Entering the Matrix: Compliance Options under the Final Clean Power Plan

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Today, the U.S. Environmental Protection Agency (EPA) released the final version of its Clean Power Plan, the agency’s effort to regulate greenhouse gas emissions from power plants built before 2012. Since the proposed rule was issued as a draft over a year ago, utilities, state regulators, consumer advocates, and environmental groups have speculated about the final form, and what it might require. This isn’t the first rule that could spur substantial changes within the electricity sector. Since 2010, we’ve seen the emergence of proposed and final rules controlling emissions of criteria pollutants, toxic gasses and metals, the disposal of coal ash, and releases of contaminated water from plant sites. However, unlike for these preceding rules, the electricity sector has been unusually quiet in speculating how the Clean Power Plan might impact their own resources. In part, this stems from the inherent complexity of the proposed Clean Power Plan, which lent itself more to a compliance matrix than to a single compliance pathway.

Cast as a flexible rule, the proposed Clean Power Plan allowed for two major approaches to compliance. States can comply on a mass basis, akin to cap-and-trade programs such as New England’s Regional Greenhouse Gas Initiative (RGGI), or on a rate basis, wherein states could throw in additional low- or no-emissions resources (e.g., renewable energy or energy efficiency) to dilute the electricity sector’s carbon intensity. For well over a decade, much of the electricity sector has grown comfortable with the idea of how mass-based trading of pollutants might impact planning. Until last year, few had considered rate-based compliance; the sudden diversity of options left the electricity planning community off kilter, and facing important questions: Who bears responsibility for building new low-emissions resources? Would states be able to trade elusive “rate credits?” What would it mean to have two electrically connected statesor even jointly dispatched stateswith overlapping rate- and mass-based compliance requirements? What would this matrix of rate- and mass-based states look like? Broadly, the electricity sector posed the questions, sat back, and waited for today.

The final version of the Clean Power Plan keeps flexibility alive, and the matrix intact. In fact, states have more compliance routes than proposed a year ago, although some previously prominent options are now firmly off the table.

A Bevy of Options

First, a little lingo. States can travel two major regulatory routes:

Emissions Standards are federally enforceable limits applied to individual electricity generating units (EGUs). These are limitations that would get built into a unit’s air permit, issued by the state, approved by EPA, and enforceable through federal law. States have experience in permitting criteria pollutants and water effluent at EGUs.

State Measures are programs, standards, and incentives put together and enforceable by a state but not enforceable by federal law. These might include state-sponsored efficiency programs, renewable portfolio standards, or even mass-based trading systems such as RGGI. States can opt to implement emissions standards approaches or state measures approaches, or even a combination of both (the mix falling under a “state measures” definition).

Under these regulatory routes, states now have three different compliance pathways.

  1. Mass-Based compliance provides targets in total tons of carbon dioxide (CO2), which are now set by EPA rather than the states. Under this rubric, states either have to stay within a specific stack emissions limit from the EGUs in their state, or can opt for a market-based program that trades equivalent allowances amongst multiple states. States could even opt to apply firm mass-based limits to individual EGUs, although the practical difficulties of doing so will likely limit this option.
  2. Statewide Rate-Based compliance sets state emissions intensity targets, in tons of CO2 per megawatt hour (MWh) of generation. It counts emissions (only) from covered sources, but generation from both covered sources and eligible low-emissions resources. Under the state average rate approach, the state has to achieve the specified target. In a twist away from the proposed rule and a supplemental proposal issued late 2014, states will have to show that each individual EGU hits either the state average rate, or other permitted rate limits that in aggregate hit the target rate.
  3. Subcategory-Specific Emissions Rates is a new option derived from traditional new source performance standards. In this approach, each EGU is assigned a specific permitted rate, one rate for steam generating units (like coal, oil, or gas-steam) and one rate for combustion turbines. The permitted emissions rates for individual EGUs under this option may be different than the state average approach.

There are a few different combinations of regulatory routes and compliance pathways that states can choose, and like any good strategy game, there are different incentives for choosing any given combination. States may opt for a simple approach, which still makes room for federal jurisdiction. Alternatively, states may opt for a more complex approach that requires substantive proof and backstops, but keeps EPA further at bay.

Not all combinations of regulatory routes and compliance pathways are available. States opting to take a rate-based approach are automatically required to take an emissions standard regulatory route. That means that if a state wants to dilute its emissions rate by adding low-emissions resources, it will have to also accept a federally enforceable rate limit at each of its units. Regardless of whether the state chooses to use EPA’s state targets or a subcategory rate of emissions, individual EGUs will have permitted limits. This gives EPA a little more of a lever on an untested approach: if states fail to implement their alternative low-emissions resources (i.e., fail to pump up efficiency and renewable energy), EPA has legal leverage over the state’s generating units. This keeps those EGUs in the game, making sure that the state hits its targets.

To demonstrate rate-based compliance under the final rule, states will need to show that there are a sufficient number of low-emitting resources diluting EGU emissions. They will also have to lay claim to those low-emitting resources. EPA anticipates that states might want to create tradable allowances for these low-emitting resources, and thus is offering tradable emissions rate credits (ERCs) produced in units of energy. Similar to renewable energy credits (RECs), and in some cases overlapping explicitly with RECs, ERCs will be the currency of rate-based states.

Under a mass-based approach, states have a few more regulatory options. They can either opt for federal permitting or submit a “state measures” plan. When a state submits a state measures plan, it must include a backstop, or a way for EPA to step in if the state’s plan fails. EPA has a fairly straightforward formula for figuring out if a state’s plan has failed, and a two-year timeline before backstop measures kick in. State measures can include either a portfolio of low emissions resources that the state anticipates will displace emissions, or a “trading ready” plan that implements market-based allowance trading (i.e. cap and trade). As with ERCs for rate-based states, CO2 allowances (traded in tons) will be the currency of mass-based states. Notably, mass-based states can’t sell ERCs to rate-based states without a firm energy contract in place.

One more wrinkle. In the proposal, EPA was ambiguous as to whether or not it would consider the impact of new fossil plants in any of the calculations for the Clean Power Plan. This left a gaping question: Can’t a state just build a slew of new fossil power (not covered under this regulation) and escape emissions reductions altogether? In the final rule, EPA addresses this problem by giving states two options: prove that your emissions reductions won’t just be taken up by new power plants, or bring the new sources under the umbrella with a joint “complementary” target.

EPA has decided that states that go with a federally permitted cap-and-trade program effectively do not require any further proof that they’ll hit the mandated targets. States opting for this direction will submit very simple compliance plans. States opting for more risky compliance pathways—at least from the regulators’ perspective—will have to submit much more substantive proof that their plan will work (more on those state plans in our next blog on this subject).

Deep in the Matrix

So what’s the catch? EPA promised flexibility, and indeed, the Clean Power Plan provides extraordinary flexibility. In fact, the plan not only provides flexibility in how states meet their targets—but also in what units those targets are counted in. Energy modelers quake when thinking about the math problems.

First, we know that many states are electrically interconnected. And this means that states’ electricity habits, use, and decisions impact on other states’ emissions. A change in your state’s energy consumption can affect my power plants, and my new wind project can impact your emissions. Electricity flow doesn’t abide by state lines. And this can lead to some problems. When one state adopts a stricter standard that raises the cost of electricity, other states with cheaper resources might just flow in to fill the gap, a process called “leakage.” The problem is fairly easy to quantify when we have just one regulation and one boundary, but when we have three different forms of the same trading regulation in 48 interconnected states, the math gets a little trickier.

Three different forms of trading regulation? Yes. First, states opting for rate-based compliance will likely set up ERC trading programs. But states opting for mass-based compliance will either be regulating only their existing sources, or both their existing and new sources with a “new source” complement. If states that regulate only existing sources trade with states that regulate both new and existing sources, we could see significant leakage to the state that only regulates existing sources. After all, their new power plants aren’t subject to this regulation at all. So to prevent this form of incongruity, mass-based states may have to opt for two different mass-based allowance programs: existing source mass-based trading, and existing and new source mass-based trading.

What happens when a rate-based state abuts a mass-based state? The market incentives in both of these states are quite different, and likely to result in some new and interesting hiccups in the electricity market. EPA and the states will be in an interesting position to anticipate, before plans are finalized, how compliance strategies in other states might impact their own electricity markets.

EPA’s Clean Power Plan is the work of an agency dedicated to getting actual emissions reductions, but looking to step on as few toes as possible. But in avoiding squashing our dactyl digits, did they inadvertently create a weaker rule and kick emission regulation in the shin?

States have a year from today to submit evidence to EPA that they’re seriously working on plans, and that their plans will result in emissions reductions. States will likely find it in their interest to do a great deal of coordination, and have until 2018 to get their books in order. Will the complex matrix of state compliance routes still exist in 2022? It’s hard to know right now what options states will find attractive. Help is available for those overwhelmed by the plethora of options. Synapse and others like us have been gearing up to help states navigate this rule for many months, and the necessary planning can be far less daunting than at first glance.

Keep an eye out for our upcoming Synapse webinars on understanding the final Clean Power Plan.