### 1

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for the final Transport Rule

Docket ID No. EPA

- HQ

- OAR

- 2009

- 0491



### Assurance Penalty Level Analysis Final Rule TSD

U.S. Environmental Protection Agency

Office of Air and Radiation

June 2011

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### Assurance Penalty Level A nalysis Final Rule TSD

This Technical Support Document (TSD) supports EPA ’ s determination that the final

Transport Rule ’s assurance provision penalty requirement provide s sufficient deterrence against

a state exceeding its assurance level. Section VII.E i n the final Transport Rule preamble

discusses the assurance provisions

, including the allowance surrender penalty analyzed in this

TSD . Th is TSD is organized as follows:

1. Background

2. Approach

3. Results

1. Background

The final Transport Rule ’ s limited interstate trading programs include assurance

provisions to ensure that the necessary reductions will occur within each covered state. The

assurance provisions limit emissions from covered units in a state to the state ’ s emissions budget

plus variability limit, i.e., the state ’ s assurance level.

As described in preamble section VI.D, EPA used a multi

- factor analysis to determine

each state ’ s emissions budget. Subsequently, as described in VI.F, EPA determined variability

limits for each state that refle ct a percentage of the state ’ s budget (e.g., 10%). This variability

limit is then added to the state budget to yield the state ’ s assurance level. If emissions from

covered sources in a state in a compliance period exceed the state ’s assurance level, then EPA

applies additional criteria to determine which owners and operators of units in the state will be

subject to an allowance surrender penalty of two allowances per ton for their share of the

emissions over the assurance level. 1 

### This penalty is in additi on to the standard program

requirement that owners and operators of covered units hold one allowance for each ton emitted;

therefore, for any emissions identified by EPA as being over the state’s assurance level, the

relevant owners and operators must subm it a total of three allowances per ton

– one of which is

for standard compliance for emitting under the program, and two of which are for the assurance

provision penalty.

As discussed in preamble section VI.F, EPA does not find reason to expect that emissi ons
from covered sources in any state will exceed that state’s assurance level. The description and

tables below describe a sensitivity analysis EPA conducted to determine whether the two

- for

- one

1 

### The assurance provision allowance surrender penalty addressed in this TSD i s distinct from the

penalties, discussed in preamble section VII.F, that apply to the trading program requirement to

hold allowances sufficient to cover emissions for each compliance period.

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### allowance surrender penalty provides a sufficient deterrent to keep emissions from covered

sources in each state from exceeding the assurance levels.

2. Approach

To determine if a penalty of two allowances for every ton of excess emissions would be

sufficient, EPA used the Integrated Planning Model (IPM) to asses s a “ TR_Penalty_Scenario ”

whose results, along with the results of other IPM model runs for the Transport Rule , can be

found in the docket. More information on IPM can be found in the Documentation Supplement

for EPA Base Case v.4.10_FTransport

– Updates f or Final Transport Rule

, which is also in the

docket

. This penalty scenario offered covered sources in each state the choice to emit beyond the

state’s assurance level and incur a fine for each excess ton worth twice the value of an allowance

(in addition to having to submit one allowance for emitting each ton, per standard compliance

procedures) . In this analysis, the “ state assurance level ” is the state’s emissions budget plus the

state’s variability limit and corresponds to the “state emissions assuranc e level” in tables VI.F

- 1

and VI.F

- 2 of the preamble

. The size of the penalty was calculated as twice the allowance price

for the relevant pollutant taken from the IPM analysis of the final rule’s remedy

(TR_Limited_Trading_Final), as shown in Table 1.

Ta ble 1. Allowance prices (2007$) in the final remedy (TR_Limited_Trading Final) and

Penalty Costs in the “ assurance penalty sensitivity ” run (TR _Penalty_Scenario)

Emission Allowance Prices ($/Ton) from

final remedy run Emission Penalty Costs ($/Ton) in th e assurance penalty sensitivity run

2012 201 4 2012 201 4



### SO 2 Region 1 (TR) 971 1,127 1,942 2,254



### SO 2 Region 2 (TR) 576 663 1,152 1,327

NO

x Annual (TR) 497 577 994 1,153

NO

x Ozone Season (TR) 1,321 1,532 2,642 3,064



### It is important to consider that while the effective fine in this scenario (twice the value of

the relevant pollutant’s allowance price) is a technically valid representation of the final rule’s

penalty structure, it is an analytic understatement of the actual deterrence value of this pen alty in

practice. The penalty in practice will have more of a deterrent effect than what this scenario

models it to have for two reasons. First, the penalty cost as modeled is fixed at twice the

allowance price in the final remedy scenario (TR_Limited_Tr ading_Final) for every ton of

emissions in excess of a state ’s assurance level. In reality

, excess emissions would increase the

allowance pr ice (and therefore the cost of the penalty itself) since allowances would have to be

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### bought and surrendered for the penalty, raising allowance demand and thus making them more

valuable. The modeling imposed a fine and did not adjust the allowance pool to account for

penalty surrenders, and so it understates the cost of the penalty incurred. Second, the model has

perf ect foresight of all future emitting behavior and thus does not take any “risk” into account

when determining whether excess emissions are “worth it” at the penalty cost modeled. In

reality, owners and operators of covered units will assign a risk premium to the nominal penalty

consequence because they do not have perfect foresight and cannot be sure of their precise

emissions until the compliance period is complete. Therefore, program participants can be

expected to act more “conservatively” than the mod eling would suggest when determining

whether excess emissions are “worth it” at the penalty cost modeled, which suggests again that

this analysis understates the deterrence value of the penalty in practice.

The sensitivity analysis presented in this TSD w as based off of the main remedy analysis

presented throughout the preamble and Regulatory Impact Analysis for this final rule. In

common with that main remedy analysis , this sensitivity analysis assumed preliminary variability

limits that were smaller tha n the variabil i ty limits finalized in this rule. Because the final rule’s

variability limits are larger than those analyzed in this sensitivity, the results presented below

overstate each state’s economic interest in violating its assurance levels. In ot her words, the

analysis examined whether or not states have an economic interest in surpassing an upper bound

in permissible emissions in 2012 and 2014 (budget plus assumed variability limit) that is less

than the actual upper bound (budget plus finalized variability limit) imposed on states in 2012

and 2014 under the final rule. It therefore follows that the state’s actual economic interest in

surpassing the actual upper

- bound would be less than the projected results presented below

analyze d for the model ed (lower than actual) upper

- bound. This relationship further increases

EPA’s confidence in the conclusions it draws from the results presented below.

3. Results

EPA compared the state

- level emissions in 2012 and 2014 in this analysis to the state

assura nce levels to determine whether the penalty level deterred excess emissions

. Tables 2

through 5 show the state assurance levels and modeled emissions from covered sources in each

state. The modeled allowance prices in 2012 and 2014 for each pollutant are shown at the

bottom of each table. The penalty for exceeding the assurance level would be equal to twice the

allowance price.

In no case do the covered emissions in a state exceed that state’s assurance level in 2012

or 2014. Th is result indicates that th e penalty offers a sufficient deterrent to ensure emissions do

not exceed assurance levels in 2012 and 2014

. Even though the modeling of this scenario

understated the actual value of the deterrent in practice, in no state did the covered sources find it

e conomic to exceed the states’ assurance levels in 2012 and 2014.

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### In some states, the covered sources in a state are modeled to have collective emissions

that are exactly equal to the state’s assurance level. These projections occur because the model

o perates under perfect foresight and perfect information, and it therefore allows sources in the

modeling to emit up to the state’s assurance level with full certainty that emissions will respect

that constraint to the last ton emitted, successfully avoidin g additional emissions which are

shown to be uneconomic under the assurance penalty. In reality, the deterrence value of the

penalty would likely lead a state’s covered sources to act conservatively by emitting below a

state’s assurance level (rather than exactly up to it) to ensure that unexpected fluctuations in

emissions do not result in a penalty.

In some cases, notably SO 2 

### Group 1 states, the covered emissions are projected to be

significantly lower than the states’ assurance levels in 2012. This w ould occur if covered

sources decide to reduce their emissions beyond what is required so they can bank the excess

allowances. These ba n ked allowances could then used to cover emissions in future years.

Specifically, the SO 2 

### Group 1 state budgets were dete rmined by the feasible emission reductions

at $500/ton SO 2 

### in 2012 and $2300/ton SO 2 

### in 2014 ( see Significant Contribution and State

Emissions Budgets Final Rule TSD). Covered sources in these states may decide to reduce their

emissions further than requir ed in 2012 and 2013 and bank the unused allowances for use in

2014 and later years . This pattern effectively smoothes their emission reductions over time to

minimize total compliance costs in those states

. The modeled allowance prices in those states

also reflect this smoothing of emission reduction patterns . F or example, as seen in Table 2, the

2012 and 2014 projected allowance prices for Group 1 SO 2 

### states are closer to each other than

the marginal cost thresholds used to formulate their budgets in those years ($500 per ton in 2012

and $2,300 per ton in 2014). This banking behavior to smooth emission reductions over time is

shown in this analysis to be entirely consistent with each state’s assurance levels in both 2012

and 2014.

As noted above, EPA’s mo deling of this scenario projects no instance in which covered

sources would find it economic to exceed a state’s assurance level in any of the programs in

2012 or 2014. This analysis also projects that the penalty provides sufficient deterrence for

virtua lly all states in these programs over the 2020

- 2030 timeframe as well. However, the

projections appear to suggest small exceedances in two states in 2020 and in three states in

2030

. 2 

### In most of these cases, the projected exceed ances are marginal

– on th e order of two

2 

### As previously noted, the se findings are based on lower variabil ity limits than included in the

final rule. EPA conducted a separate sensitivity analysis on the remedy (with results presented in

Appendix F of the RIA) incorporating the final variability limits. This analysis shows a dramatic

reduction in the number o f states projected to approach their assurance levels in the 2020 and

2030 projections

. For example, while the original remedy analysis (on which this TSD’s

sensitivity analysis is based) projected in 2020 that 11 states would approach their assurance

lev els for SO2, 2 states for annual NOX, and 1state for ozone

- season NOX , the revised remedy

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### hundred tons of pollutant

. EPA does not believe that these longer

- run results actually indicate a

likelihood of these exceedances occurring. I t is important to note that this modeling assumes

perfect foresight and perfect information, even into the 2020

- 2030 timeframe, and that under

those assumptions, unit owners and operators would be willing to expend banked allowances in

those years even to the point of paying assurance penalties on them. In reality, operators of

covered units do not h ave perfect foresight or perfect information and will therefore act more

conservatively than “optimal” banking patterns fro m IPM modeling would indicate.

As a result, EPA expects sources will collectively continue to respect the ir states’

assurance level s in those instances by sustaining the Transport Rule emission reductions into the

2020

- 2030 timeframe and banking allowances f urther into the future to guard against

un anticipated developments that the model does not capture . Consequently, EPA does not

bel ieve that these limited small instances of projected exceed ances in 2020 or 2030 are likely to

occur in the actual operation of these programs

. However, EPA will monitor the pattern of

compliance with these programs over the long

- run and will be prepared to adjust the penalty

accordingly if evidence suggests that increased deterrence would be necessary at those later

stages to encourage states to respect their assurance levels. At this point, EPA believes that it is

best to be sure in the initial years tha t the assurance penalty is effective in keeping emissions

within variability limits, while encouraging trading to lower costs and increase flexibility and

avoiding actions that have a chilling effect on activities

. While doing this, EPA believe it is

impo rtant to remain mindful that we do want assurance of meeting emission reductions over

time.

EPA believes these findings support a determination that the penalty requirement of

surrendering two additional allowances for each ton of excess emissions provide s a sufficient

deterrent in the final Transport Rule such that EPA does not expect the covered sources in any

state to exceed the state’s assurance levels under these programs.

sensitivity analysis (including the larger, finalized variability limits ) saw only 5 states approach

assurance levels for annual SO2, no state for annual NOX, and 1 s tate for ozone

- season NOX.

With many fewer states even approaching their assurance levels in the long term with the final

rule’s variability limits, states are even less likely to exceed assurance level s in the 2020

- 2030

timeframe than the findings presen ted in this TSD’s sensitivity analysis based on lower

variability limits originally modeled

.

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### Table 2. Annual SO 2 

### Group 1 State Assurance Levels and Emissions in 2012 an d 2014

(TR_Penalty_Scenario)

2012 2014

State Assurance

Level Penalty Case

Emissions State Assurance

Level Penalty Case

Emissions

(thousand tons) (thousand tons) (thousand tons) (thousand tons)

Illinois 258 210 137 128

Indiana 314 241 177 177

Io wa 118 75 83 78

Kentucky 208 146 117 117

Maryland 33 27 31 30

Michigan 214 190 158 158

Missouri 228 182 183 177

New Jersey 7 6 7 7

New York 23 20 13 13

North

Carolina 151 117 63 63

Ohio 341 229 151 151

Pennsylvania 307 250 123 123

Tennessee 163 9 7 65 65

Virginia 78 67 39 39

West

Virginia 161 119 83 83

Wisconsin 87 77 44 44



### Table 3. Annual SO 2 

### Group 2 State Assurance Levels and Emissions in 2012 and 2014

(TR_Penalty_Scenario)

2012 2014

State Assurance

Level Penalty Case

Emissions State As surance

Level Penalty Case

Emissions

(thousand tons) (thousand tons) (thousand tons) (thousand tons)

Alabama 238 219 235 173

Georgia 174 159 105 93

Kansas 46 41 46 46

Minnesota 46 43 46 45

Nebraska 72 65 72 70

South

Carolina 97 85 97 97

Texas 26 8 244 268 266

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### Table 4. Annual NO X 

### State Assurance Levels and Emissions in 2012 and 2014

(TR_Penalty_Scenario)

2012 2014

State Assurance

Level Penalty Case

Emissions State Assurance

Level Penalty Case

Emissions

(thousand tons) (thousand tons) ( thousand tons) (thousand tons)

Alabama 80 74 79 68

Georgia 68 61 45 40

Illinois 53 48 53 49

Indiana 121 110 119 110

Iowa 42 37 41 38

Kansas 34 31 28 24

Kentucky 94 84 85 76

Maryland 18 16 18 17

Michigan 66 59 64 57

Minnesota 33 31 33 31

Missouri 58 52 54 49

Nebraska 29 26 29 27

New Jersey 8 7 8 8

New York 20 18 20 17

North

Carolina 56 48 46 42

Ohio 102 85 96 84

Pennsylvania 132 118 131 117

South

Carolina 36 33 36 36

Tennessee 39 33 21 20

Texas 147 133 147 137

Virginia 37 33 37 35

West

Virginia 65 56 60 53

Wisconsin 35 31 33 30



### Table 5. Ozone Season NO X 

### State Assurance Levels and Emissions in 2012 and 2014

(TR_Penalty_Scenario)*

2012 2014

State Assurance

Level Penalty Case

Emissions State Assurance

Level Penalty Case

Emissio ns

(thousand tons) (thousand tons) (thousand tons) (thousand tons)

Alabama 35 32 35 30

Arkansas 18 15 18 17

Florida 31 28 31 29

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Illinois 23 21 23 21

Indiana 52 47 51 47

Iowa 18 16 18 16

Kansas 15 13 12 10

Kentucky 40 35 36 3 2

Louisiana 16 14 16 14

Maryland 8 7 8 7

Michigan 28 25 27 24

Mississippi 12 11 12 11

Missouri 25 22 23 21

New Jersey 4 3 4 4

New York 10 8 10 8

North

Carolina 24 21 20 18

Ohio 44 35 42 36

Oklahoma 24 21 24 21

Pennsylvania 57 50 57 50

South

Car olina 15 14 15 15

Tennessee 17 14 9 8

Texas 69 63 69 64

Virginia 17 14 17 15

West
Virginia 28 23 26 22

Wisconsin 16 13 15 13

* As discussed in section III of the Transport Rule preamble, the final rule does not include the states of Iowa,

Kansas, Mich igan, Missouri, Oklahoma, or Wisconsin in the ozone season program. EPA issued a supplemental

proposal to include these six states in the Transport Rule ozone season program.