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The keys to the future of the U.S. Environmental Protection Agency’s (EPA) Clean Power Plan lie in the playbook that each state is required to develop that will allow it to meet the carbon reduction mandates.

State implementation plans are regulatory schemes commonly used to get states to administer and enforce federal EPA standards under the Clean Air Act. Once the EPA finalizes a standard, it is left up to the states to figure out the specific measures that will achieve the standards – which are then are codified under state law.

It can take several months, if not years, to get these state plans on the books, particularly if legislation, rather than a regulatory rulemaking, is required.

In the case of the Clean Power Plan, time is short. The EPA requires that by September 2016, the states must submit either a final plan or an initial proposal along with a request to extend their deadline to September 2018. If a state fails to submit a plan, or the EPA deems it inadequate, the agency will then impose a federal implementation plan to regulate the existing power plants in that state.

The enormous task of writing a state implementation plan falls at the feet of state regulators, public utility commissions and possibly even state legislators, all of whom will benefit from the input of the regulated electric utilities. The extent to which all these groups can collaborate in the coming months will be vital to the state’s planning process. It may also prove to be a bit of a cat-and-mouse game since the various state utilities may be positioned differently for certain outcomes, and will need to work together with the very same officials who regulate their business.

Mass-Based vs. Rate-Based Plans

One of the first decisions state officials need to consider is whether to structure their state implementation plan for a rate-based program that sets a carbon intensity limit measured in pounds of CO2 per megawatt-hour of generation, or a mass-based program, which sets a limit or “cap” on the overall tonnage of CO2 going up all the power plants’ collective stacks.

EPA has outlined the basic parameters of these those two programs. A rate-based program makes available Emission Rate Credits (ERCs), with each credit equal to one megawatt-hour (MWh) generated from what is regarded as an emissions reduction measure. This can include such things as new or uprated existing nuclear generation, combined heat and power generation, upgraded transmission lines, energy efficiency improvements, or generation from renewable energy projects built after 2012. The downside of a rate-based program is that it is extremely burdensome to administer, requiring extensive emissions and generation evaluation, monitoring, verification and reporting to ensure that ERCs truly represent reduction measures and are not double-counted.

A mass-based plan is easier to implement, and is likely favored by the EPA. Emissions allowances – allocated to existing generation units based on historical performance – can be traded among utilities either within the state or across the U.S., similar to the existing Acid Rain or Cross State Air Pollution Rule regulatory programs.

The downside to a mass-based program is that EPA will require that the state use its own authority to address the “leakage” incentive to reduce emissions from existing plants by replacing them with new plants that are not regulated under the Clean Power Plan.

The attractiveness or suitability of either program will depend upon a state’s projected mix of generation and economic conditions over the coming years. For example, rate-based plans may more readily allow for demand growth, as well as incentivize future nuclear development and biomass co-firing. On the other hand, states expecting to retire coal plants and replace them with increased dispatch of natural gas and renewable energy capacity may instead favor mass-based plans.

Meanwhile, the utilities will need to conduct studies to determine their feasible carbon and other emissions reduction options. These studies will have to examine several variables, including:

•  Production costs, capital investments, costs of imported power;
•  Wholesale and retail electricity price projections;
•  Price projections for emissions credits and allowances;
•  Potential stranded assets and rate recovery;
•  CO2 emissions profiles of available generation strategies.

At the same time, reactions of customers, competitors and political officials will be closely monitored to envisage the best path forward.

Trading-Ready Programs

Trading programs can be established under either rate-based or mass-based programs. EPA structured the Clean Power Plan to make both ERCs and allowances “trading ready” credits that can be readily shared across a utility’s portfolio or exchanged with other utilities within a state.

However, interstate trading will only be allowed among utilities in states that select the same type of program (mass- or rate-based). Since it is generally recognized that larger shared markets will provide for lower costs for the tradable credits and corresponding compliance and electricity costs, it will be helpful for both states and their utilities to know which program their neighbors are considering for their plans.

States can also choose to jointly develop an implementation plan to enable a comprehensive multi-state trading program. Since 2009, nine Northeastern states have operated the Regional Greenhouse Gas Initiative (RGGI) CO2 cap-and-trade program. This program could be modified or expanded to other states to collectively achieve compliance with the Clean Power Plan requirements.

States can also opt into a Clean Energy Incentive Program (CEIP) in which EPA will provide matching early action credits to wind and solar projects, or low income community energy efficiency programs operating in 2020 and 2021 – before the initial Clean Power Plan compliance period begins in 2022. States must indicate whether they intend to participate in the CEIP in the September 2016 plan submissions.

Next Steps

State regulators have a tremendous challenge ahead of them in dealing with all of the options, as well as their various stakeholders and politics. Compliance with interim standards will ratchet tighter over eight years until the final standards must be met in 2030. State and utility planners need to figure out what type of generation can be installed, modified or eliminated within that time frame.

Ultimately, the impacts and success of each state plan will be determined by how it is structured and implemented – assuming the Clean Power Plan survives all the pending legal and political challenges. States have little time to divine their best path forward. Given what is at stake, utilities must make sure they have a vital role in the kitchen as the ingredients of these state plans are mixed and baked.

Published originally on Black & Veatch Solutions.