Technical Support Docum ent (TSD) for the Transport Rule Docket ID No. EPA-HQ-OAR-2009-0491



## Analysis of Constellation Energy Group’s Allocation Suggestion that Uses Title IV Allowances

U.S. Environmental Protection Agency Office of Air and Radiation July 2010

1Background In developing the Transport Rule proposal to replace the Clean Air Interstate Rule (CAIR), EPA carefully considered the propos ed Transport Rule program’s impact on existing programs. These impacts include d the impact of the proposed program on banked Title IV allowances in the Acid Rain Program. One of the specific issues considered was whether the proposed program would have the undesirable effect of promoting the use of the Title IV allowance bank. The Title IV allowance bank represents early reductions by sources in the Acid Rain Program. Fu rther, source owners and operators made and implemented early reduction decisions on the assumption that banked Title IV allowances would continue to have value in the future. However, the proposed Transport Rule program could result in significantly reduced values for Title IV allowances before the start of the propos ed program (i.e., January 1, 2012), thereby resulting in SO 2 emissions increases before that date. 1 These policy considerations were weighed in light of legal, policy, and implem entation concerns such as those discussed below. In a letter dated June 25, 2009, Conste llation Energy Group (Constellation) outlined a number of concerns and suggesti ons regarding development of the rule to replace the CAIR. In a follow-up meeting, Constellation verbally elaborated on a possible SO 2 allowance allocation methodology -- men tioned in the letter -- for the CAIR replacement program. Conste llation stated that an SO 2 allocation methodology could be created to reward sources that made early SO 2 emission reductions and therefore banked

1 In fact, because the emission reduction requirements of the proposed Transport Rule program would result in nationwide SO 2 emissions well below the 8.95 million ton cap under the Acid Rain Program, the proposed program would likely result in Title IV allowances having little or no value.

2Title IV allo wances. This document provides EPA’s summary and analysis of Constellation’s suggested approach. Constellation’s suggested approach for SO 2 allowance allocation Constellation’s suggested approach assumed that the CAIR replacement program would begin in 2015 and use trading th at would rely on newly created SO 2 allowances. EPA’s understanding is that, under this suggested approach, new SO 2 allowances (comprising for each state that state’s budget) in the new pr ogram would be allocated to sources in the state as follows. First, after Title IV compliance dete rminations for 2014 are completed, EPA would allocate new SO 2 allowances (for up to the first 5 vintage years, i.e., 2015-2019) to each source covered by the CAIR replacement program. 2 The allocations would be based on the amount of pre-2015 Title IV allowa nces that were in the source’s allow account as of the allowance transfer dead line for 2014 (i.e., March 1, 2015) and that remained unused after EPA deducted the amount necessary for compliance for 2014. Accumulation of banked pre-2015 T itle IV allowances would be “voluntary” in that the CAIR replacement program rules would not ba r the use of these allowances. EPA would select an allocation ratio for new SO 2 allowances based on banked pre-2015 Title IV allowances (i.e., 1 new SO 2 allowance for a specified amount of banked Title IV allowances). New SO 2 allowances would be the only allo wances that could be used for compliance in the new program. The total amount of new SO 2 allowances allocated (including both those allocated based on banked Title IV allowances and any allocated ance

2 It is unclear from Constellation’s oral presentation whether a source holding banked Title IV allowances would qualify for and receive new SO 2 allowances only once for the entire period, 2015-2019, or separately for each year during that period.

3using any other m ethodology) to sources in a state for a vintage year could not exceed that state’s SO 2 budget under the new program. Sources receiving new SO 2 allowances based on their banked Title IV allowances would retain those Title IV allowances, which would remain usable for compliance with the Acid Rain Program for years after 2014. 3 Second, to the extent any new SO 2 allowances would remain in a state’s SO 2 budget for a vintage year after completion of the allocations based on banked Title IV allowances, those remaining allowances would be allocated to source s in the state using some other allocation methodology. Constella tion’s suggested appro ach did not specify any methodology for allocating the remaining allowances. Constellation stated that its suggested approach woul d provide an incentive to preserve Title IV allowance banks before th e start of the CAIR replacement program. According to Constellation, sources would preserve the Title IV allowance banks by burning lower sulfur coal, operating existing scrubbers to maximize SO 2 removal, increasing dispatch of low-emitting units, a nd investing in new scrubbers. With the commencement of the new program and th e imposition of more stringent emission reduction requirements than under the Acid Rain Program for 2015 and thereafter, emissions by sources covered by the new pr ogram would be limited by the amount of
new SO 2 allowances that they held, and the c overed sources would not be able to use their banked Title IV allowances to exceed that emissions limit. Assumptions for analysis Constellation assumed that the CAIR replacement program would begin on January 1, 2015. EPA’s analysis evaluating Constellation’s suggested approach takes

3 However, the Title IV allowances would likely have little or no value once the CAIR replacement program began. See n.1.

4into account that the proposed Tr ansport Rule program would impose SO 2 emission reduction requirements beginning on January 1, 2012. Analysis Because of the following concerns about the legality, efficacy, and implementation of Constellation’s suggest ed approach, EPA did not include the suggested approach in the proposed Transport Rule remedy or in the detailed, alternative remedies discussed in the preamble of the proposed Transport Rule. Legal concerns EPA believes that there woul d be significant legal risk in using Constellation’s suggested approach for allocating new SO 2 allowances in the proposed Transport Rule program. Specifically, EPA believe s that, if this approach we re adopted in a final rule, there is a significant risk that, on appeal, th e Court would conclude that the approach was inconsistent with North Carolina v. EPA , 531 F.3d 896, 921-22 (D.C. Cir. 2008), where the Court held, among other things, that EPA la cked authority to modify or eliminate, through the CAIR program, the authorization to emit provide d by a Title IV allowance for the purpose of harmonizing Titles I and IV. First, Constellation’s suggested appro ach would effectively reward continued holding, and impose a heavy burden on current us e, of Title IV allowances. Holding -- rather than using -- Title IV allowances w ould be the best way for a source owner or operator to ensure access to free, new SO 2 allowances for up to the first 5 years of the proposed Transport Rule program (i.e., 2012-2016) . In fact, in light of the reasonable possibility that the allocation of new SO 2 allowances based on banked Title IV allowances would exhaust the SO 2 budget for one or more States and prevent the

5allocation of any new SO 2 allowances in those States using any other allocation methodology, holding (i.e., not using) Titl e IV allowances could be the only way for sources in those States to get free, new SO 2 allowances for the year involved. In summary, under the suggested approach, a source ’s use of Title IV allowance bank could have the result of significantly reducing, or in some cases eliminating entirely, the source’s ability to obtain free, new SO 2 allowances for the first 5 years of the proposed Transport Rule program. Consequently, be cause Constellation’s suggested approach could significantly burden the use of banked Title IV allowances, it could be seen as interfering with the use of banked Title IV a llowances and therefore in effect modifying the Title IV allowances’ authorizations to emit. EPA recognizes that under Constellation’s suggested approach, sources would not be required to hold Title IV allowances, but instead would receive a be nefit for allowances voluntarily held. However, because of the importance to sources of obtaining free, new SO 2 allowances, EPA does not believe the voluntary nature of this provision would provide a sufficient basis for distinguishing the suggested approach from SO 2 allowance allocation provisions reversed in North Carolina

. Second, there is a significant risk that th e Court would view the sole purpose of Constellation’s suggested approach as bei ng the preservation of the emission reductions achieved by the Title IV program, rather th an the implementation of the statutory mandate of section 110(a)(2)(D )(i)(I) of the Clean Air Act. There would not necessarily be any correlation between (1) the amount of banked Title IV allowances a source would hold after March 1, 2012, for which the source would receive free, new SO 2 allowances and (2) either that source’s SO 2 emissions in 2010 and 2011 or the degree to which total

6em issions in 2010 and 2011 from the state wher e the source is located would contribute to nonattainment or interfere with maintenan ce in any downwind state. This is because sources could hold banked Title IV allowa nces for many reasons, including reasons having little or no connection with the sources’ emissions or total emissions in the sources’ state. For example, a source c ould hold banked Title IV allowances but be located in a state whose SO 2 budget would likely be oversubscribed by other sources in the state that hold banked Title IV allowances. In order to maximize the total amount of free, new SO 2 allowances that the owner of that source would receive, the owner could easily transfer, before March 1, 2012, banked Title IV allowances from that source to one of owner’s other sources in another state whose State SO 2 budget would not likely be oversubscribed. In short, a source’s banked Title IV allowance holdings after March 1, 2012 would not necessarily reflect emission re ductions by the holding source or even by the sources in the state where the holding sour ce is located. It is therefore doubtful that the Court would find that the allocation of new SO 2 allowances based on banked Title IV allowances was related to, much less necessary for, implementation of Title I requirements. EPA is also concerned that the above-desc ribed legal risk woul d potentially put in jeopardy the first several years of the proposed Transport Rule program in exchange for relatively limited potential environmental bene fit. Constellation’s suggested approach would potentially prov ide environmental benefit duri ng the relatively short period remaining before the start of the proposed Transport Rule Program (i.e., mid-2010 (the time frame for issuance of the proposed rule ) or mid-2011 (the projected time frame for issuance of a final rule) through the end of 2011) when sources could increase SO 2

7em issions by using banked Title IV allowa nces. However, if adopted by EPA, the suggested approach would create significant legal risk for the proposed program for the entire period for which allocations of new SO 2 allowances would be made using that approach, i.e., for up to 5 years (2012 through 2016). Policy and Implementation Concerns EPA believes that the effectiveness of th e Constellation proposal in discouraging use of the Title IV allowance bank is uncerta in and questionable. Under the suggested approach, the owners and opera tors of a covered source would presumably compare the reasonably predictable savings from using hi gher sulfur coal or turning down or off existing controls during mid-2010 or mid-2011 through the end of 2011 to the more speculative benefit of receiving free, new SO 2 allowances for certain years during the period, 2012 through 2016. The likelihood of receiving free, new SO 2 allowances, and the amount that might be received, would likely vary from state to state, depending on several factors. These factors would include: th e size of the State SO 2 budget and so the amount of new SO 2 allowances available for allocation; the num ber and ownership of sources qualifying for
new SO 2 allowances, based on Title IV allowance hol dings, in the state; and the levels of those sources’ Title IV allowance banks af ter March 1, 2012. For example, as discussed above, a state’s SO 2 budget could be too small, as compar ed with the total amount of new
SO 2 allowances for which sources in the state would otherwise qualify. In that case, one or more sources with banked Title IV allo wances in the state c ould receive fewer new
SO 2 allowances for a vintage year than the amounts for which those sources qualified. Source owners and operators woul d know the sizes of the State SO 2 budgets when a final

8Transport R ule was issued (e.g., projected to be mid-2011). However, the owners and operators could only speculate about how many new SO 2 allowances might actually be received because the number and owners hip of the sources eligible for new SO 2 allowances and the sizes of their Title IV allowance banks would not be known until after March 1, 2012, long after decisions on banki ng Title IV allowances during mid-2010 or mid-2011 through the end of 2011 would have to be implemented. With, in addition, the above-discussed legal risk that adoption of Constellation’s su ggested approach in a final rule could be reversed on appeal, it is likely that owners and operators would significantly discount the to tal value of the new SO 2 allowances that they might be awarded based on banked Title IV allowances. EPA therefore believes that it is unlikely that a significant number of owners and opera tors would decide to take actions during mid-2010 or mid-2011 through the end of 2011 to maintain or reduce emission levels in order to qualify for free, new SO 2 allowances. Finally, EPA is concerned that Cons tellation’s suggested approach would significantly disrupt the market for the new SO 2 allowances because this approach would result in delay of the allocation of all new SO 2 allowances for the first year of the proposed Transport Rule program. New SO 2 allowances could not be allocated for any vintage year (e.g., 2012) based on holdings of banked Title IV allowances until after the completion of Title IV compliance determin ations for 2011, i.e., until around mid-2012. The same timing would apply to any new SO 2 allowances remaining to be allocated by another methodology, which could only be impl emented after EPA knew whether, and, if so, how many, new SO 2 allowances were remaining. Th is would create a high level of uncertainty in the market for the new SO 2 allowance by reducing the time for compliance

910 planning and allowance trading for 2012 and w ould likely raise allowa nce prices and the compliance cost of the proposed Transport Rule program. EPA typical ly tries to allocate allowances before the first year for which the allowances can be used for compliance.