1 Deliberative

– Do not cite or quote Technical Support Document (TSD) for the final Transport Rule Docket ID No. EPA

- HQ

- OAR

- 2009

- 0491

Assurance Penalty Level Analysis Final Rule TSD

U.S. Environmental Protection Agency
Office of Air and Radiation
June 20112 Deliberative

– Do not cite or quote Assurance Penalty Level A nalysis Final Rule TSD This Technical Support Document (TSD) supports EPA ’ s determination that the final Transport Rule ’s assurance provision penalty requirement provide s sufficient deterrence against a state exceeding its assurance level. Section VII. E in the final Transport Rule preamble discusses the assurance provisions , including the allowance surrender penalty analyzed in this TSD . This TSD is organized as follows: 1. Background 2. Approach 3. Results

1. Background The final Transport Rule ’ s limited interstate trading programs include assurance provisions to ensure that the necessary reductions will occur within each covered state. The assurance provisions limit emissions from covered units in a state to the state ’ s emissions budget plus variability limit, i.e., the state ’ s assurance level. As described in preamble section VI.D, EPA used a multi

- factor anal ys is to determine each state ’ s emissions budget. Subsequently , as described in VI.F, EPA determined variability limits for each state that refle ct a percentage of the state ’ s budget (e.g., 10%). This variability limit is then added to the state budget to yi eld the state ’ s assurance level. If emissions from covered sources in a state in a compliance period exceed the state ’s assurance level, then EPA applies additional criteria to determine which owners and operators of units in the state will be subject to an allowance surrender penalty of two allowances per ton for their share of the emissions over the assurance level. 1 This penalty is in additi on to the standard program requirement that owners and operators of covered units hold one allowance for each ton emitted; therefore, for any emissions identified by EPA as being over the state’s assurance level, the relevant owners and operators must submit a total of three allowances per ton

– one of which is for standard compliance for emitting under the program, and two of which are for the assurance provision penalty

. As discussed in preamble section VI.F, EPA does not find reason to expect that emissi ons from covered sources in any state will exceed that state’s assurance level. The description and tables below describe a sensitivity anal ys is EPA conducted to determine whether the two

- for

- one

1 The assurance provisio n allowance surrender penalty addressed in this TSD is distinct from the penalties, discussed in preamble section VII.F, that apply to the trading program requirement to hold allowances sufficient to cover emissions for each compliance period.3 Deliberative

– Do not cite or quote allowance surrender penalty provides a sufficient deterrent to keep emissions from covered sources in each state from exceeding the assurance levels.

2. Approach To determine if a penalty of two allowances for every ton of excess emissions would be sufficient, EPA used the Integrated Planning Model (IPM) to asses s a “ TR_Penalty _Scenario ” whose results, along with the results of other IPM model runs for the Transport Rule , can be found in the docket. More information on IPM can be found in the Documentation Supplement for EPA Base Case v.4.10_FTransport

– Updates f or Final Transport Rule , which is also in the docket

. This penalty scenario offered covered sources in each state the choice to emit beyond the state’s assurance level and incur a fine for each excess ton worth twice the value of an allowance (in addition to having to submit one allowance for emitting each ton, per standard compliance procedures) . In this analysis, the “ state assurance level ” is the state’s emissions budget plus the state’s variability limit and corresponds to the “state emissions assuranc e level” in tables VI .F

- 1 and VI.F

- 2 of the preamble

. The size of the penalty was calculated as twice the allowance price for the relevant pollutant taken from the IPM analysis of the final rule’s remedy (TR_Limited_Trading_Final), as shown in Table 1.

Ta ble 1. Allowance prices (2007$) in the final remedy (TR_Limited_Trading Final) and Penalty Costs in the “ assurance penalty sensitivity ” run (TR _Penalty_Scenario)

Emission Allowance Prices ($/Ton) from final rem edy run Emission Penalty Costs ($/Ton) in th e assurance penalty sensitivity run 2012 201 4 2012 201 4 SO 2 Region 1 (TR) 971 1,127 1,942 2,254 SO 2 Region 2 (TR) 576 663 1,152 1,327 NO x Annual (TR) 497 577 994 1,153 NO x Ozone Season (TR) 1,321 1,532 2,642 3,064

It is important to consider that while the effective fine in this scenario (twice the value of the relevant pollutant’s allowance price) is a technically valid representation of the final rule’s penalty structure, it is an anal ytic understatement of the actual deterrence value of this pen alty in practice. The penalty

in practice will have more of a deterrent effect than what this scenario models it to have for two reasons. First, the penalty cost as modeled is fixed at twice the allowance price in the final remedy scenario (TR_Limited_Trading_Final) for every ton of emissions in excess of a state ’s assurance level. In reality , excess emissions would increase the allowance price (and therefore the cost of the penalty itself) since allowances would have to be4 Deliberative

– Do not cite or quote bought and surrendered for the penalty, raising allowance demand and thus making them more valuable. The modeling imposed a fine and did not adjust the allowance pool to account for penalty surrenders, and so it understates the cost of the penalty incurred. Second, the model has perf ect foresight of all future emitting behavior and thus does not take any “risk” into account when determining whether excess emissions are “worth it” at the penalty cost modeled. In reality , owners and operators of covered units will assign a risk premium to the nominal penalty consequence because they do not have perfect foresight and cannot be sure of their precise emissions until the compliance period is complete. Therefore, program participants can be expected to act more “conservativel y” than the modeling would suggest when determining whether excess emissions are “worth it” at the penalty cost modeled, which suggests again that this analysis understates the deterrence value of the penalty in practice.

3. Results EPA compared the state

- level emissio ns in 2012 and 2014 in this analysis to the state assurance levels to determine whether the penalty level deterred excess emissions

. Tables 2 through 5 show the state assurance levels and modeled emissions from covered sources in each state. The modeled allowance prices in 2012 and 2014 for each pollutant are shown at the bottom of each table. The penalty for exceeding the assurance level would be equal to twice the allowance price.
In no case do the covered emissions in a state exceed that state’s assura nce level in 2012 or 2014. This result indicates that the penalty offers a sufficient deterrent to ensure emissions do not exceed assurance levels in 2012 and 2014

. Even though the modeling of this scenario understated the actual value of the deterrent in practice, in no state did the covered sources find it economic to exceed the states’ assurance levels in 2012 and 2014. In some states, the covered sources in a state are modeled to have collective emissions that are exactl y equal to the state’s assurance level. These projections occur because the model operates under perfect foresight and perfect information, and it therefore allows sources in the modeling to emit up to the state’s assurance level with full certainty that emissions will respect that constraint to the last ton emitted, successfull y avoiding additional emissions which are shown to be uneconomic under the assurance penalty . In reality , the deterrence value of the penalty would likely

lead a state’s covered sources to act conservativel y by emitting below a state’s assurance level (rather than exactl y up to it) to ensure that unexpected fluctuations in emissions do not result in a penalty.
In some cases, notably

SO 2 Group 1 states, the covered emissions are projected to be significantl y lower than the states’ assurance levels in 2012. This would occur if covered sources decide to reduce their emissions beyond what is required so they can bank the excess allowances. These banked allowances could then used to cover emissions in future ye ar s.5 Deliberative

– Do not cite or quote Specificall y, the SO 2 Group 1 state budgets were determined by the feasible emission reductions at $500/ton SO 2 in 2012 and $2300/ton SO 2 in 2014 ( see Significant Contribution and State Emissions Budgets Final Rule TSD). Covered sources in these states may decide to reduce their emissions further than required in 2012 and 2013 and bank the unused allowances for use in 2014 and later ye ars . This pattern effectivel y smooths their emission reductions over time to minimize total compliance costs in those states

. The modeled allowance prices in those states also reflect this smoothing of emission reduction patterns . F or example, as seen in Table 2, the 2012 and 2014 projected allowance prices for Group 1 SO 2 states are closer to each other than the marginal c ost thresholds used to formulate their budgets in those years ($500 per ton in 2012 and $2,300 per ton in 2014). This banking behavior to smooth emission reductions over time is shown in this analysis to be entirel y consistent with each state’s assurance levels in both 2012 and 2014. As noted above, EPA’s modeling of this scenario projects no instance in which covered sources would find it economic to exceed a state’s assurance level in any of the programs in 2012 or 2014. This analysis also projects that the penalty provides sufficient deterrence for virtually all states in these programs over the 2020

- 2030 timeframe as well. However, the projections appear to suggest small exceedances in two states in 2020 and in three states in 2030

. In most of these cases, the projected exceedances are marginal

– on the order of two hundred tons of pollutant

. EPA does not believe that these longer

- run results actually indicate a likelihood of these exceedances occurring. It is important to note that this modeling a ssumes perfect foresight and perfect information, even into the 2020

- 2030 timeframe, and that under those assumptions, unit owners and operators would be willing to expend banked allowances in those years even to the point of paying assurance penalties on them. In reality, operators of covered units do not have perfect foresight or perfect information and will therefore act more conservativel y than “optimal” banking patterns fro m IPM modeling would indicate. As a result, EPA expects sources will collective ly continue to respect the ir states’ assurance level s in those instances by sustaining the Transport Rule emission reductions into the 2020

- 2030 timeframe and banking allowances f urther into the future to guard against
un anticipated developments that the m odel does not capture . Consequentl y, EPA does not believe that these limited small instances of projected exceedances in 2020 or 2030 are likel y to occur in the actual operation of these programs

. However, EPA will monitor the pattern of compliance with these programs over the long

- run and will be prepared to adjust the penalty accordingl y if evidence suggests that increased deterrence would be necessary at those later stages to encourage states to respect their assurance levels. At this point, EPA believe s that it is best to be sure in the initial years that the assurance penalty is effective in keeping emissions within variability

limits, while encouraging trading to lower costs and increase flexibility and avoiding actions that have a chilling effect on activities

. While doing this, EPA believe it is important to remain mindful that we do want assurance of meeting emission reductions over time.6 Deliberative

– Do not cite or quote EPA believes these findings support a determination that the penalty requirement of surrendering two additional allowances for each ton of excess emissions provides a sufficient deterrent in the final Transport Rule such that EPA does not expect the covered sources in any state to exceed the state’s assurance levels under these programs.7 Deliberative

– Do not cite or quote Table 2. Annual SO 2 Gr oup 1 State Assurance Levels and Emissions in 2012 and 2014 (TR_Penalty_Scenario)

2012 2014

State Assurance Level Penalty Case

Emissions State Assurance Level Penalty Case

Emissions (thousand tons) (thousand tons) (thousand tons) (thousand tons) Illinois 258 210 137 128 Indiana 314 241 177 177 Iowa 118 75 83 78 Kentucky 208 146 117 117 Maryland 33 27 31 30 Michigan 214 190 158 158 Missouri 228 182 183 177 New Jersey 7 6 7 7 New York 23 20 13 13 North Carolina 151 117 63 63 Ohio 341 229 1 51 151 Pennsylvania 307 250 123 123 Tennessee 163 97 65 65 Virginia 78 67 39 39 West Virginia 161 119 83 83 Wisconsin 87 77 44 44

Table 3. Annual SO 2 Group 2 State Assurance Levels and Emissions in 2012 and 2014 (TR_Penalty_Scenario) 2012 2014

S tate Assurance Level Penalty Case

Emissions State Assurance Level Penalty Case

Emissions (thousand tons) (thousand tons) (thousand tons) (thousand tons) Alabam a 238 219 235 173 Georgia 174 159 105 93 Kansas 46 41 46 46 Minnesota 46 43 46 45 Nebra ska 72 65 72 70 South Carolina 97 85 97 97 Texas 268 244 268 2668 Deliberative

– Do not cite or quote Table 4. Annual NO X State Assurance Levels and Emissions in 2012 and 2014 (TR_Penalty_Scenario)

2012 2014

State Assurance Level Penalty Case

Emissions State Assurance Level Penalty Case

Emissions (thousand tons) (thousand tons) (thousand tons) (thousand tons) Alabam a 80 74 79 68 Georgia 68 61 45 40 Illinois 53 48 53 49 Indiana 121 110 119 110 Iowa 42 37 41 38 Kansas 34 31 28 24 Kentucky 94 84 85 76 Maryland 18 16 18 17 Michigan 66 59 64 57 Minnesota 33 31 33 31 Missouri 58 52 54 49 Nebraska 29 26 29 27 New Jersey 8 7 8 8 New York 20 18 20 17 North Carolina 56 48 46 42 Ohio 102 85 96 84 Pennsylvania 132 118 131 117 South Carolina 36 33 36 36 Tennessee 39 33 21 2 0 Texas 147 133 147 137 Virginia 37 33 37 35 West Virginia 65 56 60 53 Wisconsin 35 31 33 30

Table 5. Ozone Season NO X State Assurance Levels and Emissions in 2012 and 2014 (TR_Penalty_Scenario)*

2012 2014

State Assurance Level Penalty Case

Emissions State Assurance

Level Penalty Case

Emissions (thousand tons) (thousand tons) (thousand tons) (thousand tons) Alabam a 35 32 35 30 Arkansas 18 15 18 17 Florida 31 28 31 299 Deliberative

– Do not cite or quote Georgia 32 27 21 18 Illinois 23 21 23 21 Indiana 52 47 51 47 Iowa 18 16 18 16 Kansas 15 13 12 10 Kentucky 40 35 36 32 Louisiana 16 14 16 14 Maryland 8 7 8 7 Michigan 28 25 27 24 Mississippi 12 11 12 11 Missouri 25 22 23 21 New Jersey 4 3 4 4 New York 10 8 10 8 North Carolina 24 21 20 18 Ohio 44 35 42 36 Okla homa 24 21 24 21 Pennsylvania 57 50 57 50 South Carolina 15 14 15 15 Tennessee 17 14 9 8 Texas 69 63 69 64 Virginia 17 14 17 15 West Virginia 28 23 26 22 Wisconsin 16 13 15 13
* As discussed in section III of the Transport Rule preamble, the final rule does not include the states of Iowa, Kansas, Michigan, Missouri, Oklahoma, or Wisconsin in the ozone season program. EPA issued a supplemental proposal to include these six states in the Transport Rule ozone season program.