[Federal Register Volume 62, Number 181 (Thursday, September 18, 1997)]
[Proposed Rules]
[Pages 48972-48981]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-24836]


=======================================================================
-----------------------------------------------------------------------

ENVIRONMENTAL PROTECTION AGENCY

40 CFR Parts 52 and 81

[MI 52-01-7260; FRL-5894-6]


Approval and Promulgation of Implementation Plans; Michigan

AGENCY: Environmental Protection Agency (EPA).

ACTION: Proposed rule.

-----------------------------------------------------------------------

SUMMARY: The Environmental Protection Agency (EPA) is proposing 
approval of the requested revisions to the Michigan State 
Implementation Plan (SIP) for ozone, carbon monoxide, sulfur dioxide, 
nitrogen dioxide, particulate matter and lead. The requested revisions 
are Michigan's Emissions Averaging and Emission Reduction Credit 
Trading Rules and supporting documents. These rules were submitted by 
the State of Michigan on April 17, 1996 as an optional revision to the 
SIP. The EPA has determined through its evaluation of the rules that 
they can be approvable upon submission of corrections to certain 
deficiencies that are identified in this notice.

DATES: Comments on this proposed action must be received by October 20, 
1997.

ADDRESSES: Written comments should be addressed to: Carlton T. Nash, 
Chief, Regulation Development Section, Air Programs Branch (AR-18J), 
United States Environmental Protection Agency, Region 5, 77 West 
Jackson Boulevard, Chicago, Illinois 60604.
    Copies of the State's submittal and EPA's analysis (Technical 
Support Document) are available for inspection at the following 
location: United States Environmental Protection Agency, Region 5, Air 
and Radiation Division, 77 West Jackson Boulevard, Chicago, Illinois 
60604. (Please telephone Alexis Cain or Rick Tonielli before visiting 
the Region 5 Office.)

FOR FURTHER INFORMATION CONTACT: Alexis Cain at (312) 886-7018 or Rick 
Tonielli at (312) 886-6068.

SUPPLEMENTARY INFORMATION:

I. Background

    Michigan submitted these rules as a SIP revision to allow sources 
of emissions of ozone precursors (NO<INF>X</INF> and VOCs) and non-
ozone criteria pollutants (CO, SO<INF>2</INF>, NO<INF>2</INF>, PM-10 
and lead) flexibility in complying with requirements already in the 
SIP. The program provides emissions sources with a financial incentive 
to reduce emissions below levels required by applicable Federal and 
State requirements and below their actual emissions of the recent past. 
Sources that make these extra reductions beyond requirements generate 
emission reduction credits (ERCs) that they can use later or sell to 
other sources. ERCs may be used by sources to comply with emissions 
limits. The program is not a means of limiting emissions; instead, 
trading and averaging are meant to provide an opportunity to comply 
with existing emission limits in a more cost effective manner. 
Michigan's emissions trading credit and averaging rules are not a 
required SIP submission under the Clean Air Act (the Act).

Outline of State Program

    Michigan's SIP submittal includes both ``open market'' trading and 
emissions averaging. In an open market trading system, credits are 
first generated, then subsequently traded, so that generation and use 
of the credit are separated in time. Open market programs rely on 
continual credit generation to ensure that use of previously generated 
credits is balanced by generation of new credits, so that ``spikes'' in 
emissions are not created by credit use. Sources participating in an 
open market trading program generate discrete emission reductions, 
referred to as emission reduction credits (ERCs) in the Michigan 
program, by reducing emissions below a baseline over a discrete time 
period. The generation baseline is established by existing 
requirements, and is determined by the lower of allowable emissions or 
actual past emissions. Credits can either be used at a later time by 
the generator source or be sold to another source; the use of credits 
allows a source to emit above its emission limit while remaining in 
compliance.
    The Michigan program also allows emissions averaging at sources 
that are subject to Reasonably Available Control Technology (RACT) 
requirements and are under common ownership and control. Under 
Michigan's emissions averaging provisions, one source can exceed a 
permitted emissions limit, as long as there is a simultaneous 
reduction, equaling 110 percent of the exceedance, at another source 
under the same ownership or control, but not necessarily at the same 
location. In both the open market and emission averaging provisions of 
Michigan's rule, 10 percent of the emission reductions generated are 
retired for an environmental benefit.
    Sources can trade and average emissions of volatile organic 
compounds (VOCs) as a group, nitrogen oxides (NO<INF>X</INF>), and all 
criteria pollutants other than ozone. VOC and NO<INF>X</INF> ERCs must 
be designated as either ozone season or non-ozone season credits; VOC 
and NO<INF>X</INF> ERCs generated outside of the ozone season cannot be 
used during the ozone season.
    Under the Michigan plan, sources which generate ERCs or engage in 
emissions averaging must provide the Michigan Department of 
Environmental Quality (MDEQ) with a notice that includes information 
about the source

[[Page 48973]]

generating the reductions, the methods of generating the reductions, 
the amount of reductions, and the methods used to measure the 
reductions. An official representative of the source must certify that 
the information contained in the notice is ``true, accurate and 
complete,'' that the emission reductions generated are ``real, surplus, 
enforceable, permanent and quantifiable,'' and that the reductions have 
not been used elsewhere for averaging or credit generation. ERCs and 
averaging plans are not valid until MDEQ certifies that this notice is 
complete. The rule requires MDEQ to make a determination of 
completeness within 30 days. Similarly, sources which wish to trade or 
use ERCs must provide to MDEQ a notice which includes information about 
the source using the ERCs, the number of ERCs to be used, the 
requirements being complied with through the use of ERCs, and a copy of 
the generation notice for the ERCs that will be used. A responsible 
official must certify that the information is ``true, accurate, and 
complete'' and that the source will be operated in compliance with all 
applicable requirements, including requirements for the use of ERCs.
    As mentioned previously, the Michigan program requires a retirement 
of 10 percent of ERCs generated, and of 10 percent of the reductions 
used in an emission averaging program, to create a benefit for the 
environment. In addition, VOC and NO<INF>X</INF> ERCs are discounted 10 
percent per ozone season. All ERCs expire five years after being 
generated.

Basis for Evaluation of SIP Revision

    In 1994, EPA issued Economic Incentive Program (EIP) rules and 
guidance (40 CFR part 51, subpart U), which outlined requirements for 
establishing EIPs that States are required to adopt in some cases to 
meet the ozone and carbon monoxide standards in designated 
nonattainment areas. Michigan is not required to submit an EIP, so its 
emission trading and averaging program need not necessarily follow the 
EIP rule; however, subpart U also contains guidance on the development 
of voluntary EIPs.
    The EPA has also published a proposed policy on open market trading 
programs (60 FR 39668, August 3, 1995) and a model open market trading 
rule (60 FR 44290, August 25, 1995), which will be published as 
guidance. This guidance will describe the elements of an open market 
trading program that EPA considers to be desirable, and those that are 
necessary for a program to be approvable as a SIP revision. As of this 
writing, this guidance has not been finalized. Moreover, Michigan began 
to develop its emissions trading program prior to the proposed guidance 
on open market trading. Therefore, EPA does not expect Michigan's rule 
to conform to this guidance.
    Michigan's submittal is being evaluated on the basis of whether it 
meets the requirements of SIPs as described in section 110 of the Act. 
In particular, review focuses on whether the SIP as revised would be 
enforceable, whether the revision would negatively affect the SIP's 
ability to provide for attainment and maintenance of the National 
Ambient Air Quality Standards (NAAQS), whether it would protect against 
violations of Prevention of Significant Deterioration (PSD) increments, 
and whether it would violate any other provisions of the Act.

II. Analysis of State Submittal

A. Size of Tradable Units

    Under Michigan's program, ERCs are denominated in tons, but not 
necessarily in whole tons. While the rule itself does not specify the 
fractions that can be used, MDEQ staff indicate that credits may be 
denominated in tenths of tons, if such precision is merited by the 
measurement accuracy of the quantification protocol. While it would be 
preferable from EPA's perspective to denominate all credits in whole 
tons, Michigan's procedure is acceptable. No procedure is identified in 
the rule for rounding the amount of credits generated or the amount 
used. The EPA would suggest specifying that ERC users round up to the 
nearest unit when determining the amount of ERCs needed, and ERC 
generators must round down to the nearest unit when determining the 
amount of ERCs generated. Although it is not specified in the rule, 
MDEQ staff have indicated that they will require use of a similar 
procedure.

B. Benefit Sharing With the Environment

    Michigan appropriately requires that generators of ERCs retire 10 
percent of the ERCs generated as an environmental benefit when 
providing notice of generation.

C. Trading of Oxides of Nitrogen

    While the intent of the trading rules is clearly to allow trading 
of NO<INF>X</INF>, the ozone precursor, as well as NO<INF>2</INF>, the 
criteria pollutant, Rule 1203(2) indicates that the program ``applies 
only to volatile organic compounds as a class of compounds and all 
criteria pollutants, except ozone.'' In order to allow for trading of 
NO<INF>X</INF> as well as NO<INF>2</INF>, this statement must be 
changed to add NO<INF>X</INF> to the list of compounds eligible for 
trading.

D. Claiming Ownership of ERCs

    Michigan's rule does not include a discussion specifying which 
parties are eligible to generate credits in situations where more than 
one party has a potential claim. This issue is significant because the 
rights to credits generated by a particular credit generation strategy 
will be unclear in some cases. For instance, a manufacturer of a device 
that reduces automobile emissions might attempt to register credits 
based on the sale of the device within Michigan. However, an owner of a 
vehicle fleet might also attempt to register credits based on his or 
her installation of those same devices within the fleet. Registration 
of both sets of credits would double count the emission reductions, 
leading to excess credits being generated.
    MDEQ must address the issue of ownership claims in its procedures 
for approving notices of credit generation. Guidance will be 
forthcoming on this issue from EPA.

E. ERC Generation Issues

1. ERC Generation Baseline
    Rule 1207 explains how the baseline from which a source may 
generate credits is determined. Calculations must be based on the 
source's emissions over the most recent 2 years or most recent 2 ozone 
seasons, unless it can be shown that another time period is more 
representative of actual emissions. Measurement must be based on 
continuous emission monitoring (CEM) or parametric monitoring if 
required by applicable requirement or if practical and reasonable; 
otherwise, measurement for stationary sources will be based on emission 
monitoring methods specified by applicable requirement or approved by 
MDEQ. The baseline is calculated using an equation that includes the 
lower of the actual or allowable emission rate, a capacity utilization 
factor representative of the historical production rate of the source, 
and the average actual operating hours of the source.
    The generation baseline is determined by the emissions that 
occurred prior to ``the initiation of an activity to reduce emissions 
for the purposes of creating emission reduction credits.'' <SUP>1</SUP> 
(Rule 1207(1)) However, Michigan's rule also

[[Page 48974]]

requires that reductions which generate ERCs be ``surplus,'' defined as 
``those emission reductions made below an established source baseline 
which are not required in the state implementation plan, any applicable 
federal implementation plan, any applicable attainment demonstration, 
reasonable further progress plan, or maintenance plan and which are not 
mandated by any applicable requirement.'' Thus, the generation baseline 
must be adjusted to reflect new requirements.
---------------------------------------------------------------------------

    \1\ For mobile source emissions, the baseline can be established 
by the emissions projected in the absence of an emissions reduction 
action, ``where a period of historical operations and actual 
emission data or activity levels cannot be used to determine 
emissions.'' (Rule 1207(2)(b)(3))
---------------------------------------------------------------------------

    The rules do not set any limit on the age of emissions data that 
can be used to establish a generation baseline, although the 
requirement to show that other data is more representative when not 
using the previous 2 years as a baseline should limit, in practice, how 
far back a source could go. The EPA strongly urges MDEQ to reject the 
use of any baseline calculated based on data from any date prior to 
November 15, 1990.
2. ERC Generation Start Date
    Michigan's emissions trading rules allow credits to be generated 
from actions dating back to 1991, accruing starting in 1991. Allowing 
use of credits generated prior to enactment of the program has 
potentially troublesome aspects. Credits generated prior to enactment 
of the rule could flood the market, creating widespread use of cheap 
credits and discouraging the generation of new credits. With generation 
of new credits suppressed and abundant old credits in use, total 
emissions could exceed levels that would have occurred in the absence 
of the trading program.
    However, several aspects of Michigan's program provide some 
protection against this potential problem. First, credits generated 
prior to enactment of the rules are discounted 50 percent, rather than 
the usual 10 percent. Second, credits last only 5 years beyond the time 
that the reductions occur. Therefore, reductions generated in the early 
1990s will have a very limited life. Finally, credits generated from 
early reductions must be registered within 1 year of enactment--by 
March 17, 1997, a date which has already passed, allowing the State to 
determine immediately the total number of pre-enactment credits that 
are registered and in circulation.
    While EPA would prefer that the program not allow credits to be 
generated prior to enactment of the trading rule, and that credits not 
be generated from actions taken more than 1 year prior to enactment, it 
is willing to accept Michigan's approach, contingent upon receipt from 
the State of the following: an accounting of the number of pre-
enactment credits generated and the remaining life of these credits, 
and an analysis which demonstrates to EPA's satisfaction that the 
potential use of these credits is unlikely to have a detrimental effect 
on attainment or maintenance of the NAAQS or on any other requirement 
of the Clean Air Act.
3. Credit Generation Through Activity Level Reductions
    Michigan's program allows stationary sources to generate ERCs 
through curtailing production, provided that the notice of generation 
is submitted prior to the curtailment of operations. It also allows 
sources which are shut down to generate ERCs for 5 years following the 
shutdown. Therefore, given the 5 year limit on ERC life, shutdown 
credits could be used a maximum of 10 years after the shutdown occurs.
    Maintenance and attainment plans often rely upon emission 
reductions caused by production decreases at some sources (i.e., 
shutdowns and curtailments) to help counteract increased emissions 
caused by higher levels of production at sources subject to emission 
rate limits, where emission increases are allowed to occur when net 
production increases. Under Michigan's open-market trading system, 
however, while increases in production at sources with emission rate 
limits will still lead to emissions increases, production decreases 
will not generate offsetting emissions reductions, since the reductions 
resulting from production decreases can generate ERCs that are used to 
allow higher emissions elsewhere. Therefore, overall emissions may 
increase without a net increase in production under the trading 
program; this is clearly a detriment to the environment.
    Another problem potentially created by use of shutdown credits is 
that load-shifting could occur among small sources such as gas stations 
or print shops. Such sources could reduce emissions and generate ERCs 
by shutting down or reducing production; however, the economic activity 
of these sources will likely be picked up by new or existing sources in 
the same areas, replacing the emissions for which ERCs were just given. 
Since emissions created by increased operating rates by other existing 
sources are not limited, and since new small sources are not subject to 
an offset or cap requirement, the net effect of allowing shutdowns and 
curtailments to generate ERCs would be to increase overall emissions. 
Michigan's rule 1207(5) provides protection against load-shifting among 
sources under common ownership or control. However, it does not protect 
against load shifting among sources under different ownership or 
control.
    Moreover, allowing generation of ERCs from shutdowns and 
curtailments could lead to generation of ERCs from emissions reductions 
already relied upon in an attainment or maintenance plan, as mentioned 
previously. Attainment and maintenance plans represent an effort to 
prevent future violations of the NAAQS by projecting emissions 
increases that will result from economic growth, factoring in the net 
of shutdowns and curtailments, and insuring that emissions controls 
will constrain emissions adequately despite net economic growth.
    In order to correct this deficiency, Michigan can pursue one of 
three options. The simplest and best option, from EPA's perspective, is 
to prohibit the generation of ERCs from shutdowns and curtailments. A 
second option is to prohibit the use of shutdown credits for compliance 
with federal requirements in any area that has or needs an approved 
attainment or maintenance demonstration. A third option is to prohibit 
the use of shutdown credits for compliance with federal requirements in 
any area that needs but lacks an approved attainment or maintenance 
demonstration, while demonstrating to EPA's satisfaction that none of 
Michigan's approved maintenance and attainment plans will be 
compromised by the use of these credits. To make this demonstration, it 
will be necessary to show that these plans do not rely in any way on 
emission reductions created by source retirements or curtailments, and 
that there is not an unacceptable level of risk that these credits 
would interfere with future attainment or maintenance requirements. If 
it decides to pursue this option, MDEQ must also seek public comment on 
this form of credit generation.
4. Overcompliance With an Alternative RACT Determination
    Emissions sources which cannot comply with a RACT limit because it 
would not be technically feasible or economically reasonable can 
receive an alternate RACT determination. Serious equity concerns would 
be raised if such sources were allowed to generate credits by reducing 
emissions below their alternative emission limit, while other sources 
were required to base credit generation on their RACT limit. Therefore, 
Michigan's rule appropriately disallows the use of an alternative 
emission limit above an applicable RACT limit for the purpose of 
setting a baseline. A source that has an

[[Page 48975]]

alternative emission limit can generate credits only by reducing 
emissions below the RACT limit.

F. ERC Emission Reduction Quantification Protocols

    The credibility of an emission trading program depends on the 
ability of sources and regulatory agencies to judge the value of the 
currency--in Michigan's case, the emissions reduction credits-- used in 
the program. Thus, it is vital that the criteria used for judging the 
adequacy of emissions quantification protocols be clearly understood by 
all parties. Moreover, it is important that sources understand the 
elements of quantifying emissions reductions in an emission trading 
program (i.e., the need to establish a baseline, the need to ensure 
that reductions are not overestimated) that do not arise when 
quantifying emissions simply for the purpose of demonstrating 
compliance. In a program where no agency pre-certification of the 
validity of credits takes place, it is vital that the basis for an 
enforcement action against generators and users of bad credits be 
clearly delineated. Furthermore, while EPA does not wish to delay the 
use of emission trading for sources in categories that do not have EPA-
approved quantification protocols, a source in a category that already 
has an EPA-approved protocol must use it, unless it gains EPA approval 
for use of an equally-good protocol.
    Michigan's emission trading program already contains the 
requirement that emission reduction credits be real, surplus, 
enforceable, permanent, and quantifiable. In order to ensure that these 
criteria are met, Michigan must take two steps; first, incorporate into 
the emissions trading rules a requirement that sources in categories 
without EPA-approved protocols must follow a set of EPA-approved 
protocol development criteria that have been provided to MDEQ (Letter 
from David Kee to Dennis Drake, July 1, 1997) when developing protocols 
for their source category, and second, commit in the SIP to require use 
of existing and future EPA-approved protocols for quantifying emission 
reductions at applicable sources, and to allow sources to deviate from 
an EPA protocol only if they first get the approval of EPA.

G. Potential Uses of ERCs

1. RACT Compliance Alternative
    The Michigan rule appropriately allows ERCs to be used as a RACT 
compliance alternative. The EPA recommends that in conjunction with its 
trading program, Michigan consider halting alternative RACT 
determinations/variances, given that ERCs provide an alternative means 
of compliance for sources that cannot otherwise meet RACT. At a 
minimum, the State should consider the cost and availability of ERCs 
when making economic feasibility-based alternative RACT determinations.
2. New Source Review Requirements
    a. Synthetic minor sources: A ``synthetic minor'' source is one 
that has the potential to emit at major source levels defined by the 
New Source Review (NSR) program, but whose emissions are artificially 
limited by its permit to levels below those that would subject it to 
the major source requirements of NSR. Michigan's Rule 1204(6) allows a 
synthetic minor source to use ERCs to make a temporary increase in 
emissions that would bring its total emissions above the major source 
threshold, without making the source subject to the requirements that 
would normally apply to sources which exceed the threshold, such as New 
Source Review and Title V. This increase must not exceed major 
modification levels as specified in 40 CFR 52.21; ``temporary increase 
in emissions'' is defined in Rule 1201(ee) as an increase ``which 
occurs for less than 12 months and which does not occur more than once 
in a 24 month period.''
    This provision is unacceptable because of its potentially serious 
environmental consequences. It would allow sources that would otherwise 
be required to undergo New Source Review to use emission reduction 
credits to avoid this requirement. For example, assume that a synthetic 
minor source with a potential to emit of 150 tons per year (tpy) has 
agreed to a limit of 90 tons per year in order to avoid major source 
status. Assume that this source wishes to increase its emissions to 117 
tpy. Under the Michigan program, the source could purchase 27 tons of 
ERCs to compensate for the increase. The 27 tons would have been 
generated by a source or sources which reduced emissions by 30 tons, 
leading to the retirement of 10 percent of these reductions for an 
environmental benefit. Thus, the environment would see a net 
improvement of 3 tons from the trade.
    In the absence of the trading program, however, a 90 tpy synthetic 
minor source that increases its production above 100 tpy would undergo 
New Source Review; as a result, the source would be required to comply 
with the provisions of Best Achievable Control Technology (BACT) or 
Lowest Achievable Emission Rate (LAER), which would frequently result 
in a reduction of the source's total emissions by an amount 
substantially larger than 3 tons. This loss of reductions means that 
the synthetic minor provisions of the Michigan rule could, in many 
cases, result in a significant loss of environmental benefit. In 
summary, emissions would be higher under the synthetic minor program 
than they would be without it, since the emission reductions required 
by BACT or LAER will usually be greater than the 10 percent reduction 
for the environment that a trading program would achieve.
    The EPA's position is that ERCs may be used to comply with, but not 
to avoid, Clean Air Act requirements. This policy applies to New Source 
Review and Title V permit requirements. By allowing this use of ERCs to 
avoid a requirement, even temporarily, the trading rule allows 
emissions to be higher than they would be otherwise.
    There is also an important legal basis for finding this provision 
to be deficient. According to 40 CFR 52.21(r)(4): ``At such time that a 
particular source or modification becomes a major stationary source or 
major modification solely by virtue of a relaxation in any enforceable 
limitation which was established after August 7, 1980, on the capacity 
of the source or modification otherwise to emit a pollutant, such as a 
restriction on hours of operation, then the requirements or paragraphs 
(j) through (s) of this section shall apply to the source or 
modification as though construction had not yet commenced on the source 
or modification.''
    This deficiency can be corrected by removing Rule 1204(6) from the 
SIP submittal. In the absence of Rule 1204(6), synthetic minor sources 
in Michigan will be prevented from using trading to avoid requirements, 
but they will still be allowed to use trading to compensate for any 
emissions increases that would not trigger new requirements in the 
absence of the trading program.
    b. Compliance with NSR and PSD Emission Limits: Michigan's rule 
prohibits the use of credits in place of installing equipment 
determined to constitute BACT or LAER requirements under the NSR 
program. However, credits can be used for compliance with the BACT or 
LAER emissions rate when the required equipment has been installed and 
is being properly maintained, but the emissions rate is nonetheless 
being exceeded. This provision will allow a source that exceeds 
permitted emissions, despite installing and properly maintaining the 
required equipment, to remain in compliance until permit limits are 
revised to reflect the emission

[[Page 48976]]

reductions actually achieved by the required technology. The EPA 
believes that this is an appropriate use of credits, and suggests that 
the rule could be strengthened by specifying what steps will be taken 
by the State to limit the amount of time the source remains out of 
compliance with BACT or LAER.
    c. Offsets and Netting: Michigan allows use of credits for offsets 
or netting at new or modified sources, with the following restrictions:
    i. New sources which use ERCs for offsets must cover a minimum of 
2.5 years of operation, and modified sources must cover the period of 
time from issuance of an NSR permit to the date of issuance or renewal 
of an operating permit.
    ii. For renewal of an operating permit, the source must obtain ERCs 
covering 5 years, or the term of the operating permit.
    iii. The NSR permit must contain an enforceable commitment that the 
source may not receive an operating permit or operating permit renewal 
unless the operating permit contains an enforceable condition requiring 
the source to obtain offsets for 5 years or the period of time for 
which the permit is issued.
    iv. ERCs used as offsets or for netting must be generated in the 
``nonattainment area where the new or modified source is located or an 
adjacent nonattainment area of equal or higher classification or other 
area that contributes to the exceedance of a national ambient air 
quality standard in the nonattainment area where the new or modified 
source is located.'' Also, use must be in accordance with Clean Air Act 
Section 182 and Michigan rule R 336.1220 (the State's ``major offset 
rule'').
    Section 182 of the Clean Air Act requires that offsets obtained 
from a different nonattainment area must be both from the same or 
higher classification and must contribute to a NAAQS exceedance in the 
relevant nonattainment area. This contraction in the rules appears to 
be an oversight; Rule 1211(3)(a) must be modified to reflect the 
language of Section 182 of the Clean Air Act.
    Michigan's rule would allow ERCs to be banked for the purpose of 
netting. As stated in the technical support to the SIP, ``the 
reductions are still required to be made at the same stationary source 
and must be contemporaneous and of sufficient quantity to qualify under 
NSR regulations.'' Under the current definition of netting (40 CFR 
52.21), emissions increases and decreases considered for the purpose of 
netting must be ``contemporaneous,'' defined as occurring within a 
period beginning 5 years before the date that construction is expected 
to commence on the proposed modification and ending when the increase 
from the modification occurs. Since ERCs expire 5 years after being 
generated under the Michigan rule, the contemporaneous requirement 
would not be violated under Michigan's rule.
    For both offsets and netting, the technical support to the trading 
rule SIP submission indicates that MDEQ's intention is to allow ERCs to 
be used only in a manner consistent with New Source Review 
requirements. This intention must be stated explicitly as an 
enforceable requirement of the rules.
3. NESHAP and NSPS Requirements
    Michigan's rule appropriately prohibits the use of credits to 
comply with National Emission Standards for Hazardous Air Pollutants 
(NESHAP) and New Source Performance Standard (NSPS) emission 
limitations or work practice standards.
4. Certain Mobile Source Standards
    Michigan's rule appropriately prohibits the use of credits to 
comply with ``Federally mandated mobile source requirements.''
5. Title IV Acid Rain Requirements
    Michigan's rule appropriately prohibits Title IV sources that 
participate in the Title IV acid rain cap-and-trade program from using 
SO<INF>2</INF> and NO<INF>X</INF> credits generated under Michigan's 
trading rule to fulfill Title IV requirements.

H. ERC Use Requirements

1. Ownership of Credits Prior to Use
    In open market trading programs, it is vital that sources that use 
credits be required to own the credits prior to use. This requirement 
ensures that sources will not be able to use trading to avoid the need 
to maintain a compliance margin by simply using credits to ``true up'' 
after having exceeded their emission limits. Clearly, it is the intent 
of the Michigan program to require ownership of credits prior to use--
Rule 1208(7) requires that emission reductions be generated prior to 
being used or traded; Rule 1214(1) requires a user source to submit a 
Notice of Use to MDEQ (which includes a copy of the Notice of 
Generation for the credits being used); the price paid for credits must 
be in the Notice of Use or submitted separately to the State within 
seven business days of the use or trade; and Rule 1216(1) places 
liability upon the source for assuring compliance with all applicable 
requirements. However, the rules do not contain a straightforward 
requirement that credits must be owned before use, nor do they specify 
that failure to hold sufficient credits is a violation. These 
deficiencies must be corrected in the rules.
2. Use Baseline
    A trading program must specify the baseline for users of emissions 
reduction credits, so that users know how to calculate the number of 
credits that will be needed for compliance. While Michigan's intention 
seems to be that the baseline will be established by allowable 
emissions--that is, the maximum level of emissions that would have 
occurred had the source met its compliance obligations without the use 
of emission reduction credits--the rules do not make this intention 
explicit. The rules must include a specific definition of the user 
source baseline.
3. Temporal Requirements
    The Michigan rule appropriately prohibits use during the ozone 
season of NO<INF>X</INF> and VOC ERCs generated outside of the ozone 
season. The rule allows ERCs generated during the ozone season to be 
used during the entire year. This provision is appropriate because it 
could encourage sources to shift emissions of ozone precursors from the 
ozone season to the winter months, creating environmental benefits.
4. Geographic Requirements
    Emission trading involves shifting of emissions from one area to 
another. An emission trading program requires restrictions on the 
geographic scope of trading in order to ensure that localized air 
quality problems are not created. In particular, a trading program must 
ensure that emission reductions generated in areas of clean air are not 
used to allow emissions increases in areas of poor air quality. The 
nature of the geographic restrictions needed depends on the transport 
characteristics of the pollutant being traded. Pollutants that affect 
air quality long distances from the location of their emission can 
potentially be traded over a large area, while pollutants that affect 
air quality in a small area should not be traded beyond that area.
    The Michigan rule includes some provisions to discourage the 
shifting of emissions from low pollution areas to areas with higher 
pollution. Under the Michigan rule, trading can occur within the same 
or a contiguous attainment area, between contiguous nonattainment areas 
of the same classification, or from a nonattainment area to an 
attainment

[[Page 48977]]

area anywhere else in the state, on a 1:1 ratio. ERCs used in a 
nonattainment area but generated in an attainment area or a 
nonattainment area of lower classification elsewhere in the state must 
be discounted by the ratios specified for the higher classification 
area in section 182 of the Act, in addition to the 10 percent discount 
for the environment. For instance, there would be a total 25 percent 
discount for a trade from an attainment area to a moderate 
nonattainment area (10 percent for the environment, 15 percent for the 
geographic shift). The rule does not specifically address the issue of 
trades between noncontiguous areas of the same classification.
    Despite these provisions, the current geographic restrictions in 
Michigan's SIP are not sufficient to ensure that ERCs will be used in a 
manner that would maintain or improve air quality. EPA is concerned 
that sources in attainment areas could generate large numbers of ERCs 
by reducing emissions from an uncontrolled baseline. These ERCs could 
then be used to allow for emissions increases or to forego reductions 
in nonattainment and maintenance areas where emission controls are 
required and where reductions are necessary to achieve attainment. 
Moreover, it is unlikely that these trades would be balanced by an 
equal volume of trades in the opposite direction, since sources in 
attainment areas are subject to fewer requirements and would have less 
need of ERCs than sources located in nonattainment areas. For example, 
Michigan has some VOC RACT rules which apply only in nonattainment and 
maintenance areas, or that have lower applicability thresholds in those 
areas. Sources subject to these requirements could potentially use VOC 
credits that were generated outside the area from an uncontrolled 
baseline. This would result in a net decrease in air quality, since 
credits would be shifted into the more highly polluted area where the 
requirements applied. For these reasons, trading between attainment and 
nonattainment areas may not balance out, despite the required discounts 
for attainment area ERCs used in nonattainment areas.
    Trading between nonattainment or maintenance areas and attainment 
areas could be acceptable in cases where the State provides a 
demonstration that pollution emitted in an attainment area affects a 
nonattainment or maintenance area. EPA feels that it would be difficult 
to demonstrate that emissions from the entire State affect air quality 
in Michigan's nonattainment areas for ozone or for the other criteria 
pollutants. However, EPA agrees with Michigan that a more regional 
approach to protecting air quality is needed.
    a. Geographic Restrictions on Trading of Ozone Precursors: EPA's 
proposal for an interim implementation policy (IIP) for a potential new 
ozone standard (61 FR 65752-65762, December 13, 1996) includes an 
example of a possible regional approach to trading of VOCs and 
NO<INF>X</INF>. This proposal suggests that nonattainment areas be 
allowed to take credit for reductions occurring within an expanded area 
extending 100 km from the nonattainment area boundary for VOCs and 200 
km from the nonattainment area boundary for NO<INF>X</INF>. While the 
IIP proposal would allow this expanded geographic area to be used for 
the purpose of meeting post-1996 and post-1999 rate-of-progress 
requirements, EPA believes that the same geographic limits could be 
adopted to fit the trading allowed in the Michigan rule. Revising the 
Michigan rule to allow trading and averaging of VOC and NO<INF>X</INF> 
emissions within these geographic limits would enable sources to escape 
the current restrictions caused by attainment and nonattainment area 
designations, while also ensuring that the air quality in the area 
where trading occurs will be, on average, improved. Making this 
revision would eliminate EPA's transport-related approvability issues 
for NO<INF>X</INF> and VOCs. These geographic limits, of course, need 
apply only to sources which use trading to meet Federal, or SIP, 
requirements.
    b. Restrictions on Trading of Criteria Pollutants other than Ozone: 
Because of the highly localized impacts that can be created by 
emissions of the criteria pollutants other than ozone, all trades and 
averaging involving above de minimus levels of these pollutants must be 
evaluated for their localized impacts. For these pollutants, trading 
between an attainment area and a nonattainment or maintenance area is 
unacceptable, and trading above de minimus levels even within areas is 
acceptable only if an evaluation indicates that the trade will not 
cause an air quality problem.
    Trading of emissions of sulfur dioxide, nitrogen dioxide, 
particulate matter, carbon monoxide and lead, as allowed under 
Michigan's program, creates concerns that do not arise in the trading 
of ozone precursor emissions. Trading of criteria pollutants other than 
ozone raises questions about whether the trading program would be 
adequately protective of the National Ambient Air Quality Standards 
(NAAQS), given that stationary source emissions of these pollutants can 
create highly localized air quality problems (CO and fine particulates 
can be either an area-wide or a localized problem). Moreover, a shift 
in emissions of these pollutants from, for instance, a tall stack to a 
short stack can make a major difference in air quality. Therefore, for 
criteria pollutants other than ozone, special protections are needed to 
ensure that use of ERCs does not lead to NAAQS violations. Whereas 
attainment and maintenance plans for ozone focus on reducing the 
region-wide emissions of ozone precursors, for the other criteria 
pollutants, the specific location of the emissions is of vital 
importance. Rule 1204(1) provides some protection against violations of 
the NAAQS or of attainment or maintenance plans, stating that:

emission averaging and the use of emission reduction credits in an 
attainment area shall not cause a violation of a national ambient 
air quality standard, allotted prevention of significant 
deterioration increments, or an applicable attainment area 
maintenance plan. Emission averaging and the use of emission 
reduction credits in a nonattainment area shall result in emission 
reductions consistent with the requirements for reasonable further 
progress for the nonattainment area and the attainment demonstration 
and maintenance plan specified in the state implementation plan.

    Michigan has developed procedures to ensure proper State review of 
ERC uses and emission averaging of criteria pollutants other than ozone 
that could cause concerns, and to ensure that modeling is done to 
predict the air quality impact of potentially problematic ERC uses and 
averaging. MDEQ's procedures for review of notices of use and emission 
averaging, containing adequate modeling requirements, must be submitted 
as part of the SIP to provide added protection against potential 
adverse environmental impacts created by trading of criteria pollutants 
other than ozone.
5. Intersector Trading
    Michigan's rule specifies that ERC trading between mobile and 
stationary sources is allowed. This provision is appropriate, since it 
increases the number of options for trading.
6. Interpollutant Trading
    The Michigan rule appropriately prohibits the use of ERCs for one 
criteria pollutant or ozone precursor to allow for increases in a 
different criteria pollutant or ozone precursor, ``except for 
interstate trading where the use is consistent with a regional ozone 
control strategy and the state implementation plan.''

I. Notice and Recordkeeping Requirements

    The Michigan rule requires that notices of generation or emission

[[Page 48978]]

averaging and notices of use and their supporting documentation 
accompany ERC trades, and establishes responsibility with the ERC users 
and generators, or emission averagers, to store and maintain this 
information. Michigan requires that copies of the notices and their 
supporting documentation be stored on site no less than five calendar 
years after the date of expiration of the emission averaging plan or 
after the date the ERC is used, expired, or retired. These 
recordkeeping requirements are appropriate.
1. Notice of ERC Generation
    The Michigan rule requires sources to file a Notice of Intent to 
Generate credits. For emission reductions generated between January 1, 
1991, and the effective date of the rule, sources have 1 year from the 
effective date of the rule to file such Notices. For post-enactment 
reductions, there is no specified filing deadline, since credit life is 
limited to 5 years after the year of generation. The rule appropriately 
requires that the Notice of Generation be included in the Notice of 
Use.
    The EPA suggests that Michigan require notification of the relevant 
Metropolitan Planning Organization in the event of mobile source 
generation activities, and that the Notice of Intent to Generate 
include a certification that the protocol used to quantify reductions 
was acceptable.
    MDEQ staff have developed a system for tracking ERCs by serial 
number. While the system assigns serial numbers for each batch of ERCs 
generated, not for each ton (as EPA would prefer), the Michigan system 
seems adequate to enable accurate tracking in the registry of each 
credit throughout its life.
2. Notice of Intent to Use ERCs
    Michigan requires that sources submit to the State a Notice of 
Intent to Use. The State then has 30 days to make a completeness 
determination of the notice. The notice requires a description of the 
``source, process, or process equipment'' where the credits will be 
applied. The EPA recommends that, to simplify compliance determination, 
the source, process, or process equipment be identified by permit or 
identification number.
    The party using credits is required to include the price paid for 
the credits, either within the notice or by separately notifying the 
State within seven business days of the use or trade. The Michigan rule 
does not require the user to notify the State when credits are used. 
However, the Notice of Intent to Use is required to include the 
effective dates of use of the emission credits (1214(1)(h)). Any 
methods used and operational changes made to accommodate the use of 
credits become legally enforceable upon the effective date of the 
completeness notice issued by the State. Furthermore, the rule requires 
the State to create an emission trading registry for ``recording and 
tracking emission averaging and the use and trading of emission 
reduction credits.'' The EPA feels that these provisions are adequate.
    Michigan also requires that notices of intent to use include 
identification of ``the methods and procedures used to quantify 
emissions and to determine compliance with all applicable 
requirements'' and ``calculations demonstrating compliance through the 
use of emission reduction credits.''
3. Public Availability of Information
    EPA policy is that any information required to determine emissions 
and to judge the quality of an ERC must be publicly available and 
therefore not designated confidential. Sources that wish to use ERCs 
must have access to this information, as must the general public. 
Michigan Rule 1213(5) allows portions of information in notices of ERC 
use or generation to be determined to be confidential under sections 
11(2) and (3) of Act No. 451 of the Michigan Public Acts of 1994. 
However, Act No. 451 specifies in part that ``data on the quantity, 
composition, or quality of emissions from any source'' may not be held 
confidential, and that ``data on the amount and nature of air 
contaminants emitted from a source shall be available to the public.'' 
EPA feels that these provisions in Act No. 451, as cited in the trading 
rule, adequately guarantee public access to the information needed to 
determine emissions from sources participating in trading and to 
evaluate the quality of ERCs.
    MDEQ must also ensure access to information collected by sources as 
part of an environmental self-audit that demonstrated erroneous or 
willful generation or use of invalid credits. As discussed in the 
following section, these sources may be eligible for a 30-day 
reconciliation period under certain circumstances; the state must be 
able to review this information to verify that such an opportunity is 
appropriate.

J. Enforcement and Compliance Provisions

1. Compliance Certification
    If either a generator or user of credits under the Michigan rule 
self-reports to the State errors in calculations, methods, etc. 
resulting in the generation or use of invalid credits, a reconciliation 
period of up to 30 days is generally permitted without penalty for the 
party at fault to purchase valid credits or to revise its planning to 
compensate for its errors. This reconciliation period is available to 
those who provide a notice within 30 days of discovery that includes an 
explanation that the circumstances causing the credits to be invalid 
have not occurred before, and a description of corrective steps that 
will be taken to ensure that the error does not occur again.
    The EPA would prefer that no reconciliation period be granted, or 
that some lesser penalty be identified for those sources that self-
report mistakes than those who do not; allowing a reconciliation period 
without any penalty lessens the incentive for generators and users of 
credits to ensure that credits are valid. However, this provision of 
Michigan's rule is acceptable because it limits the relief provided by 
the reconciliation period; it is available only to those sources self-
reporting errors. In addition, granting of a reconciliation period does 
not bring a source into compliance with the underlying requirement 
being violated, leaving them subject to enforcement.
2. Violations and Penalties
    Generators of credits which are discovered by the State to be 
invalid must purchase three times the amount of the invalid credits, 
which are then donated to the environment. The EPA supports the use of 
this type of penalty and the donation of the credits to the 
environment, and also recommends that provisions which address the 
circumstance in which a user knowingly uses invalid credits be added to 
the rule.
    Donation of credits to the environment under this subrule does not 
exclude a party from other penalties: ``A donation of emission 
reduction credits under this subrule shall not be considered to be a 
civil or criminal penalty * * * a person may also be subject to civil 
and criminal enforcement actions, fines, and imprisonment as provided 
under the act.'' (1216(3))
3. Assignment of Regulatory Liability
    In an open market program where credits are certified, the user can 
rely on the State's evaluation of credit quality (which is in turn 
based on an evaluation of the accuracy and validity of quantification 
methods). Without this certification, it falls upon the user to 
evaluate the quality of quantification techniques when determining how 
many credits are needed for compliance purposes, and upon the market to 
create

[[Page 48979]]

financial value for credits based on their quality.
    The Michigan rule requires that a credit be registered before use, 
but not certified; the State performs only a completeness determination 
of the Notice of Generation. The EPA strongly supports Rule 1216(1), 
which specifies that both the generator and user are held responsible 
for the generation of invalid credits. This feature of Michigan's rule 
provides an added incentive to the user to conduct the checks of credit 
validity that are not performed due to the absence of a credit 
certification process in the rule.
    This open market program design places considerable importance on 
the quality of quantification protocols, so that accurate 
determinations of credit value can be made by potential users. For this 
reason, the trading rules should include the provisions discussed in 
Section II (F) of this action requiring that Michigan follow EPA-
approved protocols and protocol development criteria.

K. Effect of Trading on Hazardous Air Pollutant Emissions

    The Michigan rule 1204(3) prohibits any use of ERCs or averaging 
that would result in an increase in the maximum hourly emission rate of 
a toxic air contaminant from an existing stationary source or area 
source, unless it can be demonstrated to the MDEQ that the increased 
rate will not cause or exacerbate the exceedance of a toxic air 
contaminant screening level based on the methodology in State rule 
R336.1230. This provision places the burden on sources to determine 
whether increased emissions of toxic air contaminants will result from 
emission averaging or ERC use. In addition, the Michigan rule allows 
the MDEQ to prohibit any use of credits or averaging that would result 
in an increase in any of a list of 14 toxic, persistent pollutants, if 
it determines that the increase would be ``inconsistent with the act or 
protection of public health, safety or welfare.'' <SUP>2</SUP> It would 
be up to the MDEQ to determine when such an inconsistency arose.
---------------------------------------------------------------------------

    \2\ The pollutants are mercury, alkylated lead compounds, 
cadmium, arsenic, chromium, polychlorinated biphenyls, chlordane, 
octachlorostyrene, toxaphene, hexachlorobenzene, benzo(a)pyrene, DDT 
and its metabolites, 2,3,7,8-tetrachlorodibenzo-p-dioxin, and 
2,3,7,8-tetrachlorodibenzofuran.
---------------------------------------------------------------------------

    The Michigan approach is considerably different from the one 
favored by EPA. The EPA's favored approach would not restrict increases 
in maximum hourly emissions of toxic pollutants, or restrict total mass 
increases of toxic, persistent pollutants, but rather would require 
sources that participate in open market trading to disclose all 
estimated or measured negative effects of credit trading on emissions 
of the hazardous air pollutants (HAPs) listed in section 112 of the 
Act.
    Many VOCs are listed as hazardous air pollutants (HAPs) in section 
112 of the Act, and emissions of particulate matter may include 
hazardous air pollutants. Emissions of these toxic pollutants are often 
reduced incidentally by compliance with VOC or particulate matter 
limitations. Accordingly, ERC generation could have the effect of 
lowering toxic emissions from a facility. However, trading could also 
result in higher levels of toxic emissions; if a facility that emits 
HAPs uses ERCs to satisfy a VOC or particulate matter requirement, the 
facility's emissions of HAPs could be higher than if the facility had 
installed controls. This would be an example of a foregone decrease in 
toxics emissions. Whether or not emissions of toxics are increased or 
decreased at a given source due to trading or averaging, Federal and 
State air toxics standards must continue to be achieved.
    EPA believes that citizens have the right to know if emissions 
trading may adversely affect the emissions of HAPs from a nearby 
facility, and therefore have a possible impact on public health. 
Disclosure of impacts on toxics emissions would also assist the State 
in determining if credit generation or use would trigger any air toxics 
program requirements at a particular facility and would allow 
identification and potential resolution of environmental justice issues 
as required in Executive Order 12898. Therefore, EPA requires that a 
State that implements an open market trading program must, at a 
minimum, require facilities to disclose the effect of open market 
emissions trading on HAP emissions. Disclosure must, at a minimum, 
follow the Toxics Release Inventory reporting requirements. States must 
also examine the effects of the open market trading program on HAP 
emissions as part of the periodic program performance audit.
    Michigan's Rule 1217(1)(c) requires that audits address ``whether 
the program has caused any localized adverse effects to the public 
health, safety, or welfare or to the environment.'' We interpret this 
provision to require examination of the effects of trading on HAPs, as 
well as on air quality impacts related to the criteria pollutants. 
However, Michigan's program lacks a requirement that the effects of 
trades also be disclosed to the public at the time of registration of 
use of credits. Michigan must include this requirement in its SIP.

L. Interstate Trading

    In order to accommodate a more regional approach to air quality 
management, it must be recognized that traditional boundaries, such as 
state lines, do not necessarily accurately reflect the geographic areas 
that are most relevant for emission trading purposes. For this reason, 
EPA agrees with Michigan's intent to allow interstate emissions 
trading.
    However, allowing the exchange of credits between two states that 
may have considerably different air quality management programs raises 
a variety of issues that must be addressed. Safeguards must prevent 
multiple uses of the same ERC unit, ensure enforceability of credits 
generated out of state, and require that States properly account for 
emission shifts in attainment planning and Reasonable Further Progress 
milestone demonstrations. Michigan must provide a federally enforceable 
commitment that it will not allow the use of credits from other states 
without first entering into an adequate Memorandum of Understanding 
(MOU) with that State. Michigan may either submit an MOU that addresses 
these concerns to EPA for approval prior to undertaking trades with 
another State, or include in its SIP revision a list of items that the 
State commits to address in each future interstate MOU. With the latter 
option, a future MOU need not undergo EPA review and approval, but the 
SIP must ensure that any subsequent MOU addresses the consistency 
between key trading rule elements in each State, including:
    1. The ERC identification system;
    2. Sharing of required Notices and a compatible credit tracking 
system;
    3. Geographic limitations (for instance, a VOC trade between 
Michigan and Colorado should not be allowed);
    4. Credit lifetimes and expiration dates;
    5. Record retention requirements;
    6. The list of acceptable credit generation and use activities;
    7. Consistent treatment of credit generation and use protocols;
    8. Credit generation base case definitions; and
    9. Ozone season definition and any other temporal requirements.
    Additionally, an MOU must contain a clear statement that each State 
will enforce emission limitations under its jurisdiction and a 
procedure for incorporating emission shifts caused by trading in each 
State's attainment and

[[Page 48980]]

maintenance plans and demonstrations, RFP plans and demonstrations. The 
MOU must make a determination on which State's laws determine whether a 
credit is valid. EPA agrees with MDEQ that any out-of-State credit must 
comply with the user State's requirements.

M. Protection of Class I Areas

    The EPA has a policy of providing special protection for Class I 
areas (pristine environments such as international parks and large 
national parks and wilderness areas), as required under sections 160 
through 169 of the Clean Air Act. This policy includes keeping Federal 
Land Managers informed of activities that could affect air quality in 
Class I areas. In accordance with this policy, to receive EPA approval, 
emissions trading programs must include provisions requiring that the 
relevant Federal Land Manager be notified 30 days before any ERC use 
activity occurs in, or within 100 km of, a Class I area. Michigan's 
rule contains no such notification provisions. This deficiency could be 
corrected by rule revision, or by procedures submitted as part of the 
SIP which require MDEQ staff to forward notices of use or notices of 
emissions averaging which involve increases within 100 km of a Class I 
area to the Federal Land Manager.

N. Federal Operating Permits

    In order to allow for open market emission trading, Michigan must 
revise its federally required operating permit program to cite the 
trading rule in order to recognize ERC use as a compliance alternative 
for permitted sources that are covered by the emissions trading rule. 
Prior to ERC use, every permitted source that intends to use ERCs or 
emissions averaging must possess a permit containing language that 
references the emissions trading and averaging rules and allows ERCs to 
be used for compliance demonstrations.

O. Open Market Program Audits

    Michigan requires an evaluation of the emission trading program and 
a public report to be made at least every 3 years, or more frequently 
if deemed necessary by the State. The EPA supports the provisions that 
specify that an audit evaluate:

--Whether the program is consistent with achievement and maintenance of 
the NAAQS and has resulted in emission reductions consistent with 
reasonable further progress toward attainment;
--Whether monitoring, recordkeeping, reporting, and enforcement have 
resulted in a sufficiently high level of compliance;
--Whether the program has caused any localized adverse effects to 
public health, safety, or welfare or the environment;
--Whether the program is achieving reductions across a spectrum of 
sources, including area and mobile sources; and
--Whether individual source audit provisions have resulted in a 
sufficient number of audits.

P. Contingency Measures

    Michigan's rule states that if, after the triennial program 
evaluation, MDEQ determines that program revisions are necessary, it 
will revise the program and submit a SIP revision to EPA within 6 
months. This provision is appropriate. EPA considers that program 
revisions would be warranted if ERC generation has been greater than 
ERC use, resulting in emissions spiking on days of poor air quality or 
failure to meet area wide RACT-level or other required emission 
reductions; if trading or averaging has led to an increase in exposure 
to hazardous air pollutants or criteria air pollutants, or if Class I 
areas have been adversely affected by the generation or use of ERCs.

Q. Early NO<INF>X</INF> Reductions

    For EPA to approve an open market trading rule, it needs to be 
convinced that ERC generation is likely to keep pace with ERC use, so 
that there will not be significant emissions ``spikes'' created by the 
use of a large number of ERCs in a short period of time. For VOCs, EPA 
has determined that the risk that there will be such spikes is 
sufficiently small that this issue can be dealt with through periodic 
audits and contingency measures. However, for other pollutants, 
particularly NO<INF>X</INF>, EPA has greater concerns. Under open 
market trading, large NO<INF>X</INF> sources which are not currently 
subject to any emissions limits would be able to bank large volumes of 
early reductions generated through early compliance with forthcoming 
Title IV Acid Rain program requirements. When used later, these large 
volumes of ERCs could create spikes large enough to compromise 
attainment.
    Michigan's program protects against this problem within the State. 
Rule 1212(2) limits the life of credits ``generated by emission 
reductions which are necessary to comply with a proposed applicable 
requirement and which occur after the date the applicable requirement 
is proposed but before final compliance dates'' to five calendar years 
or to one calendar year after the effective date of final compliance, 
whichever comes first. Therefore all NO<INF>X</INF> credits generated 
through early compliance with Title IV requirements will expire on 
January 1, 2002, or 1 year after the applicable requirements become 
effective. As a result of the limited life of these credits, unless a 
market demand for NO<INF>X</INF> credits within Michigan is created 
prior to January 1, 2002, most or all of the credits generated in this 
fashion will result in early reductions without risk of being used 
within Michigan.
    Given this protection, EPA's remaining concern is that the 
NO<INF>X</INF> ERCs generated through early compliance with Title IV 
requirements not be used in other States after January 1, 2002. To 
allay this concern, MDEQ must outline the existing procedures in the 
SIP, or add such procedures, that insure that these credits expire in 
accordance with Michigan rules and cannot be used in other States.

R. Property Rights

    Michigan's emissions trading program does not contain a statement 
that emission reduction credits do not constitute a property right. All 
tradeable emissions reduction credits or allowances under the Act are 
limited authorizations to emit pollutants, and do not constitute a 
property right. Section 403(f) of the Clean Air Act, which deals with 
sulfur dioxide allowances under the Acid Rain program, states:

    An allowance allocated * * * is a limited authorization to emit 
sulfur dioxide * * * Such allowance does not constitute a property 
right. Nothing in this subchapter or in any other provision of law 
shall be construed to limit the authority of the United States to 
terminate or limit such authorization.

Congress included this requirement to ensure that allowance holders 
understood that they were barred from claiming a governmental taking 
under the 5th Amendment of the U.S. Constitution. Property status could 
produce undesired and perverse results, such as requiring a government 
agency to compensate the owner of a pollution source when its emissions 
are limited. The absence of property status authorizes the 
participating air pollution control agency to limit or terminate credit 
use in extreme circumstances. The same logic applies to emission 
reduction credits.
    States should actually terminate credits only when other options 
have failed to provide for meeting the State's underlying Act 
obligations. Although EPA would not expect this to occur, and would 
expect that the program will

[[Page 48981]]

achieve real and cost-effective emissions reductions without having to 
resort to credit limitation, this contingency measure must be available 
to provide confidence that States will make continued progress toward 
their air pollution control goals.
    In order to ensure that sources cannot claim that ownership of an 
ERC issued under Michigan's program grants them a property right, 
Michigan must include in its SIP a statement that ERCs do not 
constitute a property right, either directly in the rule or in the form 
of a letter from the Attorney General.

III. Proposed Action

    The EPA is proposing to approve this revision to the Michigan SIP 
for the reasons outlined above. EPA will not take action toward final 
approval of this SIP revision until the deficiencies discussed in this 
document are corrected. Nothing in this action should be construed as 
permitting or allowing or establishing a precedent for any future 
request for revision to any state implementation plan. Each request for 
revision to the state implementation plan will be considered separately 
in light of specific technical, economic, and environmental factors and 
in relation to relevant statutory and regulatory requirements.
    Under the Regulatory Flexibility Act, 5 U.S.C. 600 et seq., EPA 
must prepare a regulatory flexibility analysis assessing the impact of 
any proposed or final rule on small entities. 5 U.S.C. 603 and 604. 
Alternatively, EPA may certify that the rule will not have a 
significant impact on a substantial number of small entities. Small 
entities include small businesses, small not-for-profit enterprises, 
and government entities with jurisdiction over populations of less than 
50,000.
    EPA's proposed approval of the Michigan's request under section 110 
of the Act does not affect any existing requirements applicable to 
small entities. Any pre-existing Federal requirements remain in place 
after this approval. Federal approval of the state submittal does not 
affect its state-enforceability. Moreover, EPA's approval of the 
submittal does not impose any new Federal requirements. Therefore, EPA 
certifies that this approval action does not have a significant impact 
on a substantial number of small entities because it does not remove 
existing requirements or impose any new Federal requirements.
    Under section 202 of the Unfunded Mandate Reform Act of 1995 
(``Unfunded Mandates Act''), signed into law on March 22, 1995, EPA 
must prepare a budgetary impact statement to accompany any proposed or 
final that includes a Federal mandate that may result in estimated 
costs to State, local or tribal governments in aggregate; or to the 
private sector, of $100 million or more. Under section 205, EPA must 
select the most cost-effective and least burdensome alternative that 
achieves the objectives of the rule and is consistent with statutory 
requirements. Section 203 requires EPA to establish a plan for 
informing and advising any small governments that may be significantly 
or uniquely impacted by the rule.
    EPA has determined that the approval action proposed does not 
include a Federal mandate that may result in estimated cost of $100 
million or more to either State, local, or tribal governments in the 
aggregate, or to the private sector. This Federal action maintains pre-
existing requirements under State or local law, and imposes no new 
Federal requirements. Accordingly, no additional cost to State, local, 
or tribal governments, or to the private sector, result from this 
action.
    This action has been classified as a Table 2 action for signature 
by the Regional Administrator under the procedures published in the 
Federal Register on January 19, 1989 (54 FR 2214-2225), as revised by a 
July 10, 1995 memorandum from Mary Nichols, Assistant Administrator for 
Air and Radiation. The Office of Management and Budget (OMB) has 
exempted this regulatory action from Executive Order 12866 review.

List of Subjects in 40 CFR Part 52

    Environmental protection, Air pollution control, Carbon monoxide, 
Sulfur dioxide, Particulate Matter, Lead, Hydrocarbons, 
Intergovernmental relations, Nitrogen dioxide, Ozone, Reporting and 
recordkeeping requirements.

    Authority: 42 U.S.C. 7401-7671q.

    Dated: September 4, 1997.
David A. Ullrich,
Acting Regional Administrator.
[FR Doc. 97-24836 Filed 9-17-97; 8:45 am]
BILLING CODE 6560-50-U