CHAPTER 9 EMISSIONS TRADING ON LOCAL, REGIONAL, NATIONAL, AND INTERNATIONAL SCALES

• Jurisdiction: United States

Air Quality Regulation For The Natural Resources Industry
(2000)
CHAPTER 9
EMISSIONS TRADING ON LOCAL, REGIONAL, NATIONAL, AND INTERNATIONAL SCALES
James A. Holtkamp
LeBoeuf, Lamb, Greene & MacRae L.L.P.
Salt Lake City, Utah 84101-1685

[Page 9-1]

1000 Kearns Building

136 South Main Street

I. INTRODUCTION.

The U.S. Clean Air Act (the "Act") and the clean air laws of the various states in the United States are generally an example of "command and control" at its best and worst.¹ Clean air regulation exemplifies "command and control" at its best to the extent that it has resulted in significant reductions in emissions from factories, power plants and vehicles, so much so that for the first time in decades, the Los Angeles basin is no longer the most polluted airshed in the country.² "Command and control" at its worst, however, is evidenced by the extraordinary resources consumed by companies and agencies in dealing with mind-numbingly complex requirements for controlling emissions, monitoring, reporting, inspecting, enforcing and defending against enforcement of air pollution control requirements. Too often, that expenditure of resources results in little or no environmental benefit.

The federal Clean Air Act³ provides for an alternative to traditional regulation in certain circumstances through the use of market forces to establish how necessary reductions will be achieved. Emissions trading is one of several market-based approaches

[Page 9-2]

to environmental protection, which range from pollution charges to subsidies to encourage pollution control.⁴

The Clean Air Act and associated regulations provide for emissions trading both directly and indirectly. An example of the direct approach is found in Title IV of the Act, which was added in the 1990 amendments to the statute.⁵ Title IV and the rules and guidance promulgated thereunder are known as the Acid Rain Program. As described in more detail later in this paper, the Acid Rain Program establishes a "cap-and-trade" program, under which a nationwide cap is established for sulfur dioxide ("SO2") emissions from power plants, and each plant is allocated allowances to emit SO2. The allowances can be purchased, sold, traded, used or saved, thereby allowing the plant operator to make the most economic choice of how to deal with SO2 emissions.

The indirect approach arises from the requirements of the Act's provisions relating to new and modified sources in non-attainment areas that a major source or major modification of an existing source cannot be constructed without offsetting emission decreases somewhere else in the airshed.⁶ As soon as the proponent of a new source or modification approaches the operator of an existing source to find out whether the existing source has or will reduce its emissions to create offsets, a market is created.

Generally speaking, then, there are two types of emissions markets. One is based on emissions reductions beyond required levels, which can then be transferred to a source which needs to increase emissions above applicable limits. The other type of market is an allowance-based cap-and-trade system, in which an overall emissions cap is set and sources are allocated a certain number of authorizations or allowances to emit. The sources are prohibited from emitting more than the amount of allowances in their possession.

[Page 9-3]

II. EMISSIONS REDUCTION TRADING.

A. Offsets. The Act lays the foundation for emissions offsets trades by providing that no new source or major modification of an existing source may be approved in a nonattainment area unless and until there is an equivalent or greater decrease in the applicable emissions from another source or sources in that airshed. For example, section 182(b)(5) of the Act⁷ requires that a new or modified major stationary source of emissions of volatile organic compounds in a moderate ozone nonattainment area must offset each ton per year of additional volatile organic compounds with a reduction of 1.15 tons in the same airshed. In response to proposals to accommodate this requirement through trades of emissions rights, EPA promulgated an Emissions Trading Policy ("Policy").⁸

The Policy sets forth general principles EPA uses in evaluating emissions trading programs. The Policy defines emissions trading to include bubbles, netting, emissions reduction credits ("ERCs") and banking of ERCs.

A bubble is an imaginary dome over several individual points or sources of emissions. A bubble allows existing plants or groups of plants to increase emissions at one or more sources or emission points in exchange for compensating decreases in emissions at other sources or emission points. The emissions are treated in the aggregate rather than individually, and thus operators have considerable flexibility in electing which and what types of controls to implement, as long as the aggregate emissions decrease.

Netting is very similar to a bubble and consists of the use of ERCs within a facility to avoid new source review for increases in emissions from an emissions point within the facility. The U.S. Supreme Court upheld the netting concept in 1984.⁹ Under

[Page 9-4]

the EPA definition, increases and decreases anywhere on the plant property from emission units are generally eligible for netting without triggering permit requirements as long as 1) plant wide emissions do not significantly increase, and 2) there is no interference with attainment and maintenance of the NAAQS.

Banking is the process of identifying, recording and maintaining ERCs for future use. An ERC or emission offset bank typically consists of a registry of offsets maintained by the state air quality agency.

The Policy specifies that ERCs may be created and banked only for emission reductions that are surplus, enforceable, permanent, and quantifiable. Emission reductions are surplus only if they are not required by government mandate.¹⁰ The first step is to establish a baseline emission level, which is the level of required emissions beyond which reductions must occur for ERCs to be generated. The process of establishing a baseline, including determining whether to use allowable or actual emissions,¹¹ will generally be determined by the attainment status of an area.

An emissions reduction is enforceable if it is approved by the state and is enforceable by EPA at the time the ERC is used. Enforceable emission limits may be in a permit or a SIP.

An emissions reduction is permanent if there is no legal mechanism to allow the resumptions of emissions from the source in the future.

To be quantifiable, the emission reductions which generate the ERCs must be calculated both before and after the reduction.

The Policy lays out the procedures for using ERCs. The emissions trades must involve the same pollutant and satisfy applicable ambient air quality monitoring and other tests. The Policy also provides that trades are subject to subsequent EPA approval as

[Page 9-5]

case-by-case SIP revisions, although states may develop generic rules for trades which are not subject to the SIP revision requirement as long as the emissions limits produced under the generic rule will not interfere with timely attainment and maintenance of NAAQS or otherwise jeopardize compliance with the NAAQS.

B. Economic Incentive Program. The 1990 Amendments to the Clean Air Act provide for economic incentive programs ("EIPs") which either must or may be adopted for certain nonattainment areas, depending on the classification of the areas. The term "economic incentive program" is defined in the Act as:

[A] nondiscriminatory system ... of State established emissions fees or a system of marketable permits, or a system of State fees on sale or manufacture of products the use of which contributes to ozone formation, or any combination of the foregoing or other similar measures. The program may also include incentives and requirements to reduce motor vehicle emissions and vehicle miles traveled in the area.¹²

The Act requires the use of EIPs for certain nonattainment areas, and identifies EIPs as one of three options for use in certain other nonattainment areas.¹³ Specifically, a state is required to develop an EIP if it fails to submit an adequate demonstration of reasonable further progress towards attainment in extreme ozone nonattainment areas or in serious carbon monoxide nonattainment areas. The use of EIPs is an option in the case of such a failure in serious and severe ozone nonattainment areas.¹⁴

EPA published rules governing EIPs on April 7, 1994.¹⁵ Under the EIP regulations, the use of credits for emissions reductions for trades, sales or offsets, may

[Page 9-6]

qualify as an EIP.¹⁶ On August 3, 1995 the EPA published a proposed model open market trading rule which would establish a model program for state open market emissions trading.¹⁷ State adoption of the model rule into its SIP would allow sources to substitute emissions reductions purchased from other sources for the installation of pollution control equipment.

Most states in the United States have ERC trading systems in place.¹⁸ ERCs are widely used to comply with the requirement to offset emissions increases in nonattainment areas with emissions reductions in the same airshed. A company wishing to construct a new source may satisfy the offset requirements by purchasing ERCs from a source that has permanently reduced its emissions and registered or banked them with the state air pollution control agency.

C. Case Study. To illustrate how an ERC transaction might work, let us suppose that Acme Refining Company plans to build a new refinery in metropolitan Gotham, which is a serious ozone nonattainment area. The refinery has the potential to emit 100 tons per year of volatile organic compounds ("VOCs"), a precursor of ozone, which is in excess of the 50 tons per year threshold for "major source" classification under the Act.¹⁹ It cannot get a permit to construct the...