BOARD MEETING DATE: June 6, 2003
AGENDA NO. 39

Recommendations Regarding Reentry of Power Producing Facilities into RECLAIM Program

SYNOPSIS:

At the May 11, 2001 Board meeting, power producing facilities were separated from the rest of the RECLAIM market. This measure was taken to assure adequate power supply at a reasonable cost in a deregulated electric utility market. Pursuant to Rule 2015(b)(7), these facilities would rejoin the full RECLAIM program in the 2004 compliance year, only if it is determined by the Board in a public hearing prior to July 2003 that their reentry will not result in any negative impact on the remainder of the RECLAIM facilities or on California’s energy security needs. This item presents staff’s recommendations regarding reentry of power producing facilities into the RECLAIM program.

RECOMMENDED ACTION:

1. Determine, in accordance with the requirement of Rule 2015 paragraph (b)(7), that reentry of the Power Producing Facilities will not result in any negative impact on the remainder of the RECLAIM facilities or on California’s energy security needs.
    
2. Direct the staff to proceed with developing proposed rule amendments to the RECLAIM program to further consider reentry of the Power Producing Facilities in the full RECLAIM program.

Barry R. Wallerstein, D.Env.
Executive Officer

Background

The Regional Clean Air Incentives Market (RECLAIM) program was adopted in October 1993. The program sets an emissions cap and declining balance for many of the largest NOx and SOx facilities in the Basin. The program was designed to provide additional incentives for industry to reduce emissions and advance pollution control technologies. In addition, the program was designed to give facilities added flexibility in meeting emission reduction requirements. Facilities within the RECLAIM program have the option of complying with their allocation by either installing control equipment or purchasing RECLAIM Trading Credits (RTCs) from other facilities. RECLAIM includes many different industries, including power producers who have a large share of RECLAIM allocations. For the 2000 compliance year, power producers held 14 percent of the total RECLAIM allocations.

Between compliance year 1994 and 1999, NOx emissions at RECLAIM facilities, in aggregate, were below allocations, and the price of NOx RTCs remained relatively stable. However, beginning June 2000, RECLAIM program participants experienced a sharp and sudden increase in NOx RTC prices for both 1999 and 2000 compliance years. This was due mainly to an increased demand for power generation and delayed installation of controls by power plants as compared to what would otherwise have been required under Rule 1135 – Emissions of Oxides of Nitrogen from Electric Power Generating Systems. The electric power industry purchased a large quantity of RTCs and depleted the available RTCs. This situation was compounded because few other RECLAIM facilities added control equipment

The Board, at its October 2000 meeting, directed staff to form an Advisory Committee to help examine issues affecting the price of NOx RTCs and recommend actions that could be taken to stabilize RTC prices. This effort resulted in staff’s development of a White Paper on Stabilization of NOx RTC Prices, which included a series of recommendations developed to help address the energy situation and stabilize prices. At the January 19, 2001 Governing Board meeting, the Governing Board directed staff to proceed with rule development based on the recommendations in the White Paper.

May 2001 Amendments

At the May 11, 2001 Board meeting, power producing facilities were separated from the rest of the RECLAIM market. Staff developed a series of amendments to the RECLAIM rules and three proposed new rules to implement improvements to the RECLAIM program. The proposed amendments worked together to lower and stabilize RTC prices by increasing supply, reducing demand, and increasing the exchange of RTC trading information. These amendments were designed to expedite installation of the emissions control equipment at power plants, while reducing the impacts of the California electricity crisis on the RECLAIM market and facilitating the development of reliable statewide electricity supply. The new and amended rule amendments and the new rules included the following key elements:

• For existing large power plants: bifurcation from the rest of the RECLAIM market, requiring installation of Best Available Retrofit Control Technology (BARCT) through compliance plans, and a temporary mitigation fee program for emissions in excess of allocations, which is used by the District to obtain emission reductions;
• Initiation of a temporary, limited, pilot RECLAIM Air Quality Investment Program (AQIP) for new power plants and structural buyers, allowing access to mobile and area source credits;
• Requiring large RECLAIM facilities to file a plan to demonstrate compliance with NOx RTCs held by those facilities for Compliance Years 2001 through 2005;
• Improving registration and timely reporting of RTC trades; and
• Modifying procedures for late electronic reports.

In addition to modifying several existing rules, three new rules were adopted, including: Rule 2009 – Compliance Plans for Power Producing Facilities; Rule 2009.1 – Compliance Plans and Forecast Reports for Non-Power Producing Facilities; and Rule 2020 – RECLAIM Reserve which includes a Mitigation Fee Program for power producing facilities, a RECLAIM AQIP for certain facilities, and a mechanism to use credits from the State’s Emission Reduction Credit Bank for new peaking generation units able to begin operation by September 1, 2001.

Reentry of Power Producing Facilities into RECLAIM

One of the key amendments made in May 2001 regarding power producing facilities, which is the subject of this Board letter, was a provision that was added to Rule 2015 – Backstop Provisions. Paragraph (b)(7) states that power producing facilities would "rejoin the full RECLAIM program in the 2004 compliance year, only if it is determined by the Board in a public hearing prior to July 2003 that their reentry will not result in any negative impact on the remainder of the RECLAIM facilities or on California’s energy security needs." Pursuant to these requirements, staff has conducted an assessment of the impacts on the RECLAIM market and on the energy security needs of California.

Impacts on the RECLAIM Facilities

During the energy crisis of 2000-2001 the power producing industry was facing a very unique set of conditions. The major contributing factors that were present then include: drought conditions in the northwest which curtailed hydroelectric power production, limited energy being supplied within the state of California (due to deregulation), uncontrolled equipment at power producing facilities and heavy dependence on the spot market. Due to long-term contracts negotiated by the State of California and addition of air pollution controls at local Power Producing Facilities, it is highly unlikely that these conditions will occur simultaneously in the future.

Staff has conducted some technical analysis regarding whether Power Producing Facility reentry into the RECLAIM could result in a negative impact on the other facilities currently in the program. The analysis relied on the scenario, what if the State of California were to again experience a similar electrical generating crisis that occurred in 2000-2001. When considering the electricity generation levels of that time period (i.e., 9,000 MWh maximum), including peaking units, along with current emission rates after the Power Producing Facilities implementation of controls at BARCT levels (emissions from boilers are reduced from a range of 36 - 100 ppm to 5 – 7 ppm and turbine emissions were reduced from approximately 25 ppm to 17 ppm), the 14 facilities are anticipated to emit approximately 1,395 tons per year of NOx. For the 2003 to 2010 compliance years, the facilities’ initial allocations totaled 1,705 tons per year for each year. However, taking into consideration trading activity, current RTC holdings for the same compliance years range from 1,550 to 2,330 tons per year NOx for the 2003 to 2010 compliance years. This represents a surplus in current RTC holdings ranging from 155 to 935 tons per year. Therefore, staff has concluded that current RTCs held by the facilities are sufficient to cover the emissions resulting from an electrical generation demand at the level seen in the 2000-2001 timeframe.

Furthermore, an analysis of California Energy Commission (CEC) data prepared for the District in July 2001 in conjunction with the 2003 AQMP projects generation of electricity from these power producers in the year 2010 to be 10,600 GWh. This forecast takes into account growth (i.e., increased demand from population and industry growth) and potential supply availability. The emissions corresponding to this generation are 930 tons per year NOx. Allocations and current holdings for the 2010 compliance year are 2,330 tons per year. This data shows that for 2010 the surplus between RECLAIM RTC holdings and the CEC projected emissions is 1,400 tons NOx. Based on this estimated data, there appear to be sufficient allocations to cover the anticipated demand for energy.

Due to the installation of BARCT pursuant to Rule 2009 – Compliance Plan for Power Producing Facilities, the allocations held and projected demand, power producing plants are likely to be net sellers in the RECLAIM market. Concerns were raised that power producing plants may adversely delay the installation of controls by other RECLAIM facilities due to a significant amount of excess RTCs. However, it should be noted that the larger non-power producing emitting facilities are in the process of installing air pollution controls (i.e., BARCT) under compliance plans of Rule 2009.1. In addition, the Draft 2003 AQMP will be seeking further reductions from the RECLAIM program. On balance, there should not be any market impacts by reentry of the Power Producing Facilities.

Analysis of California Energy Security Needs

According to the CEC, the current assessment of electricity demand and supply looks promising through 2005. However, beyond 2005 the supply and demand forecast becomes increasingly uncertain. Several assumptions have been made by the CEC in preparation of the forecast. These assumptions include:

• 1/3 of the voluntary conservation seen during the energy crisis will persist in 2003;
• Conservative rating for power from the Pacific Northwest and in state hydro-power;
• Derated generation from thermal power plants;
• Imports available on the spot markets assume dry hydro condition; and
• Only power plants that have a 75% chance of coming on line were included.

In a deregulated environment, it is difficult to ascertain energy security. However, with all in-basin power plant units installing BARCT, emission rates from power generation equipment are decreased by 80 percent or more from uncontrolled levels. A power producing unit typically operates well below 30 percent capacity annually and in 2001 in-basin units would have operated at about 35 percent capacity using current emission rates. It would take all units, on average, to operate at approximately 55 percent of capacity to cause a shortage in RTCs. Although staff cannot conclude with certainty there will not be another energy crisis in the state, it is unlikely that the RECLAIM program would be a contributing factor to the potential energy security issues. On the contrary, in-Basin power plants can increase generation substantially at much lower emission rates without adversely affecting the RECLAIM market. Therefore, with current RTC holdings, the RECLAIM program will not necessarily restrict in-basin generation. The CEC has also identified several factors that have helped to improve the power situation, and therefore the forecast. These include: 18 new power plants which add over 4,980 MW; 7 additional power plants scheduled to come on-line in August 2003; 25 renewable energy power plants have received funding through CEC; energy efficiency projects; and the construction of power plants in other states throughout the West, including peaking plants.

Stakeholder Comments

Staff met with the RECLAIM Working Group on May 1 and 13, 2003, as well as held one conference call on May 9, 2003, to receive input on the initial recommendation for Power Producing Facility reentry into the RECLAIM program and potential safeguards needed to prevent recurrence of the 2001 events. Power producer reentry has been generally endorsed by the group. However, environmental community representatives expressed concern over the potentially large quantity of surplus RTCs being made available into the market due to reentry of the Power Producing Facilities, which could allow other RECLAIM facilities to forgo installing control equipment longer. Due to the potential for surplus of RTCs and a perceived lack of incentive to install controls, the environmental representatives would like consideration of a reduction to the Power Producer Facilities’ allocations or an across-the-board shave of all RECLAIM allocations to achieve reductions beyond that sought in the draft 2003 AQMP.

Industry representatives requested that power plants be brought back to the market without trading restrictions. With respect to potential safeguards, they are concerned that any safeguard measures adopted in conjunction with Power Producer Facility reentry, such as whole-sale removal of facilities/industries from the program, could lead to potential market instability and uncertainty. These representatives would prefer the facilities to reenter RECLAIM without any trading restrictions or industry-specific reductions in their allocations. Any reductions in allocations associated with the AQMP control measure, they suggest, should be done across the board. This would allow the utilities to sell credits in order to recover a fraction of costs for control equipment installed by the Power Producing Facilities, a fundamental principle for a trading program. Industry representatives state that there was a unique convergence of events that led to the 2000-2001 energy crisis that are extremely unlikely to occur again, such as deregulation, changes of ownerships, and need for added controls. Due to the current level of controls at Power Producing Facilities, any future increased demand in electricity generation, such as that which occurred in 2000-2001, would not cause a similar demand on RTCs or price spikes. They suggest that any rule amendments to bring Power Producing Facilities back into RECLAIM should include one or more relief mechanisms that could allow access to RTCs in the event of increased prices or the need to allow additional time to install control equipment. Such mechanisms could include:

• banking for carry-over credits, such as that allowed under EPA’s Acid Rain program; or
• greater access to mobile and area source credits through the private market, as well as the Mitigation Fee Program or AQIP;

Small municipal Power Producing Facilities bifurcated from RECLAIM raised a number of additional concerns. Specifically, compared to the overall Basin market, the RTCs held by municipal power generators are small, (approximately 5 percent of the power producer RTC holdings or less than 1 percent of the entire RECLAIM NOx market), thereby having a limited affect on the overall market. These facilities have requested consideration in allowing them to buy and sell in the market without requiring them to use the Mitigation Fee Program to address shortfalls. The uncertainties created by potential future year deductions in allocations, that are inherent to that program if emission reductions are not met by the District, are problematic for them. These municipal Power Producers Facilities have also requested that staff reevaluate the need for environmental dispatch requirements in Rule 2009 for additional operational flexibility.

Suggestions by both industry and environmental representatives will be discussed in future RECLAIM Working Group meetings held in conjunction with the RECLAIM rulemaking efforts.

Conclusion

Staff does not anticipate any negative short-term impacts either on the RECLAIM facilities or the energy needs of California due to Power Producer reentry. Impacts beyond 2005 are less certain due to the variables and unknowns cited by the CEC. Staff proposes that rule development proceed to amend the RECLAIM rules to bring the Power Producing Facilities back into the RECLAIM program.

Staff also proposes that, as a part of rule development, appropriate safeguards be investigated to prevent potential future energy market anomalies, resulting in RTC price spikes. These provisions would be part of the rule language, so if specific triggers occur, the solutions could be implemented very quickly. Triggers or signals may include certain levels of power producer trading activity, weighted increase in RTC price over a specific time period, or utilization of power plant units. Safeguards may include, but not be limited to, additional RTC generation opportunities, Mitigation Fee Program for potential excess emissions from power producers, trading restrictions, such as a limit on a facility’s ability to sell existing RTC holdings below their initial allocation, as provided by the District, or others. Further discussions with the U.S. EPA would be needed regarding continuation of the Mitigation Fee Program. In addition, excess credits generated under the current Mitigation Fee Program may be used to pre-fund the program, if applicable. Whether these safeguards would also be applicable to non-power producing facilities will be examined as part of the rule development.

Recommendations

Staff recommends that 1) the Board determine that reentry of the Power Producing Facilities will not have any adverse impacts on the remainder of RECLAIM facilities or on California’s energy security needs, and 2) the Board direct staff to begin rule development to consider amending the RECLAIM rules to bring the Power Producing Facilities back into the full RECLAIM program and to make further recommendations based upon further public input during the rulemaking process. At the same time, staff will analyze and investigate the need for appropriate safeguards. Such safeguards may become part of the proposed rule changes. In addition, to address the concerns of the municipal power producers, staff will examine the environmental dispatch requirements of Rule 2009.

Staff will continue discussions with the RECLAIM Working Group, as well as other stakeholders, during the rule development process. It is anticipated that rule provisions regarding the reentry of Power Producing Facilities into the RECLAIM program will be brought back to the Board at its October 2003 meeting.

/ / /