In 2012[1], the Environmental Protection Agency (EPA) suffered a legal set-back as the Court of Appeals for the District of Columbia (D.C. Appeals Court) struck down the agency’s Cross-State Air Pollution Rule (CSAPR). CSAPR set emission reductions goals for sulfur dioxide and nitrogen oxide for not only the pollution sources in the state, but also attempted to regulate these emissions that are blown across state lines.
From an energy risk management perspective, the decision by the U.S. Supreme Court to grant the petition for a writ of certiorari (the process by which the Supreme Court determines what cases it will hear) could have far reaching impacts on the costs of power in major deregulated electricity markets.
To evaluate the impact of a reversal of the lower court’s decision, an understanding of the following issues is critical:
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The original decision striking down CSAPR;
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The questions that the Supreme Court will tackle when it hears the case; and
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The potential impact of the Supreme Court’s decision on prudent energy risk management practices
The D.C. Court Decision
The EPA is a creature of statute, meaning that its authority is limited to the grants of power contained in the statute that the EPA is enforcing. In a 2-1 decision, the D.C. Appeals Court found that CSAPR exceeded the statutory authority granted to the EPA.[2]
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[1] Originally, the DC Court issued a stay of the order in December of 2011 as the rule was supposed to go in to effect on January 1, 2012. The actual decision striking down CSAPR was not issued until August of last year.
[2] In striking down the Act, Justice Kavanaugh actually opined as follows:
[f]irst, the statutory text grants EPA authority to require upwind States to reduce only their own significant contributions to a downwind State’s nonattainment. But under the Transport Rule (CSAPR), States may be required to reduce emissions b more than their own significant contributions to a downwind State’s nonattainment. EPA has used the good neighbor provision to impose massive emissions reduction requirements on upwind States without regard to the limits imposed by the statutory text. Whatever its merits as a policy matter; EPA’s Transport Rule violates the statute. Second, the Clean Air Act affords States the initial opportunity to implement reductions required by EPA under the good neighbor provision. But here, when EPA quantified States’ good neighbor obligations, it did not allow the States the initial opportunity to implement the required reductions with respect to sources within their borders. Instead, EPA quantified States’ good neighbor obligations and simultaneously set forth EPA-designed Federal Implementation Plans, or FIPs, to implement those obligations at the State level. By doing so, EPA departed from its consistent prior approach to implementing the good neighbor provision and violated the Act.
Translating Justice Kavanaugh’s decision into layman’s terms, CSAPR was struck down for two reasons. First, CSAPR could require states to reduce their emissions more than their “fair share” of the impact that pollutants emitted in that state has on neighboring states that are downwind from the source of the pollution. In other words, it potentially imposed too high a burden on the sources of pollution in the upwind states. While implicitly recognizing that there may be sound public policy reasons for this approach, the EPA does not have carte blanch to make public policy decisions as its authority is limited by the language in the Clean Air Act.
Second, under the regulatory scheme created by the Clean Air Act, the EPA can set goals for states to attain. However, under the primus inter pares principles of federalism[3], the states must first be given a chance to implement action plans, known as State Implementation Plans (or SIPS) to meet these goals before the federal government can simply impose its own plans. Since CSAPR not only set emissions targets, but also determined how states should meet these goals, the states were denied the opportunity to implement their own action plans. In other words, this was a case of regulatory over-reaching.[4]
Issues the Supreme Court will consider
In deciding to hear the case, the Supreme Court has indicated that it will consider three separate issues, which are:
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Did the appellate court base its decision on issues not properly before it;
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Do states have to wait for the EPA to determine what a state’s contribution is to air pollution in other states before a state must adopt its own implementation plan; and
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Does the definition of “significant contribution” to another state’s poor air quality depend on the cost-effective emissions reductions which can be implemented or is it based on the physically proportional contribution to air pollution in other states? [5]
In reviewing the issues laid before the Supreme Court, the one with the potential largest impact on forward energy prices involves the last one. Assuming that the Supreme Court reverses the Appeal Court and addresses all of the issues before it, the third question posed above has the greatest potential impact on future power costs.
The reason that this third issue poses the greatest risk on prices is the impact it could have on the total emission reductions required under the Clean Air Act. If the Supreme Court finds that the EPA has the authority to require states to reduce their emission based on the amount of cost-effective solutions, this could force greater reductions than a proportionality test. As the target level of emissions reductions increases, the costs of obtaining those emissions, which ultimately flows through to the end user, increases.
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EME Homer City Generation v. Environmental Protection Agency, et.al., No 11-1302, August 21, 2012, Court of Appeals for the District of Columbia Circuit, at 7.
[3] This is sometimes referred to as the principle of cooperative federalism in which states are given the first “bite at the apple” to implement federally mandated targets.
[4] Justice Rogers scathing dissent, while beyond the scope of this piece, argues that the majority erred in its ruling by exceeding its own authority to review rules promulgated by the EPA, misinterpreting the plain language of the Clean Air Act, and ignoring years of prior decisions by the court.
Likely Outcomes
Given the Supreme Court’s current make-up, it is unlikely that the Justices will simply over-turn the Appellate Court ruling. While they could remand the case back to the lower courts, given the issues before it, the Court is unlikely to simply do this. The most likely outcome is that this Court will uphold the Appeal’s Court decision to strike down CSAPR and clarify the scope of the EPA’s authority under the Clean Air Act.
However, should the Court take a different course of action, either by re-instating CSAPR or remanding the case back to the lower courts with additional guidance on how the case should be considered, there could be implications in forward heat rates across several power markets. When CSAPR was first announced by the EPA in 2011, power markets spiked sharply. While they returned to more normal levels, the uncertainty around the fate of CSAPR has created a regulatory uncertainty premium. If the Supreme Court remands the case back to the lower courts, the power markets are likely to increase in response to such a determination.
If the Court does not uphold the Appeals Court decision, then there will likely be a brief spike in heat rates for the first few days after the decision is announced. However, a decision to upholding CSAPR by the Supreme Court would not change the fundamentals much, as coal plants are already retiring as the writing on the wall is clear that additional emissions reductions are coming for coal plants. In any case, even if CSAPR is re-instated in some fashion, it will not have as deep of an effect in the forward markets as it would have had back in January 2012, when the first phase was slated to begin.
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