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Allowance Trading
; Issue Papers
HEADQUARTERS LIBRARY
ENVIRONMENTAL PROTECTION AGENCY
WASHINGTON, D.C. 20460
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UNITED STATES ENVIRONMENTAL PROTECTION AGENCY
' . ,, WASHINGTON, D.C. 20460
'A3
.JAN 17 I99J
OFFICE OF
AIR AND RADIATION
MEMORANDUM. » -
SUBJECT: Agenda for Allowance Trading Subcommittee
FROM:
TO:
Renee .Rico, Chief
Allowance System Branch, EPA
Allowance Trading Subcommittee Members
Happy New Year!
Please review the attached agenda for the subcommittee, meeting
carefully, and as preparation, read the papers indicated in
parentheses.
We have a lot to cover in, subcommittee, so let me briefly
outline where I see us ne'eding to head during the day.
. First, we will be setting our schedule and priorities for.the
next' three meetings (February, March and April). EPA will come
with a scheme of getting through issues to prepare for the: full
'ARAC. Second, we will discuss issues relating to the Allowance
Auqpfron and. Direct Sale, including the provision for the IPP
guarantees. The Auctions and Sales issues will be discussed a^: the
full ARAC committee meeting the next morning. Therefore, the
subcommittee will need to decide what it, wants to say the next
day. Third, we will have some presentations .made on some
fundamental issues associated with trading, including special
presentations by tax and accounting experts.
.*-".,. * "
Ann Murtlow from AES has prepared ah issue paper on election
sources, but given the tightness of the day, we will defer a full
discussion of this issue to the next meeting.
For. those on the subcommittee who desire, we will be reserving
space for a no-host dinner for subcommittee members and EPA staff
for Monday evening, January 28th. We'll take a head count first
thing Monday morning.
See you there.
Primal on
Paper
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ALLOWANCE TRADING SUBCOMMITTEE
PAPERS FOR JANUARY 28 & 29, 1991
CODE & TITLE PAGE
A3 - Agenda for Allowance Trading Subcommittee
A4 - Design Analysis for The Title IV Auctions 1
A5 - Design Analysis,for The Title IV Written 5
Guarantees for IPPs
A6 - Direct Sales (Discussion Paper) 11
A7 - The Allowance Transfer System 14
(Discussion Paper)
A8 - Issue Paper on Multi-Unit Allowance 20
Pooling For Compliance
A9 - Key Issues on Opt-in Provisions Title IV, 27
section 410
A10 - A Future Market in S02 Emissions Allowance 30
Contracts
All - Issues Associated with Implementation of 37
Title IV of the Clean Air Act Amendments
of 1990
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ARAC ALLOWANCE TRADING SUBCOMMITTEE
'. AGENDA
January 28, 1991
Omni Shoreham .Hotel
Washington, D.C.
9:00 a.m.
9:15 p.m.
10:15 a.m.
12:45 a.m.
2:00 p.m.
3:30 p.m.
3:45 p.m.
Announcements; Revisions;to Agenda
Setting Schedule for February,
March, and April
Presentation on Auctions and Sales
(Papers A4, A5, and A6)
- Presentation
- Discussion
Lunch
Allowance Trading Papers
-Transactions (Paper A7)
- Multi^unit pooling.(Paper A8)
r y' ' - ."
BREAK '
Special Presentation, on Tax and
Accounting Issues
O'Connor
Rico/O'Connor
EPA
EPA
4:45 p.m.
5:00 p.m.
Summary of Progress,
Next Steps
Meeting Adjourns
O'Connor
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- - DESIGN ANALYSIS FOR THE, : ,: ' ", -
TITLE IV AUCTIONS ,: .
'' \ .... * J _ "* i
' . ' ' ' , ' .» -" i * " *'.**. ' * * *«
'.:. The. auctions (and direct sales) provisions of the-1990 Clean Air Act are intended
to provide certainty that units will have an assured back-up source of allowances.beyond
.those which are allocated initially, or, in the case of new units,,if the/market fails to
provide the needed allowances that access to such allowances is assured.
SEC. 416 (d) Auctions .", ; ' '-
EPA is required to sell allowances-in yearly spot auctions and advance auctions
beginning; in 1993. Allowances sold in spot auctions are usable the year in which they
are sold except for allowances sold in 1993 and 1994, which are usable in 1995.
Allowances sold in advance auctions are only .usable 7 years after-purchase. Advance
allowances provide utilities assurance that allowances will be available .for future use;
they also help to/facilitate utilities' long-term planning. Any person is allowed to
participate in the auctions. '
STRAWMAN DESIGN FOR THE AUCTION
o. - When Auctions 'Are He|d: For the convenenience of bidders and for
.> administrative ease, it would be best that both auctions (the advance and .
spot) be held on the same day. Both auctions will offer EPA and privately-
contributed allowances1 (to be discussed later .in this paper).
-'. -. - ."':-: - ' - -,".. " -' ,.-- ' ' : :' "-''
o ' Form of the Auction: The auction will be of the "discriminating" form, i.e.
winning bidders will pay their bid price. Explanation: The discriminating
form of auction appears to be consistent with the language of the Act;-and
' , is easy for bidders to understand since, it is the most familiar form..
Cutoff .Date For Bids: Bidders for each auction will send sealed bids to the
manager of. the auctions no later than 3 working-days prior to the date of
the auctions. Explanation: three days is a reasonable time for the manager
of the auction to enter bids into the; computer system; in addition, EPA
would not want to be .holding bidders money for long periods of time.
.''' t. ... ..'' ' '.-,,''' ' . -';' .
Bid Contents: Sealed bids will be sent to the, auction manager on a
standard bid form (to be developed by EPA). The bid will specify name,.
account number, allowance quantity and price, and include a certified
check or cashier's check for the total bid price regardless of the type of
auction (spot or advance) Bidders are bidding in. Allowance bidders will
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be required to provide the information for EPA to set up allowance '
accounts if they do not already have one so that allowances won at auction
can be transferred directly to the accounts. A "new account form" will be
sent in with bids; if the bid is not won, the account will not be established.
(Note: procedures for establishing accounts are discussed in a separate
paper and will be treated in separate, but cross-referenced regulations.)
Explanation: standard bid forms will streamline data entry and provide a -
legal record of the bid, as opposed to faxes or computer transmissions.
Requiring a certified or cashier's check for the total amount bid will ensure
serious bids, reduce default problems, reflect the complete transfer of
allowance ownership rights upon the bid award, and ease the
administrative burden of having to collect and keep track of periodic;
installment payments. Of course, bids for advance allowances may be
priced lower than those for spot allowances, since the present value of an
allowance useable seven years in the future may be less than the present
value of an allowance useable in the year of purchase.
Bid Amount & Number of Bids: No restrictions will be placed on the
number of allowances a bidder can bid for; however, EPA will reserve the
right to restrict, prospectively, if circumstances prove necessary in the
future. Multiple bids will also be unrestricted, but each bid will be treated
individually and require a separate bid form and certified or cashier's
check. Explanation: There do not appear to be any compelling reasons
that the number of allowances bid for, or multiple bids should .be
restricted. Furthermore, restrictions are viewed as obstacles to a well-
functioning auction, and PUCs may restrict unnecessary bidding by affected
sources. Separate bid forms for each bid will speed bid sorting and reduce
errors.
Tie Bids: In the case of tie bids (multiple bidders at the "cutoff price"),
EPA will allocate the available allowances by lottery. In a lottery system,
all parties have an equal chance of winning. Lottery winners will receive
all they bid for (or a partial amount if the amount left to-allocate cannot
satisfy bids) until the supply is exhausted. Explanation: The "winner-take-
all" approach is less ambiguous and thus avoids confusion when allowances
are awarded after the auction.
Announcement of Results: EPA is required to report publicly the nature,
prices, and results of each auction. Names of all bidders and their bids
(winners and losers), and any cut-off price will be announced on an
electronic bulletin board within the EPA tracking system. Bidders will
simply dial into the system to view the results. A written version will also
be published in various documents (newspapers, periodicals and/or the
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Federal Register) soon after each auction. Explanation: Publishing all bid-
prices and the cutoff price provides information for market participants to
gauge the demand and the price range for allowances. Though some might
object to the publishing of names, advisors to EPA indicate that the names
will facilitate information flow and market trading. An electronic system
appears to be the quickest and most efficient way to convey the auction
results.
o How Proceeds From the EPA Auctions Will Be Transferred: Pursuant, to'
the legislation, EPA has 90 days after the auctions to transfer proceeds to
the original holders of .the auctioned allowances. EPA will send checks for
amounts (based on a pro rata calculation) to the owners and operators
from whom allowances were withheld. As stated in the CAA, any unsold
EPA allowances will be returned at the end of the year, on a pro rata
basis, to the original holders of those allowances. This will be done
electronically in the allowance tracking system. EPA will not pay interest
oh the proceeds it can hold for up to 90 days; however, for routine
transactions; EPA intends to process and disburse proceeds sooner than 90
days. Explanation: Government agencies need only pay interest on money
held by them if explicitly stated in law. The CAA is silent on this issue.
-. j ' ~ '
o Who Will Run the Auctions: This will be decided when the strawman
design is agreed upon by all interested parties.
o When in the-Year Will the Auctions Occur?: There are two logical choices
for when during the year the auction should occur. The choices are:
1. Early in the year. Holding the auction early will allow IPPs and
others not allocated yearly allowances a chance to try to purchase
allowances at auction before having to resort to buying high priced
allowances in the direct sale. An early auction will also allow new
and existing units time to plan for end-of-the year compliance.
Holding the auction early however, will eliminate the opportunity
for last minute buying of spot allowances for end-of-the year
compliance. (The Direct Sale Program could serve this function if it
is still running in the year .2000 when spot allowances will be
offered.) In addition, holding the auction early (before the sale) will
mean tharany unsold sale allowances will have to be transferred
into the following year's auction.
2. Late in the year. Holding the auction late in the year will allow the
auction to serve as a last resort for spot allowances at year end.
Also, if the auction follows 'the sale, any unsold allowances from the
sale can be transferred into the current year's auction.
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As stated in the law [SEC 416 (d)(2)], allowances will be allocated on the basis of
bid-price (as opposed to a single "clearing" price), starting with the highest-priced bid and
continuing until all allowances for sale by EPA have been allocated. After the EPA
allowances have been auctioned off, allowances submitted by others will be sold in the
same manner; however, holders of these allowances may specify a minimum price.
(These allowances will be referred to as "private" allowances.) The proceeds from the
sale of private allowances will be transferred at the time of the auction by the purchaser
to the seller.
How Private Allowances Will be Auctioned: By law, EPA allowances must
be allocated first, and privately-contributed-allowances second; together
they constitute the total supply of allowances for sale in the EPA auctions.
All bids to the auctions will be ranked from highest to lowest EPA will
allocate its allowances based on bid price until there are no more left to
sell. When EPA runs out of allowances, bidders next in line will receive
private allowances. Private allowances with the lowest (or no) minimum
price will be matched first to the bid just losing EPA allowances. This
matching process will continue in ascending order of minimum price until a
cutoff price is established. A cutoff price will be established when EPA
can no longer match bids with privately-contributed allowances because
sellers have set their minimum price higher than any remaining bids (see
Figure 1 on page 5). Allowance holders wanting to sell allowances in the
auctions will have to-notify EPA, in writing, 5 working days prior to the
auctions, of the number of allowances they want to sell and at what
minimum price (if any). Explanation: Matching privateiy-contributed-
allowances having the lowest minimum price with bids just losing EPA
allowances is consistent with a policy of rewarding the seller who can
provide compliance at the lowest cost. Selling private allowances in the
EPA auctions is simple administratively, and consistent with the EPA
auction format (selling spot and advance allowances only). Notification of
intent to sell 5 working days prior to the auction is a reasonable time for
EPA to reserve private allowances and for private sellers to make their
choices.
Others have suggested to EPA that the private allowances be given their own auction
so that buyers and sellers could be matched to negotiate specific deals (i.e streams of .
allowances). An auction, however, is not the appropriate format for negotiating deals.
For example, a private allowance holder wishing to offer a multi-year stream of
allowances would have to state in the offer the timing and conditions of the payment
Unless a bidder is willing to accept an offer on the seller's precise terms, a brokerage or
negotiation format, rather than an auction format, is far more useful for selling streams
of allowances.
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DESIGN ANALYSIS FOR THE TITLE IV
WRITTEN GUARANTEES FOR IPPs
r: Section 416(c)(3) requires EPA to provide independent power producers (IPPs)
planning to construct new facilities with a "written guarantee" that allows the purchase of
required allowances at a fixed price of $1500. It provides IPPs, at a time when a market for
allowances has not yet developed, with a means of demonstrating to their lenders that they
will have access to a sufficient number of allowances to fully operate planned faculties.
SUMMARY OF THE WRITTEN GUARANTEE PROVISIONS
. '' . ~ ' . * ..
'" o Definition'of an IPP: an owner of.operator of a new independent power production *
facility that: "
commences commercial operations after passage of the GAA;
is nonrecourse project-financed (financing is based,only on the .
returns to- the project - there is -no recourse: to 'Other assets for
repayment of the loan); '-.- , . "' ' ,*;-.--.:;
sells 80% of electricity generated at wholesale; and
'.. -. . does not sell electricity to< any affiliate or,-if it-does,
demonstrates it cannot obtain allowances from such an affiliate.
o -Required demonstration by IPPs: an IPP is entitled to a written guarantee from EPA
within 30 days of application allowing the purchase of required allowances at $1500
each if it demonstrates that it:. . ,
,.-.;...< ' ' ' . -. ;
- proposes to construct a new facility;
will apply for financing between January 1990 and the date of
. the 1993 auction; . - ,:
- v; submitted written offers.to each unit listed in .Table A .(all
grandfathered utilities) to purchase .the required allowances at
$750each; -I - . *- .. ' - ' .'. / "",- .-^, ' .
- has not received ah acceptance within 180 days of the offers
(IPPs may be required to demonstrate that they have made a good faith (but
* unsuccessful) effort to obtain allowances, including participation in the auction, and
'-pledge to continue to make a good faith effort to obtain allowances.)
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STRAWMAN DESIGN FOR THE WRITTEN GUARANTEE PROGRAM
1. Requirements for IPPs Applying for Written Guarantees
o Information Concerning the New Facility: The applicant must submit sufficient
information to establish that it "proposes to construct a new independent power
production facility for which allowances are required." This shall include, at a
minimum: (1) the location of the proposed facility; (2) the proposed size and type
of the facility; (3) an estimate of uncontrolled SO2 emissions; (4) the required
regulatory emissions limits for the facility and a description the pollution control
devices intended to be installed; (5) an estimate of the residual emissions for which
allowances will be needed; (6) the proposed start-up date of the facility and its
expected operating lifetime; and (7) the duration of the power sales agreement ,(if-
there is a signed agreement). Specific supporting documents will also be required
as attachments to the application form.
**
Discussion: This information request will be the primary way of limiting
applications to bona fide projects. A checklist of project milestones that can
be used to refine the information requested for planned new facilities and to
specify the kinds of supporting documents that-must be provided along with
the application form. Such milestones might include:(l) a signed power sales
agreement; (2) a notice from a utility that an IPP has won a power of
purchase solicitation; (3) a signed fuel supply agreement; (4) a completed site
lease (if applicable) or proof of land acquisition; (5) a signed steam sales
agreement (if applicable); (6) a signed construction contract (if applicable);
(7) air or other environmental permits (accepted for application or
completed) -
o Application for Financing: The applicant must provide EPA with a pro-forma pledge
that it intends to "apply for financing" before the date of the 1993 auction.
Discussion: Obtaining financing for IPP projects is not a single step process,
such as obtaining a mortgage or car loan, nor. do IPP developers necessarily
use a uniform process for obtaining financing. Because of ambiguities in .
determining whether an applicant has "applied" for financing, EPA intends to
require a pledge regarding financing and .to use the information requested
regarding the planned new facility as the means of limiting applications to
bonafide projects. "
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o Deposits; Applicants will not be required to submit deposits. .
Discussion: There are two issues. The first is whether the language for the
direct sales program requiring applicants to make a 50 percent deposit within
six months after the "request" to purchase is approved applies to IPP written
guarantees (Sec.416 (c)(2)). Language requiring IPPs to continue to make-
good faith efforts to, obtain allowances from the private market and the
annual auction and allowing IPPs a right of first refusal in purchasing
allowances from the direct sales subaccount is incompatible with requiring a
SO percent deposit because that would .virtually lock IPPs into using the
written guarantees. In addition, requiring such a large deposit (50 percent of
$1500 times the total number of allowances necessary to operate a facility
over its proposed lifetime) in advance of when financing typically is available
would have the practical effect of precluding most IPPs from taking advantage
of the written guarantees. The second is whether a small, non-refundable
deposit should be used as a means of limiting applications to those projects*
that are likely to actually be completed. To require such a deposit would be
superfluous since the information requested regarding planned facilities
should be sufficient to limit applications to bonafide projects. (Also, IPPs
probably would forfeit the deposit because it is unlikely, that the written
guarantees actually will be exercised.)
o Submission of S750 Offers: An applicant must submit a signed statement that
it submitted written offers to each unit listed in Table A to purchase the
required allowances at .$750 each and .that it has not received an
unconditional acceptance within 180 days of the offers. No requirements will
be placed on the terms of such offers, other than that $750 must be paid for
the allowances. Applicants must maintain and make available to EPA, at its
request, copies of such written offers, along, with anyresponses to such offers.
Discussion: Applicants must make such offers to satisfy the plain language of
. the Act. However, it would be inappropriate for EPA, to evaluate the
"reasonableness" of the nature and terms of the offers made' by IPPs to
utilities. .
o Demonstration of Continued Good Faith Efforts: Applicants will be required
to make a pro-forma pledge that they will continue to make good faith efforts
to potato allowances, but they will not be required to submit paperwork
actually demonstrating such efforts. Applicants will be required to retain
copies of their bids in the annual auctions and any written offers made to
Phase I facilities and to make such documents available to EPA at its request.
Failure of IPPs to continue making good faith efforts to obtain allowances will
. result in termination of the written guarantee.-
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Discussion: This requirement essentially is self-enforcing because it is in the
financial self-interest of IPPs to obtain allowances priced at less than $1500. ' ' ^^
2. Design of Features of the Written Guarantee Program
o Cut-off Date fo^ Applications: No specific cut-off date for applications will
be established. However, anyone submitting an application after the auction
date in 1993 must demonstrate that the project was planned before that date
and that negotiations to purchase the allowances required to operate the
facility over its lifetime or the length of the power sales agreement,
commenced before the auction date in 1993 and were unsuccessful.
Discussion: The language of the Act requires that applicants must
demonstrate that they propose to construct a new facility and that they will
apply for financing before the auction in 1993. However, no explicit date is
established as a cutoff date for the application for written guarantees. The
proposed approach allows IPPs that attempt to negotiate long-term contracts
for allowances the flexibility of obtaining written guarantees should those
negotiations fail. Other options to be consider include: establishing the 1993
auction date as the cut-off date and extending the cutoff date for a year or
two beyond 1993.
o Duration of Written Guarantee: The written guarantee will allow the
applicant to purchase, beginning no earlier than the year 2000, allowances in
* each calendar year over the lifetime of the power sales agreement or the
useful life of the unit.
,.o Transferabilitv of Written Guarantees: Written guarantees can be exercised
only for the planned facility for which the application was made, it can be
transferred to new owners, should the facility be sold.
o Cap for Written Guarantees: The aggregate annual cap for allowances reserved
through written guarantees will be set at 50,000.
The Act establishes a direct sales subaccount of 50,000
allowances to be used for both written guarantees and for direct sales. It also
establishes a direct sales schedule in which 25,000 advance allowances are to
be offered each year from 1993 to 1999 and 25,000 spot and 25,000 advance
allowances are to be offered each year after the year 2000. However, the
written guarantees are not tied to the direct sales schedule and have
precedence over direct sales. Therefore, the entire 'amount of allowances in
the direct sales subaccount should be made available to IPPs and only
residual allowances (those not reserved under written guarantees) should be
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offered in the direct sales program. (The direct sales schedule will be altered
either by subtracting the guaranteed allowances from the spot allowance
category first and then subtracting any remaining reserved allowances from
the advance allowance category, or by subtracting an equal number from each
.category.) .'-,
First-come, first served: Written guarantees will be processed and approved within
30 working days according to the order in which applications are received, beginning
with the date the regulations go into effect.-(EPA will time/date stamp applications.)
Applicants who have filed applications that are deficient will be notified within 30
working days and will have ten working'days in which to resubmit their application.
Failure to do so within this time period, or resubmittal of a deficient application, will
result in the application being processed according to the new, rather than the initial,
filing date. -
".. , ~ . - f, ,
Discussion: Because written guarantees are restricted only to units that IPPs
propose to construct, it is likely that applications for written guarantees would
be submitted to EPA gradually over an extended period of time, rather than
in a lump that exhausts the 50,000 allowances that are available. Thus, it does
not appear at this time that other methods .for establishing the order of
applications, such as lotteries, are necessary for this program. Providing IPPs
who have filed deficient applications additional time to refile will slow the
approval process only when the sum of the contingency guarantees approved
and those applied for in "deficient" applications exceeds the cap of 50,000
allowances. .
Time Period During which the Written Guarantee Must be Exercised and
Payment Made: \yritten guarantees must be exercised during a two-week
period in March-of each year beginning in the year 2000. Full payment for
the allowances.requested, must be made at that,time. Any allowances
reserved through written guarantees thai are not purchased at this time will
be placed in the direct sales-program as spot allowances, if the program has
not already been terminated. If it Has been terminated, such allowances will
be added to the spot allowances offered in the following year's auction.
Discussion: The proposed time period during which IPPs must exercise their
option to purchase allowances at the fixed price of $1500 each (inflation
adjusted) allows IPPs to participate in the annual auction.to obtain needed
allowances (at a lower price) and provides some time to purchase allowances.
in the private market should they be unsuccessful in the auction. IPPs must
exercise their written guarantees for EPA to know how many allowances are
available for sale in the direct sales program. The earlier in the year this is
done, the longer the direct sales program will be available as a last resort for
operators of other facilities.
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3. Terminating the Written Guarantee Program ' v,
o Written Guarantees and Termination of the Direct Sales Program: Termination of ^^
the direct sales program will not result in termination of written guarantees. EPA
will maintain a separate subaccount to cover allowances reserved through written
guarantees.
Discussion: The Act requires the Administrator to terminate the direct sales
subaccount if less than 20 percent of the allowances available have been
purchased in any two consecutive calendar years. The Act does not indicate
whether termination of the direct sales subaccount also terminates the written
guarantees. However, linking the termination of direct sales to written
guarantees in this manner would contradict the plain meaning of a "guarantee"
and would be at odds with the intended purpose of the written guarantees,
which is to assure lenders that IPPs will have access to allowances over the
operating lifetime of the planned facility.
o Termination of Written Guarantees: Written guarantees will be terminated by EPA
if the planned project has not begun operating by the year 2000 or the planned start-
up date of the facility, whichever is later, or if the applicant fails to make a
continuing good-faith effort to obtain allowances.
Discussion: The language in the Act implies that EPA could terminate a
written guarantee if continued efforts to obtain allowances are not pursued.
It does not indicate whetfier the successful acquisition of allowances is
grounds for terminating the written guarantee. If the market price for
allowances is less than $1500 and a market for allowances develops as
expected, it is likely that most, if not all, IPPs with written guarantees would
not exercise their rights. However, if the price of allowances rises .above
^$1500 at some point in time, IPPs would want to begin exercising their rights
to purchase allowances as granted in the written guarantees. In this situation,
written guarantees would function less as a safety valve and more as a subsidy.
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DIRECT SALES
Discussion Paper : * .
The Clean Air Act amendments of 1990 require that EPA sell 25,000 advance
allowances (useable 7 years after purchase) each year beginning in 1993. Beginning in the
year 2000 and after, EPA will be selling an additional 25,000 allowances called spot
allowances. Spot allowances will be useable upon purchase. The Act requires that spot and
advance allowances be sold for $1500 per allowance (adjusted by. the consumer price index
for 1990). Requests to purchase allowances shall be approved in the order of receipt until
all allowances are solid. After requests to purchase allowances have been approved,
applicants are'required to pay 50% of the total purchase price within 6 months after their
approval. The remainder of the price will be paid on or before the transfer of allowances!
Proceeds from the sale will be transferred within 90 days after the sale, on a pro rata basis
to those from whom
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4. First-come, first-served: The Act requires that requests to purchase allowances from the
Direct .Sales Program must be approved by EPA in the order in which applications are
received (after IPPs with written guarantees have been given the option to purchase
allowances). If the price of allowances is, or expected to be, below $1500, the direct sales
program is unlikely to be used and could realistically end in 1995 if less than 20% of the
total allowances are sold in the two previous years. However, if the price rises above $1500,
the direct sales program could be substantially over-subscribed. A preferred option for
awarding allowances in the direct sales program includes:
o Interpret the language of the Act literally and establish a queue of applicants based
on the order in which applications (in some standardized form) are received after a
certain time on a given day. . '
S.Over-subscription to the Program: Over-subscription to the program.could be handled by
EPA establishing a queue of applicants and "wait-listing" those who are not allocated
allowances. If there are not enough allowances left to satisfy demand .at.the end of the line,
but before the waiting list, EPA could check the application of a buyer, at the end of the
.queue for a box on the application indicating if that buyer would accept a partial allocation.
If that applicant checked no, the applicant next in line would be considered.
6. Requests to purchase and approval pf those requests: As the CAA states, direct sale
allowances will be allocated on a first come, first served basis, and applicants to the direct
sale must send in a 50% deposit within 6 months after their request to purchase has been
approved. If the "request to purchase" is simply an application indicating name, address, and
the, amount requested to buy, EPA has little to "approve" since anyone can buy allowances
and in any amount. Therefore, the purpose of the EPA "approval" is simply to allow the
buyer to secure the option to buy allowances within six months. EPA prefers the. following
option:
o Interpret the language literally and allow potential buyers to send in their
applications after a certain time period. Applications would be approved on a first
come, first served basis as they came in; and allowances would be reserved as
approvals are made. Applicants have to send in a 50% deposit within 6 months (or
before the date of the sale) after approval or lose their place in line. The
remainder of the cost will be paid on the date of the sale. This option allows
applicants time to buy allowances from other sources (private market or the auction)
before committing to the direct sale. This option, however, will most likely permit
frivolous applications because it costs nothing to apply. If the direct sale became
over-subscribed, EPA. could "wait list" applicants. Those who fail to pay their 50%
in six months, will, lose their status in line, allowing people on the waiting list to
move up. Previously wait-listed-people will then be "approved" and have six months
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or until the close of the sale to deposit 50% or make the fall payment EPA will not
reasonably know how many allowances will actually be bought until all deposits are
in. .. ' " ' - - '.'-
A certified or cashiers checks for the 50% deposit and the remaining balance should be
the preferred method of payment: All outstanding payments need to be received by EPA
by COB on the last day of the sale period. Otherwise, allowances not fully paid for will go
into the auction subaccount and any deposits will be forfeited. Within 90 days after the end
"of the sale period all proceeds shall be distributed pro rata including any forfeited deposits.
To ensure authenticity and streamline processing, applications should consist of written
standardized forms which EPA would develop. . . -
7. Payment'and price for allowances from the "advance sales"'program: The Act requires
that an applicant must pay 50 percent of the.sales price ($1500 inflation adjusted) within 6
months, after approval to purchase and the remainder on or before the .transfer of
allowances. Because this provision .applies to "advance" sales as well as "spot" sales, the
purchaser is paying for an allowance in the advance sale it will be unable to use for seven
years. This .provision appears to be fair and; reasonable and eliminates the administrative
burden of having to track deposit payments for advance allowances. The buyer will be
.acquiring the right to the allocation of allowances just as if it were purchasing another firm's
accounts receivable; .Thisi bririgSv the buyer economic and practical advantages at the
expense of the unit from which,allowances were withheld, even though the allowances
cannot be used for compliance immediately. In addition, because of the likelihood that
inflation rates will continue to rise slightly every year, and the $1500 price for allowances*
will always be adjusted by the 1990 GPI, the nominal price paid for an advance allowance
in the year 2000 will be less than that for a spot allowance bought in 2007. Though the CPI
adjustment does not include discounting for the. time value of money, the difference in
nominal inflation-adjusted prices at least partially mitigates the failure to discount further.
In addition, not-discounting for the time value of money is the premium buyers must pay
for the right to circumvent the market to ownership of allowances seven years in advance
of their use date.
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A-7 . ' .
-. ' THE ALLOWANCE TRANSFER SYSTEM
.Discussion Paper
I. Background "...
«. sa - . ' .,,;.
Developing regulations >and procedures will involve using a
core workgroup of relevant offices in EPA. The core workgroup will
address the options and issues ' involved with, promulgating the
allowance tracking- ..system, allowance transfer system regulations
(trading and banking), and the auctions, and sales regulations. The
workgroup's analyses', and issues will be presented to the acid rain
advisory committee ,(ARAC) for review. . In some cases, this will
involve developing a"strawman proposal, and in other cases it may
involve presenting an options paper. . This paper examines.some of
the issues ..surrounding the ;,allowance transfer .system; how the
allowance transfer .system could be designed,. EPA's role in
receiving and.recording allowance transfers', and considerations for
allowances: allocated to "opt-in"; sources..
II. Introduction v
EPA- must ..proinulgate a regulation to establish the allowance
system by May 15, 1992V Tinder The Clean Air Act amendments of 1990
(The Act), the allowance system shall include, but not be limited
to, requirements for the allocation, ' transfer, and use of
allowances. Regarding .transfers. The Act states that,* "Transfers
of allowances shall not be effective until written certification
of .the transfer,.signed by a responsible official of each party to
the transfer, is received and recorded by the. Administrator."
Additionally, the .'Act requires EPA's regulations to .permit the
transfer of allowances.prior to the issuance.of such.allowances.
Such recorded pre-.issuance transfers will be deducted from the
number of allowances which would otherwise be allocated to the
transferor and added to those allowances issued to the transferee.
In addition, EPA .must establish an allowance tracking system (for
issuing, recording, and tracking.allowances), which specifies all
necessary requirements.for an orderly and competitive functioning
of the allowance system. ..''.' ".-, ;
The Act provides the general framework for the allowance
transfer "system. It does not, however, specify how the system is
to be designed. Designing a simple and^. efficient transfer system
is crucial to the success of the acid-rain program. EPA's role in
receiving and recording allowance transfers is also important for
ensuring an efficient, market, for allowance trading. For the
.purposes of discussion, this paper presents one. possible model
for the allowance transfer system and EPA's role in receiving and
recording transfers. This paper is divided into three parts: 1)
Basic Transfers, 2) The Notification Process, and 3) special
Considerations for Opt-in Source Allowances.
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III. Issues ... .
A. Basic Transfers One Possible Model
Under the Act, affected units will be allocated sulfur dioxide
emission allowances. Phase I allowance allocations are listed in
Title IV of the Act, and Phase II allowance allocations will be
calculated by EPA. Beginning in 1995 for Phase I units and in 2000
for Phase II units, allowances will be issued annually. While
allowances will be issued annually, affected units nay .transfer
future year allowances to which they are entitled based on the
statutory allocation formulas. While the statute allocates
allowances "for units" it permits transfers among designated
representatives and anv person. This means that any person not
initially allocated allowances that purchases and holds allowances
would need a separate account in the allowance tracking system.
Thus, EPA will need to develop procedures for establishing new
accounts.
i. Allowance Transactions
EPA's role in allowance trading is to receive and record
allowance transfers. Streamlining the mechanics of receiving and
recording allowance transfers is vital for facilitating market
transactions. In order to foster an effective trading program, the
process should entail the minimum involvement of EPA consistent
with the statutory requirements.
Utilities as well as non-utility participants will generally
be free to work out any transfer they want. When two parties agree
to a transfer, they must notify EPA to make it "official". Once
EPA records the transfer (by debiting the seller's account and
crediting the buyer's account) in the allowance tracking system it
becomes official.
At the risk of oversimplification, a transfer could be made
the same way a bank check is written. The seller can write the
"allowance check" and give it'to the buyer. The buyer can then
endorse it and cash it in by sending it to EPA for recordation or
could choose to endorse it, but instead of notifying EPA and
triggering the account debiting and crediting mechanism, simply
sell the allowance "check" to someone else. In this case the check
could change hands many times before a buyer decides to endorse it
and send it to EPA for recordation (i.e. debiting the account of
the initial seller and crediting the account of the last buyer).
The "check" will need to contain certain information on both
parties, in order for EPA to record the transfer. Below is a
potential list of the minimum information EPA would need from both
parties to record a transfer.
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The seller would need to'include:
' v-' .-- - ' . ' .. v- " "
- Unit and designated representative system identification
. numbers ' '". ,'' -.,.; ... ..-*.'
Name and telephone number of'designated representative
- Signature : (and -date .of signature) ' of the designated
representiative -'."v- -.. - '<. w-. .- .- ' : ,- '-. "- '-.'
Amounts . and use dates of allowances being transferred
(earliest-date, each allowance can be used) : .
The buyer would need to, included ,-> ;, /
Unit and designated representative system identification
numbers . - *. , ' "'.
Name-and telephone number;of designated representative
- Signature .(and date of signature) of, the designated
represent at iye ... - . - v - .
A sample transfer.might work as follows. Unit A enters into
an agreement and sells allowances to a broker by writing him .a
"check11 (Note: unit A could either' make -the ?'check" out rto the
broker .or not) . The broker intends to hold .the ?!check" for several
months (thinking al-lbwance prices may rise) and then to sell these
- allowances to another unit that needs them for'compliance purposes.
Because he's planning:to sell, the "check", he does'not fill in his
information arid: only, .endorses the ^check" if .made out. to him.
Several months later when the broker finally sells the allowances
to unit Br. -unit'tB. "would vf ill in its. information, endorse the
!.'check" and notify EPA. so the, allowances' can: be officially
transferred to,dts account. If all the procedures are followed
correctly; .EPA-would vrecord rthe-transfer to make it official by
debiting, unit A^s .account and crediting unit B's. Consistent with
the statutory requirements, the notification (the check) must.be
.sighed by responsible-'officials of both parties to the transfer,
in ^ijis ;case the designated.representatives of unit A and unit B.
Infniis instance, the\broker never 'Officially.,,held .the allowances
since, ..whether endorsed or not, the check was never,'presented to
EPA.for. the purposes of crediting,the allowances to the broker's
account. They were officially,., held, by unit A, even though the
broker bought them, until EPA recorded the. transfer to unit B..
.. .'<*: .'*,--. ','-. .< ... v ,-. ....-' - -.-..-* '. .- ., :
ii.,. Notifacation Process .,
There would be two, possible" methods for notifying (i.e.
cashing the "check")- EPA-(or its agent) of allowance transfers; 1)
electronic reporting and 2) written reporting. ^Electronic
reporting would be similar to electronic funds transfers currently
used-in the bank ing., industry., EPA could produce a standardized
: electronic" format that would be completed by the party .that
endorses the check .and sent to.EPA via computer. . In this case,
Personal. Identification Numbers (PINs) would be used in place of
signatures. . . For written- notification EPA could produce an
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"allowance check" which would be a .standardized form to. help
facilitate transfer reporting. Utilities choosing to send written
notification could either fax the information to EPA at the
tracking center (where data entry takes place) for quick
recordation, or mail (certified?) it to EPA at the tracking center.
Faxing the information is only possible i'f EPA does not need
original signatures of the designated representatives. :,
Once EPA has received the transfer notification (the "check") ,
the data entry team would need to make sure the form is correctly
filled out, the information is complete, and that the seller has
enough current or future allowances to cover the trade. This would
include: l) confirming that both parties have accounts in the
allowance system (adding an account for any party that is not
already in the system), 2) checking the number and dates of
allowances, and 3) making sure the form is signed and dated by both
responsible officials (also known as designated representatives)
or that the PIN numbers are correct in the case of electronic
reporting. .' .
If the transfer information is complete and the- seller holds
or will hold enough allowances, EPA (data entry) would record the
transfer by entering it in the tracking system (debiting the
seller's account and crediting the buyer's account). Certainly,
utilities will be free to trade future allowances to which they are
entitled. However, EPA would riot allow a unit to trade more
allowances than it had or would be entitled to in the future. For
example, if unit A has a Phase II allocation of 10,000 allowances,
it would be able to transfer up to 10,000 allowances each year.
If unit A wrote a "check" for 11,000 year 2010 allowances, EPA
would not record the transfer and would notify both the buyer and
seller of the check that -unit A has insufficient allowances to
cover the transaction . '"'.-'' . '
' ' 's
Once'EPA records.the transfer it is official. The transfer
participants would know it's official when the transaction appears
in their account in the allowance tracking system (showing the
transfers which took place and their new balance) . No permit
Allowing affected sources to trade allowances they are not
entitled to could erode emissions reductions by implicitly
permitting otherwise unauthorized "borrowing" of allowances. To
prevent this, the mechanics or protocol of the allowance transfer
system must block transfers of allowances not held by the
transferor. . .
2 Similar to a monthly bank statement, tracking system account
statements might have to be issued on a regular basis- throughout
the year. These statements could show the account holder's
beginning balance, all transfers which took place, and ending
balance. '
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review would be necessary or required for sources that simply
transfer allowances. If the information is incomplete or the
seller does not have enough allowances to cover the trade/ then
EPA would*not record such transfers and would notify both parties
as to why the trade was not recorded. 'At the end of the year, EPA
would do the accounting procedures and send put a final notice3.
Discussion Questions! ' '"'.- -
, t .. ,-',4 : : , " '*
Is this "checking account", model appropriate for the allowance <
trading! system . (taking., into- account potential . tax and ""
.'account ing, implications)? ." . ,
"..'*' ".'...»' * - , . ;
- Consistent with the Uniform /Commercial Coder does the
"allowance .check" need to be recorded within a given amount
.' ., of time (six months for example)> or else become invalid?
While electronic .or faxed transfer notifications. would be
enough for purposes, should EPA require a written copy
(perhaps the original) of the transfer form for EPA's internal
recordkeeping? ' ;
'"'.-.<.' '
- . Similar to a monthly bank statement; should EPA send out
periodic account balance statements to all account holders?
How often? ... v ; . ;
-"--. ' . '*»",-,' " ... ' .
After EPA. records a transfer, should EPA send each account
. holder a-notice showing the- transaction which took place?
If the information is incomplete or the seller does not have
.enough allowances to cover .the trade, how should EPA notify
. the trading parties that the transfer can not .be recorded?
' .' ' . '.- < -v /: ' ' , "-:. .
:B. Special Considerations for Opt-in Source Allowances
', The , preceding -. discussion covers the allowance system in
general. However, allowances allocated to sources that elect-in
to the allowance system- are V subject to certain additional
limitations .that will- affect how these allowances are treated.
Specifically, any unit that elects-in to the allowance system shall
'not transfer or bank allowances produced as a result of reduced
utilization or shutdown. This .has implications for both the
allowance transfer and tracking systems.
-- The ^opt-in" allowances -would be subject* to the same.
requirements as other allowances, .except when an opt-in source
shuts-down or reduces its utilization. In such cases, the excess
allowances, (e.g. produced through shut-down) would stay with the
End-of-year procedures will need to be developed.
.'.. ' ' 5
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source to which they were allocated. Then, at the end of the year
these allowances would disappear because they could not be banked
or carried over.. The mechanics of handling these "opt-in"
allowances must.be consistent with the larger allowance system such
that recordation would not occur until the year in which allowances
become useful even for future allowance transfers consummated
and recorded with EPA several years in advance. Whenever a
transfer of allowances from an opt-in source is sent to EPA for
recordation, the actual physical debiting and crediting could not
take place until the end of the year. Recordation would take place
'only after the determination-that the source was in full operation
throughout the year and that no. allowances were made available as
a result of reduced utilization'or shut-down. During the course of
the calendar year, the number of allowances in accounts that have
pending .opt-in allowance transfers would not reflect the debit and
credit associated with recordation, but would contain a note that
the sources had notified EPA of an allowance transfer'and that the
transfer is pending .
. This poses a risk to purchasers of "opt-in" allowances. For
example, assume an industrial unit has elected-in to the system and
is allocated 5,000 allowances per year starting in the year 2000.
The industrial unit immediately sells 2,500 allowances for each
year from 2000 to 2010 to an independent power producer (IPP). The
industrial unit writes an "allowance check" and gives it to the
IPP, who endorses it and sends it to EPA for recordation. Both the
industrial unit's and IPP's accounts would now contain a note that
such allowance transfers are pending. After the end of the year
2000, EPA determines that the industrial source was in full
operation throughout the year 2000 and subsequently records the
first transfer of 2,500 allowances (by debiting the industrial
source's account and crediting the IPP's account). On March 31,
2001, the industrial unit shuts down permanently. At this point,
the IPP will have received only the 2,500 allowances for the year
2000. The remaining 2,500 allowances each year.from 2001 to 2010
would not be transferred to the IPP's account or carried over in
the industrial sources account. Therefore, these allowances would
never be made available for use to offset emissions. Clearly, this
presents a problem for the IPP, who was planning on these
allowances in order to comply. The buyer must bear,-the risks
involved with purchasing "opt-in" allowances.
4 This would only apply to opt-in sources, not to existing
utility units.
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A-8
ISSUE PAPER ON MULTI-UNIT ALLOWANCE POOLING FOR COMPLIANCE
I. Background
Some utilities "pool" electricity production across several
units. Within a pool electric generation is treated as fungible so
that generation demand is dispatched to a given unit within - the
pool based on a variety of economic and other efficiency factors.
The scope of such pools varies/ sometimes involving only a single
operating company, sometimes including units from more.than one
holding company. Title IV treats sulfur dioxide emissions and
allowances as 'fungible as well since allowances are freely
transferable among units and a unit simply has to hold allowances
in an amount equal to its emissions in order to meet compliance.
' "; '
The language of the Senate Committee report suggests that one
of the purposes' -of creating a system of fungible allowances/
emissions was'to allow power pools to continue to operate as such
and to integrate emissions/allowance dispatching into their overall
dispatching ^protocol'." ~ .".. : ,
II .' Statutory Language
This paper will net address the legality of permitting pool*
based compliance in lieu of unit-by-unit compliance. Instead, it
will focus on the practical and policy consequences of the two
different approaches. Clearly, though, .the. statute includes
provisions that, to 'a small; extent, open the question. of whether
pool-wide compliance is permissible. .,
Section 403 (g) states:
"It shall be unlawful for any affected unit to emit, sulfur
dioxide in excess of the number of allowances held -for that
unit for that year by the owner or operator of the unit."
Section 403 (d) (2) provides:
* f f
"In order to insure electric reliability, such, regulations
shall not prohibit or affect temporary increases and decreases
.in emissions within utility systems, power pools of utilities
entering into allowance pool agreements, that result" from
their operations, including emergencies and central dispatch,
and such temporary emissions increases and decreases shall not-
require transfer of allowances, among units nor shall it
require recordatioh. The owners or operators: of such '-units
shall act through a designated representative. Notwithstand-
ing the preceding sentence, the^total tonnage of emissions in
any calendar year (calculated at the end. thereof) from 'all
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units in such a utility system, power pool, or allowance pool
agreements shall not exceed the total allowances for such
units for the calendar year concerned."
III. Impact of Unit-by-Unit Compliance on Power/Allowance Pools
It appears that even under a unit-based compliance regime
utility systems and power pools will still be able to use pooling
strategies in meeting both their emissions limitation and dispatch
requirements.
Logically, each utility system and power pool will probably
choose to pool the allowances allocated to each of its units and
integrate its dispatch and emissions control strategies so that at
the end of each year total emissions from all of the system's or
pool's units will not exceed the number of pooled allowances. Even
under a pool-wide compliance regime, to effectuate this strategy,
the system's managing authority, would have to cull and sum
emissions data from each unit in the system in order to determine
total, pool-wide emissions. Permitting pool-wide compliance
demonstrations would simplify the management authority's task,
however. Once total emissions were determined, this total would
merely have to be matched to the total number of allowances in the
pool.
At the same time, though, requiring the allowance pool to
demonstrate compliance on a unit-by unit-basis does not impose an
appreciable burden. Under such a regime, the pool could still
operate on the basis of aggregated emissions and allowances. To
reconcile such operations with the unit-based .compliance regime,
the pool' s management authority would only have to draw from the
allowance pool under the authority's control the number of
allowances needed to cover a unit's emissions and assign or
transfer those allowances to the.unit in question. On a mechanical
level, such a procedure might entail the manager's creating in
EPA's allowance tracking system an allowance account into which all
the allowances held for each unit in the pool would be transferred.
At the end of the year, following the Agency's standard allowance
transfer procedures, the pool manager would transfer from the pool
account into each unit's individual account the number of allowanc-
es needed to cover each unit's emissions for that year. This
method transferring individual unit allowances into a single
pool-wide account and then transferring allowances from the account
back to the individual units in amounts needed to cover emissions
would not only replicate pooling but also allow the pool manager
to circumvent the more complex, and unncessary procedure of
transferring allowances to and from individual units. other,
similar options could be crafted. Thus, the additional step
imposed on the pool manager by a unit-based compliance regime would
consist of simply sorting each unit's emissions and allowances by
2
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means of the EPA's allowance account and transfer system without
interferring with the .ability of the-pool to operate as.such in
actual«: practice. , .>*'->-, ,- '. f .' -''.'..
. . .. --...'. - -V ' \ * - V-" . ':'. * ' > ':''
Because allowances and emissions'are fungible and because all-
units are included in Phase II, no special regulatory provisions
would be.required in .order to allow pools to function-In this way
within a unit-based compliance framework. In Phase I, however,
some pools may-find themselves with some units that are affected
and some that are not. In. these cases, the statute permits
affected units.to submit substitution plans to include unaffected
units, in a compliance program. Accordingly, a power pool that
included some Phase I. units could, submit a substitution plan
bringing all of .its units into .Phase -I. The statutory provisions
governing .substitution plans appear to contemplate only unit-by-
unit substitution,, but this only means,that EPA would accommodate
pools .as if all the units were operating in the Phase II system
(but with emissions limits and allowance allocations ..appropriate'to
Phase I reduction requirements). Pursuant to the requirements of
the substitution plan provisions and the specifications of each
plan, .the/ Agency would establish allowance accounts for each
substitution unit and., permit;'transfer of .allowances-Into'a pool
account and then out-.to each unit's'account as needed to cover its
emissions. . -.'' ' ..r ,--.'.' . «'''." ,
.'* .-',.' *-'' ' . '. '"';': .- " '"; ''.'''
IV. Effect of Pool-Based Compliance on Compliance and Enforcement
The compliance, permitting and; enforcement- scheme of the title
appears .clearly to rest on the individual unit or plant. Not only*
are. the statutory, emissions limitation requirements expressed
exclusively in terms .of the individual unit, but the functional
elements of the title' .the permits, the emissions :monitoring
requirements and the.imposition .of liability for excess emissions -
- depend on a unit-based approach.. Under such an approach, the
regyiatory authority, need look only at a unit's permit, .allowance
accSunt and.emissions data .to determine whether a unit is in
compliance;, or to demonstrate that a unit is liable, for excess
emissions fees and offsets as a result of-being out of compliance.
-, - Under; a pool-wide compliance- regime, the basic compliance
elements could perhaps be fashioned to capture an aggregation of
units. Emissions monitoring; requirements would be imposed on each
individual plant and the total emissions-limitation requirement for
the pool as well as the total allowance allocation would be equal
to the sum of those for each individual unit in the. pool. .In all
likelihood the permits issued to.individual units in the pool would
have to be linked to an overall permit issued to the pool as a
whole... - '"-. : . - .- . - .* -.' ;'. ;.-". ' "'.. ~
Most difficult, though, would.be preserving the self-executing
elements of the.excess emissions requirements of the: title', m the
case of the $2,000, per ton .fee, .the pool's permit would have to
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make the pool's management authority directly and. automatically
liable for payment, with no-account taken, for liability purposes,
of questions of apportionment of the payment among the units within
the pool. Such questions would be disposed' of by private arrange-
ment among the pool members (even in a unit-by-unit regime with
individual unit owners and operators paying the fee, the pool
arrangement would most likely provide for a defraying of such
expenses among the pool members). '
The self-executing element of the offset requirement might be
nearly impossible to replicate. The statute requires that where a
unit's emissions exceed its allowances, the Agency is to reduce the
unit's subsequent allocations to offset the excess. In the context
of a pool, the Agency would be required to withold allowances so
that the pool's subsequent aggregate allocations would be reduced
in the amount necessary to offset the pool's excess emissions. The
.statutory allowance allocation provisions are based on individual
units. Thus, the only plausible way to effectuate a reduction in
the pool's aggregate allowances would be to include in each unit's
.permit a statement making the unit liable for a reduction in its
allowance allocation equal to its pro rata share of any emissions
excess of which the pool as a whole may be guilty. While this is
not impossible, it does suggest how complex a system of permits
would be required to subject the units in a pool to precisely those
emissions/allowance compliance requirements imposed in the title.
In Phase II, where the program will rely on state authorities
for permitting and compliance, pool-based compliance could present
practical problems especially if multi-state pools are involved.
A pool, liable for excess fees and offsets as a result of aggregate
emissions exceeding aggregate allowances, could frustrate a state
enforcement authority or citizens group by basing a challenge to
liability on data or factors pertinent to plants outside the
authority's geographical jurisdiction.
In addition, state authorities could have a formidable burden
to bear in approving compliance plans and issuing permits for
multi-state pools and in ensuring enforcement and liability across
several jurisdictions. This, as well as the general need to ensure
liability for the pool as a legal .entity, could result in the
compliance planning and permitting process presenting significant
burdens for the units in the power pool itself. This becomes
especially clear if contrasted with the option of submitting
individual unit plans stating a commitment to hold allowances equal
to emissions and simply engaging -the mechanics of transferring
allowances among units in the pool at the end of each year.
Finally, any enforcement authority's burden would be signifi-
cantly complicated under a regime in which compliance and liability
was pool-based. Instead of being able to bring an enforcement
action in a -context in which : the inquiry was confined to the
emissions data of one plant, an enforcement action against a pool
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could .require the authority to confront disputes about emissions
data'for every unit.in the pool.
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MULTI-UNIT POOLING EXAMPLE
Pool ABC consists ^ of . 5 plants and 10 units. Its original
allocation oftallowances, by unit are:
* _«"7 .;"-"...'*,'
*.**"""" ' ; -A
Unit Allocat-ion '' "'."*'
1 1,000 - .
2 . 1,000- :
3 1,000' '..'''" :
4 1,000 "-...
5... - 1,000 :
6 1,000 -.'.
7 2^000
8 2,000
9 2,000 .
10 2/000 .- *
; . . . s.
TOTAL 14,000 .
*, _ ".i
POOL-WIDE COMPLIANCE
In Case 1, the total emissions of the pool are less than the
total allowances -held by the, 'pool (14,000 allowances held;
emissions of 13,650) . Under a :unit-by-unit .compliance requirement,
Units 4, 5 and 7 would have been; out of compliance.
In Case 2, emissions are higher than in Case 1 for Units 1, 2
and 3. Emissions for the pool exceed the allowances held (14,250
vs. 14,000). .The pool would be out of compliance as a whole, with
5 units (1, 3, 4, 5, and 7) where emissions exceeded available
allowances.
CASE 1 CASE 2
Allowances held In-Compliance Out of Compliance
Unit for Year X Emissions Emissions
1 1,000 900 . 1,200
2 1,000 950 1,000
3 1,000 950 1,300
4 1,000 1,100 1,100
5 1,000 1,050 1,050
6 1,000 900 900
7 2,000 2,100 2,100
8 2,000 2,000 2,000
9 2,000 1,800 1,800
10 2,000 1,900 1,900
TOTAL 14,000 13,650 14,250
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Unit by Unit Compliance
In Case 1, the pool is able to make inter-pool allowance
transfers to cover the potential excess emissions in Units 4, 5 and
7, and still maintain a carry-over balance of 350 allowances into
the new year. ' -
In Case 2, the pool cannot come into compliance by merely
conducting trades with-in the poolan overall, poolwide deficit of
350 allowances exists. This shortfall would have to be made up
through purchase of allowances from outside the..pool. In the
example trades, Units 3 and 5 would be subject to the excess
emissions fee and the offset requirements without an additional
infusion of allowances. However, if the compliance regime was
genuinely pool-based and allowances were held in one pool-wide
account, the enforcement authority would not be able to attribute
excess emissions to individual units.
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KEY ISSUES ON OPT-IN
TITLE IV. SECTION 410
Prepared by
Ann D. Murtlow
The AES Corporation
Do industrial boilers fall under the category of process sources in
Section 410 (d)? . ,
The term "process source" is not defined in the Amendments. Rather
it appears that Section 410 (d) gives the Administrator authority to
define this by regulation, as well as to define the requirements that
such a-source must meet in order to opt-in and receive allowances.
It does appear, however, that an industrial boiler, by definition, was not
intended to be included under 410 (d), as a process source, but rather
under 410 (a) as a "unit that is not, nor will become, an affected unit
-under Section 403 (e), 404, or 405". By definition in Section 402 (24) an
industrial source includes "units" (defined as a fossil fueled combustion
device) that do not serve a generator that produces electricity,
nonutility units and process sources. The differentiation between units
and process sources indicates that industrial boilers" are separate from
the definition'of.process sources.
If an industrial unit opts-in under Section 410, what emission rate is
used to calculate its allowances?
..
Section 410 (c) indicates that a non-affected unit (which for the
purposes of this paper will not include process sources) that opt-in
will be issued allowances based on the lesser of the unit's 1985 actual or
allowable emission rate. If the unit did not operate in 1985, the lesser
of the actual or allowable emission rate from a .later year, as determined
by the Administrator, will be used. This implies that full credit will be
given to these units even if the emission rate is greater than the Phase ,
1 and Phase 2 emission limitations of 2.5 Ib/MMBtu and 1.2 Ib/MMBtu,
respectively!.. At the December 1990 Allowance Trading Subcommittee
Meeting, Joe. Goffman confirmed that this was the legislature's intent.
He indicated that the unit's allowances would be part of the industrial
source inventory used by EPA to track and quantify emissions from these
sources. , -
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What procedure will be used to determine eligibility under the opt-in
provisions? How long will this process take?
1 *~ '(-' .
Section 410.(a) indicates that "An .election shall be submitted, to the
Administrator for approval, along with a permit application and
proposed compliance plan". EPA has indicated that a standard
application form wpuld be created for affected units. This type
of standardized form would'also-be useful for streamlining opt-ins.
It also appears, given the discussion in bullet #2 above, that the
submittal of compliance plans will only be applicable to process units
which need to clean up to reach the emission limitation determined to
be acceptable by the Administrator under Section 410 (d). This
emission limitation would then be used to calculate the number of
allowances to be issued. The lengtrrof the election process is also of
concern since the creation of allowances under Section 410 may become
a tool to support financing of IFF projects before the allowance market
fully matures. ..
Can a unit clean up sometime after the date of enactment but before
promulgation of the regulations and still receive allowances for the
interim period provided that opt-iri requirements are met?
A non-affected unit (as defined above) may reduce its SO2 emissions
after date of enactment but prior to promulgation of the opt-in and
. permitting regulations.1 If, subsequently, this unit applies for opt-in
and meets the requirements set forth in the regulations, it will
receive allowances based on the formulas in Sections 410 (b) and (c).
If 1985 data is not available, some pre-date of enactment data should
be used in order to ensure full credit to the unit. If the unit has
reduced emissions in order to create saleable allowances under the
opt-in provisions, will it receive allowances for the operating period
between date of enactment and official opt-in? This seems fair given
that the benefit is also realized during this period.
Will units opting in under Section 410 be subject to the NOX reduction
requirements in Section 407?
Section 407, through omission, excludes units opting in under Section
410 from regulation as affected units with respect to NOX reduction.
This seems logical since it is unlikely that a unit would opt-in if it is
subjected to. the cost associated with both NOX and SQz reduction costs
While it may seem unfair to give opt-in units the benefit of
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allowance issuance without the downside of NOX reduction, the
legislature has intentionally offset this through the provisions in .
Section 410 (0- This section prohibits opt-in units from banking or
transferring allowances produced as a result of-reduced utilization or
shutdown, a limitation which is not placed on other affected units. This
ensures fair treatment under the Amendments and full environmental
benefit. . , « ,,
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X FUTtmES MARKET IN SOZ EMISSION ALLOWANCE CONTRACTS
Can it facilitate the achievement of market based *
cost reductions in pollution control?
By Philip'J. .Senechal , January 4, .1991
INTRODUCTION! " '. ' * '
How that we have all agreed that we are not,going to .freeze
in our tracks in front of this innovative act, let's reestablish
some basic points. '',..'
The intent of TITLE IV of the Act is to .reduce Acid
Deposition, encourage energy conservation, and the use of renewable
and clean alternative'technologies among, other things. However,
coupled with that intent, a market based .pollution allowance
trading-program was designed to serve a number of purposes, not the
least of; which is to provide .incentives to reduce emissions. The
arguments .in the balance of this paper do not .ignore .or address the
fact -that the primary purpose of the Act is to reduce pollution.
All issues here are secondary to the environmental goals'. . .
The market based system was provided to reduce compliance
costs, and provide opportunity for new units and growth, while
adhering to the environmental goals of the act. If the program
works as intended, reducing emissions'will not be as economically
painful to those targeted as pollution reduction programs have been
in 'the past. The implications are significant.' If it is
successful,, it can be a model .for potential solutions to other.
environmental .problems. including the global warming issue that we
are now facing. The only.way it can wprk is if those utilities who
can comply at relatively low cost, over comply and sell allowances
earned to those who can not. , :
The best chance for this program to be successful is to have
an open, active and liquid market.- .
1 «* " - ' «"
DEVELOPING THE MARKET; . - ?
.. Because of the .conservative nature of the utilities and the
consumer issues that "state public utility commissioners must deal
with,: there is a legitimate concern that the-market will not start.
Some utilities will argue that.:if they take action to either over
comply, ,or under comply, and sell .or buy .allowances respectively,
their actions could be deemed imprudent. The other side of that
argument'might be in the presence of .an active and liquid market
that public .utility commissioners might deem a utility acted
imprudently if it did not take advantage of .relatively obvious
market opportunities. These issues .make utility compliance
planning very difficult at this point. . specific environmental
deadlines/have to be met. Some utilities are already on the
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critical path for planning, designing and building emission control
equipment. Yet it is not clear, in terms of total compliance,
whether least cost means doing the minimum to meet the mandated
requirements, or over complying, and selling allowances to generate
revenues. The utilities and the public utility commissioners would
greatly benefit from a clear vision of the real marketplace.
Utilities would have a better idea of what least cost really is;
and public utility commissioners would have better information on
which to determine prudent or imprudent behavior. With market
information readily available, all affected parties can take more
comfort in their decisions/ and feel less anxious about ex post
facto criticism.
AUCTIONS;
The drafters of the Act, concerned about market failure, have
partially addressed these issues by requiring fixed price sales and
different types of auctions of allowances obtained through a tap
of 2.8% of the total annual allowance supply. The sales and
subsequent auctions are to not only insure a supply of necessary
allowances for new units and I.P.P. 's, but also to stimulate
trading activity, by providing demand and value information. At
the December 12 ARAC subcommittee meeting there was significant
debate about the feasibility of published volume and price
information. The issues were not settled. However, there should
be no debate. Without full disclosure of the auction sales volume
and price information no signal will have been sent to the market
and the auction will have failed to serve its purpose.
To a certain extent, an auction that is well planned and
publicized may indeed help to start the market. It will provide
a source of allowances for those I.P.P. 's and others who need to
buy them. However, it will not necessarily provide clear enough
information about what the true value of an allowance is. If a new
source or I.P.P. can not negotiate a sale with a legitimately
cautious utility, and has no other recourse but to pay $1,500. for
an allowance in a fixed price auction, the benefits derived by the
parties in the transaction are not likely to be balanced. At a
minimum it provides an available source for those who must purchase
allowances to operate or continue to operate*
If, however, the market develops such that it becomes liquid
and active, the auctions may not be successful (relative to other
auctions) , or necessary. If allowances are being actively traded
at prices lower than $l,500/ton, it is unlikely that anyone will
choose to buy them at an EPA auction for $1,500. Prudent buyers
would go to the marketplace to get the best deal. So who loses?
Nobody loses in this case. In an ideal marketplace, buyers
will agree to buy at prices below their marginal cost of compliance
and; sellers will sell at prices above their marginal cost of
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compliance/. If. other risk factors are -considered, the distance;
from marginal cost will be. a little greater.- Those transactions
will provide the optimum benefit to all,parties involved. Benefits
will be distributed wore evenly and therefore more desirably than
they .would in a fixed price auction with no other recourse.
; .The spot sales and private vauctions ' which are. to be.
administered by the EPA,f provide, a: better representation of the
real value of allowances. It 1 was" debated whether, these auctions
should be private or public. < Also, at issue is how sellers and
bidders,should be matched, rRather than address the specific issue
of auction .mechanics/ the purpose of this paper is to-advocate free
.and -open markets. ';,..; it is enough to say at, .this point that- any
auction designTthat .manipulates the outcome is not likely to be.
balanced and .if~ it is not, we are not providing the optimum result
to all interested parties,:individually or. collectively. If the
market develops .on its own/, these issues are probably moot'.
Sellers and.buyers without an unbalanced advantagerwill avoid a
manipulated .auction'; If real values are ^higher than $1,500.,
sellers will only grudgingly turn over 2.8% of their allowances as
mandated for the fixed .price, sale. ; If values are lower than
$1,500., the EPA may not have any bidders and' will eventually get
out of the auction business. If the EPA facilitates the rapid
development of an open public market,.', many of 'these problems can
be avoided. , . -.-. ., . .' .... . . '" V ' - .!.'. .;.-"
DEVELOPMENT.OP A FUTURES MARKET! - .
The'development of: a-futures market concurrently with the
developments of.,a cash market could accomplish this': task.. .According
to Sandor ("Some Preliminary Thoughts on the Feasibility of a
Pollution "Allowance Futures .'Market1',. Attachment A),, the
simultaneous" development of futures,and cash markets is possible.-
An active futures market can provide many'benefits to everyone
including the EPA. ., - ;,'-..-- » - ;. ....
* '4, * ,- <..,.
ADMINrSTRATIVE iBENEFITSi : '-.
One of the tasks facing the EPA is the establishment of a
dependable tracking system for the allowances that they issue. It
is important to know when one-is issued, .when it .is sold,-who now
owns it, and finally, when it is delivered.1 Philip O'Connor,
chairman of the subcommittee on allowance.trading, and others, have
suggested that each allowance ,be given.a serial identification
For this and later discussions, the word delivered means
that a utility consumes the allowance .by emitting one ton
of so,.. . .' ..-,.-:' '/ ..,_';_.
» . 1- '«.. ^
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number (S.I.N.) not only for this purpose, but'also to provide the
mechanics for the establishment of a database for future research;
This is a good starting point but a wider list of specifications
may ultimately have -to be added. The establishment of SO,
allowance futures contracts could provide the EPA with a simple
mechanism for dealing with this task.
Future contract transactions, whether they be agricultural,
options, or financial instruments, are conducted by the clearing
house for that particular exchange. Each time a trade occurs, the
clearing house acts as an intermediary and takes the opposite
position on all contracts. The exchange publishes all prices,
volumes, and open1 interest. This can be of significant value to
the EPA and may provide the basis for an efficient tracking system.
Furthermore, the futures market -in and of itself provides
information about the physical market, because futures markets
become cash markets at delivery time. The exchange can in fact
operate a physical market as well as a futures market. it is
possible that they could be persuaded to do so for SO, allowance
transactions.
3ENEFITS TO CONSUMERS. SHAREHOLDERS AND UTTMTTESi
Assuming that the closer the selling price approaches the
marginal, or expected marginal cost in a risk-free market, the more
equitable the outcome will be for all direct and indirect
beneficiaries of the transaction. It is possible that a futures
contract for S02 emission .allowances can facilitate this process.
The problem remains that the utilities still know too little about
the potential success of the cash market to comfortably risk
investment in overcompliance, in anticipation of of f sett ing revenue
streams. Another probability is that if there were only 2 groups
of utilities and one had a marginal compliance costs of $500. and
t*ieJ^£n*r had a marginal compliance costs of $1,500. per ton, and
bottf Vere to continue to exist, it is likely that the later would
buy allowances from the former and there would be economic benefits
realized by both. In fact, without a clear view of the market, the
utilities are concerned that their decisions and actions would not
pass a prudency review. However, in the presence of an active and
liquid futures market, this utility fear can be minimized.
The presence of the futures market can give the utility
current information so that they can hedge their positions, and
thereby transfer the risk of holding allowances, deliverable in the
future, to speculators who are professional risk takers. Those who
take long positions risk a reduction in value. That risk can be
offset or reduced by taking opposing positions in the futures
market. It is possible that the speculators can provide early
liquidity to the utilities which can not only minimize risk but
also offset the carrying cost of the compliance equipment.
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Sandox*, Teweles and Jones imply that this marriage of speculators
and hedgers . is one of the necessary ingredients of a successful.
contract. > Very, active trading could help to establish a realistic
value for allowances. Working says that hedgers are motivated to
do so by the, following: .'.''.
'"'"'. ' . ' *
l. -: It facilitates buying and selling decisions.
2. It gives greater freedom for business action.
3. It gives a 1 reliable;basis for storage of commodity
surpluses. ' ' ''-. «
4. Hedging reduces business risks/
The ultimate benefits to >: utilities, shareholders, and.
consumers in an allowances futures market"'- would be similar,.
Although it is not a primary purpose 'of the futures market, it does
present the best opportunity to sell a particular allowance at the
best price, and therefore make the market more efficient. This
best view of the market will facilitate decision making.
The continuing concern of utility executives is that they will
not derive any real benefits for their companies and consumers
through this mechanism.^ They would have been happier with simple
cost sharing. However, in many conversations that I have had with
utility executives, who would be responsible for the purchase or
disposal of allowances, I observed several.things. One is that
almost universally these executives are skeptical about the success
of the market. They are. also concerned about multi-state
operations and .conflicting regulations. Generally, however, they
feel that if the market develops well, they would be likely to
participate as actively as they can. In fact, allowances would
become another product to be manufactured, and purchased or sold.
Contracting and trading strictly among utilities could be slow and
cumbersome with some -.transactions taking months if not years to
Richard .L.. Sandor, "Innovation By An Exchange: A case
Study of the Development of the Plywood Futures
Contract." Journal pf Law and Economics. April 1973, page
'126.. '' '- ' ..'..-:
Teweles & Jones,, The Futures game. Who Wins. Who Loses.
Mix, 2nd Edition, 1987, pages 41 - 53.
Working, "Hedging Reconsidered/11 Journal of Farm
Economics. 35, No. 4, November 1953, pages 544 - 561.
Teweles & Jones, The Futures Game,. Who Wins. Who Loses.
., 2nd. Edit ion, 1987, page 35.
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oo
consummate. This has already been demonstrated in transactions
that have taken place under the California program, for airborne
pollutants. . ,
Futures trading can provide an alternative. Futures trading
is likely to be much more active than cash markets. In fact,
futures trading volume can be 20 or more times higher than actual
physical transactions before delivery finally takes place.*
Although futures prices are not necessarily the same as actual cash
prices, they tend to move in parallel. As the time of delivery
approaches, the futures price tends to converge with the real cash
price. This activity will provide those who need to buy and sell,
the best view of what allowances are worth at any given point in
time. Economists and regulators refer to -this, as price discovery.
It has been reported that some contracts are successful because
speculators who are acting as market makers on the floor of the
exchange, will buy and sell at any reasonable price initially to
help develop a liquid market.7
If all the above is true, is it realistic to think that a
futures market could develop? It is beyond the scope of this paper
to try to provide a detailed accounting of the ingredients
necessary for the establishment of a viable futures market for SO,
allowances. in general, however, it appears that the proper
conditions do exist. sandor describes this in more detail in
Attachment A. But as the process develops, much more analyses will
have to be done.
CONCUJSIQN; .
Consumers, utilities and their shareholders will benefit if
the market based pollution allowance program develops to the
fullest extent possible. The market is likely to work the best,
and the utilities can make the best decision with the least
criticism, if information about demand and value is readily
available. A market independent of manipulation can best serve
this purpose. A futures market in S02 allowances can help develop
and demonstrate the true value of allowances, it can also provide
the mechanics for delivering that information to those in the
market while relieving the EPA of an administrative burden. It is
possible that the utilities can minimize capital carrying costs.
Towolea & Jones, The Pictures Game . Who wins f Who Loses .
2nd Edition, 1987, page 23.
Richard L. sandor, "Innovation By An Exchange: A Case
Study of the Development of the Plywood Futures
Contract,11 Journal of Law and Economics. April 1973.
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They can minimize risk of price and supply changes by hedging their
positions and transferring the risks to speculators. The futures
market Which is likely to be much more active than the cash market
provides utilities the opportunity to both buy and sell when prices
are most favorable to them.
'-.».' __ . p .
Generally consumers, shareholders and the utilities will
benefit from lower total compliance costs. Not forgetting that the
intent of the Act is to reduce pollution, an active market makes*
compliance more palatable economically. With its success, future
environmental problems can be addressed with a higher level of
confidence and lower level of confrontation.
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- L- - r v o i-1 -
G.L. (J«rry) Gunter
Commissioner
State of Florida
Public l&etfnce Commission
January 16,1991
' FLETCHER BUILDING
101 EAST GAINES STREET
TALLAHASSEE 32301-8153
(904) 488-5573
TO:
FROM:
Members of the Acid Rain Advisory Committee
Subcommittee on Allowance Trading,and
Commissioner G.' L (Jerry) <
'Florida Public Service Commission \\ *^>
SUBJECT: Issues Associated with Implementation of Title IV of the Clean Air Act
Amendments of 1990
What follows is a brief discussion and identification of issues associated
with implementation of Title IV of the Clean Air Act Amendments of 1990. Clearly, this
discussion is not exhaustive-nor is it meant to be. Rather, the discussion attempts to
identify some of the issues specific to Florida,.as well as some issues not yet fully-
discussed in subcommittee.. . .
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"L C'UBLIC '--ERUKE COHM '^04-4*7-0509' Jan -17.91 11:2':> No .014 F.03--11
OUTLINE
^llSisloSiA^
A major issue for the State of .Florida will be the mechanism chosen for allocation
of growth allowances above the 40,000 ton limit imposed by the CAAA. Evidence
clearly indicates that a difference of more than 40,000 tons would be created if all
utilities in Florida chose the three most advantageous years between 1980 and
1989 for their unit baselines. The alternatives currently are:
- the method currently being used by E1A/EPA (basically, a ratio of utility growth
allowances to total slate growth allowances without regard for the 40,000 ton
limit), or
- an alternative method, favored by some Florida utilities, utilizing a ratio of total
utility allowances to total state allowances, including baste, bonus, and growth
allowances (claims are that this is the "intended" method)
How should an allowance tracking system be designed?
- what are the theoretical requirements for efficient markets?
how should allowance pools be treated?
* for example, will pools be allowed to "balance" for all participating units, or are
year-end requirements unit specific?
/
How much information will be required to ensure a fluid and working allowance
trading market? .
should EPA require "full disclosure?"
merely amounts, but not dollars or names?
- amounts and dollars?
Will separate information requirements be necessary for private trades versus the
EPA-run auctions?
Should the EPA auction be followed by the "private" auction utilizing the same pool
of bidders? or,
- should the private auction be a separate bidding?
should the private auction have the same structure?
How should EPA structure the annual auctions required in the CAAA? Are there
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statutory limitations on available choices?
discriminating price auction
- uniform price auction
second-price auction/
-' " " *
Will EPA run the auctions or appoint an agent?
1 How often will accurate allowance balances be available?
.*!*"
-' will trades be recorded in a timely manner?
- will potential traders know the availability of allowances?
How will "designated representatives" be designated?
what will be done, re: holding companies?
will Gulf or Southern Company Services be the owner/operator of "Gulf
. Power" units?
* how will FERC interact with state commissions with respect to interstate
trading of allowances?
* who, if anyone, decidcs'prudence? .
How will requirements of other sections interact with the acid rain title?
for example, will air toxics requirements preempt steps taken to meet acid rain
requirements down the road?
Will it be possible for persons participating in the EPA sales of allowances to satisfy
the 50 percent payment requirement in ways other than certified check or cash?
e.g., letter of credit
' * *
How will losing bidders receive refunds? ... . .
* - ' '**
Will a "true-up" period be allowed atyear end? ' . _ '_ t-\
''.r . .; '.' ''''"':
how Jong will the period be?
Will it be possible for utility owners/operators to modify their required March/June
1991 election concerning methodology for allocations of Phase 1 and Phase II
allowances if circumstances or data change? . ,
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ID
*
DISCUSSION
Growth State Provision. {Section 405(i)] In addition to allowances allocated
pursuant to other subsections of section 405, and section 403(a)(I), beginning January 1,
2000, units subject to emissions limitations under section 405(i) [those located in "growth
states"] shall receive additional Phase II allowances pursuant to a formula contained in" '
section 40S(i).1
The formula essentially allows the owner/operator of each subject unit to choose
the "most favorable" three consecutive years between 1980 and 1989 for baseline
calculations. However, there is a 40,000 ton cap on the number of additional allowances
to be allocated pursuant to section 405(i). Estimates are that Florida utilities would
receive approximately 126,000 tons in aggregate pursuant to this formula if no tonnage
cap was imposed. Thus, the number of allowances allocated to the individual utility units
must be "pro rated"-therein lies the debate.
Unfortunately, no mechanism for distributing the 40,000 tons pro rata is explicitly
included in the language of the final legislation-thereby allowing various interpretations.
Generally speaking, the parties to the debate seem to favor one of two mechanisms.
Method #1 entails development of a ratio of total utility to state allowances by which
the 40,000 tons will be weighted. In this method, all allowances (basic, bonus, and
calculated growth) are used in the calculation. On the other hand, method #2 calculates
the ratio using only calculated growth allowances without regard to the 40,000 ton
stale* are defined as those that (a) experienced a growth in population in excess of 25 percent
between 1980 and 1988, and (b) that had an installed electrical generating capacity of wore than 30,000,000 lew
fa 198&YU, Florida.
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v/
"''*/'' ' ' 5
limitation.2 At the present time, advance allowance calculations by the EPA/EIA utilize
" h ' . *'"-.. * -
; method #2, whereas the supporters of meihod.#l claim that method #1 reflects
legislative intent. .- .
.''* ' '' - ' ' . - ' ' ' " ' ; .
,, Although bolh interpretations-may be supportable, method #1 most closely tracks
the language in the final legislation.3 However, if the provision is meant to offset
growth, or expected growth within Florida, method #2 is probably more appropriate
since it would allocate a larger percentage of the 40,000 tons to Florida Power and
Ught-the largest and fastest growing utility in FJorida-than would method #1.
' . ' . «* -
Allowance Tracking System. The development of a working and efficient
allowance trading market critically depends on the implementation of. a well-designed
allowance tracking system, lliercforc, guidance might be sought from the economics
." v . ,
literature describing requirements for efficient markets (Pareto optimality).
- In general, an allocation is Pareto optimal if and only if no person can be made
better off.without making another worse.off.4 The principle to be established is this: the
allocation of resources In an economy is efficient in exchange if and onfy if the marginal rate
' *. ..-":'..«*' v* - '.. '
*C«1.1 - (Utility's Bask Allowances + Bonus Allowances 4 Calculated Growth Allowances] / [Total State
Baste Allowances + Bonus Allowances t CufcuUlcd Growth Allowances] x 40,000 - Share
,*''*,' ' " '.' -..*''.' ^ * ' ' ' "
Cal. 2 fUlflil/s Calculated Growth Allowances] / (Total Slate Calculated Growth ARowanccs].z 40,000 =
Share _ -, . - . . '' _ . ' . - ' '
. *A» well as tbo definition of "pro rata" as coataioed in HH. 3030 as paucd by the U^. House of
Representaliws* Commillcc on Energy and Commerce. [See Report 101-490, Part I, p. 651.] .
4. "' '*'* * ' ' ' " ' '
*Morc spedifkally, Pareto-optlnuIUy rciquires: (1) c/ficicncy in exchange, (2) efficiency in production, and
(3) eflkieney of the product mix. Some economists, notably Abba Leriter, add a fourth criteria, that of
distributional efficiency/ ' . *
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yz_
6
<
of substitution (MRS- ) of one good for another is the same for each person consuming
both of. the goods."rS
In practice, an individual's MRS^ involves a subjective evaluation of satisfaction
(utility in economics jargon). Any time that two consumers of each good have different
MRS values, there is "room for a deal." Overall efficiency requires that the MRS be
equal between any two consumers, and between any two goods in the economy. Clearly,
we are not likely to meet this rcquirenient-for reasons too numerous to discuss here.
However, in the market for allowances, one might hope to achieve an equalization of the
MRS between two broad categories of "goods": emissions allowances (x), and control of
emissions (y). The allocation of allowances would then be efficient only if the MRS^ of
allowances (x) and of control (y) is equal across utilities.6
, * . + *s
'As noted in Friedman (1984), "if a policy results in at least one consumer of a good
being charged a price different from the price charged other consumers of the good, the
policy will generally be inefficient. * 7 In application, assuming economic agents have
'well-behaved preferences and production technologies, any Pareto-optimal allocation of
resources can be achieved as a general competitive equiltbriunv-as long as costless
transfers of initial endowments are allowed.8 The requirement that transfers of initial
endowments be costless is especially important for our purposes. A well-designed
5Sec Lee S. Friedman, Miprneeonomic Policy Analysis McGraw Hill, New York, 1984:28.
T"hi» analysis b sligbtly more complicated than portrayed here since control may involve production, as
might U«c creation of cntiasioiu allowances. ' -"
7Scc Friedman (1984), p. 30. '
ibkL, p. 385.
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allowance tracking system can help easure that this requirement is met. Lack of
.-''' ' ' ' ;1?' '>-.';"''
information regarding supplies of allowances on the part of potential buyers will entail '
expenditures, possibly, substantial, to acquire sufficient information on which to base
compliance decisions and. allowance trades. Therefore, as much information as practical
.'-..'-. ' ""-,,
regarding allowance allocations and trades should be gathered and made public by the
EPA, as soon as possible. . >[':-
A separate issue associated with the allowance tracking system is whether a ./'
"true-up" period will be allowed.following each year's allowance auditing. That is, at the
..- . V .'-'"' - - - '/' . '-.''" ' ' .'. .v''",'
end of each calendar year, should the owner/operator of each utility unit be allowed to
:: \, *", / " .._ ... ', .'';" ' . '.-'" . '' / '"
augment his allowance balance during, say.. .a three-month true-up period? Since
' '<- .*'.-" -.
allowances are issued annually, there should be no logical reason to forbid use of a given
year's allowances to offset emissions during that year, even if the allowances were
._'.'"'' , *J.
acquired following the year-end. ' . ,
'-."»..' ' > " , ^ >'-.:
' ' *>, '..' '.-'- ->.'
Still another issue surrounds the availability of accurate emissions allowance
.-, - -X -"' " :?:> '';'. '.": '",* -:":^' '." " ' .'* "-.
balances. How often will the balances be updated and, made available to potential
i%. '"'/ ->.'.-:- < *A' -'"'_ '. . '-."" .' '
allowance traders?: An accurate and readily available array of account balances would
'" '. » . ** : J ' "
.,.-,_,. '-=>.»' '-'.-'.'. '"-.' '' *' '''- '" ' '/'' 7-"- ".'.'"
help ensure a fluid and active.market for allowance trades. ".
...... - '.- .. / :- ''.' ' "-'' ' '': * '' :\ "-/; ;"" -^i-
A further problem may arise with respect to accuracy of/account balances: the.
... .-.-"',.._.,' ;,i^';,.....'"".' '-.^ . ;'"'«' '' ' ''-'"'
issue is, when do trades have to be reported to the EPA for subsequent recordation?
Although no specific lime frame is specified within the legislation, it would seem prudent
for the EPA to specify "reasonable" time frames'in its. regulations, perhaps .within 30
days, 60 days, etc.
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* " '...... 8
EPA Auctions. The Clean Air Act Amendments of 1990 require that the EPA
hold annual allowance auctions beginning in 1993, for both "spot" and "advance"
allowances. These auctions are expected to operate as both a last resort for those
needing allowances, as well as a "pump priming" mechanism. A number of issues arise
with respect to these auctions. First, does the Act allow a choice of bidding
mechanisms? And, if so, how should the auction be designed? Second, how much
information must be released following completion of the auction-must names of
i ^
winning bidders be announced? Third, will the EPA run the auction or appoint an
agent? Fourth, should the -EPA auction be immediately followed by the "private" auction
of allowances submitted for EPA disbursement? Fifth, should this private auction have
the same structure as the EPA's auction? Can it? Sixth, how will losing bidders receive
* **», ' ' .
deposit refunds?
Another interesting question arises with respect to eligible bidders. The
legislation does not appear to preclude "hoarding" on the part of speculators-perhaps
\'
resulting in the possibility of groups (like the Nature Conservancy) purchasing allowances
with withholding being the express intent of the purchase-thereby effectively reducing
i ' '
the operating cap. More importantly, what provisions need.to be made to guarantee
against financial failure of allowance brokers or speculators?
Permit*. A number of issues also arise with respect to implementation of the
permit provisions.* For example, will utilities be allowed to modify selections of
allowance allocation methodologies after such choices in early 1991?. What if the data
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underlying these choices are found to be faulty in retrospect?
Closely related to this problem is the question of the detail to be required in
compliance plans and permit applications (both Phase I EPA permits and Phase II state
permits). Although EPA position papers imply little data will be required of affected
units planning "normal" compliance, what assurance is there that this "low-level" data
requirement will be carried forward throughout the rulemaking process? Only if such is
the case will compliance flexibility be maintained-hclping to ensure that least-cost
compliance remains feasible.
Other Issues. Various other issues also exist. Some of these will likely have
* simple solutions, while others.may require more study. For example, the legislation
requires that persons desiring to purchase allowances under the EPA sales provisions pay
50 percent of the amount owed within 6 months of approval of the request to purchase.
*' - * '
* > *
T$teurrenl presumption appears to be that such a requirement could only be satisfied.
by actual transfer of funds. However, there are numerous financial instruments available
that might equally satisfy the deposit requirement, while allowing the purchaser to
*'* *. '
continue earning interest on his funds unti! the time of actual asset transfer.
Related issues arise with respect to EPA auction bids. For example, how will
bidders "authenticate" their bids? Will deposits be required? And, if deposits are
required, bow will losing bidders receive refunds?
Clearly, a mechanism to "weed out" sham bids would be useful. However,
substantial sums of money will be involved, and lost revenue on funds tied up in the
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' <4
EPA process could also be substantial. As in the sales discussion above, a financial
instrument that allows continued earnings accrual while ensuring the seriousness of the
bid would be preferable to requirements that funds actually be submitted with bids.
As noted previously, the intent of this discussion has not been to identify, nor to
resolve the multitude of issues facing ARAC and EPA. Rather, the intent has been to
identify and discuss a few of the major issues facing us in our attempt to fashion
regulations implementing Titles IV and V of the Clean Air Act Amendments of 1990.
The regulations ultimately put in place must not only be workable, they must also
provide the structure to achieve the letter as well as the spirit of the Act.
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," t '' ^,-1 -, '' Summary, of Notes
12-14-90 Meeting on Allowance Trading & Auctions
Elections of Phase 1 & 2 Allowances .
A number of participants, had questions regarding whether
elections are'binding or permanent. In particular, participants
wanted to know if an election could be altered if the data upon
which it was based was changed by EPA.
There was onuch discussion about the availability of information
on which to base, elections and the data that EPA would have
available'to calculate allowances.
Participants indicated that the definition of the capacity factor
in terms of "potential" capacity was nebulous. Commentors urged
EPA to identify areas of ambiguity in. making elections and to
indicate its position. - EPA responded by. saying it was
.considering going*!.through notice and comment on a range of small
definitional issue. ,
; ?,"'*., - ' ' * *
One commentDr suggested that utilities should not respond on
elections and let EPA determine which election would give-them .,
the most allowances. It. was pointed out that this decision would
be non-appealable and placeVthe utility "at peril." .«=
A Florida utility questioned what EPA was doing to develop non-
1985 data., EPA responded that it.is using EIA to develop the
information and the data will be available by March or April. -
" . v - - - .'.'.
%: -v '?'
Direct Sales and IPPs -.
EPA deferred issues regarding the Direct Sales Program to a
subsequent meeting. In response to a question regarding why, EPA
listed three reasons: (1) the IPP written guarantee language is
confusing and EPA needs to clarify it, (2) the sales regulations
are not part of the. statutory deadline for March,.and (3) the
auction has a fast approaching deadline. The issues that will
have to be dealt with on Direct Sales include: first-come, first-
served, and who should conduct the sales. A commentor raised the
issue of "need" regarding "first-come, first-served'1 and -
suggested that utilities should have preference over: brokers.
Sales and Auctions
EPA began the discussion by stating the reasons the auction and
direct sales.program were included in the CAA: to deal with.
potential market failure; to deal with growth by utilities; and
to facilitate the private market for allowances. -
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A long discussion ensued regarding whether the CAA mandates a '
discriminating price auction or whether it allows for a uniform
price auction. Among the points made were the following.
- The Congressional Staffs' intent was to create a
discriminating price auction based on the House Bill.
However, the language of the CAA is ambiguous and it
may be possible to argue that it is compatible with a
uniform price auction.
- Most people are familiar with discriminating (non-
uniform) price auctions. On the other hand, people
often, are confused by uniform price auctions.
- A commentor suggested that a discriminating auction
would best serve the "pump-priming1' function of the
auction. Another suggested that a uniform price
auction would eliminate the need for strategic bidding. "
Another commentor indicated that there are different
views of how each type of auction might perform in
various circumstances and that it is not clear that one
type of auction necessarily should be favored over
another for auctioning allowances.
' - It was suggested that EPA should begin with a
discriminating auction, but that it should retain the
flexibility to experiment with or to impose a uniform
price auction if problems arise with the discriminating
auction. It was argued that utilities readily could
> "learn how to work with each system. EPA responded that
it would be at least 3 or 4 years before it would have
the time to review the performance of the
discriminating auction and, by then, the two types of
auctions probably would be indistinguishable.
- The discussion ended with apparent agreement that EPA
should begin with a discriminating auction, as this
type of auction is more consistent with the language of
the Act, it is more easily understandable, and people
have more familiarity with it.
EPA indicated that it planned to hold the spot and advance
auction on the same day and use the same bid form for each with
bidders specifying on the bid form which auction'they were
participating in. In response to a question, EPA stated that the
language of the Act requires one auction per year. The timing of
the auction will be put "on hold" because this issue is related
to the Direct Sales provision.
One commentor indicated that it planned on entering the auction
and making multiple bids. It was concerned that a requirement
that certified checks accompany all bids would result in
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unacceptably large amounts of capital to be outstanding and
suggested that other financial instruments could be used to
.insure that payment was made for allowances won at auction, e.g.,
letters of credit. . -
. ' '
:- In response, a commentor suggested that with many
/ bidders participating in the auction it would be
difficult for EPA.to check letters of credit. One
member suggested checking the DOE's, experience with the
Strategic Petroleum.Resource. ' .' - '.
.' .< .. .'".. -' .-: -. .' ' .,'.,.-,*. '- :
-Utilities were urged to explore this -issue in more -
detail .if it was important to them and to' provide EPA
with alternatives. ': , "\ ^
There appeared to be a consensus that EPA should not place any
restrictions on. the amounts or number of bids.
EPA indicated that it was considering two methods, of allocating
allowances in the case of tie bids a pro rata allocation or a
lottery. There was no discussion on the issue.
* ""
t *'"$
EPA stated that it planned to use an electronic transfer system
to transfer allowances.won at auction to the accounts of winning
bidders. ... This ^precipitated a comment that the 'allowance tracking
system should be set up to meet customer and market trading needs
and that it would be unfortunate if budget limitations
compromised the system. The commentor asked whether a franchise
system would be used in which customers would be charged for
services rendered. Under that approach regular business
incentives would insure that a "state-of-the-art" system would be
maintained. It was suggested that a subcommittee be formed to
evaluate this issue. :, .."'"
Private Auction ,
Although EPA was not ready to discuss the design of the private
auction, there was much discussion on this issue. The major
points made or questions asked in the discussion included the
following. . .
-Is the private auction required to be an extension of
the public auction .or could it be held on a separate
day?
- EPA would have great.difficulty in conducting a private
auction if it allowed all sorts of allowances to be
auctioned, particularly streams of allowances. EPA should
auction the same things it will in public auction.
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- EPA, to the extent allowed by the CAA, should stay out of
the business of conducting private auctions. This could be
handled better by the private market, should there be a
demand for the service. Although one commentor suggested
that EPA should designate a broker to develop the private
auction, most participants appeared to support the position
that the private market could best handle this function.
- The Chicago Board of Trade representative expressed
considerable interest in creating and managing a private
market^ for allowances..
- IPPs indicated that they were interested in purchasing
streams of allowances. It was pointed out that the private
market could arrange for trading of allowance streams if
there were willing buyers and sellers.
The general consensus of the discussion appeared to be that EPA
should design the private auction to be consistent with its
public auction and make the private auction mechanism available
to allowance holders but, beyond this, should not actively
compete with the private sector in facilitating private trading.
It was recommended that EPA should provide the committee with a
"strawman" of the private auction design as soon as possible.
Publication of Information fromthe Auction ' " .
EPA led off the discussion by outlining three options for
announcing the results of the auction: announcing the cutoff
price; publishing winning bids and amounts; or publishing winning
bids, amounts, and names of bidders. The CAA requires EPA to
adopt either of the two latter options.
The ensuing discussion revealed numerous points of view regarding
the information that should be supplied from the auction.
Interspersed in the discussion were comments regarding how much
information should be made available from the allowance tracking
system.
- If the function of the auction is "pump-priming11
publishing names would be useful. A utility
representative indicated that it may want to use the
names of winning bidders to identify potential
allowance buyers or sellers.
- If utilities are in negotiations at the time of the
.auction, publishing names of winning bidder would
compromise negotiations. A possible method for dealing
with this problem is to make publication of names
voluntary. If there is a market for secrecy, contracts
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can be made in the private market, although it was
.pointed out- that participants in the auction might be
able to disguise their identify.
-Many utility commissions have decided that,the details
of certain purchases by utilities, e.g., coal
purchases, should remain confidential. However, that .
treatment should not be extended to a. "publicly .. v/<
created" commodity. Utility regulators generally took
the position that the bias should be to make public' the
maximum amount of information. ' Backing away from this
should only be done for good cause.
- The representative from the Chicago Board of Trade
stated.that they are involved in many markets that have
both public and private components. Information made
available from the public components has not . , ,.
compromised the private markets. ._
This issue became a bit confused because some participants'
comments were directed at how much information should be provided
by EPA's tracking system regarding allowance holdings,and the
details of purchases and sales . . ' -
.--. . '-..'-. - - "' r '<*.*''.' " ' "-
- Some commentorSt suggested that EPA's tracking system
provide for full disclosure of all allowance holdings
.and all 'transactions. Utility commission .. . ;*_ f-
representatives indicated they would find useful :'.'
information regarding, allowance holding, of non- , . \
regulated units and units outside their, jurisdiction.
It would be less costly for EPA to provide this "
information than for utilities to develop it. .
. -' . *".,.»
One commentor suggested that, in deciding how. much
information to release, EPA should take account of the.
= needs of state utility commissions for'information, ,/.
given that they can easily-obtain such data from the
utilities under their jurisdiction.
The discussion turned to EPA's approach to designing an allowance
tracking system. The following points were made. .
- The investment community apparently-needs documentation
regarding allowances, such as a dated certificate. > .
.»' . * ' ' «*"*".*
- Utility auditors need a way of verifying allowance holdings.
- Each allowance should have a unique number identifying.
its origin. « : ". ;.
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- EPA should commit.itself to ensuring that .transactions clear
within a-certain time period;
- The participants urged EPA to develop a "strawman" of the
tracking system to focus discussion. For example,
participants wanted to know whether EPA was planning to
track individual allowances or whether the system would be a
. simple credit/debit system. ~
Opt-in Issue .
Industrial sources were concerned about uncertainties regarding
how to resolve this issue.
One commentor suggested that it was unfair for industrial sources
to generate excess credits from their baseline emissions, as
opposed to a 1.2 Ib/mmBTU standard. It was pointed out that this
is what the CAA requires and that the object is to bring such
sources into the system.
Concluding Remarks
The Chairman suggested that interested parties should submit
materials to EPA and raise issues at least one week in advance of
the next meeting (although participants are free to send
materials through other channels) and urged participants to
becomeeducated and to develop positions on upcoming issues. He
suggested it would be useful for EPA to: (1) catalogue consensus
versus contentious issues; and (2) provide a legal opinion- on
some issues to'resolve arguments.
The Chairman also indicated that he will set up meetings with
people who are active in running markets similar in nature to the
envisaged allowance market. (The Chicago Board of Trade
representative offered his assistance.) He indicated interest in*
exploring the issue of what PUCs need in the way of information
an how allowances may be treated in an accounting sense.
Miscellaneous Closin
Arthur Anderson indicated that they and other public
accounting firms are beginning to think about how to
treat allowances in an accounting sense.
Paul Joskow suggested that it would be useful for the
group to have some sense of EPA's position on -program
evaluation. EPA responded by saying it is drafting a
program implementation strategy.
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-?- A workshop has been scheduled by NRRI to be -held in
Arlington (Jan. 30 and 31st). Ken Rose is to provide
some materials (on the data base) to the group.
''**'.
It is important-to get the regulatory role of POCs and
state environmental agencies relative to the allowance
system "on the table.11 ; .
Follow - Up Activities
. Request for a briefing on EPA1s program evaluation efforts
Send out list of subcommittee.membership
Send out minutes of meeting
Send address list of Allowance System Branch
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