AIR POLLUTION:

Wrapped up in politics, granddaddy of cap-and-trade plans has an uncertain future

In the eyes of health advocates and some policymakers, the nation's fleet of power plants has its share of decrepit clunkers, relics that are barely sticking around.

But some people might apply a similar description to the cap-and-trade program that Congress created 20 years ago to cut air pollution from those power plants. The plan was wildly successful in its time, but over the past decade, U.S. EPA's plans to keep cleaning up the air through emissions trading were torn to shreds by judges and left in tatters by the wide partisan divide on Capitol Hill.

Now, as the Obama administration tries to cobble back together its signature cap-and-trade program under the Clean Air Act, it faces a daunting array of lawsuits, political pressures and regulatory snags. But supporters of trading are trying to stay optimistic.

They are poring over EPA's new rules for interstate soot and smog, which will set emissions limits for power plants in 27 Eastern states. Power producers aren't sure what to make of the final plan, which runs 1,323 pages -- not including a 414-page economic analysis and a 99-page explanation of how the emissions allowances will be doled out.

But Tom Williams, a spokesman for North Carolina-based Duke Energy Corp., said the company is glad that EPA is still trying to use emissions trading. Like its two predecessors, the Cross-State Air Pollution Rule is designed so dirtier power plants can buy credits from plants that clean up the air more cheaply.

"The cap-and-trade approach was vilified by many in Congress, but it was actually a Republican idea, and it works," Williams said in an interview. "It worked well with the Clean Air Act of 1990, and I hope it will work here too.

"One thing about markets," Williams added after a brief pause, "is they always have surprises."

In the aftermath of the debate over a climate and energy bill in 2009 and 2010, the phrase "cap and trade" became Republican shorthand for an intrusive, expensive federal boondoggle -- which, from critics' point of view, is a good description for just about any Obama administration policy that would make businesses spend money on new health and environmental safeguards.

The irony is that cap and trade has long been backed by power companies as a cheaper alternative to so-called command-and-control rules that tell companies to use a certain technology or shut down. It started with the Acid Rain Program, which made deep cuts in soot-forming sulfur emissions from coal plants, stopping an estimated 19,000 early deaths each year at an annual cost of $3 billion -- a fraction of what the George H.W. Bush administration predicted when it started the program in the early 1990s.

EPA predicts that its latest rules would stop tens of thousands of extra premature deaths at a cost of a few billion dollars each year.

But it remains to be seen whether the new emissions market, which will make its debut next year and phase in tougher pollution limits at the start of 2014, will end up being a vibrant trading floor or a bureaucratic mess.

The agency is working under tight legal constraints. When a George W. Bush-era sequel to the Acid Rain Program was rejected in 2008, the court told EPA that it needed to limit the amount of pollution that crosses state lines, which means power companies can't have the kind of freewheeling, nationwide exchange that the agency had in mind.

The court was specific in its objections to the old program, but EPA staffers still tried to make their replacement plan as flexible as possible, Administrator Lisa Jackson told reporters after releasing her version of the program in early July.

"We feel we've respected those limits and we are confident this will stand up to challenge," she said.

Analysts say that compared to the proposal, the final rule was more lenient on interstate swaps. That will give power companies more leeway to buy credits from the plants that make their pollution cuts at the lowest cost, no matter where they are.

But it's little consolation for companies with billions of dollars on the line. Electric utilities need to be able to plan decades ahead because power plants are "big, chunky, expensive assets," said Chris MacCracken, an analyst at ICF International Inc.

They know the new trading program will no doubt be taken to court. And at the same time, power companies will need to be thinking about EPA's proposed rules for toxic emissions such as mercury, coal ash and cooling water, said Steve Fine, another analyst at ICF, in an interview. (The company has held technical consulting contracts with EPA for the past 35 years.)

Without action by Congress, parts of the trading program could start to collapse within a few years, analysts say. If every power plant needs to clean up its acid gases under new toxic emissions standards that were proposed this spring, there will be little demand for sulfur credits, and they are likely to become almost worthless.

The market for smog-forming nitrogen oxides is seen as more stable, but it too is wrought with uncertainty. Right now, the Obama administration is deciding whether to update the standard for the safe amount of smog in the air -- something that would create a need for another round of trading rules in a year or so, EPA says.

All this makes risk-averse utilities, and the traders who make their living on the emissions markets, uneasy.

"An allowance is only worth something if the regulations allow it to be," Fine said. "That spooks a lot of people -- the uncertainty around markets and the fact that regulations can, and apparently do, change awful often."

An industry divided

For a decade now, many power companies have been crying out for Congress to come up with a long-term fix for emissions trading.

Some of them are willing to accept tougher air pollution limits than EPA has established, so long as they get certainty on deadlines and get to avoid more onerous command-and-control rules, such as the mercury standards that were proposed this spring. It would also allow them to sleep a little easier by avoiding some of the litigation that is bound to follow EPA's new emissions trading plan.

"The bottom line is, it's a minefield of technical complexity with a lot of room for people to complain," said Thad Huetteman, an emissions trading consultant and a former chairman of the Environmental Markets Association. "So, if there's anything that's going to be interrupted by litigation, it's this."

Still, the negotiations have proved fruitless so far on Capitol Hill.

They were led most recently by Sens. Tom Carper (D-Del.) and Lamar Alexander (R-Tenn.), who introduced a "three-pollutant" bill last session to create a nationwide trading program for sulfur dioxide (SO2) and nitrogen oxides (NOx) and set limits on mercury from the power sector.

With a final rule later this year, EPA is planning to make every plant control mercury emissions because of a court ruling that said the George W. Bush administration's Clean Air Mercury Rule, another cap-and-trade plan, was illegal.

Talks on the three-pollutant bill stopped last fall, and have been written off for this session while House Republicans try to pass legislation to block EPA's rules for power plants altogether. Carper said last month that the negotiations ended because some utilities decided they would rather try their luck with the new Congress.

"I think there's reason to believe that a legislative approach is going to be more cost-effective than a regulatory approach," he said. "We had an opportunity to do that last year, and the industry said 'No, not yet.'"

"The ball's in their court," Carper added, referring to the power companies. "When they feel like they want to put it back in play, we're ready" (E&ENews PM, June 14).

One major reason the legislation has stalled is a divide so pronounced that the Edison Electric Institute -- the main trade group for the utility industry -- has declined to give an opinion on EPA's latest trading plan at all.

Some power companies have become cheerleaders for the new rules, knowing they have little to lose because they get little of their electricity from coal. Other utilities that get more of their electricity from older coal plants without modern controls have been vigorously lobbying against them. Hardly a week passes without a new study from one faction saying the rules will save lives and an analysis from the other saying that they will destroy jobs and hike energy prices.

Duke Energy Corp., the nation's sixth-largest power producer, hasn't aligned itself with either group.

In a sense, the Charlotte, N.C.-based company is a microcosm of the utility industry, with a fleet of power plants that closely mirrors where the entire United States gets its electricity.

The company says its capacity is about 47 percent coal, 25 percent natural gas, 20 percent nuclear and 8 percent renewables, most of it hydropower. Last year, 45 percent of U.S. electricity came from coal, 24 percent came from natural gas and 20 percent came from nuclear, according to 2010 data from the U.S. Energy Information Administration.

But that's not to say that Duke, which does most of its business in North Carolina and Indiana, doesn't have its own interests.

The reason EPA had to redesign its trading program was that it lost a court challenge from North Carolina, which argued that the George W. Bush-era plan allowed neighboring states such as Tennessee to keep polluting its air.

North Carolina had moved on its own a few years earlier, passing a law called the Clean Smokestacks Act that ordered the state's coal plants to cut their emissions by installing scrubbers. Because the law required power companies to upgrade their plants rather than buy emissions credits from other states, Duke has a cleaner fleet than some competitors do, Williams said.

Having already paid for controls, the company could have allowances to sell to its competitors -- and that would mean extra profits.

A crossroads on trading

There's no denying that cap and trade -- or at least its name -- is going through a rough patch.

But analysts said there's little chance that the United States will move away from emissions trading, given its popularity with businesses. The tides will turn and Congress will come back to cap and trade, for climate change as well as conventional air pollution, Huetteman of the Environmental Markets Association predicted.

"The utility sector knows, knows, knows this stuff is coming on carbon," Huetteman said. "They already have those obligations on SO2 and NOx. They'll keep the political wheels greased to make sure they'll have their continued access to trading, and I think they fully expect, someday, to have that for CO2 as well."

The Obama administration's desire to expand trading will soon be tested on its new climate change rules for power plants and refineries, which are due next year under a settlement with environmental groups.

EPA has never crafted this type of greenhouse gas rule before, making it a completely blank slate. And unlike other kinds of pollution, carbon dioxide mixes evenly in the atmosphere and is safe to breathe, meaning that a ton is interchangeable no matter where it comes from.

But with climate change so thoroughly politicized, the rules are sensitive.

Republican critics on Capitol Hill have made a mantra of saying that EPA is trying to do through regulation what President Obama and the Democrats couldn't do through legislation. Top officials at EPA, such as air chief Gina McCarthy, have responded by insisting that the agency isn't trying to replicate a cap-and-trade bill by putting a limit on emissions from power plants.

But still, during a listening session for power companies earlier this year, many said they want the agency to offer as much trading as it can (E&ENews PM, Feb. 4).

So do members of the environmental think-tank crowd. Under the section of the Clean Air Act that allows for "New Source Performance Standards," there's plenty of room to design those kinds of programs, according to a report released last week by scholars from Resources for the Future and two law schools.

Michael Livermore, the executive director of New York University's Institute for Policy Integrity, said it would be a mistake to give that up just because critics would raise the specter of cap and trade.

"If we ever want to get serious about greenhouse gas reductions, it will include these kinds of things," Livermore said in a recent interview. "We're not going to, as a society, impose double costs completely unnecessarily because of some silly rhetorical issue. I think it will get figured out."

An upcoming review of federal air pollution rules for nitric acid plants could be an early chance, his group said in a recent report.

That's because nitric acid plants, which make a key ingredient for fertilizer, produce 88 percent of the nation's industrial nitrous oxide emissions. Better known as laughing gas, nitrous oxide is 300 times better than carbon dioxide at trapping heat in the atmosphere.

And while the hopes for existing coal plants rest largely on capturing carbon dioxide at the smokestack and trapping it underground, there are well-established ways to cut nitrous oxide emissions by more than 80 percent.

When those emissions are made equivalent to carbon dioxide, the controls cost as little as $2.20 per ton of CO2 -- well below EPA's estimate of the "social cost of carbon," and far less than most lawmakers suggest for a carbon tax.

Livermore imagines a program in which power plants could offset some of their carbon emissions by buying credits to pay for nitrous oxide controls at nitric acid plants. It would be a quick and cheap way to cut emissions, he said.

Bill Herz, who is following the rules as vice president of scientific programs at the Fertilizer Institute, said he thought the group's cost estimates were a little low. He noted that some nitric acid plants have voluntarily gone ahead and listed themselves on an exchange, called the Climate Action Reserve, to offer offsets to companies that need to cut emissions under rules such as California's new global warming law.

The big hurdle to creating a program linking power plants and nitric acid plants, Herz said, is that there's a political risk in making wide use of emissions trading.

"EPA is bound by what the federal legislators would do," he said. "They may or may not be supportive of the various state, regional and voluntary markets, but ... I don't think they're going to get out in front of the legislative process."

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