Latham & Watkins Environment, Land & Resources

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1 Number 1315 April 5, 2012 Client Alert In limiting for the first time GHG emissions from new EGUs and particularly in requiring a single standard regardless of fuel choice the performance standard recently proposed by EPA includes a number of potentially significant issues for participants in the US power sector. Latham & Watkins Environment, Land & Resources EPA Proposes Greenhouse Gas Performance Standards for New Fossil Fuel-Fired Power Plants On March 27, 2012, the US Environmental Protection Agency (EPA) released a prepublication version of a proposed rule to establish, for the first time, a new source performance standard (NSPS) for greenhouse gas emissions (GHGs) from fossil fuel-fired electric generating units (EGUs). The proposed rule, to which EPA committed under a settlement with a group of states and environmental organizations, 1 requires new fossil fuel-fired power plants to meet an output-based standard of 1,000 pounds of carbon dioxide per megawatt-hour of electricity generated (pounds CO 2 /MWh). While the settlement called for EPA to propose standards governing both new and existing sources, EPA s proposed rule covers only GHGs from new sources; it also exempts new simple cycle plants and so-called transitional plants that have permits and will commence construction within the next 12 months. A separate settlement also requires EPA to develop performance standards for GHGs from refineries; 2 these standards are not included in the proposed rule. Overview of the Proposed Rule Under the proposed rule, which would amend 40 C.F.R. Part 60, new fossil fuelfired EGUs larger than 25 megawatts would be required to limit emissions to 1,000 pounds CO 2 /MWh on an average annual basis, subject to certain exceptions. The proposed rule would not apply to transitional sources (i.e., those that have construction permits in place and that commence construction within 12 months of publication of the proposed rule), new simple cycle EGUs, modifications to or reconstructions of existing units, new units located in noncontinental areas, including Hawaii and the territories, nor to existing EGUs. In addition, biomass-only facilities would not be subject to the proposed regulations, nor would biomass-fired boilers that co-fire with less than 250 MMBtu/h of any fossil fuel. EPA s proposed standard covers both coal and natural gas plants, but it leaves only the thinnest reed of opportunity for new coal-fired plants the option to meet the natural gas-based performance level by averaging emissions over a 30-year period. Somewhat surprisingly, given statutory direction to consider cost and effect on the overall energy system, the proposed rule does not contain any other mechanism that would allow for greater compliance flexibility, including averaging, banking and trading of emissions credits, or the ability to credit other investments, including lowcarbon renewable energy investment or demand-side energy efficiency improvements. Latham & Watkins operates worldwide as a limited liability partnership organized under the laws of the State of Delaware (USA) with affiliated limited liability partnerships conducting the practice in the United Kingdom, France, Italy and Singapore and as affiliated partnerships conducting the practice in Hong Kong and Japan. Latham & Watkins practices in Saudi Arabia in association with the Law Office of Mohammed A. Al-Sheikh. In Qatar, Latham & Watkins LLP is licensed by the Qatar Financial Centre Authority. Under New York s Code of Professional Responsibility, portions of this communication contain attorney advertising. Prior results do not guarantee a similar outcome. Results depend upon a variety of factors unique to each representation. Please direct all inquiries regarding our conduct under New York s Disciplinary Rules to Latham & Watkins LLP, 885 Third Avenue, New York, NY , Phone: Copyright 2012 Latham & Watkins. All Rights Reserved.

2 The standard contained in the proposed rule explicitly is based on the performance of natural gas combined cycle (NGCC) units, 3 which EPA defines as the best system of emission reduction (BSER). The standard would permit the construction of new coal-, coal refuse-, oil- and petroleum coke-fired boilers and IGCC units, but only if they utilize carbon capture and sequestration (CCS), 4 effectively banning conventional coalfired plants that do not incorporate these technologies. Because of the 30-year emissions averaging provision, however, it is possible for coal-fired EGUs without CCS to be constructed and operate for up to 10 years, so long as they meet stringent near-term performance standards, as noted below, and incorporate emissions reductions technologies in a timeframe that allows them to comply with the emissions limits over a 30-year period. While some participants in EPA s listening sessions urged EPA to define BSER on a fuelspecific basis so as to preserve national fuel diversity and advance other important interests, EPA rejected this approach in favor of a standard based on the current emissions profile of NGCC units. As part of the rulemaking process, EPA will accept public comment on the proposed rule for 60 days following publication in the Federal Register. EPA also announced that it will hold public hearings on the proposed rule, and that comments made during these public meetings will be included as part of the rulemaking record. Background of EPA s Development of Performance Standards for GHGs General Framework for Performance Standards Under the Clean Air Act Section 111 of the Clean Air Act (CAA) 5 grants EPA the authority to establish standards governing the emission of air pollutants from stationary sources. Specifically, Section 111(b) requires EPA to develop performance standards for any source which the EPA Administrator finds causes, or contributes significantly to, air pollution which may reasonably be anticipated to endanger public health or welfare. 6 Section 111 of the CAA requires that these performance standards adopt the best system of emission reduction which (taking into account the cost of achieving such reduction and any nonair quality health and environmental impact and energy requirements) the Administrator determines has been adequately demonstrated. 7 EPA has promulgated NSPS for EGUs covering a range of pollutants; such regulations are codified at 40 C.F.R Part 60. The statutory requirements governing EPA s rulemaking authority under the CAA specifically require EPA to consider the costs of regulation, including a requirement that, [b]efore publication of notice of proposed rulemaking with respect to any standard or regulation to which this section applies, the Administrator shall prepare an economic impact assessment respecting such standard or regulation. 8 This economic impact assessment shall be as extensive as practicable, 9 and shall contain an analysis of the costs of compliance, the potential inflationary or recessionary effects, the effects on competition with respect to small business, the effects on consumer costs, and the effects on energy use. 10 How We Got Here: EPA s Process of Developing Performance Standards for GHGs In February 2006, EPA published a final rule including amendments to the NSPS for EGUs. 11 A group of states and environmental organizations challenged EPA s decision not to include standards of performance for GHG emissions as part of the 2006 rulemaking. 12 In 2007, following the Supreme Court s 2 Number 1315 April 5, 2012

3 decision in Massachusetts v. EPA, 13 in which the Court found that GHGs fit the definition of an air pollutant under the CAA, EPA sought remand of the 2006 rulemaking in order to reexamine the issue of whether the NSPS for EGUs should include performance standards for GHGs. In 2009, EPA issued an Endangerment Finding, 14 providing the legal justification for subsequent rulemakings relating to GHG emissions. 15 In December 2010, EPA entered into a proposed settlement with the states and environmental petitioners whereby the Agency agreed to issue a proposed rule by July 26, 2011 proposing standards of performance for GHGs for new and modified EGUs, as well as for existing sources under Section 111(d) of the CAA. EPA also agreed to adopt a final rule including performance standards for GHGs no later than May 26, EPA entered into a similar settlement agreement in December of 2010 for certain refinery sources, but subject to a slightly longer time frame. Following the settlement agreements, EPA held a series of five listening sessions between February 4, 2011 and March 4, 2011 to obtain stakeholder input on the design of the performance standards for GHG emissions from EGUs and refineries. In June 2011, the parties agreed to extend the deadline for the proposed rule to September 30, On September 15, 2011, EPA said it needed more time. The environmental petitioners initially threatened litigation, but then agreed not to sue under the Settlement Agreement until November EPA s release of its proposed new source rule last week ends a lengthy review by the White House and a period of significant anticipation regarding the content of the proposal. Key Elements of Proposed Performance Standard Standard The proposed performance standard requires all new fossil fuel-fired EGUs to meet the demonstrated performance of NGCC units, and proposes an electricity-output-based standard of 1,000 pounds CO 2 /MWh, regardless of what specific type of fossil fuel is used to generate power, though EPA is taking comment on a range from 950 1,100 pounds CO 2 /MWh. 16 Rather than adopting fuel-based standards that would impose different performance standards for different fuels, EPA instead takes a functional approach, seeking to ensure that all new fossil fuel-fired electricity generating units that meet specified minimum criteria will be subject to the same requirements, and therefore will be treated alike because they serve the same function, that is to serve baseload or intermediate demand. 17 As such, EPA is not proposing any subcategories for new affected sources, 18 and no averaging or emissions trading among affected sources is allowed under the proposed rule. 19 The proposed rule creates a new category TTTT for the purposes of GHG emissions which combines the electric utility steam generating units currently included in the Da category and combined cycle units currently included in the KKKK category. 20 Except for the relief provided to transitional sources (discussed below), the performance standard will be effective upon publication of the proposed rule in the Federal Register. 21 While the standard as proposed is output-based, the proposed rule also suggests that EPA ultimately may pursue a standard based on net power ultimately delivered to the end user. EPA states that [a]lthough we have proposed gross output-based emission standards, the EPA believes that the net power supplied to the end user is a better indicator of environmental performance than gross output from the power producer. Reasons for using net output include 1) recognizing the efficiency gains of selecting EGU designs and control equipment that require less auxiliary power, 2) selecting fuels that require less emissions control equipment, and 3) recognizing the environmental benefit of higher efficiency motors, pumps, and fans. 3 Number 1315 April 5, 2012

4 . Further, monitoring net output for new and reconstructed facilities can be designed into the facility at low costs. Thus, we are requesting comment on the use of net output-based emission standards for owners/operators of new facilities. 22 Alternate Compliance Option The proposed rule also includes an alternative compliance option that would allow for the averaging of emissions from coal- and petroleum coke-fired EGUs over a 30-year period. Under this option, EGUs must limit their CO 2 emissions to 1,800 pounds/ MWh on a 12-month annual average basis for up to 10 years before installing CCS capabilities. 23 No later than the beginning of the 11th year of plant operation, however, the EGU must meet a reduced CO 2 emission limit of no more than 600 pounds CO 2 / MWh on a 12-month annual average basis for the remaining 20 years of the 30-year period, for total average annual emissions that meet the proposed performance standard of 1,000 pounds CO 2 /MWh. 24 EPA adopted the 1,800 pounds CO 2 /MWh standard available to coal-fired EGUs during their first ten years of operation as the BSER 25 and asserts that the standard can be met by coal-fired facilities using supercritical steam conditions, IGCC facilities and pressurized circulated fluidized bed (CFB) boilers, 26 that this technology is available and being deployed in Europe and Asia, 27 and that it offers much more efficient operation than the subcritical boilers that have been the standard in the US. 28 EPA also is seeking comment on whether to allow an EGU to select an emission trajectory other than that included as the alternate compliance option but which would result in the same 30-year average of 1,000 pounds CO 2 /MWh. One issue that remains unresolved in the proposed rule is the implications of a new coal-fired EGU which elects to use the 30-year alternative compliance option and secures a Prevention of Significant Deterioration (PSD) permit on that basis, but which fails to install CCS by year 11, or where the carbon capture system installed fails to meet the emissions reductions necessary to average 1,000 pounds CO 2 /MWh over the 30-year timeframe. Applicability As noted above, the proposed rule applies only to fossil fuel-fired EGUs, 29 and does not apply to biomass-fired units or those involving biomass co-fired with up to 250 MMBtu/h of any fossil fuel. 30 Municipal waste combustor units subject to subpart Eb and commercial and industrial solid waste incineration units subject to subpart CCCC also are exempt, 31 as are transitional sources, 32 which the proposed rule defines as coal-fired power plants that, by the date of this proposal, have received approval for their PSD preconstruction permits that meet CAA PSD requirements (or that have approved PSD permits that expired and are in the process of being extended, if those sources are participating in a Department of Energy CCS funding program), and that commence construction within a year of the date of this proposal. 33 The Proposed Rule incorporates by reference the standard definition of commence construction in the current NSPS regulations. 34 As such, EPA s prior pronouncements on this test should remain relevant for determining the applicability of the NSPS for GHGs to transitional sources. EPA s Cost Assessment EPA based its cost assessment on the assumption that NGCC will be the predominant choice for new fossil fuelfired generation even absent this rule 35 and that because NGCC emits the least amount of CO 2 and does so at the least cost, NGCC qualifies as the BSER under the CAA. 36 Furthermore, EPA s base case analysis does not project any new coal-fired EGUs without CCS to be built in the absence of this proposal through EPA further notes that while CCS would add considerably to the 4 Number 1315 April 5, 2012

5 costs of a new coal-fired power plant, there are sources of funding available to support the deployment of CCS. 38 EPA also stated its expectation that the costs of CCS will decline in the future as CCS matures and is utilized more widely. 39 On the basis of these assumptions, EPA declared that because the [Integrated Planning Model] modeling shows that natural gas-fired plants are the facilities of choice, the proposed standard of performance in today s rulemaking which is based on the emission rate of a new NGCC unit does not add costs, 40 will not impose costs by 2030, 41 and that even under a scenario involving increased future natural gas prices and increased future electric demand, we do not project that this proposed rule will impose notable costs upon sources. 42 EPA stated that it intends to use the eight-year review of the performance standards required under CAA Section 111(b)(1)(B) to review the availability and cost of CCS. 43 Monitoring, testing and other requirements For EGUs meeting the primary performance standard of 1,000 pounds CO 2 /MWh, as well as those EGUs using the 30-year averaging compliance option, the proposed rule also imposes a number of additional monitoring, testing, recordkeeping and reporting obligations. In the proposed rule, EPA is requiring that EGUs install a CO 2 mass rate Continuous Emissions Monitoring System (CEMS) in accordance with a site-specific monitoring plan, and that the CEMS be installed and certified in accordance with the schedule included in 40 CFR part 75, section 75.4(b). 44 In addition, EPA proposed that EGUs be tested beginning in the month following initial certification of the CO 2 and flow rate monitoring CEMS to demonstrate compliance with the CO 2 emissions limits consistent with the performance testing requirements in the CAA Section 111 regulatory general provisions and CEMS certification requirements. 45 EPA also proposed that the owners and operators of a new EGU be required: (i) to comply with the notification and recordkeeping requirements in the CAA Section 111 regulatory general provisions; (ii) to report results of performance testing and excess emissions; and (iii) to record and maintain hourly average CO 2 emissions concentration, hourly average flow rate, and hourly useful electrical generation. 46 Extending the Tailoring Rule to PSD as triggered by EPA s NSPS As EPA recognizes in its proposal, its adoption of NSPS for EGUs independently triggers PSD applicability under its existing regulations. 47 EPA confirms that it intended for its Tailoring Rule actions to cover the NSPS trigger to an equal extent as the initial regulatory trigger, the promulgation of its motor vehicle standards for GHGs. To ensure that the Tailoring Rule protections extend to authorized state as well as EPA PSD permitting, EPA directs the states to examine the manner in which they previously incorporated the Tailoring Rule into their applicable state implementation plans and to take any necessary corrective actions. 48 It also states an intention to revise the NSPS regulations, although it is not readily apparent where they have done so. Paradoxically, EPA elects not to amend its PSD regulations, which surely would have been the most direct corrective route. 49 Unresolved issues and possible litigation challenges Two issues covered in the settlement agreements are not included in the proposed rule: (i) extending performance standards or guidelines to cover existing sources under Section 111(d) of the CAA; and (ii) proposing performance standards for GHG emissions from refineries. In addition, as noted above, modifications to existing sources, which are traditionally included as new sources, also are exempt from the emission limits contained in the proposed rule. Notwithstanding some soft-pedaling by the Administrator and other EPA personnel contemporaneous with the release of the proposal, the proposal itself makes it abundantly 5 Number 1315 April 5, 2012

6 clear that the agency will establish requirements for existing EGUs in the not-too-distant future. The proposal s 16 references to CAA Section 111(d) emphasize the importance of the existing source program, which, whether measured by the number of sources it will affect or by the relative scale of the emission reductions it will achieve, will dwarf the new source proposal just released. Specifically, the Agency believes it has an obligation to develop section 111(d) guidelines for existing sources and sees ultimate coverage of the sources in question as inevitable. 50 While it is unlikely that EPA will propose existing source requirements or guidelines before the upcoming election, it likely will continue active consideration of possible existing source program options. We can expect the petitioners to continue to prod EPA in this direction. Other potential issues contained in the proposed rule that might be subject to litigation include: whether EPA can rely on its prior 2006 finding that EGUs contribute significantly to air pollution which endangers public health or welfare or whether it must make a fresh cause or contribute finding for EGU GHG emissions; whether EPA may determine BSER based on demonstrated technology for only one of two fuels covered by the regulated category in reliance on current and projected economic considerations, particularly when the effect of such a selective determination has the practical effect of nullifying or severely restricting future fuel choice; whether requiring the adoption of supercritical steam conditions, IGCC facilities and pressurized CFB boilers under the alternate compliance option is consistent with BSER; the permissibility of EPA s stated intention 51 that its treatment of transitional and non-transitional sources be severable from each other; and whether EPA s cost assessment methodology is legitimate. Finally, a number of other issues remain unresolved or wholly unaddressed under the proposed rule. Some of the most noteworthy of these issues include the relationship between the GHG performance standards and the designation of best available control technology (BACT) for regulated pollutants, which as defined cannot exceed the emissions allowed by any performance standard under Section EPA and authorized state permitting authorities would be well advised simply to use the performance standard to define or satisfy BACT for new sources, an option that would eliminate the potential for conflicting limits while satisfying the statutory definition of BACT. A second unresolved issue involves whether and to what extent EPA will treat state and regional GHG emission reduction initiatives, such as California s AB 32 and the Regional Greenhouse Gas Initiative (RGGI), as equivalent to future EPA 111(d) performance requirements or state guidelines. A broad equivalency approach for its existing source program could enable EPA indirectly to address aspects of the broader, interconnected energy system that it neglects in its narrow new source proposal, such as renewable energy generation, waste-toenergy sustainability measures, energy storage and demand side efficiency opportunities. Finally, EPA may wish to reconsider the value of setting a coalspecific performance standard if such an alternative approach would lessen the risk of leakage due to the increased export and combustion of coal outside the United States. Conclusion In limiting for the first time GHG emissions from new EGUs and particularly in requiring a single standard regardless of fuel choice the performance standard recently proposed by EPA includes a number of potentially significant issues for participants in the US power sector. Those interested in participating in the rulemaking process on the proposed performance standards have 60 days following the publication of the proposed rule in the Federal Register to submit their comments to EPA. The docket for the proposed rule is EPA-HQ-OAR Number 1315 April 5, 2012

7 Endnotes 1 Notice of EPA s proposed settlement with the States and environmental organizations was published in the Federal Register as Proposed Settlement Agreement, Clean Air Act Citizen Suit, 75 Fed. Reg. 82,392 (Dec. 30, 2010). 2 EPA, Proposed Settlement Agreement, 75 Fed. Reg. 82,390 (Dec. 30, 2010). 3 See Proposed Rule at U.S.C to 7671q U.S.C. 7411(v)(1)(A) U.S.C. 7411(a)(1) U.S.C. 7617(b) U.S.C. 7617(d) U.S.C. 7617(c). 11 EPA, Standards of Performance for Electric Utility Steam Generating Units, Industrial- Commercial- Institutional Steam Generating Units, and Small Industrial-Commercial-Institutional Steam Generating Units, 71 Fed. Ref (Feb. 27, 2006). 12 State of New York, et al. v. EPA, No (D.C. Cir.). 13 Massachusetts v. EPA, 549 U.S. 497 (2007). 14 EPA, Endangerment and Cause or Contribute Findings for Greenhouse Gases Under Section 202(a) of the Clean Air Act, 74 Fed. Reg (Dec. 15, 2009). 15 In addition to the performance standard announced on March 27, 2012, EPA has also issued a number of other rulemakings relating to GHGs, including the Reporting Rule (see EPA, Reporting of Greenhouse Gases; Final Rule, 74 Fed. Reg. 56,260 (Oct. 30, 2009); the Tailoring Rule (EPA, Prevention of Significant Deterioration and Title V Greenhouse Gas Tailoring Rule; Final Rule, 75 Fed. Reg. 31,514 (June 3, 2010) ); the Tailpipe Rule (see EPA and U.S. Department of Transportation, National Highway Traffic Safety Administration, Light-Duty Vehicle Greenhouse Gas Emission Standards and Corporate Average Fuel Economy Standards; Final Rule, 75 Fed. Reg. 25,324 (May 7, 2010); and others. 16 Proposed Rule at at at at at 71-72; see also 42 U.S.C. 7411(a)(2) (defining a new source as any stationary source, the construction or modification of which is commenced after publication of regulations (or, if early, proposed regulations) prescribing a standard of performance. ). 22 at at at at at at Fossil fuel is defined to include natural gas, petroleum, coal, and any form of solid, liquid, or gaseous fuel derived from such material for the purpose of creating useful heat. Proposed Rule at 233; proposed 40 CFR Proposed Rule at at 233; proposed (b) Proposed Rule at 154; see also proposed 40 CFR (b)(3)(ii) (defining transitional source as an EGU that received a complete permit that meets the requirements of the Prevention of Significant Deterioration Program under part C of Title I of the Clean Air Act prior to [INSERT DATE OF THIS PROPOSED RULE IN THE FEDERAL REGISTER] (or that had an approved PSD permit that has expired and is in the process of being extended, if the source is participating in a Department of Energy CCS funding program). ). 34 See Proposed Rule at 45; proposed 40 CFR Proposed Rule at at at at at at at at at EPA also seeks comment on the appropriateness of applying the backup monitor requirements in 40 CFR part 75.10(e) and the missing data procedures in 40 CFR part 75, sections through 75.37, among others. 45 at (citing 40 CFR parts 60.8 and 75.4(b)). 7 Number 1315 April 5, 2012

8 46 at 91 (citing 40 CFR part 60, subpart A). 47 at 189 et seq. As discussed therein, EPA has interpreted the statutory phrase major emitting source as a major stationary source, which is a stationary source that emits or has the potential to emit 100 or 250 tons per year of any regulated new source review (NSR) pollutant. EPA regulations, 40 CFR (b) (49), define regulated NSR pollutant according to four distinct contexts, one of which is the promulgation of NSPS. EPA s Tailoring Rule specifically addressed a separate trigger (the motor vehicle GHG regulation). 48 EPA also commits to taking any further regulatory action to correct state SIPs as necessary. See id. at pages at at at 164, fn U.S.C. 7479(3). If you have any questions about this Client Alert, please contact one of the authors listed below or the Latham attorney with whom you normally consult: Robert A. Wyman robert.wyman@lw.com Los Angeles Joshua T. Bledsoe joshua.bledsoe@lw.com Orange County Daniel C. Scripps daniel.scripps@lw.com Washington, D.C. 8 Number 1315 April 5, 2012

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