EPA-340/l-73-001-b
TECHNICAL GUIDE FOR REVIEW
AND EVALUATION
OF COMPLIANCE SCHEDULES
FOR AIR POLLUTION SOURCES
Supplemental Report
On Financing Air Pollution Control
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U. S. ENVIRONMENTAL PROTECTION AGENCY
OFFICE OF ENFORCEMENT AND GENERAL COUNSEL
OFFICE OF GENERAL ENFORCEMENT
DIVISION OF STATIONARY SOURCE ENFORCEMENT
WASHINGTON, D. C. 20460

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EPA-340/l-73-001-b
TECHNICAL GUJDE FOR REVIEW
AND EVALUATION
OF COMPLIANCE SCHEDULES
FOR AIR POLLUTION SOURCES
Supplemental Report
On Financing Air Pollution Control
by
Research Triangle Institute
Research Triangle Park, North Carolina 27711
Contract No. 68-02-0607, Task No. 5
EPA Project Officer: John W. Butler
Prepared for
ENVIRONMENTAL PROTECTION AGENCY
OFFICE OF ENFORCEMENT AND GENERAL COUNSEL
OFFICE OF GENERAL ENFORCEMENT
DIVISION OF STATIONARY SOURCE ENFORCEMENT
WASHINGTON, D.C. 20460
November 1973

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The Enforcement Technical Guideline Series of reports is issued by the
Office of Enforcement and General Counsel, Environmental Protection Agency,
to assist the Regional Office in activities related to enforcement of
implementation plans, new source emission standards, and hazardous
emission standards to be developed under the Clean Air Act. Copies of
Enforcement Technical Guideline reports are available - as supplies permit -
from Division Stationary Source Enforcement, Environmental Protection
Agency, Washington, D.C. 20460 or may be obtained, for a nominal cost,
from the National Technical Information Service, 5285 Port Royal Road,
Springfield, Virginia 22151.
This report was furnished to the. Environmental Protection Agency by
Research Triangle Institute, Research Triangle Park, North Carolina,
in fulfillment of Contract No. 68-02-0607. The contents of this report
are reproduced herein as received from the contractor. The opinions,
findings, and conclusions expressed are those of the author and not
necessarily those of the Environmental Protection Agency.
PUBLICATION NO. EPA-340/l-73-001-b
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ACKNOWLEDGMENT
This report was prepared for the Environmental Protection Agency
by the Research Triangle Institute, Research Triangle Park, North
Carolina. The project was under the general direction of Mr. Harry
L. Hamilton, Jr. and the report was written by Dr. David A. LeSourd.
Valuable assistance was provided by Mr. Dennis Kulonda who served as
a summer intern with the Institute under the sponsorship of the
Triangle Universities Consortium on Air Pollution.
Mr. John Butler was the Project Officer for the Environmental
Protection Agency. The authors appreciate the many contributions
made to this study by Mr. Butler and other members of the Division
of Stationary Source Enforcement.
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TABLE OF CONTENTS
SECTION	PAGE
1	INTRODUCTION	1
2	SOURCES OF FUNDS	1
3	HOW FIRMS OBLIGATE FUNDS	5
4	SPECIAL PROBLEMS OF SMALL FIRMS	7
5	PUBLIC UTILITIES	8
6	MUNICIPALITIES	9
7	EFFECT OF TIGHT MONEY	10
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FINANCING AIR POLLUTION CONTROL
SECTION 1
INTRODUCTION
Evaluation of the air pollution control compliance schedule
submitted by a firm to its regulatory authority will be based primarily
on factors such as the availability of control equipment, the probable
time required for system design for the specific production process,
and the reasonableness of estimated construction time. An additional
factor that may come into question is whether, or to what extent, a
firm may find its ability to comply with control regulations constrained
by the time requirements of internal financial management or of
obtaining funds from investors. These special problems related to
financing are discussed in this report, while the technical problems
of compliance schedules are covered in a separate report, Technical
Guide for Review and Evalustion of compliance Schedules for Air
Pollution Sources (EPA-340/l-73-001-a).
It is the broad conclusion of this study of the financing of
compliance that, in general, financial problems will not cause delays
in compliance for firms that are in sound financial condition. In
the discussion that follows the variations of financial practices
that affect the availability of funds for air pollution control are
examined for large and small firms, complex corporation, public utilities,
government-owned sources, and marginal firms.
SECTION 2
SOURCES OF FUNDS
Almost all of the investment funds for air pollution control
are expected to come from regular business sources. These include
issuance of stocks and bonds, long and short term bank loans, and
internal operating capital. Limited amounts of credit may also be
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drawn from lending agencies such as the Small Business Administration.
Government entities will finance through bond issues, short term
notes, or by appropriation of tax revenues.
Business firms, in most instances, will not issue new common
or preferred stock to finance their pollution control investments.
Stock issues are traditionally used to finance major acquisitions
or to expand productive facilities. It is unlikely that most firms
will choose to use equity capital unless they find such funds readily
available from previously planned large equity issues that are
essentially unrelated to their control investment needs. In some
instances, where a company has chosen to build a new plant to replace
an older one, or to modernize and revamp an old plant, equity capital
is being used. In the cement industry, for example, compliance
with control regulations is being accomplished by several firms at
the same time that their production processes and facilities are being
modernized by the construction of new plants. For some firms the need to
provide controls has spurred more rapid modernization, accentuating a trend
already in existence before the passage of the Clean Air Act of 1970. Such
actions are part of long run company plans and should be well underway by
this time. A company decision to use equity financing should have little
significance for air pollution compliance scheduling.
Bond financing, especially through industrial revenue bonds,
is a major source of funds for larger corporations. Bond issues
for this purpose will normally be in amounts over $1 million and
the greater share of those for over $5 million. The bonds may be
sold through competitive bidding (normally required for utilities),
private placement arranged through an underwriter, or direct private
placement with an institutional investor such as an insurance company.
Although there are many differences in the procedures followed and
the division of responsibilities for preparation of the issue for
these forms of placement, there are no substantial differences in the
time required. A bond issue can normally be prepared and marketed
in 3 to 4 months.
It appears that many corporations will choose to issue industrial
revenue bonds in states where these are authorized. Industrial
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revenue bonds are tax exempt issues with interest rates significantly
(2-3 or more percentage points) lower than comparable corporate
bonds. They are issued by firms (or by state governments to provide
funds for firms) under special state legislative authority that
specifies the eligible uses for funds from these issues. Under present
Federal law state governments are authorized to approve industrial
revenue bond issues for pollution control investment and the Internal
Revenue Service certifies the eligibility of the proposed investment
for tax exemption.
The process of issuing industrial revenue bonds requires two
steps not involved in regular bond issues: approval by the State,
and IRS certification. It appears that State approval is quickly
available, but IRS certification can take three or more months to obtain,
depending on the complexity of the controls involved and the ability
of the firm's counsel to deal with the legal requirements. As
experience with these procedures expands and the process becomes
routine the required time may be expected to decrease. Prompt
application for IRS approval can ensure that this factor does not
delay application of controls.
It appears that the use of industrial bonds by large corporations
stems not from a need for financial assistance but simply from the fact
that they are available and economical. Large firms with substantial
power to influence the market prices for their products may reasonably
expect to recoup most or all of the cost of air pollution control
through higher prices. Their normal sources of investment funds,
either internally generated or raised in the money market, would
be adequate to the needs. By availing themselves of the industrial
revenue bond option, however, they can realize substantial savings.
Medium sized firms, which may need to borrow in the range of
$500,000-$l,000,000 may also avail themselves of the savings to be
had by using industrial revenue bonds. Firms with bond ratings of
BBB or better may sell their bonds to municipal bond trusts or
through direct placement to large lenders.
Special arrangements will have to be worked out if small firms
are to receive the benefits of interest savings through industrial
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revenue bonds. One method under consideration in several states
is the so-called bond bank. Under this arrangement a State may
issue a large tax exempt bond and use the proceeds to establish
a "bank" from which small firms may borrow at advantageous interest
rates to finance control investments. A similar plan that has been
suggested is for a number of firms to pool their funds requirements,
forming a consortium that would offer one large bond issue for sale.
Most smaller firms will finance pollution control through bank credit.
Inquiries to banks in major financial centers across the country revealed
that despite the fact that pollution control investments generally do
not generate added revenue, banks were quite willing to lend money for such
projects to companies meeting normal credit standards. Bankers
expressed a sense of community obligation to provide funds for such
needs. Two banks contacted offered preferential interest rates for
pollution control expenditures, i.e., firms would pay interest rates
from 1/2 to 2 percentage points lower than would be charged for normal
loans. A major bank in New York has even advertised its willingness
to lend at preferential rates for pollution control and has
lent 22 million dollars to landlords at these prime rates for the control
of fossil fuel combustion sources where N.Y.C. enforcement has been
stringent. Although the bank has additional funds allocated to finance
other pollution control investment, it reports that there has not
been much activity thus far.
A similar lack of present demand for bank loans for pollution
control was found in other major financial centers across the country.
Many banks queried had little experience in loans specifically
earmarked for pollution control expenditures. However, all indicated
a willingness to lend money based on a solid balance sheet.
It appears that few smaller firms have yet made attempts to
finance pollution control expenditures, but one can conclude that,
given general credit availability, smaller firms with good credit
ratings should have no difficulty in procuring funds. Firms that
are not financially sound are not likely to receive bank loans for
pollution control or for any other capital expenditure.
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The Small Business Administration (SBA) is empowered to lend
money to smaller firms for pollution control and they are willing
to accept higher risk loans but could not comment as to the extent.
In the final analysis, however, "the loan is given on the assumption
that it will be repaid." The Small Business Association of New
England (SBANE) has said that it expects the SBA to be the major
source of funds for smaller business in New England.
One other source of funds for control investment is retained
profits. Some firms with relatively modest investment requirements will
be able to avoid borrowing entirely, if they so choose. Their only
problem, therefore, will be to manage their cash flow in such a way
V
as to be able to make the required outlays.
SECTION 3
HOW FIRMS OBLIGATE FUNDS
Assuming that investment funds are available, the next question
is whether the internal procedures through which a firm budgets and
appropriates funds may impair its ability to meet the schedule for
compliance with air pollution controls. This study has uncovered
no evidence that this would be so. It does appear that a good many
firms may have to change their investment plans in ways they would
prefer to avoid, but this is not to say that such changes cannot be
accomplished within the times available under compliance schedules.
Capital budgeting is usually done one to three years in advance
in medium and large size corporations. These plans for investment
expenditures are drawn by operating divisions, including subsidiaries
in many instances, and consolidated in a corporate budget that is
subject to approval by the board of directors. The budget is normally
subject to review and revision on a monthly or quarterly basis by
a budget or executive committee representing the directors and corporate
officers. Recommendations for revisions are submitted by the operating
units of the firm and adjusted to broader corporate policy by the
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committee. Actual commitment of funds and authorization of expenditures
is accomplished by the corporate financial officers.
The capital budget is a flexible long run plan subject to frequent
revision and adaptation to short run neccesities. Faced with requirements
for implementing air pollution controls by a specified date, corporations
are capable of modifying their investment plans to accommodate these
requirements. Not uncommonly, this may require postponement of other
planned investment in order to stay below a desired ceiling on debt
or to avoid an excessive cash flow. Internal management of investment
and financial control is undoubted]y complex, but firms can obligate
available funds and revise investment plans rapidly any time prior to
the time when actual contractual commitments are made. In the compliance
process discussed in the Technical Guide for Review and Evaluation of
Compliance Schedules for Air Pollution Sources this step of obligation
of funds comes after preliminary planning and up to 30 months before
completion of control installations. It is difficult to conceive of
a firm's financial management system that could not make the necessary
decisions and provide the funds required within the time frames indicated
for compliance. This conclusion should hold for small unincorporated
firms as well as larger corporations and complex firms.
The situation is much the same for governmental units required to
comply with pollution controls, such as municipalities. As is indicated
elsewhere, the primary problem for governments may be in getting authority
to borrow required funds. Once this has been done and the loan or bond
issue established, the funds can be obligated by action of the appropriate
board or administrator. While government procedures are often somewhat
more ponderous than their business counterparts, there does not appear
to be any reason why government action to obligate available funds would
delay compliance.
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SECTION 4
SPECIAL PROBLEMS OF SMALL FIRMS
As indicated in this report, it is anticipated that small firms will
be the ones that may have difficulty arranging funds for air pollution
control investment and that they may be most adversely affected by the
financial impact of control requirements. Several studies have been
made of the extent to which air pollution control costs may be
expected to cause small firms to go out of business. The Institute
*
of Public Administration reported that without some form of subsidy,
as many as 350 gray iron foundries and 13 cement plants might be
forced to close rather than assume abatement costs. Another study, by
J. A. Commins and Associates is reported to Indicate that a number of
the smallest firms in the asphalt batching, grain handling and milling,
gray iron foundry, lime, and secondary nonferrous metal industries would
be unable to finance air pollution control costs. That report recommends
group buying of control equipment as a means of reducing the cost burden
that may force small firms to close.
Other problems also affect small firm financing. Firms that are
both new and small may not have established credit sufficient for the
investment required to meet control standards. Also small firms
in widely dispersed and highly competitive industries may not be
able to convince local banks that loan repayment is feasible.
Such small firms cannot demonstrate ability to raise prices
independently, although market prices may well rise as all firms
in the industry incur increased costs for pollution control. Until
the market reacts, however, local banks may not be convinced that
individual firms will be able to recover control costs through higher
prices and may be unwilling to make loans for control purposes.
* Institute of Public Administration, Pollution Abatement and
Unemployment: A Methodological Study. Washington, D. C., 1972,
Chapter 5.
** "Group Buying to Reduce Air Pollution Costs for Small Plants,"
J.A. Commins and Associates. Summarized in Air/Water Pollution
Reports, April 9, 1973, pp. 147-8.
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SECTION 5
PUBLIC UTILITIES
Those outside the industry may wonder whether public utilities
and other regulated firms would have special problems in connection
with the financing of air pollution controls. The answer is that,
in raising and obligating funds, their procedures are not essentially
different from those of other corporations. It is true that they
may be required by law to place their bond issues through open bids
rather than by direct placement and the bond indentures may be
somewhat more complex and restrictive, but on the other hand their
bonds are frequently easier to sell because they are regulated and
may be better able to sustain long run profits than some nonregulated
firms. The problems of public utilities are connected with the
determination of the extent to which pollution controls costs are
represented in the rate base and similar problems covered by actions
of the regulatory authorities, rather than in the financing of controls.
There is frequently a substantial lag between the time that investments
are made and the time that rate adjustments are completed. The utility
must submit an application to the state and/or Federal regulatory body
for new rates designed to provide the legal "fair rate of return." The
proceedings require the submission of detailed data by the utility,
lengthy examination of these data by the commission staff and, frequently,
extended negotiations to determine the accuracy and applicability of
specific items. Although the principle is well established that control
costs may appropriately be included in calculating the cost base for
rate determinations, these like all other costs are subject to audit
and interpretation in the actual proceedings. To this extent, pollution
control costs are not different from other utility costs as a basis for
rate determination. The same procedural delays apply.
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SECTION 6
MUNICIPALITIES
Municipalities that must install controls on municipally owned
incinerators or steam-electric plants may experience difficulties
that will not affect private corporations. These include both potential
problems of budgeting and capital planning as well as funds acquisition.
There are differences among municipalities, as well, depending on
their size, relative wealth, and their financing history. It is
difficult to generalize about municipal finance due to many influential
factors including public attitudes, political structure, quality of
management, present and past financial problems, variations in procedures
and legal authorizations, and other structural, institutional, and
historical aspects. Each municipality trends to be unique in some
way. On the other hand, it is nearly impossible to use specific munici-
palities as models for an analysis such as this without making a fairly
comprehensive and, therefore, expensive .study of each. The following
discussion, hopefully, is indicative of the problems involved in
implementation of air pollution control, but not necessarily definitive.
Many municipal facilities are operated by separate, quasi-independent
departments or agencies, with power over their own finances separate
from the general municipal budget and appropriation functions. Such
an agency with a source of revenue, as for instance a municipal
generating station, can issue revenue bonds and finance control
investment much like a private utility. If, however, a facility
such as an incinerator is run by a department subject to the general
municipal financial controls, issuance of bonds or other borrowing
for control investment may require approval of the legislative branch
of city government. Such action is sometimes caught up in politics
or enmeshed in other city problems with resulting unpredictable delays.
If the planned municipal bond issue is to be of the general
obligation type it may exceed the municipalities bond limit and
require state action to raise the limit before the municipality
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can act. In some instances such bonds may require voter approval.
In either case, substantial and unpredictable delays are possible.
It is to be expected that municipalities that already have
severe financial problems, as do so many, both large and small,
will be those experiencing difficulty in complying with control
requirements.
SECTION 7
EFFECT OF TIGHT MONEY
As this report was written (Summer 1973) it appeared that the
current inflation and the attempts to control it would lead to a
period of very tight credit and high interest rates, possibly
lasting into 1974. Without attempting to forecast conditions
in the money market it is, nevertheless, important to consider what
the potential impact would be of sharply increased costs for pollution
control equipment, construction, and capital acquisition, possibly
accompanied by a shortage of investment funds.
A tight money situation persisting through the period in which
implementation of controls is required could mean that firms would
have to borrow at higher interest rates and that their capital budgets,
for other investments as well as for controls, would be significantly
affected. It could also mean that some firms, which were marginally
able to quality for loans, would not be able to satisfy lenders that they
would be able to pay the higher interest. Such firms would then be
refused loans. Finally, very tight money could result in some form of
credit rationing by lenders, resulting in a certain number of firms
that are not marginal borrowers still being unable to obtain sufficient
funds.
Increased interest costs will pose real problems for some firms.
A doubling of interest rates over their 1972 levels could mean an
Increase in the range of 5 to 20 percent in the average annual cost
of controls for firms In various industries, depending on the relative
significance of that cost compared to labor, power, and other annual
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cost elements. A somewhat larger number of firms therefore may be
unable to stay in business and those that are viable will experience
lower profits. This situation, in itself, will not affect the ability
of firms to meet compliance schedules, although it may encourage
some firms to delay compliance as long as possible. Those that
face the probability of shutdown or merger may also seek delays
through variances. This may be most significant in the gray iron,
cement, asphalt, and coking industries where a number of firms are
threatened even at lower costs.
The potential problem of loan refusal is somewhat different.
Those firms going the bond route will probably find buyers for bonds
if the interest rate is high enough, especially where direct placement
is the vehicle. The problem arises much more commonly for firms
seeking bank loans. However, banks do not actually ration money among
borrowers except in instances of extreme credit stringency. What does
happen is that banks become more strict in their evaluation of prospective
borrowers as the money supply tightens. Firms may be forced to shop
around to find a bank that will lend to them. The poorer the credit
rating of a firm the more difficulty it may have in finding a willing
lender. During periods of tight money, each bank will tend to ration
its available funds by being stricter in its loan requirements and
turning down some applications it would have accepted when the market
was easier. Thus marginal borrowers become subinarginal. These are
probably the smaller and weaker firms in all industries. Data are
not readily available, if they exist at all, with which to specify the
numbers of firms in each industry that might fall in this category.
It should be noted, also, that considerable pressure may be
brought to bear on banks to supply funds for control investment.
Such pressure is to be expected from banking authorities, air pollution
control authorities, government executives, industry and labor
organizations, and public opinions. The actions already taken by
some banks to advertise special terns for control loans may be
a reflection of their awareness of the public relations value of
meeting this demand.
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Difficulties in finding a lender may cause some delays for
specific firms, in arranging financing for their control investments.
However, it seems most unlikely that this would lead to any serious
inability to meet prescribed compliance schedules.
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