The U.S. Environmental Protection Agency (EPA) announced today a proposed Transport Rule, which would replace the court-vacated Clean Air Interstate Rule (CAIR).
This new rule affects 31 states and the District of Columbia and would begin in 2012, one year after the Transport Rule is due to be finalized. After an initial phase-in period, the rule will be in full implementation by 2014. Twenty-eight states will be required to reduce annual sulfur dioxide (SO2) and nitrogen oxide (NOx) emissions, and 26 states will be required to reduce seasonal NOx emissions.
New Emissions Markets
To ensure that these emissions reductions occur quickly, the Transport Rule proposes that states adopt Federal Implementation Plans (FIPs), or develop their own state implementation plans. The allocation of allowances will be determined by state-specific emission budgets. The SO2 Annual Emission Budget totals 2,500,003 allowances, and the NOx Annual Emission Budget is 1,376,312 allowances. (The specific state allowance budgets are on page 353 and 354 of the proposed rule.)
In the proposed rule, EPA offers three options for administering the program. The preferred option will allow for unlimited intrastate trading, but limited interstate trading. EPA’s preferred program, in fact, creates four separate trading programs.
The SO2 market will be segmented into two different groups depending on the severity of SO2 reductions. Group 1, for states with stringent reductions, has 15 states, and Group 2, which has moderate reductions, accounts for 13 states. (The specific designation of states is shown on page 295 of the proposed rule.) All 28 states will be given initial reductions for 2012. In 2014, Group 1 states will be given more stringent reductions, while Group 2 states will have the same reductions as in 2012. States in Group 1 are not allowed to trade with states in Group 2, creating two exclusive SO2 trading markets.
There will also be a continuation of trading of annual and seasonal NOx trading markets. Twenty eight states will be required to reduce annual NOx emissions, and twenty six states must reduce NOx emissions during the ozone season. It is unclear whether or not the current banked CAIR allowances will influence the finalized rule of 2012.
The Transport Rule is structured to ensure upwind states are limited in their contribution of emissions in downwind states. As a result, the EPA is proposing “assurance” provisions, in which each state is given variability limits based on their state budget. These limits define how many allowances can be traded out of state due to the variability of actual emissions annually. The limit is either 10% of the state’s budget or 5,000 tons for annual NOx, 1,700 tons for SO2, and 2,100 tons for seasonal NOx , whichever is greater. Seasonal NOx variability limits are based on five months of data. There is also a 3-year average variability limit for each state.
Transition from CAIR to Transport Rule
SO2 Allowance Bank
Considering the sizable SO2 bank, the EPA proposes to reject a proposal to distribute Transport Rule SO2 allowances based on the number of Title IV allowances a source has in its bank. Instead, the EPA recommends in the proposed Transport Rule that no SO2 allowances be carried over into the new Transport Rule. The current Title IV Acid Rain Program will continue to exist.
NOx Allowance Bank
Because CAIR Annual NOx and Seasonal NOx have much smaller banks than the Title IV SO2 allowances, the EPA offers four different options for the use of pre-2012 banked CAIR NOx allowances.
First, the EPA could allow banked CAIR allowances to be included in the Transport Rule NOx program.
Secondly, the Transport Rule could allow for a limited amount of banked pre-2012 CAIR allowances to be included. This would be done by having a tonnage authorization level lower than one ton per allowance.
Thirdly, the EPA could factor the current pre-2012 NOx bank into the calculation of Transport Rule state budgets, and reduce the state budget to appropriately account for banked pre-2012 CAIR allowances. The EPA determined that this option is not feasible.
Finally, as recommended with the SO2 program, the EPA could not allow the use of any banked pre-CAIR 2012 allowances. This would avoid the legal and practical problems outlined in the other proposals. The EPA is requesting comments and recommendations on how to transition pre-2012 banked CAIR allowances into the Transport Rule.
The market continues to digest the proposed rule, which totals more than 1,300 pages, and the SO2 and NOx allowance markets initially traded slightly down on the release of the rule. SO2 Vintage 2009 traded down from $15 to $5 today, and Annual NOx Vintage 2010 began the day at $465 and closed at $400.
Evolution Markets will continue its analysis of the proposed rule and provide additional reports in the coming days and weeks. Should you have any questions regarding the proposed rule or its impact on the market, please contact our Emissions Markets Team at: +1 914.323.0255.