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Duke-ing It Out at the High Court: The End of New Source Review?

To what extent can the EPA force utilities to update aging fleets with expensive pollution-control technology?

Fortnightly Magazine - February 2007

sources and an hourly test for small sources, when both tests stemmed from EPA’s interpretation of the same term, “modification.” Although none of the initial briefs cited this argument or this tax case, the 4th Circuit relied only on this case in invalidating EPA’s use of the annual test.

The Hourly/Annual Distinction Is Significant

Why is this apparently small, technical interpretation so significant? Is there really a considerable distinction between the annual and hourly tests? Though it is easy to get caught up in the case’s technical jargon, the distinction between the two tests really is rather simple. The hourly test allows a utility to almost entirely refurbish its generation units without triggering environmental control requirements, whereas the annual test does not. Under the hourly test, EPA’s only consideration is whether plant-wide emissions per hour increase, even if the new, more efficient plant can operate for more hours per year. Conversely, the annual test accounts for all possible capacity factor increases and, as a result, virtually any modification allowing a plant to operate more will require upgraded pollution controls.

Does the Modification Rule Work?

Economists long have argued that the modification rule retards capital investment, thereby inhibiting the turnover of the electric industry’s generation stocks. 7 They argue that instead of ensuring that these older plants modernize, the modification rule actually creates the opposite incentive because un-modified plants have lower fixed and variable costs. Of course, a utility’s incentives differ depending on the state regulatory environment. In rate-of-return states, utilities typically can recoup their capital costs for environmental controls plus some reasonable rate-of-return. In restructured states, however, the utilities are not guaranteed a return on capital expenditures; therefore, economists argue that utilities in restructured markets are less likely to make capital investments. In fact, recent empirical evidence out of the University of California, Berkeley suggests that power plants in restructured states tend to install significantly less environmental control technology than those in rate-of-return states. 8

On the other side, environmentalists argue that these provisions are necessary to ensure that older plants do not continue running unabated. As Sean Donahue, the lead attorney for the environmental petitioners, put it, “We’re very pleased that the court agreed to review the Duke Energy decision, which rests on a flawed interpretation of the Clean Air Act , and which industry has been citing in numerous other cases in an effort to undermine essential pollution controls applicable to some of the nation’s largest sources of air pollution.”

The Load Split

Because the 4th Circuit overturned the annual test, leaving only the hourly test, facilities in the five states in that circuit (Maryland, West Virginia, Virginia, North Carolina, and South Carolina) can make significant modifications to their plants without triggering expensive environmental-control requirements. This gives facilities in these states a competitive advantage over facilities in neighboring states that serve the same customer load. Even so, because of the Supreme Court’s review, 9 facilities in the 4th Circuit probably will wait on the decision before making any major modifications.

Adding to this regulatory drama, 7th Circuit Judge Richard Posner—one