1

MEMORANDUM DATE: 12 / 2 /2015 TO: Cross - State Air Pollution Rule Update for the 2008

Ozone NAAQS ; Docket ID : EPA - HQ - OAR

– 201 5
- 0500 FROM: Reid Harvey , Director, Clean Air Markets Division SUBJECT: Inclusion of the Clean Power Plan in the baseline for

the proposed Cross
- State Air Pollution Rule Update for the 2008 Ozone NAAQS

SUMMARY As noted in Section V of the preamble for the proposed Cross - State Air Pollution Rule Update for the 2 008 Ozone NAAQS (CSAPR Update) , the EPA seeks comment on the data and assumptions used in the modeling for this rulemaking . One of the topics on which the EPA seek s comment is the use of I ntegrated P lanning M odel version 5.15 (IPM 5.15) , including illustrative modeling of the Clean Power Plan , in the baseline as well as in the analytic policy case 1 for the CSAPR Update rule making . The EPA specifically seeks comment both on using IPM 5.15 and on including the illustrative modeling of the Clean Power Plan 2 ( CPP ) in the baseline .

1 If the illustrative modeling of the CPP is included in the baseline for the CSAPR Update, then the CPP modeling would inherently also be included in subsequent policy cases that are additional to that baseline. 2 The EPA’s assessment of the CPP for regulatory impact analysis was illustrative in nature as the modeling scenarios represent one of many implementation pathways available to states and utilities. For more information on the illustrative nature of this analysis, refer to the Regulatory Impac t Analysis for the Clean Power Plan.2

This memo provides further discussion of considerations for including the illustrative modeling of the CPP in the baseline for this rulemaking, a discussion of the potential impact of the EPA’s illustrative modeling of the CPP on the CSAPR Update rulemakin g and considerations for potentially excluding the illustrative modeling of the CPP in the baseline and policy case for the final CSAPR Update rule .

CONSIDERATIONS FOR INCLUDING THE CPP IN THE CSAPR UPDATE BASELINE In accordance with Executive Order s 12866 and 13563, and Office of Management and Budget (OMB) Circular A
- 4, the analytic baseline for rulemakings should include all existing and final rules. In this case, adherence to E.O. 12866 and Circular A
- 4
means the CSAPR Update should include the fi nal CPP to the extent possible in its analytic baseline. 3 The final CPP rule , which was signed on August 3, 2015, is now a part of the business
- as - usual scenario that would be expected under market and existing regulatory c onditions in the absence of the p roposed CSAPR Update . T he EPA took steps to reflect inclusion of the CPP in the baseline of the proposed CSAPR Update, which was signed on November 16, 2015. The baseline for the proposed CSAPR Update rule is discussed in Chapters 1 and 5 of the

3 For consistency, the EPA proposes to use the same analytic baseline for the policy analysis and regulatory impact analysis for the CSAPR Update.3

Regulatory Impact Analysis (RIA) , available in the docket for this proposal. 4 One important justification for the requirement to include all existing and final rules in the baseline of subsequent rulemakings is to assure that the analysis of the subsequent rule appr opriately evaluates the impacts of that rule in and of itself in i solation from other policy actions . T his requirement supports transparent evaluation of the estimated impacts that are attributable solely to the rule under consideration . For example, in th e context of environmental regulation to reduce air pollution, implementation of this requirement assures that the assessment of the subsequent rule does not double
- count the air quality improvements that were already attributed to prior rules. Including t he illustrative modeling of the CPP in the baseline of the CSAPR Update assures that the air quality improvements evaluated in the CSAPR Update analysis are attributable to impacts on the power sector of the proposal to update CSAPR alone, and avoids double
- counting the impacts of the CPP , as well as all other federal and s tate regulations included in the IPM 5.15 base case. The RIA for the CSAPR Update reports the expected benefits, costs and impacts of the proposed

4 Docket ID: EPA
- HQ - OAR - 2015
- 05004

CSAPR update for 2017, as well as s elect impacts, including emissions changes, for 2020. The base c ase used to analyze the proposed CSAPR Update is the IPM configuration the EPA used to analyze the CPP’s rate
based illustrative plan approach . This approach was one of two illustrative policy options analyzed in support of the final CPP . 5

THE POTENTIAL EFFECT OF THE CPP ON CSAPR UPDATE In theory, including or excluding the illustrative modeling of the CPP in the baseline for the CSAPR Update could influence the EPA’s assessment of which states significantly contribute to nonattainment or interfere with maintenance of the 2008 ozone NAAQS downwind and the EPA ’s development of emissions budgets (i.e., the remedy). However, t he EPA believes that including or excluding the illustrative modeling of the CPP in the baseline and policy case for the CSAPR Update rulemaking would not have a large i mpact on the CSAPR Update. First, we note that the EPA’s modeling of the CPP does not estimate large changes in the power sector due to the CPP in the

5 The EPA ran two illustrative scenari os for the CPP in IPM, a rate
- based and a mass - based implementation scenario. In general, when discussing the inclusion of the CPP in modeling here, we are referring to the rate
- based implementation scenario. For more information on the illustrative nature of this analysis, refer to the Regulatory Impact Analysis for the Clean Power Plan.5

policy analysis ye ar used in the CSAPR Update (i.e., 2017

— based on adjustments to the IPM 2018 model run year). Of the near
- term (i.e., 2016 through 2018) changes in the power sector that are estimated in the illustrative CPP modeling, a majority of these changes were anticipated to occur in the model baseline of the CPP analysis itself , meaning that they wou ld have occur red without inclusion of the CPP and are not attributable to the CPP. Specifically, in the short
- term prior to 2022 ( note: 2022 is the beginning of the CPP implementation period), the modeling results related to the power sector, such as generation, capacity, retirements, and prices, are largely driven by planned actions and other market forces that are already underway (such as low natural gas prices relative to coal), rather than the effect of the CPP. For example, the CPP baseline model ing includes capacity reductions that the model anticipates in the absence of the CPP . 6 O f the estimated 71 GW reduction in coal generation capacity in model year 2016, roughly 60 GW occur in the baseline. The remaining changes in the power sector (e.g., 11 GW reduction in goal generation capacity) , which the illustrative modeling of the CPP assumes to occur as part of an overall least
- cost “solution” for the CPP for the power sector over a 40
- year time horizon , are also small relative to the

6 Docket ID: EPA

– HQ

– OAR

– 2013

– 06026

power sector industry . In addition, as discussed in the considerations section below, estimates of capacity reductions from the EPA’s application of I PM in this scenario are likely an overestimate of near - term effects compared to expected real world implementa tion of the CPP for at least two reasons. First, some of the simplifying assumptions used in the modeling about state implementation decision
- making don’t capture the real world ability of states to develop implementation approaches over the whole time pe riod of the CPP that will minimize near
- term effects . Second, the structure and design of the model tends to overstate near
- term effects due to assumptions about perfect foresight of future prices and market conditions that don’t reflect actual uncertainties about the future state of the world , discussed later in this memo . In addition , the way that the power sector modeling is used in the CSAPR Update limits t he potential influence of the illustrative the CPP modeling on this rulemaking . As exp lained below , the inclusion of CPP in the modeling would not have a large impact on the EPA’s application of the 4
- step CSAPR framework. Regarding steps one and two, as already noted, the illustrative modeling of the CPP does not estimate large changes in the power sector modeling for the CSAPR Update because the 2017 summer ozone season is five years in advance of the initial7

start of the CPP and thirteen years in advance o f the CPP final period in 2030 . Further, power sector emissions are only one co mponent of total nitrogen oxides ( NO X ) emissions . Emissions from mobile sources, electric generating units ( EGUs ) , and non
- EGUs are all part of the EPA’s evaluation. Thus , EGUs are only part of the comprehensive evaluation of downwind receptors expected to have problems attaining or maintaining the 2008 ozone NAAQS (i.e., step 1) and upwind states’ contributions to these identified problems in amounts sufficient to “link” them to the downwind air quality problems (i.e., step 2) . Because the modeled impact of the CPP is relatively small in comparison to power sector emissions and because power sector emissions are only one component 7 of the total emissions used to evaluate steps one and two of the CSAPR framework, we do not antic ipate that the CPP will have a large impact on the evaluation of these steps. For the proposal, the EPA conducted an analysis of the potential influence of IPM version 5.15 with the CPP in the baseline on steps 1 (i.e., identification of receptors ) and step 2 (i.e., contributions sufficient to “link” upwind states) . Details on this analysis and its results can be found in section V of the preamble.

7 The EPA notes that EGU emissions account for approximately 15 percent of NO X emissions across the contiguous U.S. in our 2017 emissions inventory used for modeling.8

In step three of the CSAPR framework, we evaluate states linked t o downwind air quality problems to ident ify upwind emissions that significantly contribute to nonattainment , or interfere with maintenance , of the 2008 ozone NAAQS downwind . Specifically, this step establishes emission s budgets (i.e., limits on emissions ) for linked states , which reflect upwind emis sion reductions and apportion ment of upwind responsibility . The EPA proposes in the CSAPR Update to establish emissions budgets (tons) by multiplying modeled state
- level emissions rates (lbs/mmBtu) and historic reported (i.e., 2014) heat
- input (mmBtu) . The proposed emissions budget
- setting approach relies only in part on power sector modeling. Specifically, the EPA proposes to use the modeled state
- level emissions rate as noted above in order to help calculate each state’s emission budget . To the extent that this emissions rate reflects modest changes in the power sector that the illustrative model ing attributes to CPP implementation in the CSAPR Update analysis year, we observe that the majority of these modeled changes redistribute gener ation from one fossil fuel
- fired electric generating unit to another. Where generation is shifted between coal
- fired units with similar NO X emissions characteristics , the resulting change in NO X emissions rate may not be significant. If generation shifts f rom coal
- to natural gas
- fired generation, then NO X9

emissions rates will generally be lower , depending on how well
controlled the unit s are . However, we note that even in the potential case of shifting generation from an uncontrolled coal
fired unit to a well
- controlled natural gas
- fired unit, the resulting emissions rate would remain non - zero and would contribute some NO X emissions to the aggregate state - level emissions rate used in the CSAPR Update emissions budget
setting. In addition , by proposing to multiply the modeled state
level emissions rates by historic reported (i.e., 2014) heat
input, the potential influence of the illustrative modeling of the CPP on the CSAPR Update’s remedy is even further reduced. The historic reported heat
- input data are not influenced by the final CPP, which was announced on August 3, 2015 and therefore post - dates the 2014 historic data used in this rulemaking . Additionally , using historic al reported heat
- input grounds the proposed emissions budget
- setting approach in historically observed, non
- modeled, data. In general, t his approach reduces the influence of the model on the CSAPR Update emissions budget
setting. Indeed, th e EPA proposes to factor in the historical heat
- input data so that model outputs alone do not directly determine the proposed CSAPR Update remedy . This approach aligns with the EPA’s general approach to using power sector modeling data at more aggregated geographic levels (i.e., state
- level or10

regional
- level) , rather than specific unit
- level results , which may be relatively more uncertain . The EPA also notes that the CSAPR Update proposal seeks comment on a range of emissions budget stringencies, reflecting power sector NO X mitigation potential that is achievable for the 2017 ozone season and cost
- effective from $500 per ton to $10,000 per ton of NO X removed. The proposed approach reflects NO X reductions at a cost threshold of $1,300 per ton. Given the multiple factors described above that mitigate the potential impact of the illustrative modeling of the CPP on the CSAPR Update emissions budgets , any potential impact of including or excluding the CPP in the baseline for the final CSAPR Update is within the range of NO X emissions budgets on which the EPA is seeking comment. Finally, we note that the illustrative modeling of the CPP has no influence on step four, implementa tion through the CSAPR NO X ozone - season allowance trading program. Specifically, the proposed CSAPR NO X ozone - season allowance allocation approach would allocate allowances to existing units , independent of the EPA’s power sector modeling. Specifically, the EPA proposes to continue using the existing CSAPR allowance allocation approach, using ozone season heat input values for the period of 2010 through 2014 . As a result, the EPA’s proposed unit

- level allocations would provide allowances to units that existed in11

the past and would not deny those allowances to those units based on modeling that would suggest that the unit may not operate in the future. T he EPA does not anticipate that including or excluding the il lustrative modeling of the CPP in the baseline would meaningfully influence the EPA’s evaluation of significant contribution to nonattainment or interference with maintenance of the 200 8 ozone NAAQS in downwind areas, particularly given the range of other factors (e.g., cost thresholds) on which the EPA is also seeking comment.

CONSIDERATIONS FOR EXCLUDING THE CPP FROM THE CSAPR UPDATE BASELINE Despite the general policy of including promulgated rules in the baseline and policy case and the limited impact of including the CPP in this rulemaking , t here are several key uncertainties associated with implementation of the CPP that are not reflected in the modeling. These uncertainties are relatively unique to the CPP, due to the wide ran ge of implementation flexibility and the role that states play in determining implementation. Thus, the EPA believes it is worth considering, and seeks comment on, whether and how the CPP should be included in the baseline and policy case for the final CSA PR Update rule.12

The i llustrative policy case for the CPP used in our baseline for the CSAPR Update proposal necessarily entailed making simplifying assumptions regarding the form of implementation of the CPP. However, those simplifying assumptions do not reflect the wide range of approaches available to states in developing the state plans that will ultimately implement the CPP . State plans will be submitted over the next several years, and the interim performance period under the CPP does not begi n until 2022. For instance, t he IPM runs did not model all of the possible “glide paths” states may develop; rather, it modeled the state goals by using the interim steps that were provided by the EPA to help states in their planning processes. In addition , the IPM runs did not assume any interstate trading, which is another implementation option available to states under the CPP. Because of the inclusion of s implif ied modeling assumptions that fail to capture all the compliance flexibilities , near term impacts on the power sector in this scenario tend to be overstated (i.e., more costly deviations) ; in fact, the CPP itself not only avoids dictat ing near - term changes but it also provides states and utilities with ample options to minimize
near - term impact s . For example, a source that would continue to cost effectively operate through procurement of emissions allowances in a trading scenario, may take a more costl y13

compliance option of retirement in a modeling scenario where that flexibility is not represen ted . Because the CPP illustrative modeling was based on an assumption that states would use a specific form of rate
- based implementation, the way in which the model optimiz ed for a least
- cost solution t end ed to front
- load actions within the model (such as generation shifts that lead to reductions of capacity for some fuel sources and increases for others ) in contrast to the emissions reduction flexibility the CPP, by design, created for states and sources. In effect, the front
- load ed results generated by t he model in this scenario are, in part, a result of a feature of the model itself. In reality, given the range of options that the CPP affords states in developing their state plans, there may be sufficient uncertainty regarding state plan design ( in addit ion to uncertainty about other key parameters such as fuel prices and supplies ) such that power plant operators will not take the actions IPM identifies as being the least
- cost solutions or will take them more slowly than modelled . Indeed, i t is even possible that , because of the flexibility permitted in designing their plans, states could choose an implementation path that would completely avoid the actions that are forecast in the model to
occur by 2018 . Thus, because the 2016
- 2018 time period is pr ior to
a pproval or promulgation of state plans or implementation of a14

federal plan, the actual effects of the CPP in that time period are far from certain. In this respect, the CPP is more analogous to the promulgation of a NAAQS, which triggers a similar planning and implementation process in which there is some uncertainty regarding how states and sources will meet the NAAQS until specific state implementation plans are adopted. Modeling based on assumptions about what those requirements will look like ca rries a higher degree of uncertainty than in the case of rules where source - specific requirements are established at the time of promulgation. For this reason, the EPA does not include specific assumed strategies of how the NAAQS will be attained in the b aselines of subsequent rulemakings prior to specific state implementation plans being adopted , and it may be appropriate to extend that practice here, given similar uncertainties associated with how states will choose to formulate their plans in order to i mplement the CPP. Therefore, the EPA requests comment on whether to include the CPP in its baseline and policy
case for the final rule.