Blog Post

Emissions Trading Isn't Dead, But It's Not Out of the Hospital Either

May 6, 2014 | Nathan Richardson

The Supreme Court's recent decision in EPA v. EME Homer City was a big victory for the agency, substantially (though not completely and finally) clearing the way for  cap-and-trade programs that had been in legal limbo for the better part of a decade.  The DC Circuit decision in the case that SCOTUS overturned prompted me to declare the effective end of emissions trading under this part of the Clean Air Act (Section 110, which deals with "conventional" or "criteria" pollutants like sulfur dioxide and nitrogen oxides). Last week's decision breathes new life into those flexible programs.

Dan Farber (whose coverage of the case has been extremely useful) writes today that the decision is also cause for optimism about flexibility (read: trading) under other parts of the Act, most importantly Section 111(d), which will soon be used to regulate carbon emissions from existing power plants (and about which we've written extensively at RFF). While the recent decision certainly doesn't hurt (and while I'm broadly optimistic that ESPS can be flexibile), unlike Dan Farber I don't think it tells us much about how SCOTUS would rule on inevitable challenges to the ESPS.

Farber points to a number of places in EME Homer City where the majority expresses its comfort with EPA considering costs when regulating and, more specifically, using market-based tools to keep costs down. But there are really two separate issues here: first, can the agency consider cost when making the decision in question and, second, does the statute allow it to use market-based tools (or consider whether they can be used when setting targets). If the answer to both of those questions is clearly yes, than there's no question that EPA can use trading policies.

But for both the §11o NAAQS program at issue in EME Homer City and for a future §111(d) ESPS, the answers aren't so clear. What's different is that the ambiguity lies in one question for the NAAQS, and the other for the ESPS.

For the NAAQS, the DC Circuit has struggled for years with the question of whether EPA is permitted to consider costs when determining whether upwind states make a "substantial" contribution to downwind pollution problems. It is this cross-state pollution that creates the policy and legal justification for a broad trading program in the first place. This is a tough question since (unless you are Justice Scalia or Justice Thomas) the statute doesn't provide a clear answer (though it probably should not have taken so long to figure this out).

But once you've established that EPA can consider costs when determining who's in and who's out, and their relative responsibilities, almost nobody questions that participating states can use cap-and-trade, that EPA can set it up as the preferred "model" option, or that if states fail to act, EPA can do cap-and-trade itself. The reason is that §110 explicitly mentions market-based tools as among those available to states regulating under the program:

Each such [state implementation plan] shall . . . include enforceable emission limitations and other control measures, means, or techniques (including economic incentives such as fees, marketable permits, and auctions of emissions rights) . . . as may be necessary or appropriate to meet the applicable requirements of this chapter. (42 USC § 7410(a)(2).

In short, it's not (or at least wasn't until last week) clear whether EPA could consider cost when setting up cross-border regulations for conventional pollutants, but market-based tools were clearly an option once that regulation was in place.

For §111(d) ESPS, the opposite is true. §111 explicitly allows EPA to consider costs when setting standards - costs are included in the definition of "performance standards" in §111(a). But it's much less clear that the agency (or states) can use flexible trading programs to achieve those standards. The best argument is that the statute's requirement that standards be based on the "best system of emission reduction", again considering cost, is sufficient to open the door for trading. Trading programs are (at least in many senses) the "best" system for low-cost emissions reduction. I think this reading is correct, and it appears to be the prevailing legal view, but it is not universal, and has not been tested in court. Once EPA proposes (and/or states implement) 111(d) trading programs, it will be.

However, this question is sufficiently different from that at issue in EME Homer City that the recent decision doesn't do much if anything to increase my confidence that we'll see trading under §111(d) ESPS.  I suppose it's useful to know we have a Supreme Court that's not rabidly anti-trading, and one that shows at least some deference to EPA's reading of the statute, but neither should be a big surprise.

To put it a different way, even if EME Homer City had come out how Justice Scalia preferred in his dissent, that holding wouldn't change my cautious optimism about §111(d) trading either. A Scalia-written holding would have echoed his opinion in American Trucking, pointing out that the statute does not direct EPA to consider cost, and that therefore it cannot simply decide to do so. But, as noted, §111 does explicitly direct the agency to consider costs. It just doesn't say whether trading is included in the tool bag marked "peformance standards". That's an entirely different question. Sooner or later, SCOTUS may have to answer it.