Projects Lose Acid Rain Protection
By Andrew Giaccia and Roy Belden
Whenever a power contract terminates or is bought out by a utility or is modified in a manner that allows the owner of the power plant to pass through new costs, it may have the unintended and costly consequence of subjecting the power plant to limits on sulfur dioxide or “SO2” emissions under the federal acid rain program.
Determining if and when SO2 emissions reduction requirements are triggered can be fraught with uncertainty and presents the risk of retroactive compliance costs and potential penalties.
The US Environmental Protection Agency has said little about when an amendment to a power contract goes too far, and to date there has been minimal enforcement. Five years ago, the federal government had little interest in enforcing other emissions limits that come into play when the source of the emissions is modified — so-called PSD/NSR violations for past modifications. Then the Clinton administration unleashed its utility enforcement initiative, and this became an issue of critical importance to the power industry. The lesson should not be lost.
Some regional EPA offices have started asking a lot of questions about acid rain program compliance during recent power plant audits.
Certain power plants that had a “qualifying power purchase commitment” in effect as of November 15, 1990 are “grandfathered” from having to comply with the federal acid rain program. This applies to any power plant that is a qualifying facility or “QF” under the Public Utilities Regulatory Policies Act or that is an independent power production facility or “IPP” under the Clean Air Act.
Plants that lose their status as QFs or as exempted IPPs are required to obtain acid rain permits, to hold sufficient “allowances” to cover their SO2 emissions, to install a continuous emissions monitor or “CEM” that meets federal acid rain standards, and to comply with other monitoring and recordkeeping provisions.
In order to be grandfathered, a plant that uses fossil fuel was required to have had one or more qualifying power contracts or other commitments — for example, a letter of intent — to sell at least 15% of the plant’s total net output in place as of November 15, 1990. If a unit is grandfathered as both an IPP and a QF, then it will remain grandfathered until it loses both its IPP and QF status or the qualifying power contract terminates or is amended in such a way that it voids the exemption. The grandfather rules were adopted by Congress — after intensive lobbying by Chadbourne — to ensure that IPPs and QFs that had already entered into fixed-price long-term PPAs (or commitments to sign PPAs) would not be unfairly saddled with unanticipated acid rain compliance costs that they had no ability to pass through to their power purchasers.
If a PPA expires or is terminated, then the power plant will usually no longer remain grandfathered. For example, in the past few years, Niagara Mohawk has bought out or terminated a number of PPAs with cogenerators in New York. EPA’s clean air markets division reviewed a number of these plants and concluded that most are now subject to the acid rain program because they no longer have a qualifying power purchase commitment that was in effect as of November 15, 1990. The only exception is a plant that qualified for a small cogeneration unit exemption based on the fact that it sold 25 megawatts or less to the grid in the first year of operation and did not exceed this limit, on average, over each subsequent three-year period.
A qualifying PPA or other commitment may be amended without loss of grandfather status; however, certain types of amendments — particularly those involving changes to pricing terms — go too far. EPA regulations provide that if “the terms and conditions of the power purchase commitment... [are] changed in such a way as to allow the costs of compliance with the Acid Rain Program to be shifted to the purchaser,” then the grandfather status will be lost.
If this language were applied literally, then no PPA amendments would ever threaten grandfather status for the simple reason that no utility would agree to amend a PPA to accept acid rain program compliance costs as part of the price it pays for electricity.
However, EPA’s clean air markets division staff has taken the position that any amendment to a PPA that presents an “opportunity” to pass through acid rain program compliance costs may void grandfather status.
The scope of EPA’s “opportunity” principle is far from clear. Very little agency guidance is available on what specific PPA changes will cause loss of grandfather status. To date, EPA’s clean air markets division has issued only one applicability determination that addresses amendments to qualifying power purchase commitments. In a February 11, 1999 applicability determination, EPA concluded that changes to energy and water pricing terms for the KIAC Partners cogeneration project at the John F. Kennedy International Airport did not trigger a loss of grandfather status.
In its analysis, EPA noted that the electricity pricing was virtually the same between the November 14, 1990 letter of intent and the subsequent PPA, except that the PPA had a lower annual dollar cap on an applicable surcharge. EPA concluded that this change would not have allowed for the passthrough of acid rain costs because the dollar cap on the surcharge was lower in the executed PPA. Based on this guidance, decreases in the amount the power supplier can charge usually should not trigger a loss of grandfather status. However, the EPA clean air markets division staff has commented that changes from a fixed price to a market-based price would potentially trigger acid rain program requirements even if market-based prices were currently much lower than the fixed price in the PPA. EPA staff reasoned that a market-based price would fluctuate and may eventually allow the passthrough of compliance costs.
EPA also considered whether increases in prices for hot water and chilled water in the JFK airport PPA would have allowed the shifting of acid rain compliance costs. The parties increased the prices for hot water and chilled water so that the power supplier would earn the rate of return contemplated in the letter of intent. Only the letter of intent was signed before the November 1990 deadline. The PPA was executed later. By the time the PPA was signed, JFK airport had scaled back plans to expand with the result that the power plant would not be able to sell as much hot and chilled water as originally planned. The power plant had also not yet secured long-term financing. EPA found that the project was no better able to bear acid rain compliance costs than before, even though it would charge more for hot and chilled water. However,, the agency said in a footnote that its decision “would not apply where price increases occur after the execution of the power sales agreement and the obtaining of any longterm financing.”
Although there is not much guidance to rely on, the JFK airport ruling and recent EPA staff statements suggest that power contract amendments will be tested under the following principles:
- Modifications that do not affect pricing or otherwise affect the energy producer’s rate of return, either directly or indirectly, may be acceptable.
- If prices decrease, it may be acceptable, provided that the decrease is not a result of converting from fixed prices to market-based prices.
- If one component of the electricity price — for example, the capacity payment or energy payment — increases while another component decreases due to an amendment, then grandfather status may be at risk. The overall effect of the amendment on pricing is the key.
- If fixed prices increase overall as a result of an amendment, then grandfather status will probably be lost.
- If any passthroughs are added — for example, for energy-related taxes — grandfather status is at risk regardless of any compensating decreases in other pricing components.
Power plants that have already unwittingly subjected themselves to the acid rain program by amending their power contracts not only face compliance costs going forward for the costs of installing part 75-compliant CEMs and purchasing SO2 allowances, but the plants may also be hit with penalties.
EPA has the authority to seek penalties of up to $27,500 a day per violation, but typically the agency will calculate a past noncompliance penalty using its “BEN model” for the purposes of settlement. Under this model, EPA will calculate the economic benefits of avoiding compliance, including the costs of SO2 allowances had they been purchased starting in 2000 (which was the beginning of phase II of the acid rain program) and any other compliance-related costs that were previously avoided like the delay in installing a part 75 CEMs. Under the model, a gravity component may also be added. The penalty amounts could be substantial in theory. However, no EPA regional offices appear to date to have pursued past noncompliance costs in cases where grandfather status was lost because PPAs expired or were amended.