Technical Support Document (TSD)

for the final Transport Rule

Docket ID No. EPA-HQ-OAR-2009-0491

Assurance Penalty Level Analysis Final Rule TSD

U.S. Environmental Protection Agency

Office of Air and Radiation

June 2011Assurance Penalty Level Analysis Final Rule TSD

	This Technical Support Document (TSD) supports EPA’s determination
that the final Transport Rule’s assurance provision penalty
requirement provides sufficient deterrence against a state exceeding its
assurance level. Section VII.E in the final Transport Rule preamble
discusses the assurance provisions, including the allowance surrender
penalty analyzed in this TSD. This TSD is organized as follows:

1. Background

2. Approach

3. Results

1. Background

The final Transport Rule’s limited interstate trading programs include
assurance provisions to ensure that the necessary reductions will occur
within each covered state.  The assurance provisions limit emissions
from covered units in a state to the state’s emissions budget plus
variability limit, i.e., the state’s assurance level. 

As described in preamble section VI.D, EPA used a multi-factor analysis
to determine each state’s emissions budget.  Subsequently, as
described in VI.F, EPA determined variability limits for each state that
reflect a percentage of the state’s budget (e.g., 10%).  This
variability limit is then added to the state budget to yield the
state’s assurance level. If emissions from covered sources in a state
in a compliance period exceed the state’s assurance level, then EPA
applies additional criteria to determine which owners and operators of
units in the state will be subject to an allowance surrender penalty of
two allowances per ton for their share of the emissions over the
assurance level.  This penalty is in addition to the standard program
requirement that owners and operators of covered units hold one
allowance for each ton emitted; therefore, for any emissions identified
by EPA as being over the state’s assurance level, the relevant owners
and operators must submit a total of three allowances per ton – one of
which is for standard compliance for emitting under the program, and two
of which are for the assurance provision penalty.

As discussed in preamble section VI.F, EPA does not find reason to
expect that emissions from covered sources in any state will exceed that
state’s assurance level.  The description and tables below describe a
sensitivity analysis EPA conducted to determine whether the two-for-one
allowance surrender penalty provides a sufficient deterrent to keep
emissions from covered sources in each state from exceeding the
assurance levels.

2. Approach

To determine if a penalty of two allowances for every ton of excess
emissions would be sufficient, EPA used the Integrated Planning Model
(IPM) to assess a “TR_Penalty_Scenario” whose results, along with
the results of other IPM model runs for the Transport Rule, can be found
in the docket. More information on IPM can be found in the Documentation
Supplement for EPA Base Case v.4.10_FTransport – Updates for Final
Transport Rule, which is also in the docket. This penalty scenario
offered covered sources in each state the choice to emit beyond the
state’s assurance level and incur a fine for each excess ton worth
twice the value of an allowance (in addition to having to submit one
allowance for emitting each ton, per standard compliance procedures). 
In this analysis, the “state assurance level” is the state’s
emissions budget plus the state’s variability limit and corresponds to
the “state emissions assurance level” in tables VI.F-1 and VI.F-2 of
the preamble. The size of the penalty was calculated as twice the
allowance price for the relevant pollutant taken from the IPM analysis
of the final rule’s remedy (TR_Limited_Trading_Final), as shown in
Table 1.

Table 1. Allowance prices (2007$) in the final remedy
(TR_Limited_Trading Final) and Penalty Costs in the “assurance penalty
sensitivity” run (TR_Penalty_Scenario)

 	Emission Allowance Prices ($/Ton) from final remedy run	Emission
Penalty Costs ($/Ton) in the assurance penalty sensitivity run

 	2012	2014	2012	2014

SO2 Region 1 (TR)	971	1,127	1,942	2,254

SO2 Region 2 (TR)	576	663	1,152	1,327

NOx Annual (TR)	497	577	994	1,153

NOx Ozone Season (TR)	1,321	1,532	2,642	3,064



It is important to consider that while the effective fine in this
scenario (twice the value of the relevant pollutant’s allowance price)
is a technically valid representation of the final rule’s penalty
structure, it is an analytic understatement of the actual deterrence
value of this penalty in practice.  The penalty in practice will have
more of a deterrent effect than what this scenario models it to have for
two reasons.  First, the penalty cost as modeled is fixed at twice the
allowance price in the final remedy scenario (TR_Limited_Trading_Final)
for every ton of emissions in excess of a state’s assurance level.  In
reality, excess emissions would increase the allowance price (and
therefore the cost of the penalty itself) since allowances would have to
be bought and surrendered for the penalty, raising allowance demand and
thus making them more valuable.  The modeling imposed a fine and did not
adjust the allowance pool to account for penalty surrenders, and so it
understates the cost of the penalty incurred.  Second, the model has
perfect foresight of all future emitting behavior and thus does not take
any “risk” into account when determining whether excess emissions
are “worth it” at the penalty cost modeled.  In reality, owners and
operators of covered units will assign a risk premium to the nominal
penalty consequence because they do not have perfect foresight and
cannot be sure of their precise emissions until the compliance period is
complete.  Therefore, program participants can be expected to act more
“conservatively” than the modeling would suggest when determining
whether excess emissions are “worth it” at the penalty cost modeled,
which suggests again that this analysis understates the deterrence value
of the penalty in practice. 

3. Results

EPA compared the state-level emissions in 2012 and 2014 in this analysis
to the state assurance levels to determine whether the penalty level
deterred excess emissions.  Tables 2 through 5 show the state assurance
levels and modeled emissions from covered sources in each state.  The
modeled allowance prices in 2012 and 2014 for each pollutant are shown
at the bottom of each table. The penalty for exceeding the assurance
level would be equal to twice the allowance price.

In no case do the covered emissions in a state exceed that state’s
assurance level in 2012 or 2014. This result indicates that the penalty
offers a sufficient deterrent to ensure emissions do not exceed
assurance levels in 2012 and 2014.  Even though the modeling of this
scenario understated the actual value of the deterrent in practice, in
no state did the covered sources find it economic to exceed the
states’ assurance levels in 2012 and 2014.   

	In some states, the covered sources in a state are modeled to have
collective emissions that are exactly equal to the state’s assurance
level.  These projections occur because the model operates under perfect
foresight and perfect information, and it therefore allows sources in
the modeling to emit up to the state’s assurance level with full
certainty that emissions will respect that constraint to the last ton
emitted, successfully avoiding additional emissions which are shown to
be uneconomic under the assurance penalty.  In reality, the deterrence
value of the penalty would likely lead a state’s covered sources to
act conservatively by emitting below a state’s assurance level (rather
than exactly up to it) to ensure that unexpected fluctuations in
emissions do not result in a penalty. 

	In some cases, notably SO2 Group 1 states, the covered emissions are
projected to be significantly lower than the states’ assurance levels
in 2012.  This would occur if covered sources decide to reduce their
emissions beyond what is required so they can bank the excess
allowances. These banked allowances could then used to cover emissions
in future years. Specifically, the SO2 Group 1 state budgets were
determined by the feasible emission reductions at $500/ton SO2 in 2012
and $2300/ton SO2 in 2014 (see Significant Contribution and State
Emissions Budgets Final Rule TSD). Covered sources in these states may
decide to reduce their emissions further than required in 2012 and 2013
and bank the unused allowances for use in 2014 and later years. This
pattern effectively smooths their emission reductions over time to
minimize total compliance costs in those states.  The modeled allowance
prices in those states also reflect this smoothing of emission reduction
patterns. For example, as seen in Table 2, the 2012 and 2014 projected
allowance prices for Group 1 SO2 states are closer to each other than
the marginal cost thresholds used to formulate their budgets in those
years ($500 per ton in 2012 and $2,300 per ton in 2014).  This banking
behavior to smooth emission reductions over time is shown in this
analysis to be entirely consistent with each state’s assurance levels
in both 2012 and 2014.

	As noted above, EPA’s modeling of this scenario projects no instance
in which covered sources would find it economic to exceed a state’s
assurance level in any of the programs in 2012 or 2014.  This analysis
also projects that the penalty provides sufficient deterrence for
virtually all states in these programs over the 2020-2030 timeframe as
well.  However, the projections appear to suggest small exceedances in
two states in 2020 and in three states in 2030.  In most of these cases,
the projected exceedances are marginal – on the order of two hundred
tons of pollutant.  EPA does not believe that these longer-run results
actually indicate a likelihood of these exceedances occurring.  It is
important to note that this modeling assumes perfect foresight and
perfect information, even into the 2020-2030 timeframe, and that under
those assumptions, unit owners and operators would be willing to expend
banked allowances in those years even to the point of paying assurance
penalties on them.  In reality, operators of covered units do not have
perfect foresight or perfect information and will therefore act more
conservatively than “optimal” banking patterns from IPM modeling
would indicate.

As a result, EPA expects sources will collectively continue to respect
their states’ assurance levels in those instances by sustaining the
Transport Rule emission reductions into the 2020-2030 timeframe and
banking allowances further into the future to guard against
unanticipated developments that the model does not capture.
Consequently, EPA does not believe that these limited small instances of
projected exceedances in 2020 or 2030 are likely to occur in the actual
operation of these programs.  However, EPA will monitor the pattern of
compliance with these programs over the long-run and will be prepared to
adjust the penalty accordingly if evidence suggests that increased
deterrence would be necessary at those later stages to encourage states
to respect their assurance levels. At this point, EPA believes that it
is best to be sure in the initial years that the assurance penalty is
effective in keeping emissions within variability limits, while
encouraging trading to lower costs and increase flexibility and avoiding
actions that have a chilling effect on activities.  While doing this,
EPA believe it is important to remain mindful that we do want assurance
of meeting emission reductions over time. 

EPA believes these findings support a determination that the penalty
requirement of surrendering two additional allowances for each ton of
excess emissions provides a sufficient deterrent in the final Transport
Rule such that EPA does not expect the covered sources in any state to
exceed the state’s assurance levels under these programs.  



Table 2. Annual SO2 Group 1 State Assurance Levels and Emissions in 2012
and 2014 (TR_Penalty_Scenario)

 	2012	2014

	State Assurance Level 	Penalty Case Emissions	State Assurance Level 
Penalty Case Emissions

 	(thousand tons)	(thousand tons)	(thousand tons)	(thousand tons)

Illinois	258	210	137	128

Indiana	314	241	177	177

Iowa	118	75	83	78

Kentucky	208	146	117	117

Maryland	33	27	31	30

Michigan	214	190	158	158

Missouri	228	182	183	177

New Jersey	7	6	7	7

New York	23	20	13	13

North Carolina	151	117	63	63

Ohio	341	229	151	151

Pennsylvania	307	250	123	123

Tennessee	163	97	65	65

Virginia	78	67	39	39

West Virginia	161	119	83	83

Wisconsin	87	77	44	44



Table 3. Annual SO2 Group 2 State Assurance Levels and Emissions in 2012
and 2014 (TR_Penalty_Scenario)

 	2012	2014

	State Assurance Level 	Penalty Case Emissions	State Assurance Level 
Penalty Case Emissions

 	(thousand tons)	(thousand tons)	(thousand tons)	(thousand tons)

Alabama	238	219	235	173

Georgia	174	159	105	93

Kansas	46	41	46	46

Minnesota	46	43	46	45

Nebraska	72	65	72	70

South Carolina	97	85	97	97

Texas	268	244	268	266



Table 4. Annual NOX State Assurance Levels and Emissions in 2012 and
2014  (TR_Penalty_Scenario)

 	2012	2014

	State Assurance Level 	Penalty Case Emissions	State Assurance Level 
Penalty Case Emissions

 	(thousand tons)	(thousand tons)	(thousand tons)	(thousand tons)

Alabama	80	74	79	68

Georgia	68	61	45	40

Illinois	53	48	53	49

Indiana	121	110	119	110

Iowa	42	37	41	38

Kansas	34	31	28	24

Kentucky	94	84	85	76

Maryland	18	16	18	17

Michigan	66	59	64	57

Minnesota	33	31	33	31

Missouri	58	52	54	49

Nebraska	29	26	29	27

New Jersey	8	7	8	8

New York	20	18	20	17

North Carolina	56	48	46	42

Ohio	102	85	96	84

Pennsylvania	132	118	131	117

South Carolina	36	33	36	36

Tennessee	39	33	21	20

Texas	147	133	147	137

Virginia	37	33	37	35

West Virginia	65	56	60	53

Wisconsin	35	31	33	30



Table 5. Ozone Season NOX State Assurance Levels and Emissions in 2012
and 2014  (TR_Penalty_Scenario)*  

 	2012	2014

	State Assurance Level 	Penalty Case Emissions	State Assurance Level 
Penalty Case Emissions

 	(thousand tons)	(thousand tons)	(thousand tons)	(thousand tons)

Alabama	35	32	35	30

Arkansas	18	15	18	17

Florida	31	28	31	29

Georgia	32	27	21	18

Illinois	23	21	23	21

Indiana	52	47	51	47

Iowa	18	16	18	16

Kansas	15	13	12	10

Kentucky	40	35	36	32

Louisiana	16	14	16	14

Maryland	8	7	8	7

Michigan	28	25	27	24

Mississippi	12	11	12	11

Missouri	25	22	23	21

New Jersey	4	3	4	4

New York	10	8	10	8

North Carolina	24	21	20	18

Ohio	44	35	42	36

Oklahoma	24	21	24	21

Pennsylvania	57	50	57	50

South Carolina	15	14	15	15

Tennessee	17	14	9	8

Texas	69	63	69	64

Virginia	17	14	17	15

West Virginia	28	23	26	22

Wisconsin	16	13	15	13

*As discussed in section III of the Transport Rule preamble, the final
rule does not include the states of Iowa, Kansas, Michigan, Missouri,
Oklahoma, or Wisconsin in the ozone season program.  EPA issued a
supplemental proposal to include these six states in the Transport Rule
ozone season program. 

  The assurance provision allowance surrender penalty addressed in this
TSD is distinct from the penalties, discussed in preamble section VII.F,
that apply to the trading program requirement to hold allowances
sufficient to cover emissions for each compliance period.

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Deliberative – Do not cite or quote

