Emissions trading programs are a long-established mechanism used by environmental regulators to reduce air pollution from the electric sector. The Title IV Acid Rain program, the NO_X Budget Trading Program, the Clean Air Interstate Rule, the Cross State Air Pollution Rule, the Regional Haze trading programs, the Regional Greenhouse Gas Initiative in the Northeast, and California’s Cap and Trade program under AB 32 all serve as examples of environmental regulations that allow compliance through trading—usually based on total tons of emissions reduced.

In the final Clean Power Plan, EPA provides a “panoply” of tools to help states utilize emissions trading programs to comply with the CO₂ reduction targets established in the rule. Clean energy, energy efficiency, and highly-efficient fossil generators will all likely benefit under the proposed trading systems. But how does emission trading actually work under the final Clean Power Plan? What gets traded and who can do the trading?

In this series of posts, we explore how EPA has designed the Clean Power Plan to facilitate the buying and selling of credits representing emissions reductions at fossil-fuel fired power plants. Part 1 focuses on rate-based trading. Part 2 will explore how states can trade allowances representing tons of CO₂ emissions.

---

Part I: Rate-Based Trading

Let’s look at how states that choose a rate-based compliance approach would be able to trade. Recall that rate-based compliance can take one of three forms:

Under rate-based compliance, fossil-fired resources would buy Emission Rate Credits, or “ERCs.” With certain exceptions, one ERC represents one megawatt-hour (MWh) of emissions-free generation. Resources purchase ERCs and add them to the denominator of their emission rate equation to determine their emission performance rate:

EPA’s subcategorized emission performance rates are the foundation upon which each of the above options is built and were determined by EPA to represent the improvement possible using the best system of emission reductions (BSER). However, because the BSER reflects impacts from shifting generation to zero- and lower-emitting resources, most existing units cannot meet these performance rates through operational changes alone. That is why EPA has designed each of the rate-based approaches to allow for emissions trading. 

How ERCs Are Produced

ERCs can be used by a fossil fuel-fired generator to demonstrate compliance with its assigned performance rate. ERCs are produced in three distinct ways

1. ERCs from eligible units.

These are what we are calling “standard ERCs.” Standard ERCs are produced by new renewable, nuclear, energy efficiency, and biomass resources and certain other measures that can be shown to reduce electric-sector CO₂ emissions (such as transmission and distribution measures that reduce line losses, upratings at existing nuclear or hydro plants, or demand response measures).

Resources such as new NGCCs, energy storage, existing unaffected units (e.g., simple cycle gas turbines), capture of CO₂ from the ambient air, non-electric sector measures (e.g., agriculture, forestry), and avoided emissions as a result of vehicle electrification are specifically not allowed to produce ERCs.

Generators or savings measures that were built or installed on or after January 1, 2013 can begin producing one ERC for every one MWh of energy generated or saved starting on January 1, 2022. There are, of course, a few exceptions to this rule.

• Prorated ERCs: EPA allows biomass and waste-to-energy resources to produce ERCs, but prorates them based on the proportion of biogenic CO₂ compared to total CO₂.

• Clean Energy Incentive Program (CEIP) ERCs: The CEIP provides an incentive for early installers of certain types of renewable energy and energy efficiency measures. Under this program, wind and solar resources and low-income energy efficiency measures installed after submission of a state’s final compliance plan (September 6, 2018 is the deadline, but states can submit plans earlier) can produce ERCs in the years 2020 and 2021 that can be used by fossil generators during the compliance period. For every MWh of energy generated by wind and solar resources, the state awards 0.5 “early action” ERCs and EPA will award 0.5 matching ERCs from a pre-established pool of ERCs. Further, for every MWh of energy savings resulting from qualified low-income energy efficiency programs, the state awards one “early action” ERC and EPA will award one matching ERC from the CEIP ERC pool. EPA has capped the CEIP ERC pool at the equivalent of 300 million short tons, though how this will be translated to ERCs has not yet been explained.

Standard ERCs (including CEIP ERCs) can be used at both combustion turbine (NGCC) units and fossil steam (coal) units to reduce their overall emission performance rate.

2. Gas-shift ERCs.

Gas-shift ERCs are produced by existing NGCC units that increase their output and displace coal. These ERCs are meant to incentivize the shift from coal to NGCC generation that is reflected in Building Block 2 of the BSER. Gas-shift ERCs represent a credit, on a pro-rata basis, to all NGCCs for the incremental generation needed to get all units generating to a 75 percent capacity factor, versus the 2012 baseline. The number of ERCs each NGCC can produce is based on a complex combination of factors, including how much better the NGCC unit’s emission rate is compared to the national fossil steam emission performance rate, the distribution of the total possible incremental generation across all NGCC units, and the total net energy output from the NGCC unit in the year for which ERCs are being calculated. Here’s the equation:

Essentially, EPA wants to give credit to existing NGCCs for upping their capacity factors since that helps to displace higher-emitting fossil generators, thereby reducing total emissions from the electric sector. As one way of trying to ensure that this shift actually happens, EPA requires that gas-shift ERCs may only be used for compliance by fossil steam units.  

3. ERCs from highly efficient existing fossil units.

The last type of ERC is produced by existing fossil steam and NGCC units that perform better than their assigned rate. The number of ERCs this type of unit can produce is determined by the total output from the unit in a given year multiplied by a factor representing how much better the unit performs compared to its assigned rate (i.e., the difference between the unit’s assigned rate and its actual rate, divided by the assigned rate). Here’s another equation:

If the actual rate is lower than the assigned rate, this equation tells us the number of ERCs that the unit produces. ERCs produced in this way reward existing generators for performance above and beyond what the state has required. However, if the actual rate is greater than the assigned rate, then this equation tells us how many ERCs the resource needs to acquire in order to meet the assigned standard.

The table below summarizes some of the important features of each ERC type.

Summary of ERC characteristics

* “New renewables” includes new wind, solar, hydro, wave, and tidal resources. “Energy efficiency” includes building codes and appliance and equipment standards. “Other” includes volt/var optimization, waste-to-energy, DSM, CHP, and other resources.

How ERCs Are Traded

Because generators under each of the compliance pathways could have a different assigned performance rate target, EPA appears to limit interstate trading of ERCs to states that have approved plans under the same compliance pathway. (This is not completely clear from the Clean Power Plan text, but seems to be EPA’s intent.) If two states both choose the R1 compliance approach, which is EPA’s preferred approach and the basis for its Model Rule, resources in each state can trade ERCs freely. In fact, as many states as choose the R1 compliance pathway can trade ERCs without having to develop a joint compliance plan.

On the other hand, if two states each choose the R2 compliance approach, they may only trade ERCs if they first coordinate with each other to establish a common state-average emission performance rate that represents the weighted average of both states’ fossil steam and combustion turbine generation and submit a joint compliance plan.

Finally, a state choosing the R3 approach, in which that state’s units are assigned unique performance rates, cannot allow its units to trade ERCs with units in other states; however, the state can set up a trading program that allows its units to trade ERCs among themselves, on an intrastate basis.

The figure below illustrates the potential trading interactions across states and compliance pathways. In this diagram, units in each single state (represented by “AA”, “BB”, etc.) may trade ERCs within each solid circle, representing trading between units in the same state. Beyond that, units can only trade with units in other states that are taking the same approach, or are working together to meet an agreed-upon approach, represented in this diagram by the dotted circles.

Potential interstate trading options

With one limited exception, ERCs can never be produced by resources or measures in a state that has opted for a mass-based compliance approach. The exception involves renewable energy resources that are physically located in a mass-based state but are electrically connected to a rate-based state. These resources must have a contract (such as a power purchase agreement) showing that the power from the renewable energy resource will serve customers in the rate-based state, thereby displacing generation in that state.

One more interesting tidbit on ERCs is that they can be produced by resources located in areas that are not covered by the Clean Power Plan, such as Vermont, Washington D.C., certain Tribal lands, and even Canada or Mexico. Qualifying resources in these regions can produce ERCs as long as they are electrically connected to a rate-based state.

One final note on trading under a rate-based compliance approach: ERCs can come from any eligible generator or measure as long as they are electrically connected to the contiguous U.S. bulk power grid. That means an ERC produced by a wind turbine in northern Maine could be sold to a coal unit in Wyoming to reduce its emission performance rate. The fact that the resource being displaced by the MWh of wind in Maine might be gas, while the resource that would have been displaced by the same MWh of wind in Wyoming is more likely coal, is not accounted for in EPA’s ERC trading options. (See our blog post When is a MWh Not a MWH? Emissions Displacement and the Clean Power Plan for more information on emissions displacement.)

Click here to read Part II on mass-based trading.