Open Market Trading Rule for Ozone Smog Precursors

ENVIRONMENTAL PROTECTION AGENCY

40 CFR Ch. I

[FRL-5267-9]

Open Market Trading Rule for Ozone Smog Precursors

AGENCY: Environmental Protection Agency (EPA).

ACTION: Proposed policy statement and model rule; Notice of public

hearing.

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SUMMARY: This notice conveys EPA's strong support for an innovative

approach in emissions trading that would bring better, faster, and less

expensive progress towards our nation's air quality goals. This

innovative approach, known as open market trading, would allow all

types of sources to trade emissions of pollutants that cause ground-

level ozone and significantly reduce the overall cost of meeting the

public health and environmental goals of the national ambient air

quality standards (NAAQS) for ozone. An important feature of this

approach is that individual trades would not have to be processed as

separate State implementation plan (SIP) revisions. Rather, open market

trades would provide sources with an alternative means of compliance,

and they would be reviewed by State and Federal authorities

predominantly during compliance determinations. The EPA believes this

open market approach can provide important emissions reduction

benefits. It can be put into operation immediately in places where

area-wide emissions budgets and source allocations needed to meet the

ozone standard have yet to be determined. The unique character of this

approach encourages and permits market participation and innovation by

smaller stationary sources and mobile sources. It also encourages

sources to make reductions early; these reductions can provide

immediate public health benefits. By providing a lower cost compliance

alternative, the open market approach can make it easier for States to

adopt additional control measures where needed to achieve attainment.

The EPA has developed today's proposed open market trading rule

(OMTR) as a new approach that would supplement, and would not modify or

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limit the adoption by States of other emissions trading approaches

available under the Clean Air Act (Act) and existing EPA rules and

policies. Today's proposal is in the form of a model rule; any State

which adopts the final version of this rule could expect its rule to be

immediately approved by EPA. This feature would enable States to begin

operation of an open market trading program without delay. The EPA

continues to encourage States to take advantage of all market-based

programs available to them, including emissions budget (cap and trade)

programs and emissions offsets, as well as emissions averaging

programs.

DATES: Comments. Comments must be received on or before October 2,

1995. Public Hearing. A public hearing will be held August 31, 1995,

beginning at 9 a.m. Persons wishing to present testimony must contact

Ms. Shelby Journigan at (919) 541-5543 by August 24, 1995. Persons

wishing to attend the hearing should contact Ms. Journigan to obtain

the location of the hearing.

ADDRESSES: Comments should be submitted (in duplicate, if possible) to

Air and Radiation Docket and Information Center (6102), ATTN: Docket

No. A-95-21, Room M1500, U.S. EPA, 401 M Street, SW., Washington, DC

20460; Phone 202-260-7548 or 202-260-7549. Fax 202-260-4400. Docket No.

A-95-21, containing information supporting the development of today's

proposal, is available for public inspection and copying between 8 a.m.

and 5:30 p.m., Monday through Friday, at the address listed below. A

reasonable fee for copying may be charged.

FOR FURTHER INFORMATION CONTACT: Nancy A. Mayer, U.S. EPA, MD-15,

Research Triangle Park, North Carolina 27711, telephone 919-541-5390,

fax 919-541-0839; or Scott L. Mathias, U.S. EPA, MD-15, Research

Triangle Park, North Carolina 27711, telephone 919-541-5310, fax 919-

541-0839.

SUPPLEMENTARY INFORMATION: The contents of today's preamble are listed

in the following outline:

I. Introduction and Overview

A. Emerging Market-Based Approaches for Ozone Control

1. Emissions Budgets (``Cap and Trade'')

2. Open Market Trading

B. Open Market and Emissions Budgets Can Work in Concert

C. Rationale and Principles for Today's Proposal

II. Summary of Proposed Rule

A. Purpose

B. Applicability

C. State Program Election and Submittal

D. Rule and Program Summary

1. Generating DER's

2. Using DER's for Compliance

3. Time and Place Use Limitations

4. Reporting, Recordkeeping, and Public Availability

5. Market Participants

6. Protocol Development and Approval

7. Enforcement

8. Program Audit

III. Discussion of Issues

A. Regulatory and Contractual Liability in the Open Market

1. Option 1: User Liability

2. Option 2: Retaining Pre-Approval Requirement

3. Option 3: Splitting Regulatory Liability Between User and

Generator

4. Option 4: Reliance on Third Party Guarantors

5. Proposed Approach

a. Generator Certification

b. Guidance for Emissions Quantification Protocols

c. Third-Party Relationships

d. ``Good Faith'' Purchasers

B. DER Generation

1. DER Formation and Baseline

2. Start Date for DER Generation

3. Converting ERC Activity into DER Activity

4. Prohibited Generation Activities

a. Shutdowns & Production Curtailments

b. Overcompliance with an Alternative Emissions Limit

C. DER Use and Transfer

1. Potential Uses

a. Use by Regulated Sources

b. Advantages to States

2. Special New Source Review Requirements

3. Special DER Use Restrictions

a. Geographic Restrictions

b. Interpollutant Trading

c. Seasonal Restrictions

4. Prohibited DER Uses

a. Compliance with Certain Mobile Source Requirements

b. Compliance with Certain Technology Standards

c. Compliance with Toxics Standards

d. Avoiding New Source Review

e. Use to Avoid Penalties

f. Use to Increase Over 1990 Emissions Levels

5. Use for Conformity Offsets

6. Use in Place of Variances

7. Holding DER's Before Use

8. Contribution to the Environment

9. Potential Market Participants

D. Characteristics of DER's

1. DER Life

2. Limited Authorization to Emit and DER Limitation or

Termination

E. Notices, Reporting and Recordkeeping

1. Notice and Certification of DER Generation

2. Notice of Intent to Use DER's

3. Notice and Certification of DER Use

4. Notice of Intent to Generate Rejected

5. Public Availability of Information

F. Federally Enforceable Operating Permits

G. DER Registries

H. Protocol Development and Approval

I. Meeting Related Federal Requirements

1. Attainment and Maintenance Plans

2. Rate of Progress (ROP) Requirements

3. RACT

J. Enforcement Issues

1. Calculation of Violations

2. State Compliance Determinations

K. Program Audits and Reconciliation Measures

L. Interstate Trading

M. Effect of VOC Trading on Emissions of Air Toxics

N. Impact of OMTR on Other Programs and Policies

1. Emissions Trading Policy Statement

2. Economic Incentive Program Rule and Guidance

3. Memorandum to Region IX Regarding Surplus Determination

4. Emissions Budget Programs

IV. Administrative Requirements

A. Public Hearing

B. Docket

C. Executive Order 12866

D. Unfunded Mandates Act

E. Paperwork Reduction Act

F. Regulatory Flexibility Act

G. Clear Air Act Section 117

I. Introduction and Overview

On March 16, 1995, President Clinton and Vice President Gore

announced 25 major initiatives for regulatory reinvention at EPA. The

number one initiative was an ``open market'' air emissions trading rule

to achieve the public health standard for ozone faster and at lower

cost. The Presidential announcement said:

EPA will issue an emissions trading rule for smog-creating

pollutants that will allow States to obtain automatic approval for

open market trading of emissions credits with accountability for

quantified results. Expanding use of market trading on a local and

regional level will give companies broad flexibility to find lowest

cost approaches to emissions reductions. The rule will encourage

experimentation with new trading options, while enabling States to

pursue more quickly allowance-based cap systems, which are already

under development in some areas. (Reinventing Environmental

Regulations; Clinton/Gore, March 16, 1995)

Today's proposal of a model rule for open market trading fulfills this

commitment. It would provide an expedited path by which States, with

EPA's cooperation, could quickly implement this new approach.

Together with ongoing initiatives to promote emissions budget (cap

and trade) programs, the open market rule signifies a major push to

introduce market-based approaches to cleaning up the air: Reducing

costs, increasing innovation, enhancing flexibility, and accelerating

attainment of health standards.

Ground level ozone, the primary constituent of smog, continues to

be one of the most pervasive pollution problems in the United States.

Exposure to ozone may cause serious respiratory health problems, such

as chest pain, coughing, nausea, and congestion.

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Elevated ozone levels have been associated with observed increases of

hospital admissions for respiratory diseases such as asthma and

decreased lung function of children attending summer camp. It is

estimated that ozone damage to crops, forests, natural systems and

synthetic materials is significant and exceeds $2 billion per year lost

to crops alone. Ozone is not directly emitted into the air, but instead

is formed in the atmosphere from reactions of ``precursor'' pollutants

in the presence of sunlight and warm conditions. The major ozone

precursor emissions are oxides of nitrogen (NOX) and volatile

organic compounds (VOC).

In the last 25 years great progress has been made toward achieving

healthy air quality under the Act. However, over 100 million people

still live in areas that do not meet the ozone health standard.

Continued reductions in ozone precursor emissions are important to

protect public health, and represent a tremendous challenge for our

nation's citizens and industries.

The 1990 Amendments to the Act established new deadlines for

meeting the health standard for ozone and substantially increased EPA,

State and industry attainment efforts. All areas that have not yet

attained and maintained the ozone standard are categorized as marginal,

moderate, serious, severe, or extreme areas. Each category has a

compliance deadline, ranging from 3 years (for marginal areas) to 20

years (for extreme areas; e.g., Los Angeles). All such areas have

requirements for reasonably available control technology (RACT) for

major stationary sources of VOC and NOX and with the exception of

marginal areas have defined rates of progress (ROP) for reducing ozone

precursor emissions.

The smog reduction programs in the U.S. are typically based on

traditional forms of environmental regulation: source-specific

emissions standards (e.g., RACT) set on a uniform basis for categories

of similar sources. Even though set as performance standards, these

regulations have a tendency to treat all sources within a category the

same and to be oriented toward the lowest common denominator, that is,

toward sources within the class that have the greatest difficulty and/

or greatest cost of control. Such standards simultaneously miss

substantial opportunities for cheap emissions controls by ``better''

sources, and impose a disproportionately high cost (per ton of

pollutant reduced) on a smaller group of sources. Government frequently

lacks information on untapped but cost-effective control options, and

sources have no incentive to be forthcoming. Government also tends to

overlook smaller or unconventional sources.

Recognizing some of these problems in traditional regulations, EPA

has developed policies permitting an increasing variety of ``emissions

trading'' approaches since the late 1970's. The EPA ``bubble,''

``netting,'' and ``offset'' programs allow certain kinds of trading of

emissions reduction obligations within the pre-existing regulatory

structure. These programs use the existing command and control

regulations as a baseline for trading.

The results of these existing programs have been mixed. Overall,

the volume of existing source trading has been small, perhaps due to

high transaction costs associated with the bubble policies. New sources

have found it possible through netting to avoid both time- and

resource-consuming Government review processes. Bubbles, netting and

offsets have reduced sources' overall compliance costs. However, there

have been significant problems of quality control, reducing the

environmental effectiveness of the programs.

A. Emerging Market-Based Approaches for Ozone Control

The 1990 Act Amendments recognized the merit of market-based

solutions to pollution control. The Amendments introduced a market-

based allowance trading system for sulfur dioxide to control acid rain.

The Amendments also included a requirement, in certain cases, for

economic incentive programs (EIP's) to be used as part of States' plans

to meet the ozone and carbon monoxide standards in designated

nonattainment areas. In 1994, EPA issued the EIP rule, which provided

rules and guidance for establishing EIP's. Two market-based approaches

have emerged that show particular promise for EIP's or other ozone

related trading systems: emissions budget programs and, more recently,

the open market approach.

1. Emissions Budgets: (``Cap and Trade'')

Emissions budget programs have been highly successful where they

have been implemented to date and offer the potential for high

integrity achievement of environmental goals and considerable cost

savings. Emissions budgets programs are predictable, flexible, offer

low transaction costs, and in practice have yielded both unexpectedly

high rates of innovation and unexpectedly lower costs. The cost of the

acid rain program is proving to be considerably lower than expected--in

large part because of the flexibility and innovation allowed under an

emissions budget program. Estimated national annualized cost of the

program at the time of enactment (1990) was $4 billion; the current

(December 1994) estimate from the General Accounting Office is $2

billion (Market-Based Pollution Control Programs, ICF Kaiser, Inc. May

11, 1995). Recent scrubber costs are about half of their historic level

and their removal efficiency has increased. Prices for low sulfur coal

are also lower than expected because of increased production, increased

use of low expense coal cleaning, bundling of allowances with fuel

sales, and competition in transportation. The Regional Clean Air

Incentives Market (RECLAIM) program is expected to cut Southern

California NOX emissions by 80 percent over 10 years while saving

about $58 million annually compared to traditional regulations (ICF

Kaiser, 1995). Well-designed emissions budget proposals offer the

highest degree of certainty for the environment and sources alike, and

EPA wants to do everything possible to support and encourage them. The

EPA is currently providing strong support for ongoing State development

of emissions budget approaches for large-scale regional control of

NOX in the Northeast Ozone Transport Region (OTR), and for VOC

emissions in Chicago and Los Angeles.

Notwithstanding their substantial benefits, emissions budget

programs are unlikely to capture all of the market-based opportunities

to achieve environmental results with reduced cost and greater

flexibility. Emissions budget programs have required considerable

start-up time and effort. They require agreement on (1) The universe of

covered sources, (2) baseline emissions levels, (3) the emissions cap

and its rate of decline, (4) the allocation of emissions allowances,

and (5) standardized monitoring and measurement techniques for

determining each source's emissions. Experience with RECLAIM and the

acid rain program shows that obtaining agreement on these points can

take several years. As a result, emissions budget programs have been

applied to date mostly to well-measured pollutants from relatively

uniform industrial sectors, e.g., oxides of sulfur (SOX) and

NOX from utilities. Start-up time should decline, however, as

experience is gained. The RECLAIM program and the Chicago program are

making great strides in extending emissions budget programs to some

categories of VOC sources.

The EPA is committed to continue providing financial and staff

support to emissions budget development projects,

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and the Agency will process emissions budget SIP revisions on an

expedited basis. Nonetheless, opportunities remain for market-based

solutions that emissions budgets are not likely to capture in the near

term. The EPA is pursuing the open market approach, in addition to

emissions budget approaches, to reach more of these opportunities for

cost reduction and flexibility while meeting public health protection

standards.

2. Open Market Trading

As stated, the open market approach has the potential to reach

market-based opportunities that emissions budgets are not capturing,

and to serve in some cases as a transitional stage until full emissions

budget programs can be developed. Open market trading programs can

begin operating without waiting for agreement on a cap, on allocations,

or on pre-established emissions measurement methodologies.1

\1\ The name ``open market'' was coined to reflect the absence

of an emissions budget or cap (so-called ``closed market'' systems).

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They can be implemented before there is agreement on an area-wide

or regional budget or other package of emissions reduction measures

fully adequate to demonstrate attainment of the ozone smog health

standard. They also have the potential to reach more diverse and

numerous types of sources (including mobile sources) than have been

covered to date by emissions budget programs.

The OMTR described today builds on the pioneering work done in a

major demonstration project overseen by the Northeast States for

Coordinated Air Use Management (NESCAUM) and the Mid Atlantic Regional

Air Management Association (MARAMA) (Emissions Reduction Credit

Demonstration Project, Phase II, Volume I Final Report, April 1995).

This project was partially funded by EPA's market-based initiative

grant program and has involved many State air pollution officials, EPA

staff, environmentalists, and representatives of major corporations in

the Northeast.

The open market system differs both in concept and execution from

the traditional emissions reduction credit (ERC) programs, ``bubbles,''

``netting,'' and ``offsets. These programs involve trading of

contemporaneous emissions rates that extend indefinitely into the

future. The open market, on the other hand involves trading of discrete

quantities (tons) of emission reductions already made. The discrete

reductions are measured from an emissions baseline that is generally

defined as the lower of actual or legally allowable emissions at the

source. Retrospective quantification of discrete reductions offers the

potential for achieving greater certainty and verifiability for all

parties regarding reductions already accomplished.

Administration of ERC programs under the 1986 Emissions Trading

Policy Statement has required a heavy investment of State, Federal, and

public resources in ``up-front'' review and clearance of specific

trades. In the effort to avoid quality control problems (``paper

trades'') that existed at points in the past, States typically devote

substantial resources and take considerable time to review individual

trades. High governmental costs and delays for the private sector have

kept the volume of emissions trades quite low.

The open market system would shift review and approval of

individual trades from the front end as a SIP revision or a permit

change, to the time of use as a compliance determination and

enforcement matter. Instead of complying with an emissions limitation

through control equipment or process changes on site, a source

operating under the open market rule may comply by buying and using an

appropriate number of tons of discrete emissions reductions (DER's).

This system places responsibility for the quality of those DER's on the

source that uses them for compliance. These features would reduce

front-end costs and delays while harnessing private sector resources to

assist government in assuring quality control. Responsibility for

compliance would motivate arms-length users to inspect carefully and

choose wisely among the DER's offered on the market, and to protect

themselves through contract indemnification provisions with sellers of

reductions, or with third party auditors, and through purchases of

extra reductions as ``insurance.'' Trades can take place before

governmental review and approval, increasing flexibility and lowering

costs.

The likely benefits of this system would be several. The fact that

reductions are accomplished before they are traded and used, encourages

earlier achievement of reductions. The private sector would be rewarded

for revealing, rather than concealing, cost-effective pollution control

opportunities. Lower cost curves would make it easier for States to

deny variances and promulgate additional needed rules. The open market

system would also expand the participating pool of sources beyond those

currently subject to direct regulation.

The practical implementation of an open market trading system gives

rise to many significant questions. These questions are identified here

and addressed in Section III of the preamble to today's notice. How

would open market trading be made consistent with air quality goals and

legal requirements? What would be EPA's role in assuring market

integrity? To promote certainty in the market as well as quality and

enforceability of reductions, what level of EPA support for emissions

reduction quantification protocols would be necessary? What would be

the appropriate degree of compliance oversight?

B. Open Market and Emissions Budgets Can Work in Concert

The EPA believes open market and emissions budget systems can

complement each other and even work together. Open market systems can

be put into place more quickly because they do not require consensus-

building on a budget, allocation disbursement and related

infrastructure. Open market systems can involve different source

sectors and smaller, more diverse sources that are not easily captured

by budgets. Open market systems can operate in concert with budgets and

positively affect areas outside the emissions budget domain.

Emissions budget systems would still offer substantial advantages

over open market systems. Under emissions budgets, sources have greater

certainty about future allowance allocations and thus greater

flexibility and ability to plan operations and trading in the future.

Reductions from shutdowns and curtailments, while not compatible with

the open market system, can be accommodated under an emissions budget

program. Thus, there will be continuing incentives to move from an open

market to a budget system, which would allow increased flexibility and

cost savings consistent with achieving health and environmental goals.

C. Rationale and Principles for Today's Proposal

The model State rule proposed in today's notice has several

features that would clear the way for widespread application of open

market trading programs. Today's proposal is designed to eliminate the

bottleneck of the single-source SIP revisions for emissions trading.

The adoption of the OMTR into the SIP would allow sources to legally

substitute DER's for on-site compliance through pollution control

equipment. Today's proposal is a model rule for incorporation into the

SIP. Once this rule is made final, EPA proposes to automatically

approve SIP revisions that adopt this rule.

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The model rule would not displace any other trading rule or option

currently approved or under development. It would open a new method of

trading and a new route for adopting that method. The model rule

describes a set of provisions that EPA has concluded are approvable in

all circumstances and in any area of the country. Variations that are

more expansive (e.g., trading over greater distances than provided in

the model rule) may be approvable in specific areas or under the

specific circumstances of a particular State. The EPA would evaluate

SIP revisions containing variations of this model rule on a case-

specific basis. The EPA is committed to working closely with any State

interested in pursuing any such variation. The EPA is available to

consult with States on the approvability of potential variations and to

provide expeditious review and decisions on any such submissions.

In producing this proposed model rule, EPA has observed the

following over-arching principles:

1. Do Not Interfere With Ongoing State Market-Based Programs

As mentioned above, one function of the OMTR is to encourage,

enable, and support emerging State trading programs, whether they are

classified as open market, emissions budget, or another trading

approach. The proposed model rule is neither mandatory nor

prescriptive. States would be free to tailor their own programs, which

may or may not include an open market trading component, and EPA

encourages States to harness compliance tools appropriate to their

particular circumstances.

2. Reduce Compliance Costs Without Compromising Environmental Integrity

A key test for any market-based strategy, including the OMTR, is to

lower the overall cost to the economy of clean air compliance, in a

manner that has equivalent or better environmental integrity.

3. Provide for a Long-Term Benefit to the Environment

The open market rule should benefit the environment in a number of

ways. Facilities may reduce emissions beyond their current levels in

order to sell the reductions, and facilities purchasing the reductions

would in turn have more flexibility to meeting their compliance

obligations, often obviating the need for source-specific emissions

limit modifications and exemptions. The open market program should

encourage early reductions through banking. It also should create an

incentive to try incremental and innovative emissions reduction

strategies, as well as reward accurate emissions measurement

procedures. To ensure an environmental benefit, the proposed rule

requires 10 percent of every credit used to be retired for

environmental benefit.

4. Maximize Flexibility and Minimize Transaction and Regulatory Costs

Reflecting one of the President's concerns with the role and

effectiveness of the Government in his reinvention initiative, a major

goal in this rule development is to improve upon the burdensome

oversight, and reporting and recordkeeping requirements that currently

exist in many pollution control programs. In this spirit, the rule

proposes requirements that are less burdensome yet consistent with the

level of quality necessary to maintain environmental integrity within

the open market system.

5. Actively Involve the Public, Industry and States in the Process

The EPA has worked with States, industry, and the public in

developing this model rule. This cooperative process will continue as

the proposed rule emerges toward its final version.

II. Summary of Proposed Rule

A. Purpose

The purpose of the model open market trading rule is to allow

sources to generate and use DER's for compliance with Title I and

various Title II VOC and NOX rules while complying with all other

applicable requirements of the Act. The model rule would provide VOC

and NOX sources with a financial incentive to reduce emissions

below levels required by applicable Federal and State requirements and

below their actual emissions in the recent past. Sources would be

permitted to make more economical decisions regarding how to comply

with pollution control requirements applicable to them. These sources

would be able to supplement or replace traditional compliance

strategies with a strategy of purchasing and using DER's.

B. Applicability

Today's notice applies to any State that adopts and submits an

identical rule to EPA as a SIP revision. The preamble to the proposed

model rule serves as a policy statement on open market emissions

trading, and explains how EPA would view specific deviations from the

proposed model rule.

C. State Program Election and Submittal

The EPA would automatically and immediately approve any State

submittal that revises that State's SIP to incorporate the identical

language of the model rule. That does not imply, however, that a State

could not develop variations on the model rule tailored to its

particular needs. The EPA would review any such rule and judge its

approvability in accordance with the adequacy and reasonableness of the

justifications for any variations from the model rule. Variations could

not be automatically approved, but EPA is committed to reviewing them

expeditiously.

D. Rule and Program Summary

This section briefly describes, in nontechnical terms, how the open

market trading system would work under the model rule proposed in

today's notice. It serves as a brief summary of the steps a source

would take to generate and/or use a DER, including any limitations. It

also describes what, when and how the source would need to tell the

State about their DER activity. A brief description of EPA's

enforcement strategy is also included.

1. Generating DER's

Any NOX or VOC source could generate DER's under the OMTR. In

contrast with traditional trading programs, where a source must accept

a permanent tightening of applicable emissions reduction requirements

in order to generate a continuing stream of emissions reduction

credits, in the open market program a generating source would not

change its legal emissions limitations. The source could generate DER's

by any action that reduces its emissions per unit of production or

operation (e.g., install pollution controls, make process changes,

switch fuels). Qualifying actions may even be temporary (e.g., a

temporary fuel switch); after the discrete period in question, the

source would have no obligation to continue emitting below its legal

limitations.

To be valid, DER's must meet the requirements of the model rule and

of guidance regarding emissions quantification that will be issued by

EPA. The DER's must be real, surplus, and verifiably quantified. The

DER's must represent real reductions in ozone-forming emissions. In

addition, they must be surplus, that is, reductions that were not

otherwise required by existing regulatory requirements or accounted for

in attainment or maintenance plans. DER's are emission reductions

generated

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over a discrete period of time, measured in units of mass (usually

tons). The generating source would be responsible for verifiably

documenting the amount of DER's it had produced, and DER's would have

to be measured through a valid quantification protocol.

To generate DER's, a source would first determine its baseline,

which reflects what the source would have emitted during the generation

period absent its DER generation strategy. In general, this would be

determined by referring to either the emissions level that would be

allowed by current law, or the facility's emissions that would have

occurred based on recent actual emissions rates. After the baseline was

ascertained, measurements would be taken and calculations would be made

to determine the amount of DER's that resulted from the specific action

taken to reduce emissions. This process must follow a valid

quantification protocol developed in one of several ways as indicated

below. The protocol would take into account an individual source's

characteristics (e.g., rates of VOC and NOX production, continuous

or batch processes, etc.) and monitoring capabilities. A source could

chose to follow a protocol that had been found to be previously

acceptable, or it could forge a new protocol following criteria that

EPA will issue in protocol guidance.

The generator would quantify its reduction by factoring relevant

source-specific information into the quantification protocol to

determine the amount of DER's generated. The generator must document

DER's in a format that would allow enforcement authorities to verify

them, to determine the user's compliance and, where necessary, to

enforce in cases of invalid DER's. Once generated, DER's could be used

at any later time for compliance with an eligible VOC or NOX

emissions reduction requirement. Like other emissions allowances

recognized under the Act, they would not be the holder's property, but

instead would be a limited authorization to emit the designated amount

of emissions.

After a DER had been generated, the source generating the DER's

would submit a Notice and Certification of Generation to the State

where the generation had taken place. This notice must contain a

certification, made under penalty of law, as to the accuracy of certain

information, including:

(a) The name and location of the source that reduced emissions;

(b) The discrete time period over which the emissions reductions

occurred;

(c) The amount of emissions reductions that occurred during the

ozone season and the amount of reductions that occurred during other

parts of the year;

(d) The unique identification number for each ton of DER's created;

(e) The emissions quantification protocols that were used to

calculate and document the emissions reductions;

(f) Information on existing requirements, if any, to which the

generator source is subject; and

(g) A signature of an authorized individual who is certifying under

penalty of law that the above information is accurate and complete.

Certain actions described in the rule would not create DER's, such

as:

(a) Facility shutdowns;

(b) Temporary or permanent production curtailments;

(c) Emissions reductions resulting from modifying or discontinuing

any activity that is otherwise illegal;

(d) Emissions reductions that occur as the result of any applicable

Federal or State requirement including compliance with MACT, BACT,

LAER, and NSPS requirements, or emission reductions relied on by the

State for meeting the ozone NAAQS; and

(e) Actions that occurred prior to the start of the relevant 1995

ozone season.

2. Using DER's for Compliance

Once DER's were generated, they could be transferred to any party

for use to comply with eligible requirements. Anyone could hold,

purchase and sell DER's. Intermediaries could act as DER brokers to

further facilitate the market process. Any source could use DER's to

cover eligible compliance obligations. Common uses for DER's might be:

(a) To comply with specified NOx and VOC emissions limits; (b) to

cover emissions increases that currently are commonly legitimized by

variances; or (c) as offsets under an EPA-approved major new source

review regulation.

A source that desired to use DER's for compliance purposes over a

specified period must determine the amount of DER's it would need.

Thus, the source must estimate its DER requirement through a valid

emission quantification protocol, similar to the process described for

DER generation, except that the user source must project its underlying

activity rate for the use period. The source must retire 10 percent of

the DER's it uses; thus it must purchase a fraction more than it needed

for compliance purposes in order to help ensure that the flexibility

and economic benefits of the open market trading program would also

produce a public health protection gain in each future year.

In order for a user source to use DER's for compliance purposes,

that source must own such DER's before the applicable date for

compliance. The user must notify its State at least 30 days prior to

its first actual use of DER's of its intentions to use such DER's. This

notice would not obligate the notifying source to use the specified

DER's. The notice would give the State the opportunity, if it wished,

to begin inspecting the validity of the DER's before they are used.

The source must ``true-up'' its original DER need estimate by using

the appropriate protocol to determine its DER compliance requirement

during or after the period in which DER's would be applied. When a

source had actually used specific DER's, it must file a Notice and

Certification of Use along with its regular compliance reports to the

State no less often than once every year. This notice would become part

of the documentation that the State would rely upon to verify that the

user had met its compliance obligations.

The model OMTR would prohibit certain DER uses. Such prohibitions

include: (a) To avoid penalties or enforcement actions by obtaining

DER's after the fact of noncompliance; (b) for netting or other means

to avoid NSR/PSD requirements; (c) to meet Act section 111 and 129

NSPS, LAER, BACT or MACT requirements; and (d) to meet requirements for

motor vehicle emissions standards, reformulated gasoline, Reid vapor

pressure standards, clean fueled fleets, employer trip reduction

programs, or vehicle inspection and maintenance programs.

3. Time and Place Use Limitations

By definition, DER's must be used at a time after their generation.

This is known as intertemporal trading. Intertemporal trading could

occur, within the same ozone season, from one ozone season to a later

one, or from the ozone season to a non-ozone season. However, DER's

generated during a time outside of the ozone season could not be used

to comply with any emission reduction obligations during the ozone

season.

User sources must also comply with certain geographic restrictions

to ensure that the new geographic distribution of emissions created by

trading would not interfere with a State's obligation to maintain air

quality or reach attainment of the ozone smog standard in a timely

manner. Due to differences in the role of natural emissions and in how

VOC and NOx react to form ozone, the

[[Page 39674]]

proposed model rule places different geographic limitations on VOC and

NOx.

Under the model rule as proposed herein, VOC reductions generated

outside any ozone nonattainment area may not be used for compliance

inside any nonattainment area. NOx emissions generated outside a SIP's

modeling domain (as defined by urban airshed modeling) may not be used

for compliance inside the modeling domain. These limitations could be

relaxed in some but not all State-specific OMTR applications due to an

area's unique meteorology. If a State submitted appropriate

justification, EPA would consider and expeditiously review any area-

specific variations on the model rule's geographic limitations.

Consistent with these geographical limitations, interstate trading

and use of DER's would be allowed and encouraged, so long as the

relevant States had entered into agreements that allowed such

transactions. Participating States must provide for an interstate DER

tracking system so the States could protect against DER's being used

more than once.

4. Reporting, Recordkeeping, and Public Availability

Sources must keep adequate and accurate records so as to ensure

that the DER's are real, quantified, surplus and verifiable. In

addition to the records they must create themselves, users would be

expected to have pertinent records of DER generation from the generator

to prove they held valid DER's. The user source then must hold such

records for a minimum of 5 years after the DER's are used.

The notices that are submitted to the State must be made available

to the public by the State under the appropriate State law regarding

public access to such documentation. This requirement applies equally

to both title V and non-title V sources. This will allow the public to

monitor specific transactions and contribute to public confidence in

the open market system.

5. Market Participants

Both sources that have and do not have title V operating permits

could, and are encouraged to, participate in the open market trading

program, especially as DER generators. One of the benefits of the open

market program is that small stationary sources and mobile sources that

are not subject to title V requirements could contribute to reducing

overall pollution levels in an area. The Notice of Intent to Use and

the Notice and Certification of Use must be filed with any applicable

operating permit.

6. Protocol Development and Approval

One key to integrity in the operation of an open market system is

accurate quantification of the amount of surplus DER's created, and

accurate quantification of the amount of DER's needed to meet

compliance obligations. For the program to be adequately enforceable by

State and Federal authorities, these measurements or calculations

require emissions quantification protocols that could be recognized by

the State and the EPA for use in the open market program. All DER

generation and use activities must be documented through the use of DER

quantification protocols that either have been approved by EPA, or that

correspond to EPA guidance on acceptable protocols. Typically, a

protocol would specify the measurement methods, monitoring methods,

calculation procedures, and documentation requirements for estimating

or measuring emissions for both the source's discrete reduction

strategy and its baseline. All protocols must include methods that are

credible and replicable.

EPA-approved protocols could come into existence in two ways.

First, EPA intends to issue EPA-approved protocols for a number of

reduction strategies. Second, EPA would work together with States and

industries to jointly review and approve quantification protocols for a

variety of source types. As a separate action, EPA also plans to issue

guidance on the development of an acceptable protocol. This guidance

would lay out specific criteria that must be met by a protocol

developed by a generator or user which had not already been approved by

EPA. The EPA intends to issue this guidance by the time the model rule

is finalized.

7. Enforcement

The user source would be responsible for complying with all

applicable requirements, and therefore would bear the burden of

demonstrating that the DER's it relied on were real, surplus, in

sufficient quantity to meet its compliance obligation, came from an

appropriate place and season, and met all other applicable requirements

of the rule. The user would be subject to enforcement proceedings for

insufficient or invalid DER holdings. The DER user, not the State,

would bear the burden of proof that the amount of DER's purchased were

sufficient to cover its compliance obligation including the

environmental discount, and that the DER use met all applicable

requirements of this rule.

From a compliance and enforcement standpoint, a lack of adequate

and credible recordkeeping would be equivalent to a lack of creditable

DER's. As stipulated in the Act, each violation (emissions limit or

recordkeeping) would be subject to maximum penalty of $25,000 per day.

Criminal sanctions could also apply as allowed under law. In assessing

penalties, EPA enforcement policy does take into account the nature and

degree of violation when determining what is an appropriate enforcement

action.

8. Program Audit

At least once every 3 years, the State would be required to audit

their open market trading program to evaluate the program's

performance. The audit would include, but would not be limited to, an

examination of the program's effects on requirements for rate of

progress (ROP) and timely attainment (credits used compared to credits

generated in a given year or ozone season), and the effects of

reconciliation measures that might have been taken as a result of

previous audit findings.

If the audit indicated a problem with implementing this rule, then

the State must consider initiating measures to reconcile the problem.

Possible reconciliation measures would include, but would not be

limited to: (a) Enhancing monitoring requirements; (b) increasing the

environmental benefit component of DER use, or limiting the use of

DER's to compensate for the difference between actual emissions and the

reductions needed to reach attainment; (c) implementing additional

technology-specific emissions reductions; (d) increasing penalties, or

(e) restricting trading.

The EPA would also perform a national audit based on the

compilation of State audit reports and if necessary, would revise the

open market program in accord with the audit's findings.

III. Discussion of Issues

This section provides more detail on the provisions of the OMTR and

issues surrounding the development of an open market trading system and

requests public comment on several issues. This section also discusses

elements of the proposed model rule that States could modify to meet

their unique needs. The EPA recognizes that States may develop

variations on this rule that are better suited to specific local air

pollution problems, and EPA will be flexible with respect to approving

a variation to the model rule if the State provides an adequate and

reasonable justification.

[[Page 39675]]

A. Regulatory and Contractual Liability in the Open Market

Currently, most emissions trades between existing sources are made

through single-source SIP revisions that must be approved by both

States and EPA. Pre-approval scrutiny of each trade is generally

effective in ensuring that trading does not interfere with air quality

requirements: For example, that the emission reductions and increases

involved are calculated from appropriate baselines and are

appropriately quantified. However, individual SIP revisions take

considerable time and involve substantial costs for both the private

sector and State and Federal governments. At least in part because of

these transaction costs, the number of emissions trades between

existing sources has been relatively low, and significant potential

opportunities to meet air quality objectives at lower cost have not

been realized.

The EPA's fundamental objectives in this proposal are to free up

the market for a higher volume of cost-effective emissions trading

while at the same time maintaining the relatively high level of quality

assurance that the current system provides. To meet these objectives,

EPA has used the following ``design criteria'' in designing the

proposed open market trading rule. The proposed rule should:

(1) Support timely attainment and maintenance of the Clean Air

Act's public health protection standards;

(2) Reduce private sector compliance costs, making it possible to

better protect the environment at lower cost;

(3) Reduce governmental costs in administering an expanded

emissions trading system;

(4) Make maximum use of private sector mechanisms for quality

assurance (liability arrangements, contractual guarantees, insurance,

third party services, etc.);

(5) Give potential market participants the ability to predict with

reasonable certainty which emission reduction actions will be found

valid and creditable by governmental authorities; and

(6) Provide the private sector with strong incentives to comply

with all requirements while at the same time giving responsible (``good

faith'') market participants reasonable expectations on potential

exposure to civil or criminal penalties.

The proposed rule, as already noted, is derived from the ``open

market'' concept developed by the EPA-supported NESCAUM-MARAMA

demonstration project and elaborated in a recent article.2 This

approach avoids the need for single-source SIP revisions by treating

emissions trading as a compliance option, that is, as another means of

compliance with applicable pollution control requirements contained in

the State Implementation Plan (SIP).

\2\ Emissions Reduction Credit Demonstration Project, Phase II,

Volume I Final Report, April 1995. Developing a Market in Emission

Credits Incremental: An ``Open Market'' Paradigm for Market-Based

Pollution Control; Richard Ayres, Bureau of National Affairs

Environment Reporter, Current Affairs December 2, 1994.

---------------------------------------------------------------------------

At present, most SIP's establish emission limitations directly

applicable to specific equipment and operations at facilities. Owners

and operators of such facilities must comply with these emission

limitations by installing emissions control equipment, making process

changes, or changing fuels or other inputs. Failure to comply is a

violation of State law and section 113 of the Clean Air Act and exposes

the source to enforcement proceedings by the State and EPA. Citizens

may also bring actions to enforce these obligations under section 304

of the Act.

Under the open market concept, sources would have the option of

complying by purchasing appropriate amounts (tons) of discrete emission

reductions (DER's) generated by others. The governmental role in

reviewing emissions trades would be transformed from prior approval

during SIP revisions to ``post-hoc'' scrutiny during compliance

determinations. Eliminating pre-approval of reductions and shifting to

review at the compliance stage would greatly free up the market and

increase trading volume, thereby reducing compliance costs and

benefitting the environment.

A key issue identified, however, in the NESCAUM-MARAMA

demonstration project and in the above-cited article is how to maintain

confidence that DER quality will remain high--that reductions will be

taken only from appropriate baselines and rigorously quantified--as

government involvement moves from prior approval to compliance

auditing.

Maintaining confidence in the quality of DER's is critical from all

perspectives. Regulatory authorities and the public need to know that

pollution will actually be reduced as projected, and the private sector

needs to know that the market will reward high quality reductions and

reject defective ones. Yet detailed compliance audits are inherently

conducted on only a fraction of sources each year, as limited

governmental enforcement resources must be targeted at a range of high

priority environmental problems.

In the stakeholder and interagency review processes conducted prior

to this proposal, a number of options were put forward for maintaining

DER quality assurance in an expanded emissions trading market. The

proposal made today is a hybrid of these options that EPA has developed

using the ``design criteria'' described above. The EPA believes this

hybrid best serves the twin objectives of freeing up the market for a

higher volume of emissions trading while maintaining sound quality

assurance incentives.

1. Option 1: User Liability

The first option considered was put forth by the original

developers of the open market concept. Building directly on the current

regulatory structure, they contemplated that liability for deficiencies

in DER's under the Clean Air Act and State air pollution laws would

remain with the party who purchased and used the DER's as a compliance

option, since that party had the original compliance obligation. The

key concepts underlying this option are that (1) DER's are compliance

products similar to pollution control equipment, and (2) as such the

user source is responsible for compliance when using DER's just as it

is when complying by use of control equipment.

Like sources using purchased control equipment or services, sources

using DER's to meet their emission limits would be able to control

their compliance risks by choosing carefully among vendors and by

negotiating for appropriate guarantees, insurance, or indemnification

provisions. Pollution control equipment and services purchased from

vendors generally come with guarantees specified in contracts or

implied under commercial law, or with specific insurance policies or

indemnification agreements as negotiated by the parties. Pollution

sources using purchased control equipment or services, however, remain

responsible for their own compliance obligations with State and Federal

pollution laws, and remain liable to enforcement authorities in cases

of non-compliance, even if the non-compliance was caused by a

shortcoming in the products or services purchased from a vendor. In

that case, sources have recourse to contractual guarantees, insurance,

or indemnification provisions. Through these provisions sources can

return to compliance (e.g., obtain satisfactory equipment) and be

compensated appropriately for damages.

Liability for compliance with State and Federal pollution laws and

the

[[Page 39676]]

prospect of enforcement for non-compliance encourage each source to pay

attention to the quality of goods and services offered by prospective

vendors of emission control equipment, fuels, and services. In the

competition for sources' business, market forces favor vendors with

great expertise, good track records for reliability, or the best

guarantees. Less capable vendors, who expose their clients to greater

risks of non-compliance, generally command lower prices--if they can

get any business at all. Market forces would be expected to operate in

the same way for DER's. In order to minimize risk, buyers would look

for quality and favor DER's that present low risks of placing users in

non-compliance. Users would remain responsible to enforcement

authorities in cases of non-compliance, but would be able to use

contractual provisions (guarantees, insurance, etc.) to shift the

financial consequences to generators or intermediaries that sold them

defective goods. The care users would take to reduce their compliance

risks would help assure the quality of DER's for the benefit of both

governmental authorities and the public.

Many participants in pre-proposal stakeholder discussions expressed

support for this option of placing liability for DER validity on the

buyer. Some participants, however, expressed concern that this option

would not provide appropriate incentives for attention to DER quality

if the seller and buyer are not in an independent, arms-length business

relationship, such as when DER transactions are internal to a company

or between companies that have close ties.

Still other participants expressed concern that buyer liability

could create excessive uncertainties and risks for buyers. They

predicted that buyer liability would reduce market activity and

suggested other options.

2. Option 2: Retaining Pre-Approval Requirement

Several commentors recommended that EPA continue to allow trading

only in reductions that have been pre-approved by governmental

authorities. They contended that an active market could develop only if

buyers have certainty that reductions offered on the market will be

accepted by governmental authorities, and that this degree of certainty

could be provided only by governmental pre-approval.

These commenters acknowledged, however, that the requirement for a

source-specific SIP revision was an expensive and lengthy process for

both industry and government and would remain a bottleneck preventing

expansion of the market, especially given current governmental

budgetary constraints. In response, these commenters suggested process

changes such as limiting the time allowed for State review or

dispensing with EPA review.

Other commenters, however, expressed concern that these process

changes would present too high a risk of approving poor quality DER's.

Governmental approval would be given despite reduced scrutiny of DER

quality. Neither buyers nor any other party would have incentives to

scrutinize the quality of DER's offered on the market once they were

governmentally approved. These commenters expressed concern that this

would lead to an influx of unsupported DER's, to the disadvantage of

generators that were trying to follow the rules, and an increase in

actual pollution levels.

3. Option 3: Splitting Regulatory Liability Between User and Generator

Other commenters suggested splitting liability for compliance under

State laws and the Clean Air Act among the generators and users of

DER's. Under this option, DER generators would bear full liability for

the validity of the DER's they sold, and users' liability would be

limited to deficiencies in how DER's were used (i.e., inaccurate

calculation of a user's compliance ``debit''). In other words, users

could purchase and use DER's without any legal risk for deficiencies in

the generation of those DER's. In a variation of this option, the user

would have the limited obligation to make up shortfalls if compliance

authorities discovered deficiencies in the DER's it relied on.

Commenters stated that one of the advantages of this approach would be

that each party would be held responsible for actions under its own

control. The transaction costs associated with constructing legal

arrangements to give the DER buyer information and certainty about DER

generation activities (inspecting potential DER purchases and

negotiating for guarantees or insurance) would be avoided, thereby

expanding the volume of trading and the cost savings.

Proponents of this option acknowledged that buyers would have fewer

incentives to inspect DER's offered to them, compared to the buyer

liability option. They contended, however, that it would be possible to

increase the frequency of governmental audits, and the size of

penalties, enough to maintain DER quality assurance. Other commenters

expressed concern that an increase in governmental auditing sufficient

to preserve DER quality would be difficult in light of budgetary

constraints, and that it would be difficult to convey appropriate

market signals about potential penalties through case-by-case

enforcement actions. Legal issues were also raised over whether State

authorities could obtain jurisdiction over out-of-state generators, and

on whether statutes of limitations with respect to generation

violations would begin to run before the DER's are used.

4. Option 4: Reliance on Third Party Guarantors

Another suggested option is to allow independent third parties to

guarantee the validity of DER generation and assume the compliance

liability for invalid DER's. In this option, independent third parties

would become subject to penalties under State laws and the Clean Air

Act if DER's were deficient. This liability would give such third

parties incentives similar to those of the buyer under Option 1 to

inspect DER's carefully and choose those that are best supported. The

user would remain liable for deficiencies in how DER's were used, as in

the split liability option above.

Proponents indicated that this approach could be of special value

when dealing with small sources that have the potential to generate

cost-effective emission reductions, but that lack the knowledge or

capacity to seize the opportunities on their own. Likewise, the

availability of such third parties might be valuable to small sources

that were potential users of DER's, but that lacked the necessary

expertise to purchase high quality DER's on their own or the

willingness to assume liability for defective DER's. Other commenters

raised questions about the legal means by which such third parties

would be made subject to regulatory liability, how to define an

independent third party, and how to handle the potential bankruptcy of

such a party.

5. Proposed Approach

The proposed open market trading rule adopts a hybrid of these

options, as well as other measures to address concerns about incentives

and uncertainties. The proposal is based largely on Options 1 and 4,

while also requesting comment on the issues raised in Option 3. The EPA

believes that the principle of buyer liability will work the best to

assure DER quality. The EPA also believes that in addition to their

major role through contractual mechanisms, third parties should be

allowed to assume regulatory liability in certain circumstances. The

proposal also reflects other significant features

[[Page 39677]]

intended to promote market activity by reducing the uncertainties

associated with buyer liability.

Accordingly, under the proposed open market trading rule, sources

may use DER's in lieu of direct pollution control measures to

demonstrate compliance with their emission reduction obligations under

State and Federal law. Today's rule proposes that the user source would

be responsible to enforcement authorities for compliance. The EPA has

taken four steps in this proposal to reduce the uncertainties and

transaction costs associated with this liability structure. Included in

these steps are provisions for third parties, in certain circumstances,

to assume the legal responsibilities of a generator. In addition, EPA

is considering and asking for comment on whether there are appropriate

circumstances in which a third party could take on a portion of the

legal liability of certain users, or liability could be divided between

user and generator.

a. Generator Certification. First, the proposal would require

generator sources to certify, under penalty of law, to the accuracy of

the underlying factual information (e.g., the accuracy of monitoring

and other data used to calculate the reductions), which supports DER's

offered for sale. If subsequent investigation should demonstrate that

such information was inaccurate, the generator would be subject to

civil and, if appropriate, criminal enforcement. It should be noted

that certification is a requirement to which pollution control

equipment vendors are not subject, but EPA believes it is an

appropriate requirement for DER generators in order to provide a

significant added measure of DER quality assurance to prospective

users, State and Federal authorities, and the public.

b. Guidance for Emissions Quantification Protocols. Second, EPA

proposes to issue guidance containing criteria for emissions

quantification protocols. Quantification of the emissions reductions

that sources have generated and the amounts that are needed by users

would have to meet the criteria in this guidance. In addition, working

with the States, industry, and the environmental community, EPA

proposes to create a mechanism for approving specific quantification

protocols for priority types of generation and use activities. A number

of such protocols would be drafted by industries, and others by EPA or

States. They would be reviewed by a multi-stakeholder process prior to

an EPA approval decision. The EPA believes these protocol guidance and

specific protocols would give generators and users, as well as

compliance authorities, a predictable ``road map'' for distinguishing

DER's that have a high likelihood of being considered valid, from ones

that are suspect or clearly inadequate.

c. Third-Party Relationships. Third, EPA proposes to encourage the

emergence of a variety of third-party relationships that could help the

market function. Within the context of Option 1, third parties could,

through contractual arrangements, assume many important functions that

would assist generators and users. Further, as suggested in Option 4

above, EPA proposes to allow third parties to assume the regulatory

liability of generators in certain circumstances. Finally, EPA is

considering and requesting comment on the possibility of allowing third

parties to take on a portion of the regulatory liability of certain

users.

(i) Third party contractual roles. Under the proposal, generators

and users could enter contractual arrangements with third parties to

perform a variety of important functions. For example, generators and

users could hire technical and legal experts to improve their ability

to create and purchase high quality DER's. Technical experts could help

generators develop quantification protocols that conform to EPA

guidance, and develop the data that plugs into such protocols. Lawyers

could provide expert opinions on the applicable State and Federal

requirements that determine a source's baseline. Similar technical and

legal services could be performed for the user, both to determine the

user's need for DER's and to pick the highest quality.

Third parties could also serve as brokers matching sellers and

buyers. Some third parties may acquire their own portfolios of DER's

and offer guarantees, insurance, or indemnification services to buyers.

Independent third parties could serve as a trusted source of expert

opinions establishing the quality of DER's. Such opinions would not

relieve the user of its regulatory liability under State law and the

Clean Air Act, but they could serve to reduce uncertainty, distinguish

high quality products, and build market confidence. The EPA

specifically requests comment on whether an opinion by an independent

third party should be required when the generator and the user are not

in an ``arms-length'' relationship.

(ii) Third parties as generators. The EPA also proposes that, under

defined circumstances, third parties could directly assume the

regulatory liability of generators. Third parties could play an

instrumental role when dealing with small batches of cost-effective

emission reductions from smaller sources. The EPA recognizes that the

requirement for generator certification could discourage participation

by small sources with the potential to make highly cost-effective

reductions. Buyers may also be reluctant to take on the task of

inspecting numerous small DER offerings from such sources. Third

parties may be more familiar with the emission reduction methods and

the DER calculation protocols than the owners and operators of such

generator sources. Third parties could offer the service of taking

operational responsibility for performing and documenting emission

reducing actions for such sources, thereby capturing inexpensive

emission reductions opportunities that smaller sources would otherwise

be unaware of, or that they would be unwilling to seize on their own

given the requirement for generator certification. The third party

could then take ownership or control of the reductions achieved,

aggregate many small batches of DER's, and offer them for sale to

users.

To promote such actions, EPA is proposing that third party

aggregators of DER's from small sources could take on the

responsibilities of generators under the rule in certain circumstances.

Specifically, this could occur where the third party enters an

agreement with the owner of the small source to take actual operational

responsibility for performing and documenting the action that generates

DER's. Under the rule, the third party would be considered an

``operator'' of the sources in question, for the purposes of the Clean

Air Act. The third party, not the numerous smaller sources, would file

the Notice and Certification of Generation and assume the legal risk

associated with the generator's certification as to the accuracy of the

information underlying its DER; the sources whose emissions the

aggregator reduced would have no liability. The user would look to the

third party operator, not the actual owners of those sources, for the

necessary documentation and certification as to the validity of the

DER's, and for appropriate guarantee or insurance provisions.

In order to qualify for this role, the third party also would need

to demonstrate financial responsibility, in order to insure that it has

an adequate stake in generating bona fide DER's, and that the neither

subsequent users nor the environment bear an undue risk in case of

fraud or bankruptcy. EPA solicits comment on what specific criteria for

a

[[Page 39678]]

showing of financial responsibility should be set forth in the final

rule, and whether any additional qualifications or requirements on such

third parties would be appropriate.

(iii) Third parties as users. EPA is considering and requests

comment on whether third parties could play a similar role on the user

side. The EPA recognizes that, as on the generation side, some sources

with the potential to reduce control costs by using DER's may

nonetheless be unwilling to take on the regulatory liability associated

with responsibility for the validity of the DER's. It has been

suggested that the rule could allow a qualified third party, by

agreement with the user source, to assume the user's liability under

State law and the Clean Air Act for the validity of the DER's used.

Under this suggested approach, the user would retain legal

responsibility for the calculation of the amount of DER's needed for

compliance, as well as all other aspects of how the user source is

operated. The third party, however, would assume legal responsibility

for the validity of the DER's acquired and used.

The EPA is considering and requests comment on this approach should

be adopted, and if so, with what appropriate conditions. Specifically,

EPA is considering and solicits comment on what conditions would be

necessary to maintain DER quality assurance incentives and capabilities

for compliance determinations and enforcement actions equal to those

associated with user liability alone. For example, to ensure that the

third party has the same motivation as would the otherwise liable user

to review DER offerings with care and choose on the basis of quality,

the third party would have to be functionally independent of the

generator from which it acquired the DER's. The third party would also

have to consent expressly to take on the legal responsibility of the

user source for deficiencies in the DER's, and to being considered an

``operator'' of user source for that purpose. The user and third party

would have to file a single, unified Notice of Intended Use. They would

have to do likewise for the Notice and Certification of Use, which

would have to include certifications under penalty of law by

responsible corporate officers of both the user and the third party as

well as to the accuracy of the facts underlying their respective

portions of the documentation. The third party would have to

acknowledge the jurisdiction of the user source's State, and that any

statutes of limitations on DER validity run from the time DER's are

used, regardless when they were generated. The third party would have

to commit to be present and make records available, on the same basis

as the user, present with the user itself, for any inspections or

related interaction with compliance authorities. As on the generation

side, a demonstration of the third party's financial responsibility

would assure that it has a sufficient stake to motivate diligence in

determining the validity of DER's, and would protect the environment

from undue risks of fraud or bankruptcy. As above, EPA solicits comment

on what specific criteria should govern a showing of financial

responsibility. The EPA is also considering and requests comment on how

this approach would affect compliance determinations and enforcement

proceedings in terms of complexity, resource demands, and

effectiveness.

d. ``Good Faith'' Purchasers. Fourth, EPA proposes to develop a

penalty or enforcement response policy in conjunction with the final

open market trading rule that would lay out in greater detail how EPA

intends to respond when DER's are determined to be deficient, despite

users' ``good faith'' efforts, and the criteria upon which good faith

would be judged. Enforcement of the Clean Air Act has a number of

objectives, including remediation of environmental harm and deterrence

of further non-compliance. The penalty or enforcement response policy

will address the case where a source has fully acted in good faith in

the purchase of DER's, including exercising due diligence in the

inspection and selection of those DER's, and yet the DER's are

subsequently determined to be deficient by compliance authorities. The

policy will make clear that EPA's focus would be on remedying the harm

to the environment from deficiencies in the DER's (i.e., the harm from

excess emissions). This could be accomplished by requiring the user

only to purchase and retire a sufficient number of DER's (perhaps with

a multiplier) to recoup the deficiencies in the DER's originally used.

The EPA requests comments on the steps a purchaser might take to be

considered a good faith purchaser and on the appropriate multiplier, if

any, should be applied in cases where replacement DER's are to be

acquired.

The EPA believes these four features of the proposal would provide

generators, users, and government authorities with sufficient guidance

and certainty so that an active market in high quality DER's would

develop.

After careful consideration, EPA rejected Option 2 (pre-approval

requirement). The EPA agrees with concerns expressed by some commenters

that retaining prior approval would maintain the bottleneck in the

current system, and that proposals to limit State governmental review

time or dispense with Federal review would run too high a risk of

giving governmental sanction to poor quality DER's.

It should be noted that nothing in the proposed model rule is

intended to prevent a State or other authorities from examining the

quality of a particular DER prior to the compliance determination

phase. Indeed, the Notice and Certification of Generation and the

Notice of Intent to Use would give a State the opportunity to review a

particular DER at an earlier stage, if it so chooses. The EPA expects

also that many sources may seek informal consultations with States or

EPA on the appropriateness of an emissions quantification protocol, the

correct application of a monitoring method, the applicable baseline

requirements, or other issues. The availability of such informal

consultations could play an important role in providing certainty and

predictability to the market. The EPA intends to continue working with

stakeholders to explore mechanisms for informal early review of

particular DER's.

With respect to Option 3, eliminating the user's responsibility for

the quality of the DER's it purchased would reduce transaction costs

and thereby expand the scope of trading leading to economic and

environmental benefits. It would also increase the importance of

governmental scrutiny during compliance determinations as a check on

DER validity and a means of ensuring achievement of the environmental

benefits. Only a fraction of sources are subject to detailed compliance

inspections each year. If users are responsible for making up

deficiencies, they will have some incentive to inspect the DER's

offered to them to assure that they are real, surplus, and

appropriately quantified. Nevertheless, it is possible that more

unsupported or invalid DER's would be sold. This would increase

pollution, damage public health, and undermine confidence in the

market. The EPA is also concerned that both of these approaches could

put the most scrupulous DER generators at a competitive disadvantage as

compared with others that may exercise less care in their DER

generation activities, unless compliance determinations are an

effective check on the supply of defective reductions. The EPA requests

comment on these issues. The EPA also requests comment on how, under a

split

[[Page 39679]]

liability approach, States would address jurisdictional issues over

out-of-State generators, or issues of responsibility for DER's

generated in the past by sources no longer in business.

The EPA requests comments on all aspects of its proposed approach

to liability.

B. DER Generation

1. DER Formation and Baseline

Under the proposed OMTR, participating sources may create

reductions by reducing their emissions for a specific period of time

below levels allowed by the approved SIP, State adopted rules (if more

stringent and not yet in the approved SIP), applicable Federal

requirements (e.g., NSPS), or historical actual emissions, whichever is

more stringent. The source would not be required to remain at that new

lower level permanently, but instead could reduce for a discrete time

period. During that period, reductions may be calculated by determining

the difference between what the source's emissions would have been

under the baseline emissions rate (actual or allowable emissions

without the DER generation strategy) and the actual emissions for the

discrete period of operation at the new lower emissions level, times a

measure of the source's operational level. The source would calculate

its DER's in one ton units.

The generation baseline establishes a benchmark for what is surplus

to all the source's applicable Federal and State requirements,

including those contained in the area's SIP. Therefore, for sources

located in areas where the attainment or maintenance plan is based on a

source's actual emissions, the generation baseline would be the lower

of the source's expected actual or allowable emissions. In areas that

have fully approved attainment or maintenance plans which are based on

sources' allowable emissions, the State has the option to let sources

use their allowable emissions as the generation baseline. For sources

not subject to any applicable VOC or NOX requirements, and located

in areas that are not required to have attainment or maintenance plans,

the baseline would also be based on the source's actual pre-generation

strategy emissions.

In some cases, the sources ``actual'' baseline emissions could be

measured directly, for example, as the pre-control device emissions. In

other cases, the baseline could be determined by reference to emissions

rates for the two years immediately prior to the generation period in

question, unless some other time period was deemed to be more

representative of the operation of the source. In such cases, the

expected actual emissions would be the product of the historical

baseline emissions rate per unit production and the actual production

during the generation period. The expected allowable emissions would be

the product of the allowable emissions rate per unit production and the

actual production during the generation period.

Some comments have expressed concern about the establishment of the

emissions baseline for sources generating DER's in areas which have

failed on a prolonged basis to submit and gain EPA approval of: (a)

Measures needed to meet rate of progress (ROP) requirements, (b)

attainment demonstrations, or (c) maintenance plans. These commenters

have argued that if a State has not yet adopted the additional

emissions control measures that would be necessary to rectify such a

SIP deficiency, DER generating sources would be operating from an

inappropriately high baseline. The commenters have suggested that steps

would need to be taken to address such situations, for example, (a)

barring further DER accrual by generators until the ROP, attainment

demonstration, or maintenance plan deficiency is remedied, or (b)

discounting DER generation by an amount proportional to the area's

overall reduction deficiency.

Other commenters have argued that while a DER generator's baseline

would be inappropriately high in such cases, all sources' baselines

would be inappropriately high, whether the sources are participating in

the open market program or not. These commenters believe that including

in the OMTR a requirement to address such SIP problems by selectively

targeting DER generators and users is unwarranted, since all sources

reap an economic benefit from not having a lower baseline and tighter

control requirements. They also believe that singling out open market

participants would act to discourage participation in the open market

system by creating undue regulatory uncertainty about the ability to

create and use DER's, thereby sacrificing the efficiency gains provided

by this regulatory approach. They have argued that States should

rectify such attainment problems without singling out open market

participants.

The EPA believes that both arguments raise valid concerns, and

requests comments on whether the OMTR should require action to address

DER generation in cases where States have such attainment problems,

and, if so, what those actions should be.

2. Start Date for DER Generation

DER's that may be used for compliance under this model rule must

have been generated after the start of the 1995 ozone season (May 1,

1995 in most cases) and must meet all other requirements of the model

rule. One of the objectives of this model rule development process has

been to make trading possible during the 1995 ozone season. Earlier

dates were considered but rejected because of the potential to

overwhelm the market with pre-existing reductions that by definition

were not motivated by the prospect of creating a tradable product of

value. Another objective of the rule is to create an incentive for

sources to make additional reductions beyond those they would otherwise

have made. It would not be consistent with this objective to give

retroactive credit for actions taken before this rule was developed and

which were made for other reasons. The EPA is also concerned that

crediting earlier reductions could lead to an imbalance in the first

years after a State program is in place. Thus, if a large-scale use of

pre-1995 reduction stockpiles occurred in that period, before large-

scale generation of new DER's had developed, it could lead to elevated

ozone levels during the use years, creating human health consequences

and jeopardizing an area's compliance with underlying Act requirements.

The EPA acknowledges that some stationary sources in the Northeast

have participated in the NESCAUM-MARAMA Demonstration Project, and have

made discrete reductions before the 1995 ozone season which they intend

to sell as DER's. While EPA has acknowledged and encouraged these

potential trades, they cannot fall within this model rule. These

facilities may need to proceed through source-specific SIP revisions.

The EPA will continue to work with the NESCAUM-MARAMA participants to

process revisions expeditiously.

3. Converting ERC Activity Into DER Activity

The EPA recognizes that there are beneficial emissions reductions

that will occur in the future under the current ERC program. Emissions

reduction activity intended for ERC use would be creditable as DER's,

provided that the activity met all applicable requirements of the OMTR.

However, the same emissions reduction activity may not be used in both

programs; the source would have to choose one program to the exclusion

of credit in the other. Reductions made before the 1995 ozone

[[Page 39680]]

season by an activity approved as an ERC could not, however, be used as

DER's.

4. Prohibited Generation Activities

a. Shutdowns & Production Curtailments. Under the proposed model

rule, DER's would be generated by actions that reduce the rate of

emissions of a source per unit of production. Typically, these actions

would consist of installing control equipment, making process changes,

or changing fuels or other inputs so as to reduce emissions per unit of

production. The proposed model rule would not allow shutdowns or

production curtailments to generate DER's.

Many participants in stakeholder meetings have argued that

shutdowns and curtailments would not be undertaken, or hastened, to

generate DER's (i.e., they would have happened anyway). The EPA has no

evidence at this time that shutdowns and curtailments would occur

earlier on account of the economic benefit derived from generating

DER's. Shutdowns and curtailments generally occur due to economic

conditions, and they do not result in an improved efficiency of

emissions per product. In addition, EPA is concerned that for major

sources under emissions rate limits, economic-related curtailments

could be used to generate DER's with no requirement to offset higher

emissions through use of DER's during full production boom periods.

Therefore, EPA believes that in general, allowing DER's to be generated

from shutdowns and curtailments could lead to increased emissions from

sources using DER's without real, additional reductions having been

made by DER generators.

As noted previously, a major purpose of this proposed rule would be

to promote innovative approaches to controlling and preventing air

pollution, involving the full range of major, minor, area, and mobile

source sectors. The EPA believes banking of DER's created from

shutdowns could provide a massive supply of inexpensive DER's that

would inhibit investment by others in measures that actually reduce

emissions per unit of production from sources that continue in

operation. The EPA believes this glut of DER's from actions that would

have otherwise occurred and that produced no additional reductions

could also lead to emissions spikes and therefore jeopardize compliance

with underlying Act requirements for attainment of the ozone standard.

In addition to concerns about the effect of shutdowns on

attainment, EPA is also concerned with load-shifting that could occur

when sources shut down. If small sources (e.g. gas stations or print

shops) reduce emissions by shutting down, their economic activity will

likely be picked up by new or existing sources in the same areas. Since

emissions created by increased operating rates by other existing

sources are not limited, and since new small sources are not subject to

an offset or cap requirement, the net effect of allowing shutdowns to

generate DER's would be to increase overall emissions.

The EPA does recognize some situations in which DER's generated

from activities that appear to be shutdowns and curtailments might be

consistent with an open market system. For example, for mobile sources,

reductions in use levels should be allowed to generate DER's if such

reductions occur in the context of a formal plan to shorten or obviate

trips and are generated with an appropriate emission quantification

protocol. Such use level reductions would not be considered

curtailments. An example of a program that could reduce motor vehicle

use levels is an employee commute option that generates emissions

reductions beyond what might be required for an area under section

182(d)(1)(B) of the Act.

Another example would be the early automobile retirement program

known as scrappage. The EPA does not consider mobile source scrappage

to be a shutdown, and scrappage programs would be allowed to generate

DER's under the proposed rule. This would be acceptable because

scrappage programs conforming to EPA guidance actually would achieve

earlier retirement of old, high-emission vehicles than would otherwise

occur.

In the process of developing this rule, a number of industry and

State groups offered other examples where shutdowns and curtailments

might be consistent with an open market system. One example is the

concept of allowing DER's to be generated from shutdowns and

curtailments when such reductions can be captured within a ``closed

loop'' of existing and new sources. Facilities that replace small

boilers with a central energy source and thus create fewer emissions

might create a net environmental benefit through small boiler

shutdowns. This differs from the more common shutdown case, where a

facility closes and the production load could shift to another

unrelated source. In general, establishing conditions by which closed

loop or other potentially beneficial shutdowns could be considered in

the open market program would add complexity to the proposed rule and

still might be problematic with respect to the intent of the rule as

outlined above. The EPA requests comments on language that would allow

for acceptable, environmentally benign or beneficial exceptions to the

common shutdown circumstances.

The EPA is also interested in public comment on whether a State

that has an approved attainment demonstration or maintenance plan that

does not rely on emission reductions from shutdowns and curtailments

may permit such shutdowns and curtailments to generate DER's. In such

cases, EPA believes that the use of DER's generated from shutdowns and

curtailments would not jeopardize attainment, since the SIP would

already contain enough emission reductions from other sources to

satisfy the attainment demonstration requirement of the Act. Thus, it

might be appropriate to allow States to credit emission reductions from

shutdowns and curtailments.

On the other hand, except where shutdowns are used for new source

offsets, air quality improves as sources shut down. Shutdowns are

already available as offsets for new sources. In the major new source

offset program, Congress decided that encouraging continued economic

development in nonattainment areas by allowing emission reductions from

shutdowns to offset new source emissions was worth the sacrifice of the

natural improvement in air quality that results from sources that shut

down. If existing sources are allowed to relax otherwise applicable

emission limits by using DER's generated from shutdowns and

curtailments, States would be giving up this built-in air quality

improvement. The EPA believes that allowing DER's to be generated from

shutdowns could be inconsistent with Congress' intent to encourage

economic development, since the value of DER's generated from shutdowns

would be expected, on the margin, to encourage sources to shutdown. The

EPA is interested in comment from the public on this matter.

In the event that shutdowns and curtailments were allowed to

generate DER's in areas with approved attainment demonstrations or

maintenance plans that do not rely on such reductions, EPA requests

comment on the period of time into the future that a shutdown source

would be allowed to continue generating credit. The EPA also requests

comment on the effect that allowing DER's to be generated from

shutdowns and curtailments would have on incentives for owners and

operators of existing, ongoing sources to invest in innovative

pollution control or prevention measures. The EPA also

[[Page 39681]]

requests comment on how to treat discrete increases in emissions that

result from full production boom periods if discrete decreases due to

production curtailments are creditable.

While EPA is proposing that the use of credits from shutdowns be

restricted under the proposed open market system, this does not imply

that such reductions cannot be used in other programs. Emission

reductions from shutdowns remain creditable in the offset program for

major new sources discussed previously, and can be used in emissions

budget systems. In emissions budget systems, the integrity of the

agreed emissions budget cannot be violated by emissions credits from

shutdowns and curtailments, since the closed system ensures that the

stated emissions target will be attained and maintained.

The Department of Defense (DoD) was especially concerned about the

impact of the rule on military base closures and the civilian

redevelopment of closure properties, as well as the ability of DoD to

use shutdown reductions to support other military installations of

other federal activities. In particular, DoD highlighted the fact that

most redevelopment of closed bases occurs over a long period of time in

a phased process. Credits for shutdown reductions are not only needed

at the time of the shutdown, but need to have an extended life to be

available to support actions 5, 10, or 15 years in the future.

The EPA believes that its current new source review (NSR) rules and

soon-to-be proposed changes to those rules will support base closure

redevelopment needs. For areas with approved attainment demonstrations,

current NSR regulations allow the use of emission reductions that are

contained in the emissions inventory at time of use--including

emissions from shutdowns and source curtailment--to be used to comply

with the NSR offset requirement.

In areas without approved attainment demonstrations, current EPA

regulations restrict the use of shutdown/source curtailments to be used

as NSR offsets where the reductions occur prior to submittal of the

permit application by the new source (with the exception of replacement

facilities). However, EPA is already planning a regulatory change as

part of the NSR update package that proposes to relax this restriction

in the Federal NSR requirements. This package is scheduled to be

proposed this fall. This would mean that under EPA's proposal, emission

reductions from shutdowns held by DoD or the local redevelopment

authority (LRA) would be available until needed for NSR offset

purposes.

The DoD was also concerned about the availability of shutdown

reductions to satisfy general conformity requirements. Since the

preamble of the general conformity rule references the NSR rules to

define offsets, any emission reductions that are consistent with EPA

guidance regarding NSR offsets are also available for conformity

offsets. This means that any mobile or stationary source emissions

increase needing conformity offsets may obtain them from both mobile or

stationary source reductions, including reductions resulting from

shutdown or curtailments if such sources are contained in the emissions

inventory at time of use. The EPA also confirms conformity offsets from

shutdown (closure reductions) could be retained by DoD or the LRA

indefinitely, freely transferred, and used for conformity purposes when

needed. The EPA requests comments on these determinations.

b. Overcompliance With An Alternative Emission Limit. In many

States, sources are given flexibility from RACT requirements when the

State grants them an alternative emission limit (AEL) that is less

stringent than the RACT standard. The OMTR would not allow sources to

generate DER's by reducing emissions below levels required by an AEL

but still above levels required by the otherwise applicable RACT

standard. Sources subject to AEL's could, however, generate DER's by

reducing emissions below the levels associated with the otherwise

applicable RACT standard.

C. DER Use and Transfer. 1. Potential Uses. One key to a strong DER

market and to minimizing compliance costs is enhancing the demand for

DER's created by allowing as many and varied uses as possible. One use

of DER's would be as a substitute for compliance with an applicable

RACT standard. However, EPA expects that there would be many other uses

as well. The philosophy of the model OMTR is that any use not

prohibited in the rule is a valid use. The EPA encourages States that

adopt this OMTR to adopt this approach.

a. Use by Regulated Sources. The EPA believes appropriate use of

DER's by sources would include, but not be limited to:

(1) Use for delayed RACT compliance;

(2) Use as compliance insurance margins to cover uncertainties in

the value of DER's or variations in process emissions or control device

efficiency;

(3) Use as a substitute for reductions to be achieved through

certain non-statutory mobile source requirements not otherwise

prohibited in the rule;

(4) Use as offsets for new stationary sources used either by a new

source or by States as an incentive for economic development;

(5) Use as part of a noncompliance settlement to compensate the

environment for past violations.

b. Advantages to States. States could also benefit from the

adoption of an open market program because the existence of DER's could

give the State more flexibility in attainment planning. For instance, a

State could eliminate the granting of alternative emission limits or

variances, or regulate emissions from occasional small-scale research

and development activities. Sources could comply with applicable

requirements through the use of DER's. These measures could increase

rule effectiveness.

2. Special New Source Review Requirements. Any proposed major

stationary source or major modification applying for a permit to

construct in an ozone nonattainment area may employ DER's to satisfy

the requirements for offsets. Offsets are governed by EPA and State

regulations for new source review (NSR).3 Nothing in today's

notice would alter EPA NSR requirements or exempts owners or operators

from compliance with applicable preconstruction permit requirements

under section 173 of the Act or regulations contained at 40 CFR

51.165(a).

\3\ 3 States have rules concerning the preconstruction review of

major stationary sources and major modifications applying for

permits to construct in nonattainment areas. These rules must be

consistent with the minimum requirements set forth under Federal

regulations at 40 CFR 51.165(a).

---------------------------------------------------------------------------

Today's model rule establishes specific criteria which the State

must ensure would be met if DER's were used for offsetting new source

emissions. In general, emissions reductions used as offsets must be

real, surplus, enforceable, permanent, and quantifiable. In addition,

section 173 of the Act sets forth specific requirements for emissions

offsets which must be satisfied by a proposed major stationary source

or major modification.

Section 173 of the Act requires that the emissions reductions be

Federally enforceable before the construction permit may be issued

(section 173(a)(1)), and achieved by the time the source or

modification commences operation (section 173(c)(1)). In using DER's

for offsets, it would be necessary for the new major source or modified

source to secure a series of DER's over the life of the source. The EPA

believes that it is reasonable to require that sufficient DER's be

obtained to offset the source's emissions on at least an annual basis.

The first year's DER's should be

[[Page 39682]]

submitted to the permitting authority prior to the public notice

announcing the proposed construction permit. The determination of the

amount of offset needed must take into account the prescribed offset

ratio for the nonattainment area of concern. The permit must contain an

enforceable condition requiring the source, each year, to have

demonstrated to the permitting authority that, at that time, it held

sufficient DER's to meet offset needs for at least the next year of

operation. Failure to obtain any required offsets in a timely manner

would be a violation of the source's permit.

Section 173(c)(2) of the Act prohibits emissions reductions

otherwise required by the Act from being used as offsets. For example,

reductions required to meet RACT, MACT, acid rain reductions, and the

phase-out of chlorofluorocarbons pursuant to statutory requirements are

not creditable as emissions offsets.

3. Special DER Use Restrictions. The proposed model OMTR would

limit the use of DER's with respect to certain generation and use

characteristics of the DER. Relevant characteristics include pollutant

type, the modeling domain or nonattainment status of the area where the

DER was generated, and the time of generation. The proposed OMTR would

provide for these limiting provisions, in part, to assure that in

nearly all cases the uses would be helpful toward reducing peak ozone

concentrations. That is, the connection between generation and use must

be correct, considering the distance between the generator and user

sources and the patterns of pollutant transport in the relevant area

(direction). States would be encouraged to assess their own unique

situations, and devise an OMTR that contains special DER use

limitations that are consistent with relevant modeling analyses that

are in the SIP.

a. Geographic Restrictions. Ozone smog formation is a difficult

problem that has resulted in various approaches aimed at resolving it.

Prior to the 1990 amendments to the Act, ozone attainment plans largely

focused on emission reductions in nonattainment areas. More recently,

attention has been focused on the issue of long-range transport and its

contribution to ozone formation and to violation of the ozone standard.

Ozone precursor pollutants mix and react together as they travel long

distances over several days, thus creating a serious problem. For

example, high ozone concentrations in the northeast occur on scales of

over 1,000 km and can persist for many days. Our current understanding

of ozone formation suggests that the relative importance of VOC and NOx

control varies with the location and scale of the ozone problem. In

general, VOC control is most likely to be effective in urbanized

nonattainment areas, and less effective in the surrounding countryside

where local natural VOC emissions can overwhelm those from human

activities. On the other hand, NOx control tends to be most beneficial

over larger distances. Therefore, the model OMTR would restrict VOC DER

use to the same area in which the DER was generated, and would permit

NOx DER trades to occur within the larger modeling domain.

While considering the general relationships among VOC, NOx and

ozone formation, it is also important to consider unique local effects

that might be characterized in a specific SIP modeling analysis. DER

uses should be consistent with relevant modeling analyses that are in

the SIP to preserve the integrity of the SIP. In these modeling

analyses, distance and direction effects are considered by analysis of

various episodes, meteorological regimes, and boundary conditions.

SIP's may define locations where emission reductions are most helpful,

marginal, or even counterproductive.

Some SIP's may have a regional NOx strategy component. A regional

strategy means that emission reductions are planned to occur across a

large area that may include sources located both within the local urban

airshed modeling domain and outside the modeling domain. A modeling

domain is the geographic area covered by an air quality model used to

support an attainment or maintenance demonstration. The domain can be

thought of as a rectangular box which is superimposed over the area

being modeled. For the current (1994) revisions to State implementation

plans (SIP's) for ozone, 23 modeling domains have been defined for

different locations in the United States. Typical domain size ranges

from 100 km x 100 km to 350 km x 350 km. Specifications for each of the

23 modeling domains are available through the U.S. EPA's Technology

Transfer Network (TTN). In addition, maps should be available from the

State agency having lead responsibility for the modeling analysis. Lead

State agencies are also identified in the TTN.

In the regional strategy knowing the precise location of each

emissions reduction is not as critical as understanding the general

distances and directions emission reductions travel from the

nonattainment area. In such cases, the modeling analysis shows ozone

reductions in the nonattainment area through both local emission

reductions within the modeling domain and by reduced regional, boundary

concentrations coming in to the area due to emission reductions outside

the modeling domain.

The above considerations are reflected in SIP attainment

demonstration or other modeling analyses conducted in support of the

SIP. Thus, in some cases a SIP's control strategy may simply call for

local reductions in a nonattainment area and, in other cases, the SIP

may be supported by modeling analyses which indicate that both local

and regional emission reductions are needed.

In general, EPA would view NOX DER's used within the same

urban airshed modeling domain as they were generated as acceptable as

long as they: (1) Are consistent with the regional concept in the SIP

strategy, and (2) address distance and direction concerns. The EPA

acknowledges that in special cases, NOX trades within a modeling

domain could result in higher NOX emissions in an urbanized area,

and may increase already high ozone levels in that area; in this case,

the use of NOX DER's in that area might not be consistent with

attainment demonstration and in such cases should be disallowed.

In addition, EPA believes that DER uses would be generally

beneficial where NOX or VOC DER's generated inside a nonattainment

or maintenance area were used by sources not located in a nonattainment

area, maintenance area or modeling domain. Trades which crossed or were

entirely outside of modeling domain boundaries could be ineffective

where the distances are great or the direction of pollutant transport

showed little benefit in reducing peak ozone concentrations from such a

trade.

Because of the complexity that would be required of EPA to list in

the model rule all possible combinations of distance and direction for

NOX and VOC trades in all areas wanting to adopt open market

trading programs, the model rule proposes to allow NOX DER use

only if the NOX DER was generated within the same modeling domain,

and VOC DER use only if the VOC DER was generated in the same area.

States would be encouraged to assess their own unique situations, and

propose an OMTR that allowed NOT2X trades from outside the

modeling domain at an appropriate discount, or allowed VOC trades with

adjacent nonattainment areas, after taking into account and justifying

the distance and direction considerations.

In addition, States could choose to adopt rules which allowed

NOX trades

[[Page 39683]]

without discount where certain distance and direction criteria were

met. For example, EPA would approve a State OMTR that allowed trades

without discounting for distance and direction where the rule included

the following criteria. Regarding distance, the generator and user

sources should be within either 200 km or 2 days transport of each

other. The transport criterion should be determined by examining the

average wind speed which occurs on days with ozone exceedances near the

user source. In all cases, the direction of the prevailing wind near

the generator source and the user source should be within a

22.5 degree sector of a straight line between the two

sources. Average wind speed and prevailing wind direction should be

based on data from National Weather Service stations near both the

generator and user sources. The prevailing direction and average speed

should be calculated over the period 7 a.m. to 7 p.m. This period

captures the time of day when emissions are typically highest, as well

as to include the portion of the day when surface wind measurements are

most representative of overall transport within the mixed layer. In

calculating the prevailing wind direction, one could include those days

with exceedances near the user source during the years used for

classification of the nonattainment area. As an alternative, one could

base the direction calculation upon all days in the ``ozone season''

for any year used for classification purposes in the area of the user

source. For distances or directions which extended beyond these

criteria, EPA believes that discounting may be necessary.

In general, EPA encourages States to propose their own geographic

requirements based on the characteristics of their areas. The model

OMTR would contain generic restrictions that States could modify to

more appropriately meet their air quality objectives. The EPA is

committed to working with States in creating the most beneficial

geographic restrictions for their specific areas.

b. Interpollutant Trading. Interpollutant trades are defined as

trades that occur between the two classes of ozone precursor

pollutants, VOC and NOX. The available scientific and modeling

information suggests both positive aspects and risks with an

interpollutant trading program. Certain trades have the potential to be

complementary, leading to greater reductions in ozone than would

otherwise occur (e.g., a facility sells NOX DER's to a buyer who

operates a VOC source in a rural area within the Northeast Ozone

Transport Region). Others, however, may be counterproductive. For

example, if a modeling analysis in the SIP identified a specific

geographical area as an area where VOC reductions were needed and

NOX reductions were not helpful over a local or regional scale,

then a reduction in NOX emissions in that area should not be

exchanged for required reductions in any other area. Since EPA cannot

account for all possible site-specific cases where interpollutant

trading is beneficial, the proposed model OMTR would not include

interpollutant trading.

States are nevertheless encouraged to submit as variations on the

model OMTR, rules of their own that would permit interpollutant trading

if adequate prior analyses had been performed which indicated that the

nature of trades meeting specific criteria was consistent with expected

lower ozone concentrations. These prior analyses might be performed by

the State(s) or by others in support of one or more SIP's. Although a

user could perform modeling analyses to support each proposed use of

specific DER's, this would not be required. In general, interpollutant

trading rules should encourage excess VOC emission reductions in

geographic locations where ozone is limited by available VOC or

encourage excess NOX emission reductions in locations where ozone

is limited by available NOX. In the event a user and generator

were in different States, review responsibility should be consistent

with the policy on interstate trades. Where such interpollutant trades

were permitted by States, the applicable rule should address distance

and direction considerations as they applied to allowable

interpollutant trades. The EPA would expeditiously review any such

variations.

c. Seasonal Restrictions. Whereas DER's generated in the ozone

season might be traded to meet emissions requirements either during or

outside the ozone season, DER's generated in the non-ozone season could

be used only to meet non-ozone season emissions requirements. Using

DER's during the ozone season that were generated outside the ozone

season should not be allowed since such uses clearly would run counter

to programs designed to attain or maintain the ozone standard and to

meet ROP requirements. Ozone season reductions are the only ones

effective in reducing peak ozone concentrations and are needed then.

Thus, the rule would not allow DER's generated during a time outside of

the ozone season to be used to comply with any air quality obligations

during the ozone season.

The time of year in which areas experience ozone concentrations

above the standard varies with location. In general, areas with greater

intensity of sunlight will experience longer ozone seasons. Thus,

southern areas tend to have longer ozone seasons than northern areas of

the country. The EPA has defined the ozone season for each State at 40

CFR part 58, Appendix D. The purpose of this definition is to set the

time of year during which States must monitor ozone concentrations.

Ozone violations are not expected to occur outside the defined ozone

season.

4. Prohibited DER Uses

The proposed model OMTR prohibits several uses of DER's for a

variety of statutory and policy reasons. The following sections explain

the rationale for each specific prohibition, and where appropriate,

seek comment on specific issues relating to the prohibition. In

general, EPA requests comment on any DER use that would be expressly

prohibited by the proposed model OMTR. Comments that explain in detail

how EPA could allow the prohibited uses given the language in the Act

and the rationale for current EPA policies would be particularly

helpful.

a. Compliance With Certain Mobile Source Requirements. The EPA

believes that compliance with national mobile source programs (i.e.,

national exhaust and evaporative emission standards for cars, trucks,

and nonroad equipment under sections 202 and 213 of the Act, plus any

national fuel standards under section 211 of the Act) cannot be avoided

through the use of DER's generated by other control measures. Some of

these national mobile source control programs have internal averaging,

banking and trading provisions, and EPA is currently examining whether

more flexibility can be built into them. However, the statutory

provisions by their terms appear to preclude compliance through DER's

generated from other sources. In addition, using DER's generated

outside of these programs (e.g., between different mobile source

programs) would be inappropriate in instances where reductions

associated with these programs occur nationally, and stationary and

area source DER's generated in a specific region would be used to

increase emissions nationally. The EPA is currently considering whether

DER's generated regionally can be credited toward meeting same-source

national requirements within a specific program (e.g., a scrapped

outboard engine could create a DER in the national marine engine

average standard structure).

[[Page 39684]]

The EPA also believes the Act would not allow the use of DER's

generated from other programs to meet the requirements of certain

regional or local mobile source control programs. Many local or

regional mobile source control programs, such as vehicle inspection and

maintenance under sections 182(b)(4) or (c)(3) of the Act, employer

trip reduction programs under section 182(d)(2)(B) of the Act, or clean

fuel fleet requirements under section 246 of the Act, have provisions

that appear to preclude compliance through DER's generated from other

sources. However, unless prohibited by other provisions of the Act,

DER's could be used to meet any regional or local mobile source

requirements that are in addition to those specifically mandated by the

Act. The EPA requests comment on whether the Act would allow the use of

DER's to meet Federal mobile source requirements and whether EPA should

adopt such an approach.

The EPA believes that emission reductions generated in the context

of an existing averaging, banking, and trading (ABT) program specific

to a particular mobile source program should not be used to generate

DER's. The same rule applies to fuel producers. The reason for this

restriction would be to avoid double use of DER's, especially since the

State may not be aware of the use of the ABT DER in the context of the

relevant program.

The EPA is concerned about quantifying DER's generated for upstream

and downstream emissions reductions strategies. An example of an

upstream activity is fuel distribution emissions--providers of natural

gas may seek to generate a DER to reflect reductions in gasoline

distribution emissions that result from sales of natural gas for

alternative fuel vehicles. In this case, the use of an additional clean

fuel vehicle does not necessarily take a known quantity of gasoline out

of the conventional fuel distribution system. However, these kinds of

emission reductions may be allowed to generate DER's if an adequate

quantification method can be devised and approved by EPA. The EPA

solicits comments on whether and under what conditions these emission

reduction strategies should be allowed to generate DER's.

b. Compliance With Certain Technology Standards. Today's proposal

is consistent with the EIP rule (59 FR 16696 (1994)) in that DER's

could not be used to meet Act sections 111 and 129, new source

performance standards (NSPS), best available control technology (BACT)

standards, or lowest achievable emissions reduction (LAER) standards.

The EPA believes it is important to begin investigating whether

compliance flexibility and costs savings can be offered to new sources.

In this regard, the Agency has proposed in the model rule that DER's be

used for offsets that satisfy new source review requirements. However,

EPA questions whether additional flexibility and cost savings can be

achieved by allowing sources subject to NSPS, BACT or LAER to utilize

the open market program to meet these control technology requirements.

In certain cases, the compliance requirements for NSPS, BACT or LAER

may inhibit new low-pollution facilities from replacing older, high-

pollution facilities as quickly as would have occurred otherwise. If

DER's were used to lower the economic hurdle in these cases, both the

environment and the economy would be better off in the long run.

The EPA requests comment on how to allow the use of DER's under the

open market program to meet NSPS, BACT and LAER requirements.

c. Compliance With Toxics Standards. Today's proposal would not

relieve sources participating in the open market trading of the

obligation to meet all requirements under section 112 of the Act.

Standards promulgated under section 112 require sources to meet maximum

achievable control technology (MACT) standards for air toxics. Often,

section 112 standards apply to the same emissions point at a facility

as RACT requirements. For example, a RACT requirement and a MACT

requirement could both require control of an emissions point to a level

achieved by a flare. In such a case, the source could not use a DER to

meet the RACT control requirement because the MACT standard imposes an

independent obligation to achieve the specified level of control. This

ensures that trading would not result in higher levels of hazardous air

pollutant emissions from a source than are permitted by Federal air

toxics control requirements.

d. Avoiding New Source Review. While allowing the use of DER's to

satisfy the requirement for offsets, EPA believes that it would be

unlawful to allow DER's to be used to avoid new source review

requirements altogether. Therefore, the model rule would specifically

prohibit the use of DER's to ``net out'' of review.

In addition, sources that had previously agreed to operational

limitations in order to avoid the new source review requirements, could

not use DER's to subsequently increase their emissions to major source

levels, and thus circumvent the provisions requiring retroactive review

as a major source or major modification.

e. Use To Avoid Penalties. The proposed model OMTR would require

sources to purchase DER's before using them. A user could not defer

purchase until after failing to comply. The EPA believes allowing such

a retroactive acquisition of DER's would encourage sources to avoid

their compliance obligations until such time as they were determined to

be out of compliance. However, as described elsewhere in today's

preamble, EPA does not wish to preclude the purchase of DER's as part

of a settlement agreement for a violation or as a potential component

of EPA's penalty policy.

f. Use To Increase Over 1990 Emissions Levels. The EPA recognizes

the possibility that a source may want to use DER's to allow that

source to relax current costly compliance obligations. Such use of

DER's may, in some cases, allow a facility to emit levels of pollution

greater than levels accounted for in the 1990 emissions inventory. The

EPA requests comment on whether in order to prevent excessive

degradation of air quality near a particular source the OMTR should

prohibit sources from using DER's to revert to pre-1990 levels. The EPA

acknowledges that it may be difficult to effectively enforce such a

provision since the State may not know with certainty the lower of

actual or allowable emissions from a particular source prior to 1990.

5. Use for Conformity Offsets

The EPA's General Conformity rule allows the conformity

requirements to be met by a Federal agency obtaining emissions offsets

(40 CFR 51.858, 93.158). The rule requires the offsets to come from

within the same nonattainment or maintenance area.

The definition of emissions offsets in the conformity rule is

intended to assure that offsets within the air programs are calculated

and credited consistently and that the term is used the same in the

conformity rules as in the EPA NSR program. All offsets must therefore

be quantifiable, consistent with the applicable SIP attainment and ROP

demonstrations, surplus to reductions required by--and credited to--

other applicable SIP provisions, enforceable at both the State and

Federal levels, and permanent within the time-frame specified by the

program. DER's used in accordance with the OMTR could meet these

requirements. Thus, the current conformity rule allows DER's to be used

as conformity offsets where they occur

[[Page 39685]]

in the same nonattainment or maintenance area.

Since the purpose of conformity is to assure that Federal actions

are consistent with SIP's, SIP's which explicitly allow the use of

DER's should logically allow the use of DER's as part of their

conformity SIP. That is, DER's which meet the SIP requirements should

also be considered to be DER's which conform to the SIP. Thus, if a

State adopts an OMTR into their SIP, such DER's should be available for

conformity offsets.

6. Use in Place of Variances

Many States currently provide for source-specific variances in the

form of compliance extensions and alternative emissions limits for

circumstances where it would be economically or technically infeasible

to install controls. States are encouraged to consider discontinuing

variances in areas where open market trading exists. Several States

have already included such provisions in their proposed EIP's. Instead

of granting variances, the State could achieve universal application of

a RACT standard and allow sources that might otherwise be granted

variances to comply through use of DER's. Discontinuing variances has

the potential to improve ``rule effectiveness'' by allowing more timely

rule compliance. This benefit could be reflected in attainment

demonstrations or maintenance plans, if approved by EPA.

7. Holding DER's Before Use

The model OMTR would require that DER's intended to be used by

sources for compliance purposes must be held before the intended use

period. This means that a particular DER generation activity must be

completed prior to the start of the use period. To meet this

requirement, a stream of DER's generated from an ongoing generation

activity could be broken and parcelled prior to the start of the use

period. This approach ensures the benefits of retrospective

quantification described elsewhere in today's preamble. Under the OMTR,

near-simultaneous trades similar to ERC trades could occur. For

example, two facilities could arrange beforehand a series of

transactions where one facility made reductions that were creditable to

another facility. The EPA believes this type of transaction could

facilitate same-season trading.

However, this near-simultaneous transaction must comport with the

30-day advance Notice of Intent to Use requirement. One way to enable

this transaction would be to prearrange such transactions 30 days in

advance and maintain a 30 day lag-time between the continuous

generation and use of the DER's. Another method might be to make an

exception for this special transaction, such that steps are taken to

assure the benefits of retrospective quantification while allowing

near-simultaneous trading. The EPA requests comment on how near-

simultaneous trading could occur or be improved in light of the 30-day

advance notice requirement.

The EPA recognizes that the near-simultaneous use and generation

might increase transactions costs since the Notice and Certification of

Generation and the Notice of Intent to Use, as well as the underlying

generation and use documentation, would have to accompany each

transaction. While these notices could be made routine and could be

kept in electronic form, EPA requests comment on procedures that could

be used in the open market trading program without compromising the

program's enforceability, that maintain the benefits of retrospective

quantification, but result in reasonable transactions costs for the

sources that wish to engage in near-simultaneous trading.

8. Contribution to the Environment

The final economic incentive program (EIP) rules (59 FR 16690

(1994)) and guidance establish as a goal for all EIP's that they be

designed to benefit both the environment and the regulated entities.

The rule and guidance requires States to design programs that would

meaningfully meet this goal, while providing flexibility to the States

in determining how best to accomplish such benefit-sharing in the

context of each specific program. Requiring that at least ten percent

of the DER's traded be retired would meet this benefit sharing goal.

The EPA believes this ten percent requirement is justified because

the OMTR has the ability to greatly reduce costs to regulated industry

and it is fair that some of those savings should be used to achieve

further emissions reductions. Such a discount is clearly appropriate in

the case where intertemporal trading is permitted. Intertemporal trades

can increase the risk of emissions spiking, which in extreme

circumstances could, in some years, negate the benefits of the early

reductions provided by banking. The discount decreases the risk of

spiking, and provides additional confidence that a retrospective

approach to auditing the effects of the program will be sufficient.

Therefore, EPA would approve the component of a State OMTR that

required a user to retire any specific percentage of at least ten

percent of the DER's it purchases for compliance use.

9. Potential Market Participants

An active market with a large number of participants helps to

promote economic efficiency in air pollution control. Subject to the

limits specified by the rule, any source that emits NOX or VOC in

an area that adopts an OMTR could participate in the open market system

as a DER generator, and any source subject to a VOC or NOX

emissions reduction requirement could participate as a DER user. The

open market system would provide an incentive for VOC and NOX

sources that have traditionally not been regulated to make pollution

reductions. Large sources, small sources, area sources, mobile sources

and non-title V sources could all participate.

The EPA anticipates that DER's will be handled much like any other

tradeable emissions reduction. They could be bought and sold by

service-providing intermediaries, brokers, or even speculators. DER's

could also be purchased and permanently or temporarily retired solely

for environmental benefit by environmentally minded individuals or

charitable organizations.

D. Characteristics of DER's

1. DER Life

The maximum length of time between DER generation and use is the

DER life. The proposed OMTR places no limit on DER life. The EPA

considered a variety of approaches to limiting DER life, and concluded

that longer lives promote market stability and diminish the risk of

emissions ``spiking.'' Market confidence increases as the life

increases, because DER holders are assured that barring unusual

circumstances, their DER's will not ``die'' before they are needed for

use. Spiking risks appear to diminish in proportion to longer DER lives

because the timing of DER use presumably becomes more random and less

tied with anticipated DER expiration. DER's with unlimited lives would

also require less recordkeeping and tracking burdens.

In recognizing the value of long DER lives, EPA found no obvious

basis for any particular number of years that DER's should last. Any

limit to DER life--however long--might encourage DER's being stockpiled

for future use, which creates the risk of spiking. Moreover, no

procedural or environmental problems have been found to date with the

unlimited lives granted for allowances in the acid rain trading

program. The EPA is therefore

[[Page 39686]]

inclined to adopt the same convention for DER's in the open market

program. The EPA requests comments on whether and for what reasons a

long finite life might be more appropriate than an unlimited DER life.

2. Limited Authorization to Emit and DER Limitation or Termination

Just as under the Title IV SO2 emissions trading program, the OMTR

would not confer property rights to the DER holder. Section 403(f) of

the Act states:

An allowance allocated * * * is a limited authorization to emit

sulfur dioxide * * * Such allowance does not constitute a property

right. Nothing in this subchapter or in any other provision of law

shall be construed to limit the authority of the United States to

terminate or limit such authorization. (42 U.S.C. 7651b)

Congress included this requirement to ensure that allowance holders

understood that they were barred from claiming a governmental taking

under the 5th Amendment of the U.S. Constitution. Like the acid rain

SO2 allowances, DER's would not be property, but would be limited

authorizations to emit the regulated pollutant. Property status is

unnecessary to secure a stable commercial setting for DER trading and

could produce undesired and perverse results, such as requiring a

government agency to compensate the owner of a pollution source when

its emissions are limited. A tradeable reduction derives its value

wholly from the regulation under which it was created. DER holders

could exercise a specific license to use DER's in the manner set out

under the model OMTR.

Program audit and reconciliation provisions in the model rule would

authorize the participating air pollution control agency to limit or

terminate DER use in extreme circumstances. States should consider this

an option only when other options have failed to provide for meeting

the State's underlying Act obligations. Although EPA would not expect

this to occur, and would expect that the program will achieve real and

cost-effective emissions reductions without having to resort to DER

limitation, this contingency measure must be available to provide

confidence that States will make continued progress toward their air

pollution control goals.

E. Notices, Reporting and Recordkeeping

As with all environmental compliance programs, appropriate

reporting and recordkeeping would be necessary to allow for the proper

enforcement of all applicable requirements and the tracking of the

overall compliance program. In addition, there is a need for the public

to obtain access to sufficient information to monitor the performance

of industry and government in meeting their obligations. In an

emissions trading program of this type, these reports are essential for

ensuring the integrity of the system and the confidence of the public

that air quality goals are being met.

Each record that must be kept, or report that must be filed, puts a

resource burden on the entity required to produce it. Therefore, it is

important to reduce the amount of recordkeeping and reporting to the

minimum necessary to ensure a high-integrity market. Three notices

would be considered necessary: (1) A notice of generation of DER's, (2)

a notice of intent to use DER's for compliance purposes, and (3) a

notice of use of DER's for compliance.

1. Notice and Certification of DER Generation

A DER generator would be required to file a Notice and

Certification of DER Generation with the State containing information

on the creation of DER's. This notice must be submitted within 90 days

after a generation action is complete, or 1 year after commencement of

the generation action, whichever is sooner. A responsible corporate

officer must certify under penalty of law that the information in this

notice is true, accurate and complete, based upon information and

belief formed after reasonably inquiry.

This notice would provide potential buyers, the States (in their

role as prospective compliance authorities), and the public the

opportunity to review the records concerning the methods (protocols)

used to generate reductions, the specific data (emissions rates,

production volumes, etc.), and the relevant baseline (lower of actual

or allowable) to verify that the DER's are real, surplus, and

accurately quantified. Second, this notice, coupled with the user's

responsibility to report a DER use, would serve as the necessary

``tracking'' record to assure that a specific DER was used only once,

since the tracking system should uncover the case of multiple use of a

ton with the same serial number. Third, the notice would provide

pertinent information for audits of the overall emissions trading

program by the State.

To provide systematic certainty and integrity to the program, the

State would assign a unique serial number to each ton of reduction.

This would allow a subsequent Notice and Certification of DER Use to be

matched to the exact tons which were generated and ensure that such

tons came from a relevant geographic location and were used only once.

Each State could establish its own numbering system, or could

collaborate with other States to design a regional or national system.

2. Notice of Intent to Use DER's

The Notice of Intent to Use DER's for compliance purposes would be

required in order to alert the State and public that a source intended

to use DER's. The State and the public would have the opportunity

thereby to examine a DER compliance strategy prior to use and prior to

the possibility of any environmental harm. The notice must be filed at

least 30 days prior to the source's first use of DER's and renewed at

least annually in cases of continued or repeated use. This notice would

serve to ensure that a prospective user held sufficient DER's prior to

use. It also would allow the State to consider the level of inspection

oversight to employ with the user. This notice only signals intent to

use DER's; a notifying source would not actually have to use them.

As part of their Notice of Intent to Use, States may want to

require sources to submit the price paid for each DER. The EPA believes

that knowledge of DER price could serve to assist States in determining

which DER's were high quality and which were low quality. Therefore,

price could serve as a signal to target a State's enforcement

resources. For example, a generator would be likely to charge premium

prices for DER's they created that were supported with high quality

documentation, whereas a generator of a less supportable DER might tend

to lower its DER price in order to compete. The lower-priced DER in

this context would denote a lower quality, or higher risk product. Of

course, in other instances low price may indicate no more than that the

generator has found a low-cost control opportunity. Nonetheless, price

might serve as a signal to a State to examine specific DER's more

carefully during compliance reviews. The EPA requests comment as to

whether price should be a required submission in the model rule.

3. Notice and Certification of DER Use

The Notice and Certification of DER Use would be required in order

to provide the State with information on the actual amount of DER's

used by a particular source for compliance purposes. It would include

information on the methods by which both the amount generated and the

amount needed for compliance purposes were calculated. A duly

authorized corporate

[[Page 39687]]

officer must certify under penalty of law that the information in this

notice was true, accurate and complete, based upon information and

belief formed after reasonable inquiry. Based on receipt of this

notice, the State could conduct compliance determinations and

inspections to ensure that the source had met all of its obligations

through the use of DER's. This notice is essential for the purposes of

compliance assurance and enforcement.

No action would be required by the State when it received a notice,

other than to make it publicly available as discussed below. The Notice

and Certification of Generation and the Notice and Certification of

Use, however, would be the State and Federal authorities' main

compliance and enforcement tools for generators and users of DER's.

To lessen the paperwork burden on sources, the information in each

of the proposed notices has been reduced to the minimum necessary.

However, the source would be required to keep full records of all of

the documentation associated with the generation and/or use of DER's at

their facility.

4. Notice of Intent to Generate Rejected

The EPA has considered creating a Notice of Intent to Generate

which would be filed before any generation activity, but prefers not to

require it in the model OMTR. Proponents advocated the notice so as to

provide the State with advance notice of the time period over which

DER's would be generated and the method that would be used to generate

them (``Emission Reduction Credit Demonstration Project,'' Phase II,

Volume I; Final Report, April 1995). Proponents cited reasonable

justifications for such a notice. The notice could provide some

preemptive assurances against invalid DER generation, and hopefully

could result in a higher level of scrutiny which would lead to a system

with enhanced environmental integrity. However, EPA believes this

benefit is outweighed by the resource burden required to be placed on

each participating source and State, since the notification is, by

definition, a non-binding assertion of intent that some facilities may

and will ultimately decide not to follow. Although the model OMTR would

not require a Notice of Intent to Generate, a State may decide that in

its particular case that the benefits of the notice outweigh the

burdens. Therefore, EPA would approve specific OMTR's that require this

notice.

5. Public Availability of Information

Adopting the model rule into the SIP would replace the need for

single-source SIP revisions. Such SIP revisions, however, serve the

purpose of providing the public with notification of each proposed

trade. Without some other vehicle for public notice, the public would

not be aware of DER trades. The EPA believes public confidence is

essential to the success of the open market program. Members of the

public have a legally recognized role in compliance assurance and

enforcement through the citizens suit provisions under section 304 of

the Act. The public must have fair access to the information related to

DER generation and use activity.

The proposed model rule would require the State to make all of the

notices received available to the public. For sources with a title V

permit, the information must be filed with or attached to the permit

and made available where the permit is available. For non-title V

sources, the State would make the notices available in a similar manner

to the title V sources. Facility documentation that is not included in,

but supports the information in, the notices must be made available

through the State's ``freedom of information'' or other laws, if

applicable, relating to the public's access to a source's compliance

documentation.

The EPA is concerned that not all States will have laws that allow

the documentation underlying the notices to be reasonably accessed by

the public if it is not submitted to the State along with the required

notices. The Agency considered a range of requirements that would

facilitate the public availability of such documentation. At one end of

the range, the Agency considered a rule requirement for sources to make

the documentation available to the public upon request. At the other

end of the range, the Agency considered a rule requirement that all

source documentation be submitted to the State along with the required

notices so that the State could make the information available. A

middle ground option would require sources to submit the underlying

documentation to the State, but waive the requirement if the source

agreed to make the documentation available to the public upon request.

The Agency requests comment on the appropriate way to ensure that the

public has reasonable access to a source's compliance documentation

without unreasonably burdening either the source or the State.

F. Federally Enforceable Operating Permits

The purpose of the title V program, codified in 40 CFR Part 70, is

to ensure effective implementation of all applicable requirements of

the Act for those sources subject to a Federally enforceable operating

permit. The title V program rules impose various important

administrative and procedural provisions (e.g., permit fees,

opportunity for public participation). The title V program does impose

a limited number of requirements relevant to source operation that

supplement the applicable requirements of the Act in order to enhance

their implementation. For example, a source's title V permit must

specify methods for monitoring and certifying compliance, and must

address these if the applicable requirement fails to otherwise provide

them. The provisions of the Part 70 rule that provide for individual

source emissions trading under permit-specific caps and for trading

under a SIP are currently the subject of rulemaking.

If adopted into a State's SIP, the provisions of the OMTR become

part of the underlying requirements reflected in a source's operating

permit. Therefore, changes in a source's operating permit language are

not necessary for the source to participate in the open market program.

However, for the benefit of both the source and the public, language

that specifically addresses the ability of the source to comply with

applicable requirements through emissions trading could appear in the

permit. The EPA intends to issue permit writing guidance that would

include language on open market trading that could be incorporated into

individual permits.

G. DER Registries

Open marketplace participants would require access to information

that enabled them to make accurate and informed decisions about the

supply, demand, quality and expense of DER's. This information could be

efficiently transferred among participants through one or more

registries that sent and received relevant DER information. Registries

should provide convenient and inexpensive public access, should not

interfere with the ability of ``small'' market players to participate,

and should help assure that specific DER's are not used more than once.

Comprehensive, high-quality information should be readily available

at reasonable cost to all participants and the public. Such information

might include: DER source listings, generator source type, location,

contact name of DER holder or holder's agent, DER

[[Page 39688]]

generation period, DER price, specific use restrictions if applicable,

generator and user nonattainment area classification, and DER user's

needs and requirements.

The EPA also believes that small market players, i.e., generator or

user sources that generate or use relatively small market quantities,

should not be disadvantaged by registry access requirements or the

listing fee structure. The EPA does not wish in any way to discourage

small sources from taking advantage of the benefits of open market

trading.

The EPA has addressed the issue of double-counting of DER uses

through the proposed rule's notice requirements. States must ensure

that unique identification is assigned to each ton of DER's generated

and reported in the Notice and Certification of Generation that each

generator source would be required to submit. States could then check

that a specific DER was used only once by cross-referencing DER use

notices with the DER generation notice. This check would be more

complicated in a case where use occurred in a State other than the

generator source's State. Therefore, the proposed OMTR would require

that States that allow such uses must have a memorandum of

understanding (MOU) or similar agreement approved by the EPA, which

facilitates checking for double-use of DER's.

While EPA recognizes that this function might best be performed

through a national registry, a question remains as to whether EPA,

State governments, or the private sector should provide these services.

The EPA is inclined to encourage registry development in the private

sector. For resource and efficiency reasons, EPA believes the private

sector is a more appropriate choice than EPA. Thus EPA requests comment

on (1) whether the private sector should provide such services; (2)

whether registries should be subject to regulation to assure access and

coverage of relevant information; (3) whether EPA or the State should

operate registries; and (4) whether a national registry, as opposed to

multiple regional or local registries, is necessary for the open market

program to function properly.

H. Protocol Development and Approval

A key to integrity in the operation of the open market trading

system is accurate quantification of the amount of surplus DER's

created and of the amount needed to meet compliance obligations.

Emissions quantification is generally divided into two conceptual

components. First, emissions quantification protocols specify the type

of data needed on emissions rates and operating rates (e.g., monitoring

methods, emissions factors, production rate or other activity measures)

and address other critical methodological issues (e.g., data quality

and statistical considerations). Second, specific data must be

developed pursuant to such protocols and used to calculate specific

results. Quantification protocols can be defined to varying degrees of

specificity in advance of particular emissions reduction actions. The

actual data used in particular cases, naturally, can be developed and

evaluated only case-by-case.

A number of cross-cutting factors must be considered regarding the

development of emissions quantification protocols. On the one hand,

both emission sources and compliance authorities have strong interests

in certainty. Federal and State authorities want to be sure that

methods are technically sound and that sources can be held to follow

them. Sources want methods they can use with assurance of predictable

outcomes at the time of compliance determinations. Based on these

concerns, some State and industry stakeholders have urged that

protocols be reviewed and approved by EPA before DER's are introduced

into the market. This would give both sources and compliance

authorities a common yardstick with which to gauge the validity of

DER's and the greatest certainty of outcomes, without requiring

redundant resource investment by multiple States.

On the other hand, a protocol pre-approval requirement would

greatly strain governmental resources and significantly dampen

development of the open market system. Given the variety of source

types eligible to participate and the variety of emissions reduction

strategies available to them, dozens (possibly hundreds) of specific

quantification protocols would be needed. Resource constraints on EPA

and States could severely limit the number of such protocols that could

be developed and approved in the near future, even with the benefit of

partnerships with industry and others. Many DER generation and use

actions could be delayed or precluded by the unavailability of pre-

approved protocols and the lack of a route for proceeding without such

protocols.

In response to these cross-cutting considerations, EPA has tried to

develop a middle ground that provides a sufficient measure of certainty

and predictability with due regard for governmental resource

constraints and the need for flexibility to adapt to new situations.

The EPA intends to issue guidance containing criteria for acceptable

emissions quantification protocols. The criteria would set forth

meaningful standards for the kinds and quality of data required to

support the calculation of amounts of emissions reduced by generators

or needed by users. DER Generators and users would be able to employ

these criteria to develop specific quantification protocols for their

applications. Compliance and enforcement authorities would be able to

use these criteria to determine whether submitted protocols, and

associated data, are sufficient to establish compliance. The guidance

would be issued with the final model OMTR and revised and expanded as

necessary from time to time. Generators and users would be able to rely

on, and would be held to, the guidance in effect at the time they

generated DER's or at the time they determined their need for DER's to

meet compliance obligations, respectively.

In addition, EPA intends to create a mechanism for working with

States, industry, and the environmental community to develop and

approve specific quantification protocols for priority types of

generation and use activities. It is envisioned that some such

protocols would be drafted by industries, and others by EPA or States.

They would be reviewed by a multi-stakeholder process prior to an EPA

approval decision. The EPA believes that in many cases emissions

quantification protocol development may not be a large additional

burden. This could be especially true for protocols that determine the

amount of DER's needed to be in compliance, since user sources subject

to emissions limits may be already familiar with the task of evaluating

their emissions levels.

The EPA specifically requests comments on two variations on this

basic approach. In both cases, sources would develop their own

protocols subject to EPA's protocol guidance criteria where no pre-

approved protocol existed. Where EPA-approved protocols existed,

however, two options could be followed. In one case, a source would be

required to use the pre-approved protocol unless it obtained EPA's

approval of an alternative protocol. In the other case, a source would

be allowed to use an alternative of its own design in lieu of the pre-

approved protocol, so long as the alternative conformed to the criteria

in EPA's protocol guidance.

The model rule would allow State OMTR's to incorporate EPA's

protocol guidance and specific pre-approved protocols by reference. In

this way, a

[[Page 39689]]

source which generated or used DER's would be on notice that it was

legally bound by the protocol guidance or specific protocols (as

applicable) that were in effect at the time of their generation or use

action. Incorporation by reference would provide fair notice and

binding effect while avoiding the need for continual SIP revisions as

new specific protocols were adopted and as EPA's protocol guidance was

revised. In the interest of assuring enforceability, EPA is also

considering whether each EPA-approved protocol and/or the EPA protocol

guidance should be incorporated directly into State SIP's and requests

comment on the sufficiency of the incorporation by reference approach.

The EPA acknowledges, however, that there are risks for both

sources and authorities associated with allowing operation under

protocol guidance as proposed. Generators would be allowed to introduce

DER's into the market based on specific protocols that they devised

pursuant to the guidance, without advance approval. Compliance agencies

would have to determine the protocol's consistency with the guidance at

the time of the compliance determination, after sources had made use of

the reductions. Despite the fact that the proposed rule assigns users

the burden of proof of DER validity, it may be more difficult at this

stage for compliance authorities to reject DER's based on unsound

methodologies. Further, at least a portion of the resource burden

associated with evaluating protocols in advance would be shifted to

State and Federal compliance authorities later in the process. The EPA

requests comment on these issues.

The EPA believes this combination of protocol guidance and specific

protocols would give generators and users, as well as compliance

authorities, a predictable ``road map'' for distinguishing DER's that

have a high likelihood of being considered valid from ones that are

doubtful or clearly inadequate. The EPA requests comment on all aspects

of this approach.

I. Meeting Related Federal Requirements

The Act requires SIP's to include provisions to meet specific rate

of progress (ROP) requirements applicable to certain ozone

nonattainment areas under section 182. The Act also requires SIP's to

provide for the attainment and maintenance of the NAAQS. SIP's must

include specific emissions limits within a nonattainment area to meet

ROP and, in moderate or above nonattainment areas, as well as certain

marginal areas, the SIP must require RACT. SIP's may also include

modeling analyses which result in emissions limits over an area larger

than the nonattainment area--the modeling domain--as needed to attain

the NAAQS. Emissions trades between sources far apart could cross

multiple nonattainment areas and modeling domains and, thus, impact

ROP, RACT and attainment requirements contained in more than one SIP.

As noted above, the proposed rule would limit certain DER uses with

respect to pollutant, modeling domain, and nonattainment area. These

provisions recognize the regional nature of the ozone nonattainment

problem and the specific limitations are intended to help assure

consistency with any attainment or maintenance plan and ROP

requirements.

In addition, the model rule would require an audit of the trading

program to evaluate, among other items, the effect of the program on

the attainment demonstration and ROP requirements. The provisions would

require a retrospective look at the effects of the trading program at

least once every three years. Where an inconsistency with the

attainment or maintenance plan or ROP is determined by the State, the

State must institute measures to correct the problem.

1. Attainment and Maintenance Plans

The EPA recognizes that the intertemporal use of DER's may, under

certain circumstances, place pressure on an area's attainment

requirements. If numerous DER's generated prior to the attainment date

were used near the attainment date, the additional emissions from

sources that avoided otherwise required reductions could lead to

violations of the NAAQS and delay attainment.

In addition, emissions trades between sources far apart could cross

multiple nonattainment areas, States, and modeling domains and, thus,

impact ROP and attainment or maintenance plan requirements contained in

the SIP's.

The validity of attainment and maintenance plan modeling analyses

could be eroded by trading if the location and amount of emissions

significantly changed from the initial plan assumptions. Such shifts

would add uncertainty to predictions of the ozone levels expected on

peak ozone days. In a worst-case scenario, reductions created during

non-episodic conditions could be used during episodic conditions,

exacerbating peak ozone levels.

The EPA must evaluate these potential planning concerns in light of

section 110(l) of the Act, which provides that EPA--

shall not approve a revision of a plan if the revision would interfere

with any applicable requirement concerning attainment and reasonable

further progress * * * or any other applicable requirement of this Act.

Whether DER use would interfere with an attainment demonstration

depends on numerous factors involving the amount, timing, and location

of trades. Limitations in the model rule (e.g., spatial limitations)

could reduce the risk of such interference. Based on available

information, EPA does not have evidence at this time that would lead it

to believe that an overly large number of DER's will be used during the

year of an attainment deadline, or at any other time that could

precipitate exceedances of the standard. Rather, it seems reasonable to

assume that DER's will be generated fairly steadily as opportunities

for better controls arise, in response to continuing demand by DER

users. Moreover, certain sources may require use of DER's over a long

period of time; under these circumstances, it is doubtful that the

intertemporal or spatial aspects of the OMTR would interfere with

attainment. The EPA acknowledges, however, that generation of DER's

could be bunched at particular points in time, such as new control

deadlines, by sources that are able to implement controls prior to the

required date. Also, use of DER's could be bunched just after such

deadlines. If this phenomenon occurs on a large enough scale and at a

particular time, attainment could be jeopardized. On balance, EPA has

concluded in this proposal that current information does not establish

a sufficient risk of this scenario to constitute interference with

attainment. Although the open market trading program adds an element of

uncertainty to the attainment planning, attainment demonstrations have

many other unavoidable uncertainties which may include growth

projections, biogenic emissions, mobile source emissions, rule

effectiveness, model boundary conditions, and model precision. The EPA

invites comments on its analysis and conclusions on this point.

It is possible to imagine trades that could adversely affect a

SIP's attainment or maintenance strategy by creating ``spikes'' over

permissible aggregate emissions levels. The mere possibility of such

events does not mean that the program would necessarily interfere with

attainment planning. It does, however, offer support for the need of

periodic trading program audits to monitor trading.

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2. Rate of Progress (ROP) Requirements

ROP requirements must be met in nonattainment areas. Section

182(b)(1)(A) of the Act, applicable to ozone nonattainment areas

classified as Moderate or higher, provides that the SIP--

shall provide for such specific annual reductions in emissions of

volatile organic compounds and oxides of nitrogen as necessary to

attain the national primary ambient air quality standard for ozone

by the attainment date applicable under this Act.

Section 171(l), applicable to all nonattainment areas, contains a

similar requirement. Section 182(b)(1)(A) further requires a 15 percent

reduction in VOC by the end of 1996. Section 182(c)(2)(B), applicable

to areas classified Serious and higher, generally requires a 9 percent

reduction in VOC or NOX for each 3 year period thereafter, until

attainment.

An area's success in meeting ROP requirements depends on many

factors, including growth rate, rule adoption schedule, and control

effectiveness. In many cases, trading would clearly not impact ROP: for

example, in areas not covered by ROP programs; in areas trading

NOX emissions and affected by VOC-only ROP programs; for same

pollutant trades within a single nonattainment area; and for trades

involving emissions reduction from sources in one nonattainment area

over one ozone season. In addition, where the SIP's nonattainment area

reductions were greater than ROP requirements, VOC trading within that

margin would not affect ROP and, thus, would be acceptable. In general,

EPA believes that an audit program should be part of a State's ROP

planning, because, like attainment planning, it may be affected by

trades under an OMTR. The intertemporal aspect of trades, as well as

trades across nonattainment areas, raise the possibility that under

certain circumstances, trading could jeopardize ROP.

The EPA has made use of a computer model which allows a rough

approximation of the impact of intertemporal trades on attainment and

ROP plans, under various simplified assumptions about overall market

activity and some alternative policy choices. As discussed above with

respect to attainment planning, hypothetical circumstances may arise in

which large quantities of DER's are generated in year 1 and used in

year 2, or generated in one area and used in a neighboring area, to a

degree that interferes with reduction targets in year 2 or in the

neighboring area.

However, for much the same reasons discussed above with respect to

attainment planning, EPA believes it reasonable to assume that

intertemporal trading will not be of the magnitude necessary to

interfere with the 1996 and subsequent ROP targets. For the same

reasons, EPA believes it reasonable to assume that OMTR trading will

not cause annual emissions spikes that may interfere with the section

182(b)(1)(A) requirement concerning annual reductions as necessar

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