# Open Market Trading Rule for Ozone Smog Precursors

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/fr%3A95-18869

## Record

- **Collection:** Federal Register
- **Document type:** Proposed Rule
- **Published:** August 3, 1995
- **Citation:** 60 FR 39668

## Text

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

[[Page 39669]]
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.

[[Page 39670]]
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,

[[Page 39671]]
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.

[[Page 39672]]

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

[[Page 39673]]
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 in

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A95-18869. Public record. Not legal advice.