Some fear NOx controls will spawn outages and higher power prices.
Utility executives say the EPA's plan to reduce ground-level ozone in the nation's eastern half by controlling emissions of nitrogen oxides in upwind states could undermine electric reliability and force power prices higher.
And that prospect loomed larger in late June, after the U.S. Court of Appeals for the D.C. Circuit turned down a last-ditch effort to sink the EPA plan, widely known as the "SIP Call." Seeing no reason to interfere any longer, it denied motions for rehearing and left intact its ruling issued March 3 that the Environmental Protection Agency had struck a proper balance under the Clean Air Act between air quality and technological cost constraints. At the same time, the court lifted a stay in force since May 1999 that had suspended the deadline for those upwind areas to prepare a state implementation plan (SIP) for NOx control and file with the EPA.
Of course, the EPA's opponents are still alive in the U.S. Supreme Court, which will review the EPA's aggressive 8-hour standard for measuring nonattainment of air quality standards for ozone. And many downwind states might still be heard on their "section 126 petitions"--fixing blame for their ozone nonattainment on upwind polluters. But the SIP Call still stands. The EPA last year had lowered its sights by asking the D.C. Circuit to evaluate its NOx plan under the old, less-stringent one-hour standard. Thus, this latest ruling from the court of appeals would not be undone by a Supreme Court order striking down the new eight-hour standard. All the same, many in the energy industry still question the basic philosophy behind the SIP Call.
"The EPA is changing the rules in mid-game with a flurry of new regulations--not based on objective science--and with unrealistic deadlines," cried William T. McCormick Jr., chairman and chief executive officer at CMS Energy, at a May press briefing in Washington, D.C.
"Electric reliability will be seriously degraded, especially in the Midwest, because of the large number of plant outages needed to backfit selective catalytic reduction and other technologies over the next three years to meet EPA's 2003 deadlines," he said.
McCormick's comments highlight industry concern that the EPA rule will force utilities to have their power plants offline for longer than planned to install technology for reducing emissions. That time offline could cause reliability problems if the outages extend into times of high power demand.
McCormick cites a study released in February by the North American Electric Reliability Council, "Reliability Impacts of the EPA NOx SIP Call," in which NERC found impacts of the EPA rules ranging from insignificant to cause for concern.
In particular, the NERC study predicted significant impacts on electric reliability in the Midwest, both in the ECAR region (East Central Area Reliability Coordination Agreement) and in MAIN (Mid-America Interconnected Network Inc.). It cited smaller reliability impacts on the Eastern Seaboard, in the MAAC (Mid-Atlantic Area Council) and SERC (Southeastern Electric Reliability Council) regions. But reliability studies performed by the EPA and others on the NOx SIP Call refute NERC's reliability claims, highlighting the fight between industry and environmentalists.
"The EPA NOx SIP Call process has been politicized," says one source, brushing off the differing reliability conclusions.
But an environmental policy expert at the Department of Energy sees potential problems if proper steps are not taken. Says the source, "There are a number of actions that can be taken by the industry to mitigate the potential impacts of the SIP Call, such as the coordination of planned outages. However, [this is] at a time when the reliability of the industry is already being called into question."
Utility executives say they already have gone to great lengths to comply with environmental objectives.
"Since 1970, the amount of coal used for electricity has nearly tripled, yet total emissions have been cut by about a third. Electric utilities meet or exceed numerous clean air requirements," says CMS chief McCormick.
Furthermore, he adds that the equipment required to meet new EPA rules is too expensive, and will force his company to increase prices. As an example, American Electric Power in its annual report estimated that it would have to allocate $1.6 billion to comply with the new standards.
But while CMS Energy may be able to pass increased costs through to distribution customers through its regulated cost of service, merchant generators that buy and sell at market-based rates in deregulated markets say they expect that they will have to be content with less profit.
SIP Call in a Nutshell
As it was first issued three years ago , the EPA rule required 22 states and the District of Columbia to reduce emissions of nitrogen oxides, which react with other chemicals in the atmosphere to form ozone (smog). In addition, the EPA set up a NOx budget, establishing the maximum amount of NOx allowed to be emitted in each state affected by the NOx SIP Call, based on a new eight-hour standard to measure ozone attainment, which replaced the one-hour standard set in 1979. The process of setting a NOx emissions budget for each state drew distinctions among certain categories of boilers, engines, and electric generating plants, including some and excluding others from tabulations of NOx emissions and calculations of required tonnage reductions. However, in the final SIP, each state remains free to decide how it will achieve the actual emissions reductions required by the EPA.
Jenny Noonan, policy analyst in the Office of Air Quality Planning and Standards at EPA, says states will have to submit a state implementation plan by late October, now that the federal appeals court has lifted the stay. When asked, she said she still expected the agency to stick with its planned deadline of May 2003 for full compliance with NOx reductions.
"The court made a couple of small adjustments," added Noonan. "It remanded [the case] back to EPA [regarding] Georgia, Missouri and Wisconsin." The court took Wisconsin out of the SIP Call, finding no proof that emissions floating out over Lake Michigan affected downwind states. In Georgia and Missouri, it found that only a portion of NOx sources exerted any material effect on downwind states, and asked the EPA to rethink its budget calculations. Speaking in late June, Noonan said the EPA expected shortly to issue a proposal addressing those issues.
Kimber Scavo, environmental protection specialist at the EPA, says that if the EPA were using an eight-hour standard for assessing ozone levels rather than a one-hour standard, Wisconsin and several other states would be included in the NOx SIP Call.
As an EPA expert explains, "The one-hour standard is good at measuring peak concentrations of ozone in the air. The one-hour standard is very good at measuring the amount of smog over a one-hour period.
"But the health data that we collected showed that it is not only bad for your health to be exposed to ozone at the very highest levels. Instead, the health data shows that for children and the elderly, being exposed at a lower level over a longer period of time is very dangerous to your lungs and can cause damage.
The eight-hour standard measures the amount of ozone in the air over an eight-hour period. It is a rolling average. It is the highest eight hours of the day." The eight-hour standard is before the U.S. Supreme Court. The court will consider whether EPA overstepped its constitutional authority when ordering compliance under the eight-hour standard. (See sidebar, "Measuring Emissions.")
"We, as a company, are very sure that there will, in all likelihood, be an eight-hour standard," says Joe Maher, spokesman for Duke Power. "The question is what number do you use. What is the standard? The EPA had proposed 80 parts per billion. The lawsuit filed against the EPA found that there was no clear link between the science and the number that was picked as the standard."
Although Duke Power has no objection to the one-hour standard, the company would support a reasonable eight-hour standard, says Maher.
Most utilities already have begun deploying technology to reduce NOx emissions in anticipation of the ruling. Meanwhile, states have flexibility in choosing how to achieve the NOx reductions needed to meet the budget, notes Noonan at the EPA. Utilities will select from a combination of, among other options, a cap-and-trade allowance program, selective catalytic reduction (SCR), or selective non-catalytic reduction (SNCR) technologies.
Sampling techniques can make the difference.
In the appeal pending before the U.S. Supreme Court , a key issue concerns use of an eight-hour standard to measure attainment with ambient air quality targets for ozone. The Environmental Protection Agency in July 1997 chose the new eight-hour test to replace the old one-hour standard.
Under each standard, however, compliance or nonattainment can depend heavily on how and when the data is sampled.
In some areas, the seasonal pattern of ozone makes it unnecessary to measure for months at a time. Missing daily measurements can be inferred, based on actual measurements and averages of measurements taken on other days.
THE ONE-HOUR STANDARD. Compliance is attained if, over a three year period, the maximum hourly average concentration of ozone exceeds 0.12 parts per million on an average of only one day (or less) per year. The hourly average is deemed valid if concentrations are measured for at least 75 percent of the hours from 9 a.m. to 9 p.m.
The EPA rule provides this mathematical formula to account for sampling and missing data and to calculate the number of "eceedances," as the EPA calls them: e = v + [(v/n) x 8 x (N-n-z)].
THE EIGHT-HOUR STANDARD. Satisfied if, over the most recent three-year period of consecutive and complete calendar years, the average of each year's fourth-highest maximum ozone concentration for any running eight-hour period does not exceed 0.08 parts per million.
(There are 24 different running eight-hour periods for any given day, and thus 24 different possible measured averages for any one day, or 8,760 for the year. The fourth-highest such 8-hour average for one year is added to the fourth-highest average for each of the two other years, and the sum is divided by three.)
Again, not all hours or days need be measured. A day is deemed to be measured if valid 8-hour measured averages are available for at least 75 percent of the possible hours in the day (i.e., at least 18 of the possible 24 different running 8-hour periods). A year is deemed "complete" if data is measured over that 3-year time for at least 90 percent of the days in the ozone sampling season, and no less than 75 percent of the days in the sampling season in any one calendar year.
SCR technologies achieve the greatest reductions, says Joseph S. Graves, senior vice president at PHB Hagler Bailly. But, he explains, although most other technologies can be installed within a normal planned plant outage, the installation of SCR technology can take longer than the usual four weeks allotted. The uncertain amount of time required for SCR installation can raise reliability concerns, he says.
And SCR technology can be expensive, depending on the size of the plant.
"In the case of a base-load plant, that would be a good candidate of SCR," says Jerry Eyster, vice president at PHB Hagler Bailly. "You can spread the capital over many kilowatt-hours, but you would be unlikely to put the SCR unit on the cycling unit because it would be very expensive per kilowatt-hour. There you might put [some other technology] where you have a high operating cost but lower capital. You are making decisions on technology to fit the operating characteristics of your plant."
Meanwhile, the EPA does not believe that the order is at risk of further legal challenges.
"The court denied both the petitioners' request for rehearing at the three-judge-panel level and [also rehearing by the full compliment of the court]. So we are confident that the [appeals court] has supported the NOx SIP Call, and we are going ahead," Noonan says.
Noonan adds that the EPA assumes an emission rate of 0.15 million British thermal units from utilities in those states included under the SIP Call. For states that fail to submit a plan, the EPA says it can establish how the states will comply with the new order by submitting a federal implementation plan (FIP).
A Rule Based in Science or Economics?
Utility interests argue that EPA's new rule is based on economics rather than science.
"The problem is that EPA has based this rule not on air quality analysis but a cost analysis," says Kathy Beckett, an attorney with Jackson and Kelly PLLC, representing the Midwest Ozone Group. The MOG is an ad hoc coalition of nearly 30 electric utilities, coal and petroleum companies, and affiliated organizations.
"Those sources they picked that could reduce NOx at an average of $2,000 per ton were removed. That was the rule of thumb they used to identify control. The problem we have is that the Clean Air Act doesn't say you should pick cost and then design emission-reduction programs," Beckett argues.
She notes that the Clean Air Act instructs the EPA to look at the ambient air quality standards, decide which parties are impacting them, and then decide control.
Beckett's argument carries a certain irony. Usually, private industry will ask regulators to consider costs in setting environmental policy. But here, it is the other way around. This flip-flop did not go unnoticed by one of the D.C. Circuit judges who reviewed the EPA's NOx SIP Call.
Judge Stephen F. Williams called it a "gamble"--a risky strategy by certain states with small NOx contributions. He speculated that if the law in fact barred the EPA from considering cost along with health effects, the agency would have acted differently. Instead, it would have scaled back on its SIP Call. Said Williams, "If EPA were barred from considering costs, it would never have included such states."
Williams implied that this gamble led some of private industry petitioners to switch back and forth in briefs and oral arguments on whether EPA should or should not consider costs--so much so that he believed that "a summary of the different vacillations is in order."
Overall, Williams concluded that "no party makes any claim that EPA was either confined to adopting rules whose benefits exceeded their costs, or permitted to use that criterion in selecting its final rule."
EPA's Scavo refutes the industry's claim that the SIP Call is based on economics.
"The way we figured out the remedy was to apply highly cost-effective control measures. But that is not how we determined how many states are in and who the requirements apply to; we based that on air quality analysis," she says.
"We did air quality analysis and modeling to determine which states caused other states problems because of transport of ozone. That was all based on air quality. We determined the control strategy by what was highly cost-effective to reduce NOx emissions."
Scavo adds that EPA did a cost analysis and determined that measures costing between $1,000 and $2,000 per ton were cost-effective. "That is how we came up with the controls that we apply to their emission inventory to come up with the budget."
Furthermore, she notes that utilities would have preferred a remedy on a cost-per-ton basis, instead of just a uniform number that every state had to meet.
For example, says Scavo, "If a certain state contributed x amount of parts per billion [PPB] of ozone, we should have applied a cost per PPB instead of saying, 'we think you should mitigate transport by applying highly cost-effective measures.' They don't agree with the way we developed our control strategy, and we did use cost for that and the court upheld that."
Moreover, she says that if EPA had used the utilities' preferred remedy, a state with less emissions leaving the state than its counterparts might have had a less-stringent NOx budget applied to its utilities.
In fact, in its March 3 opinion affirming the EPA's SIP Call, the court of appeals addressed this issue head-on and ruled for the government. As the court noted, the statute itself (the 1990 amendments to the Clean Air Act) barred emissions that "contribute significantly to nonattainment." In the court's view, that language implied at least some consideration of cost factors:
"The term 'significant' does not in itself convey a thought that significance should be measured in only one dimension--here, in the [opponents'] view, health alone. Indeed, 'significant' is a very odd choice. ... In some contexts, 'significant' begs a consideration of cost."
What it Means for Merchant Generators
Merchant generators like Dynegy will be affected by EPA's NOx SIP Call rule, although the amount of emissions reduction needed for new plants to comply is uncertain, says Lisa Krueger, vice president of environmental health and safety for Dynegy.
"With the merger of Illinova, Dynegy has roughly 3,800 megawatts of generation in the state of Illinois. Of that, roughly 3,100 is coal-fired generation. Those are existing units that will require a significant reduction in NOx emissions to meet the NOx SIP Call," she says.
Krueger adds that the reductions on gas-fired generation within Illinois and in other states affected by the NOx SIP Call will depend in part on the NOx budget for the state and how it is allocated in the state.
"States may be taking different approaches. Some states will be allocating to new sources. There will be a cost impact on new plants because not only will they have to meet NOx limits imposed by other environmental provisions, but they have to deal with the possibility that they will not be allocated enough NOx credits."
Furthermore, Krueger says programs for trading emissions typically achieve emissions reductions, but because of the low levels sought in the NOx SIP Call, the benefits of trading will be less dramatic.
The ruling fundamentally will change the NOx emissions markets, says Eric Thode, director of public relations at Enron North America.
"Because the plants have to put equipment on to reduce NOx emission, they are going to reduce the need for NOx credits. The market for 2003 will be a completely different market. Trying to compare what might happen to prices in the market today to the future is impossible to do because as you reduce NOx , there is going to be less need for credits and more than likely the price falls in the long-term," he says.
Conversely, Andy Kruger, vice president at Cantor Fitzgerald's Environmental Brokerage Services unit, believes that prices for NOx allowances in the NOx SIP Call program will not go beyond the highs seen in the current NOx market.
"I don't think it will go higher, nor do many of the players that I have spoken to for a number of reasons. First, about cost, people will find ways to control that. [Second], we have a lot more information available now. We have at least a lesson in history," he says.
Kruger explains that the industry's familiarity with environmental cap-and-trade programs such as SO2 will provide a comfort level for utilities in dealing with cap-and-trade program associated with the NOx SIP Call.
Furthermore, he agrees with Enron's Thode that the market for 2003 will be entirely different from the current NOx allowance cap-and-trade program and thus difficult to compare.
Nevertheless, Kruger says success of the NOx cap-and-trade program will depend on whether utilities, which start with fewer allowances than they require, can cut down their NOx emissions by means such as adapting SCR technology and become a seller.
"If everybody becomes a buyer and no one becomes a seller, you are going to have a problem," he says.
Adds PHB Hagler Bailly's Graves, "You are likely to have fewer allowances for sale, and that creates some concerns [about] how liquid the NOx market will be.
"The real issue is can A comply more than it needs to and create allowances to sell, and can it do that because its marginal cost of compliance is less than B's. And B's alternative is to put on its own equipment," he says.
PHB Hagler Bailly's Eyster explains further. He describes an example in which one generator might have an opportunity to reduce NOx at $1,500 per ton, and another generator has a cost of $6,000 per ton.
"There is a price in between where they could agree that the $6,000 person buys allowances that the other generates, and they are both better off. The one that puts on the $1,500 technology creates allowances beyond what they need, and sells them to the person who doesn't have to spend $6,000."
Eyster says, "What they spend is the allowance price, which would be presumably higher than $1,500 but not all the way to $6,000."
More Lawsuits Ahead?
Although the legal tactics utilities are pursuing in response to the SIP Call quickly are running out, experts says they still can appeal within 90 days to the U.S. Supreme Court, appeal to Congress, or hope that a Bush administration would be more receptive to energy company woes.
"Do we pursue going to the Supreme Court? Do we pursue Congress? There are two lawsuits going on. One deals with the eight-hour and the other deals with the NOx SIP Call. We might be able to find some constitutional issues with the ruling," says Midwest Ozone Group's Beckett.
"An option would be to find a stay while the Supreme Court decides. There will be a filing in 90 days," she says.
Beckett explains the constitutional issue that she might raise.
"One constitutional issue deals with the very same concept that is in the eight-hour ozone appeal to the Supreme Court. That dealt with an unconstitutional delegation of authority.
"What the D.C. Circuit Court in the NOx SIP Call said is it did not see the same [unconstitutional delegation] as in the eight-hour standard because it saw 22 states affected," she says.
According to Beckett, the D.C. Circuit Court ruling suggests that because the NOx SIP Call rule does not affect everyone in the country, there is no basis for ruling the delegation of authority unconstitutional.
"Having said that, are constitutional issues only constitutional when it only affects half? Since the NOx SIP Call only affects a few states, the EPA actions would not be subject to constitutional review," she says.
Beckett admits that would be a difficult argument to pursue in court. Rather, when all legal remedies are exhausted, she says, the industry will go to Congress.
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