmental benefits. The final
    result was a seven year exemption. *See id.* If a utility failed to
    meet this annual limit for a boiler during any year, the unit was
    subject to the more stringent Phase II limit for Group 1 boilers
    beginning in 2000, or the year following the exceedance, whichever
    was later. *Id.*

[^276]: ^?^. [EPA 1999 Compliance Report]{.smallcaps}, *supra* note
    Error: Reference source not found, at 16.

[^277]: ^?^. *Id.* 1990 emission rates for these units ranged from 0.17
    to 1.15 lb/mmBtu. Ten units in the Early Election Program were not
    operating in 1990: Cliffside 1, 2, 3, and 4; Riverbend 9 and 10;
    W.H. Zimmer 1; Cross 1; J.K. Spruce 1; and Glen Lyn 52. Reductions
    for these units were calculated by ELI from their 1995 emissions
    rates.

[^278]: ^?^. The net benefits total is given for 118 units using unit
    data presented in [EPA Compliance Reports]{.smallcaps} from
    1997-1999. The calculations do not include any reductions made by
    units that were already operating at or below Phase I limits in
    1990, nor by the thirty-three units located in OTC states that had
    to comply with lower limits under state law. Early election units in
    OTC states were located in Connecticut (one), New York (nine),
    Pennsylvania (seventeen), and northern Virginia (six), and were
    required to meet OTC RACT requirements at least as stringent as
    those of Title IV by 1995. It was also assumed that emissions rates
    of units emitting at or below Phase I limits in 1990 reflect either
    unit design or changes made to the unit prior to the development of
    the Early Election Program, and so would not have risen above Phase
    I limits during Phase I.

[^279]: ^?^. Detriments were calculated for seventy-two units using unit
    data presented in [EPA Compliance Reports]{.smallcaps} from
    1997-1999. The calculations exclude the OTC units and all those
    whose average 1997-1999 emissions were at or below Phase II levels.
    The added emissions from these seventy-two units in 2000-2007 is the
    difference between the actual emissions rate achieved during Phase I
    and the more stringent Phase II emissions rate, multiplied by seven
    years. However, if it is assumed that these plants would have
    emitted at a rate 10% below Phase II levels as a typical margin of
    safety, detriments increase to 483,783 tons, creating net benefits
    of only 73,708 tons from the program.

[^280]: ^?^. [EPA 1999 Compliance Report,]{.smallcaps} *supra* note
    Error: Reference source not found[.]{.smallcaps} Low-cost compliance
    methods include low excess air and burners out of service, which can
    achieve only 10% to 20% NO~X~ reduction but cost very little.
    [STAPPA/ALAPCO 1994]{.smallcaps}, *supra* note Error: Reference
    source not found, at 16-17. Some operators interviewed report they
    had never optimized their boilers until Title IV provided the
    incentive through the Early Election Program.

[^281]: ^?^. Analysis derived from [EPA 1999 Compliance
    Report,]{.smallcaps} *supra* note Error: Reference source not
    found[,]{.smallcaps} app. C-2. The lateness of the promulgation of
    Phase II rules may have been a factor that led some firms to
    designate units that already met the Phase II standard. Although
    firms had until January 1, 1997, to identify the units they would
    enter into the Early Election Program, most firms practically had to
    do so before the Phase II rules were finalized on December 19, 1996.
    *See* Clean Air Act, 40 C.F.R. § 76.8 (2000) (Early election for
    Group 1, Phase II boilers); Acid Rain Program; Nitrogen Oxides
    Emission Reduction Program---Phase II Final Rule, 61 Fed. Reg.
    67,112 (Dec. 19, 1996).

[^282]: ^?^. *See* Clean Air Act, 40 C.F.R. § 76.10 (2000). The firm
    must show that it installed a low-NO~X~ burner or equivalent at the
    unit that was designed to meet, but then could not meet, the
    applicable emissions limitation, and provide operating data showing
    it was properly installed and operated in accordance with the design
    specifications.

[^283]: ^?^. *See* Interview with Brian McLean, Director of EPA Clean
    Air Markets Division, in Washington, D.C. (July 18, 2000).

[^284]: ^?^. [EPA 1999 Compliance Report,]{.smallcaps} *supra* note
    Error: Reference source not found[,]{.smallcaps} at 14. Emissions
    rates of Table A units gradually moved lower during Phase I, from
    0.45 lb/mmBtu in 1996, 9% below the average emissions limit, to 0.42
    lb/mmBtu in 1999, 14% below the average limit. *Id.*

[^285]: ^?^. *Id.* Many substitution units had already met New Source
    Performance Standards that are only moderately higher than the Phase
    I limits. As a group, the substitution units collectively emitted
    only 0.52 lb/mmBtu NO~X~ in 1990, well below the 0.77 lb/mmBtu
    emitted by Table A units. *Id.*

[^286]: ^?^. *See* Interviews with utility representatives.

[^287]: ^?^. Title IV provides for an excess emissions penalty of \$2000
    for each ton emitted in excess of a unit's emissions limitations
    requirement. 42 U.S.C. § 7651j(a) (1994). The Act also provides
    civil and potential criminal penalties for each violation. *Id.*
    § 7413.

[^288]: ^?^. *See* Interviews with utility representatives.

[^289]: ^?^. *See supra* Part III.C.

[^290]: ^?^. *See* Interviews with utility representatives.

[^291]: ^?^. There are also business reasons to install OFA
    simultaneously with low-NO~X~ burners during the same unit outage,
    to preclude having to take the unit off-line for another extended
    period of time for installation of the OFA system alone.
    Simultaneous installation would yield revenue savings and could
    avoid system reliability problems for the purchaser of the power.
    *See* Interviews with utility representatives.

[^292]: ^?^. *See* 1992 Acid Rain Program: Nitrogen Oxides Emission
    Reduction Program; Proposed Rule, 57 Fed. Reg. 55,632 (Nov. 25,
    1992).

[^293]: ^?^. Research by General Electric Energy and Environmental
    Research Corporation and others have found that

    rather than completely replacing a burner, it may be possible to
    modify a conventional circular burner to effectively control fuel
    air mixing . . . . \[S\]ince the hardware changes are simple, the
    retrofit costs for Low-NO~X~ Burner Modifications are much lower
    than for new Low-NO~X~ Burners. Usually there is no need to change
    flame scanning and ignition equipment, electric actuator drives or
    registers, and no need to modify coal conduits or the windbox. As a
    result the capital cost is typically on the order of only 25% to 50%
    of the cost of Low-NO~X~ Burners

    for comparable NO~X~ control. Todd Melick & Roy Payne, *Low NO~x~
    Burner Modifications for Cost Effective NO~x~ Control*, Presentation
    at EPRI-EPA-DOE Combined Utility Air Pollutant Control Symposium
    (Aug. 1999) (notes on file with author).

[^294]: ^?^. Interviews with technology vendors.

[^295]: ^?^. A commonly applied low-NO~X~ burner technology in United
    States coal-fired boilers, the low-NO~X~ concentric firing system is
    specifically designed for tangentially-fired boilers. These require
    the replacement of all fuel and air nozzles; however, no major
    changes in the structure, windbox, or waterwall are needed. Most of
    these systems include overfire air. [EIA, Reducing Nitrogen Oxide
    Emissions: 1996 Compliance with Title IV Limits]{.smallcaps} (1998),
    *at* http://www.eia.doe.gov/cneaf/electricity/nox_emissions/ (last
    modified Dec. 14, 2000).

[^296]: ^?^. *See* Acid Rain Program; Nitrogen Oxides Emission Reduction
    Program---Phase II Final Rule, 61 Fed. Reg. 67,112, 67,142 (Dec. 19,
    1996).

[^297]: ^?^. *Id.*; *see also* EIA, *supra* note Error: Reference source
    not found, tbl. 3, at 10.

[^298]: ^?^. 42 U.S.C. § 7651f (1994).

[^299]: ^?^. *Id.* § 7651f(b)(2).

[^300]: ^?^. Acid Rain Program; Nitrogen Oxides Emission Reduction
    Program---Phase II Final Rule, 61 Fed. Reg. 67,112, 67,114 (Dec. 19,
    1996). "For cyclone fired boilers, gas reburning and SCR are the
    best continuous control systems that are available and meet the cost
    comparability criteria." *Id.*

[^301]: ^?^. *Id.* at 67,142-43.

[^302]: ^?^. Elec. Power Research Inst., *First Demonstration of
    Overfire Air on Cyclone Steam Generator Reduces Costs of NOx
    Compliance*, [EPRI Innovators]{.smallcaps} 1 (Oct. 1998) (on file
    with author) \[hereinafter EPRI, *First Demonstration*\]; E-mail
    from David O'Connor, Electric Power Research Institute, to Byron
    Swift, Environmental Law Institute (Nov. 29, 1999) (on file with
    author).

[^303]: ^?^. The first models were completed in early 1996, and the
    first successful demonstration of overfire air technology began in
    1997. *See* E-mail from David O'Connor, *supra* note Error:
    Reference source not found; David O'Connor et al., *The State of the
    Art in Cyclone Boiler NO~x~ Reduction*, Presentation at EPRI-EPA-DOE
    Combined Utility Air Pollutant Control Sympos. (Elec. Power Research
    Inst.) (Aug. 1999) (notes on file with author); EPRI, *First
    Demonstration*, *supra* note Error: Reference source not found.

    The results have clearly demonstrated the technical and operational
    feasibility of OFA as a commercially viable NO~X~ control approach
    for cyclones. The application of the technology on 5 cyclone
    furnaces . . . showed maximum NO~X~ reductions reaching 50- to 75%
    from uncontrolled levels using combustion air staging techniques.
    Preliminary observations and tests . . ., showed no substantial
    impacts from slagging, fouling, or corrosion of waterwall tubes when
    fueled by western coal.

    Elec. Power Research Inst., Report No. TR-113643, *NO~x~ Control
    Field Test Results on Coal-Fired Cyclone Boilers---CNCIG Programs*
    (Sept. 1999) (on file with author). These articles indicate that
    many cyclones could achieve the 0.86 lb/mmBtu standard using
    overfire air, especially those firing PRB coal, with baseline
    emissions of 1.1 to 1.2 lb/mmBtu.

[^304]: ^?^. *See* E-mail from David O'Connor, Electric Power Research
    Institute, to Byron Swift, Environmental Law Institute (Jan. 15,
    2001) (on file with author).

[^305]: ^?^. *Id.* (noting that current R&D projects for cyclones
    continue on two fronts: (1) further NO~X~ reduction, using a
    technique called Rich Reagent Injection, and (2) improving the
    operability and results from using overfire air with cyclones,
    including ongoing corrosion assessments and controls issues).

[^306]: ^?^. Acid Rain Program; Nitrogen Oxides Emission Reduction
    Program---Phase II Final Rule, 61 Fed. Reg. 67,112, 67,164 (Dec. 19,
    1996).

[^307]: ^?^. This system results in more complete burnout of the fuel
    and formation of N~2~ rather than NO~X~. Many firms added overfire
    air technologies to low-NO~X~ burners to achieve further NO~X~
    reductions. Some did this to gain benefits due to averaging their
    units, and others did it to comply with the EPA's initial Phase I
    rule, which would have required the use of overfire air but was
    later overturned in court. Interviews with utility representatives.

[^308]: ^?^. EPRI reports that nearly a third of those with overfire air
    ports initially suffered post-retrofit waterwall wastage:

    Early retrofits of low-NO~X~ burners without OFA generally did not
    increase waterwall wastage, but when low-NO~X~ burner systems with
    OFA ports were introduced to reduce NO~X~ emissions further, wastage
    began showing up throughout the power industry. . . . Of some 150
    boilers retrofitted with low-NO~X~ burners featuring OFA, as many as
    40 have reported increased waterwall wastage, or discovered wastage
    where there was none before.

    Elec. Power Research Inst., *Guidelines to Ward off Boiler Waterwall
    Wastage*, [EPRI Fossil Plant News]{.smallcaps} (Winter 1999).

[^309]: ^?^. *Id.*

[^310]: ^?^. *See infra* Part III.E.1.

[^311]: ^?^. The EPA has relied on its authority to address the
    transport of ozone between states to promulgate a "SIP call" that
    requires a group of at least nineteen eastern states to reduce
    summertime NO~X~ emissions by 2004. Finding of Significant
    Contribution and Rulemaking for Certain States in the Ozone
    Transport Assessment Group Region for Purposes of Reducing Regional
    Transport of Ozone, 63 Fed. Reg. 57,356, 57,380, 57,401 (Oct. 27,
    1998) (covering twenty-two states, and achieving reductions
    equivalent to a 0.15 lb/mmBtu rate standard by 2003); *cf.* Michigan
    v. EPA, 213 F.3d 663 (D.C. Cir. 2000), *cert. denied*, 121 S. Ct.
    1225 (2001) (upholding lower court decision limiting application to
    nineteen states and extending deadline to 2004). The EPA's rule
    encourages the states to achieve most of these reductions in the
    utility sector, through a regional emissions cap and allowance
    trading program that reduces these emissions from 1.5 to 0.5 million
    tons. 63 Fed Reg. at 57,434, tbl.III-5.

[^312]: ^?^. The OTC comprises the states of Maine, New Hampshire,
    Vermont, Massachusetts, Connecticut, Rhode Island, New York, New
    Jersey, Pennsylvania, Maryland, Delaware, the northern counties of
    Virginia, and the District of Columbia.

[^313]: ^?^. *See* 42 U.S.C. § 7511(c) (1994).

[^314]: ^?^. *See* Memorandum of Understanding Among the States of the
    Ozone Transport Commission on Development of a Regional Strategy
    Concerning the Control of Stationary Source Nitrogen Oxide Emissions
    (Sept. 27, 1994), *at*
    [http://www.sso.org/otc/att2.htm](http://www.sso.org/otc/formalact.htm#MOU94-1)
    \[hereinafter Memorandum of Understanding\]. Phase I included the
    installation of reasonably available control technology (RACT). In
    Phase II, starting in 1999, states adopted an emissions cap and
    allowance-trading program to reduce region-wide NO~X~ emissions. The
    OTC states plan another cut in NO~X~ emissions in 2003. *Id.* This
    is consistent with the EPA's plan, generally referred to as the
    "NO~X~ SIP call," that affects a broader group of at least nineteen
    states. *See* Finding of Significant Contribution and Rulemaking for
    Certain States in the Ozone Transport Assessment Group Region for
    Purposes of Reducing Regional Transport of Ozone, 63 Fed. Reg.
    57,356 (Oct. 27, 1998).

[^315]: ^?^. *See* Memorandum of Understanding, *supra* note Error:
    Reference source not found.

[^316]: ^?^. Pennsylvania law defines RACT for large coal-fired units as
    "the installation of low NO~X~ burners with separate overfire air."
    25 [Pa. Code]{.smallcaps} § 129.93(b)(1) (2001). New Jersey requires
    utility boilers to meet the following standards: Tangentially-fired
    burners: 0.38 lb/mmBtu; wall-fired: 0.45 lb/mmBtu; and cyclone 0.55
    lb/mmBtu. [N.J. Admin. Code]{.smallcaps} tit. 7, § 27-19.4 (2000).
    New York State RACT regulations set standards for dry-bottom
    coal-fired tangential plants at 0.42 lbs./mmBtu, wet-bottom
    coal-fired tangential plants at 1.0 lbs./mmBtu, wall-fired dry
    bottom plants at 0.45 lbs./mmBtu, and for wall-fired wet bottom
    plants at 1.0 lbs./mmBtu. [N.Y. Comp Codes R. & Regs.,]{.smallcaps}
    tit. 6 [§ ]{.smallcaps}227-2.4 (1997).

[^317]: ^?^. *See supra* note Error: Reference source not found.

[^318]: ^?^. *See* Memorandum of Understanding, *supra* note Error:
    Reference source not found. The OTC NO~X~ Budget Program was
    developed in collaboration with the EPA, industry, utilities, and
    environmental groups. Under the OTC program, budget sources were
    allocated allowances by their state government. Each allowance
    permits a source to emit one ton of NO~X~ during the summer period
    (May through September). Allowances may be bought, sold, or banked.
    However, regardless of the number of allowances a source holds, it
    cannot emit at levels that would violate other federal or state
    limits (e.g., federal NSPS, Title IV, or state NO~X~ RACT rules).
    *See* [EPA 1999 OTC NO~X~ Compliance Report,]{.smallcaps} *supra*
    note Error: Reference source not found.

[^319]: ^?^. State Allocations And Emissions in 1999 under the OTC NO~X~
    Budget Program (in tons) were:

    State1990 Baseline Emissions1999\
    Allocation\*1999\
    EmissionsConnecticut11,1306,3125,830Delaware13,5106,1426,160Massachusetts41,33019,68017,293New
    Hampshire14,5896,7883,463New Jersey46,96321,29215,390New
    York85,64254,27647,267Pennsylvania203,181103,66879,166Rhode
    Island1,099580274Total417,444218,738174,843\*Includes early
    reduction credit allowances of 24,635. *See* [EPA 1999 OTC NO~X~
    Compliance Report,]{.smallcaps} *supra* note Error: Reference source
    not found, exh. 1, at 2, *available at*
    http://www.epa.gov/airmarkets/cmprpt/otc99/\
    index.html (last updated Dec. 11, 2000).

[^320]: ^?^. *Id.* at 1.

[^321]: ^?^. *Id.* at 2.

[^322]: ^?^. Joel Bluestein, Energy and Environmental Analysis, Inc.,
    *OTR NO~X~ Market: Lessons Learned* (1999) (unpublished report
    presented at missions Marketing Associates in Oct. 1999) (cited in
    Byron Swift, *Command Without Control: Why Cap-and-Trade Should
    Replace Rate Standards for Regional Pollutants*, 31 [Envtl. L.
    Rep.]{.smallcaps} 10,330 (Mar. 2001)); [Gas Research Institute, Low
    Cost Options for Achieving Deep NO~x~ Reductions]{.smallcaps}, *at*
    http://www.gri.org (Apr. 2000).

[^323]: ^?^. The EPA estimated the average cost of reductions in the
    electric power sector to be \$1468 per ton of NO~X~. [EPA 1998
    RIA,]{.smallcaps} *supra* note Error: Reference source not found, at
    ES-2. Compliance cost is reflected in the price of an allowance, and
    during the year 2000, allowance prices for 1999 or 2000 tons for the
    Ozone Transport Region were in the \$500 to \$1,000 range. *See,
    e.g.*, Cantor Fitzgerald Environmental Brokerage Services Website,
    *at* www.cantor.com/ebs (last modified Apr. 5, 2001).

[^324]: ^?^. [State and Territorial Air Pollution Program Administrators
    & Association of Local Air Pollution Officials (STAPPA/ALAPCO),
    Controlling Nitrogen Oxides Under the Clean Air Act: A Menu of
    Options 18]{.smallcaps} (July, 1994); [Gas Research
    Institute,]{.smallcaps} *supra* note Error: Reference source not
    found.

[^325]: ^?^. [Gas Research Institute,]{.smallcaps} *supra* note Error:
    Reference source not found, at Fig. 1.

[^326]: ^?^. *See* Nicholas Ashford, *An Innovation Based Strategy for
    the Environment*, *in* [Worst Things First? The Debate over
    Risk-Based National Environmental Priorities]{.smallcaps} (A.M.
    Finkle & D. Golding eds., [1994)]{.smallcaps}.

[^327]: ^?^. 42 U.S.C. § 7411 (1994).

[^328]: ^?^. *Id.*

[^329]: ^?^. The initial NSPS for power plant boilers built prior to
    1998 established NO~X~ emissions limits of 0.50-0.80 lb/mmBtu for
    coal-fired boilers, 0.30 lb/mmBtu for oil-fired boilers, and 0.20
    lb/mmBtu for gas-fired boilers. Clean Air Act, 40 C.F.R. § 60.44a
    (2000).

[^330]: ^?^. *Id.* § 60.44a(d); *see also* Revision of Standards of
    Performance for Nitrogen Oxide Emissions from New Fossil-Fuel Fired
    Steam Generating Units, 63 Fed. Reg. 49,442, 49,448-49 (Sept. 16,
    1998).

[^331]: ^?^. The New Source Review standards, BACT and LAER, establish
    more stringent requirements that specify NSPS only as a floor. *See,
    e.g.*, 42 U.S.C. §§ 7479(3) (describing the standard for Best
    Available Control Technology), 7501(3) (describing the standard for
    Lowest Achievable Emissions Rate).

[^332]: ^?^. 42 U.S.C. § 7479.

[^333]: ^?^. *Id.* §§ 7475(a)(4), 7479(3).

[^334]: ^?^. *Id.* § 7503(a)(2).

[^335]: ^?^. Acid Rain Program; Nitrogen Oxides Emission Reduction
    Program---Phase II Final Rule, 61 Fed. Reg. 67,112, 67,113 (Dec. 19,
    1996); STAPPA/ALAPCO 1994, *supra* note Error: Reference source not
    found, at 24-29; Marvin Schorr & Joel Chalfin, *Gas Turbine NO~X~
    Emissions Approaching Zero---Is It Worth the Price?*, Presentation
    at Air & Waste Mgmt. Ass'n 92d Annual Meeting, St. Louis, MO (June
    20, 1999) (notes on file with author); Leslie Witherspoon & Ken
    Smith, *NO~X~ Control Technology Options and Development Activity
    for Mid-Range Natural Gas Fired Turbines* (1999), Unpublished
    Presentation (notes on file with author).

[^336]: ^?^. *See generally* Tina Kaarsburg & Julie F. Gorte, *Promoting
    Productivity and Clean Air with Innovative Electric Technologies*,
    [Northeast Midwest Econ. Rev]{.smallcaps} (Nov./Dec. 1999).

[^337]: ^?^. *See supra* Part II.D.5.

[^338]: ^?^. *See supra* Part III.D.

[^339]: ^?^. [Ellerman et al.]{.smallcaps}, *supra* note Error:
    Reference source not found, at 228-29.

[^340]: ^?^. *Id.* (noting that no-cost reductions made by businesses
    switching to lower-sulfur coal that was also cheaper than what they
    formerly used amounted to approximately 425,000 tons of SO~2~
    reductions per year, out of a total annual reduction of 3,888,000
    tons).

[^341]: ^?^. [DOE Annual Energy Outlook 2001,]{.smallcaps} *supra* note
    Error: Reference source not found, at 75, 78 (noting that advanced
    natural gas combined cycle technology generates electricity at lower
    cost than advanced coal). Dramatic technology innovation in
    developing the dry low-NO~X~ turbine has meant that new gas plants
    both cost less and are far cleaner than coal boilers or older gas
    technologies, emitting NO~X~ at or below 0.05 lb/mmBtu (uncontrolled
    coal boilers emit at 0.65 to 1.50 lb/mmBtu); *see also* Schorr &
    Chalfin, *supra* note Error: Reference source not found;
    [STAPPA/ALAPCO 1994,]{.smallcaps} *supra* note Error: Reference
    source not found, at 22.

[^342]: ^?^. Sources would then clean up pollution to the point at which
    the marginal cost of removing a ton of pollution equals the social
    benefit from having that ton removed. In this situation, the
    economic costs perceived by private firms reflect the overall social
    and economic value of pollution reduction, creating efficiency in
    attaining social welfare.

[^343]: ^?^. Although the political process grappled with the cost of
    the programs in both cases, actual costs of compliance turned out to
    be far lower than predicted. For the SO~2~ program, information at
    the time of the Act's passage in 1990 indicated that costs would be
    \$300 to \$1000 per ton, far higher than the observed cost of
    allowances at around \$150. Also, the Direct Sales Reserve provision
    of Title IV that authorizes sales of allowances at \$1500 is another
    indication of the perceived value of additional reductions, and
    again far higher than the actual costs. *See* 42 U.S.C. § 7651o
    (1994). Had an accurate understanding of the costs been available,
    it is quite likely that Congress would have set the SO~2~ cap lower,
    suggesting that the current cap is set too high to align private
    costs with social benefits.

[^344]: ^?^. Seven northeastern states have petitioned the EPA to
    strengthen the secondary NAAQS for NO~X~, SO~2~ and PM 2.5. The
    petitioners "suggest that the acid rain provisions in title IV of
    the CAA do not go far enough to ensure full recovery of sensitive
    ecosystems." Petition for Secondary National Ambient Air Quality
    Standards for Nitrogen Dioxide, Sulfur Dioxide, and Fine Particle
    Matter and Related Request, 65 Fed. Reg. 48,699, 48,700 (Aug. 9,
    2000) \[hereinafter Northeastern States Petition\]. The petition
    cites in support of its assertions the [National Acid Precipitation
    Assessment Program, Biennial Report to Congress]{.smallcaps} (May
    1998), *available at*
    <http://www.nnic.noaa.gov/CENR/NAPAP/NAPAP-96.htm>; and [EPA, Pub.
    No. EPA-452/R-97-002, Nitrogen Oxides: Impacts on Public Health and
    the Environment]{.smallcaps} (Aug. 1997), *available at*
    <http://www.epa.gov/ttncaaa1/t1/reports/noxtech.pdf>; which
    "document increasing damage caused by acid deposition to the lakes
    and forests in the Northeastern States and other environmental
    effects. . . ." Petition for Secondary National Ambient Air Quality
    Standards for Nitrogen Dioxide, Sulfur Dioxide, and Fine Particle
    Matter and Related Request, 65 Fed. Reg. at 48,701.

[^345]: ^?^. *See supra* notes Error: Reference source not found, Error:
    Reference source not found.

[^346]: ^?^. [EPA 1998 RIA,]{.smallcaps} *supra* note Error: Reference
    source not found[,]{.smallcaps} at ES-6 (noting that total benefits
    are between \$964 and \$3654 per ton of NO~X~ reductions in 1990, or
    between \$1262 and \$4786 in 1999 dollars). In comparison, costs
    were estimated to be \$1468 per ton in 1990. *Id.* at ES-3.

[^347]: ^?^. *See* Figure 2-1. The reduction in sulfate particulate
    emissions alone is estimated by Resources for the Future to be
    approximately \$5335 per ton of SO~2~ reductions. [ELI Cleaner
    Power,]{.smallcaps} *supra* note Error: Reference source not found,
    at 14 (estimating \$24.5 billion in benefits from a 4,592,000 ton
    reduction in SO~2~ emissions); *see also* [Clean Air Task
    Force]{.smallcaps}, *supra* note Error: Reference source not found,
    at 4-5 (noting that a 75% reduction in SO~2~ leads to benefits of
    over \$100 billion from particulate reductions, or over \$10,000 per
    ton of reductions).

[^348]: ^?^. Although the EPA set these standards based on its best
    estimates of technology availability and cost, in retrospect these
    forecasts were not accurate for most technologies, and in particular
    failed to include unexpected innovation. This is particularly
    evident for wall-fired boilers and for cyclone boilers (where no
    reductions were required because of the perceived high costs). In
    both cases, it turned out that innovations could have provided
    inexpensive reductions to and below the standards. On the other
    hand, reductions at tangentially-fired boilers cost more than
    predicted. *See supra* Part III.D.5.b.

[^349]: ^?^. One can imagine that a very different scenario would have
    developed had Title IV established an allowance auction with a price
    floor set at \$300, the lower end of most cost estimates in 1990;
    far less SO~2~ would have been released during Phase I.

[^350]: ^?^. *See* Figure 3-7.

[^351]: ^?^. [U.S. General Accounting Office]{.smallcaps}, [Air
    Pollution: Allowance Trading Offers an Opportunity to Reduce
    Emissions at Less Cost]{.smallcaps} 37-41 (Dec. 1994); Paul R.
    Portney, *Economics and the Clean Air Act*, [J. Econ.
    Persp.]{.smallcaps} 4(4), 173-81 (Fall 1990) (cost estimate of \$7
    billion based on the Waxman-Sikorski bill of the 98th Congress (H.R.
    3400), mandating scrubbers for fifty plants to gain a 10-million ton
    reduction).

[^352]: ^?^. Historically, pollution standards under the CAA have been
    established as rate standards measuring the concentration or
    percentage of a pollution in end-of-pipe emissions. See, for
    example, air standards such as Reasonably Available Control
    Technology (RACT) for existing sources, Best Available Control
    Technology (BACT) for new sources, and Maximum Achievable Control
    Technology (MACT) for hazardous pollutants. 42 U.S.C. §§ 7502(c)(1),
    7475(a)(4), 7412(g)(2)(A) (1994). Water standards include Best
    Available Technology Economically Achievable ("BAT"). *See* 33
    U.S.C. § 1311(b)(2)(A) (1994). The use of rate standards is
    appropriate when addressing the local concentration of a pollutant,
    which was of concern in the early years of the CAA. However, they
    become less and less appropriate in addressing total pollutant
    loadings and regional issues such as urban ozone formation and
    interstate transport of NO~X~. Rate-based standards are a major
    cause of the inflexibility in current environmental laws that is
    identified in the National Advisory Council for Environmental Policy
    and Technology (NACEPT) reports, ELI studies, and other reinvention
    publications as one of the major environmental regulatory issues.
    *See, e.g.*, [EPA, Pub. No. EPA-101/N-91/001, Permitting and
    Compliance Policy: Barriers to U.S. Environmental Technology
    Innovation]{.smallcaps} 39 (1991), *available at*
    http://www.epa.gov/clariton/clhtml/pubtitle.html (last updated Nov.
    30, 2000) \[hereinafter [EPA Permitting]{.smallcaps}\].

    Specifically, policy makers should reconsider the way 'best
    available technology'-based regulations are now developed and
    applied. Such regulations use agency established technology-based
    limits and use a technology to demonstrate that the limits are
    achievable. Even though these are performance-based requirements,
    they have a strong tendency to lock in the technology that is used
    to demonstrate achievability. To some extent, reliance on 'best
    available technology'-based regulations impedes the development and
    introduction of innovative technologies.

    *Id.*; *see* [Envtl. Law Inst., Barriers to Environmental Technology
    Innovation and Use]{.smallcaps} (1998) \[hereinafter [ELI
    Innovation]{.smallcaps}\]; Debra Knopman & Emily Fleschner, *Second
    Generation of Environmental Stewardship: Improve Environmental
    Results and Broaden Civic Engagement* (Progressive Policy Inst.,
    ed.) (May 1, 1999), *at* [http://www.ppionline.org/ndol/print.cfm?\
    contentid=767](http://www.ppionline.org/ndol/print.cfm?contentid=767)
    (arguing that first generation approaches to environmental problems
    impede innovation while second generation approaches drive
    innovation and improve accountability); [Nat'l Academy of Public
    Admin., Setting Priorities, Getting Results: A New Direction for the
    EPA]{.smallcaps} 102 (Apr. 1995); William D. Ruckelshaus & Karl
    Hausker, Enterprise for the Environment, *The Environmental
    Protection System in Transition: Toward a More Desirable Future* 3
    (Jan. 1998), *available at*
    <http://www.csis.org/pubs/pubse&e.html#env_trans>; [Thinking
    Ecologically: The Next Generation of Environmental
    Policy]{.smallcaps} (Marian R. Chertow & Daniel C. Esty eds., 1997).

[^353]: ^?^. *See supra* Part II.A.

[^354]: ^?^. *See infra* note Error: Reference source not found.

[^355]: ^?^. Stringent rate standards under NO~X~ New Source Review only
    allow the use of control technologies such as SCR and SCONOX.
    "SCONOX" is a trademarked catalytic absorption system developed by
    Goal Line Environmental Technologies, LLC. *See* [California
    Environmental Technology Certification Program, SCONOX: Goal Line
    Environmental Technologies]{.smallcaps}, *at*
    http://www.calepa.ca.gov/calcert/CertifiedTech/GoalLine.\
    htm (last modified Dec. 20, 2000) \[hereinafter California
    Environmental Technology Certification Program\]. Many states
    require SCR even for clean gas plants, and whether or not cleaner
    fuels or processes such as the dry low-NO~X~ burner can be used is
    the subject of current EPA guidance deliberations. *See, e.g.*,
    Notice of Availability for Draft Guidance on BACT for NO~X~ Control
    at Combined Cycle Turbines, 65 Fed. Reg. 50,202 (Aug. 17, 2000).

[^356]: ^?^. EPA, RACT/BACT/LAER [Clearinghouse Annual Report for 1998:
    A Compilation of Control Technology Determinations]{.smallcaps} EPA
    456/R-98-0004 (June 1998). Interviews with federal and state air
    pollution control officials, representatives of utility companies,
    vendors of pollution abatement technologies, and environmental
    organizations.

[^357]: ^?^. *See* Byron Swift, *Grandfathering New Source Review and
    NOx---Making Sense of a Flawed System*, 31 [Env't Rep.]{.smallcaps}
    1538 (July 21, 2000); STAPPA/ALAPCO 1994, *supra* note Error:
    Reference source not found, at 53-54.

[^358]: ^?^. *See* 42 U.S.C. §§ 7479(3), 7501(3) (1994).

[^359]: ^?^. *See, e.g.*, [Mass. Regs. Code]{.smallcaps} tit. 310,
    §§ 7.00, 7.02 (2001); [Mass. Dep't of Envtl. Reg., Conditional
    Comprehensive Plan Approval of Mystic Station 13]{.smallcaps} (2000)
    (requiring end-of-pipe SCR technology to reach 2 ppm in addition to
    dry low-NO~X~ burner),
    http://www.state.ma.us/dep/energy/mystic/mysca.pdf. This problem is
    addressed in Notice of Availability for Draft Guidance on BACT for
    NO~x~ Control at Combined Cycle Turbines, 65 Fed. Reg. 50,202-02
    (2000), suggesting that BACT not require the addition of SCRs on
    low-emitting gas turbines, and arguing that adding costs to such
    turbines actually increases NO~X~ because the power from the new
    generation would be expected to displace power from far dirtier
    facilities. Environmental groups strongly objected to the proposal.
    *See* Inside Washington Publishers, *Activists Threaten Litigation
    on Permit, Turbine Policies*, 11 [Clean Air Report]{.smallcaps} 4
    (Sept. 28, 2000).

[^360]: ^?^. Swift, *supra* note Error: Reference source not found.

[^361]: ^?^. The variable cost of operating SCONOX is almost double that
    of SCR for gas turbines, yet SCONOX achieves only a very small
    marginal reduction of NO~X~, from 3 ppm to 2 ppm (equivalent to
    moving from 0.0100 to 0.0072 lb/mmBtu, both extremely low). *See*
    California Environmental Technology Certification Program, *supra*
    note Error: Reference source not found; [Mass. Dep't of Envtl.
    Reg.]{.smallcaps}, *supra* note Error: Reference source not found.
    If one compares this 1 ppm to the incremental energy used by SCONOX
    in comparison to SCR, the energy used, were it taken from the grid,
    leads to emissions of about 1000 pounds of NO~X~, 2 tons of SO~2~
    and over 100 tons of CO~2~ for every ton of NO~X~ abated. *See* [DOE
    Annual Energy Outlook 2001,]{.smallcaps} *supra* note Error:
    Reference source not found, tbl. A8, at 132. If one also considers
    the embedded energy use in all the other added operating costs of
    SCONOX, these indirect emissions would be even higher. This example
    shows how the inflexibility of rate standards leads to perverse
    environmental results, and prevent cost reductions.

[^362]: ^?^. Goal Line Envtl. Technologies, L.L.C., *SCONOX Available
    for Gas-Fired Boilers*, 1 [Catalytic Solutions for Clean
    Air,]{.smallcaps} *at* http://www.glet.com/update_10-99.htm#SCONOx\
    AVAILABLE (Oct. 1999).

[^363]: ^?^. This type of rate standard was motivated by political
    concerns to assure jobs for miners and others whose jobs depended on
    continued extraction of high-sulfur eastern coals. *See* [Ackerman &
    Hassler]{.smallcaps}, *supra* note Error: Reference source not
    found, at 44-45. The 1971 NSPS was also a rate standard, imposing a
    concentration limit based on Btu input, which was slightly more
    flexible. *See supra* Part II.A.

[^364]: ^?^. EPA, RACT/BACT/LAER [Clearinghouse Annual Report for 1998:
    A Compilation of Control Technology Determinations]{.smallcaps} EPA
    456/R-98-004 (June 1998). *See* Interviews with federal and state
    air pollution control officials, representatives of utility
    companies, vendors of pollution abatement technologies, and
    environmental organizations.

[^365]: ^?^. *See supra* Part III.E.3.

[^366]: ^?^. This situation is further exacerbated by the new source/old
    source distinction under the NO~X~ standards, which is discussed in
    Part III.E.2. This distinction in CAA regulation focuses
    requirements on new sources that are already so clean that reducing
    their emissions does not significantly reduce total NO~X~ pollution,
    but by placing high burdens on these clean new sources, may
    perversely provide economic incentives to keep old plants on line.

[^367]: ^?^. *See supra* Part III.D.1.

[^368]: ^?^. *See supra* Part III.D.5.

[^369]: ^?^. *See supra* note Error: Reference source not found.

[^370]: ^?^. BACT and LAER require a case-by-case assessment and
    approval of compliance technology. *See, e.g.*, 42 U.S.C.
    §§ 7479(3), 7501(3) (1994); *see also* *supra* note Error: Reference
    source not found. For a glimpse of the intensive negotiations about
    technology choices involved in the application such standards, see
    Environmental Appeals Board, *Formal Opinions; Clean Air Act
    Prevention of Significant Deterioration (PSD) Permit Appeals*, *at*
    http://www.epa.gov/eab/eabpsd.htm (last updated Apr. 23, 2001).

[^371]: ^?^. *See* *supra* Part II.C.5.c; Clean Air Act, 40 C.F.R.
    § 60.43a(g) (2000).

[^372]: ^?^. *See supra* text accompanying note Error: Reference source
    not found.

[^373]: ^?^. Rate-based standards and short averaging times work best
    when there is limited dispersion of a pollutant, and the rate is
    related to the size and output of the source. Therefore, rate
    standards are likely to perform better with vehicles than with
    stationary sources, and with pollutants with highly localized
    effects. The regional nature of the effects of NO~X~ and SO~2~, and
    the great variability in size of stationary sources, would indicate
    the use of long averaging periods for these pollutants.

[^374]: ^?^. *See, e.g.*, Tim Woolf & Bruce Biewald, *Electricity Market
    Distortions Associated with Inconsistent Air Quality Regulations*,
    13 [Electricity J.]{.smallcaps} 42-49 (2000) (analyzing the market
    distortions that exist partially due to varying rate standards for
    old and new sources and advocating uniform standards), *available
    at* <http://www.synapse-energy.com/publications.htm>.

[^375]: ^?^. Clean Air Act, 40 C.F.R. § 60.44a(d) (2000). This final
    rule was adopted in Revision of Standards of Performance for
    Nitrogen Oxide Emissions from New Fossil-Fuel Fired Steam Generating
    Units, 63 Fed. Reg. 49,442, 49,444 (Sept. 16, 1998).

[^376]: ^?^. *See* 42 U.S.C. §§ 7479(3), 7501(3); *see also supra* text
    accompanying note Error: Reference source not found.

[^377]: ^?^. EPA, [Pub. No.]{.smallcaps} EPA-456/R-98-004,
    [RACT/BACT/LAER Clearinghouse Clean Air Technology Center Annual
    Report for 1998: A Compilation of Control Technology
    Determinations]{.smallcaps} (1990 ed., 8th Supp. 1998), *available
    at* http://www.epa.\
    gov/ttn/catc/dir1/rblc98.pdf. Measurement of ppm varies considerably
    between technologies due to different test methods, and so is a
    particularly poor measure of overall pollution. *See* Clean Air Act,
    40 C.F.R. § 60, app. A, method 19 (showing that ppm varies greatly
    depending on percent of oxygen in exhaust air).

[^378]: ^?^. It now takes five to ten years between initiation and
    implementation of a major rulemaking process, which is a far slower
    pace than the rate of development of technology change.

[^379]: ^?^. *See* [Gas Research Institute]{.smallcaps}, *supra* note
    Error: Reference source not found.

[^380]: ^?^. Note that rate standards under the CAA could be improved to
    be uniform and output-based, and then would meet some of these
    objectives. However, even such improved rate standards would suffer
    from the problems of restricting technology and compliance choices,
    not promoting compliance above the rate limit, not creating a
    continuous driver for improvement, and imposing high transaction
    costs.

[^381]: ^?^. A system of pollution charges or fees may also provide
    similar benefits if the charges are set high enough, but such
    systems have rarely been implemented in the United States. Although
    such fee-based systems are theoretically attractive, studies have
    shown that in practice, pollutant fees or taxes have almost never
    been able to be established at levels high enough to affect
    behavior. *See* [Organization for Economic Cooperation and
    Development, Environmental Taxes in OECD Countries]{.smallcaps}
    (1995).

[^382]: ^?^. Traditional rate-based regulations create a dichotomy
    between environmental compliance and all other aspects of firm
    behavior that has been referred to as a "green wall" separating
    environmental compliance from the rest of the firm. *See*
    [Environmental Strategies for Industry: International Perspectives
    on Research Needs and Policy Implications]{.smallcaps} 8-12 (Kurt
    Fischer & Johan Schott eds., 1993); Patricia S. Dillon,
    *Implications of Industrial Ecology for Firms*, *in* [The Greening
    of Industrial Ecosystems]{.smallcaps} (Braden R. Allenby & Deanna J.
    Richards eds., 1994). The integration achieved by cap-and-trade
    programs serves to overcome this division.

[^383]: ^?^. *See supra* Part III.C.

[^384]: ^?^. *See supra* Part II.C.9.

[^385]: ^?^. *See supra* Part IV.E.3.

[^386]: ^?^. In the early 1990s, the EPA's National Advisory Council for
    Environmental Policy and Technology (NACEPT) recognized that
    "\[e\]nvironmental improvements in process and materials-require
    long-term, continuous investment in the development of new, more
    economically and environmentally efficient technologies which make
    it possible to leapfrog to a new level of environmental improvement
    and economic efficiency." [EPA, Pub. No. EPA-100/R-93-004,
    Transforming Environmental Permitting and Compliance Policies to
    Promote Pollution Prevention 5]{.smallcaps} (1993), *available at*
    <http://www.epa.gov/clariton/c/html/pubtitle.html>. NACEPT also
    observed that the command-and-control environmental regulatory
    system severely constrains innovation because government regulators
    tend to require regulated entities to only use existing technologies
    that are known to meet the emissions limitations. [EPA
    Permitting]{.smallcaps}, *supra* note Error: Reference source not
    found; *see also* [ELI Innovation]{.smallcaps}, *supra* note Error:
    Reference source not found.

[^387]: ^?^. *See supra* text accompanying notes Error: Reference source
    not found-Error: Reference source not found; *see also* Figures 4-2,
    4-3.

[^388]: ^?^. *See supra* Part II.C.6.a.

[^389]: ^?^. This rate level is significant because the permanent
    emissions cap in Phase II was based on multiplying baseline
    emissions by 1.2 lb/mmBtu. Therefore most units by Phase II would,
    on average, have to meet or exceed this rate.

[^390]: ^?^. *See supra* Part II.C.6.a.

[^391]: ^?^. The lost opportunity is revealed by the OTC NO~X~ cap,
    which led some firms to make up to 30% NO~X~ reductions through
    operational changes alone, which had not been implemented under the
    previous rate standards. Although New Source Review standards
    theoretically apply again to a plant if it undergoes a major
    modification, this happens infrequently. In practice, NSR can result
    in perverse incentives for firms to not improve plant performance or
    make operational changes that might trigger the costs of New Source
    Review.

[^392]: ^?^. As Figure 3-7, describing NO~X~ regulations, shows, dirtier
    plants may in practice actually face much lower costs, giving no
    incentive to move towards cleaner technologies. The "equal effort"
    approach embodied in current standards creates weak drivers for
    firms to innovate through developing newer, cleaner technologies.

[^393]: ^?^. This was evident in cyclone boilers and NO~X~, where
    industry launched a research effort when it learned of the EPA's
    initiative to regulate cyclones in Phase II, discovered an
    inexpensive technology that would lower NO~X~ to the proposed rate
    level, and then scaled down the research effort. This aspect of rate
    standards is explored in major studies such as Nicholas Ashford et
    al., *Using Regulation to Change the Market for Innovation*, [9
    Harv. Envtl. L. Rev.]{.smallcaps} 419 (1985); Kurt Strasser,
    *Cleaner Technology, Pollution Prevention and Environmental
    Regulation*, [9 Fordham Envtl. L.J.]{.smallcaps} 1 (1997).

[^394]: ^?^. *See supra* Part III.D.5.

[^395]: ^?^. *See supra* Part III.D.5.c.

[^396]: ^?^. *See* [ELI Innovation]{.smallcaps}, *supra* note Error:
    Reference source not found, at 9, 25; *see also*
    PricewaterhouseCoopers, 1999 Money Tree Survey, *at*
    http://www.pwcmoneytree.com.

[^397]: ^?^. *See* Interviews with environmental financiers; *see also*
    [ELI Innovation]{.smallcaps}, *supra* note Error: Reference source
    not found.

[^398]: ^?^. EPRI's 1999 Annual Report shows a research program of
    \$364,856,000, including \$102,600,000 in supplemental project
    funding by its members. Almost all projects are applied and oriented
    towards improving existing plants and technologies. [Elec. Power
    Research Inst., Annual Report]{.smallcaps} (1999), *available at*
    www.epri.com.

[^399]: ^?^. Roughly half of the DOE's \$2.1 billion fiscal year 2000
    appropriation for "Energy Resources" is oriented towards new power
    technologies and energy conservation. [U.S. Dept. of Energy, FY 2001
    Budget Request to Congress (2000)]{.smallcaps}; *see also* EIA[,
    Pub. No. SR/OIAF/1999-03, Federal Financial Interventions and
    Subsidies in Energy Markets 1999: Primary Energy,]{.smallcaps}
    *available at*
    http://www.eia.doe.gov/oiaf/servicerep/subsidy/index.html (last
    modified July 10, 2000) (noting that overall, "nearly two-thirds of
    Federal energy R&D (\$2.8 billion) is allocated to basic research")
    An additional \$1.6 billion in applied research is divided between
    research to develop new technologies and research to improve
    existing technologies. *Id.* at 25.

[^400]: ^?^. [Frank P. Grad, Treatise on Environmental Law]{.smallcaps}
    § 2.03\[14\] (1995); Clean Air Act Amendment of 1977, S. Rep. No.
    95-127 (1977); H. Rep. No. 95-294, at 11-14 (1977).

[^401]: ^?^. *See supra* note Error: Reference source not found.

[^402]: ^?^. Even without controls, modern gas combined-cycle plants
    emit virtually no SO~2~, particulates, or air toxics. Their NO~X~
    levels are around 0.05 lb/mmBtu, which is well below the NSPS and
    ten to forty times lower than that of coal units. Because they are
    more efficient than coal plants, they also emit roughly half the
    CO~2~. *See* [State and Territorial Air Pollution Program
    Administrators & Association of Local Air Pollution Officials
    (STAPPA/ALAPCO), Reducing Greenhouse Gases and Air Pollution: A Menu
    of Harmonized Options 49]{.smallcaps} (1999).

[^403]: ^?^. *See* Figure 3-7. Modern gas plants are cheaper to build
    than coal plants, and achieve 55% efficiency instead of the 34%
    average for coal plants. This offsets the relatively more expensive
    fuel cost for natural gas, and the DOE estimates that 90% of new
    generation between the years 2000 and 2020 will be gas-fired. *See*
    [DOE Annual Energy Outlook 2001]{.smallcaps}, *supra* note Error:
    Reference source not found, at 65, 78.

[^404]: ^?^. XONON is a flameless catalyst module developed by
    Catalytica Combustion Systems. *Nutech, Ultra Low NOx Combustor*,
    *at* http://www.nutech.org/stationary/fuel_burn/\
    boilers/other/xonon.html (n.d.).

[^405]: ^?^. Federal funding of the Advanced Turbine Systems program has
    risen from \$5 million in Fiscal Year (FY) 1992 to \$33 million in
    FY 1999. EIA, *supra* note Error: Reference source not found, at 33.

[^406]: ^?^. *See supra* Parts II(A), III(E)(2).

[^407]: ^?^. *See supra* note Error: Reference source not found (noting
    that 90% of industry research efforts focused on existing plant and
    equipment).

[^408]: ^?^. *See supra* Part III.E.2.

[^409]: ^?^. *See* 42 U.S.C. § 7502 (1994).

[^410]: ^?^. This is particularly true for carbon dioxide, the principal
    greenhouse gas. Since CO~2~ is a long-lived gas that lasts for
    centuries once emitted, it is critical to achieve major carbon
    reductions in the next decade or two. The most feasible way to do so
    is to invest heavily in new gas-fired plants that are more efficient
    and far cleaner than the older coal-fired power plants. Yet our
    NO~X~ policies make such new investment considerably more difficult,
    leading to continued emissions from older plants. The cost burden of
    NSR is especially severe for smaller gas-turbine units that are
    precisely those used for co-generation at industrial sites, and
    could achieve the greatest efficiency gains and greenhouse gas
    reductions.

[^411]: ^?^. *See supra* Part IV.B.

[^412]: ^?^. *See supra* Part III.E.1.

[^413]: ^?^. *See supra* Part IV.G.4.

[^414]: ^?^. *See* C[ohen]{.smallcaps}, *supra* note Error: Reference
    source not found, at 25-44.

[^415]: ^?^. This resulted in twenty-nine separate formulas for
    allowance allocation that have little to do with achieving program
    goals, but have a great deal of economic impact in redistributing
    allowances between firms. *See* [Ellerman et al.]{.smallcaps},
    *supra* note Error: Reference source not found, at 16;
    M[cLean,]{.smallcaps} *supra* note Error: Reference source not
    found, at 8.

[^416]: ^?^. *See* [Cohen]{.smallcaps}, *supra* note Error: Reference
    source not found, at 152-66.

[^417]: ^?^. *See generally* [Ellerman et al.]{.smallcaps}, *supra* note
    Error: Reference source not found, at 31-35; [Cohen]{.smallcaps},
    *supra* note Error: Reference source not found, at 152-66
    (discussing the legislative history of the Clean Air Act).

[^418]: ^?^. *See* Acid Rain Program; Nitrogen Oxides Emission Reduction
    Program---Phase II Final Rule, 61 Fed. Reg. 67,112, 67,113 (Dec. 19,
    1996).

[^419]: ^?^. The OTC NO~X~ reduction program, which included both
    rate-based standards in its first phase and an emissions cap and
    allowance-trading standard starting in 1999, took extensive
    discussions between states to establish the overall regulatory
    framework, baselines, and allocations. See the series of multistate
    memoranda and resolutions starting in 1991 that are listed at the
    Ozone Transport Commission homepage, *at* http://www.sso.org/otc/.

[^420]: ^?^. *See* Clean Air Act, 40 C.F.R. § 60.44a (2000); Revision of
    Standards of Performance for Nitrogen Oxide Emissions from New
    Fossil-Fuel Fired Steam Generating Units, 63 Fed. Reg. 49,442,
    49,444 (Sept. 16., 1998) (setting NO~X~ New Source Performance
    Standard of 1.6 lb/MWh).

[^421]: ^?^. Industry sued the EPA over its new NAAQS for ozone and fine
    particulate matter smaller than 2.5 microns. National Ambient Air
    Quality Standards for Ozone, 62 Fed. Reg. 38,856, 38,856 (July 18,
    1997), *struck down in part by* Am. Trucking Ass'n v. EPA, 175 F.3d
    1027, 1037 (D.C. Cir. 1999), *modified on reh'g by* 195 F.3d 4 (D.C.
    Cir. 1999), *aff'd in part, rev'd in part sub nom.* Whitman v. Am.
    Trucking Ass'n, 121 S. Ct. 903 (2001).

[^422]: ^?^. *See* Brian Mclean, *Evolution of Marketable Permits: The
    U.S. Experience with Sulfur Dioxide Allowance Trading*, 8 [Int'l J.
    Envtl. & Pollution]{.smallcaps} 19 (1997). "If EPA failed to put
    implementing regulations in place, emission limitations stated in
    the law would apply to every source . . . . Coupled with the
    automatic noncompliance penalties, this provision encouraged the
    industry to support the timely promulgation of regulations to avoid
    the more costly statutory fallback." *Id.*

[^423]: ^?^. Several major environmental groups and fifty utilities sued
    the EPA over its initial final rule for substitution units that
    would have allowed firms to count the reductions achieved by
    building a scrubber on a unit after 1985 but before 1990. *See*
    Proposed Settlement; Acid Rain Core Rules Litigation, 59 Fed. Reg.
    42,227 (Aug. 17, 1994); Proposed Settlement; Acid Rain Core Rules
    Litigation, 59 Fed. Reg. 28,522 (June 2, 1994). The EPA agreed to
    change its rule to not allow this result. *See* Clean Air Act, 40
    C.F.R. § 72.41 (2000); Acid Rain Program: Permits, 59 Fed. Reg.
    60,218, 60,220 (Nov. 22, 1994).

[^424]: ^?^. Only two other judicial challenges were brought, which
    focused only on a specific provision that outlined the extension
    allowances available to utilities that installed scrubbers. In one
    challenge, three utilities unsuccessfully sought to require the EPA
    to process extension allowance applications in order of receipt
    before issuing its final regulations for the acid rain program.
    Monongahela Power Co. v. Reilly, 980 F.2d 272, 278 (4th Cir. 1992).
    A second unsuccessful challenge was brought by an individual
    utility, Indianapolis Power and Light Company, challenging the EPA's
    failure to adjust its emissions data to account for an extended
    period of time a unit was out of operation due to unexpected major
    repairs. Indianapolis Power & Light Co. v. EPA, 58 F.3d 643, 643
    (D.C. Cir. 1995).

[^425]: ^?^. The EPA promulgated NO~X~ regulations in March 1994 (almost
    two years after the May 15, 1992, deadline set by statute),
    following lengthy but unsuccessful efforts to achieve a negotiated
    rulemaking that covered, among other things, low-NO~X~ burner
    technology issues. Acid Rain Program; Nitrogen Oxides Emission
    Reduction Program---Phase I, Final Rule, 59 Fed. Reg. 13,538 (Mar.
    22, 1994).

[^426]: ^?^. Following issuance of the regulations, the industry
    successfully challenged the EPA's decision that "low NO~X~ burner
    technology" included overfire air. *See* Al. Power Co. v. EPA, 40
    F.3d 450 (D.C. Cir. 1994) (vacating the rule). As a result,
    utilities were not required to comply until January 1, 1996, after
    the EPA had re-issued the rule in April 1995, a full year after the
    statutory compliance deadline for Phase I NO~X~ emissions
    limitations. *See* Acid Rain Program: Nitrogen Oxides Emission
    Reduction Program: Direct Final Rule, 60 Fed. Reg. 18,751 (Apr. 13,
    1995).

[^427]: ^?^. Challenges to SO~2~ program implementation were primarily
    based on individual EPA allocation decisions. *See* Tex. Mun. Power
    Agency v. EPA, 89 F.3d. 858, 858 (D.C. Cir. 1996) (upholding EPA
    utility-specific allocation decisions); Madison Gas & Elec. Co. v.
    EPA, 25 F.3d 526 (7th Cir. 1994) (challenging successfully the EPA's
    failure to award bonus allowances).

    The NO~X~ Phase II challenges were broad challenges that could have
    potentially delayed implementation of NO~X~ emissions limitations
    for Group 1, Phase II and Group 2 boilers. *See* Appalachian Power
    Co. v. EPA, 135 F.3d 791, 822 (D.C. Cir. 1998). The petitioners
    failed in several broad challenges to Phase II, Group 1 regulations
    and succeeded in part with their challenges to Group 2 regulations.
    *Id.*

[^428]: ^?^. Clean Air Act, 40 C.F.R § 72.31 (2000); [EPA, Pub. No.
    OMB-2060-0258, Acid Rain Program: Phase II Permit
    Application]{.smallcaps} (1998), *available at*
    http://www.epa.gov/airmarkets/\
    forms (last updated Jan. 19, 2001)[.]{.smallcaps}

[^429]: ^?^. *See supra* Part II.C.11.

[^430]: ^?^. About 90% of SO~2~ trades under the Acid Rain Program are
    recorded under the EPA Allowance Tracking System in less than
    twenty-four hours. Kruger et al., *supra* note Error: Reference
    source not found, at 121. *See* [EPA 1999 Compliance
    Report,]{.smallcaps} *supra* note Error: Reference source not found.

[^431]: ^?^. *See* [EPA 1999 Compliance Report]{.smallcaps}, *supra*
    note Error: Reference source not found, at 12-13.

[^432]: ^?^. *See* Anthony Arcone & Josh Margolis, *New Source Review
    ERC Trading---The Good, The Bad and The Difficult*, [Envtl. Fin.
    21]{.smallcaps} (Oct. 2000).

[^433]: ^?^. 42 U.S.C. § 7479(3), 7501(3) (1994). The procedure is
    detailed in [EPA, Draft New Source Review Workshop Manual;
    Prevention of Significant Deterioration and Nonattainment Area
    Permitting]{.smallcaps} (1990). The results of individual
    determinations are collected in [EPA, Pub. No. EPA-456/R-99-004,
    RACT/BACT/LAER Clearinghouse Clean Air Technology Center Annual
    Report for 1999: A Compilation of Control Technology
    Determinations]{.smallcaps} (1990 ed., 9th Supp. 1999), *available
    at* http://www.epa.\
    gov/ttn/cact/dir1/rblc99.pdf.

[^434]: ^?^. For BACT, the law requires these be made "on a case-by-case
    basis, taking into account energy, environmental, and economic
    impacts." 42 U.S.C. § 7479(3). Contested cases are frequent, and
    results of litigation are reported by state, or in cases of federal
    direct jurisdiction, in cases before the EPA Environmental Appeals
    Board, *at* http://www.epa.gov/eab/eabpsd.htm.

[^435]: ^?^. 42 U.S.C. § 7651a.

[^436]: ^?^. *See id.* § 7651d.

[^437]: ^?^. [EPA 1999 Compliance Report]{.smallcaps}, *supra* note
    Error: Reference source not found, at 2; [EPA 1999 OTC NO~X~
    Compliance Report]{.smallcaps}, *supra* note Error: Reference source
    not found, at 2.

[^438]: ^?^. Title IV requires "CEMS, \[or\] any alternative monitoring
    system that is demonstrated as providing information with the same
    precision, reliability, accessibility and timeliness as that
    provided by CEMS." 42 U.S.C. § 7651k(a).

[^439]: ^?^. *Id.* § 7651j(a).

[^440]: ^?^. *Id.* § 7413.

[^441]: ^?^. *See* [EPA, Rule Effectiveness Study]{.smallcaps} (1993)
    (noting a compliance rate of 80% for traditional air programs). In
    the five years of Phase I, there were only thirty-eight actions
    against forty-five plants (ninety units) for more minor infractions
    such as violations of monitoring, record keeping, and reporting
    rules. This number of violations in comparison to the 2500 units
    covered by the Acid Rain Program monitoring requirements results in
    a 96% compliance result for the program over five years, again much
    better than typical compliance rates under the EPA's air programs.
    Zofia Kosim, *Acid Rain Program: Compliance and Enforcement*,
    Presentation at Elec. Utilities Envtl. Conference, Tucson, Ariz.
    (Jan. 9, 2001) (notes on file with author).

[^442]: ^?^. [EPA 1999 Compliance Report]{.smallcaps}, *supra* note
    Error: Reference source not found, at 2; [EPA 1999 OTC NO~X~
    Compli-ance Report]{.smallcaps}, *supra* note Error: Reference
    source not found, at 2.

[^443]: ^?^. EPA 1993 [Rule Effectiveness Study,]{.smallcaps} *supra*
    note Error: Reference source not found.

[^444]: ^?^. Sources that find themselves out of compliance at year end
    can purchase allowances to achieve compliance within sixty days of
    the end of the year. Clean Air Act, 40 C.F.R. § 77.3 (2000).

[^445]: ^?^. *See supra* Part III.D.5.

[^446]: ^?^. [EPA 1999 Compliance Report]{.smallcaps}, *supra* note
    Error: Reference source not found, exh. 8, at 13.

[^447]: ^?^. *Id.* at 2, 13.

[^448]: ^?^. *Id.* exh. 9, at 14; *see also supra* Part III.D.4.

[^449]: ^?^. 1999 emissions were 174,843 tons compared to allowance
    allocations of 218,738 tons. Banked allowances may only be used up
    to 10% of authorized allowances in each year. Banked allowances are
    reduced by a variable ratio (2:1 in 2000) for use over that 10%
    threshold. The differences in banking rules for SO~2~ and NO~X~ are
    motivated in part by the greater sensitivity of health benefits to
    short-term fluctuations in NO~X~. *See* [EPA 1999 OTC NO~X~
    Compliance Report,]{.smallcaps} *supra* note Error: Reference source
    not found, at 2-3.

[^450]: ^?^. *See supra* Part III.D.3.

[^451]: ^?^. *See supra* Part II.C.9.

[^452]: ^?^. Data derived from analysis of EPA [Compliance
    Reports]{.smallcaps} 1995-1999.

[^453]: ^?^. *Id.*

[^454]: ^?^. SO~2~ information from EPA Allowance Tracking System; NO~X~
    averaging plans in [EPA 1999 Compliance Report,]{.smallcaps} *supra*
    note Error: Reference source not found[,]{.smallcaps} app. C-1.

[^455]: ^?^. *See generally* [GAO 2000 Effects]{.smallcaps}, *supra*
    note Error: Reference source not found, at 7 (discussing the
    movement of allowance trading); Swift, *supra* note Error: Reference
    source not found (showing major reductions in largest plants,
    several of which were scrubbed). For acid rain trading program
    information, see http://www.epa.gov/\
    airmarkets/trading.html (last updated Dec. 11, 2000).

[^456]: ^?^. [DOE Annual Energy Outlook]{.smallcaps} 2001, *supra* note
    Error: Reference source not found, fig. 73, at 67.

[^457]: ^?^. *Id.*

[^458]: ^?^. Bruce Biewald et al., *Grandfathering and Environmental
    Comparability: An Economic Analysis of Air Emission Regulations and
    Electricity Market Distortions*, *at*
    http://www.synapse-energy.com/publications.htm (Jan. 26, 1998).

[^459]: ^?^. *See* *supra* Part IV.B.

[^460]: ^?^. *See* Northeastern States Petition, *supra* note Error:
    Reference source not found. Also, legislation has been introduced in
    both House and Senate to significantly reduce emissions of four
    pollutants emitted by power generating plants (SO~2~, NO~X~, CO~2~
    and mercury). *See* Clean Power Act of 2001, S. 556, 107th Cong.
    (2001); H.R. 1256, 107th Cong. (2001).

[^461]: ^?^. This is the other fundamental alternative for objectively
    neutral regulation, and is implemented through market-based
    regulations such as pollutant charges set at a uniform price, or
    emissions cap and allowance trading systems. Under these approaches,
    all firms face an equal cost per ton of pollution, which is
    indicated by the allowance price in cap-and-trade systems, or the
    level of a pollutant charge or fee.