EPA's Clean Power Plan: Rewarding Good Performance
On August 3rd, President Obama announced the most ambitious step yet under his far-reaching Climate Action Plan. The Clean Power Plan (CPP) is an EPA regulation that would require substantial reductions in greenhouse gas emissions (GHGs) from power plants through the year 2030.
The regulation was met with heaps of praise from some quarters and vociferous criticism from others, taking over social media like few regulations have ever done. Love it or hate it—and it seems no one is in the middle—the CPP represents a remarkable achievement for an Administration that has made no secret of its desire to transform the way the United States uses energy.
In my last blog post, I described how EPA’s proposal to lower the ozone standard would actually penalize good performance in certain parts of the country. Does the CPP suffer from the same flaws as the ozone proposal?
The short answer is no. The CPP is a better designed than EPA’s National Ambient Air Quality Standard (NAAQS) program. To understand why the CPP rewards good performance, let’s evaluate it against the appropriate criteria.
Regulation should be carefully considered before initiation; the identification of a compelling public need, such as a material failure of markets, is a necessary prerequisite. Check.
Economists argue that competitive markets are socially efficient, and only when there is a “market failure” may governmental intervention be warranted. Such a market failure would include an “externality”, such as the societal harm posed by carbon dioxide emissions from fossil-fuel-fired power plants, which is not captured by market prices. The scientific consensus against anthropogenic emissions of GHGs is very solid, representing clear social harm.
Regulators should target bad performance and let superior performance escape regulatory coverage. Check.
The objective of the CPP is to significantly lower greenhouse gas (GHG) emissions from power plants, which is the largest source of such emissions in the United States. Specifically, the final rule requires states to achieve, in aggregate, a 32% reduction in GHG emissions compared to 2005 levels from “affected electricity-generating units (EGUs)” within its borders.
An affected EGU is a fossil fuel-fired electric utility steam generating unit (steam generating unit or integrated gasification combined cycle) or stationary combustion turbine that sells >25 MW to a utility power distribution system and has a base load rating >260 GJ/h heat input of fossil fuel. The definition of “affected EGU” excludes smaller power plants that emit relatively small amounts of carbon dioxide.
In determining the “best system of emission reduction” (BSER) for affected EGUs in each covered state, EPA is penalizing the most carbon-intensive EGUs. Affected EGUs that are not carbon-intensive are better off under the program and could even escape regulation altogether if a state opts to impose the emissions performance rate directly to each affected EGU.
However, it is arguable whether the rule is set at the appropriate level of stringency. The Agency could have set a higher or lower bar for affected EGUs while still targeting bad performance.
Regulators should set a reasonable effective date and provide credit for early action. Check.
Many states criticized EPA’s proposed effective date of 2020 and the short deadline for submitting plans to implement the new program. In the final rule, EPA has set the effective date for 2022 “because states and utilities reasonably needed that additional time to take steps to start achieving reductions”. State implementation plans (SIPS) are to be submitted to EPA by September 6, 2016 or as late as September 6, 2018 if a state received an extension. For states that choose not to submit a final plan in time, EPA will implement a federal plan, which the Agency has proposed for public comment.
For states that choose to participate, EPA is providing incentives for early action in the 2020-2022 time frame. The Clean Energy Incentive Program (CEIP) would give states allowances or emission reduction credits (ERCs) for eligible renewable energy projects that commence construction after submittal of the state plan and for end-use energy efficiency projects that commence operation after submittal of the state plan. Credit will be given for power generation or reduction in energy demand during the 2020 - 2022 time period. The program is a matching program. Credit will be provided 1:1 for eligible renewable energy projects and 2:1 for eligible energy efficiency projects, with half the credit coming from the state and half from EPA. The total amount of credit is not to exceed 300 million short tons of CO2, and EPA will provide states with the largest compliance obligations with a larger proportion of the federal matching pool of credits.
According to the Agency, the purpose of the CEIP is to (1) generate emission reductions prior to 2022 that would not otherwise occur, and (2) promote wind, solar, and demand-side energy efficiency projects relative to other reduction strategies (e.g., fuel switching from coal to gas).
Affected EGUs would prefer to seek credit for “good performance” actions well before the effective date. However, critics point out that such actions reflect “business as usual,” especially if it occurred prior to the announcement of the program. Therefore, EPA is allowing credit to be awarded only for projects that are truly “new” (i.e., occur after submittal of the final plan and generate emission reductions in the years preceding the effective date). Another issue is determining the amount of credit available for early action. In the final rule, EPA has attempted to allocate a sufficient amount of credit (not too low) to provide a real incentive but not so much that would limit state and EGU flexibility across the entire compliance period.
Regulators should set verifiable performance standards and provide flexibility for regulated entities to achieve the performance target. Check.
EPA has determined that a combination of three so-called “building blocks” (heat rate improvements at affected coal-fired steam generating units, substituting gas for coal among existing units, and substituting new renewable energy generation for affected EGUs) in specific percentages or quantities comprise the “best system of emission reduction . . . adequately demonstrated” (BSER) for the purpose of the rule. The Agency then utilized BSER to establish source subcategory emission performance rates for two subcategories of EGUs: fossil steam units and NGCC units; and finally translated these performance rates into state goals in terms of both emission-based limits and mass-based limits.
These performance rates provide a great amount of flexibility for states in developing their implementation plans and for affected EGUs. States must first choose one of two possible approaches: a standards approach or a state measures approach.
Under a standards approach, a state would impose requirements on affected EGUs, either individually or in the aggregate. To meet its required performance rate, each affected EGU could lessen its utilization; employ building blocks 1, 2, and/or 3; purchase ERCs or allowances (if a state chooses to set mass-based limits); or some combination of these compliance options.
Under a state measures approach, a state would have to meet an average emissions performance rate based on the weighted average of emission rates for affected EGUs for both subcategories within its borders. To meet its average emission performance rate, a state could employ a variety of strategies involving the building blocks, ERCs, and/or state measures that could include, for example, renewable portfolio standards or other complementary measures beyond affected EGUs.
Whichever approach a state chooses to adopt, emission reductions must be verifiable. The Agency has developed guidelines for states to follow in developing their SIPs to ensure verifiable emission reductions.
Should a state not choose any of these alternative approaches, EPA will impose a federal plan. The Agency is proposing a federal plan would be either a rate-based emissions trading program or a mass-based emissions trading program: EPA intends to finalize just one kind of program in the final federal plan. However, the Agency appears to be leaning one way: it notes that the mass-based trading program has been successfully implemented before (e.g., the acid rain trading program from the 1990s) and is simpler to administer.
Regulators should employ market mechanisms when practicable to ensure that the regulatory objective is achieved at the lowest cost. Check.
Market-based policy instruments are used in environmental policy to leverage market forces to deliver environmental results. Such instruments include pollution taxes, tradable emission permits, etc. Compared to more traditional “command-and-control” regulation (such as mandating use of a particular pollution control device), market-based policy instruments offer several advantages, including greater cost-effectiveness, greater incentives for technological innovation, and incentives for greater-than-required emission reductions.
The CPP allows states the option of creating trading programs (a rate-based program employing ERCs or a mass-based program employing emission allowances) to achieve compliance. A state need not employ such an approach, but it can if it wants to, and it can do so by itself or in conjunction with other states (e.g., the Regional Greenhouse Gas Initiative).
If utilizing prescriptive standards (as opposed to performance standards), regulators should allow for an alternative compliance mechanism if the regulated entity demonstrates that its performance is as good as or better than the prescribed pathway. Check.
The most prescriptive approach under the CPP would be if a state adopts a strict “standards approach”, requiring each affected EGUs to meet a particular emission performance rate for the interim period and the final period. As previously described, even under such a prescriptive approach, an affected EGU has a number of options to demonstrate compliance. The use of ERCs for compliance provides substantial flexibility for affected EGUs, including allowing increased nuclear generation, apart from BSER.
Regulators should aim to make compliance as understandable and easy for regulated entities to ensure a high compliance rate. Check.
EPA has taken many steps to make the final rule more understandable and easier to ensure compliance. As previously noted, EPA has changed the effective date to give states more time to develop plans, but the Agency has also provided more detailed guidance on the content of state plans, and has proposed model plans that any state can adopt (emissions-based or mass-based) to ensure approval. The interim targets present more of a “glide path” than originally proposed, which will make compliance easier for covered states and tribes.
Regulators should review a regulatory program periodically and make adjustments made based on this periodic review. Check.
EPA has made it clear that it will periodically evaluate each state’s performance against its SIP “glide path” trajectory of performance from 2022-2029 to achieve its the 2030 target. The Agency is requiring each state to take steps toward its final 2030 goal; the three step periods are 2022-2024, 2025-2027, and 2028-2029, and each state must also ensure it achieves its interim target on average during the eight-year transition period.
Conclusion: The CPP will reward, and not penalize, good performance. Those who oppose do so for other reasons (e.g., such as whether EPA overstepped its legal authority). Check.
Together, these criteria can be boiled down to just one simple maxim: The better the performance of a regulated entity, the less its regulatory burden should be. The CPP follows this maxim. Affected EGUs that perform relatively well in terms of emissions per unit of power generation will likely face lower costs than those EGUs that perform relatively poorly. (We do not yet know exactly how each state will regulate its EGUs, but the incentives are strongly in favor of good-performing EGUs.) Indeed, it is difficult to imagine a scenario where a state will do the opposite and still meet its 2030 goal.
Admittedly, the focus of this blog post—rewarding good performance—is narrow. Indeed, a regulatory program can satisfy these criteria and yet not be economically advisable if the social benefits of the program do not exceed the social cost or if the regulation does not maximize net social benefits.
In the case of the CPP, the regulation passes an economic test. Based on its own cost-benefit analysis accompanying the final rule, EPA concluded that the monetized benefits greatly exceed the monetized costs. Somewhat surprisingly, the cost-benefit analysis does not include alternative formulations of BSER (e.g., Building Block 1 and 2, or Building Block 1 and 3) that the Agency deems legally defensible, so it is unclear if the final rule truly maximizes net benefits. So yes, the final rule is good, but perhaps it could be even better.
I have not delved into the legal issues surrounding the CPP. Whether EPA strayed from its statutory authority in developing this rule is an issue that will be decided by the courts over the next few years. And this is an important caveat. A regulatory program—even one economically efficient—cannot be successful if regulators exceeded their legal authority in its design.