BOARD MEETING DATE: May 3, 2002
AGENDA NO. 30

Emission Reduction Credit System Modernization White Paper

SYNOPSIS: 

At the February 1, 2002 Board meeting, the Board approved a series of eight strategic initiatives introduced by Chairman Norma Glover. The objective of Strategic Alliance Initiative #1 is to improve the current emission reduction credit (ERC) system to help the South Coast region attain clean air while allowing for growth and a strong economy. The AQMD staff has been working with an ERC System Working Group and has developed a White Paper – Emission Reduction Credit System Modernization, to assess the availability of ERCs under the AQMD’s Regulation XIII – New Source Review program and identify options that would improve the future supply of ERCs necessary for economic growth.

COMMITTEE: 

Stationary Source, March 22 and April 26, 2002, Reviewed

RECOMMENDED ACTION:

1. Receive and file attached report.
   
    
2. Direct staff to proceed with rulemaking to implement recommendations.

Barry R. Wallerstein, D.Env.
Executive Officer

Background
Regulation XIII - New Source Review (NSR) is a critical component of the AQMD’s attainment strategy and ensures that all new, modified, and relocated sources apply Best Available Control Technology (BACT) and the residual emissions are fully offset. In addition, NSR ensures that new violations of ambient air quality standards are not created, nor existing conditions further exacerbated.

In 2001, the ERC open market experienced a sharp increase in the demand for ERCs, primarily from new and expanding electric generating facilities due to the power crisis. This increased demand resulted in low supplies and high costs of ERCs in the open market. The most dramatic increase was for PM10 where 45 pounds per day were used in 2000 and 1,650 pounds per day were used in 2001. The availability of ERCs at reasonable costs is important to ensure that economic growth in the region is not negatively impacted.

In response to potential negative impacts, Strategic Alliance Initiative #1 – Modernization of the Emission Reduction Credit System was proposed. The objective of this initiative is to develop options to stabilize ERC availability and cost in order to sustain healthy economic growth in the region while maintaining safeguards for public health.

A Work Plan for implementation of Initiative #1 was approved at the Board’s February 1, 2002 public meeting. The Work Plan included the formation of a Working Group, two sets of regional meetings, and the development of a White Paper that would be presented to the Governing Board at its May 3, 2002 public meeting.

Public Process
An ERC System Working Group was established that included representatives from the EPA, CARB, local government, business, and environmental representatives (see Attachment A for a list of members). The ERC System Working Group met four times during the development of the White Paper. The Working Group meetings were open to the public.

Options and recommendations for this initiative were developed through a public process. In addition to ERC System Working Group meetings, two sets of regional public consultation meetings were held in Los Angeles, Orange, and San Bernardino counties. The first set of regional public meetings was held on March 26 and 27, 2002. These kickoff meetings presented a general overview of the objective, scope, and background of Strategic Alliance Initiative #1. The second set of regional public meetings was held on April 17, 18, and 22, 2002. These meetings presented a preliminary analysis, findings and proposed recommendations. Although these regional meetings were lightly attended, greater public participation is anticipated if rulemaking is pursued.

White Paper
The White Paper includes a summary of the current regulatory framework, availability and cost of ERCs in the open market and the AQMD’s NSR Account. In addition, the White Paper includes policy alternatives that other agencies have considered, options for stabilizing future ERC availability and price, and recommendations. (Please refer to Attachment D – White Paper on Modernization of the Emission Reduction System).

        Current Offsetting Requirements
Under Regulation XIII, offsets are either obtained from the open market, which includes individually held credits, or from the AQMD’s NSR Account. Current offsetting options in the open market are primarily limited to using ERCs, which are a continuous stream of credits. Regulation XIII also allows use of Mobile Source Emission Reduction Credits (MSERCs). EPA has approved the concept of using MSERCs for NSR offsetting purposes in its approval of Regulation XIII. The lack of federally approved MSERC protocols, however, has significantly limited their use under Regulation XIII.

The AQMD’s NSR Account contains offsets for facilities that are eligible to use the Priority Reserve. In addition the AQMD uses emission reductions from the AQMD’s NSR Account to offset emissions from sources that are exempt from obtaining offsets from the open market. This ensures that Regulation XIII is consistent with state and federal NSR requirements.

        Analysis
The AQMD staff assessed the existing and projected availability of ERCs in the open market and the AQMD’s NSR Account. Based on staff’s assessment, there is a significant portion of unused ERCs in the open market that facilities are not likely to trade, referred to as Least Likely to be Traded (LLT) ERCs. In general, facilities are holding LLT ERCs for future business expansion and growth plans. As a result, the amount of ERCs that are "available" in the open market is lowered. Accounting for LLT ERCs, the projected availability of ERCs in the open market is approaching low levels, which is consistent with the increased price for ERCs. PM10 ERCs are of the greatest concern, and NO_x, SO_x, and CO ERCs are of next concern. At this time, the availability of VOC ERCs is not a primary concern. However, due to the high use rate, potential interpollutant/interdistrict trades, and increasing cost, the availability of VOC ERCs should be monitored.

Regarding the AQMD’s NSR Account, the availability of emission reductions is relatively stable. Although NO_x levels in the AQMD’s NSR Account are low, demand for NO_x emissions is currently stable. The AQMD’s NSR Account is a critical component of EPA’s and CARB’s approval of Regulation XIII, as it is used in demonstrating that Regulation XIII is equivalent to state and federal NSR requirements.

Based on this assessment, the AQMD staff finds that options to modernize the ERC system should focus on the open market. As required under Rule 1310 – Analysis and Reporting, the AQMD staff will continue to prepare the Annual Regulation XIII Status Reports, monitoring the emissions available in the AQMD’s NSR Account.

        Modernizing the ERC System – AQMD Staff Proposal
A series of mechanisms has been identified to modernize the ERC system. Recommendations presented below are designed to enhance the existing ERC system. Concepts that will impact requirements for offsetting or installation of BACT are key elements to the approval of Regulation XIII and are outside of the scope of this Initiative. In addition, since Regulation XIII has been approved in the State Implementation Plan (SIP), the AQMD staff is working closely with EPA and CARB to ensure that options are consistent with state and federal requirements. There are three main elements proposed for modernizing the ERC system: (1) expanding the use of short-term credits; (2) allowing ERC sharing; and (3) creating an offset budget in the SIP. In addition to these three main elements, there are a series of additional enhancements to optimize the generation and use of ERCs.

        Expanding Use of Short-Term Credits
Under this option, short-term credits such as MSERCs, area source credits (ASCs), and ERC shares, can be combined together to create a stream of credits. Thus, this option seeks to expand the applicability of existing mobile and area source pilot credit generation rules to Regulation XIII and to develop new rules that can be approved by EPA and CARB.

        ERC Sharing
The concept of ERC sharing will allow a facility that is holding a stream of unused ERCs to split the stream and sell or "share" the first few years of the ERC stream to another facility. The shared portion of the ERC stream can be used as a short-term credit. The remaining portion of the ERC remains as a stream of ERCs, at its original value. This option is expected to allow those facilities that are holding on to unused ERCs for future business growth plans to "share" portions of their ERC stream while addressing their future business needs.

        SIP Offset Budget
The concept of the SIP Offset Budget is to create a set-aside emissions account in the SIP that can be used for compliance with Regulation XIII. The SIP Offset Budget will provide an overall safety net for short-term credit use, ensuring the availability of ERCs.

Sources that elect to use ERCs from the SIP Offset Budget must pay a fee, that is yet to be established. The fee will be used to replenish emission reductions in the SIP Offset Budget. Emission reductions will be replenished either programmatically through implementation of the SIP or individually through new credit generation projects and any excess emission reductions from implementation of measures that are surplus to the SIP. Though replenishing reductions programmatically as opposed to through individual projects and control measures is the preferred approach, EPA has raised issues with this concept. The AQMD staff will continue to explore this approach, as it alleviates the need to manage individual emission reduction projects and it is anticipated that the SIP can be designed in such a way that it would include sufficient emission reductions to programmatically mitigate emissions from NSR sources that elect to use emissions from a SIP Offset Budget.

To ensure that the environment is kept whole, in the event the SIP Offset Budget is not fully replenished with new emission reductions from individual projects, the AQMD staff is exploring the possibility of using backstop reductions. The AQMD staff is looking into the potential use of surplus emission reductions from the existing Regulation XIII sources that can be used as backstop reductions. The AQMD staff will work with EPA and CARB to identify appropriate reductions that can be used as backstop emission reductions.

        Additional Enhancements
In addition to the overall modernization of the ERC system, the following additional enhancements were also identified:

• Issue all new ERCs in units of pounds per year instead of pounds per day;
• Extend the ERC application filing period from 90 to 180 days;
• Lower EIP environmental discount for mobile or area source projects that reduce diesel particulate;
• Standardize interpollutant trading protocols; and
• Discourage use of ERCs for non-Regulation XIII compliance such as Rule 2202 – On-Road Vehicle Mitigation Options, variances, abatement orders, and CEQA mitigation.

Key Issues
The AQMD staff’s proposal to modernize the ERC system represents those options that are the most promising in meeting the objectives of Initiative #1 as well as meeting EPA and CARB approval. Initial key issues that have been identified by EPA and CARB have focused on the concepts of ERC sharing, discounting procedures, and identifying creditable reductions for the SIP Offset Budget. Options that were discussed through the Working Groups and with EPA and CARB that raised the most significant approval issues are on a lower priority and are not being recommended for implementation at this time. If the Governing Board directs staff to proceed with rulemaking, the AQMD staff will continue to work with EPA and CARB and other interested stakeholders to develop the implementation details and resolve key issues.

Impacts
Implementation of the proposed recommendations to modernize the ERC system is expected to stabilize the availability and costs of ERCs in the open market. These mechanisms to stabilize the availability of ERCs are needed to ensure that economic growth in the district is not significantly impacted, while ensuring progress towards air quality goals and meeting EPA and CARB approval requirements. During the rulemaking process, the AQMD staff will conduct a more detailed assessment of the potential options. In addition, the AQMD staff will prepare the appropriate CEQA and socioeconomic impact assessments. Regarding staff resource impacts, potential resource impacts on permitting will be carefully considered and balanced. A recommendation to pursue rulemaking to implement options presented to modernize the ERC system is expected to be handled with existing resources.

Recommendation
The AQMD staff recommends proceeding with rulemaking to implement the recommendations to modernize the ERC system. Through the annual Regulation XIII Status Report, the AQMD staff will continue to report to the Governing Board the availability of emission reductions in the AQMD’s NSR Account and the open market. In addition, the AQMD staff is committed to continue discussions with EPA and CARB and other stakeholders through the rule development process, including a rule amendment working group.

Attachments

1. Emission Reduction Credit System Working Group
2. Summary of Recommendations
3. Summary of Key Issues
4. White Paper on Modernization of the ERC System

Chairman of ERC System Working Group
Norma Glover - South Coast Air Quality Management District Governing Board Chairman

Co-Chairman of ERC System Working Group
Jane Carney - South Coast Air Quality Management District Governing Board Member

ERC System Working Group Members
California Air Resources Board - Lynn Terry (Beverly Werner)
California Council for Environmental and Economic Balance - Bill Quinn
California Manufacturers Association - Curt Coleman
California State University Fullerton - Dean of Business & Economics - Anil Puri *
City of Los Angeles - Dee Allen (Christopher Patton)
City of West Covina - Michael Miller
Clean Air Now - Virginia Field*
Communities for a Better Environment - Bahram Fazeli*
Construction Industry Air Quality Coalition - Jeb Stuart
Gladstein & Associates – Cliff Gladstein
L.A. Economic Development Corporation - Jack Kyser (Greg Freeman)
Natural Resources Defense Council - Gail Ruderman-Feuer*
Orange County Business Council - Julie Puentes
Regulatory Flexibility Group - Mike Carroll
Small Business Alliance – Bill LaMarr
South Coast Air Quality Management District Executive Officer- Barry Wallerstein
South Coast Air Quality Management District Staff- Elaine Chang
South Coast Air Quality Management District Staff- Laki Tisopulos
Strategic Connections, Inc. - Jack Wyatt*
U.S. Environmental Protection Agency - Region IX - Jack Broadbent

* Invited but did not participate in any of the ERC System Working Group
  Meetings.
  Alternate member identified in parentheses.

ATTACHMENT B
SUMMARY OF RECOMMENDATIONS

ATTACHMENT C
SUMMARY OF KEY ISSUES

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