Blog Post

EPA’s Clean Power Plan Model Trading Rule Can Achieve the Goal, But Not Without Changes

Feb 2, 2016 | Dallas Burtraw

January 21 was the deadline to submit comments to the Environmental Protection Agency (EPA) on two proposed elements of the Clean Power Plan: 1) the proposed federal implementation plan, which would be put into effect in any state that does not submit a state implementation plan; and 2) the model trading rules, designed to facilitate emissions trading among states and utilities. RFF researchers provided ten recommendations that are salient to the discussions around the mass-based approach to these two issues. Of these, six pertain to the initial distribution of emissions allowances in a cap-and-trade program.

A key challenge facing the Clean Power Plan is the possibility that emissions could increase through substitution of generation to new natural gas units that might not be covered in state compliance plans. Under Section 111(d) of the Clean Air Act, EPA has authority to regulate existing sources while new sources are regulated through 111(b) performance standards. States have the prerogative to exclude new sources from their 111(d) compliance plans. If they do so, emissions from new sources would be additional to the caps imposed on the existing sources.

EPA adopted a useful strategy to overcome the incentive to substitute generation to new uncovered sources by proposing to initially distribute valuable emissions allowances on the basis of updated information about a plant’s share of electricity generation. However, extensive modeling at RFF and elsewhere indicates that EPA’s approach may be insufficient.  EPA put the right pieces on the chessboard, but they need to be deployed differently. 

In our recommendations, we suggest:

  1. EPA should make the New Source Complement, thereby covering all sources, an element of the mass-based model rule. The federal plan should retain the mass-based option for states.

The simplest approach would be to require states to cover all sources if they adopt the model rule and therefore automatically win eligibility to trade with other states. If states choose not to adopt this version of the model rule, the burden would be on them to demonstrate that leakage would not occur.

  1. If EPA chooses not to require states that use a mass-based approach to adopt the New Source Complements, then EPA should require updated allocations for 100 percent of the emissions allowances.

If states regulate only existing sources under a cap-and-trade program, RFF analysis suggests that the portion of allowances based on updated information should be expanded, perhaps to 100 percent of the allocation, if this “leakage” to new sources is to be avoided. 

  1. EPA should recognize that updating allocation to existing natural gas combined cycle (NGCC) units and new non-emitting units reduces leakage to new NGCC units. Updating allocation to all affected units covered under the cap achieves comparable results and may have advantages.

A key question is which technologies are eligible to receive allowances when using an updating approach. The most potent approach to ensure that substitution from existing sources to new natural gas units does not occur is to allocate to existing natural gas units. However, allocation to new non-emitting units also is effective. Perhaps surprisingly, expanding allocation to all affected units, including existing coal units, achieves nearly the same emissions outcome as allocating to only gas and non-emitting units. This may have policy and legal advantages because it would treat all affected sources in a symmetric manner. 

Expanding allocation to existing non-emitting sources would have a negative effect on emissions because these sources have little ability to change generation and it waters down the production incentive for other sources. However, if these sources might otherwise retire, EPA might want to consider this.

We also suggest other fine-tuning to EPA’s approach using updating allocation:

  1. If EPA does not require coverage of new sources in the model rule, EPA should reduce the delay between generation and updating allocation and eliminate the threshold on utilization.
  2. Any free allocation not based on updated generation shares in the model rule or federal plan should be directed either to local distribution companies on an updating basis or to generators, assigning equal prominence to both approaches rather than the exclusive focus on allocation to generators in the current proposal.
  3. States that attempt to demonstrate equivalence in their plans should use an appropriate baseline assumption for other states’ actions, and should be compelled to evaluate “other environmental outcomes.”

The bottom line is that EPA has the tools to ensure that leakage to new sources does not occur. But to assure that outcome, EPA needs to revise its allocation strategy. It also needs to consider other changes to the program implementation, which we will discuss in a subsequent blog post.