Office of Inspector General
Evaluation Report
Open Market Trading Program
for Air Emissions
Needs Strengthening
Report No. 2002-P-00019
September 30, 2002
ooo
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inspector General Offices
Conducting the Evaluation:
Office of Program Evaluation
Southern Audit and Evaluation Resource Center
Regions Covered:
Regions 2 and 5
Program Office Involved:
Office of Air and Radiation
Abbreviations
CEMS Continuous Emissions Monitoring System
EPA U. S. Environmental Protection Agency
NAAQS National Ambient Air Quality Standards
OIG Office of Inspector General (EPA)
OMT Open Market Trading
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UNITED STATES ENVIRONMENTAL PROTECTION AGENCY
WASHINGTON, DC 20460
OFFICE OF
INSPECTOR GENERAL
September 30, 2002
MEMORANDUM
SUBJECT:
FROM:
TO:
Report No. 2002-P-00019
Open Market Trading Program for Air Emissions Needs Strengthening
Kwai-Cheung Chan /s/
Assistant Inspector General for Program Evaluation
Jeffrey R Holmstead
Assistant Administrator for Air and Radiation
Attached is our final report on the Environmental Protection Agency's (EPA's) Open Market
Trading (OMT) Program The objectives of our evaluation were to determine (1) whether EPA's
basis for proposing to approve selected air emissions OMT programs was adequate; (2) the extent
of use of EPA-approved emissions quantification protocols and whether accurate, reliable data
underlie OMT trades in these programs; and (3) the extent of EPA and state compliance assurance,
enforcement, and oversight activities relative to OMT trades.
This report contains findings lhat describe problems the Office of Inspector General (OIG) has
identified and the corrective actions the OIG recommends. This report represents the opinion of the
OIG and the findings contained in this report do not necessarily represent the final EPA position.
Final determinations on matters in this report will be made by EPA managers in accordance with
established resolution procedures.
ACTION REQUIRED
In accordance with EPA Order 2750, as the action official, you are required to provide this Office
with a written response within 90 days of the final report date. The response should address all
recommendations. For corrective actions planned but not completed by the response date, please
describe the actions that are ongoing and provide a timetable for completion. Where you disagree
with the recommendation, please provide alternative actions for addressing the findings reported.
We have no objection to the release of this report to the public. We appreciate the efforts of your
staff, and the staff in the regions and states we visited, in working with us to develop tins report.
Should you or your staff have any questions, please contact Rick Beusse, Director for Program
Evaluation - Air Quality Issues, at (919) 541-5747, or John Bishop, Project Manager, at
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(919) 541-1028. Additional copies of this report may be obtained from us or our website,
www.epa.gov/oigearth.
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Open Market Trading Program for
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Executive Summary
The Environmental Protection Agency's (EPA's) air emissions Open Market Trading
(OMT) program was created to provide sources with greater flexibility in meeting Clean
Air Act requirements. The OMT program allows sources to use emission credits
generated from past emission reduction efforts to meet other requirements. Credits can
be held for later use, sold, transferred to another company location, or permanently
retired. OMT programs are usually voluntary, involve a variety of sources, and do not
have an expressly defined cap, or limit, on the amount of emissions available for trading.
EPA anticipates significantly greater OMT program participation in the future.
Purpose
The Office of Inspector General initiated this evaluation as a result of concerns raised by
two environmental groups that EPA's OMT program contained fundamental problems.
Of the three States lhat have applied to EPA for approval to operate an OMT program,
we evaluated the two States - Michigan and New Jersey - with the most active
programs.1 The objectives of our evaluation were to determine:
EPA's basis for proposing to approve selected clean air OMT programs and
whether the basis is adequate.
The extent of use of EPA-approved emissions quantification protocols2 to calculate
tradeable emissions credits in selected states' OMT programs, and whether
accurate, reliable data underlie OMT trades in these programs.
The extent of EPA and state compliance assurance, enforcement, and oversight
activities relative to OMT trades, and whether OMT programs affect the ability of
regulatory agencies to detect and/or deter noncompliance.
Results in Brief
Several factors hindered Hie two OMT programs we reviewed from achieving their
goals. Foremost among these factors were the lack of safeguards, use of data of
uncertain quality, and limited regulatory agency oversight of trading activities. Many
sources have opted not to participate, and the problems in one State (New Jersey)
have become so significant that it has announced its intention to terminate the program
According to EPA, the other State - New Hampshire - had less than 10 emissions credit transactions as of
June 2001.
Emissions quantification protocols detail the actions or activities that sources will undertake to reduce
emissions below previous (historical) levels, as well as the type and quality of the measurement method(s) that will
be employed.
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OMT Programs Lacked Safeguards
The Michigan and New Jersey OMT programs lacked key safeguards primarily because
EPA's basis for proposing approval of these programs was non-binding guidance
documents instead of regulations. As a result, the two EPA Regions did not require the
two States to implement all the safeguards that EPA's guidance documents indicate are
needed to minimize the risk of invalid and questionable credits. Examples of missing
safeguards follow.
Opportunity for public comment on proposed trades not provided. Although
the public is supposed to be able to not only see proposed trades in advance but
also have the opportunity to participate in the decisionmaking process, neither the
Michigan nor New Jersey OMT programs provided the opportunity for public
comment on proposed trades.
Shutdown credits allowed in one program. No credits are to be allowed for
facilities that shut down their operations in one State because of the difficulty of
ensuring that these activities are not reinstated in another State. Nonetheless,
shutdown credits comprised about 23 percent of Michigan's total OMT credits,
and about 80 percent of the State's volatile organic compound emissions credits.
EPA officials explained that EPA did not issue OMT regulations because, in response
to EPA's only attempt at issuing regulations, State officials expressed concern that such
regulations would impede their flexibility in designing OMT programs, hi its response
to our draft report, EPA reiterated its support for use of non-binding guidance, but we
continue to believe that the safeguards in the Economic Incentive Program Guidance
need to be required through regulations.
Uncertain Data Quality Underlies OMT Trades
Accurate, reliable, and complete emissions data are essential to the success of EPA's
OMT program. However, we noted the following factors that contributed to uncertain
quality of the OMT data underlying trades we reviewed:
Approved quantification protocols not used. Our reviews of 84 randomly
selected trades in Michigan and New Jersey disclosed that no EPA- or State-
approved quantification protocols were used to calculate credits. Not using such
protocols increases the risk of credits being invalid and unreliable.
Many emissions measurement methods questionable for trading. Better
quality data is generally needed to calculate OMT credits than to assure facility
compliance with emissions standards. Compliance measurements only need to
ensure that emissions levels have not been exceeded, while OMT measurements
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need to be more precise to calculate the amount of extra emissions saved.
Continuous emissions monitors produce data sufficient for trading purposes, but
only 11 of 1he 56 credit generation and use transactions we reviewed used such
monitors to calculate OMT credits; the other 45 used their compliance methods,
Minimal Compliance Assurance, Enforcement, and Oversight Activities
Contributed to Risks of Questionable Trades
EPA performed little compliance assurance, enforcement, or other oversight activities
of the two OMT programs, and yet - in the course of carrying out other, non-OMT
initiatives - questionable credits were identified by EPA and the OIG.
Questionable credits identified by EPA. Although not targeted for its OMT
activities, a New Jersey utility - PSEG - was inspected by EPA and alleged to
have violated clean air requirements by modifying two plants without obtaining
required permits that would have established lower compliance levels. With
lower levels, these plants' emission reduction credits would not have been as
great as initially claimed. EPA and PSEG reached a settlement in January 2002
wherein PSEG agreed to retire about 18,600 tons of pollutants it had generated.
The eliminated credits - valued at over $16 million - represented about 90
percent of the credits available for trade in the New Jersey program.
Invalid credits identified by OIG. Our analysis of selected New Jersey trades
identified another utility - Conectiv - that used cooler, off-season ozone credits
to meet the warmer, more polluted, ozone season requirements, a violation that
resulted in the firm paying a $140,000 fine. The inappropriate use of these
credits could have been detected if the State had reviewed the data
Although EPA's analysis of 10 early trades in New Jersey identified concerns with the
validity of some credits, EPA has not targeted OMT activities for additional oversight to
reduce the risk of invalid credits. In our opinion, a risk-based approach to targeting
OMT facilities could lessen the likelihood of trades involving invalid emissions credits.
Michigan Oversight Detected Improper Credits. Michigan examined Hie data
underlying its trades in order to reduce the risk of improper trades. As a result,
Michigan identified two invalid trades before their data were entered into the OMT
registry. New Jersey did not conduct such reviews of credits because their program
was designed to be self operating, with no State reviews. Table 2.2 (in Chapter 2)
provides a detailed comparison of the approaches to oversight in the New Jersey and
Michigan OMT programs.
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Recommendations
We are making a number of recommendations to the Assistant Administrator for Air
and Radiation, including that EPA:
Develop and propose Federal regulations for OMT programs.
Ensure that shutdown credits are not allowed to be traded in OMT programs.
Require die use of EPA- or state-approved emissions quantification protocols
prior to allowing trades to occur.
Develop and require the use of a risk-based targeting approach for Federal and
state compliance assurance, enforcement, and oversight of OMT trades.
Agency and State Comments and OIG Evaluation
In his September 26,2002, response to our draft report, the EPA Deputy Assistant
Administrator for Air and Radiation stated that this OIG evaluation will help EPA
strengthen the OMT program. He also noted that many of the issues pointed out in our
report are common to the broader air pollution control program and deal with issues
that EPA has been struggling with for several years. He also suggested that this report
provide additional information on the extent that these issues occur in other parts of the
air pollution control program. While we agree that these issues may be prevalent in
other parts of this program, the scope of our work did not include identifying the
existence or prevalence of these issues in the broader air pollution control program.
The Deputy Assistant Administrator also provided specific comments and clarifications
which have been incorporated into the final report, as appropriate. The Deputy
Administrator's complete response can be found in Appendix 1.
Michigan and New Jersey generally agreed with the report and suggested technical
clarifications to the report which have been incorporated, as appropriate. Michigan's
full response can be found in Appendix 2; New Jersey's full response can be found in
Appendix 3.
IV
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Table of Contents
Executive Summary i
Chapters
1 Introduction 1
2 OMT Program's Success Hindered by Lack of Regulations 9
3 Uncertain Data Accuracy, Reliability, and Completeness
Detracted from OMT Program 19
4 Minimal Compliance Assurance, Enforcement, and Oversight
Activities Contributed to Risks of Invalid and Questionable Trades 27
Appendices
1 EPA Office of Air and Radiation Response 33
2 Michigan Department of Environmental Quality Response 45
3 New Jersey Department of Environmental Protection Response .. 48
4 Overview of New Jersey and Michigan OMT Programs 52
5 Details on Scope and Methodology 54
6 OIG Sampling Procedures and Results 56
7 OIG Memorandum Regarding Michigan Shutdown Credits : 60
8 Details of PSEG Settlement 63
9 Five Attributes of Environmental Data Quality 64
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10 EPA Region 2 Letter to New Jersey 65
11 New Jersey Response to EPA Letter 67
12 EPA Region 2 Response Letter to New Jersey 69
13 Distribution 71
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Chapter 1
Introduction
Purpose
The Office of Inspector General (OIG) initiated this evaluation as a result of concerns
raised by the Public Employees for Environmental Responsibility and the New Jersey
Chapter of the Sierra Club, hi a February 2001 letter to the OIG, these groups
expressed concerns that the Environmental
* .
Prrrfwfirvn Anpnm;*c fl^pA'c^ fYnpn IWTnrlfp't
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Trading (OMT) program for air emissions
contained fundamental problems related to .
*
quantifying emissions and enforcing Clean
Air Act requirements. Also, they questioned whether concerns raised in four prior OIG
audit reports, issued from 1996 to 1998, had been effectively addressed in EPA's
OMT program.
The objectives of our evaluation were to determine:
EPA's basis for proposing to approve selected air emissions OMT programs and
whether the basis is adequate (given the applicable findings and recommendations
of the four OIG reports issued since 1996).
The extent of use of EP A-approved emissions quantification protocols to
calculate tradeable emissions credits in selected states' OMT programs, and
whether accurate, reliable data underlie OMT trades in selected states' OMT
programs.
The extent of EPA and state compliance assurance, enforcement, and oversight
activities relative to OMT trades, and whether OMT programs affect the ability of
regulatory agencies to detect and/or deter noncompliance.
Background
The 1990 Clean Air Act encourages the use of incentive-based approaches to
controlling air pollution due largely to the increasing cost of achieving emissions
reductions at some facilities. One approach, known as emissions trading, is to allow
facilities whose cost of reducing emissions is comparatively low to sell emission credits
to other facilities that have higher costs for reducing the same amount of pollution.
Properly implemented, according to EPA, this approach allows an area to meet its
emission reduction target while reducing the overall cost to industry.
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EPA's Economic Incentive Programs, which include programs for emissions trading,
have been increasingly promoted as a cost-effective means of achieving environmental
goals. According to EPA, emissions trading offers regulated sources greater flexibility
in meeting Clean Air Act requirements by allowing alternative and often more
economical means of achieving regulatory compliance. There are three main categories
of emission trading programs, as shown in Table 1.1:
Table 1.1: Three Main Categories of Emission Trading Programs3
Cap-and-trade programs
An overall limit is defined for a specified group of participants who are mandated
to operate, collectively, within that limit, or cap. Participants may sell excess
emission credits gained through additional emission reductions actions, or
purchase such emission credits from participating sources.
Emissions offset programs
These are required for new and expanding sources in nonattainment areas.
These sources are required to purchase sufficient emission credits from other
sources to offset environmental impacts.
Open Market Trading
A more recent program, open market trading allows sources to use emission
credits generated through past emission reduction efforts to meet current or future
requirements. Facilities can purchase emission credits rather than install costly
emission control equipment. Credits can be held for later use, sold, transferred to
another company location, or permanently retired. In contrast to cap-and-trade
programs, OMT programs are usually voluntary, involve a variety of different
industries, and do not have an expressly defined cap, or limit, on the amount of
emissions available for trading.
Since the OMT program is a discretionary program, sources are not forced to
participate, but may do so if the State Implementation Plan under which they operate
has been approved by EPA. A State Implementation Plan represents tiie detailed
control strategies for bringing nonattainment areas into compliance or ensuring that
attainment areas maintain compliance. OMT programs are intended to provide an
innovative approach to emissions reductions and provide flexibility in meeting
compliance requirements. For example, in lieu of strict compliance with Reasonably
Available Control Technology requirements and other permit limits, facilities may use
credits purchased under the OMT program to release more emissions than they would
otherwise have been allowed to release. In theory, the purchased emissions credits
have been generated from extra emissions reductions activities that occurred earlier.
Although open market trading programs have not been widely used to date, EPA
anticipates significantly greater OMT program participation in the future. According to
agency officials, program participation will likely increase in coming years as the costs of
There are a number of variations of emissions trading programs related to these three categories.
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industry compliance rise due to states developing ever more stringent control strategies
to bring nonattainment areas into attainment
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OMT Applies to Five Principal Air Pollutants
Under the Clean Air Act, EPA establishes air quality standards for selected pollutants to
protect public health and Hie environment Known as National Ambient Air Quality
Standards (NAAQS), EPA has set such air quality standards for six principal air
pollutants (also referred to as criteria pollutants). Under the 2001 Economic Incentive
Program guidance, only five of the six NAAQS criteria pollutants should be included in
OMT programs, as shown in Table 1.2:.
Table 1.2: NAAQS Pollutants That May Be Traded in OMT Programs
Pollutant
Carbon Monoxide
Nitrogen Dioxide
Ozone
Particulate Matter
Sulfur Dioxide
Description
Colorless, odorless gas that at elevated levels is most serious for
those with cardiovascular disease. Most carbon monoxide results
from motor vehicle and non-road vehicle exhausts.
Reddish-brown, highly reactive gas that at elevated levels affects the
respiratory system. A major source is high-temperature combustion
operations such as automobiles and power plants.
Ozone is formed when its precursor pollutants - nitrogen oxides and
volatile organic compounds - combine in the presence of sunlight.
At higher emissions levels, ozone contributes to respiratory problems.
Nitrogen oxides are emitted by motor vehicles and power plants;
volatile organic compounds by motor vehicles, chemical plants, and
other industrial sources. Ozone is the most wide-spread and
persistent air quality program in the United States.
Coarse participate matter is emitted directly into the atmosphere from
sources, such as dust from roads, or as a result of wood combustion.
Particulate matter is associated with aggravation of respiratory
conditions, such as asthma.
Sulfur Dioxide results mostly from fuel consumption at coal-fired
power plants. High concentration results in breathing impairment in
sensitive populations; longer exposure can cause respiratory illness.
EPA's Economic Incentive Program indicated that the sixth criteria pollutant - lead -
should not be traded because, according to EPA, it has many properties similar to toxic
air pollutants and was also considered an environmental equity concern. Additionally,
EPA's January 2001 Economic Incentive Program guidance does not include trading of
air toxics, except those toxics already contained in volatile organic compounds. Such
volatile organic compounds that contain air toxics should only be traded under certain
limited circumstances and are subject to additional risk reducing controls.
OMT Operating Principles
There are three fundamental principles that apply to all EPA Economic Incentive
Programs, including air emissions OMT programs:
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Integrity
Equity
Environmental benefit
Table 1.3 presents those principles and additional criteria that OMT programs, by virtue
of being Economic Incentive Programs, must meet
Table 1.3: Fundamental Principles for OMT Programs
Principle
Integrity
Equity
Environmental
Benefit
Key Criteria
Surplus
Quantifiable
Enforceable
Permanent
Equal
protection
Demonstrated
Improvement
Definition
Traded emissions are not otherwise relied on to
meet State Implementation Plan or other state air
quality requirements
Traded emissions must use emissions measures
that are reliable and replicable
Trading information must be independently
verifiable such that the liable party is identifiable
and accountable for violations
Source achieves extra emissions reductions over
a period of time and the state ensures that no
emission increases occurred over the same
period of time
No community or segment of the population
receives a disproportionate share of a program's
benefits, nor do they receive disproportionate
adverse impacts from emissions shifts or
foregone emission reductions
OMT programs must result in emissions
reductions at least 10 percent lower than would
have been achieved if the source complied
directly with emissions standards
Source: "Improving Air Quality with Economic Incentive Programs," EPA-452/R-01-OQ1, Jan. 2001.
We concentrated our review on EPA and state agency implementation of two of the
fundamental principles above - integrity and environmental benefit Evaluation of the
equity principle is being conducted in a separate OIG review. For the issues we found
related to the integrity and environmental benefit principles, Chapter 2 contains a
discussion of key OMT program safeguards, including emission quantification protocols
(quantifiable) and shutdown credits (surplus, demonstrated improvement). Chapter 3
contains a discussion of protocols, emission measurement methods, data quality, emissions
verification, and OMT registry review (surplus, quantifiable). Chapter 4 contains a
discussion of compliance assurance and enforcement issues (enforceable, permanent,
demonstrated improvement).
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In addition to these fundamental emission trading program principles, OMT programs must
also specify the quality of the data that will be needed to provide reasonable assurance that
program goals are met and that valid trading decisions are made. Known as data quality
objectives and required by EPA Order 5360.1, to be useful such data needs to be denned
using five key attributes - precision, accuracy, completeness, representativeness, and
comparability. Chapter 3 provides more information on the data quality objectives
process.
Emission Quantification Protocol Pivotal to Effective OMT Programs
Emissions quantification protocols provide an in-depth description of the actions that a
facility plans to take to reduce emissions beyond their required levels, as well as the
measurement method that will be employed to accurately measure both their historical
emissions levels and their new emissions levels after the changes are made. Specifically, if
a facility has achieved a reduced emission level, the difference between that new level and
die required (or historical actual, whichever is lower) emission level represents the amount
of OMT emissions credits generated, as shown in the following:
Illustration 1.1: Amount of credits generated from
reducing emissions below required levels
Required (or historical)
emissions level
« Reduced emissions
level
Process for Certifying OMT Credits
EPA guidance calls for OMT participants to file three key certifications or notices with the
state involved:
Certification of generation: To be submitted to the state by sources that generate
OMT credits. These certifications should be submitted within certain time frames or
before certain actions are taken.
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Notice of intent to use: To be filed with the state by a source wishing to use OMT
credits, at least 30 days before the start of the intended use. These notices are to be
made publicly available to allow citizens the opportunity to understand the impact of
OMT activities on Iheir communities.
Certification of use: To be filed by all OMT participants that have used OMT
credits, no later than 90 days after the end of the use period or 1 year after the start
of a source compliance period for which credits are used, whichever is sooner.
These certifications are also to be made publicly available.
EPA guidance also calls for state OMT programs to incorporate a "tracking system" to
track the generation and use of emission reductions, help ensure compliance, target
enforcement resources, and conduct periodic OMT program performance audits. The
guidance calls for state OMT tracking system information to be readily available to the
public to allow it to easily and accurately calculate the emissions of each participating
source or source category.
Current Status
As of August 2002, only three states had applied to EPA to have OMT programs
approved, as shown in Table 1.4:
Table 1.4: Status of OMT Program Approvals (August 2002)
State
Michigan
New Hampshire4
New Jersey
EPA Region
Evaluating Proposal
Region 5
Region 1
Region 2
Date EPA
Proposed Approval
February 7, 2001
February 7, 2001
January 9, 2001
Current Status
Under EPA review
Under EPA review
. Under EPA review5
While other states have emissions trading programs that fall under the categories of cap-
and-trade or emissions offset programs, only these three have developed OMT programs
that have been submitted to EPA for approval as State Implementation Plan revisions.
Once EPA evaluates the state's submittal, the Agency may reject the application, work
with the state to improve the application, or publish a notice of intent to approve the
state's application for a State Implementation Plan change to allow the new program. In
accordance with the notice-and-comment rulemaking process, EPA must evaluate and
respond in the record to all comments received during foe open public comment period
According to EPA, New Hampshire had less than 10 OMT credit transactions as of June 2001; thus this
state was not included in our evaluation scope.
^Jew Jersey has since proposed terminating its OMT program.
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i
on the envisioned changes. None of Ihe three OMT programs had received final
approval from EPA as of August 2002.
In response to EPA's June 2002 letter concerning New Jersey's State Implementation
Plan revision related to its OMT program, in August 2002 New Jersey stated its intent to
terminate its OMT program. EPA and New Jersey have continued to discuss the impact
of the termination of New Jersey's OMT program and the approach to be used in
bringing sources that have been using OMT credits into compliance with underlying
requirements. These letters, including EPA's most recent letter, are found in Appendices
10,11, and 12.
Details on the Michigan and New Jersey OMT programs, including how they compare to
EPA's Economic Incentive Plan Guidance, are in Appendix 4.
Scope and Methodology
We conducted evaluation fieldwork in the Michigan Department of Environmental
Quality, hereafter referred to as Michigan, and in the New Jersey Department of
Environmental Protection, hereafter referred to as New Jersey; in EPA Region 2
(responsible for overseeing New Jersey) and EPA Region 5 (responsible for overseeing
Michigan); EPA's Headquarters Air and Enforcement offices; at selected environmental
groups and industry associations, and at four companies participating in the OMT
programs in Michigan and New Jersey. Michigan and New Jersey were selected for
review because (1) EPA staff indicated that these States had the most active OMT
programs; (2) both States had already submitted State Implementation Plan revision.
requests to EPA that requested Federal approval of their OMT programs; and (3) EPA
had allowed these States to operate OMT programs for over 5 years under EPA's
enforcement discretion policy, such that both States had years of implementation data and
experiences available for review.
We reviewed a randomly selected group of 42 trades in Michigan and 42 trades in New
Jersey (14 emissions credit generations, 14 transfers of credits, and 14 credit uses in each
State). These were selected from a universe of 792 trades (451 in Michigan and 341 in
New Jersey) and stratified into the above categories to ensure that we examined the
critical points in emissions trading transactions.
Since OMT program issues related to the fundamental principle of equity are being
addressed in a separate OIG evaluation, OMT equity issues were not included in our
evaluation scope. We conducted our evaluation generally in accordance with the
Government Auditing Standards issued by the Comptroller General of the United
States. There was a scope limitation related to full access to New Jersey records of
OMT activities. Further details on our scope and methodology, including the scope
limitation, are in Appendix 5. Details on our sampling methods and results are in
Appendix 6.
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Prior Audit Coverage
Four prior OIG reports addressed issues salient to the OMT program and were
considered during our evaluation:
"EPA's Development of Its Proposed Open Market Trading Rule"
(Report No. E1KAB5-01-0126-6400046, dated March 28,1996): This report
addressed the need for EPA to improve its OMT program and its control over
trades through strengthening the emission quantification protocol process, by
developing source specific protocol development guidance, actual protocols, or a
nationwide database of approved protocols for general access.
"Emission Factor Development" (Report No. 6100306, dated September 30,
1996): This reported that emission factors did not produce reliable emission
measurements for individual facilities, and that steps to improve the reliability of the
emission factors were needed. This report noted, "flie need for reliable emission
factors will be critical to the success of open market trading programs."
"The Effectiveness and Efficiency of EPA's Air Program" (Report No.
E1KAE4-05-0246-8100057, dated February 27,1998): This addressed the need
for additional resources to develop and improve emission factors.
"Consolidated Report on OECA 's (Office of Enforcement and Compliance
Assurance's) Oversight of Regional and State Air Enforcement Programs"
(Report No. E1GAE7-03-0045-8100244, dated September 25,1998): This
pointed out inconsistent and/or inadequate state identification and reporting of
Clean Air Act violations and the need for adequate EPA oversight of state
identification and reporting of violations (inadequate identification and reporting of
violations could impact OMT compliance assurance and enforcement efforts).
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Chapter 2
OMT Program's Success Hindered by
Lack of Regulations
The fact 1hat EPA issued non-binding guidance for OMT programs instead of regulations
hindered the program's opportunity for success. Further, key provisions of the guidance
provided were not followed Many sources have opted not to participate in the OMT
programs, and problems were so significant that one of the States that initiated the
program (New Jersey) has announced its intention to terminate its OMT program. EPA
did not issue OMT regulations because in 1996, in response to EPA's only attempt at
issuing OMT regulations, state officials had expressed concern dial a single set of
regulations for all states would impede Iheir flexibility. As a result of the lack of
regulations, safeguards intended to protect the public have not been consistently applied,
and the risk of invalid and questionable credits being traded was increased.
EPA Opted For Guidance In Lieu of Regulations
hi 1995, EPA proposed an OMT Rule to provide a model that states could use to
expedite approval of state programs for open market trading of emissions. This was
designed to be a voluntary OMT program. However, during the comment phase on the
proposed rule, several states contended that the model was too restrictive and they would
not use it They indicated that the rule did not provide states with enough flexibility to
meet their sometimes unique emissions trading needs.
As a result, in lieu of the OMT Rule, EPA opted to develop its Economic Incentive
Program guidance, to be used not only for OMT programs but for other Economic
Incentive Programs as well. The guidance was finalized in January 2001. It was also
EPA's intent to use this guidance in assessing the programs for approval. The guidance
provides a framework for developing and approving flexible programs designed to
achieve environmental benefits at less cost, including OMT programs. However, neither
Ihe states nor EPA Regional Offices are required to follow the guidance.
Guidance Lists Various Safeguards
Although EPA's Economic Incentive Program guidance is non-binding, if correctly
followed and implemented, the guidance provides for many safeguards that could help
regulators achieve the goals of the OMT program and minimize the risk of invalid trades.
Key provisions of the guidance are shown in Table 2.1:
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Table 2.1; Key Provisions of EPA's Economic Incentive Program Guidance
ft.
j 'JS.4? O O
Approved Quantification
Protocols Needed for
All Trades
Meaningful
Public Participation
Key to Effective
OMT Programs
Shutdown Credits Discouraged
Limits Placed on
Types of Pollutants Traded
Hazardous Air Pollutant
Trading Subject to Additional
Controls
Additional Monitoring, Record
Keeping, and Reporting
Procedures Urged
EPA approval of OMT emission quantification protocols is
expected. These protocols provide the plan that describes
the technical procedures an emitting source uses to
calculate the amount of emissions/emission reductions
associated with OMT program credit transactions.
Effective public participation is a basic tenet of the Clean Air
Act, and includes access to key information and the
opportunity to influence decisionmaking. The public is
supposed to be able to not only see proposed trades in
advance but should have the opportunity to participate in the
decisionmaking process "in a meaningful way." 1'
The guidance states that OMT credits cannot be created
through shutdown of facilities. However, because the OMT
program is voluntary, states may include shutdown credits
in their programs. EPA was concerned that a facility may
shut down in one state, generate and sell credits, but then
relocate their operations to other states.
Under the guidance, only five of the NAAQS criteria
pollutants can be included in OMT programs: carbon
monoxide, nitrogen dioxide, ozone, particulate matter, and
sulfur dioxide. The sixth criteria pollutant - lead - is not to
be traded, according to the guidance.
The guidance recognizes the additional risk that
accompanies trading volatile organic compounds that may
contain hazardous air pollutants. The guidance calls for
state OMT programs to consider options for prevention/
mitigation of unacceptable impacts from volatile organic
compound transactions involving hazardous air pollutants.
The guidance calls for state OMT programs to develop
monitoring, record keeping, and reporting procedures to help
ensure that credit participants are meeting OMT program
requirements. These procedures are needed to enable
states to determine OMT compliance and whether
enforcement actions are required. OMT programs should be
evaluated, at a minimum, every 3 years, with the results of
the evaluation provided to EPA.
1/ Economic Incentive Program Guidance stressed public participation for volatile organic compound
trades.
Guidance Not Basis for Approving Michigan, New Jersey OMT
Programs
While EPA intended the 2001 Economic Incentive Program Guidance to be the basis for
approval of OMT programs, this has not been the case for the New Jersey and Michigan
OMT programs. This was because these States submitted their State Implementation
Plan revision requests prior to the finalizalion of the January 2001 guidance. Instead,
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EPA evaluated these programs based on three documents existing before the January
2001 guidance was issued:
The 1994 Economic Incentive Program Rule.
The 1995 proposed Rule for OMT programs, which EPA never finalized.
An Agency position presented in a March 10,1998, letter from the Office of Air
and Radiation to Congressman Thomas J. Bliley, discussing additional OMT
program development policy. In this letter, EPA stated it would work with ihe
states to develop OMT programs tailored to their individual circumstances, with the
1995 proposed OMT Rule used as overall guidance.
EPA Regions 2 and 5 did not ask New Jersey and Michigan, respectively, to revise Iheir
State Implementation Plan submittals to reflect EPA's latest thinking regarding the
safeguards needed for OMT programs. Instead, these Regional Offices determined it
would be better to approve the States' existing programs and then work with 1he States
in future years to improve any areas of concern. Specifically:
New Jersey: This State submitted a State Implementation Plan revision request to
EPA Region 2 in 1998. EPA Region 2 officials said they used the three documents
discussed above to evaluate New Jersey's proposed revision, particularly the 1994
rule. Rather than require New Jersey to meet the final 2001 guidance to obtain
Federal approval, EPA said it would notify New Jersey of any deficiencies in Ihe
OMT program 18 months after the final Economic Incentive Program Guidance
was issued. However, EPA Region 2 staff acknowledged that it is generally easier
to get states to make changes before rather than after a State Implementation Plan
is approved.
Michigan: This State originally submitted a State Implementation Plan revision
request to EPA Region 5 in 1996. Region 5 proposed approval of Michigan's
revision in 1997 based on the 1994 rule and 1995 proposed rule noted above.
Michigan revised its original submission to address Region 5 concerns from 1997,
and resubmitted the request in 1999. EPA evaluated the 1999 resubmission with
the same criteria as the 1996 submission, wife the addition of the expanded Agency
policy noted in the March 10,1998, letter to Congressman Bliley. Similar to
Region 2, Region 5 personnel said they believed they could have Michigan address
any deficiencies in their OMT program after their State Implementation Plan was
approved.
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Key Provisions of 2001 Guidance Not Followed
In Designing or Reviewing OMT Programs
We found that key provisions of the 2001 guidance were not followed in designing or
reviewing the two States' OMT programs, specifically regarding the use of protocols and
ensuring that the programs contained other key safeguards. A comparison of key
provisions called for by EPA's Economic Incentive Program guidance with the practices
in the New Jersey and Michigan OMT programs follows.
Table 2.2: Comparison of New Jersey and Michigan OMT Programs
with EPA's Economic Incentive Program Guidance
Program guidance calls for
EPA approval of quantification
protocols. None issued to
date.
Program guidance calls for
emissions credit registry;
does not address when
credits must be verified.
Program guidance allows
unlimited lifetime for credits.
Program guidance does not
allow shutdown credits.
No EPA involvement in
documentation or data review
except for proposed State
Implementation Plan
revisions.
Program guidance calls for
trading information to be
available to the public.
Guidance does not require
public comment on trades.
Guidance does not require
EPA compliance monitoring.
No protocol approval
required. Protocols included
in third party verification.
Credits not verified prior to
entry in Registry; third party
verification required prior to
use of credits.
Credits have unlimited
lifetime.
Shutdown credits not
allowed.
No State involvement in
reviews or documentation
except for proposed State
Implementation Plan
revisions.
Information on credit
generation available only
after credits entered in
Registry. Contractor for
State shut down Registry.
State recently added limited
information to State website.
No opportunity for public
comment on trades.
Field inspectors have
minimal involvement in
program.
No protocol approval required.
State review includes
protocols.
State completeness review
conducted prior to credits
being entered onto Registry.
Credits have a 5-year lifetime.
Shutdown credits allowed.
State performs
documentation and data
reviews and maintains
documentation.
Information on credit
generation available only after
credits entered in Registry.
Registry information available
on State web site.
No opportunity for public
comment on trades.
Field inspectors are
consulted as part of State
completeness review, if
necessary.
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No EPA enforcement
oversight since no Federally
approved programs.
State enforcement oversight
non-existent unless situation
brought to their attention.
State enforcement oversight
minima).
Program guidance calls for
program evaluation every
3 years.
No formal OMT program
evaluation or audit since
State program began in
1996.
Program evaluation
completed. Report in draft.
OMT Programs Did Not Use EPA-Approved Quantification Protocols
An EPA Office of Air Quality Planning and Standards official noted that it was not
anticipated that EPA Regional Office staff would review emissions quantification
protocols, even though the 2001 Economic Incentive Program Guidance indicated feat
this EPA review would be done. Contrary to that guidance, the requirement that emission
quantification protocols be approved by EPA is not a provision in the New Jersey OMT
program, despite concerns with the quality of quantification protocols being used in New
Jersey. For example, EPA Region 2 reviewed 10 quantification protocols submitted by
New Jersey as a part of its 1998 OMT State Implementation Plan revision request, and
found deficiencies in all 10 of the protocols. In the opinion of New Jersey's
Environmental Commissioner, the lack of such safeguards has contributed to the
implementation problems that the New Jersey program has experienced.
The Michigan program also does not require EPA approval of emission quantification
protocols prior to trading. However, in practice, the Michigan completeness review of
OMT credit transactions does include a State review of quantification protocols. Further
details on protocols are in Chapter 3.
Public Participation Process Ineffective
The public is supposed to have the opportunity to participate in the OMT program
decisionmaking process "in a meaningful way," under the public participation
requirements of the Clean Air Act From our random sample of 84 transactions in New
Jersey and Michigan (from a universe of 792 transactions in both States), we found no
evidence of public participation in OMT program actions. The information that the public
could obtain from the New Jersey OMT program registry did not include the credit
generation strategy nor fee emissions credit calculation procedures necessary for the
public to have meaningful input into fee decisionmaking process.
Additionally, during the course of our review, fee limited information feat had been
available via fee Internet was no longer available when New Jersey's registry contractor
ceased operations in September 2001. An alternative for providing information to fee
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public regarding New Jersey trades provided only listings of credit transactions.
Additional information on the New Jersey registry problems are in Chapter 3. Michigan's
OMT program also does not include key public participation requirements, as mandated
by the Clean Air Act While the Michigan registry does provide some information about
the emissions credit generation strategy, it does not address emissions credit calculation
procedures, instrumentation, or data quality.
Shutdown Credits Allowed In Michigan OMT Program
The New Jersey OMT program does not allow the generation of emission credits through
facility shutdown activities. However, Michigan does allow the generation of credits
through facility shutdown activities, even though EPA's 2001 Economic Incentive
Program Guidance for OMT programs specifically prohibits shutdown credits. In our
sample of 42 transactions for Michigan, we found that 7 generation and use transactions
included shutdown credits (6 of the transactions involved credits generated and 1
involved credits used). Shutdown credits are problematic because, while a facility may
shut down in Michigan and generate credits, the facility may relocate operations to a
nearby state where emissions may potentially increase, negating the effect of the reduced
emissions in Michigan6. We did not attempt to determine whether firms that generated
shutdown credits reinstituted operations in other states.
Due to the precedent-setting nature of using shutdown credits for OMT programs, we
sent a memorandum to the EPA Assistant Administrator for Air and Radiation to
reconsider approving Michigan's use of shutdown credits (see Appendix 7). Michigan
was using shutdown credits because that State had developed its OMT program prior to
the 2001 Economic Incentive Program Guidance. Approximately 23 percent of the
generated credits listed in Michigan's OMT Registry, and 80 percent of the volatile
organic compound emission credits generated and listed in the Registry, have resulted
from shutdowns.
In its response to ihe draft report, EPA pointed out that Michigan has taken actions to
minimize ihe potential negative impacts of the use of shutdown credits. EPA noted that
the majority of shutdown credits generated under Michigan's program to date have
already expired or been retired voluntarily. Thus, EPA believes that it is unlikely that
shutdown credit use in the State of Michigan will lead to air quality problems.
Nonetheless, in its response to the draft report, EPA noted that if Michigan's program is
approved with the shutdown provision allowed, it intends to require the state to amend its
program within 3 years of final approval to disallow the further use of shutdown credits.
According to EPA, shutdown credits do not belong in the OMT program because the concept of OMT is
to generate credits by overcontrolling emissions, not by shutdowns.
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Lead Credits Generated in Michigan OUT Program
Lead is not allowed to be included in the credit transaction activities of the New Jersey
OMT program. However, Michigan's program allows lead to be a part of the OMT
program, although the 2001 Economic Incentive Program Guidance specifically states
lead should not be included in Economic Incentive Programs. Again, this occurred
because the Michigan OMT program was developed prior to the 2001 guidance. In
commenting on our draft report, EPA agreed that lead should not be traded in OMT
programs and stated that the Agency is prepared to ask Michigan to remove lead as a
tradeable commodity from their OMT program
Trading Activities Limited by Lack of Federal Approval
State environmental officials in both New Jersey and Michigan noted that the lack of
Federal approval of their OMT programs for more than 3 years hindered operations of
die programs. New Jersey has been in EPA's review process since 1998 and Michigan
since 1996. Additionally, EPA pointed out that, in addition to Ihe lack of Federal
approval, other reasons have also contributed to the limited use of OMT programs to
date. These other reasons included low demand for short term emissions reductions,
such as those provided under OMT programs, and the limited list of allowable uses for
emissions credits. Nonetheless, our work indicated that the lack of Federal approval was
a significant contributing factor to the limited trading activities in the two states reviewed,
New Jersey: New Jersey officials said that fee lack of Federal approval of the
OMT program made potential users of the program hesitant to participate.
New Jersey presented the following credit activity information (see Table 2.3)
concerning OMT program operations, from its beginning in 1996 through
September 2001, the last month the registry was operational. Of the six NAAQS
criteria pollutants, New Jersey only included the two precursor pollutants for the
ozone criteria pollutant in its OMT trading program.
Table 2.3: New Jersey OMT Program Activity, 1996 to September 2001
Nitrogen Oxide
35,000
1,560
855
Volatile Organic Compounds
980
330
210
The OMT numbers presented above came into question in the spring of 2002, after
a $337 million settlement with the largest generator of credits in New Jersey was
signed, hi early 2002, EPA, the U.S. Department of Justice, and the State of New
Jersey entered into a settlement agreement with PSEG Fossil, LLC, a New Jersey
utility that participated in the OMT program. Allegedly, PSEG had made
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modifications at two of its facilities where OMT credits were generated, which
should have triggered facility permit revisions and additional emissions controls that
would have resulted in lower emissions limits. However, with lower emission limits,
the number of OMT credits that could have been generated would have been
significantly less. As a result of this settlement, PSEG agreed to retire 372,380
generated credits (about 18,600 tons), or more than 90 percent of the generated
credits that were available for use in the New Jersey OMT registry in January
2002. The eliminated credits were valued at over $16 million. Details of the PSEG
settlement are in Appendix 8.
Michigan: Michigan officials also noted that the lack of Federal approval of the
Michigan OMT program affected the extent of participation in this program from
the beginning of the program in 1996 through July 2002, as shown in Table 2.4:
Table 2.4: Michigan OMT Program Activity, 1996 to July 2002
s^a.*.*,, v^egpBKB^'^^p *,".", i
L 5. «. . .- /V ' ^f?f*tf*f VX V V V V!
Nitrogen Oxide
55,057
1,710
33,039
Volatile Organic Compounds
6,976
209
3,253
Carbon Monoxide
3,287
74
342
Sulfur Dioxide
12,476
1,671
Particulate Matter
443
76
Lead
0.3
The Michigan credit retirement accounts include the 10 percent of credits retired
("for the benefit of the environment") when the generated credits were entered into
the Michigan OMT registry, as well as generated credits that had passed the 5-year
time limit without use. Michigan obtains and retires 10 percent of the emissions
credits at time of entry into the registry to help ensure that the environmental
benefits of trading happen. According to Michigan officials, its OMT program
experience to date indicates substantial emission reductions have been realized due
largely to the 5-year life of generated credits in its OMT program. Almost 50
percent of all credits generated in Michigan have been retired because of the
expiration of the 5-year life of Ihe credits.
However, as previously noted, the credits in the Michigan registry include credits
generated from facility shutdowns, contrary to EPA's 2001 guidance. Although
EPA indicated it will be evaluating this aspect of Michigan's program, since
Michigan shutdown credits may be generated for 5 years after the shutdown of the
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anitting source, along with the 5-year credit life, some of the shutdown credits
would be available for use for 10 years after the source ceased operations7.
Conclusions
Hie regulatory flexibility that industry seeks, and the environmental benefits that the public
demands from alternative approaches to strict adherence to Clean Air Act requirements,
will likely not be realized without a Federal rulemaking establishing rninimurn OMT
safeguards. EPA's January 2001 Economic Incentive Program Guidance provides a
framework for OMT programs and suggests some pragmatic safeguards. However,
states are not required to follow this guidance in designing their OMT programs, and EPA
Regional Offices have inconsistently applied this guidance in evaluating proposed OMT
programs to date.
Both the Michigan and New Jersey OMT programs have strengths and limitations that, in
the absence of a rulemaking, may or may not appear in other OMT programs. However,
it is clear that the lack of safeguards has contributed to problems in the OMT programs
we reviewed. Implementation problems have been so significant in the New Jersey
program that the Commissioner recently concluded that "the program has failed" and that
the State should terminate its OMT program.
Using EPA guidance selectively rather than having regulatory requirements to establish
and approve state OMT programs has hindered the ability of OMT programs to become
widely used and accepted. EPA officials have noted that they believe forthcoming
revisions to the ozone standard will increase the need for Economic Incentive Programs,
including OMT programs. We believe that the future anticipated need for state OMT
programs substantially heightens the need for EPA's OMT program to be addressed in a
regulatory manner. This should provide for ample opportunity - through the notice-and-
comment rulemaking process - for public input into the nature and substance of the
safeguards to be required, to ensure that all trades satisfy Ihe OMT principles of integrity
and environmental benefit
Recommendations
We recommend that the Assistant Administrator for Air and Radiation:
2-1. Develop and propose Federal rules and regulations for OMT programs, including
requirements for safeguards consistent with the principles of integrity, equity, and
environmental benefit presented in the Agency's Economic Incentive Program
guidance, as well as appropriate public notice and comment
See OIG's Memorandum regarding this subject to the Assistant Administrator for Air and Radiation dated
April 5, 2002, in Appendix 7 of this report.
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2-2. In developing the Federal rules and regulations for OMT programs,
ensure that facility shutdown credits are not allowed to be traded in OMT
programs.
Agency and State Comments and OIG Evaluation
In his September 26,2002, response to our draft report, the EPA Deputy Assistant
Administrator for Air and Radiation asked for clarification regarding our recommendation
that EPA issue Federal regulations for OMT programs. As opposed to recommending
that EPA should have issued the OMT Model Rule as a Federal regulation, our report
and recommendation focus on Ihe need for EPA to issue a Federal regulation requiring
appropriate safeguards for assuring that OMT program goals are achieved. We continue
to believe that non-binding guidance is not appropriate for this program.
EPA officials also noted that they used the non-binding guidance available at the time to
review the two state OMT programs for approval, and that it was their intention to work
with the states to add additional safeguards to these programs in the years after approval.
We continue to believe that appropriate safeguards necessary to assure that program
goals are met should have been applied to these programs prior to final approval.
Michigan and New Jersey also suggested technical clarifications to the report which have
been incorporated as appropriate in this Chapter. The full responses from EPA,
Michigan, and New Jersey are in Appendices 1,2, and 3, respectively.
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Chapters
Uncertain Data Accuracy, Reliability, and
Completeness Detracted from OMT Program
Three factors generally contributed to the uncertainty of OMT data, including (1) the
lack of approved emissions quantification protocols, (2) heavy reliance on compliance
measurements as being adequate for calculating emissions for trading purposes, and
(3) the inconsistent use of data quality objectives. As discussed in Chapter 2, no EPA-
approved quantification protocols were used during the calculation of credits to explain
the method used for the calculation, which increased the risk of credits being invalid.
Also, one of the States reviewed (New Jersey) did not conduct any reviews of the data
to ensure it had accurate, reliable, and complete data on its OMT program trades.
Without sufficient data or regulatory reviews to ensure accuracy, inappropriate
transactions can occur. For example, a New Jersey utility (Conectiv) used
inappropriate credits that could have been detected during State reviews of the data;
however, the OIG staff detected the problem in the course of their evaluation, notified
appropriate New Jersey officials of their finding, and the firm was assessed and
subsequently agreed to pay a $140,000 fine. New Jersey officials explained that they
specifically designed their program to be self implementing, with no State reviews, due
to limited resources.
Different Approaches Used to Evaluate OMT Data
New Jersey and Michigan took different approaches to evaluating OMT data
underlying trades. New Jersey relied on a third party contractor to operate its Registry
and third-party verifiers to do such evaluations, while Michigan operated it own
Registry and relied on State regulators to evaluate OMT data underlying trades.
New Jersey: In designing its OMT program, New Jersey intended for the
program to be self-implementing. Their program allows credit users to rely on
third-party verification. Under their program, if verified credits are eventually
found to be invalid, the credit user is not liable for the invalid credits nor is the user
subject to penalty; however, the user is expected to replace invalid credits with
valid credits. New Jersey officials said they relied on third party verifiers because
important OMT functions, such as credit verification, can be time and labor
intensive, and they did not want the program to become a burden for the State.
Additionally, Ihey were directed by State statute to "consider the role of a third
party in the banking, verification, validation of use, enforcement, and program
audits associated with emission reduction credits, and to the maximum extent
possible, create and preserve opportunities for private sector participation in any
s emissions trading program...." Therefore, they designed the OMT program to
operate with minimal State oversight
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Michigan: Tills State systematically reviewed the reasonableness of emissions
data underlying the OMT trades, which approached the level of adequacy
recommended by the OIG and suggested by EPA's Economic Incentive
Program guidance. We noted that Michigan detected and invalidated the
emissions data from two companies attempting to trade invalid emissions under the
OMT program prior to entering raeir data in the registry. Details on the Michigan
approach are in the accompanying box.
WiiSl^^iisli^^Mj^pi^
EPA-Approved Protocols Not Used
Our reviews of a random sample of 84 OMT credit transactions (from a total universe of
792 credit transactions in both States) disclosed that no EPA-approved quantification
protocols were used during the calculation of credits. A protocol is a document that
describes, on a technical level, tiie method used to calculate the amount of emissions
associated with an OMT credit transaction. Review and approval of protocols is
important in ensuring the accuracy and reliability of OMT emission credits. The lack of
EPA-approved emission quantification protocols for use in OMT program credit
calculations increases the risk of credits being invalid
EPA's January 2001 Economic Incentive Program Guidance specified that protocols be
used, and that states provide protocols to EPA for approval. This guidance contains
general quantification protocol criteria and requires EPA approval for all quantification
protocols. The guidance also notes that if EPA does not respond within 45 days of
receipt of the protocol, the protocol may be used without EPA approval.
EPA also issued, in June 2001, "Preliminary Open Market Trading Emission
Quantification Stationary Source Technical Guidance." This provides minimum
quantification criteria, generic emissions quantification protocol outlines, and
completeness checklists. The guidance includes information about the use of the data ''
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quality objective process in quantification protocol design. This guidance, which
concentrates on the emissions of die ozone precursor pollutants nitrogen oxides and
volatile organic compounds, also discusses established methods currently used for
measuring those types of emissions and various emission quantification techniques that
can be used to estimate emission rates and activity levels.
According to a key EPA air program official, emission quantification protocol reviews
are time-consuming and EPA staff resources are not available to cany out that function.
Further, the official noted that, since protocol approval by the EPA Regions is only
discussed in Agency guidance and is not required, the official doubted that the EPA
Regions would implement the protocol approval process.
Neither New Jersey nor Michigan provided EPA with protocols for approval, except
that New Jersey did provide EPA Region 2 with 10 protocols (developed by industry)
as part of an early OMT demonstration project However, EPA Region 2 found the
protocols to be deficient with regard to meeting both the EPA and New Jersey OMT
program requirements.
Emission Measurement Methods May Not Always Be Adequate
to the credit transactions we reviewed, the emission measurement methods used to
calculate OMT credits were the same as compliance measurement methods. As such,
these methods may not have been sufficiently precise for emissions trading purposes.
For compliance measurement purposes, Hie measurement only needs to indicate that a
certain emissions level has not been exceeded However, the measurement to determine
the exact amount of OMT credits available or needed should generally be more precise.
As shown in Illustration 3.1, in order to trade emissions, more precise data may be
needed on the amount of emissions than is usually obtained for compliance purposes
because compliance measurements are only concerned as to whether the source
maintains its emissions below specified limits - precisely how much below, or how much
variability there is about a measure (as long as it is still below the limit) are not a concern
in a compliance measurement
Illustration 3.1: Illustration of the differences in data needs for
purpose of ensuring compliance versus emissions trading
S O
Figure A
Compliance Measurements
Figure B
Emissions Trading Measurements
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Compliance measures are only concerned with staying below the shaded area in
Figure A. However, in emissions trading, the preciseness of the data inside the two
shaded areas in Figure B is important. Compliance measurements are only concerned
with keeping emissions below the facility's permit limit (Figure A). For compliance
purposes, regulators only need to determine that a permit limit has not been exceeded.
However, in order to trade emissions, EPA enforcement officials asserted that precise
measurements are needed because the difference between the numbers obtained -
factoring out any uncertainty about the two data points - is considered the amount of
emissions available for trading (Figure B). Variability in measurements is important
because the generating source is now going to sell the difference between two emission
levels: (1) the actual historical level of emissions, and (2) the new actual level of
emissions.
When a continuous emission monitoring system (CEMS) is required in a facility for
compliance emissions measurement and is therefore also used to calculate OMT credit,
the amount should be sufficiently precise for OMT credit purposes. This is because
actual emissions are measured with a CEMS. However, for the 56 emissions credit
generation and use transactions in our sample for which measurements were needed, we
determined the continuous method was only required and used for 11 of the 56
transactions (10 out of 28 for New Jersey and 1 out of 28 for Michigan), hi the other
instances, less reliable compliance measurement methods, such as the use of
mass balance or emission factors, were the basis for credit generation calculation. These
methods are based on less reliable estimation techniques; additionally, no data quality
objectives had been established for OMT programs' use of these methods for
calculating emissions. While use of a CEMS may not be appropriate or feasible in many
cases, more precise methods of measuring should be considered than those used, or
additional oversight should be provided.
Data Quality Objectives Not Consistently Used
Data quality objectives are explicit statements that describe the type, amount, and quality
of data needed to support environmental regulatory decisions. EPA's concept of data
quality stresses the importance of collecting data in relation to the decision to be made.
As noted above, in order to trade emissions, more precise data may be needed on
OMT credit generation and use than is often obtained for compliance purposes.
According to EPA's data quality objectives order (Order 5360.1), five attributes of data
should be known before the data is used for regulatory decisions. These include
quantitative measures of precision, accuracy, and completeness, and qualitative
statements regarding data representativeness and comparability. However, data quality
objectives were not consistently used to minimize the risk of invalid trades in the 84
trades we reviewed in New Jersey and Michigan. In our opinion, using the data quality
objectives process to establish the minimum quality of the data underlying trades in OMT
programs would reduce the risk of invalid trades. Appendix 9 presents more
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information on each of the attributes essential to knowing the quality of the data
underlying OMT trades.
Emissions Verification Approach in New Jersey a Concern
New Jersey's OMT program included a third party verification process to review the
validity of credits prior to use. The process required either a professional engineer or an
accountant to verify that the credits generated were real, surplus, quantifiable, and met
other OMT regulations. A key safeguard was the stipulation that the verifier could not
be an employee of the credit generator. However, an employee of the credit user was
not prohibited from verifying OMT credits for use by his/her employer. We believe this
is a design weakness that presented the possibility of a potential conflict of interest since
the credit user - 1he person's employer - may have needed the credits to avoid
emissions violations.
Registry Data Not Always Reviewed
Both New Jersey and Michigan used registries to record and manage OMT credit
transactions and to provide information to the public. However, we found problems
with the New Jersey registry regarding reviews for accuracy, reliability, and
completeness. While tie Michigan registry generally functioned well, we noted that
some improvements in documentation could be made. Neither State had performed a
vulnerability assessment over their computer data systems to provide reasonable
assurance of their computer outputs, as described in the General Accounting Office's
guides on information systems. In the case of New Jersey, copies of these guides8 were
supplied to 1he State to assist in their development of a new registry after their
contractor-operated registry failed.
New Jersey Approach Emphasized Self-Implementing Philosophy
New Jersey designed its OMT program to be self-implementing, and decided to
privatize important aspects of the program, including allowing a third party (an
independent contractor) to operate the official registry of all OMT trades. This registry
was accessible by the general public via a public Internet web site, which included
information on credit generation, transfer, and use. This contractor also maintained the
official (hard copy) documentation. This contractor received compensation from fees
charged to OMT credit participants rather than State funds, so the continued operation
of the registry depended on an active OMT program.
GAO/A1MD-00-21.3.1 provides standards for, among other things, Physical Control Over Vulnerable
Assets and Control Activities Specific For Information Systems; GAO-01-1008G, "Internal Control Management and
Evaluation Tool," is a guide that also addresses information systems.'
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Due at least in part to die self-implementing approach used by New Jersey, as discussed
earlier, State regulations required OMT participants to provide notices to Ihe registry
operator on credit transactions they wished to initiate. However, the credit data in the
notices were not reviewed for accuracy,
reliability, or completeness by the registry OUT credits totaling 1,376 tons
. c. T *u e notmffi* Registry far one firm.
operator or the State. In the course of
negotiating a settlement with PSEG, EPA Region
2 noted that 1,376 tons of OMT credits used for one firm from 1996 through 2001
were not entered into the registry. Further, the registry's contractor ceased operations
in September 2001, and the registry was no longer available. Nonetheless, the registry
represented Ihe official record of trades in New Jersey.
Two Enforcement Cases Impact New Jersey Registry
In one instance, we noted that a New Jersey electric utility company - Conectiv - used
inappropriate credits that could have been detected if State reviews for data adequacy
had been conducted. This company obtained non-ozone season credits but used them
during ozone seasons from 1996 through 2000, a violation of the New Jersey OMT
program. The OIG informed New Jersey of this inappropriate use, and the State
initialed an enforcement action against the firm. The firm agreed to pay the State a
$ 140,000 fine, which it paid on June 8,2002.
Another incident had a significant impact on New Jersey's OMT registry. A New
Jersey electric utility - PSEG - installed additional controls at two of its plants and
claimed to have reduced emissions below the level required to maintain compliance with
the Clean Air Act However, EPA alleged that the two plants had not obtained a New
Source Review permit as required and that they had overstated the amount of their
OMT credits generated. In 2002, PSEG agreed to retire 372,380 generated credits
(about 18,600 tons of pollutants). This amounted to more than 90 percent of the
generated credits available for use in the New Jersey OMT registry and it significantly
impacted on the availability of credits for use by other New Jersey industries. This was
a contributing factor to New Jersey proposing termination of its OMT program (see
Appendices 10 and 11). Details on the PSEG case are in Appendix 8.
Michigan Reviews Reduced Risk of Invalid Trades
Michigan's Tier 1 and Tier 2 completeness reviews significantly reduced the risk of
invalid credit information being entered onto the registry. The State entered the
information and managed Ihe web site that was available to the public. Based on our
request for randomly selected files, Michigan's ability to produce those files in a timely
and relatively complete manner, and our review of data and supporting documentation
related to those files, we believe this registry was generally managed well. However, we
noted that supporting documentation for 5 of the 42 transactions could not be located,
even though information on the trades could be located on the registry. These five
transactions all involved credit transfers.
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Conclusions
Accurate, reliable, and complete data are essential to the successful implementation of
an OMT program. Using EPA-approved quantification protocols, in combination with
data quality objectives and appropriate emissions measures, is one way that the risks of
questionable OMT credit data can be reduced. The OMT verification process is
preseniry dependent on the integrity of the credit generators to meet all other regulations
that could impact the credit generation and use processes. The New Jersey approach to
OMT program implementation and operation, as illustrated by its self-implementing
program features, versus an up-front involvement with a functioning review program like
that in Michigan, demonstrates that adequate regulatory involvement and review of credit
transactions can reduce the risk of invalid credits.
Recommendations
We recommend that the Assistant Administrator for Air and Radiation:
3-1. Require the use of EPA- or state- approved emissions quantification protocols
prior to trades occurring, including the use of data quality objectives for the data
underlying trades, and ensure that appropriate compliance measures are used.
3-2. Require the OMT programs to perform vulnerability assessments over their
computer data systems to provide reasonable assurance of the accuracy of
computer records, data, and outputs in accordance with the General Accounting
Office's guides on assessing the vulnerability of information systems.
Agency and State Comments and OIG Evaluation
In his response to our draft report, the EPA Deputy Assistant Administrator for Air and
Radiation noted that alternatives to EPA-approved emission quantification protocols
existed prior to the approval requirement in the 2001 Guidance but that the 2001
Guidance now requires EPA approval of all protocols. His response acknowledged that
the fundamental standard for State Implementation Plan approval of OMT programs has
clearly changed. He also suggested some clarifications in other areas, which were
incorporated into the final report, as appropriate.
Michigan and New Jersey also suggested technical clarifications to the report, which
have been incorporated as appropriate in this Chapter. The full responses from EPA,
Michigan, and New Jersey are in Appendices 1,2, and 3, respectively.
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Chapter 4
Minimal Compliance Assurance, Enforcement,
and Overnight Activities Contributed to Risks of
invalid and Questionable Trades
EPA performed little compliance assurance, enforcement, or other oversight activities of
the New Jersey or Michigan OMT programs. EPA officials said that, since the State
programs had not been Federally approved, there was no requirement for EPA
oversight of the States' OMT activities. Regarding the States' oversight of their own
programs, we found that New Jersey designed its OMT program to be self-
implementing and self-regulating, and did not regularly monitor OMT program activities.
Michigan performed a preliminary completeness review of all emissions credit trading
transactions that provided greater assurance of compliance and lessened the risk of
invalid and questionable credits.
Compliance Assurance Monitoring Strengthens OMT
As discussed in Chapter 3, Michigan performs a completeness review of all State OMT
credit transactions before any credit information is entered into the State-run OMT
registry and before any credit transactions can occur. This State review provides
greater compliance assurance over credit transactions before they occur. The number of
emission credits involved in the credit transaction determines the level of review. Credit
transactions involving the higher level of review involve additional examination by
Michigan Department of Environmental Quality field inspectors, who consult facility
inspection reports and other detailed field office information on the facilities reviewed.
New Jersey used a "hands off' approach in monitoring and overseeing OMT credit
transactions and used an outside contractor to operate its OMT registry. Besides
working to get their OMT State Implementation Plan revision request approved by
EPA, New Jersey essentially was not involved in monitoring or overseeing its OMT
program operations.
EPA did not implement compliance assurance activities related to OMT credit
transactions in either State. EPA Regions 2 and 5 generally obtained information from
the State OMT registries concerning OMT credit transactions in New Jersey and
Michigan, respectively, in connection with the State Implementation Plan reviews for
those two States. However, EPA did not monitor specific OMT activities or
transactions from a compliance assurance perspective, such as emission credit
generation, transfer, or use, unless the Regions received a question on a specific OMT
activity related to the State Implementation Plan revision approval and comment
process.
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EPA noted that they performed more oversight duties with pending OMT State
Implementation Plan revisions than they usually do for other pending State
Implementation Plan revisions. Specifically as it relates to the New Jersey OMT
program, EPA pointed out that it participanted in a stakeholder workgroup from 1995
to 2000, reviewed ten credit generation strategies used in the New Jersey program, and
was involved in the PSEG settlement negotiations. However, in our opinion, these
activities indicated concerns with the OMT program in New Jersey and should have
resulted in closer scrutiny of Ihe New Jersey OMT program.
Enforcement Discretion Basis for Limited
EPA Enforcement Actions at OMT Sources
EPA officials involved in the OMT program stated that Federal oversight of Ihe program
was unnecessary given the absence of Federal approval of any state OMT programs.
However, facilities participating in both States have used OMT emission credits to meet
Clean Air Act requirements. EPA has the option of exercising "enforcement discretion"
in cases where EPA is reviewing a State Implementation Plan revision proposal that is
expected to be approved by the Agency. Under "enforcement discretion," EPA
enforcement staff may decide whether or not to take an enforcement action against a
facility that is not meeting Federal regulations if the applicable state program has not yet
been Federally approved but is in the EPA approval process.
EPA Regions 2 and 5 have worked with New Jersey and Michigan, respectively, in the
submission of State Implementation Plan revision requests that would allow the state
programs to be approved by EPA Regional officials were familiar with the design of the
States' OMT programs in connection with dealing with the State Implementation Plan
revision requests submitted to EPA However, no compliance assurance or oversight of
the State OMT programs themselves had been conducted by EPA staff, although
sources in both States used the OMT programs to meet Federal Clean Air Act
regulations. In commenting on our draft report, EPA officials noted that now that they
have decided to withdraw the proposal to approve the New Jersey program, they are
working with New Jersey officials to bring sources that had been using OMT credits into
compliance with underlying Clean Air Act requirements.
Some Enforcement Actions Involved OMT Programs
Although no OMT sources were specifically targeted for OMT compliance assurance or
enforcement activities by EPA, in the normal course of business a few OMT sources
were identified by EPA as having compliance problems and, in turn, to have generated
or used questionable or invalid emissions credits. The most notable case involved
PSEG, a utility in New Jersey. Details on this $337 million enforcement case are in
Appendix 8. In summary, EPA alleged that PSEG modified two plants without proper
permits and without sufficient reductions in emission levels to meet clean air
requirements. Following settlement discussions, PSEG agreed to retire 372,380 OMT
credits (about 18,600 tons of pollutants), representing about 90 percent of the generated
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credits listed on the New Jersey registry as available for use as of January 2002. Hie
retired credits had an estimated market value of over $16 million. PSEG's OMT credits
not retired as a result of the negotiations mentioned above were considered valid by
EPA Region 2. PSEG retained 75,440 credits of those for their own use; the other
credits had been transferred to other OMT program credit users earlier. Those other
users had either already used the credits or continued to hold them for future use.
The 2001 EPA Economic Incentive Program guidance and New Jersey OMT
regulations hold credit users responsible for purchasing valid credits for use in OMT
transactions. Specifically, the OMT program approach to credit validity responsibility is
generally a "buyer beware" policy. Therefore, if the PSEG credits transferred to other
users and credits already used had been found to be invalid, enforcement actions against
multiple credit users would be necessary at the Federal and State levels, most likely at a
considerable expenditure of enforcement resources.
The OIG review of selected New Jersey OMT files also identified a credit violation for
Conectiv, an electric utility company. Conectiv was required by its alternate emission
limit State permit to obtain OMT credits for the difference between emissions allowed
under Reasonably Available Control Technology requirements and its permitted
alternate emission limit. As a result, Conectiv obtained non-ozone credits and then used
those credits during high ozone seasons from 1996 through 2000, in violation of New
Jersey OMT regulations. New Jersey requires companies that rely on emission credits
during the high ozone season, which are the warmer months of the year, to purchase and
use credits that are based on pollution reductions achieved during similar high ozone
periods. The OIG informed New Jersey of this discrepancy, and the State included
these violations in ongoing settlement discussions with Conectiv. The resulting consent
decree included a $140,000 fine related to the improperly used OMT credits. Conectiv
paid the fine to New Jersey in June 2002.
Unlimited Credit Life May Cause Enforcement Difficulties
We also noted that the unlimited credit life of OMT credits may cause enforcement
difficulties. Trading information must be independently verifiable such that the liable
party is identifiable and accountable for any violations. Since EPA enforcement activities
are limited by the 5-year statute of limitations in the Clean Air Act, the concept of
unlimited lifetime of OMT credits, as allowed in EPA's 2001 Economic Incentive
Program guidance, may negatively impact EPA's ability to pursue enforcement actions
successfully.
Although untested by case law, EPA enforcement officials indicated that the generation
of emission credits could, in some cases, be considered discrete actions that occurred
beyond the 5-year statute of limitations. Therefore, in those cases, enforcement actions
against the source that generated invalid credits would not be allowed, even if the use of
the invalid credits was more recent than 5 years. While the Michigan OMT program
limited the life of credits to 5 years, the New Jersey OMT program has no limits on the
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life of emissions credits. Also, as noted in Chapter 2, the Michigan OMT program
allows credits generated from facility shutdowns. Since Michigan shutdown credits may
be generated for 5 years after the shutdown of the emitting source, along with the 5-year
credit life, some of the shutdown credits would be available for use for up to 10 years
after the source ceased operations9. EPA has proposed approval of Michigan's
program, including use of shutdown credits, but is considering whether to proceed with
final approval. EPA noted that no decision has been made on this issue. In its
comments on the draft report, EPA stated that, if they proceed with final approval, they
would require the Michigan program to fix the shutdown credit issue within three years.
Regulatory Agency Oversight Varies Significantly
Neither EPA nor the two States reviewed had performed an overall review of OMT
programs to assess the operation of their programs and identify strengths and
weaknesses. Michigan had begun an evaluation of its OMT program, and review of the
preliminary draft report on the evaluation indicated that the evaluation focused on OMT
program activity and Michigan Department of Environmental Quality's processes related
to that program.
New Jersey Department of Environmental Protection staff asserted that a State review
of their OMT program was not required until the program was Federally approved
However, State regulations required a triennial review of New Jersey's program, which
had been in existence since 1996. Since New Jersey did not review OMT credit
transaction data or notices of individual trades, the need for a review of the overall OMT
program was particularly pertinent. The lack of regular periodic oversight or monitoring
of the OMT program by New Jersey may have contributed to the State being less
prepared for the OMT program problems that arose.
Conclusions
Michigan's OMT-related compliance assurance process provided greater assurance that
trades were real, surplus, and quantifiable, and reduced the risk of invalid or
inappropriate credit transactions being entered into its OMT registry. Due to the
effectiveness of Michigan's up-front completeness reviews, Michigan significantly
reduced the risk of emissions-related enforcement activities. In contrast, New Jersey
adopted a self-implementing, self-directed OMT program that had minimal New Jersey
oversight involvement As a result, questionable credit transactions occurred that
resulted in enforcement actions related to those transactions. According to EPA and
State officials, these enforcement actions required considerable agency resources to
develop the cases and settle the violations.
We believe that emission-related enforcement difficulties ate more likely to occur when
regulatory agency oversight of OMT programs has been inadequate. Up-front
9See QIC's Memorandum to the Assistant Administrator for Air and Radiation, dated April 5, 2002,
regarding this subject, in Appendix 7 of this report.
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involvement in OMT program compliance assurance activities by tie applicable
regulatory agencies can significantly reduce the risk of occurrence of invalid credit
transactions and the resultant need for expensive, time-consuming enforcement actions
later when trades are alleged to be invalid or questionable. Additionally, the unlimited
life of emissions credits, such as in the New Jersey program, is believed to affect tie
ability of regulatory agencies to deter noncompliance, since some credits may be
generated beyond the 5-year statute of limitations.
Recommendations
To obtain reasonable assurance that tie OMT principles will be achieved, we
recommend tiat the Assistant Administrator for Air and Radiation:
4-1. Develop and require the use of a risk-based approach for Federal and state
oversight of OMT trades, including revising EPA's Compliance Monitoring
Strategy, to require states with OMT programs to use the risk-based approach.
4-2. hi developing the risk-based approach for Federal and state oversight of OMT
trades, at a minimum, tie risk-based approach should require enhanced
regulatory agency scrutiny of:
all precedent-setting trades.
all large volume trades.
all high-risk trades, such as those involving volatile organic compound-
containing air toxics.
trades with significant public comments or concerns.
trades employing less reliable emissions calculation techniques, such as those
involving mass balance calculations and/or emissions factors.
trades in industries with poor compliance records.
trades by facilities with poor compliance records.
trades with the potential for environmental equity impacts.
4-3. Establish a limit on tie life of OMT credits consistent with the Clean Air Act
statute of limitations period, presently 5 years.
Agency and State Comments and OIG Evaluation
The EPA Deputy Assistant Administrator for Air and Radiation noted that the need for
more oversight of the New Jersey and Michigan OMT programs is premature because
these programs have not been approved by EPA However, as stated in our report, we
continue to believe that, since the OMT participants have used OMT emission credits to
meet Clean Air Act requirements, EPA has an obligation to adequately oversee OMT
activities.
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EPA also noted that the PSEG case should not be portrayed as a failure of the OMT
credit validation process but as a successful outcome under the normal course of
enforcing. While we recognize EPA's successful enforcement action, we believe that a
risk based approach to targeting selected OMT participants for closer scrutiny would
identify questionable credits earlier and minimize the risk of large volume invalid trading
activity.
EPA also noted that the recommendation for a risk-based approach to oversight of
OMT program activities was unclear, and that oversight of OMT activities has the
potential for much higher regulatory agency resource commitments. Our
recommendation recognizes the resource commitments necessary to ensure that the
OMT program goals are met, and as such, tries to provide EPA with a pragmatic
approach to balancing limited resources against the need to minimize risk in trading
activity. A risk-based approach would allow EPA to focus its oversight activities on
higher risk sources, such as large volume participants, new credit generators and users,
and sources wilh recent violations.
Michigan and New Jersey also suggested technical clarifications to die report, which
have been incorporated as appropriate in this Chapter. The full responses from EPA,
Michigan, and New Jersey are in Appendices 1,2, and 3, respectively.
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Appendix 1
EPA Office of Air and Radiation Response
MEMORANDUM
SUBJECT: Open Market Trading Program for Air Emissions Needs Strengthening Report
No. 2001-0001067
FROM: Robert D.Brenner
Deputy Assistant Administrator
TO: Kwai-Cheung Chan
Assistant Inspector General for Program Evaluation
Thank you for the opportunity to comment on your draft evaluation report: "Open
Market Trading Program for Air Emissions Needs Strengthening." We appreciate the efforts of
your staff to provide an independent review of open market trading (OMT) programs and the
experience that New Jersey and Michigan have had with these programs to date.
While your analysis appears even-handed overall, we do have several questions and
comments to offer for consideration before you issue your final report Our comments are divided
into two sections: general observations, which are included in this letter, and more detailed
comments in die attachment
General observations
1) Misleading language: We found several places in the report where the language used
could easily be misconstrued by those not familiar with the details of open market
trading, or with how the States of New Jersey and Michigan put this concept into place.
For example, the executive summary includes the phrase, "Opportunity for public
comment not provided" As written, this implies that the public has not had the
opportunity to comment on the issue of the guidance for open market trading, on specific
State rules, or on individual trades.
In our attached detailed comments, we cite numerous opportunities for comment on the
2001 Economic Incentive Program (EIP) guidance issued by the Office of Air and
Radiation (OAR) and on the New Jersey and Michigan rules. In fact, the 2001 EIP
Guidance document provides information to help the public participate in the
development of these programs. We hope your final report will clarify the meaning of this
and other comments.
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2) Guidance or rule? In your draft report, you raise the question of whether the OMT
guidance and by inference the 2001 EIP Guidance should have been issued as a rule
rather than guidance. We will carefully consider your advice as we move ahead to our
next update of the 2001 EIP Guidance. However, we feel it is important that this report
include our reasons for choosing to update the initial 2001 EIP Guidance as a guidance
document.
As you know, we proposed an OMT Rule in 1995. We later decided to fold this into the
broader 2001 EIP Guidance. We did consider issuing the 2001 EIP Guidance as a rule,
but we decided against that approach so that we would not hinder the broad range of local
creativity and innovation needed to reduce emissions in different areas of the country with
differing air quality problems. No single rule would be able to anticipate the breadth of
options States may need to use to reduce emissions in a cost-effective and environmentally
responsible manner. With that in mind, we developed the guidance document to help
States design EIP's that are appropriate for their areas.
3) Another major point discussed throughout your draft report is that key provisions of the
Environmental Protection Agency's (EPA) 2001 EIP Guidance were not followed in the
design and review of the Michigan and New Jersey OMT Programs. This statement is
misleading since EPA stated in its proposed approval rulemakings that die basis for
proposing approval of the Michigan and New Jersey OMT Programs was the guidance
available at the time these programs were developed and submitted (i.e., before 1999),
which did not include the 2001 EIP Guidance. In the proposed SIP actions, EPA outlined
a process for revising the State programs in the future to be consistent with the 2001 EIP
Guidance. This is mentioned briefly in the Report in Chapter 2, but this statement should
be clarified in the Executive Summary.
Also, with respect to New Jersey's OMT Program, the Report should describe the
ongoing dialogue between EPA and New Jersey for 1he past several years regarding State
implementation program (SIP) approval of fee Program. The recent correspondence
(letters dated June 24,2002, August 13,2002 and September 10,2002) between EPA
and the State of New Jersey demonstrates the continuous nature of these discussions. A
more detailed discussion of this correspondence in the Report will help provide a more
accurate status of New Jersey's OMT Program and EPA's rulemaking process.
4) Our final general point highlights a common problem associated with OMT or almost any
smaller program associated with a broad program area Many of the issues pointed out in
your report are common to the broader air pollution control program. For example, the
issues of SIP processing times and enforcement discretion arise in implementing many
parts of the Clean Air Act Mentioning the issues here without mentioning the larger
context appears to say that the trading program independently raises these issues which is
incorrect
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Many of the issues you highlight in the draft report are issues with which OAR and EPA's
Regional Offices have been struggling for several years, and I appreciate your thoughtful review
and comments. Your evaluation, combined with our experience with the New Jersey and Michigan
programs, will help EPA strengthen the OMT guidance - and in turn, help States develop effective
EIP's that will help the Nation meet its air quality goals.
Should you have any questions concerning these comments, please do riot hesitate to call
me or contact Ron Evans (919-54-5488) who is my technical coordinator for developing these
comments.
Attachment
OAQPS:AQSSD:ISEG:REVANS:sjoumigan:MC C339-01:919 541-5488:9/25/02
Control No. OAR-0200766 Due Date: 9/24/02
n
o
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justify SIP disapproval. Most importantly, Michigan's program restricts the use of shutdown
credits to: 1) NSR offsets, used in compliance with NSR requirements (as is allowable under the
2001 EIP Guidance); and 2) compliance with applicable requirements in areas that neither have
nor need an attainment demonstration or maintenance plan (in other words, in attainment areas lhat
are not maintenance areas). As a result, compliance uses of shutdown credits will be limited to
areas that meet the national ambient air quality standards and have done so for a long time.
Moreover, a majority of the shutdown credits generated under Michigan's program have already
expired or been retired voluntarily. For VOCs, data provided by Michigan indicate lhat as of
April 2002, only 1,438 tons of credit will be available for use as a result of shutdowns that have
been registered to date. Therefore, it is unlikely that shutdown credit use will lead to any air
quality problems. Nonetheless, if EPA proceeds with approval of Michigan's program, we expect
that final action will include a statement that EPA expects Michigan to revise its program within.3
years of final approval to become consistent with 2001 EIP Guidance policies related to shutdown
credits.
6. Pages 14 to 16 state mat the lack of Federal approval is the reason that these open market
trading programs were not very popular. While this could be one of the reasons, there are
certainly others. Another reason lhat will continue even after EPA approval of the programs is Ihe
low demand for short term reductions. Most needs for emission reductions are long term.
Sources needing long term reductions much prefer long term emission reductions rather than
discrete emission reductions in open market trading. The EPA intends to encourage the use of
innovative and nontraditional control strategies as States are developing their original attainment
plans for the 8 hour ozone and PM fine standards. In addition, while the delay in Federal approval
may have made sources reluctant to participate in the trading programs, the link between Ibis fact
and the recommendations made on page 17 (Federal regulations for OMT programs, elimination
of shutdown credits) is not dear.
The Report discusses that officials from Michigan and New Jersey noted the lack of
Federal approval of their OMT Programs hindered operation of the program. The Report should
indicate other reasons why sources haven't participated. Based on Region 2's discussions with
New Jersey and industry-over the years, many sources did not participate in the program because
of the limited list of allowable uses for credit
7. "Conclusions": "EPA Regional Offices have inconsistently applied [the 2001 ED? Guidance]..
. in evaluating proposed OMT programs to date.? It isn't clear that a regulation is needed to make
EPA actions more consistent- to the extent that EPA may have treated OMT program
submissions inconsistently, this inconsistency occurred in relation to programs submitted prior to
the finalization of the 2001 EIP Guidance when the status of EPA guidance related to OMT
programs was unclear. The OMT programs submitted in the future will be judged against the
2001 ED? Guidance and, therefore, will not face this ambiguous situation, even in the absence of
regulation.
8. "Conclusions":. "Selective use of EPA guidance "rather than having regulatory
requirements to establish and approve OMT programs has hindered the ability of OMT
programs to become widely used and accepted." It is valid to state that uncertainty about what
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is approvable and about what the policy is has helped discouraged some States from developing
OMT programs and has contributed delays in action on the programs that have been submitted.
However, it isn't clear feat a highly prescriptive federal regulation will encourage widespread
adoption of OMT. Some of the IG's recommendations, such as requiring opportunities for public
participation in every trade, would likely discourage States from adopting OMT.
9. "Public participation process ineffective": The EPA and the States took several steps to
include interested parties in the design, implementation and oversight of the 2001 EIP Guidance
and State programs. While flaws have been uncovered in these programs, this does not
necessarily imply lhat the public participation process was ineffective. The EPA and the State will
continue to seek comment and input from interested parties as the State programs are further
developed and the 2001 EIP Guidance is updated and revised.
10. Pollutant inclusion in new 2001 EIP Guidance. During the public comment period on the draft
2001 EIP Guidance, a public interest group pointed out that including Lead raised issues about
trading toxic compounds which the 2001 EIP Guidance had not fully explored. In addition, Lead
could be excluded because there is little need for reductions in Lead in the future from a criteria
pollutant perspective. These two circumstances caused EPA to remove Lead from the pollutants
covered by the 2001 EIP Guidance. The EPA is prepared to ask Michigan to remove Lead from
their OMT program,
Although the new 2001 EIP Guidance didn't include PM fine, EPA is now developing a
separate document that provides guidance on using innovative strategies for reducing PM fine
concentrations. The EPA will then revise the 2001 EIP Guidance to include PM fine. The EPA is
also fine tuning its guidance for the 8-hour ozone standard to reflect the unique needs for
controlling a longer-averaging time ozone standard.
11. New Jersey's OMT SIP revision request was submitted in 1998, not 1996.
CHAPTERS
1. The Report discusses the fact that no EPA-approved quantification protocols were used to
calculate credit. Again, the requirement at the time in which these Programs were developed and
adopted is different than the current requirement of EPA's 2001 EIP Guidance. The EPA's OMT
guidance at the time was that if an EPA-approved protocol existed, it had to be used, unless
sources seeking an alternative received EPA approval. Otherwise sources can develop their own
protocols based on protocol development criteria contained in regulation. The EPA's 2001 EIP
Guidance now requires EPA approval of all protocols. The standard for SIP approval has clearly
changed and EPA planned for this fundamental change in the larger context of making these
Programs consistent wife the 2001 EIP Guidance in the future.
2. Emissions measurement methods may not be accurate: The report states feat mass balance is a
less reliable emissions quantification technique than CEMs "since they were only based on
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estimates." CEMs provide estimates as well- it's just that these estimates are considered highly
reliable (for some sources). A mass balance and CEM data are equally based on estimates, and
EPA believes that each can have a role in quantifying emissions reductions used to generate credits
in OMT programs.
3. "Data quality objectives not consistently used:" It isn't clear that fee data quality objectives
meant for evaluating the usefulness of data for making regulatory decisions ought to be binding on
sources that report emissions data under an OMT program, any more than on sources that report
emissions data under other programs.
CHAPTER 4
1. The need for more oversight Reports from several areas have highlighted the potential for
much higher resource commitments for oversight and enforcement in areas that implement
emissions trading programs. However, for New Jersey and Michigan, this issue is premature as
these trading programs are not approved in the SIP yet
2. The draft report correctly states that the enforcement settlement with PSEG removed a
majority of the credits from the New Jersey OMT bank. The draft report discusses how EPA
identified questionable credits by PSEG under its New Source Review enforcement initiative. It
must be emphasized that fee question regarding the appropriate emission limit for PSEG's power
generating facilities originated purely as a New Source Review issue and not as an OMT credit
validation issue. This is important because the New Source Review enforcement initiative affected
other programs in which PSEG's units were subject, not just OMT, including RACT, Acid Rain
and NOx Budget This particular issue should not be portrayed as a failure of the OMT credit
validation process, but as a successful outcome under the normal course of enforcing. This case is
no different from any other situation in which the inspection or review of a source's compliance
status determines fee source's emission rate is in violation of applicable requirements. The
difference here is fee effect fee remedy had on fee underlying programs. The PSEG settlement
had little effect in fee Acid Rain and NOx Budget Programs because those programs include many
other sources generating credit Conversely, PSEG happened to be fee largest generator of credit
in New Jersey's OMT Program. Therefore, fee agreement to retire most of PSEG's credit had a
huge effect on fee OMT Program.
3. Region 2 should be given credit when it questioned fee relationship between fee PSEG New
Source Review enforcement initiative and PSEG's participation in fee OMT and NOx Budget
Program more fean 1 year prior to fee start of fee OIG evaluation. In March 2000, when fee
Region issued a Section 114 letter to PSEG, fee Region 2 air program office and enforcement
office began sharing information on PSEG's facilities. Also, in fee course of negotiating a
settlement wife PSEG, Region 2 requested PSEG and New Jersey to provide information on any
credit use by PSEG. The PSEG provided Region 2 wife credit use information feat was not listed
in fee New Jersey OMT registry. Region 2 forwarded this information to fee OIG, bringing
attention to fee fact that New Jersey's registry failed to enter 1,376 tons of credits used by PSEG
from 1996 through 2001.
42 Report No. 2002-P-00019
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Open Market Trading Program for
Air Emissions Needs Strengthening
4. We applaud the OIG in identifying the inappropriate use of credit by Conectiv. Region 2
agrees this dear violation of New Jersey's OMT regulation could have been detected by New
Jersey had the State reviewed data being entered into the registry. However, Region 2
emphasizes this situation was a failure of implementing the program and not a specific deficiency in
the regulation
5. Credit Life. The comment is made to limit credit life to the 5-year statute of limitations on
enforcement actions. The EPA recognizes this issue. The EPA believes in some areas in some
situations a long credit life may be a better program. However., to rectify the issue mentioned here
the new 2001 EIP Guidance requires special provisions for areas that wish for credits to last
longer than 5 years. Every generator who wishes for their credits to last more that 5 years must
make an enforceable statement that they will not use the statute of limitations as a defense in any
enforcement action.
6. On page 28 the top paragraph says EPA plans to approve the Michigan program as is, with the
use of shutdown credits allowed,"... and with the recommendation (emphasis added) that
Region 5 require Michigan's OMT program meet 2001 EIP Guidance regarding shutdown credits
within 3 years." The EPA has proposed approval of Michigan's program, but is considering
whether to proceed with final approval. This decision has not been made yet If EPA does
proceed with final approval, we expect to more lhan recommend a change in the shutdown credit
provisions; we would expect to require the MI program to fix the shutdown credit issue within 3
years.
7. The risk based approach is unclear. We can't evaluate its validity without some additional
support Maybe this section should be strengthened to make it clearer what is meant In addition,
it isn't clear what in the report indicates the need for a risk-based approachthe supporting
information for it is missing.
8. We believe the report is incorrect in stating that EPA performed little compliance assurance,
enforcement, or other oversight activities of Ihe New Jersey OMT programs. Though Region 2
may not have targeted its limited resources for OMT-related enforcement initiatives since the State
programs had not been federally approved, Region 2 did conduct several oversight efforts to
understand Ihe implementation of Ihe Programs while reviewing and processing the OMT SIPs. In
fact, Region 2 performed more oversight duties with these pending OMT SIP revisions than it
usually does for other pending SIP revisions. In the case of New Jersey this included: (1)
participation in New Jersey's stakeholder work group from 1995 to 2000, (2) reviewing the ten
credit generation strategies from reductions occurring prior to adoption of New Jersey's OMT
Program, and (3) involvement in the PSEG New Source Review settlement negotiations. Rarely
does Region 2 provide such oversight of the implementation of a State-adopted program that is
pending SIP rulemaking.
With respect to the ten credit generation strategies mentioned in the Report, Region 2 believes Ihe
Report is misleading by suggesting the Region failed to follow through on the deficiencies of these
ten strategies. Region 2 specifically discussed in the proposed action on New Jersey's OMT
Program that the results of the review were provided to New Jersey for the State to work with
43 Report No. 2002-P-00019
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Open Market Trading Program for
Air Emissions Needs Strengthening
industry in addressing Region 2's comments. Region 2 stated in the proposal it would follow up on
these strategies when the OMT Program is federally enforceable. It should be. emphasized that
these are credit generation sources and not credit users. While EPA could decide to enforce
underlying requirements upon credit users, EPA has no authority to enforce against credit
generators, or determine the credit invalid, until the OMT Program is federally enforceable. Also,
Region 2's review of the ten credit generation strategies provides evidence that EPA Regional
Offices will implement the 2001 EIP Guidance's protocol approval process, contrary to
statements in the Report.
One other point of clarification regarding fee ten credit generation strategies: New Jersey did not
"grandfather" credits from the NESCAUM/MARAMA Demonstration Project. New Jersey
provided a limited period of time within its regulation for any source to submit early reduction
credits for emission reductions which occurred prior to rule adoption. Ten sources submitted early
reduction credit generation strategies, some of which participated in the Demo Project
Independent of the OMT regulation, New Jersey conducted a public notice and comment
rulemaking process in approving the 1992 and 1993 PSEG credits under the Demo Project.
9. The Report is only telling part of the story in stating EPA has not targeted OMT activities for
enforcement In the case of New Jersey, Region 2 has twice offered to work with the State to
address compliance issues with sources that currently hold credits or that have been using credits
to comply with SIP approved regulations (June 24,2002 and September 10,2002 letters).
Region 2 intends to work with New Jersey to address this compliance issue and will be sensitive to
the fact that these sources used credits in a good faith effort to comply with State and Federal
regulations.
44
Report No. 2002-P-00019
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Appendix 2
Michigan Department of Environmental Quality Response
S IAI1< O" MlCHMrAN
DEPARTMENT OF ENVIRONMENTAL QUALITY
T.ANSJM,
JOHN ENGLER . RUSSELL J. HARDING
September 26, 2002
Mr. John M. Bishop, Project Manager
Office of Inspector General (N238-01)
U.S. Environmental Protection Agency Mailroom
Research Triangle Park, NC 27711
Dear Mr. Bishop:
The Michigan Department of Environmental Quality (MDEQ), Air Quality Division (AQD),
appreciates the offer to comment on the draft report on Open Market Trading (OMT).
Understanding the time limits imposed upon the Office of Inspector General (OIG), the AQD
has kept comments to a minimum. In general, the report is well written and easy to
understand.
Comments
General:
On page 1 of appendix 6, under the paragraph for "completeness" the word "decision
makers" is misspelled.
Chapter 2:
The draft report contains the following statement: "As the result of the lack of
regulations, safeguards intended to protect the public have not been consistently
applied and invalid and questionable credits have been traded in some instances."
The AQD is uncertain whether this statement is applicable to Michigan or is regarding
the United States Environmental Protection Agency's (EPA's) role in the issuance of
regulations for trading programs. Clarification is necessary before AQD can properly
respond.
Table 2.1 includes the following statement: "EPA was concerned that a facility may
shut down in one state, generate and sell credits, but then relocate their operations to
other states." The AQD shared this same concern. The AQD does not allow load
shifting per Rule 1207(5). Rule 1207(5), promulgated pursuant to Part 55, Air Pollution
Control, of the Natural Resources and Environmental Protection Act, 1994 PA 451, as
amended, requires a statement of compliance as part of the notice submittal. In
addition, as part of the review procedures for processing generations, the AQD
requests information regarding load shifting from the companies involved in the
program. As detailed below:
Rule 1207(5) states "Any baseline calculated under subrule (2) of this rule shall be
adjusted by subtracting from the baseline any emission increases from another source,
CXJKSTfTUTION HALL 325 WE6T ALUEQAN STREET P.O. 30X3Q26Q LANSING. MICHIGAN48303.7760
n p*'« {517J 373-7G33
45 Report No. 2002-P-00019
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process, or process equipment in the same source category and under common
ownership or control resulting from a shutdown or curtailment of the source, process, or
process equipment making the emission reductions."
*
Submittal and review procedures state:
"If the emission reduction strategy is a permanent or temporary shutdown or a
curtailment of operations, then it is necessary that one of the following be included in the
submittal to ensure
that all emission reductions being claimed are "real" (in that an actual reduction in air
emissions has occurred):
(i) A demonstration that the baseline emission level has been adjusted to account for
any "load shifting" as required pursuant to Rule 1207(5), or
(ii) An explanation of why there was no "load shifting" as a result of the shutdown or
curtailment of operations, including a statement that this did not occur."
The draft report contains the following statement: "As the result of the lack or
regulations, safeguards intended to protect the public have not been consistently applied
and invalid and questionable credits have been trading in some instances." The AQD
cannot respond without OIG defining what they consider an "invalid" emission credit.
The AQD does not allow any emission reduction credits (ERCs) that are not real,
surplus, enforceable, permanent and quantifiable. The AQD would also like to note that
we have not allowed any invalid or questionable credit transactions. The statement
suggests that Michigan may have had problems in this area, which is without any
evidence provided by OIG. The AQD recommends that OIG delete or revise the
statement.
Chapter 3:
In the draft report, OIG "... noted that supporting documentations for 5 of the 42
transactions could not be located even though information on the trades could be
located on the registry." The AQD is currently reviewing the filing procedures for the
trading program to insure that files are not misplaced or lost. In addition, electronic back
up copies of all letters and staff analyses are maintained.
Chapter 4:
In the paragraph with heading of "Some Enforcement Actions involved OMT programs,"
a general statement is made regarding enforcement activities and that "some OMT
sources may have generated or used questionable or invalid emission credits." As
stated above, the AQD cannot respond without OIG defining what they consider an
"invalid" emission credit.
In Appendix 3, OIG states: "We found that all the generation and use sample
transactions were entered into the Michigan OMNT Registry on the Internet. We could
not find any transfer transactions on the Registry." The AQD has been working with our
computer assistance group under the Michigan Department of Information Technology
to correct this problem. At this time, it appears to be a software glitch that occurs when
the database is updated. It should be noted that the information is in the database and
AQD staff were able to pull this information for the auditors to review.
Michigan's OMT program has been functioning since 1996. Although not used extensively
because of Michigan's attainment of all criteria standards, the program has provided a very
workable option for companies seeking a more cost effective means of complying with various
air standards. It is a sound program that came about through many hours of discussions
among experts in the field of emissions trading, MDEQ staff, and various stakeholders. As with
46 Report No. 2002-P-00019
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any new program, there are tweaks that are needed to improve its functioning and to address
scenarios that were not originally anticipated. The MDEQ will continue to pursue these as
needed.
The AQD would like to reiterate that our OMT program is a voluntary statewide program, which
includes volatile organic compounds and all criteria pollutants except ozone. Any person,
stationary, area or mobile source may participate in the program, at their option. In order to be
considered creditable under the program, all emission reductions must be:
1. Surplus, reductions made below an established source baseline and not required by any
applicable requirement;
2. Real, in that all emission reductions have actually occurred prior to use;
3. Quantifiable, in that all reductions can be measured and are replicable;
4. Enforceable, in that they can be enforced by both MDEQ and the EPA;
5. Permanent, in that the reductions continued throughout the time the ERCs were generated.
All sources wishing to participate in the program must have been included in the most recent
emission inventory and emission reductions must have occurred after March 16,1996. To
ensure that the emission trading program is used in a manner consistent with attainment and
maintenance of NAAQS and state and federal requirements, ERCs and Emission Averaging
Plans cannot be used to avoid or comply with the following requirements:
New Source Performance Standards (IMSPS)
t National Emission Standards for Hazardous Air Pollutants (NESHAPs)
Maximum Achievable Control Technology (MACT)
Best Available Control Technology for Toxic Air Contaminants (TBACT)
i
ERCs can be used to comply with Best Available Control Technology (BACT)/Lowest
Achievable Emission Rate only when the required control equipment has been properly
installed, operated and maintained.
Thank you for the opportunity to comment on the draft report before it is finalized. If you have
any questions concerning our comments, please contact Ms. Theresa Walker, AQD, at
517-335-2247, oryou may contact me.
Sincerely,
Dennis M. Drake, Chief
Air Quality Division
517-373-7069
cc: Mr. Russell J. Harding, Director, MDEQ
Mr. Arthur R. Nash Jr., Deputy Director, MDEQ
Ms. Theresa Walker, MDEQ
47 Report No. 2002-P-00019
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Appendix 3
New Jersey Department of Environmental Protection
Response
September 26, 2002
Mr. John M. Bishop
Project Manager
Office of the Inspector General
USEPA
Room 113
EPA Administration Building
79TW Alexander Drive
Research Triangle Park, N.C. 27711
Re: Comments of New Jersey Department of Environmental
Prote ction on Open Market Trading Inspector General
Draft Report
Dear Mr. Bishop:
Enclosed please find the comments of the New Jersey Department of
Environmental Protection on the Draft Report of the USEPA Inspector General regarding
Open Market Trading programs. We thank you for the opportunity to review the
document and provide comments to the Office of the Inspector General. As I will be out
of the office for the next four business days, I ask that you contact Lisa Jackson, Assistant
Commissioner of Compliance and Enforcement, if you have questions about the
document or require assistance. Assistant Commissioner Jackson will coordinate
whatever assistance you need. She can be reached at (609)777-0122.
Thank you.
Sincerely,
Catherine A. Tormey
Counselor to Commissioner
c: Lisa Jackson, Assistant Commissioner
Samuel Wolfe, Assistant Commissioner
48 Report No. 2002-P-00019
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General Comments
The report points out a number of inconsistencies between the New Jersey OMET program and
the EPA's 2001 Economic Incentive Program (Eff) Guidance. The EIP Guidance was not issued
until several years after New Jersey promulgated its OMET program.
The report also refers to New Jersey's failure to require the use of EPA-approved quantification
protocols. EPA has not approved open market trading quantification protocols, and has not
offered the service of approving protocols developed by market participants or states (although
several EPA staff did informally provide helpful information pertaining to acceptable quantification
in specific cases). New Jersey's rules do require that any quantification protocol used "conform
with all applicable guidance issued by the EPA" New Jersey's rules also include detailed
requirements governing how quantification must be performed.
The report inaccurately describes the state's program as "buyer beware." The program allows
credit users to rely on a third-party verification - if verified credits are eventually found to be
invalid, the user is not on the hook for penally liability, but simply has to replace the bad credits
wilfa valid ones. This is the opposite of "buyer beware" - which would leave the user liable for
penalties for invalid credits, regardless of whether the user had relied on a third-party verification
or even if the user had conducted its own thorough due diligence. There is no requirement that
"credit purchasers would ensure the validity of emissions credits prior to their purchase and use."
Chapter 1
Current Status:
Footnote 2 referenced in Table 1.4 indicates that New Jersey was "requesting termination" of its
OMT program in an August 2002 letter. No such request was made to EPA.
Chapter 2
Key Provisions of 2001 Guidance Not Followed to Designing or Reviewing OMT Programs
In the row of Table 2.2 pertaining to quantification protocols, it should be noted that the New
Jersey program requires that any protocol used "conform with all applicable guidance issued by
the EPA."
Chapter 3
Different Approaches Used to Evaluate OMT Data
1. to the second sentence the draft states that New Jersey relied on both third party
contractors and verifiers to evaluate OMT data In fact the New Jersey program relies on third
party verifiers who must be either a P.E. or C.P.A. licensed in New Jersey. The words
"contractors and" should be deleted from the sentence, because no other "contractors" can verify
credits.
49 Report No. 2002-P-00019
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2. The paragraph entitled "New Jersey" needs revision.
New Jersey: In designing its OMT program, New Jersey decided to privatize important aspects
of 1he program, including Ihe evaluation of OMT data underlying trades. Rather than having state
regulators analyze Ihe data underlying Ihe generation or use of credits, New Jersey relied on third-
party verifiers to do this work. New Jersey officials said that they relied on third-party verifiers
because the data analysis was resource-intensive, and no state monies were budgeted for state
regulators to perform this work. In addition, the statute authorizing the state's OMT program
required the state to "consider the role of a third party in the banking, verification, validation of use,
enforcement, and program audits associated with emissions reduction credits, and to the maximum
extent possible, create and preserve opportunities for private sector participation in any emissions
trading program..." The decision to rely upon Ihird-party verifiers was therefore consistent with
the direction set by state statute and with the direction set by state budgets.
EPA-Approved Protocols Not Used
1. The first sentence refers to a random sample of 84 OMT credit transactions and states that
none of these transactions employed EPA-approved quantification protocols. It would be more
accurate to say, "We reviewed a random sample of 84 OMT credit transactions. Since no
applicable EPA-approved quantification protocols were available at the time of those transactions,
none of them relied on such protocols."
Emission Measurement Methods May Not Always Be Adequate
1) The points being made in this section diverge from the position of EPA's January 2001
Economic Incentive Program Guidance which reads:
" As a general principle, when quantifying the amount of emission reductions generated or needed
for compliance, a source must use measurement techniques no less accurate than those required
for the source to demonstrate compliance. Sources are not required to use measurement
techniques more accurate than those required for the source to demonstrate compliance."
New Jersey Approach Emphasized "Buyer Beware" Philosophy
1) The above heading is not only inaccurate; it also seems unrelated to the subject of the
section. Something like "New Jersey Approach to Registry Operation" seems more to the point.
2) Please replace the first sentence wife fee following: "In designing its OMT program, New
Jersey decided to privatize important aspects of the program, including fee operation of a registry
of all credit transactions."
3) The second paragraph in this begins "Due at least in part to the 'Buyer Beware' approach
used by New Jersey..." The relevance of this opening clause to the substance of fee paragraph is
unclear. The paragraph discusses how New Jersey required that trades be documented, and
certain program failures in feat regard. None of this has anything to do wife Buyer Beware.
50 Report No. 2002-P-00019
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Appendix 1
New Jersey - Open Market Emissions Trading
1) .To make it more accurate, I recommend modifying the third sentence in the first paragraph
as follows: The New Jersey Department of Environmental Protection's rules created a 90 day
window-of-opportuni1y for companies with "early" reductions (i.e., reductions made on or after
May 1,1992, but before August 2,1996, when the OMET rules became effective), including
[grandfalhered the] Demonstration Project participants^ protocols, and] to generate OMET
credits [into its OMET program] based on these reductions, but only if Ihe generation satisfied the
applicable requirements in the rule, including those for quantification protocols.
2) The fourth sentence in the first paragraph uses the phrase "model project"; for consistency
of terminology, this should probably be revised to "Demonstration Project"
Appendix 2
Objectives, Scope and Methodology
Evaluation Process
In the last paragraph, the Inspector General states: "However, due to the State of New Jersey's
refusal to grant us access to certain OMT-related documents in their possession which they
withheld claiming (1) attorney-client priviledge, and (2) enforcement sensitive priviledge, our
evaluation scope was limited" We would prefer lhat the sentence read that NJDEP "declined to
provide access to a limited number of documents that the Department asserted were priviledged
based upon advice of counsel." In addition, we believe it is appropriate to acknowledge in that
sentence or paragraph that the State maintained and provided to the Inspector General reviewers
a Priviledge Log of the limited number of documents not provided for review because of priviledge
assertions.
51 Report No. 2002-P-00019
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Appendix 4
Overview of New Jersey and Michigan
OMT Programs 10
New Jersey - Open Market Emissions Trading11
The New Jersey Open Market Emissions Trading program became operational in August 1996.
Prior to establishing its OMT program, New Jersey participated in the 1992-1996 Emission
Reduction Credit Demonstration Project conducted by the Northeast States Coordinated Air Use
Management and Mid-Atlantic Regional Air Management Association. After a public notice - and
- comment rule making process, tiie New Jersey Department of Environmental Protection allowed
the Demonstration Project participants, protocols, and credits to be included in its OMT program.
The Demonstration Project participants generated the majority of credits traded and used within
the OMT program during the Demonstration Project In the New Jersey OMT program, credits
have an unlimited life; that is, the credits are available for use for an unlimited timeframe. The
program restricts trading to nitrogen oxides and volatile organic compounds. New Jersey OMT
regulations specifically forbid the generation of credits by the closing of facilities or product lines
(shutdown credits). Credits generated during the non-ozone season (winter) cannot be used
during the ozone season (summer).
To ensure compliance, the New Jersey OMT regulations rely heavily on credit participants' self
certification and credit verification by third parties. New Jersey follows a "buyer beware"
philosophy, which places the burden of verification on users of credits. In New Jersey, the OMT
participants may not use credits until verified by an engineer or certified public accountant who is
not employed by Ihe credit generator. The OMT credit verification process is intended to ensure
that the credits are real, surplus, and properly quantified. The user must also purchase and retire
an additional 10 percent of the total credits used for the benefit of the environment
Participants earn credits based on emission quantification protocols, which define the process for
generating and measuring emission reductions. OMT regulations do not require these protocols to
be approved by the state or EPA, though an existing EPA-approved protocol that meets OMT
regulations must be used, if applicable. Otherwise, the protocols must meet criteria in the state
OMT regulations.
Personnel from the New Jersey Department of Environmental Protection did not administer or
monitor the OMT program directly. New Jersey contracted with a third-party to create and
maintain the electronic OMT database (Registry) and its supporting documentation. By accessing
the Registry, the public and government offices could track the generation, verification, transfer,
The Michigan OMT program is based on Emission Reduction Credits where 1 credit equals 1 ton of
emissions. The New Jersey OMT program is based on Discrete Emission Reductions Credits where 1 credit equals
100 pounds of emissions. For this appendix, we used the generic term "credit" for both.
The New Jersey OMT regulations also address the trading of credits under the Greenhouse Gas
program. The EPA Economic Incentive Program guidance does not include greenhouse gases (such as carbon
dioxide and methane); therefore, we did not include this Greenhouse Gas program in our evaluation of OMT
programs.
52 Report No. 2002-P-00019
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use, and retirement of credits. The Registry contract did not involve State funds. The OMT
regulations required participants to submit all notices to the contractor for processing and data
entry into the Registry. The fees paid to the contractor by the participants constituted the contract
revenue. While the information in the Registry and documentation that supported it belonged to
the State, the software driving the Registry belonged to the contractor. The Registry operator
ensured that required data was provided, but did not otherwise review the data and information
provided for accuracy or reliability.
Michigan - Emission Averaging and Emission Reduction Credit Trading u
Michigan implemented its OMT program in 1996. The Michigan program allows credit
generation, trading, and use for six pollutants: nitrogen oxide, volatile organic compounds, carbon
monoxide, sulfur dioxide, particulate matter, and lead (although lead is not allowed by EPA's
Economic Incentive Program Guidance). Environmental benefit is obtained by retiring 10 percent
of the credits when they are entered into the Registry and by limiting credit life to 5 years. Credits
generated during the non-ozone season cannot be used during the ozone season.
The Michigan OMT program allows the generation of shutdown credits, which is specifically
prohibited by the 2001 Economic Incentive Program Guidance. Michigan's OMT regulations
define shutdown as, "the permanent cessation of operation of a source, process, or process
equipment for any purpose...." The participant can generate credits every year for a period of
5 years after the shutdown.
If a Federally approved protocol exists, the Michigan program requires that the approved protocol
be used. Otherwise, EPA approval of quantification protocols is not required by the Michigan
program. However, State completeness reviews do include a review of quantification protocols.
The Michigan OMT program is administered in-house by Michigan's Department of
Environmental Quality. The State maintains the on-line Registry and documentation, and performs
any necessary reviews. The State performs a standardized review of all notices (generation, trade,
use, and retirement), called a Tier 1 review. If the amount of credits are more significant,
Michigan's regulations require a second, more detailed, Tier 2 review (generation and use only).
The review process must be completed before the credits are entered into the public Registry.
We did not include emission averaging in the scope of this evaluation.
53 Report No. 2002-P-00019
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Appendix 5
Details on Scope and Methodology
EPA OIG conducted evaluation fieldwork in the States of Michigan and New Jersey; EPA
Regions 2 and 5; and at EPA's Headquarters Air and Enforcement Offices. These EPA offices
include the Office of Policy Analysis and Review, 1he Office of Air Quality Planning and
Standards, and the Office of Enforcement and Compliance Assurance.
New Jersey and Michigan were selected as uie State OMT programs for review because
(1) EPA Office of Air Quality Planning and Standards staff indicated that these States had the
most active OMT programs; (2) both States had already submitted State Implementation Plan
revision requests to EPA which requested Federal approval of their OMT programs; and (3) EPA
had allowed Michigan and New Jersey to operate OMT programs for over 5 years under EPA's
enforce/nent discretion policy. The policy described in the last item allows certain clean air-related
activities to take place without incurring a Federal enforcement action, as long as the activities are
envisioned to be approved in Ihe future through EPA approval of a State Implementation Plan
revision, or other similar Federal approval mechanisms. As of August 2002, neither State
program had been Federally approved.
Within the States of New Jersey and Michigan, and within EPA Regions 2 and 5, respectively, we
discussed OMT issues with policy, program, oversight, inspection, compliance, and enforcement
managers and staff, and we obtained and reviewed related files and correspondence on key OMT
implementation issues dating back to the inception of the programs in both States.
We also sought any studies or evaluations demonstrating the effectiveness of OMT programs, in
particular cost-benefit studies or evaluations of the assertion that OMT programs achieve more
environmental benefits at less cost
Within EPA, we interviewed program staff at the national and regional levels to gain an
understanding of EPA's policies and guidance concerning open market trading. We closely
examined EPA's Economic Incentive Program Guidance, which we accepted as the primary
criteria to assess the state programs.
We contacted industry associations and environmental groups for information and input on OMT
issues, as well as key state and local agency associations. We also obtained information and input
on OMT issues from selected participants in the two State OMT programs we reviewed. In
Michigan, we met with a major automotive manufacturer and a manufacturer of automobile
mirrors. Both companies participated in the State OMT program, one as a credit generator and
one as a credit user. In New Jersey, we met wrtii two electric utility companies - one utility both
generated and used OMT credits, while Ihe other used OMT credits.
The evaluation was generally performed in accordance with the Government Auditing Standards
issued by the Comptroller General of Ihe United States as they relate to economy, efficiency, and
program results audits. However, due to toe State of New Jersey's decision to not grant us
access to certain OMT-related documents in their possession based on advice of counsel, our
evaluation scope was limited. As part of this evaluation, we assessed compliance with applicable
54 Report No. 2002-P-00019
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laws and regulations. Because of severe problems within the New Jersey program, we did not
perform a review of internal controls. Except as noted in this report, we did not identity instances
of noncompliance with Ihe Clean Air Act
Sample Selection
To evaluate the OMT program according to the objectives listed above, we reviewed a randomly
selected sample group of (1) 42 trades from a total universe of 451 trades in Michigan, and
(2) 42 trades from a total universe of 341 trades in New Jersey. We reviewed three major types
of OMT transactions: credit generation, credit transfers, and credit uses. We obtained the
electronic OMT databases from each State. We did not independently assess the quality of the
database output as a whole. After we reformatted both databases, we used Windows Integrated
Data Extraction and Analysis software to extract three sample sets of credits (Generation,
Transfer, and Use) for each State. A discussion of the sampling methodology for each State
follows. Additional discussion of the sampling approach, methodology, and results is contained in
Appendix 6.
55 Report No. 2002-P-00019
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Appendix 6
OMT Sampling Procedures and Results
We reviewed a randomly selected group of trades in the Michigan and New Jersey OMT
programs. This was done to determine, on a sample basis, the extent of (1) use of EPA-approved
emissions quantification protocols to calculate tradeable emissions credits in selected states' OMT
programs, and whether accurate, reliable data underlie OMT trades in these programs; and (2)
EPA and state compliance assurance, enforcement, and oversight activities relative to OMT
trades, and whether OMT programs afifect the ability of regulatory agencies to detect and/or deter
noncompliance.
New Jersey and Michigan provided electronic copies of both States' OMT program activity
database. We did not independently assess the databases for quality, accepting the information as
provided for use in sample selection.
Three major types of credit transactions in the OMT trading programs were sampled - credit
generation, credit transfers, and credit use. We used Windows Integrated Data Extraction and
Analysis software to randomly select trades for review. A total of 14 sample items were selected
for each of the 3 types of OMT transactions to be reviewed, for a total of 42 sample items
selected. The samples selected were based on a 90 percent confidence level, which was deemed
appropriate for the questions posed and the fact that we would be generalizing our findings only to
these OMT programs at the state levels for the respective States, and not to other states or other
regions.
For the Michigan OMT program, which had a total universe of 451 trades, a total of 42 sample
items were selected, 14 in each of the three OMT transactions areas to be reviewed, as noted.
The State of New Jersey had experienced problems with its OMT Registry and its contractor
during the OIG evaluation. The contractor who operated the New Jersey OMT Registry and
provided maintenance of the OMT records ceased operations in September 2001. New Jersey
was not able to obtain the electronic databases and hard copy files for approximately 4 months.
Since we were unsure of Ihe completeness of the OMT files obtained, we selected a total of 60
sample items from a total universe of 341 trades for the New Jersey OMT program, 20 for each
of the 3 transaction areas. The sample selections were numbered consecutively. In the event that
a sample selection item hard copy file was not available, we moved to the next consecutively
numbered sample item as a substitute until such time as 14 sample files were obtained for each
OMT transaction reviewed. We were able to find 14 sample items for each OMT transaction
reviewed for the State of New Jersey.
The New Jersey database for credit generation was adjusted to remove one credit major
generation source. During the course of our evaluation, PSEG, the company which generated the
majority of emission credits in the New Jersey OMT program, entered a settlement agreement
with EPA, the U.S. Department of Justice, and the State of New Jersey, to remove over 372,380
emissions credits from the New Jersey OMT program (about 18,600 tons of emissions). As such,
this company and its OMT emissions credit trading activities were not included in our credit
generation sample but were separately reviewed. In the Michigan database, the credit use
database file included both use and retirement transactions. Since we were reviewing the credit
56 Report No. 2002-P-00019
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use function only, the retirement transactions were removed from the data used to select the credit
use sample for Michigan.
New Jersey
The New Jersey OMT Registry contractor ceased operation of the Internet Registry site in
September 2001. The Registry contractor also maintained the OMT records. New Jersey had
problems obtaining the OMT Registry database, as well as the OMT records. New Jersey had
also informed us that they had not systematically reviewed the OMT database or the records since
the OMT program began operations in 1996. Based on this information, we decided that our
sampling program for New Jersey should provide for substitute sample selections in case some
OMT files were not available. Therefore, 3 sets of 20 samples were selected from which 14 in
each set would be used. We instructed the State to produce the files supporting the first 14
samples. If the file for a sample could not be found, the State was advised to take the next sample
from the subject sample set until they had 14 documented samples for each of the 3 transactions;
credit generation, credit transfer, and credit use. A total of 42 OMT transactions were reviewed
in New Jersey.
For New Jersey's OMT generation sample set, PSEG and its OMT trading activities were
separately reviewed because, as discussed above, PSEG entered into a settlement agreement with
EPA and the U.S. Department of Justice to remove over 18,600 tons of emissions credits from the
New Jersey OMT program.
The New Jersey OMT program included credits related to the State's greenhouse gas program.
Since the greenhouse gas program was outside the scope of our evaluation, we did not include
these credits in the universe from which we extracted our sample sets.
Using the substitution formula discussed previously, we were able to locate the official files on 42
sample items, 14 in each of 3 OMT transaction areas to be reviewed. The New Jersey OMT
program requires that OMT participants provide notice of ihe OMT transactions that they plan to
complete. We checked each sampled file to ensure that the correct notices were provided. One
of the 42 sample items, a use transaction, did not include a copy of the notice of use. We did not
find that any of the emissions quantification protocols required for generation and use transactions
had been approved by EPA, contrary to the 2001 Economic Incentive Program Guidance. New
Jersey OMT regulations require that OMT emission credits be verified as real and surplus prior to
use. We found that all of the credits had been verified as required prior to use. There was also
verification of the credits involved in the sampled transfer transaction files, as well as in 7 of the 14
sampled generation files, although verification was not required for generation and transfer
transactions. When emission credits are used during an ozone season, the credits used must have
also been generated during an ozone season. Generated credits must be identified according Ihe
season when generated, ozone or non-ozone. All of the generation files identified the season when
credits were generated, as did the transfer files. We did find that three of the use transactions
incorrectly used non-ozone season credits during the ozone season.
We also checked to see if the sampled transaction files had corresponding data entries in the OMT
Registry, the Internet database that provided information about OMT activities to the public, New
Jersey Department of Environmental Protection, and EPA. We found that 10 of the transfer
activities and 8 of the use activities had not been recorded in the OMT Registry.
57 Report No. 2002-P-00019
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The following table summarizes the sample findings for New Jersey.
New Jersey OMT Sample Results
Generation
14
14
14
Transfer
14
N/A
14
14
Use
13
14
11
Michigan
The full title of the Michigan program is Emission Averaging and Emission Reduction Credit
Trading. Since our evaluation was limited to open market trading, we did not examine any items
related to Emission Averaging. Michigan maintained both credit use and credit retirements in the
same database file. We removed foe credit retirement transactions from the database in order to
review credit uses only. The random sample for credit uses was selected from the database after
the removal of credit retirement transactions. We randomly selected 14 transactions for each
OMT activity we reviewed - credit generation, credit transfer, and credit use. A total of
42 sample transactions were reviewed in Michigan.
The Michigan OMT regulations require that OMT participants provide notice of OMT
transactions that they plan to complete. We checked the sample files for the generation, transfer,
and use transactions to ensure that the required notices were provided. We could not find four
notices related to the transfer transactions. The Michigan Department of Environmental Quality
performs a completeness review for all OMT transactions, issuing a completeness letter when the
State review of the OMT activity finds the documentation of the OMT activity is adequate. Tier 2
reviews are performed for all transactions; Tier 2 reviews, which are more in depth, are triggered
at identified levels of emissions for generation and use transactions.
We found that one sample file in the generation transactions, one sample file in the use
transactions, and five of the transfer transactions lacked evidence of the Tier 1 review. We found
evidence of the Tier 2 review for all of the sample files where required. Copies of the
completeness letter were missing from four of the generation transactions sample files, five of the
transfer sample files, and two of the use sample files. However, we did not find that any of the
quantification protocols for generation and use transactions had been approved by EPA, though
Hie Tier I/Tier 2 reviews by Michigan did include a review of the quantification protocol.
Michigan allows the generation and use of credits generated by shutdown of facilities or
curtailment of facility operations, which is not allowed by the 2001 Economic Incentive Program
Guidance. Six of the sampled generation transactions showed that the emission credits were .
generated by shutdown activities. One of the transfer files involved transfer of shutdown credits.
One of the use transactions used shutdown credits. We found that all of the generation and use
sample transactions -were entered into the Michigan OMT Registry on the Internet We could not
find any transfer transactions on the Registry. In its response to our report, Michigan officials
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Report No. 2002-P-00019
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indicated that a software problem occurs when the database is updated, but that the transfer
information has been made available on the Registry. The following table summarizes the sample
findings for Michigan.
Michigan OMT Sampling Results
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Appendix 7
OIG Memorandum Regarding Michigan Shutdown Credits
UNITED STATES ENVIRONMENTAL PROTECTION AGENCY
OFFICE OF INSPECTOR GENERAL
1200 Pennsylvania Avenue, NW
Room 3301 NE Mall
Washington, DC 20460
April 5, 2002
MEMORANDUM
SUBJECT: Observations on the Use of Shutdown Credits in
Michigan's Air Emissions Open Market Trading Program
FROM: J. Rick Beusse /s/
Director for Program Evaluation, Air Quality Issues
TO: Jeffrey R. Holmstead
Assistant Administrator for Air and Radiation
In connection with our in-process evaluation of EPA's Air Emissions Open Market Trading
(OMT) Program, we recently conducted field work at Michigan's Department of Environmental
Quality. Below are observations we wish to bring to your immediate attention.
Use of Shutdown Credits Mav Be Contrary to EPA Guidance
Michigan's Emission Reduction Credit Trading program (hereafter referred to as its OMT
program) allows the use of "shutdown" credits in attainment areas. (In essence, shutdown credits
result when permitted sources reduce emissions by closing facility operations or product lines). In
March 2002, EPA indicated that it intends to approve Michigan's OMT program, as revised in
1999, including the use of shutdown credits. The basis for approving OMT programs since
January 2001 has been EPA's "Improving Air Quality With Economic Incentive Programs"
guidance document, EPA-452/R-01-001, January 2001 (hereafter referred to as EIP guidance),
which does not characterize emissions reductions from shutdowns as "surplus." According to the
EIP guidance, before emissions credits are eligible for inclusion in an emissions trading program,
they must not only be surplus but must also meet three other fundamental integrity elements
(quantifiability, enforceability, and permanence). In apparent contradiction with the EIP
guidance, EPA considers Michigan's shutdown reductions as eligible for inclusion as credits in the
State's OMT program.
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While in Michigan, we observed that approximately 23 percent of the State's total open market
emission credits generated - - and 80 percent of its volatile organic compound (VOC) emission
credits generated - - have resulted from shutdowns. Further, we noted that shutdown credits have
been used in Michigan's program. Under the Michigan OMT program, closed facilities are
allowed to generate emission credits for 5 years from the year in which the facility closes. Since
OMT credits under Michigan's program are valid for 5 years after the year in which they are
generated, closed facilities can generate credits - - and credit buyers can use those credits - - over
a period of almost 11 years after the facility's operations are closed.1
Additionally, under Michigan OMT rules, when permitted sources close facility operations in
Michigan and receive emissions credits for shutdowns, these same or similar facility operations
may be restarted in other states (if allowed by the applicable state(s)). hi this scenario, sources
could be, in effect, shifting their air emissions elsewhere while generating shutdown credits in
Michigan, which then may also be sold to other companies in Michigan. EPA has acknowledged
that, under this scenario, overall emissions may increase and that"... this is clearly a detriment to
the environment."
Key Events in EPA's Consideration of Michigan's Proposed OMT Program
We recently discussed the above matters with key officials from the Air Programs Branch, Air and
Radiation Division, EPA Region 5, and the Office of Air Quality Planning and Standards. We
learned that Region 5 initially opposed the inclusion of shutdown credits in Michigan's 1996
OMT program proposal. However, in 1997, the Office of Air and Radiation took the position
that the use of shutdown credits could be allowed under EPA policy if Michigan met certain
conditions. Based on this position from EPA Headquarters, Region 5 has offered Michigan three
options: (1) prohibit shutdown credits; (2) allow shutdown credits but prohibit their use in non-
attainment or maintenance areas; or (3) demonstrate that the use of shutdown credits would not
be contrary to their attainment or maintenance plans. Michigan chose option 2 - - to allow the
statewide generation of shutdown credits while prohibiting their use in non-attainment or
maintenance areas. However, option 2 appears to be contrary to the final EIP guidance issued in
January 2001.
Since EPA tentatively accepted Michigan's shutdown credit proposal prior to the issuance of
EPA's January 2001 EIP guidance, Region 5 chose not to require Michigan to modify its proposal
based on this subsequent EPA guidance at that time. We understand that Region 5 anticipates
giving final approval to the existing Michigan proposal in the near future with the possibility of
revisiting the issue of shutdown credits in future revisions of Michigan's OMT program.
Given the precedent-setting nature of approving open market trading programs, the magnitude
and longevity of shutdown credits in the Michigan program to date, and the difficulty of
withdrawing federal approval of State Implementation Plan revisions once made, we believe that
The maximum period would be 10 years and 11 months.
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EPA's final approval of Michigan's OMT program should include a careful consideration of the
shutdown credit issue at the EPA headquarters level. Once the shutdown credits are "grand-
fathered" into a state's program, they may be more difficult to eliminate later. Additionally, once
a precedent is established that allows the generation and use of shutdown credits in open market
trading programs, other states may wish to adopt similar policies.
If you or your staff have any questions, please call me at (919) 541-5747, or John Bishop, RTP
Audit Manager, at (919) 541-1028.
cc. John Seitz, Director, OAQPS
Thomas V.- Skinner, Regional Administrator, EPA Region 5
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Appendix 8
Details of PSEG Settlement
On January 24,2002, the U.S. Department of Justice, EPA, and State of New Jersey announced
a major Clean Air Act settlement agreement, in Ihe form of a $337 million Consent Decree, wifli
PSEG Fossil LLC, a large New Jersey electric power generation company. The final Consent
Decree was approved and entered by Ihe U.S. District Court for the District of New Jersey on
July 30,2002.
In the Consent Decree, Department of Justice, EPA and New Jersey alleged that PSEG violated
the Clean Air Act's Prevention of Significant Deterioration and Nonattainment New Source
Review Requirements and New Jersey's State Implementation Plan. Specifically, Department of
Justice, EPA, and New Jersey alleged that PSEG made major modifications at its Hudson and
Mercer coal-fired power generation facilities without installing necessary pollution controls and
without obtaining proper permits that would have resulted in lower emission limits and reduced
emissions. Hie Hudson and Mercer facilities were the same coal-fired facilities that PSEG had
used to claim emissions credits for reducing emissions beyond the required levels.
Settlement negotiations in 2001 and 2002 between EPA, the U.S. Department of Justice, and the
State of New Jersey wilh PSEG concerning the alleged New Source Review violations did not
originally address the issue of questionable PSEG-generated OMT credits. In discussions with
EPA Region 2 enforcement officials during our fiddwork at EPA Region 2 offices, the OIG raised
issues concerning the validity of PSEG's credits, their possible disposition, and the impact on
EPA's ability to enforce against violators in future cases involving the OMT credits generated by
PSEG. Since PSEG had generated OMT credits at both facilities, OIG questioned the validity of
the credits because reduced emission levels indicated that few, if any, credits could have been
generated if the plants were, indeed, subject to New Source Review. EPA Region 2 officials
agreed to look into the issue of OMT credits for this source. Consequently, in the settlement
reached in January 2002, PSEG agreed to retire 372,380 OMT credits (about 18,600 tons of
pollutants) of the 647,504 it had generated under the OMT program. The credits to be retired
represented 90 percent of the generated credits listed on the registry as available for use as of
January 2002 and had an estimated market value of over $16 million.
PSEG's OMT credits not retired as a result of the negotiations mentioned above were considered
valid by EPA Region 2. PSEG retained 75,440 credits of those for their own use; the other
credits had been transferred to other OMT program credit users earlier. Those other users had
either already used the credits or continued to hold them for future use.
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Appendix 9
Five Attributes of Environmental Data Quality
According to EPA's data quality objectives order (Order 5360.1), five attributes of data should
be known before the data is used for regulatory decisions. These are described below.
«,"* '" """"'X' 0 ?<&* '* '"'''^
Precision
Accuracy
Completeness
Representativeness
Comparability
mm^^m^^^mm^^£%^'^^s
Precision is the average amount of variability experienced in measuring
emissions; it is sometimes expressed as a relative standard deviation, such as
plus or minus 15 percent. The lower the percentage, the more precise the data.
Accuracy refers to the amount of bias that a measurement may have. For
example, an improperly calibrated piece of testing equipment may bias a reading.
Completeness refers to the number of readings that must be taken before a
confident judgment can be made. For example, if 4 of 5 readings yield the same
information, decision makers may say that a reliable profile of the facility's
emissions exists.
Representativeness involves a qualitative assessment as to whether a reading
fairly represents the emissions from a facility. Factors that could affect
representativeness include the methods used and weather conditions at the time
the readings were taken.
Comparability is the ability to fairly compare emissions results from the same
facility at different times. Using different sampling and testing equipment, or
different methodologies, could result in an inability to make such comparisons.
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Report No. 2002-P-00019
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APPENDIX 10
EPA Region 2 Letter To New Jersey
June 24, 2002
Commissioner Bradley M. Campbell
New Jersey Department of Environmental Protection
401 E. State Street, 7th Floor
P.O. Box 402
Trenton, NJ 08625-0402
Dear Commissioner Campbell:
This is to follow up on our recent discussion with respect to the current and future
direction of the State of New Jersey's Open Market Emissions Trading (OMET) program.
As you know, over a year ago EPA proposed to approve New Jersey's OMET program as
a State Implementation Plan (SIP) revision. I believe we both agree that since then a number of
problems have surfaced that must be addressed before the OMET program could be approved
into New Jersey's SIP.
In September 2001, the company contracted by New Jersey to operate the OMET registry
shut down Ihe Internet-accessible registry and telephone hotline. Since public availability and
accountability are fundamental to proper implementation and oversight of the OMET program,
the lack of the registry impedes New Jersey's and EPA's oversight and enforcement of the
program.
In addition, in February 2002 the U.S. Department of Justice on behalf of EPA, together
with the New Jersey Department of Law on behalf of New Jersey Department of Environmental
Protection, lodged a consent decree with PSEG Fossil, LLC (PSEG), regarding alleged violations
of New Source Review requirements as part of EPA's coal-fired power plant enforcement
initiative. During the course of resolving this matter, serious questions were raised about the
effectiveness of the OMET program's credit validation process and about its impact on potential
enforcement actions. In addition to highlighting these problems, the PSEG agreement resulted in
a significant reduction of available OMET credits.
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Another concern is that sources that have relied on credits from the New Jersey OMET
program to comply with the New Jersey SIP are currently out of compliance with the SIP until
and unless the proposed SIP approval of the OMET program is finalized. Even if the program
were approvable, it is questionable whether the credits they purchased are still valid. These
sources, many of which relied on the program in good faith, have to be in compliance with the
existing SIP requirements.
)
It is important that we meet quickly to decide how to address these issues, including our
approach to those sources that have relied on the program for compliance purposes.
We remain committed to working with you to resolve these problems and develop an open
market trading program that provides the flexibility that permittees need while protecting air
quality. I will call you soon so that we can arrange a meeting.
Sincerely,
/s/
William J. Muszynski, P.E.
Deputy Regional Administrator
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Appendix 11
New Jersey Response to EPA Letter
August 13, 2002
Jane M. Kenny, Regional Administrator
United States Environmental Protection Agency
Region 2
290 Broadway
New York, New York 10007-1866
Re: New Jersey Open Market Emissions Trading Program
Dear Administrator Kenny:
I am writing to respond to Deputy Regional Administrator Muszynski's June 24,2002
letter, regarding the current and future direction of New Jersey's Open Market Emissions
Trading (OMET) Program.
Our review of the OMET program at the outset of the McGreevey Administration has led
me to conclude that the program has failed. Several aspects of the program's original
design and implementation contributed to that failure:
The program's ostensible clean air benefits were limited by the failure to include
safeguards to ensure that the program would in fact reduce emissions.
The prior Administration had privatized the development and operation of the
program's registry of credit transactions and telephone hotline; as Mr. Muszynski
pointed out, the company that the State had selected for these tasks shut down both
the registry and the hotline last fall.
* The prior Administration had also chosen to privatize Ihe work of verifying the validity
of credits under the program. A recent enforcement investigation raised questions
about whether that work had been performed correctly and effectively.
Another enforcement investigation revealed that some facilities may have built a
portion of their compliance strategy entirely on the prospect of using emission credits,
even though there has never been a guarantee that they would find a willing seller of
the credits needed for compliance.
The program allowed credits to be based on emission reductions that occurred years
before the credits are actually used. That long time lapse undermined the credibility of
the program.
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These problems with the OMET program, some of which go beyond what the EPA
identified in its January 9, 2001 proposed approval of the State Implementation Plan (SIP)
revision for the program, have led me to conclude that New Jersey should terminate the
OMET program, while protecting the expectations of those regulated parties that
currently hold credits or that have been using credits. Our next step will be to publish a
notice in the New Jersey Register, outlining our plans for the program and calling a public
meeting to discuss that direction.
Your letter states that the users of credits under the OMET program are vulnerable to
enforcement action because the SIP revision for the program has not received EPA
approval. When OMET market participants have fully complied with the State regulations
that established the OMET program, there is no violation of State law and no basis for
State enforcement action.
However, I understand that the EPA may be contemplating its own enforcement actions
against credit users. We would like to work with you to make such actions unnecessary
when the credit users have fully complied with the State rules. This could be achieved by
EPA's issuance of a limited approval of the pending SIP revision, which would merely
protect those regulated parties that have used or may use credits before the program is
terminated through rulemaking.
To ensure that all market participants learn of these plans at about the same time, I am
forwarding copies of this letter to them. I would be pleased to meet with you and your
staff to discuss this further.
Sincerely,
/s/
Bradley M. Campbell
Commissioner
c: OMET Market Participants
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Appendix 12
Region 2 Response Letter to New Jersey
9-10-02
Commissioner Bradley M. Campbell
New Jersey Department of Environmental Protection
401 E. State Street, 7* Floor
P.O. Box 402
Trenton, NJ 08625-0402
Dear Commissioner Campbell:
This is in response to your August 13, 2002 letter in which you reviewed the problems in
New Jersey's Open Market Emissions Trading (OMET) Program and concluded that the State
should terminate the program as currently designed. You also suggested that a limited approval
by EPA could be a means of addressing non-compliance of sources that have used or are using
OMET credits until such time as the State terminates the OMET Program.
A limited approval of the pending revision to the State Implementation Plan (SIP) is not a
viable option under 40 Code of Federal Regulations, Part 51. EPA reserves the limited approval
approach to those instances where the problems in the regulation or program are discreet and
separable and don't affect the outcome of the program, which is not the nature of the problems
identified here. It is clear from your response that you do not want EPA to proceed with the final
SIP rulemaking on New Jersey's OMET Program as it is currently designed and we will publish a
notice in the Federal Register withdrawing EPA's proposed conditional approval of the OMET
Program in the near future.
EPA stands ready to work with New Jersey to craft a program that achieves air quality
benefits earlier and at a lower cost than more conventional approaches. I know that our staff are
scheduled to discuss ways to address compliance issues with sources that currently hold credits or
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that have been using credits to comply with SIP approved regulations. As we discussed, in any
such efforts we would be sensitive to the fact that these sources used such credits in a good faith
effort to comply with state and federal regulations.
I look forward to working closely with you to resolve any remaining issues and in planning
New Jersey's future use of innovative approaches to pollution control.
Sincerely,
/s/
William J. Muszynski, P.E.
Deputy Regional Administrator
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