Most states are still sorting through the details of EPA’s Clean Power Plan (CPP) final rule. Given its significant, though generally positive, departure from the proposed rule, and EPA’s initial plan submittal deadline of September 6, 2016, states might justifiably feel squeezed between a plethora of new questions and fast-approaching deadlines.

States that dive directly into the details of CPP compliance, however, risk putting the EPA’s CPP cart before their own horse. It may be reflexive to ask, “What’s the best CPP plan for my state?” but answering that question wisely requires a vision of the state’s energy future. Planning for the CPP is an optimization challenge, and the electricity sector possesses extraordinary experience in optimization. Before officials can optimize CPP compliance, however, they need to identify and agree upon state energy goals and priorities. Consider, for example:

  • The electric power sector is undergoing a fundamental transformation in its technologies and practices, creating new opportunities, but also threatening traditional utility business models. Does the state want its CPP compliance policies to align with that transformation, or try to buck it?
  • Some CPP compliance options appear attractive, like retiring old, higher-emitting electricity generating units (EGUs) in favor of new, lower-emitting units. But changes to the grid (like the ability to manage electricity demand as well as supply), waning electricity demand per dollar of GDP, declining costs of renewable distributed generation and storage, and growing environmental constraints (e.g., new limits on traditional air pollutants like ozone, increasing water concerns, etc.) raise the specter that today’s natural gas infrastructure investments may turn into tomorrow’s stranded costs. Would the state prefer to deal with these challenges one-by-one as they materialize, or try to pre-empt them by looking for solutions that simultaneously address multiple problems?
  • States need to consider the balance between greater sovereignty and lower costs. Broader markets provide more compliance options and thereby reduce compliance costs. But states participating in a multi-state market for compliance instruments (e.g., allowances, emission rate credits) will necessarily cede some individual authority to enjoy these benefits.
  • States must also consider trade-offs between compliance certainty, clean energy penetration, and cost. Clean energy compliance options undertaken with greater rigor (e.g., third-party verification) offer more certainty, for example, but will necessarily incur additional cost.

States face other threshold issues as well. All states seek economic development and job growth, but policy options may vary depending on whether they target long-term or short-term growth. Similarly, all states want high reliability, but there are disparate ways to secure it—some of them very expensive. And speaking of securing reliability, how does electric system security rank as a state priority? Even state policymakers’ emphasis on electricity bills versus electricity rates can impact policy choices.

As they wrestle with these larger questions, policymakers may not even be able to identify all valid concerns, let alone resolve them into a clear, focused vision for the state’s energy future and its CPP compliance strategy. That’s why input from stakeholders will be so important in the development of CPP plans. Fortunately, proactively seeking such input will also fulfill CPP requirements for stakeholder involvement.

Configuring the CPP “Cart”

Once states have an overarching vision, they can move with purpose into the details of CPP planning and configure their “cart.” Several key CPP decisions are needed before September 2016, when states must either submit their initial compliance plans or request an extension.

One important initial choice is whether to pursue a compliance strategy that reduces the total mass of CO2 emitted by EGUs or regulates the rate of CO2 emissions coming from them. These two options—mass-based and rate-based—are widely acknowledged and reasonably well-understood by policymakers. Preference appears to be growing for the mass-based approach, which is not surprising, given EPA’s assessment that it would be nearly 40 percent less costly and significantly more flexible. Also, many states already have significant experience with mass-based trading systems for sulfur dioxide and, in some cases, CO2.

With greater flexibility comes greater responsibility, however, so states choosing a mass-based approach will have additional decisions to make regarding CO2 allowances. These include:

  • By what mechanism will the state distribute its budgeted allowances? Will the state allocate allowances for free to sources, based on historical generation or emissions (e.g., the acid rain program), auction them (e.g., the Regional Greenhouse Gas Initiative (RGGI), the California model), or distribute them by some other means? Allowances could also be distributed on the basis of electricity output (e.g., one allowance per MWh generated by conventional and renewable supply resources or avoided through energy efficiency measures). Secondary questions also arise. States that decide to auction allowances will have to determine how to use auction revenues—for additional clean energy investment (e.g., RGGI), taxpayer relief via the states’ general fund, ratepayer relief via distribution to load-serving entities, or other purposes? States electing not to auction allowances may want to consider set-asides (e.g., to encourage clean energy development) and how they should be allocated.
  • What time period will allowance distribution reflect? This is not an issue if states auction allowances, but other distribution approaches will require looking back at historical generation or emissions, or looking ahead to reflect predictions.
  • Will the state plan reflect its geographic borders, or a larger multi-state area? Most states belong to a multi-state regional transmission organization or balancing area that schedules when EGUs run, so as to minimize system costs and enhance reliability. But CO2 emissions from these EGUs will be regulated by the state in which they are located. In addition, some utilities own EGUs in multiple states or balancing areas. State CPP plans will have to triangulate these issues to achieve compliance and maintain reliability at reasonable cost.
  • Will the state engage in trading with other states? As noted above, electricity is transmitted across state boundaries, and electricity demand, energy efficiency programs, and renewable energy investments all influence which EGUs operate and when. States may find it easier to comply by taking advantage of EPA’s “trading ready” approach or other multi-state linkages.
  • How will the state avoid “source leakage” from older to new EGUs? The simplest and cleanest method may be to include all sources in a single compliance pool and trading system (by utilizing the “EPA Mass Goal for Existing Units with EPA New Unit Complement” pathway). Some states, however, may wish to administer separate compliance approaches for older and new EGUs.
  •   Will the state recognize early compliance actions through EPA’s Clean Energy Incentive Program (CEIP) or through other means?   EPA created a pool of 300 million extra allowances to encourage renewable energy development and stimulate energy efficiency programs in low-income communities in 2020-2021. Although not binding, a state’s initial submission by September 2016 should indicate whether it plans to participate in the CEIP. In addition, some states are considering other, non-CEIP ways to recognize early actions or address low-income issues through allowance allocations.

The Clean Power Plan represents the first time that EPA has regulated CO2 emissions from a major U.S. industrial sector. The Clean Air Act puts the burden—and the opportunity—for tailoring compliance plans on the states, so many questions have arisen about optimal approaches. At this point, states may be wise to step back from the apparent urgency of the CPP and use the extra time EPA has provided to identify their energy vision and tap the wisdom of industry, community, and environmental stakeholders. With their energy vision “horse” harnessed and ready to go, states should find the CPP planning “cart” much easier to navigate.