By Roy Belden

The US Environmental Protection Agency issued new rules in late August that draw a “bright line” for when planned repairs to a power plant or other industrial facility require an air permit before they can be made.

Some utilities are facing stiff fines and costly pollution control equipment upgrades for having made too extensive repairs in the past without first getting an air permit. The new rules were issued under the “new source review,” or “NSR,” program.

The leading environmental groups and several members of Congress have already criticized the new rules as further evidence that the Bush administration is trying to “gut” the Clean Air Act. Several states — including California, Massachusetts and New York — immediately vowed to sue the federal government over its legal authority to issue the new rules. Legal challenges are expected to be filed immediately after the rules are published in the Federal Register. Senator James Jeffords (I.-Vermont) is threatening to try to block implementation of the rules in Congress.

Anyone doing “routine maintenance, repair, and replacement” of equipment at a power plant or other industrial facility does not have to get an air permit under current law. The problem is the phrase has never been clearly defined, with the result that the exemption has spawned several lawsuits and conflicting agency interpretations.

The new rules create a safe harbor for equipment replacement at a power plant or other industrial facility where three things are true. First, the owner must be replacing an existing component of a process unit with identical components or components that serve the same purpose. Second, the fixed capital cost of the replaced component and any other costs associated with the replacement activity — for example, labor and contract services — must not exceed 20% of the current replacement value of the unit. Finally, the replacement must not alter the basic design of the unit or cause the unit to exceed any emission limitations.

The new rules only address part of the “routine maintenance, repair, and replacement” exemption — how to define “replacement” — but they are a critical clarification of how the government intends to administer the exemption going forward. The new rules do not directly affect pending NSR enforcement actions against a number of utilities that replaced equipment at older coal-fired power plants, and they will not provide “amnesty” for questionable equipment modifications that occurred before the new rules take effect.

The rest of this article explains why the “routine maintenance, repair, and replacement” exemption is so important to the regulated community and discusses the types of replacement activities that should qualify in the future for the exemption.

Background

New and modified major sources of air pollution in both “nonattainment” areas (areas that do not meet federal ambient air quality standards) and in “attainment” areas (areas that currently meet federal ambient air quality standards) must undergo a rigorous pre-construction permitting review. “Prevention of significant deterioration,” or “PSD,” permits are issued for major sources in attainment areas, and nonattainment NSR permits are required for major emitters in nonattainment areas. Anyone needing a permit in an attainment or nonattainment area must usually agree to install state-of-the-art pollution control equipment and to comply with strict emission limits. Plants sited in nonattainment areas must also usually purchase “emission offsets.”

Over the past 30 years, the NSR permitting program has been criticized by the regulated community as being overly costly, excessively burdensome and time consuming. It is not surprising that many companies do everything they can to avoid repairs or equipment modifications that are so extensive as to require an NSR permit. The issue is what upgrades and improvements can be made to keep existing plants running efficiently and at full or near full capacity without crossing the NSR tripwire, namely an activity that constitutes a “major modification.” A major modification triggering NSR review at an existing plant occurs if there is a physical change or a change in the method of operation that would result in a “significant net emissions increase” in a pollutant regulated by the Clean Air Act.

Many power plants and other older industrial facilities never had to go through a pre-construction NSR review because they were in existence before the NSR program rules were adopted in the early 1970s.

Many of these “grandfathered” plants have made changes over the years to restore efficiency and replace worn out equipment, and most have opted not to go through an NSR permitting review but have relied instead on the “routine maintenance, repair, and replacement” exemption. “Routine maintenance, repair, and replacement” are not considered a “physical change or change in the method of operation.” Therefore, they are not a “major modification.”

Unfortunately, until now, the US Environmental Protection Agency never explained clearly what qualifies for the exemption. Many utility companies were caught off guard by the agency’s high-profile enforcement actions filed in 1999 and 2000 alleging that several coal-fired power plants failed to undergo NSR permitting for major modifications.

The current NSR regulations — before the new revisions in late August — defined “routine maintenance, repair and replacement” narrowly and said the government would consider, on a case-by-case basis, the nature, extent, purpose, frequency and cost of the work to arrive at a “common-sense” finding. This case-by-case approach has left utilities uncertain whether their planned repairs qualify for the exemption. Few companies have requested NSR applicability determinations for fear that the agency’s “we-know-it-when-we-see-it” approach would create bad precedents or ultimately delay or forestall planned plant equipment maintenance and repair work.

In the preamble to the final rules, the US Environmental Protection Agency acknowledged that the lack of certainty surrounding the “routine, maintenance, repair, and replacement” exemption has discouraged plant owners and operators from replacing equipment that might be needed to improve plant safety, reliability or efficiency. It said that in situations where plant equipment replacements presented a “close call” on whether an NSR modification was triggered, the options available to plant owners were relatively unattractive. The plant owner could apply for an NSR permit, seek an NSR applicability determination, forego replacement of the equipment, or proceed at his own risk to install the equipment.

Future Equipment Replacements

Under the new rules, equipment replacement will not require a permit where three criteria are met. First, the action must involve replacement of an existing component with an identical or functionally-equivalent component. Existing equipment can be replaced with equipment that is improved or different in some respects so long as it serves the same purpose. In the preamble to the new rules, there is an example of replacing a worn-out distillation column pump with a new and improved model. The limiting factor is that the new piece of equipment must not change the basic design parameters of the unit.

Second, the fixed capital and activity costs associated with the equipment replacement must not exceed 20% of the current replacement value of the unit. This cost threshold applies separately to each individual unit. There is some flexibility in calculating these costs. The preamble to the new rules said any one of four methods may be used to do the calculations. The four methods are: 1) replacement cost based on an estimate of the fixed capital cost of building a new process unit or the current appraised value of the unit, 2) invested cost (adjusted for inflation), 3) insurance value, where the insurance covers complete replacement, or 4) another accounting procedure based on generally accepted accounting principles. If a company chooses either of the last two methods for calculating the replacement value, a notice must be sent to the permitting agency reflecting this decision. In the absence of providing notice, a company must use either of the first two methods.

The Environmental Protection Agency had asked for comments earlier on an equipment replacement threshold of 50%. The final rules use a 20% threshold because this was more consistent with past case law and data the agency collected demonstrated that most typical replacement activities will fall within the 20% threshold. While some major replacement activities will cross the 20% trigger, the agency said that the case-by-case evaluation method for determining whether a replacement activity is exempted will still be available as an alternative mechanism.

Finally, the replacement equipment must not alter the basic design of the process unit or cause the unit to exceed an emissions limitation or an operational limitation. For electric utility steam generating units, the rule specifies maximum hourly heat input and the fuel consumption rate as basic design parameters. Owners and operators of power plants also have the option of using the maximum hourly electric output rate or maximum steam flow rate as alternatives to input-based parameters. Owners of other industrial facilities may also focus on similar input-based or output-based design parameters to determine compliance. Alternative design parameters not specified in the rule may be used with approval from the permitting authority.

In the preamble to the new rules, EPA said that an equipment replacement that improves a unit’s efficiency and enables it to return to its design parameters can qualify for the exemption. For example, if boiler tubes are replaced on a boiler and the cost is below the 20% threshold and the unit’s design parameters are not exceeded, then the replacement would qualify for the exemption even if efficiency was improved and actual emissions increased due to the fact that more fuel could now be burned. Conversely, a replacement and upgrade in the type of combustion turbine blades used would not qualify for the exemption if the unit’s process design parameters were exceeded as a result.

No Retroactive Effect

The new rules will take effect 60 days after publication in the Federal Register. The new rules will not apply retroactively. The Environmental Protection Agency said that it believes its prior case-by-case interpretations of the scope of the “routine maintenance, repair, and replacement” exemption were based on permissible constructions of the Clean Air Act. Further, the agency said that it will continue to pursue pending enforcement actions against a number of utilities with coal-fired plants.

Of note, on August 7, 2003, a federal district court in Ohio ruled that the Ohio Edison Company violated NSR permitting requirements when it made major modifications to its W.H. Sammis station without first obtaining a PSD permit. The Ohio Edison case (US v. Ohio Edison, No. 2:99-CV-1181 (C.D. Ohio 2003) was a major victory for the US Environmental Protection Agency, and the case now enters the next phase to determine the remedies for each of the eleven NSR violations identified by the court. Ohio Edison could be facing substantial penalties of as much as $27,500 a day per violation as well as significant capital costs to install state-of-the-art pollution controls on some or all of its seven coal-fired units.

In an August 26, 2003 decision, a federal district court in North Carolina took a slightly different approach and agreed with industry on a key interpretation of the scope of the “routine maintenance, repair, and replacement exemption.” The court held that the scope of the exemption should be analyzed based on what is commonly viewed as “routine” throughout the particular industry (instead of at a particular plant as found by the Ohio Edison court). The court handling the case (US v. Duke Energy Corporation, No. 1:00-CV-01262 (M.D.N.C. 2003)) said the burden will be on EPA to prove that Duke Energy’s projects do not fall within the exemption. It turned down a motion by Duke Energy to dismiss, and the matter will be scheduled for trial.

A decision in another high-profile utility enforcement case is expected later this year in United States v. Illinois Power Co. The Illinois Power case involves the status of a number of construction projects carried out between 1982 and 1994 at an Illinois Power plant located in Baldwin, Illinois. Several of the US Environmental Protection Agency’s utility enforcement cases have settled for large sums. Earlier this year, the US government settled three major NSR enforcement actions against Dominion, Southern Indiana Gas and Electric Company and Wisconsin Electric Power Company.

In the Dominion settlement — the largest Clean Air Act enforcement settlement with a utility to date — the company agreed to spend as much as $1.2 billion by 2013 to install new pollution controls and upgrade existing pollution controls at eight coal-fired power plants. The company also agreed to pay a $5.3 million civil penalty and to spend at least $13.9 million on environmental mitigation projects. Southern Indiana Gas and Electric Company agreed to settle after a federal district court rejected a number of affirmative defenses raised by the company. The parties agreed that Southern Indiana Gas and Electric Company would spend about $30 million on new pollution control devices and other plant upgrades to reduce air emissions at its Culley station. SIGECO also agreed to upgrade its oldest unit by repowering it with natural gas. SIGECO will also pay a $600,000 penalty and spend approximately $2.5 million on an environmental mitigation project.

Wisconsin Electric Power Company agreed to spend approximately $600 million to reduce SO2 and NOx emissions from five coal-fired plants, and it will install state-of-the-art pollution controls or shut down operations at 80% of its coal-fired power plants. All of the company’s coal-fired units will be subject to a system-wide cap on SO2 and NOx that will result in as much as a 70% reduction in emissions by 2013. The utility also agreed to pay a $3.2 million penalty and spend $20 million on environmental mitigation projects.

Challenge Expected

Attorneys general from several northeastern and mid-Atlantic states are expected to join several environmental groups in filing a lawsuit challenging the new NSR equipment replacement rule as soon as it is printed in the Federal Register. These same parties have already filed a suit challenging the earlier changes that the Bush administration made in the NSR program in December 2002 (New York v. EPA (DC Cir. No. 021387)). A decision by the DC circuit court is expected in the New York v. EPA case in 2004. Courts usually defer to an agency’s rulemakings on complex issues within its areas of expertise. Therefore, the litigants are expected to have a hard time persuading the court to overturn the new rules.

More Exemptions Expected

The new NSR rules released in August are final rules. They follow on the heels of proposals that EPA made in the same area in December 2002. However, the August final rules do not address all of the subjects about which EPA made proposals last December. There are other aspects of the “routine maintenance, repair, and replacement” exemption that remain to be addressed.

For example, EPA proposed an annual maintenance, repair and replacement allowance option last December. Under this proposal, industry-specific cost allowances would be established, and certain types of activities that fall under the allowance cap would qualify for the exemption. The agency is reportedly preparing a draft rule that would modify the proposal to create an allowance for “maintenance and repair” activities, such as repairing equipment parts and instrumentation, upgrading software programs, and cleaning and maintaining process equipment.

The annual allowance may be applied on a calendar or fiscal year basis, and it is intended to cover relatively small dollar amounts compared with the replacement cost of the facility. Certain activities would be excluded from the annual allowance — for example, the construction of a new process unit, the replacement of an entire process unit, and any change that would result in an increase in a source’s design parameters. EPA might still formally adopt a new annual allowance test as a method for qualifying for the “routine maintenance, repair, and replacement” exemption by the end of the year.