Why You Should Care About CAIR

Deck: 

New provisions nearly eliminate the financial impacts of the rule’s ozone regulations.

Fortnightly Magazine - January 2007

The Clean Air Interstate Rule (CAIR) promulgated by the U.S. Environmental Protection Agency in 2005 is designed to reduce ozone transport and the atmospheric interstate transport of fine particulate matter (PM2.5).1 Beginning in 2009, CAIR will regulate ozone transport by imposing limits on the emissions of NOx during the months of May through September, called the “ozone season,” and referred to hereafter as CAIR Ozone. These rules will expand and replace the current NOx Budget Trading Program (NBP), often referred to as the NOx SIP Call. Also beginning in 2009, CAIR will impose annual caps on NOx emissions, referred to hereafter as CAIR PM2.5. Most of the power plants in states east of the Mississippi River will be regulated under both sets of regulations. Although there are plants that only will be regulated under the CAIR Ozone rule, others only will be regulated under the CAIR PM2.5 rule. Several states west of the Mississippi River also will be regulated under the CAIR rules.2

The authors have spent a considerable amount of time evaluating the implications of the CAIR Ozone and CAIR PM2.5 rules for numerous clients. A key finding of our analysis, and initially a surprising one, is that the provisions under CAIR PM2.5 nearly eliminate the financial impacts of CAIR Ozone. Moreover, through its impacts on NOx emissions, CAIR PM2.5 also will affect the NBP allowance market. The reason underlying these impacts is that CAIR PM2.5 is so restrictive it creates a strong financial incentive for generators with plants regulated under both CAIR provisions to reduce their NOx emissions during the ozone season. This substantially reduces the impact of CAIR Ozone, and therefore will lead to very low allowance prices under CAIR Ozone.

Because CAIR Ozone replaces the NBP, allowances issued under the NBP can be used under the CAIR Ozone program without flow control. The result is that the low allowance prices projected for CAIR Ozone, in turn, will affect NBP allowance prices. Specifically, the low allowance prices under the future CAIR Ozone provisions reduce the value of banking NBP allowances for use in complying with the CAIR Ozone. This, in turn, will drive down the NBP allowance prices in the coming years. Moreover, for owners of plants subject only to CAIR Ozone (plants in Massachusetts, Connecticut, and Arkansas), the burden of complying with the CAIR Ozone provisions will be relatively small compared to owners of plants subject to CAIR PM2.5.

In the following sections, we quickly review the key provisions under the current NBP as well as those under CAIR Ozone and CAIR PM2.5. We then evaluate how these rules interact with one another using our proprietary projections of NOx allowance prices to: (1) explain why we expect that CAIR Ozone allowance prices will be very low; and (2) discuss the implications from the planning and strategic points of view. In addition, we examine how the pace at which NOx control retrofits, selective catalytic reduction systems (SCRs) and selective non-catalytic reduction systems (SNCRs) can be brought online affects NOx allowance prices under CAIR Ozone and CAIR PM2.5.

The Rules: NBP and CAIR Ozone

Under the NBP, the seasonal cap on NOx emissions from affected plants is 520,957 tons.3 The caps under the NBP and CAIR NOx regulations are summarized in Table 1.

The NBP currently places a cap on NOx emissionsduring the ozone season at 342,500 MW of existing generating capacity. Of this capacity, about 55 percent, or 191,900 MW, is coal-fired. The existing capacity by fuel type regulated under the various regulations is shown in Table 2. NOx emissions from new plants built in states regulated by the NBP and by the CAIR NOx provisions also will be subject to the emissions caps shown in Table 1.

Moreover, the CAIR Ozone will replace the NBP in 2009 and, initially, will impose an annual cap of 580,000 tons through 2014. Beginning in 2015, the cap will decline to 480,000 per year.4

The NOx emissions from 449,200 MW of existing capacity will be regulated under CAIR Ozone, of which 241,900 MW is coal-fired. Of the 449,200 MW, 301,700 MW5 is already regulated under the NBP.

It is important to note that even though the cap under CAIR Ozone is less stringent than the cap under the NBP over the 2009 through 2014 period, the ratio of the annual allowances allocated per megawatt of regulated capacity is lower under the CAIR Ozone provisions than under the NBP. This strongly suggests that the first phase of CAIR Ozone will be more restrictive than the NBP.

CAIR PM2.5

Under CAIR PM2.5, the annual cap on NOx emissions from affected plants will be set at 1,500,000 tons per year from 2009 through 2014. Beginning in 2015, the cap will be 1,300,000 tons.

There are 512,300 MW of existing generating capacity that will be regulated under CAIR PM2.5. Of this, 227,100 MW is existing coal-fired capacity. Also, 323,600 MW of this total is currently regulated by the NBP.6 Finally, 399,500 MW of the 512,300 MW will be regulated under both of the CAIR provisions.7

The caps under CAIR Ozone and CAIR PM2.5 discussed above do not reflect federal or state imposed restrictions on the use of allowances.

Analysis of NOx Allowance Markets

To facilitate understanding of how the NBP interacts with the NOx CAIR regulations, our starting point is an electric generating industry with the NBP in place but without either the CAIR Ozone or the CAIR PM2.5 provisions in place.8 Starting from this perspective, we clearly can see how the two sets of CAIR NOx regulations interact with the NBP, how they interact with each other, and the implications they have for planning.

For this analysis, we used Economic & Management Consulting Group’s (E&MC) Electric Power Market Model (EPMM) of the U.S. and Canadian electric systems that projects, among other things, the mix of new generating additions for each of 43 interconnected electric markets, the mix of retrofit pollution control equipment, the use of new and existing generating equipment, as well as power flows among the 43 markets. In the process of projecting the mix of new builds and retrofits, EPMM also projects capacity and energy prices for each of the markets along with allowance prices under the various federal, state, and regional emission cap-type of environmental regulations.

In terms of NPB, column 1 of Table 3 shows E&MC’s projections of NBP prices in the absence of both CAIR Ozone and CAIR PM2.5 emissions caps. For 2008, we project an NBP allowance price of $970 per ton (all prices are in 2005 dollars). Recent market transactions suggest a price of around $900 for 2008. We also project that NBP prices would decline through 2015 as SCRs and SNCRs are retrofitted to existing plants and new, more efficient generating equipment enters service. After 2015, we expect prices to rise and reach $1,030 per ton by 2025. Once again, these prices are in the absence of the CAIR Ozone and CAIR PM2.5 as shown in columns (2) and (3) of Table 3.

How does CAIR Ozone affect the NOx allowance market and allowance prices during the ozone season? As noted earlier, in the first phase of CAIR Ozone—2009 through 2014—the ratio of allowances to regulated capacity is lower than under the NBP, suggesting that CAIR Ozone will be more restrictive in its first phase than under the NBP.

Our analysis shows that CAIR Ozone would increase ozone season allowance prices above the levels that would occur under the NBP. We project a 2009 allowance price under CAIR Ozone of $2,070 per ton, which is more than twice the price that we project would occur under the NBP in the pre-CAIR NOx world. By 2025, we would expect that the prices under CAIR Ozone would be close to four times as high as the prices under the NBP. This can be seen by comparing columns (1) and (5) in Table 3. The widening of the differential would be expected since the cap under CAIR Ozone becomes more restrictive beginning in 2015.

EES North America

Moreover, the CAIR Ozone provisions will affect the prices of allowances under the current NBP prior to when CAIR Ozone takes effect. The reason is that the expected high prices for allowances under CAIR Ozone relative to prices under the NBP provide a strong economic incentive to bank NBP allowances and use them to comply with the regulations under CAIR Ozone. Also, elimination of flow control further increases the benefits from retaining NBP allowances and using them to comply with CAIR Ozone. In this hypothetical world of the NBP being replaced only by CAIR Ozone, we project that NBP allowance prices for 2008 would be twice as high as they would be in the absence of the implementation of the CAIR Ozone program. This can be seen by comparing columns (1) and (4) in Table 3.

The New Environment

So, what does CAIR PM2.5 add to this brew of regulations? With the implementation of the CAIR PM2.5 annual cap on NOx emissions, we project a 2009 allowance price of $8,830 per ton of NOx emissions under the annual cap, and a price of $22 per ton under CAIR Ozone. Thus, with proper emission control strategies, CAIR PM2.5 effectively eliminates the financial impact of CAIR Ozone. These prices are shown in columns 8 and 9 of Table 3.

To understand these results, consider the implications if, along with the CAIR PM2.5 2009 allowance price of $8,830 per ton, the CAIR Ozone price was the $2,070 per ton discussed earlier and not the $22 per ton shown in column 8 of Table 3. These prices imply that a plant regulated under CAIR Ozone and CAIR PM2.5 would pay $10,900 ($2,070 plus $8,830) for every ton of NOx it emitted during the ozone season and $8,830 for every ton emitted in the rest of the year.

In competitive markets, this $2,070 per ton differential could not be sustained if plant operators could modify the operation of their emission controls devices. This differential would provide a very strong incentive for the generators with plants regulated under both provisions of CAIR to reduce NOx emissions during the ozone season. We would expect the generators would take the additional steps necessary to reduce this $2,070 differential by further controlling emissions during the ozone season.

The magnitude of the CAIR PM2.5 allowance prices in the first few years after the provisions are implemented stands out. The reason for these very high prices stems from the assumption in our analysis reflecting limits on the extent to which retrofit SCRs and SNCRs can be installed through 2010. We estimate that it would be economic to retrofit more than 35,000 MW of generating capacity with SCRs by 2009. It is not clear, however, that pollution-control vendors could accommodate this level of demand. Based on our assessment of committed retrofits of NOx control equipment, we concluded that about 5,200 MW of SCR capacity would enter service over the 2006 through 2008 period, another 1,100 MW in both 2009 and 2010, and an additional 1,800 MW between 2011 and 2012. So by 2009, there would be about an additional 6,300 MW of SCR capacity in place—far less than the 35,000 MW that appears to be economic over that time frame.

Based on our assessment of planned SCR announcements, we assumed for this analysis that 6,000 MW of SCRs per year could be brought online in 2009 and 2010 and 3,000 MW per year of SNCR capacity over the same period, in addition to our estimates of planned NOx control retrofits.

In the absence of these limits on NOx control retrofits through 2010, we project that CAIR PM2.5 allowance prices through 2010 would be about 70 percent less than the prices reflecting limits on NOx control retrofits. This is shown in Table 4. To facilitate comparisons, columns (1) through (3) in Table 4 are from columns (7) through (9) in Table 3. Columns (4) through (6) in Table 4 reflect the results from the case where there are no limits on retrofitting NOx controls after 2008. Based on this assumption, we see that CAIR PM2.5 allowance prices would be substantially less compared to an environment in which the amount of NOx controls that can be brought into service by the time CAIR takes effect is limited.

Clearly, the ability of vendors of pollution-control equipment to install SCRs and, to a lesser extent, SNCRs between now and when the CAIR provisions take effect will have a profound impact on CAIR PM2.5 allowance market and the allowance prices in the first few years CAIR PM2.5 is in effect.

Our results up to this point have shown that the presence of CAIR PM2.5 and proper utilization of emission controls essentially eliminates the financial impact of CAIR Ozone. At the outset, however, the way we characterized the interaction between CAIR Ozone and CAIR PM2.5 was that the stringency of CAIR PM2.5 would result in very low allowance prices under CAIR Ozone. To demonstrate this we have posed the following question: What would CAIR Ozone prices be if CAIR PM2.5 had been less stringent? To answer this question, we set the annual cap under CAIR PM2.5 to 1.7 million tons for phase I, 2009 through 2014, and 1.5 million tons thereafter—200,000 tons higher than what is specified under CAIR PM2.5.

Under this hypothetical regulatory regime, we find that allowance prices under CAIR Ozone would be substantially higher than when the actual caps under CAIR PM2.5 are in place, starting at $950 per ton in 2009 and rising to $2,000 per ton by 2025. This can be seen by comparing columns (2) and (8) in Table 4. As we would expect with less stringent CAIR PM2.5 caps, the allowance prices under CAIR PM2.5 would drop dramatically—by 45 percent or more in the early years and by more than 30 percent after 2010. This is shown by comparing the prices in columns (3) and (9) in Table 4.

Another measure of the role CAIR PM2.5 plays in affecting the impacts of CAIR Ozone is the level of NOx emissions from capacity regulated under CAIR Ozone. In the absence of CAIR Ozone, but with the NBP and CAIR PM2.5 in place, we project that NOx emissions during the ozone season from sources regulated under CAIR Ozone would be between 1 to 3 percent higher depending on the year.

We want to emphasize that these results alone should not be interpreted to mean that CAIR Ozone is not an appropriate policy. The value of the CAIR Ozone policy depends on a comparison of the estimated costs it imposes and the estimated benefits that flow from its regulations. The purpose of this analysis merely is to explain how the NOx provisions of CAIR interact with each other and with the NBP.

Planning and Strategic Implications

What are the planning and strategic implications? First, the word is caution for those generators owning plants that are regulated only under CAIR Ozone, which, again, are the plants in Massachusetts, Connecticut, and Arkansas. This includes about 49,700 MW of capacity, as shown in Table 2. These generators are likely to face low allowance prices that may not justify retrofitting SCRs or SNCRs. Of course, for some of these plants, the states may require generators to retrofit NOx controls or impose other requirements irrespective of federal regulations and economic forces. But short of being forced to take some action, it appears owners of plants subject only to CAIR Ozone should follow a wait-and-see strategy.

Generators with plants in states subject to both CAIR Ozone and CAIR PM2.5 will have the greatest incentive to retrofit controls, since they will face the greatest potential allowance costs. Owners of these plants undoubtedly have spent much time and effort evaluating the economics of installing retrofit controls and will continue to do so.

Then there are the generators in states where plants will be regulated only under CAIR PM2.5 (Georgia, Minnesota, and Texas). They are in much the same boat as generators with plants subject to both sets of CAIR provisions, but will have greater operational flexibility without the seasonal ozone constraint.

Our key finding is that CAIR PM2.5 effectively will eliminate most of the financial impact of CAIR Ozone because CAIR PM2.5 is so restrictive. The model upon which this analysis is based, EPMM, is a long-run model of the electric industry and assumes perfect foresight. In the real world, a summer heat wave for example, would tend to drive up CAIR Ozone allowance prices, and the increases could be substantial. Under such circumstances, CAIR Ozone allowances could be very valuable. With proper planning and operation, however, we would expect that CAIR Ozone allowance prices on average will be very low.

 

Endnotes:

1. U.S. Department of Energy, Energy Information Administration, Annual Energy Outlook 2006 With Projections to 2030, p. 28.

2. Among the states east of the Mississippi River, plants in Georgia will be regulated only under the CAIR PM2.5 rule, plants in New Jersey, Delaware, Connecticut and Massachusetts will be regulated only under the CAIR Ozone rule, and plants in Rhode Island, Vermont, New Hampshire, and Maine will not be regulated under either of the CAIR rules. The plants in the rest of the states east of the Mississippi River will be regulated under both CAIR rules. Plants in six states west of the Mississippi River will be regulated under either or both of the CAIR rules—those in Arkansas will be regulated only under the CAIR Ozone rule, those in Minnesota and Texas will be regulated only under the CAIR PM2.5 rule, and plants in Iowa, Missouri, and Louisiana will be regulated under both of the CAIR NOx rules.

3. In some cases, states and federal settlements limit the extent to which NBP allowances can be used by generators, which we reflect in our analysis.

4. We assumed the state holdbacks under CAIR Ozone and CAIR PM2.5 would be the same as those under the NBP.

5. The 301,700 MW is the sum of the 284,500 and the 17,200 from Table 2.

6. The 323,600 MW is the sum of the 284,500 and the 39,100 from Table 2.

7. The 399,500 MW is the sum of the 284,500 and the 115,000 from Table 2.

8. The CAIR provisions for sulfur dioxide control and the Clean Air Mercury Rule (CAMR) are assumed to be in place throughout the analysis.