Allocating Air Pollution

President George W. Bush's plan for revamping the Clean Air Act and cutting emissions from coal-fired power plants has enjoyed support from electric utilities. But recently, as the Senate struggled over legislation to implement Bush's plan, a broad fracture among power generators has come to light.

Within the power sector, billions of dollars a year are at stake.

The issue revolves around the way Bush's air pollution plan would institute emission cuts. The President's Clear Skies initiative calls for a national cap on emissions of three types of pollutants: sulfur dioxide, nitrogen oxides, and mercury. Electricity generators would receive annual allowances for their emissions of these chemicals. Those that reduce their emissions below the amount covered by their quota could sell their excess pollution credits to competitors that do not (C&EN, Feb. 14, page 29).

The U.S. first used a cap-and-trade scheme for air pollutants in a program established under the 1990 Clean Air Act Amendments to control emissions that cause acid rain in the eastern half of the U.S. This highly praised market-based effort curbed pollution far less expensively than if a mandatory ceiling on emissions had been set for each facility.

Virtually all players in the debate over Bush's Clear Skies proposal endorse a cap-and-trade approach for SO₂ and NO_x. Environmental activists and others oppose trading for mercury, in part over concerns that this policy could create pollution "hot spots" around plants that buy allowances instead of controlling emissions of this toxic metal. In addition, environmental activists and some members of Congress want to add carbon dioxide to the emission-cutting effort.

A key Senate committee last week deadlocked over legislation (S. 131) to institute the Bush plan. There remains a low probability that the panel will try to move the bill again in the next 18 months (see page 10).

But the President's legislative initiative has a backup. Much of the Clear Skies cap-and-trade plan would be instituted in two regulations being finalized by the Environmental Protection Agency. EPA must, under court order, issue a rule controlling mercury emissions by March 15. A second regulation expected this month would control plant emissions of SO₂ and NO_x that blow across state lines. If enacted, Clear Skies legislation would supersede these regulations.

Despite broad agreement favoring a tradable allowance scheme for air pollution, electricity generators are split on how those emission credits will get parceled out.

One side, favored by coal-fired plants and the Bush Administration, wants the number of allowances given to each facility to be based on the heat value of the fuel it burns. Called an input-based approach, this is how pollution credits were provided under the acid rain program. This method disregards how efficient a plant is at converting fuel into electricity.

THOSE SUPPORTING this approach point out that the acid rain program sets a precedent for handing out emission credits based on fuel input. The other side, meanwhile, wants the apportionment of pollution credits to depend on how much electricity a unit produces, or what is termed an output-based approach. This method takes into account a plant's efficiency and rewards facilities that have already installed modern pollution control technology.

The output plan, too, has a precedent, though not a national one. Some states have cap-and-trade programs for NO_x that distribute emission credits based on electricity output.

Proponents of the output-based method say an input-based approach would financially punish companies that have invested in cleaner technology by forcing them to buy emission allowances from older, dirtier, coal-fired plants. Meanwhile, opponents argue that an output-based distribution of pollution credits would hurt the coal industry and could further drive up the price of natural gas.

How the federal government should allocate emission credits was debated at a Feb. 28 meeting on Capitol Hill sponsored by the Sustainable Energy Institute.

Peggy Duxbury, director of government and environmental affairs for Calpine Corp., spoke in favor of apportioning allowances to plants on the basis of electricity output. Calpine, headquartered in San Jose, Calif., generates electricity from natural gas and geothermal energy.

Under S. 131, most of Calpine's facilities would not receive enough allowances to cover their current releases of SO₂ and NO_x, which are far below average for power generators, Duxbury said. This means that Calpine would have to purchase allowances from bigger polluters that now lack modern emission controls.

Using an output-based approach "is a matter of equity and balance," she said. Tradable permits are based on free-market principles. And free markets are supposed to reward efficient operations and greater productivity, Duxbury said.

Randy LaBauve, vice president of environmental services for FPL Group, said Congress should not punish companies that invest in cleaner power generation and reward utilities that keep old, inefficient plants without modern emission controls. FPL Group, based in Juno Beach, Fla., is parent company to Florida Power & Light Co. and FPL Energy, which generates electricity in 25 states. FPL Energy is the largest developer of wind energy in the U.S. and the largest owner of solar power in the world, and it generates more than half of its electricity using natural gas, according to LaBauve.

AN INPUT-BASED allocation of emission allowances, he said, would send the signal to utilities that they should not build less polluting plants until the government forces them to. The thinking could be: "It just doesn't pay to do this in advance. Let's wait for the law to change," LaBauve said. Mary Kenkel, general manager for federal affairs and national media for Cinergy Corp., spoke in favor of distributing pollution credits based on the amount of fuel a generator uses. Cinergy, with headquarters in Cincinnati, operates coal, natural gas, cogeneration, and renewable energy plants in the Midwest.

The output approach has little political support, Kenkel asserted. She added that an output-based system would cause greatest economic harm in states with large fleets of coal-generating plants, such as Ohio, Kentucky, South Dakota, Tennessee, and Florida.

Kenkel argued that output-based allocations would be a giant wealth transfer from coal plants to nuclear, natural gas, and renewable facilities. This system would not improve the environment and would create an incentive for coal-burning generators to switch to natural gas, she said.

Chemical manufacturers, among others in industry, are deeply concerned about the rising price of natural gas because they use it as a feedstock. They do not want to see policies expanding the use of natural gas for electricity generation because that will make supplies tighter and push prices even higher.

LaBauve of FPL said the argument that cleaner generators would reap a windfall if allowances were distributed on an output basis "is a myth." Generating electricity at newer facilities with up-to-date pollution controls costs more per MW-hour than at less efficient, older, dirtier plants, he said. Distributing pollution credits based on electricity output would not make up for this cost difference and would not level the economic playing field between these two types of facilities, he argued.

Dallas Burtraw, a senior fellow at Resources for the Future, a Washington, D.C., think tank, told meeting attendees that distributing pollution credits based on electrical output is more economically efficient than an input-based system because it rewards generators that are more effective at transforming fuel into electricity.

He added, however, that an input-based system would allocate a larger chunk of the allowances to the generators that will bear the largest cost of emission reductions. This scheme does not offer as strong an incentive for cutting pollution as does an output-based distribution, Burtraw added.

Both input and output systems shortchange new, more efficient plants that come onstream after the allowances are handed out, Burtraw noted. New plants, even highly efficient ones, would have to buy allowances from existing units before they could start operation. But there may be an exception. The sponsor of S. 131, Sen. James M. Inhofe (R-Okla.), has proposed setting aside some allowances in abeyance for future coal-burning plants that use integrated gasification combined-cycle technology.

Under either an input- or an output-based allocation, the federal government would give utilities a quota of pollution credits every year on the basis of their past fuel use or power generation. Burtraw said one policy choice for calculating the quota is selecting a range of years to serve as the benchmark for all future allocations, whether calculated by fuel use or amount of electricity generated. Another option is to regularly update this information with new data to reflect changes in plant operations. New plants would benefit from updated information, he added.

In addition, Burtraw said there is another way to parcel out allowances other than having the government simply giving them to generators through an input- or output-based system. Instead, the government could auction off allowances to the highest bidders.

AN AUCTION PLAN would benefit utilities that do not pollute the air with SO₂ or NO_x, such as nuclear plants and renewable sources like hydropower or wind, Burtraw said. Meanwhile, those burning fossil fuels would see their costs going up because they would have to buy allowances, purchase pollution control equipment for their plants, or do both. Utilities aren't keen on the idea of an auction because they expect Congress to follow the precedent of the acid rain program by first handing out emission credits, then letting companies with excess credits sell to those that need more. Power companies want to avoid paying up front for every allowance they need to continue operating.

Burtraw recommends a combination of options for distributing emission allowances. "A mix might be the best policy," he says, with either input- or output-based allocations to begin with, replaced by an auction in later years of the emissions reduction program.

The stakes are high for utilities, with coal-fired plants and other generators lobbying hard to come out on top of the allowance distribution system for as long as they can.

"Different segments of industry are chasing windfalls," David Doniger, policy director of the Natural Resources Defense Council's Climate Center, told meeting attendees.

Ultimately, legislative approaches or EPA regulations may simply select one part of the utility sector to gain financially from the distribution of emission allowances.

Jeanette Pablo, a consultant representing Xcel Energy, which produces electricity in the West and Midwest, predicted that Congress, if it does pass Clear Skies legislation, would support an input-based allocation of allowance. She said, "Basically, I think the votes are going to be in favor of the coal burners."