1 November 7, 2012

MEMORANDUM

SUBJECT: Arizona Regional Haze SIP, BART Determination for Apache Generating Station,

Supplemental Economic Analysis

FROM: Larry Sorrels, Robin Langdon

Office of Air Quality Planning and Standards

TO: Colleen McKaughan

Margaret Alkon

Francisco Donez

Region IX

Background

EPA is proposing to disapprove portions of the Arizona Regional Haze State Implementation Plan

(SIP) submitted by the Arizona Department of Environmental Quality (ADEQ) on February 28, 2011. 1

EPA’s proposed action pertains to Best Available Retrofit Technology (BART) for three electric generating

stations in Arizona, including the Apache Generating Station. Specifically, EPA is proposing to

disapprove ADEQ’s BART determination 2 for NOx controls at Apache Generating Station Units 2 and 3.

For Apache Generating Station Units 2 and 3, AQED proposed low

‐ NOx burners (LNB) and over

‐ fire air

(OFA) for BART (Table 8, page 19 of the Arizona Regional Haze Technical Support Document (TSD)). EPA

assessed ADEQ’s determination and performed additional analysis. For Apache Generating Station Units

2 and 3, EPA has initially proposed selective catalytic reduction (SCR) with LNB and OFA for BART (page

52 of the Arizona Regional Haze TSD), the most stringent NOx control alternative considered by EPA for

these two units.

On June 29, 2012 during the initial public comment period, Arizona Electric Power Cooperative,

Inc. (AEPCO) provided supplemental information to EPA related to EPA’s proposed determination of the

affordability of NOx controls at Apache Generating Station. AEPCO indicated that affordability of the

controls is affected by its small size, the low income profiles of AEPCO’s service area, and AEPCO’s ability

to access financing; AEPCO also referenced Appendix Y of Part 51. 3 Appendix Y provides the following

guidance for affordability review:

1 Arizona Regional Haze Technical Support Document, July 2012, EPA Region IX.

2 EPA’s Regional Haze Rule (RHR) provides the following six factors that a BART determination must take into

account (40 CFR 51.308(e)(1)(ii)(A)): (a) the available technology to control emissions and the technical feasibility

of each technology; (b) the cost of compliance for the technically feasible control technologies; (c) the energy and

non

‐ air quality impacts of the control technologies; (d) any existing air pollution control technologies at the source;

(e) the remaining useful life of the source; and (f) the degree of visibility improvement which may reasonably be

anticipated to result from the various control technologies. Although there are six factors, the first factor is not

always explicitly stated and the remaining factors are frequently referred to as the “five

‐ factor analysis” for the

RHR BART determination.

3 Code of Federal Regulations Title 40: Protection of the Environment, Part 51

– Requirements for Preparation,

Adoption, and Submittal of Implementation Plans, Appendix Y to Part 51

– Guidelines for BART Determinations

Under Regional Haze Rule.2 1. Even if the control technology is cost effective, there may be cases where the

installation of controls would affect the viability of continued plant operations.

2. There may be unusual circumstances that justify taking into consideration the

conditions of the plant and the economic effects of requiring the use of a given

control technology. These effects would include effects on product prices, the

market share, and profitability of the source. Where there are such unusual

circumstances that are judged to affect plant operations, you may take into

consideration the conditions of the plant and the economic effects of requiring the

use of a control technology.

In addition to the materials provided on June 29, 2012 and at EPA’s request, in early September 2012

AEPCO provided supplemental information including rate case testimonies, power purchase contracts,

and annual financial reports.

To assist Region IX, we are providing this supplemental economic analysis. To further assess the

question of economic impacts of EPA’s proposed NOx controls for Apache Generating Station Units 2

and 3, the remainder of this memorandum (i) introduces and discusses an analytical framework to

assess economic impacts, (ii) discusses the potential for passing along any potential electricity rate

increases, (iii) discusses the potential to access financing, and (iv) offers conclusions. Also note that

while we considered the question of the economic impacts of EPA’s proposed NOx controls, in this

memorandum we did not consider visibility improvements or other BART

‐ related regulatory

requirements.

Economic Impact Assessment Considerations

We are aware of a few affordability assessments related to BART determinations, but none for a

small entity. 4 To consider the question of the economic impacts of NOx controls for the Apache

Generating Station, we reviewed the information provided by AEPCO, including the supplemental

information provided, as well as the Arizona Regional Haze TSD. In addition, we considered various

analytical approaches employed in non

‐ BART rulemakings and concluded that the framework for

assessing impacts on small entities provides an approach for assessing some of the economic impacts of

proposed NOx controls.

As defined by the U.S. Small Business Administration (SBA), a firm is small if, including its

affiliates, it is primarily engaged in the generation, transmission and/or distribution of electric energy for

sale and its total electric output for the preceding fiscal year did not exceed 4 million megawatt hours

(MWh). 5 In 2011, AEPCO member cooperatives sold 2,453,272 MWh of electricity. 6 For non

‐ BART

‐

related rulemakings, the Regulatory Flexibility Act (RFA) as amended by the Small Business Regulatory

Enforcement Fairness Act (SBREFA) generally requires an agency to prepare a regulatory flexibility

analysis of any rule subject to notice and comment rulemaking requirements under the Administrative

4 The Arizona Regional Haze TSD indicates that AEPCO is a small entity.

5 http://www.sba.gov/content/small

‐ business

‐ size

‐ standards

6 Annual Report for year ending Dec. 31, 2011 from AEPCO to Arizona Corporation Commission. Received May 14, 2012.

Available at

http://www.azcc.gov/Divisions/Utilities/ Annual%20Reports/2011/Electric/Arizo na_Electric_Power_ Cooperative_Inc.pdf

.3 Procedure Act or any other statute, unless the agency certifies that the rule will not have a significant

economic impact on a substantial number of small entities (SISNOSE). Small entities include small

businesses, small governmental jurisdictions, and small not

‐ for

‐ profit enterprises.

To determine whether a regulatory flexibility analysis is needed, EPA typically performs a

screening analysis for impacts on all affected small entities by comparing compliance costs to revenues

at the parent company level. This is known as the cost

‐ to

‐ revenue or cost

‐ to

‐ sales test, or the “sales

test.” The “sales test” is the impact methodology EPA employs in analyzing small entity impacts as

opposed to a “profits test,” in which annualized compliance costs are calculated as a share of profits.

The sales test is frequently used because revenues or sales data are commonly available for entities

impacted by EPA regulations, and profits data normally made available are often not the true profit

earned by firms because of accounting and tax considerations. The annualized cost per sales for a

company represents the price increase in affected product needed for the company to completely

recover the annualized costs of the regulation



### . The use of a “sales test” for estimating small business

impacts for a rulemaking is consistent with guidance offered by EPA on compliance with the RFA 7 and is

consistent with guidance published by the U.S. SBA’s Office of Advocacy that suggests that cost as a

percentage of total revenues is a metric for evaluating cost increases on small entities in relation to

increases on large entities. 8

Table 2 of EPA’s guidance includes thresholds for determining what are potentially a (i)

significant economic impact and (ii) substantial number of small entities. The criteria of significant

economic impact and substantial number of small entities work together to determine if there is a

SISNOSE or certify that there is no SISNOSE. Table 2 provides some flexibility in determining if there is a

SISNOSE, but generally if fewer than 20 percent of the subject entities have a “sales test” impact of less

than three percent, EPA can certify that there is no SISNOSE.

For this assessment we apply the “sales test” methodology described above for estimating

impacts. We are not performing a regulatory flexibility analysis, but applying part of the framework for

assessing impacts on small businesses. Specifically, we are considering the significant economic impact

criterion and not considering the substantial number of small entities criterion. The Arizona Regional

Haze TSD includes a “sales test” calculation of about seven percent in 2011 for the proposed BART

determination for Apache Generating Station Units 2 and 3 (Table 22, page 53 of the Arizona Regional

Haze TSD). Using the partial framework, a seven percent cost of compliance compared to revenues

could be considered a significant economic impact.

For the BART determination, if EPA were to propose the next best level of control as shown in

Table 22 of the TSD, or selective non

‐ catalytic reduction (SNCR) with LNB and OFA, the cost of

compliance compared to revenues would be about three percent. Applying this framework, a three

percent “sales test” calculation on a single entity appears inconclusive.

7 The RFA compliance guidance to EPA rule writers regarding the types of small business analysis that should be

considered can be found at < http://www.epa.gov/sbrefa/documents/Guidance

‐ RegFlexAct.pdf >.

8 U.S. SBA, Office of Advocacy. A Guide for Government Agencies, How to Comply with the Regulatory Flexibility

Act, Implementing the President’s Small Business Agenda and Executive Order 13272, June 2010.4 Potential Rate Increases

We considered the question of whether AEPCO could pass along the costs of compliance to the

ratepayers, i.e., could AEPCO increase the product price. Demand for electricity, especially in the short

run, is not very sensitive to changes in prices and is considered relatively price inelastic (that is, a less

than 1% reduction in electricity demand given a 1% increase in the price of electricity), although some

demand reduction does occur in response to price. A 2009 study prepared by Resources for the Future

found that the short

‐ run electricity demand elasticity aggregated across all customer classes nationwide

is –0.13, and the long

‐ run elasticity is almost three times as great, at –0.36. 9 These estimates can be

interpreted as indicating a one percent increase in electricity price will lead to a 0.13 percent decrease in

electricity demand in the short run. These results were quite consistent across different US regions as

shown in the study.

In their June 29, 2012 submittal, AEPCO indicated their customer base is relatively economically

disadvantaged and mandating the installation of EPA’s proposed NOx controls would impose a

disproportionate burden on the customers. AEPCO compared average per capita income for their

ratepayers to average per capita income for both Arizona and the United States. In the supplemental

information, AEPCO provided information on the customer base by member cooperative, zip code, and

county, including median household income, average household income, and per capita household

income. 10 The supplemental information reflected the following member cooperatives and counties:

 Duncan Valley Electric Cooperative

– Greenlee, Arizona and Hidalgo, New Mexico

 Graham County Electric Cooperative

– Graham and Cochise, Arizona

 Mohave Electric Cooperative

– Mohave, Arizona

 Sulphur Springs Valley Electric Cooperative, Inc.

– Cochise, Santa Cruz, Pima, Arizona

 Trico Electric Cooperative, Inc.

– Pima and Santa Cruz, Arizona

 Anza Electric Cooperative, Inc.

– Riverside, California

We reviewed the supplemental information on per capita and median household income.

Because electric utility bills are likely paid at the household and not individual, or per capita, level, we

calculated the number of AEPCO’s customers that comprise a household

‐‐ from 1.4 to 6.3 people

comprise a household (with an average of 2.3 people per household). As such, we believe that median

household income is an appropriate metric for beginning to assess whether AEPCO customers would

bear a disproportionate share of NOx control costs. 11 In 2011 the median income for U.S. households

was $50,502. 12 Using the supplemental information provided by AEPCO, we calculated that the median

income for AEPCO’s ratepayers was $49,303. In addition, we aggregated the data on median household

9 Paul, Anthony, Myers, Erica and Palmer, Karen. “A Partial Adjustment Model of U.S. Electricity Demand by

Region, Season, and Sector.” Resources for the Future, Discussion Paper 8

‐ 50. April, 2009. Available at

http://www.rff.org/RFF/Documents/RFF

‐ DP

‐ 08

‐ 50.pdf

. 10 This detailed information can be located starting on page 430 of the supplemental information provided by

AEPCO in September 2012. In addition, Attachment 3, page 16 of the September 18, 2012 letter submitted by

Earth Justice indicates that AEPCO left out data for four zip codes. As indicated in Attachment 3, because AEPCO

used a proprietary source for the income estimates we are not able to precisely confirm how the omission affects

our analysis, if at all.

11 The median is commonly used as a measure of central tendency for data measurement and is less affected by

outliers and/or skewed data compared to using the average.

12 http://www.census.gov/p rod/2012pubs/acsbr11

‐ 02.pdf

.5 income by zip code into four incomes ranges. 13 Seventy

‐ one percent of the median household incomes

by zip code were in the $40,000 and above income ranges and twenty

‐ nine percent were in the median

household income range of $20,000

‐ $39,999.

As a regulated utility, AEPCO has its electricity rates set by the Arizona Corporation Commission

(ACC), the state body that regulates AEPCO’s electricity pricing. AEPCO should be able to recover the

costs of compliance with BART or other environmental requirements through rate adjustments. 14 As

provided in the supplemental information provided by AEPCO, the company has approached the ACC

twice in the past twelve years with requests to increase rates, and the ACC approved a rate increase in

August 2005. 15

Potential Access to Financing

Appendix A of the Consolidated Mortgage, Security Agreement and Financing Statement 16

indicates that AEPCO’s maximum debt limit is $600 million. In addition, the long

‐ term debt as of

December 31, 2011 was $178.8 million. 17 In their June 29, 2012 comments AEPCO indicated that

securing additional financing is both time consuming and expensive. To better understand the

difference between the $600 million debt limit and the current long

‐ term debt level of $178.8 million as

well as to potentially understand the time and expense associated with securing additional financing, we

contacted the U.S. Department of Agriculture’s Rural Utilities Service (RUS).

Based on information we received during a conversation with RUS representatives, we

understand that AEPCO's ability to access financing for NOx controls is a separate question from

affordability of the controls. The RUS representatives indicated

In terms of financing, AEPCO is eligible under the terms of their mortgage to finance additional

debt related to air pollution controls. Because under the terms of the mortgage AEPCO needs

sufficient revenue to meet the financial metrics of Times Interest Earned Ratio and Debt Service

Coverage ratio, financing controls would likely require a rate increase. Both incurring additional

debt and increasing rates require approval from the Arizona Corporation Commission (ACC).

Securing approval from the ACC for increasing rates can likely be time consuming

‐‐ the time

needed to secure ACC's approval has, on at least one occasion, resulted in AEPCO being close to

not meeting the financial metrics under their mortgage.

We do not have the expertise to conclude whether AEPCO can readily secure approval from the ACC for

incurring additional debt or raising rates.

13 We aggregated household income into the following four ranges: $20,000

‐ $39,999; $40,000

‐ $59,999; $60,000

‐ $79,999; and $80,000

‐ $100,000.

14 U.S. EPA, Regulatory Impact Analysis for the Mercury and Air Toxics Standards (MATS). December, 2011. p. 7

‐

16.

15 AEPCO filed with ACC for a rate increase in September 2009, but in April 2010 revised its request to a small

decline in rates. More information on this rate request can be found at

http://images.edocket.azcc.g ov/docketpdf/0000110293.pdf

. 16 The Consolidated Mortgage, Security Agreement and Financing Statement begins on page 115 of the

supplement information provided by AEPCO; Appendix A is located on page 159.

17 Balance sheet information can be found in a Report of Independent Auditors for the December 31, 2011 and

2010 balance sheets. The Report begins on page 1380 of the supplemental information provided by AEPCO.6 Conclusions

We drew upon a framework to analyze impacts on small entities used in other rulemaking

contexts. As discussed above, in other rulemakings EPA typically performs a screening analysis for

impacts on all affected small entities by comparing compliance costs to revenues at the parent company

level.

For Apache Generating Station Units 2 and 3, we applied part of the screening framework to

assess the potential impact on AEPCO. Specifically, we considered the significant economic impact

criterion. Employing this part of the screening framework to information in the Arizona Regional Haze

TSD, a seven percent cost of compliance compared to revenues would be considered a significant

economic impact. For the BART determination if EPA were to propose the next best level of control, the

cost of compliance compared to revenues would decrease to about three percent. A three percent

“sales test” calculation on a single entity is inconclusive. We next considered the potential impact in the

context of AEPCO’s ability to pass along some increase in rates, i.e., increase the electricity price to their

customers.

Because short

‐ run demand for electricity is relatively inelastic, ratepayers are not likely to

consume significantly less electricity if the price increases. As such, AEPCO may be able to pass along

the costs of compliance with BART to the ratepayers, but doing so introduces the question of how much

of a product price increase can ratepayers afford. We compared median household income across the

ratepayer base to U.S. median household income and concluded they were not significantly different,

and concluded that it shows that the median income of the ratepayer base is similar to national median

household income. Using a more established framework, we also briefly reviewed how EPA generally

assesses questions of economic impact in its regulatory analyses. 18 Applying the small entity screening

framework used by EPA in other rulemaking contexts results in the conclusion that a seven percent cost

‐

to

‐ sales is significant, and examining historical analytical guidance indirectly suggests that a five percent

product price impact would trigger additional economic analysis. However, we understand that

establishing a significant economic impact does not directly address the question of affordability.

18 An historical executive order, Executive Order 12044, triggered an economic impact analysis if, among other

criteria, the total additional cost of production exceeds five percent of the product price. Additional discussion of

historical executive orders that guide economic analyses in the regulatory development process can be found at

http://www.whitehouse.gov/omb/OIRA_QsandAs

.