This example method involves input based allocations for existing fossil units, with updating to take into account new generation on a modified output basis. It also utilizes a new source set aside for new units that have not yet established baseline data to be used for updating. Providing allowances for new sources addresses a number of commenter concerns about the negative effect of new units not having access to allowances.

Under the example method, allocations are made from the State's EGU NOx budget for the first five control periods ( 2009 through 2013) of the model cap and trade program for existing sources on the basis of historic baseline heat input. Commenters expressed some concern regarding the proposed January 1, 1998 cut off on line date for considering units as existing units. The cut off on line date was selected so that any unit meeting the cut off date would have 573 at least 5 years of operating data, i. e., data for 1998 through 2002 ( which was the last year for which annual data was available). The EPA is still concerned with ensuring that particular units are not disadvantaged in their allocations by having insufficient operating data on which to base the allocations. The EPA believes that a 5 year window,

starting from commencement of operation, gives units adequate time to collect sufficient data to provide a fair assessment of their operations. Annual operating data is now available for 2003. The EPA is finalizing January 1, 2001 as the cutoff on line date for considering units as existing units since units meeting the cut off date will have at least 5 years of operating data ( i. e., data for 2001 through 2005).

The allowances for 2014 and later will be allocated from the State's EGU NOx budget annually, 6 years in advance,

taking into account output data from new units with established baselines ( modified by the heat input conversion factor to yield heat input numbers). As new units enter into service and establish a baseline, they are allocated allowances in proportion to their share of the total calculated heat input ( which is existing unit heat input plus new units' modified output). Allowances allocated to existing units slowly decline as their share of total calculated heat input decreases with the entry of new units.

After 5 years of operation, a new unit will have an 574 adequate operating baseline of output data to be incorporated into the calculations for allocations to all affected units.

The average of the highest 3 years from these 5 years will be multiplied by the heat input conversion factor to calculate the heat input value that will be used to determine the new unit's allocation from the pool of allowances for all sources.

Under the EPA example method, existing units as a group will not update their heat input. This will eliminate the potential for a generation subsidy ( and efficiency loss) as well as any potential incentive for less efficient existing units to generate more. This methodology will also be easier to implement since it will not require the updating of existing units' baseline data. Retired units will continue to receive allowances indefinitely, thereby creating an incentive to retire less efficient units instead of continuing to operate them in order to maintain the allowances allocations.

Moreover, new units as a group will only update their heat input numbers once  for the initial 5 year baseline period after they start operating. This will eliminate any potential generation subsidy and be easier to implement,

since it will not require the collection and processing of data needed for regular updating. 575 The EPA believes that allocating to existing units based on a baseline of historic heat input data ( rather than output data) is desirable, because accurate protocols currently exist for monitoring this data and reporting it to the EPA,

and several years of certified data are available for most of the affected sources. The EPA expects that any problems with standardizing and collecting output data, to the extent that they exist, can be resolved in time for their use for new unit calculations. Given that units keep track of electricity output for commercial purposes, this is not likely to be a significant problem.

A number of commenters expressed support for the EPA's proposal in the SNPR that the heat input data for existing units be adjusted by multiplying it by different factors based on fuel type. Contrary to some commenters' claims,

determining allocations with fuel factors would not create disincentives for efficiency. With the use of a single baseline for existing units, neither adjusted input, nor input, nor output based allocations would provide additional incentives for energy efficiency. All sources have incentives to reduce emissions ( improving efficiency is a way of doing this) as a result of the cap and trade program, not because of the choice of an allocation based on a single historic baseline. 576 The EPA acknowledges that since allowances have value,

different allocations of allowances clearly do impact the distribution of wealth among different generators. However,

in general, the economics of power generation dictate that generators selling power will seek to operate ( and burn fuel)

to meet energy demand in a least cost manner. The cost of the power generated ( reflecting the bid price per megawatt hour) will include the cost of allowances to cover emissions,

whether the generator uses allowances that it already owns,

or whether it needs to purchase additional allowances. With a liquid market for allowances, allocations for existing sources ( whose baseline does not change) are a sunk benefit or sunk cost, not impacting the existing generator's behavior on the margin. Thus, the use of fuel factors in our allocating method would not be expected to result in changes in generators' choices for fuel efficiency.

In its example allocation approach, the EPA is including adjustments of heat input by fuel type based on average historic NOx emissions rates by three fuel types ( coal,

natural gas, and oil) for the years 1999 2002. As noted in the SNPR, such calculations would lead to adjustment factors of 1.0 for coal, 0.4 for gas and 0.6 for oil. The factors would reflect the inherently different emissions rates of different fossil fired units ( and consequently also reflect the different burdens to control emissions. 577 129Energy Information Administration, " Annual Energy Outlook 2004, With Projections to 2025", January 2004. Assumptions for the NEMS model. http:// www. eia. doe. gov/ oiaf/ archive/ aeo04/ assumption/ tbl38. h tml However, allocating to new ( not existing) sources on the basis of input ( and particularly fuel adjusted heat input)

would serve to subsidize less efficient new generation. For a given amount of generation, more efficient units will have the lower fuel input or heat input. Allocating to new units based on heat input could encourage the building of less efficient units since they would get more allowances than an equivalent efficient, lower heat input unit. The modified output approach, as described below, will encourage new,

clean generation, and will not reward less efficient new coal units or less efficient new gas units.

Under the example method, allowances will be allocated to new units of each fuel type with an appropriate baseline on a " modified output" basis. The new unit's modified output will be calculated by multiplying its gross output by a heat rate conversion factor of 7,900 btu/ kWh for coal units and 6,675 btu/ kWh for oil and gas units. The 7,900 btu/ kWh value for the conversion factor for new coal units is an average of heat rates for new pulverized coal plants and new IGCC coal plants ( based upon assumptions in EIA's Annual Energy Outlook ( AEO) 2004129). The 6,675 btu/ kWh value for the conversion 578 factor for new gas units is an average of heat rates for new combined cycle gas units ( also based upon assumptions in EIA's AEO 2004). A single conversion rate for each fuel type will create consistent and level incentives for efficient generation, rather than favoring new units with higher heatrates

For new cogeneration units, their share of the allowances will be calculated by converting the available thermal output ( btu) of useable steam from a boiler or useable heat from a heat exchanger to an equivalent heat input by dividing the total thermal output ( btu) by a general boiler/ heat exchanger efficiency of 80 percent.

New combustion turbine cogeneration units will calculate their share of allowances by first converting the available thermal output of useable steam from a heat recovery steam generator ( HRSG) or useable heat from a heat exchanger to an equivalent heat input by dividing the total thermal output ( btu) by the general boiler/ heat exchanger efficiency of 80 percent. To this they will add the electrical generation from the combustion turbine, converted to an equivalent heat input by multiplying by the conversion factor of 3,413 btu/ kWh. This sum will yield the total equivalent heat input for the cogeneration unit.

Steam and heat output, like electrical output, is a useable form of energy that can be utilized to power other 579 processes. Because it would be nearly impossible to adequately define the efficiency in converting steam energy into the final product for all of the various processes, this approach focuses on the efficiency of a cogeneration unit in capturing energy in the form of steam or heat from the fuel input.

Commenters expressed concern about a single conversion factor, arguing for different factors for different fuels and technologies. The EPA recognizes these concerns and agrees that different new fossil generation units have inherently different heat rates, largely dictated by the technology needed to burn different fuels. A single conversion rate for all units would provide new gas fired combined cycle units with relatively more allowances, relative to their emissions,

than it would for new coal fired units.

The EPA maintains that providing each new source an equal amount of allowances per MWh of output, given the fuel it is burning, is an equitable approach. Since electricity output is the ultimate product being produced by EGUs, a single conversion factor for each fuel, based on output,

ensures that all new sources burning a particular fuel will be treated equally.

Some commenters support allocating allowances to all new generation, not just fossil fuel fired CAIR units. The EPA notes that including new non CAIR and non fossil units in the 580 130 Some commenters stated that, if allocations were provided for non emitting new generation, they also should be provided to all such generation, including nuclear units.

131 For instance, would the addition of a single new wind turbine at a wind farm constitute a " new unit"? allowance distribution would raise issues, about which the EPA lacks sufficient information for resolution at this time for the EPA's example method. It would be necessary to clearly define what types of generating facilities that could participate and what would constitute " new" non fossil generation. 130 Commenters did not provide any analysis of the impact of possible definitions on generation mix, or electricity markets. Further, in order to include all generation, there would be a need to establish application and data collections procedures and determine appropriate size cut offs and boundaries of this generation  since in many such instances there is no clear analog to discrete fossil " units". 131 There also are associated issues about developing appropriate measurement and data reporting requirements for such sources. Commenters supporting this approach did not address any of these matters in any detail.

However, the EPA encourages States that are interested in including such units in their updating allocations to consider potential solutions and include them in their SIPs.

Under the example method, new units that have entered 581 132 As noted earlier in this section, the EPA is now considering new units to be those that went online after January 1, 2001 rather than 1998. service, but have not yet started receiving allowances through the update, will receive allowances each year from a new source set aside. The new source allowances from the set aside will be distributed based on their actual emissions from the previous year. Such an allocation approach will generally provide new units sufficient allowances to cover their emissions during the interim period before the units are allocated allowances on the same basis as existing units.

Today's example method includes a new source set aside equal to 5 percent of the State's emission budget for the years 2009 2013 and 3 percent of the State's emission budget for the subsequent years. In the SNPR, the EPA proposed a level 2 percent set aside for all years.

Commenters noted their concern that the amount of the set aside in the early years of the program should be higher to reflect the fact that the set aside will initially need to accommodate all new units entering into service from 1998 through 2010.132 In order to estimate the need for allocations for new units, the EPA looked at the NOx emissions from units that went online starting in 1999 as projected by the Integrated Planning Model ( IPM) runs 582 modeling CAIR for the years 2010 and 2015. These IPM emissions projections indicated over 57,000 tons of NOx emissions in 2010 and about 74,000 tons of NOx emission by 2015 from new sources need to be covered under set asides throughout the CAIR region. The 2010 number represents almost 4 percent of the Phase I NOx regional cap, while the 2015 number represents about 6 percent of the Phase I regional cap. Consequently, today's example method includes a 5 percent set aside for the initial period ( 2009 2013). It should be noted that by 2014, the set aside would need to cover new sources from the entire period 2004 2013.

The choice of a 3 percent new source set aside, starting in 2014, reflects concerns that adequate allowances be provided for the 10 years of new units to be covered by the set aside in 2014 and subsequent years. ( The set aside in 2014, for example, would need to accommodate all units that went on line between 2004 and 2013).

Individual States using a version of the example method may want to adjust this initial 5 year set aside amount to a number higher or lower than 5 percent to the extent that they expect to have more or less new generation going on line during the 2001 2013 period. They may also want to adjust the subsequent set aside amount to a number higher or lower than 3 percent to the extent that they expect more or less new generation going on line after 2004. States may also 583 want to set this percentage a little higher than the expected need, since, in the event that the amount of the set aside exceeds the need for new unit allowances, the State may want to provide that any unused set aside allowances will be redistributed to existing units in proportion to their existing allocations.

For the example method, the EPA is finalizing the approach that new units will begin receiving allowances from the set aside for the control period immediately following the control period in which the new unit commences commercial operation, based on the unit's emissions for the preceding control period. Thus, a source will be required to hold allowances during its start up year, but will not receive an allocation for that year.

States will allocate allowances from the set aside to all new units in any given year as a group. If there are more allowances requested than in the set aside, allowances will be distributed on a pro rata basis. Allowance allocations for a given new unit in following years will continue to be based on the prior year's emissions until the new unit establishes a baseline, is treated as an existing unit, and is allocated allowances through the State's updating process. This will enable new units to have a good sense of the amount of allowances they will likely receive

in proportion to their emissions for the previous year. This 584 133 With the alternate approach from the NOx SIP Call, States could distribute a new source set aside for a control period based on full utilization rates, at the end of the year the actual allowance allocation would be adjusted to account for actual unit utilization/ output, and excess allowances would be returned and redistributed, first taking into account new unit requests that were not able to be addressed. methodology will not provide allowances to a unit in its first year of operation; however it is a methodology that is straightforward, reasonable to implement, and predictable.

In the SNPR, the example method from the NOx SIP Call model rule was proposed as an alternate approach. 133 However,

the EPA has found this approach to be complicated for both the States and the EPA to implement. Additionally, the NOx SIP Call approach would introduce a higher level of uncertainty for sources in the allocation process than necessary.

While the EPA is offering an example allocation method with accompanying regulatory language, the EPA reiterates that it is giving States' flexibility in choosing their NOx allocations method so they may tailor it to their unique circumstances and interests. Several commenters, for instance, have noted their desire for full output based allocations ( in contrast to the hybrid approach in the example above). In the past, EPA had sponsored a work group to assist States wishing to adopt output based NOx 585 134 Auctions could provide States with a non distortionary source of revenue.

135 5 percent of the allowances would go to a new source setaside allocations for the NOx SIP Call and believes it is a viable approach worth considering. Documents from meetings of this group and the resulting guidance report ( found at http:// www. epa. gov/ airmarkets/ fednox/ workgrp. html) together with additional resources such as the EPA sponsored report " Output Based Regulations: A Handbook for Air Regulators"

( found at http:// www. epa. gov/ cleanenergy/ pdf/ output_ rpt. pdf)

can help States, should they choose to adopt any output based elements in their allocation plans.

As an another alternative example, States could decide to include elements of auctions into their allowance allocation programs. 134 An example of an approach where CAIR NOx allowances could be distributed to sources through a combination of an auction and a free allocation is provided below.

During the first year of the trading program, 94 percent of the NOx allowances could, for example, be allocated to affected units with an auction held for the remaining 1 percent of the NOx allowances135. Each subsequent year, an additional 1 percent of the allowances ( for the first 20 years of the program), and then an additional 2.5 percent 586 thereafter, could be auctioned until eventually all the allowances are auctioned. With such a system, for the first 20 years of the trading programs, the majority of allowances would be distributed for free via the allocation. Allowances allocated for these earlier years are generally more valuable than allowances allocated for later years because of the time value of money. Thus, most emitting units would receive relatively more allowances in the early years of the program,

when they are facing the expenses of taking actions to control their emissions. Even though the proportion of allowances allocated to existing sources declines in the later years of the program, these sources receive for free a very significant share of the total value of allowances ( because the discounted present value of allowances allocated in the early years of the program is greater than the discounted present value of the allowances auctioned later).

Auctions could be designed by the State to promote an efficient distribution of allowances and a competitive market. Allowances would be offered for sale before or during the year for which such allowances may be used to meet the requirement to hold allowances. States would decide on the frequency and timing of auctions. Each auction would be open to any person, who would submit bids according to auction procedures, a bidding schedule, a bidding means, and by fulfilling requirements for financial guarantees as 587 specified by the State. Winning bids, and required payments,

for allowances would be determined in accordance with the State program and ownership of allowances would be recorded in the EPA Allowance Tracking System after the required payment is received.

The auction could be a multiple round auction.

Interested bidders would submit before the auction, one or more initial bids to purchase a specified quantity of NOx allowances at a reserve price specified by the State,

specifying the appropriate account in the Allowance Tracking System in which such allowances would be recorded. Each bid would be guaranteed by a certified check, a funds transfer,

or, in a form acceptable to the State, a letter of credit for such quantity multiplied by the reserve price. For each round of the auction, the State would announce current round reserve prices for NOx and determine whether the sum of the acceptable bids exceeds the quantity of such allowances,

available for auction. If the sum of the acceptable bids for NOx allowances exceeds the quantity of such allowances the State would increase the reserve price for the next round.

After the auction, the State would publish the names of winning and losing bidders, their quantities awarded, and the final prices. The State would return payment to unsuccessful bidders and add any unsold allowances to the next relevant auction. 588 In summary, today's action provides, for States participating in the EPA administered CAIR NOx cap and trade program, the flexibility to determine their own methods for allocating NOx allowances to their sources. Specifically,

such States will have flexibility concerning the cost of the allowance distribution, the frequency of allocations, the basis for distributing the allowances, and the use and size of allowance set asides.

E. What Mechanisms Affect the Trading of Emission Allowances?

1. Banking a. The CAIR NPR and SNPR Proposal for the Model Rules and Input from Commenters Banking is the retention of unused allowances from 1 calendar year for use in a later calendar year. Banking allows sources to make reductions beyond required levels and " bank" the unused allowances for use later. Generally speaking, banking has several advantages: it can encourage earlier or greater reductions than are required from sources,

stimulate the market and encourage efficiency, and provide flexibility in achieving emissions reductions goals. When sources reduce their SO2 and NOx emissions in the early phases, the cap and trade program creates an emissions " glide path" that provides earlier environmental benefits and lower 589 cost of compliance. This " glide path" does allow emissions to exceed the cap and trade program budget   especially in the initial years after the adoption of a more stringent cap.

The use of banked allowances from the Acid Rain and NOx SIP Call Programs in the CAIR NOx and SO2 cap and trade programs is discussed below in section VIII. F of this preamble.

The January 30, 2004 CAIR NPR and June 10, 2004 CAIR SNPR proposed that the CAIR NOx and SO2 cap and trade programs allow banking and the use of banked allowances without restrictions. Allowing unrestricted banking and the use of banked allowances is consistent with the existing Acid Rain SO2 cap and trade program. The NOx SIP Call cap and trade program, however, has some restrictions on the use of banked allowances, a procedure called " flow control,"

described in detail in the June 10, 2004 CAIR SNPR.

Comments Regarding Unrestricted Banking after the Start of the CAIR NOx and SO2 Cap and Trade Programs Many commenters supported the EPA's proposal to allow unrestricted banking and the use of banked allowances for both SO2 and NOx, agreeing that flow control is a complex and confusing procedure with undemonstrated environmental benefit. Further, they agreed that banking with no restrictions on use will encourage early emissions reductions, stimulate the trading market, encourage efficient 590 pollution control, and provide flexibility to affected sources in meeting environmental objectives.

Other commenters objected to the EPA's proposal to allow unrestricted use of banked allowances. All of these commenters supported some use of flow control in the CAIR cap and trade programs, most supporting its use for both SO2 and NOx.

Some commenters disagreed with the EPA's assessment that the use of flow control in the Ozone Transport Commission ( OTC) cap and trade program was complicated to understand and implement and caused market complexity. One commenter further elaborated that flow control was accepted by industry. Another commenter claimed that the EPA has not analyzed the impact of the flow control mechanism.

Some commenters supportive of flow control stated that flow control was " successful" in the OTC and NOx SIP Call trading programs and " worked well" and " achieved the desired effect," without supporting those statements.

b. The Final CAIR Model Rules and Banking The EPA acknowledges that the OTC NOx cap and trade program has functioned for several years despite the complexity introduced by the flow control procedures.

Industry and other allowance traders have adapted to these complex procedures, yet there are ongoing questions from the regulated community about how the procedures actually work. 591 As an example, one commenter, while disagreeing with the EPA's assertion that flow control is overly complex, goes on to describe incorrectly the implementation of flow control.

The NOx SIP Call cap and trade program includes similar procedures but flow control was not triggered in the first 2 years of the program ( 2003 and 2004), so there is no experience to be drawn from that program.

The EPA maintains that the benefits of utilizing these complex procedures is questionable. The EPA has analyzed the use of the flow control procedures in a paper released in March 2004, " Progressive Flow Control in the OTC NOx Budget Program: Issues to Consider at the Close of the 1999 to 2002 Period." The lessons learned from this analysis were as follows:

1) Flow control can create market pricing complexity and uncertainty. The need for implementation of flow control for a particular control period is not known more than a few months in advance, and the value of banked allowances varies from year to year, depending on whether flow control has been triggered for the particular year. Therefore, when deciding how much to control, a source has some increased uncertainty about the value of any excess allowances it generates.

2) Flow control can have a bigger impact on small entities than on large entities. Large firms with multiple allowance accounts can shift banked allowances among those 592 accounts to minimize the number of banked allowances surrendered at a discounted rate.

3) Flow control does not directly affect short term emissions, so it may not serve the environmental goals for which it was created.

Incorporating these lessons learned, the EPA is finalizing the CAIR NOx and SO2 cap and trade programs with no flow control mechanism.

2. Interpollutant Trading Mechanisms a. The CAIR NPR Proposal for the Model Rules and Input from Commenters Mechanisms for interpollutant trading allow reduced emissions of one pollutant to be exchanged for increased emissions of another pollutant where both pollutants cause the same environmental problem ( e. g., are precursors of a third pollutant). Interpollutant trading mechanisms are typically based upon each precursor's contribution to a particular environmental problem and are often controversial and scientifically difficult to design because of the complexities of environmental chemistry. Determination of conversion factors ( i. e., transfer ratios that relate the impact of one pollutant to the impact of another pollutant)

can be dependent upon location, the presence of other pollutants that are necessary for chemical reactions, the time of emissions, and other considerations. 593 The January 30, 2004 CAIR NPR did not propose a specific interpollutant trading mechanism but rather took comment on interpollutant trading in general as well as the following specific issues:

( 1) What would be the exchange rate ( i. e., the transfer ratio) for the two pollutants ( 2) How can the transfer ratio best achieve the goals of PM2.5 and ozone reductions in downwind States and,

( 3) How would the interpollutant trading accommodate the different geographic regions of the PM2.5 and ozone programs?

Comments Regarding the Potential Interpollutant Trading The EPA received several comments on interpollutant trading with the most commenters generally opposed to including provisions to allow for the interchangability of SO2 and NOx allowances.

Several commenters pointed out that the CAIR ozone attainment benefits result from the NOx emissions reductions,

and contend that the EPA has not shown that SO2 emissions impact ozone. Therefore, the commmenters conclude that it would be inappropriate for SO2 allowances to be traded and used for compliance with the NOx cap. Some commenters supported the consideration or use of interpollutant trading if it was one directional, i. e., NOx allowances could be used for compliance with the SO2 allowance holding requirements, 594 but not vice versa. This could result in fewer NOx emissions and more SO2 emissions.

Some commenters supported the consideration or use of interpollutant trading and emphasized the scientific difficulty in developing accurate transfer ratios. Of these commenters, some added that interpollutant trading would be appropriate if the EPA conducted a thorough analysis of the potential impacts that interpollutant trading would have on:

nonattainment areas' ability to come into attainment; the allowance markets and prices; and the integrity of the NOx caps in light of the potentially large SO2 allowance bank that might be carried forward into the CAIR trading programs.

A few commenters noted that the EPA is directed by the CAA to study interpollutant trading and has approved SIPs that allow the trading of ozone precursors under specific circumstances.

b. Interpollutant Trading and the Final CAIR Model Rules Interpollutant trading can provide some additional compliance flexibility, and potentially lower compliance costs, if appropriately applied to multiple pollutants that have reasonably well known impacts on the same environmental problem. The EPA acknowledges that it has the authority to create interpollutant trading programs and has done so, in other regulatory contexts, in the past. However, for several 595 reasons, the EPA determined that direct interpollutant trading is not appropriate in the CAIR.

The final CAIR includes separate annual SO2 and annual NOx model rules to address PM2.5 precursor emissions, and an ozone season NOx model rule to address summertime ozone precursor emissions. The EPA believes it is not appropriate for the CAIR model rules to allow annual SO2 or NOx allowances to be used for compliance with ozone season NOx allowance holding requirements because this has the potential to adversely impact the ozone season emissions reductions and ozone air quality improvements from CAIR. This is significant because the EPA, as required by the CAA, has promulgated a national air quality standard for 8 hour ozone based on a determination that the standard is necessary to protect public health. Section 110( a) 2( D) requires States to prohibit emissions in amounts that will significantly contribute to nonattainment in, or interfere with maintenance by, any other State with respect to any air quality standard,

including ozone. In this rule, EPA has designed the annual ( SO2 and NOx) and ozone season ( NOx) emission caps to achieve the emissions reductions necessary to address each State's significant contribution to downwind PM2.5 and ozone nonattainment, respectively, and to prevent interference with maintenance. If sources were permitted to use annual SO2 or annual NOx allowances for compliance with ozone season NOx 596 allowance holding requirements ( i. e., the ozone season NOx cap), then there would be no assurance that upwind States'

ozone season NOx reduction obligations would be met, and CAIR's projected ozone improvements in downwind nonattainment areas could be significantly reduced. As a result, should interpollutant trading be permitted between the annual and ozone season programs, the EPA could not demonstrate that the use of a CAIR ozone season cap and trade program would result in the emissions reductions necessary to satisfy upwind States' obligations under section 110( a) 2( D) to reduce NOx for ozone purposes.

The EPA believes it is also inappropriate to use annual NOx allowances for compliance with the annual SO2 allowance holding requirements, and vice versa. The EPA agrees with commenters that emphasize that the chemical interactions for PM2.5 precursors are scientifically complex and must be accurately reflected in any transfer ratio in order to maintain the integrity of the market. For example, EPA analysis has shown ( see January 30, 2004 NPR) that PM2.5 precursors, such as NOx and SO2, may have non linear interactions in the formation of PM2.5. Any uniform,

interpollutant transfer ratio would have to be an average and would introduce significant variability concerning the impact of interpollutant trading on emissions and significant uncertainty concerning the achievement of the CAIR Program's 597 emission reduction goals. The EPA did not receive a response to the request in the January 30, 2004 NPR for information on an appropriate value for a potential transfer ratio. While the EPA did receive one comment that recommended the use of a trading ratio of two NOx allowances for one SO2 allowance, no comments presented supporting analysis that could be used to develop transfer ratios.

While many commenters supportive of allowing interpollutant trading in the CAIR claimed that it would provide additional compliance flexibility to sources, the EPA contends that use of the newly created CAIR trading markets is sufficiently flexible. Sources may develop integrated,

multi pollutant control strategies and use the separate allowance markets to mitigate differences in control costs ( within the boundaries of emissions caps). In other words, a source can choose the level to which they can cost effectively control one pollutant and, if necessary, buy or sell emission allowances of the other pollutant to compensate for any expensive or inexpensive control cost. When markets are used to provide for trading of multiple pollutants,

sources benefit from the additional compliance flexibility while the caps assure the achievement of the overarching environmental goals.

In the June 10, 2004 SNPR, the EPA solicited comment on how an interpollutant trading mechanism might accommodate the 598 slightly different geographic regions found to be significant contributors for PM2.5 and ozone under the CAIR. No commenters provided supporting analysis or input on this issue.

In summary, the EPA received comments that generally opposed including a specific interpollutant trading mechanism. No commenters provided analysis to demonstrate the benefit of including a specific interpollutant trading mechanism nor was there analysis provided in response to the EPA's solicitation in the June 10, 2004 SNPR for input on:

transfer ratios, addressing two different environmental issues, and having slightly different annual NOx and ozone season NOx control regions. Furthermore, because the NOx and SO2 markets provide very flexible mechanisms for trading of the two pollutants, the EPA does not believe there is a compelling need to go further at this time. Therefore, EPA is not finalizing provisions in the CAIR model rules that specifically address interpollutant trades.

F. Are There Incentives for Early Reductions?

When sources reduce their SO2 and NOx emissions during the first phase of a multi phase cap and trade program, it creates the emissions " glide slope" of a cap and trade approach that provides early environmental benefit and lowers the cost of compliance. Early reduction credits ( ERCs) can 599 provide an incentive for sources to install and/ or operate controls before the implementation dates. Allowing emission allowances from existing programs to be used for compliance in the new program is another mechanism to encourage early reductions prior to the start of a cap and trade program.

This section discusses the potential use of mechanisms to provide incentives for early reductions in the CAIR.

1. Incentives for Early SO2 Reductions a. The CAIR NPR and SNPR Proposal for the Model Rules and Input from Commenters.

The January 30, 2004 CAIR NPR and June 10, 2004 CAIR SNPR acknowledge the benefit of early reductions and provide for the use of title IV SO2 allowances of vintage years 2009 and earlier to be used for compliance in the CAIR at a oneto one ratio. In other words, title IV allowances can be banked into the CAIR Program. This provides incentive for title IV sources to reduce their emissions in years 2009 and earlier because these allowances may be used for CAIR compliance without being discounted by the retirement ratios applied to the 2010 and later SO2 allowances. No other mechanism, such as SO2 ERCs were proposed by the EPA.

Comments Regarding the Incentives for Early SO2 Reductions The EPA received comments on incentives for early SO2 reductions with the majority supporting the EPA proposal to encourage early emission reductions by allowing the CAIR 600 sources to use 2009 and earlier vintage title IV SO2 allowances for CAIR compliance. Some supporters noted concerns in meeting the CAIR's stringent Phase I SO2 requirements as another reason to allow the banking of undiscounted title IV allowances into the CAIR.

Some commenters expressed concern that achieving the SO2 caps would be delayed if a large number of SO2 allowances were being banked into the CAIR. Based upon experience with implementing the Acid Rain Program, the EPA acknowledged in the SNPR that crediting early reductions does create a glide slope   where emissions are reduced below the baseline before the implementation date and " glide" down to the ultimate cap level sometime after the program begins. This gradual reduction in emissions is a key component to cap and trade programs having lower cost of compliance than command

andcontrol approaches. One commenter proposed that the EPA needs to assess the likelihood that allowing the banking of undiscounted title IV allowances would delay the attainment of the Phase I SO2 cap until Phase II. Because the EPA included this mechanism ( i. e., the use of 2009 and earlier vintage SO2 allowances for compliance in the CAIR) in the policy case modeled as part of this rulemaking, EPA analysis includes the benefits and costs that would result from the level of SO2 reductions that would take place with banking of undiscounted title IV allowances. 601 One commenter advocated the use of SO2 ERCs. It was not clear whether these would be awarded in addition to banking title IV allowances into the CAIR or the ERC mechanism would take the place of banking SO2 allowances into the CAIR.

b. SO2 Early Reduction Incentives in the Final CAIR Model Rules.

The CAIR SO2 model rule allows CAIR sources to use title IV SO2 allowances of vintage 2009 and earlier for compliance with the CAIR at a one to one ratio. This approach was part of the CAIR policy case assumptions used in the rulemaking modeling and the EPA has shown that the SO2 cap and trade program, with this early incentive mechanism, will achieve the level of SO2 reductions needed to meet the CAIR goals.

These reductions take place on a glide slope that includes early emissions reductions as well as some use of the SO2 allowance bank as sources gradually reduce emissions toward the cap levels.

The EPA did not include SO2 ERCs because the Acid Rain Program cap and trade program, which affects a large segment of the CAIR source universe, makes it impossible to determine whether sources are reducing their SO2 emissions below levels required by existing ( i. e., the Acid Rain Program) programs.

Furthermore, given that most sources with substantial emissions receive SO2 emission allowances under the Acid Rain Program, a significant number of SO2 allowances are expected 602 to be banked into the CAIR. These banked allowances would be available to CAIR sources in the early years of the program and make ERCs largely unnecessary.

2. Incentives for Early NOx Reductions a. The CAIR NPR and SNPR Proposal for the Model Rules and Input from Commenters.

In the June 10, 2004 SNPR, the EPA proposed to provide incentives for early NOx reductions by allowing the use of NOx SIP Call allowances of vintage 2009 and earlier to be used for compliance in the CAIR. Further, the EPA did not propose, but solicited comment on the potential use of NOx ERCs to provide an additional incentive for sources to reduce NOx emissions prior to CAIR implementation. In addition to the general solicitation for comment on NOx ERCs, the EPA solicited input on the following specific approaches that could be utilized: ( 1) the EPA could maintain the NOX SIP Call requirements and allow sources to use ERCs only for compliance with the annual limitation, to ensure that ozoneseason NOX limitations are met. Under this scenario, the additional States subject to the CAIR that have been found to significantly contribute to ozone nonattainment may also have to be included in the ozone season cap; ( 2) the EPA could limit the period of time during which ERCs could be created and banked; ( 3) the EPA could cap the amount of ERCs that can 603 be created; and ( 4) the EPA could apply a discount rate to ERCs.

Comments Regarding the Incentives for Early NOx Reductions The EPA did not receive comment on the proposed use of NOx SIP Call allowances of vintage years 2009 and earlier for compliance in the CAIR. In fact, several commenters characterized the CAIR proposal as not including any incentives for early NOx emissions reductions.

The EPA received several comments on the potential use of NOx ERCs with the majority in favor of some sort of ERC mechanism. Several commenters advocated the use of ERCs to mitigate concerns that they would not be able to meet the stringent Phase I CAIR reduction requirements. One commenter wanted early reductions to facilitate the ozone attainment in 2010 but believed 2010 attainment could only be helped if there were some restrictions on the number of ERCs that could be created.

Some ERC supporters wanted credit for wintertime emissions reductions only, while a few believed that credit should be given for reductions at any time of year. One commenter advocated providing ERCs for wintertime reductions only as part of a broader proposal to create a bifurcated NOx trading system ( i. e., separate wintertime and summertime allowances and trading markets.) 604 Many of the commenters supporting the use of ERCs advocated that they be distributed from a pool of allowances similar to the CSP used in the NOx SIP Call. ( The NOx SIP Call CSP was a fixed pool of NOx allowances that were distributed on a first come first serve, prorated, or need basis, depending upon the State). Commenters noted that the CSP approach has already been part of a litigated rulemaking and provides the added benefit of limiting the total number of allowances that can be distributed for early reductions.

Other commenters proposed that should the final approach use a pool of allowances, this pool should not remove allowances from the existing State NOx budget. Another commenter suggested that allowances from a CSP could be distributed based upon a NOx emission rate, such as 0.25 lbs/ mmBtu.

Allowances could be distributed to any source emitting below the target emission rate.

Several commenters were concerned that too many NOx ERCs ( as well as NOx SIP Call allowances) could be introduced into the CAIR and the ability of the NOx cap and trade program to meet the annual and ozone season reduction goals could be compromised. Some commenters suggested that crediting early reductions at a discount ( e. g., two tons of NOx reductions earn 1 ERC) could mitigate this concern. Other commenters noted that a CSP style mechanism also provides safeguards against an overabundance of ERCs. Another commmenter noted 605 that restrictions on the use of ERCs similar to the progressive flow control ( PFC) mechanism used in the NOx SIP Call   PFC restricts the use of banked NOx allowances for compliance in years where the NOx bank is greater than 10 percent of the allocations   could help to ease concerns of flooding the market with NOx ERCs.

One commenter believed that the EPA's projection that the potential pool of NOx ERCs could be as large as 3.7 million tons ( presented in the June 10, 2004 SNPR) is unrealistically high. The commenter contended that technical limitations of Selective Catalytic Reduction ( SCR)

operation would not permit facilities to simply run all of their SCRs year round. More specifically, the commenter believes the lower operating loads, typically of the wintertime dispatch, would not meet the minimum conditions necessary for SCR operation ( i. e., at lower capacity the stack gas temperatures will not support the use of the catalyst). Fewer wintertime opportunities to operate the SCRs is believed by the commenter to result in a smaller projected ERC estimate. This was an estimate used for discussion purposes and was not directly used in the development of the CSP.

A few commenters advocated providing credits to any source that reduced emission rates below those used to determine the CAIR State budgets. One commenter suggested 606 that the rates be based on those rates used to determine the NOx SIP Call caps.

A few commenters proposed that the EPA should develop a strategy for crediting NOx reductions from sources that have implemented control measures in response to State level regulations that are more stringent than the NOx SIP Call.

Another commenter advocated only providing ERCs in States subject to both the NOx SIP Call and the CAIR.

Some commenters did not support the use of NOx ERCs in any form. These commenters believe that the use of ERCs would delay attainment of the CAIR emission caps.

b. NOx Early Reduction Incentives in the Final CAIR Model Rules.

The CAIR ozone season NOx cap and trade rule will allow the proposed use of NOx SIP Call allowances of vintage years 2008 and earlier for compliance in the CAIR. This mechanism would provide incentive for sources in NOx SIP Call States to reduce their ozone season NOx emissions and bank additional allowances into the CAIR. Because today's final ozone season cap and trade rule includes a mandatory ozone season NOx cap in 2009 ( this modification is discussed in section IV), the provisions to allow the banking of NOx SIP Call allowances into the CAIR are adjusted to reflect this implementation date. 607 136 The 200,000 ton pool includes the 1,503 tons that would be DE and NJ's share. Section V of today's action describes in detail the State by State apportionment of the total CSP. The CAIR annual NOx cap and trade rule will provide additional incentives for early annual NOx reductions by creating a CSP for CAIR States from which they can distribute allowances for early, surplus NOx emissions reductions in the years 2007 and 2008. The earning of CAIR CSP allowances for NOx emission reductions does not begin until 2007 because this is the first year after the State SIP submittal deadlines. The CAIR CSP will provide a total of 200,000136 CAIR annual NOx allowances of vintage 2009 in addition to the annual CAIR NOx budgets.

The CAIR's CSP is patterned after the NOx SIP Call's CSP, which is part of an established and extensively litigated rulemaking. Similarities include: limiting the total number of allowances that can be distributed; limiting the years in which CSP allowances can be earned; populating the CSP with allowances vintaged the first compliance year;

and using distribution criteria of early reductions and need.

The EPA will apportion the CSP to the States based upon their share of the final, regionwide NOx CAIR reductions.

Similar to the NOx SIP Call, States may distribute these CAIR NOx allowances to sources based upon either: ( 1) a demonstration by the source to the State of NOx emissions 608 reductions in surplus of any existing NOx emission control requirements; or ( 2) a demonstration to the State that the facility has a " need" that would affect electricity grid reliability. Sources that wish to receive CAIR CSP allowances based upon a demonstration of surplus emissions reductions will be awarded one CAIR annual NOx allowance for every ton of NOx emissions reductions. ( Should a State receive more requests for allowances than their share of the CAIR CSP, the State would pro rate the allowance distribution.) Determination of surplus emissions must use emissions data measured using part 75 monitoring.

The EPA elected to include the CSP in response to several comments noting the benefit of early NOx reductions and some commenters concerns in complying with the stringent Phase I CAIR NOx cap. While EPA analysis has shown that sources had sufficient time to install NOx emission controls,

the EPA does believe that it would be appropriate to provide some mechanism to alleviate the concerns of some sources which may have unique issues with complying with the 2009 implementation deadline. In addition to mitigating some of the uncertainty regarding the EPA projections of resources to comply with CAIR, the CAIR CSP also effectively provides incentives for early, surplus NOx reductions.

The EPA agrees with the comments that advocate allowing sources to earn CAIR annual NOx allowances only for those 609 reductions that are in surplus of the sources' existing NOx reduction requirements. By allowing sources in NOx SIP Call and non NOx SIP Call States to demonstrate that their yearround early reductions are truly " surplus" and, therefore,

deserving of CSP allowances, the EPA is responding to comments that the EPA should allow sources in non NOx SIP Call States to receive credit for early reductions. Some commenters advocated crediting sources in the ozone season NOx cap and trade program that emitted below the emission rate used to determine the ozone season budget. The EPA did not accept this recommendation because a source that is allowed to bank NOx SIP Call allowances into the CAIR ozoneseason NOx program and receive early reduction credit from CAIR's CSP would be essentially " double counting" that emission reduction.

The EPA did not restrict the use of the NOx allowances awarded from the CSP because several aspects of the CSP already address concerns that too many total credits would be distributed and that they would flood the markets. First,

the CSP is a finite pool of NOx allowances. Second, by requiring sources to reduce one ton of NOx emissions for every NOx allowance awarded from the CSP ensures that significant reductions are made prior to the CAIR implementation date.

G. Are There Individual Unit " Opt In" Provisions? 610 In the SNPR, EPA described a potential approach for allowing certain units to voluntarily participate in, or " opt in," to the CAIR. Originally, EPA proposed to have no opt in provision but included language in the SNPR on what a potential opt in provision may look like. This " potential"

opt in provision would have allowed non EGU boilers and turbines that exhaust to a stack or duct and monitor and report in accordance with part 75 to opt into the CAIR The opt in unit would have been required to opt in for both SO2 and NOx. The allocation method for opt ins assumed a percentage SO2 reduction from a baseline and for NOx,

allocations were equal to a baseline heat input multiplied by a specified NOx emissions rate, the same NOx emissions rate EGUs were subject to in the assumed EGU budgets. Allocations were updated annually and after opting in units would have had to stay in the CAIR for a minimum of 5 years. The EPA received many comments in favor of and very few comments against including an opt in provision in the final rule. As a result, EPA is including an opt in provision in this final rule that is based on the approach described in the SNPR but includes several modifications and additions in response to comments as described below. In general, EPA believes there is value to including an opt in provision but believes that sources that opt in should be responsible for a certain level of reduction below its baseline because of the additional 611 flexibility provided to that source by opting into a regional trading program and because of the possibility that participation in the CAIR may reduce or eliminate future potential required reductions. Therefore, the following optin approach has as its goals to provide more flexibility to the units opting in as well as to potentially provide more cost effective reductions for the affected EGUs but also to ensure a certain level of reduction from the units opting into the program.

1. Applicability Some commenters suggested that the opt in provision not be limited to boilers and turbines but should be open to any unit. The EPA strongly believes that any unit participating in an emissions trading program be subject to accurate and reliable monitoring and reporting requirements. This is the purpose of part 75. The EPA has developed criteria for boilers and turbines to satisfy the requirements of part 75 but has not developed criteria for all non boilers and turbines and, therefore, cannot be confident their emissions can be monitored with the high degree of accuracy and reliability required by a cap and trade program. Continuous Emissions Monitoring Systems or " CEMS" are typically what is required by EPA to participate in a cap and trade program.

In response to comments received suggesting that non boilers and turbines be allowed to opt in, EPA is 612 expanding applicability of the opt in provision to include,

in addition to boilers and turbines, other fossil fuel fired combustion devices that vent all emissions through a stack and meet monitoring, recordkeeping, and recording requirements of part 75.

2. Allowing Single Pollutant Some commenters suggested that sources should be allowed to opt in for only one pollutant instead of requiring the source to opt in for both SO2 and NOx as EPA proposed. These commenters argued that some sources may only emit significant amounts of one of the two regulated pollutants and that it would not make sense to require reductions in both pollutants from such a source. The EPA agrees with this comment and will allow units to opt in for one pollutant, i. e., NOx, SO2,

or both. Another commenter suggested that EPA allow non EGUs subject to the NOx SIP Call to opt into the CAIR for NOx only without requiring any reductions in SO2. This commenter argued that these non EGUs could simply turn on their SCRs during the non ozone season and easily achieve significant NOx reductions. The EPA agrees that the relatively small number of non EGUs subject to the NOx SIP Call that have SCRs could achieve significant NOx reductions by operating their SCRs during the non ozone season. As stated above, EPA is allowing sources to opt in for one pollutant and thus non

EGUs subject to the NOx SIP call may opt in for NOx only. 613 3. Allocation Method for Opt Ins In the SNPR, EPA proposed allocating allowances to optin units on a yearly basis. The amount of allowances allocated would be calculated by multiplying an emission rate by the lesser of a baseline heat input or the actual heat input monitored at the unit in the prior year.

The baseline heat input would be calculated by using the most recent 3 years of quality assured part 75 monitoring data. When less than 3 years of quality assured part 75 monitoring data is available, the heat input would be based on quality assured part 75 monitoring data from the year before the unit opted in.

For SO2, EPA proposed that the emission rate used to calculate allocations would be the lesser of, the most stringent State or Federal SO2 emission rate that applied in the preceding year or the emission rate representing 50 percent of the unit's baseline SO2 emission rate ( in lbs/ mmBtu) for the years 2010 through 2014 and 35 percent of the unit's baseline SO2 emission rate ( in lbs/ mmBtu) for 2015 and beyond. For NOx, EPA proposed that the emission rate would be the lower of the unit's baseline emission rate, the most stringent State or Federal NOx emission limitation that applies to the opt in unit at any time during the calender year prior to opting into the CAIR Program, or 0.15 lb/ mmBtu 614 for the years 2010 through 2014 and 0.11 lbs/ mmBtu for the years 2015 and beyond.

In today's final rule, EPA is making a number of changes to its proposed methodology for calculating allocations for opt in units.

With regards to baseline heat input, EPA is requiring that sources may only use part 75 monitored data for years in which they have maintained at least a 90 percent monitor availability. The EPA is making this change because part 75 contains missing data provisions that require substitution of data when monitors are unavailable. When units have low monitor availability, units are required to report more conservative ( e. g., higher) heat input values. This is to provide an incentive to maintain high monitor availability ( since under a cap and trade program sources would be required to turn in more allowances if they reported higher emissions). When setting baselines, sources have the opposite incentive, reporting a higher heat input would result in a higher baseline and thus a greater allocation.

With regards to the SO2 emission rate used to calculate allocations, EPA is requiring that the emission rate used to calculate allocations would be the lesser of, the most stringent State or Federal SO2 emission rate that applies to the unit in the year that the unit is being allocated for, or the emission rate representing 70 percent of the unit's 615 baseline SO2 emission rate ( in lbs/ mmBtu). The EPA is changing the percentage emission reduction upon which allocations are based because some commenters suggested that instead of using percentage emission reduction requirements that are the same as the requirements for EGUs as a basis for allocating to opt ins, EPA should require emissions reductions based on similar marginal cost of control. The EPA agrees with the basic concept that emissions reductions for opt ins should be based on similar marginal costs. One commenter submitted results from a study of industrial boiler NOx and SO2 control costs that indicated the use of similar marginal cost of control would result in approximately a 30 percent reduction in NOx and SO2 by 2010. While the commenter provided limited data to allow EPA to evaluate the commenter's estimates, EPA is using this percentage reduction requirement for the opt in provision. The same commenter stated that it may be possible to achieve more than a 30 percent reduction in SO2 and NOx by 2015 by employing future unspecified technology advances. Because these future technology advances are not specified nor demonstrated, EPA is not requiring more than a 30 percent reduction in SO2 and NOx in 2015 and beyond for opt ins. The EPA is changing the requirement to use the lowest required emission rate for the year preceding the year in which allowances are being allocated to the lowest emission rate for the year in which 616 allowances are being allocated. The EPA is making this change because EPA believes that such data should be available and that this more accurately reflects the intent of the rule to ensure that the source is not being allocated a greater number of allowances than the emissions a source would be allowed to emit under the regulations it is subject to in the year the allocations are being made. The EPA is finalizing parallel provisions with respect to NOx.

4. Alternative Opt In Approach Some commenters suggested that EPA include an alternative approach to opting into the CAIR. This alternative would allow units to opt in as early as 2010 and receive allocations at their current emission levels in return for a commitment to make deeper reductions by 2015 than would be required under the general opt in provision described above. Therefore, for the years 2010 through 2014,

the unit would be allocated allowances based on the same heat input used under the general opt in provision ( e. g., the lesser of the baseline heat input or the heat input for the year preceding the year in which allocations are being made)

multiplied by an emission rate. This emission rate would be the lower of the emission rate for the year or years before the unit opted in or the the most stringent State or Federal emission rate required in the year that the unit opts in.

For SO2 for the years 2015 and beyond, the unit would be 617 allocated allowances based on the same heat input multiplied by an emission rate. This emission rate would be the lower of a 90 percent reduction from the baseline emission rate or the most stringent State or Federal emission rate required in the baseline year. For NOx, the same methodology would be used, except that the emission rate used for the years 2015 and beyond would be the lower of 0.15 lbs/ mmBtu or the most stringent State or Federal emission rate required in the baseline year. The EPA believes the environmental benefit of achieving deeper emissions reductions in the future ( 2015)

from sources that may otherwise not make such deep emissions reductions is worth including in this final rule.

5. Opting Out In the SNPR, EPA proposed that opt in units be required to remain in the program a minimum of 5 years after which time they could voluntarily withdraw from the CAIR. Some commenters expressed concern over this proposed approach,

arguing that because EGUs affected by the CAIR are not allowed to voluntarily withdraw from the CAIR that opt in sources should not be allowed to voluntarily withdraw either.

The EPA recognizes that opt in sources such as industrial boilers and turbines tend to be more sensitive to changing market forces than EGUs. As a result, EPA believes it is appropriate to allow opt in sources who voluntarily participate in an emissions reductions program to be able to 618 end their participation or (" opt out") after a specified period of time. As proposed, EPA believes a period of 5 years is appropriate and is finalizing a rule to allow opt in sources to opt out after participating in the CAIR for 5 years. This option to opt out after 5 years does not apply to sources that opt in under the alternative approach.

Sources that opt in under the alternative approach may not opt out at any time.

6. Regulatory Relief for Opt in Units The CAIR does not offer relief from other regulatory requirements, existing or future, for units that opt in to the CAIR cap and trade program. Any revision of requirements for other, non CAIR programs would be done under rulemakings specific to those programs.

As discussed above, EPA is including two different approaches for opt in units to follow, a general and an alternative approach. The EPA is including both approaches in this final rule in response to comments supportive of including an alternative means and to provide greater flexibility for sources to participate in the CAIR trading program. Opt in sources may select which approach is more appropriate for their particular situation. An opt in source may not switch from one approach to the other once in the program. States have the flexibility to choose to include both of these approaches, one of these approaches, or none of 619 them in their SIPs. EPA is not requiring States to include an individual unit opt in provision because the participation of individual opt in units is not required to meet the goals of the CAIR. However, States cannot choose to have an individual unit opt in approach different than what EPA has finalized in this rule and still participate in the inter

State trading program administered by EPA.

H. What Are the Source Level Emissions Monitoring and Reporting Requirements?

In the NPR, the EPA proposed that sources subject to the CAIR monitor and report NOx and SO2 mass emissions in accordance with 40 CFR part 75.

The model trading rules incorporate part 75 monitoring and are being finalized as proposed. The majority of CAIR sources are measuring and reporting SO2 mass emissions year round under the Acid Rain Program, which requires part 75 monitoring. Most CAIR sources are also reporting NOx mass emissions year round under the NOX SIP Call. The CAIRaffected Acid Rain sources that are located in States that are not affected by the NOx SIP Call currently measure and report NOx emission rates year round, but do not currently report NOx mass emissions. These sources will need to modify only their reporting practices in order to comply with the proposed CAIR monitoring and reporting requirements. 620 Because so many sources are already using part 75 monitoring, there were very few comments on the source level monitoring requirements in this rulemaking. The comments the EPA received related to sources not currently monitoring under part 75. Commenters suggested that alternative forms of monitoring ( e. g., part 60 monitoring) would be appropriate for these sources. The EPA disagrees. Consistent, complete and accurate measurement of emissions ensures that each allowance actually represents one ton of emissions and that one ton of reported emissions from one source is equivalent to one ton of reported emissions from another source.

Similarly, such measurement of emissions ensures that each single allowance ( or group of SO2 allowances, depending upon the SO2 allowance vintage) represents one ton of emissions,

regardless of the source for which it is measured and reported. This establishes the integrity of each allowance,

which instills confidence in the underlying market mechanisms that are central to providing sources with flexibility in achieving compliance. Part 75 has flexibility relating to the type of fuel and emission levels as well as procedures for petitioning for alternatives. The EPA believes this provides the requested flexibility.

Should a State( s) elect to use the example allocation approach, the EPA would modify the part 75 monitoring and reporting requirements to collect information used in 621 determining the allowance allocations for Combined Heat and Power ( CHP) units. More specifically, provisions for the monitoring and reporting of the BTU content of the steam output would be added to the existing requirements. The information on electricity output currently reported under part 75 would not need to be revised to allow States to implement the example allowance allocation approach.

In the SNPR, the EPA proposed continuous measurement of SO2 and NOX emissions by all existing affected sources by January 1, 2008 using part 75 certified monitoring methodologies. New sources have separate deadlines based upon the date of commencement of operation, consistent with the Acid Rain Program. These deadlines are finalized as proposed.

I. What is Different between CAIR's Annual and Seasonal NOx Model Cap and Trade Rules?

Today's action finalizes not only the proposed CAIR annual NOx program and annual SO2 program, but also a CAIR ozone season NOx program. Because the CAIR ozone season NOx program is the only ozone season NOx cap and trade program that the EPA will administer, NOx SIP Call States wishing to meet their NOx SIP Call obligations through an EPAadministered regional NOx program will also use the CAIR ozone season rule. The EPA believes that States and affected 622 sources will benefit from having a single, consistent regional NOx cap and trade program. This section of today's action highlights any key differences between the CAIR ozoneseason NOx model rule and the NOx SIP Call model rule, as well as the CAIR annual and ozone season NOx model rules.

Differences Between the CAIR Ozone Season NOx Model Rule and the NOx SIP Call Model Rule While the CAIR ozone season NOx model rule closely mirrors the NOx SIP Call rule ( as does the other CAIR rules),

the EPA has incorporated into the CAIR model rules its experience with implementing trading programs ( including seasonal NOx programs). These modifications include the following.

F. Unrestricted banking: The CAIR ozone season NOx model rule will not include any restrictions on the banking of NOx SIP Call allowances ( vintages 2008 and earlier) or CAIR ozone season NOx allowances. The NOx SIP Call rules include " progressive flow control" provisions that reduce the value of banked allowances in years where the bank is above a certain percentage of the cap. ( See section VIII. E. 1 of today's rule for a detailed discussion).

G. Facility level compliance: The CAIR ozone season NOx model rule will allow sources to comply with the allowance holding requirements at the facility level. 623 The NOx SIP Call rules required unit by unit level compliance with certain types of allowance accounts providing some flexibility for sources with multiple affected units. ( See the June 2004 SNPR, section IV for a detailed discussion).

The EPA believes that these changes improve the programs and that both CAIR and NOx SIP Call affected sources will benefit from complying with a single, regionwide cap and trade program.

Differences Between the CAIR Ozone Season and Annual NOx Model Rules The CAIR ozone season and annual NOx model rules are designed to be identical with the exception of ( 1) provisions that relate to compliance period and ( 2) the mechanism for providing incentives for early NOx reductions. For compliance related provisions, the EPA attempted to maintain as much consistency as possible between the CAIR annual and ozone season NOx model rules. For example, reporting schedules remain synchronized ( i. e., quarterly reporting) for both of the CAIR NOx model rules. For the annual and ozoneseason NOx model rules, the EPA did define 12 month and 5 month compliance periods, respectively.

Incentives for early NOx reductions differ between the CAIR annual and ozone season programs. For the annual NOx program, early reductions may be rewarded by States through a 624 CSP. ( See section VIII. F. 2 of today's action for a detailed discussion.) The CAIR ozone season NOx model rule provides incentive for early emissions reductions by allowing the banking of pre 2009 NOx SIP Call allowances into the CAIR ozone season program.

J. Are There Additional Changes to Proposed Model Cap and Trade Rules Reflected in the Regulatory Language?

The proposed and final rules are modeled after, and are largely the same as, the NOx SIP Call model trading rule.

Today's final rule includes some relatively minor changes to the model rules' regulatory text that improve the implementability of the rules or clarify aspects of the rules identified by the EPA or commenters. ( Note that sections VIII. B through VIII. H of today's action highlight the more significant modifications included in the final model rules).

One example of a relatively minor change is the inclusion of language in the SO2 model rule that implements the retirement ratio ( 2.00) used for allowances allocated for 2010 to 2014 and the retirement ratio ( 2.86) used for allowances allocated for 2015 and later, that clarifies the compliance deduction process and that provides for roundingup of fractional tons to whole tons of excess emissions.

More specifically, the definition of " CAIR SO2 allowance"

states that an allowance allocated for 2010 to 2014 625 authorizes emissions of 0.50 tons of SO2 and that an allowance allocated for 2015 or later authorizes emissions of 0.35 tons of SO2   which corresponds with the 2.86 retirement ratio.

Other, less significant modifications were also included in the regulatory text of the final model rules. These include:

H. Units and sources are identified separately for NOx and SO2 programs ( e. g., CAIR NOx units, CAIR Nox ozone season units, and CAIR SO2 units) since States can participate in one, two, or three trading programs;

I. The definition of " nameplate capacity" is clarified;

J. The language on closing of general accounts is clarified; and,

K. Process of recordation of CAIR SO2 allowance allocations and transfers on rolling 30 year periods is added to make it consistent with Acid Rain regulations.

Another example of where today's final model trading rules incorporate relatively minor changes from the proposed model trading rules involves the provisions in the standard requirements concerning liability under the trading programs.

The proposed CAIR model NOX and SO2 trading rules include,

under the standard requirements in § 96.106( f)( 1) and ( 2) and § 96.206( f)( 1) and ( 2), provisions stating that any person who knowingly violates the CAIR NOx or SO2 trading programs or 626 knowingly makes a false material statement under the trading programs will be subject to enforcement action under applicable State or Federal law. Similar provisions are included in § 96.6( f)( 1) and ( 2) of the final NOx SIP Call model trading rule. The final CAIR model NOx and SO2 trading rules exclude these provisions for the following reasons.

First, the proposed rule provisions are unnecessary because,

even in their absence, applicable State or Federal law authorizes enforcement actions and penalties in the case of knowing violations or knowing submission of false statements.

Moreover, these proposed rule provisions are incomplete.

They do not purport to cover, and have no impact on,

liability for violations that are not knowingly committed or false submissions that are not knowingly made. Applicable State and Federal law already authorizes enforcement actions and penalties, under appropriate circumstances, for nonknowing violations or false submissions. Because the proposed rule provisions are unnecessary and incomplete, the final CAIR model NOx and SO2 trading rules do not include these provisions. However, the EPA emphasizes that, on their face, the provisions that were proposed, but eliminated in the final rules, in no way limit liability, or the ability of the State or the EPA to take enforcement action, to only knowing violations or knowing false submissions.

IX. Interactions with Other Clean Air Act Requirements 627 A. How Does this Rule Interact with the NOx SIP Call?

A majority of States affected by the CAIR are also affected by the NOx SIP Call. This section addresses the interactions between the two programs.

The EPA proposed that States achieving all of the annual NOx reductions required by the CAIR from only EGUs would not need to continue to impose seasonal NOx limitations on EGUs from which they required reductions for purposes of complying with the NOx SIP Call. Also, EPA proposed that States would have the option of retaining such seasonal NOx limitations.

The EPA also proposed to keep the NOx SIP Call in place for non EGUs currently subject to the NOx SIP Call and to continue working with States to run the NOx SIP Call Budget Trading Program for all sources that would remain in the program. In response to commenters, EPA is making several modifications to its proposed approach.

States Affected by the CAIR for Ozone and PM2.5 Will Be Subject to a Seasonal and an Annual NOx Limitation A number of commenters recommended leaving the current NOx SIP Call ozone season NOx limitation in place as a way to ensure that ozone season NOx reductions from EGUs required by the NOx SIP Call would continue to be achieved. Some commenters argued this would also help non EGUs currently subject to the NOx SIP Call by allowing them to continue trading with EGUs in a seasonal NOx program. Many of the 628 same commenters suggested a dual season or bifurcated CAIR trading program as a mechanism for maintaining an ozone season NOx limitation for EGUs under the CAIR. In response to these commenters, EPA is requiring that States subject to the CAIR for PM2.5 be subject to an annual limitation and that States subject to the CAIR for ozone be subject to an ozone season limitation. This means that States subject to the CAIR for both PM2.5 and ozone are subject to both an annual and an ozone season NOx limitation. The annual and ozone season NOx limitations are described in section IV.

States subject to the CAIR for ozone only are only subject to an ozone season NOx limitation. To implement these NOx limitations, EPA will establish and operate two NOx trading programs, i. e., a CAIR annual NOx trading program and a CAIR ozone season NOx trading program. The CAIR ozone season NOx trading program will replace the current NOx SIP Call as discussed in more detail later in this section.

What Will Happen to Non EGUs Currently in the NOx SIP Call?

A number of commenters were concerned that the cost of compliance for non EGUs in the NOx SIP Call would increase if they were not allowed to continue to trade with EGUs. In response to these commenters, EPA is modifying its proposed approach. The EPA is allowing States affected by the NOx SIP Call that wish to use EPA's model trading rule to include 629 non EGUs currently covered by the NOx SIP Call in the CAIR ozone season NOx trading program. This will ensure that non

EGUs in the NOx SIP Call will continue to be able to trade with EGUs as they currently do under the NOx SIP Call. This will not require States to get additional reductions from non EGUs. Budgets for these units would remain the same as they are currently under the NOx SIP Call. States will,

however, be required to modify their existing NOx SIP Call regulations to reflect the replacement of the NOx SIP Call with the CAIR ozone season NOx trading program. The EPA will continue to operate the NOx SIP Call trading program until implementation of the CAIR begins in 2009. The EPA will no longer operate the NOx SIP Call trading program after the 2008 ozone season and the CAIR ozone season NOx trading program will replace the NOx SIP Call trading program. If States affected by the NOx SIP Call do not wish to use EPA's CAIR ozone season NOx trading program to achieve reductions from non EGU boilers and turbines required by the NOx SIP Call, they would be required to submit a SIP Revision deleting the requirements related to non EGU participation in the NOx SIP Call Budget Trading Program and replacing them with new requirements that achieve the same level of reduction. 630 Compliance with the NOx SIP Call for States that Are Subject to Both the CAIR Ozone Season NOx Reduction Requirements and the NOx SIP Call If the only changes a State makes with respect to its NOx SIP Call regulations are: 1) to bring non EGUs that are currently participating in the NOx SIP Call Budget Trading Program into the CAIR ozone season program using the same non EGU budget and applicability requirements that are in their existing NOx SIP Call Budget Trading Program; and 2) to achieve all of the emissions reductions required under the CAIR from EGUs by participating in the CAIR ozone season NOx trading program, EPA will find that the State continues to meet the requirements of the NOx SIP Call.

If the only changes a State makes with respect to its NOx SIP Call regulations are not those described above, see section VII for a discussion of how the State would satisfy its NOx SIP Call obligations.

States in the NOx SIP Call but not Affected by the CAIR ( Rhode Island)

Rhode Island is the only State in the NOx SIP Call that is not affected by the CAIR. To continue meeting its NOx SIP Call obligations in 2009 and beyond, Rhode Island will have two choices. It may either modify its NOx SIP Call trading rule to conform to the new CAIR ozone season NOx trading rule if it wishes to allow its sources to continue to participate 631 in an interstate NOx trading program run by EPA or, it will need to develop an alternative method for obtaining the required NOx SIP Call reductions. In either case, Rhode Island must continue to meet the budget requirements of the existing NOx SIP Call.

Use of Banked SIP Call Allowances in the CAIR Program As explained earlier in today's final rule, banked allowances from the NOx SIP Call may be used in the CAIR ozone season NOx trading program.

Other Comments and EPA's Responses One commenter wrote that because attainment demonstrations for early action compacts were made based on having EGUs and non EGUs together in the NOx SIP Call, EPA could not allow EGUs to leave the NOx SIP Call and still have valid early action compacts ( EACs). As discussed above, EPA is allowing States to keep EGUs and non EGUs in the NOx SIP Call together in one ozone season program ( CAIR ozone season trading program). The NOx reductions required by the CAIR ozone season trading program are slightly more stringent than the reductions required by the NOx SIP Call. As a result,

the attainment demonstrations for EACs would remain valid under the CAIR. Having said that, the EAC program will have ended ( April 2008) before the CAIR rule is implemented.

Thus, the compacts will no longer be applicable when the CAIR takes effect. 632 Another commenter proposed to have non EGUs under the NOx SIP Call subject to an annual NOx cap similar to EGUs under the CAIR so that non EGUs could continue to trade with EGUs. By adopting a CAIR ozone season trading program that includes non EGUs covered by the NOx SIP Call, non EGUs will be able to continue to trade with EGUs.

B. How Does this Rule Interact with the Acid Rain Program?

As EPA developed this regulatory action, much consideration was given to interactions between the existing title IV Acid Rain Program and today's action designed to achieve significant reductions in SO2 emissions beyond title IV. Requiring sources to reduce emissions beyond what title IV mandates has both environmental and economic implications for the existing title IV SO2 cap and trade program. In the absence of an approach for taking account of the title IV program, a new program ( i. e., the CAIR) that imposes a significantly tighter cap on SO2 emissions for a region encompassing most of the sources and most of the SO2 emissions covered by title IV would likely result in a significant excess in the supply of title IV allowances, a collapse of the price of title IV allowances, disruption of operation of the title IV allowance market and the title IV SO2 cap and trade system, and the potential for increased SO2 emissions. The potential for increased emissions would exist in the entire country for the years before the CAIR 633 implementation deadline and would continue after implementation for States not covered by the CAIR. These negative impacts, particularly those on the operation of the title IV cap and trade system, would undermine the efficacy of the title IV program and could erode confidence in cap and trade programs in general.

Title IV has successfully reduced emissions of SO2 using the cap and trade approach, eliminating millions of tons of SO2 from the environment and encouraging billions of dollars of investments by companies in pollution controls to enable the sale of allowances reflecting excess emissions reductions and in allowance purchases for compliance. In view of these already achieved reductions and existing investments under title IV, the likelihood of disruption of the allowance market and the title IV cap and trade system, and the potential for SO2 emission increases, it is necessary to consider ways to preserve the environmental benefits achieved under title IV and maintain the integrity of the market for title IV allowances and the title IV cap and trade system.

The EPA maintains that it is appropriate to provide States the opportunity to achieve the SO2 emission reductions required under today's action by building on, and avoiding undermining, this existing, successful program.

The EPA has developed, in the model SO2 cap and trade rule, an approach to build on and coordinate with the title 634 IV SO2 program to ensure that the required reductions under today's action are achieved while preserving the efficacy of the title IV program. The EPA's approach provides States the opportunity to impose more stringent control requirements for EGUs' SO2 emissions than under title IV through an EPAadministered cap and trade program that requires the use of title IV allowances for compliance at a ratio of 2 allowances per ton of emissions for allowances allocated for 2010 through 2014 and 2.86 allowances per ton of emissions for allowances allocated for 2015 or thereafter. ( The program also allows the use of banked title IV allowances allocated for years before 2010 to be used at a ratio of 1 allowance per ton of emissions.) Title IV allowances continue to be freely transferable among sources covered by the Acid Rain Program and sources covered by the model SO2 cap and trade program under CAIR. However, each title IV allowance used to comply with a source's allowance holding requirement in the CAIR model SO2 cap and trade program is removed from the source's allowance tracking system account and cannot be used again for compliance, either in the CAIR model SO2 cap and trade program or the Acid Rain Program.

In addition, as discussed above, if a State wants to achieve the SO2 emissions reductions required by today's action through more stringent EGU emission limitations only but without using the model cap and trade program, then EPA 635 is requiring that the State include in its SIP a mechanism for retiring the excess title IV allowances that will result from imposition of these more stringent EGU requirements. In this case, the State must retire an amount of title IV allowances equal to the total amount of title IV allowances allocated to the units in the State minus the amount of title IV allowances equivalent to the tonnage cap set by the State on SO2 emissions by EGUs, and the State can choose what retirement mechanism to use.

Further, as discussed above, if a State wants to meet the SO2 emissions reductions requirement in today's action through reductions by both EGUs and non EGUs, then EPA is also requiring the State's SIP to include a mechanism for retiring excess title IV allowances. In that case, the amount of title IV allowances that must be retired equals the total amount of title IV allowances allocated to the units in the State minus the amount of title IV allowances equivalent to the tonnage cap set by the State on EGU SO2 emissions, and the State can choose what retirement mechanism to use.

Finally, as discussed above, if the State wants to achieve the SO2 emissions reductions requirement in today's action through reductions by non EGUs only, then EPA is not imposing any requirement to retire title IV allowances.

1. Legal Authority for Using Title IV Allowances in CAIR Model SO2 Cap and Trade Program. 636 The EPA maintains that it has the authority to approve and administer, if requested by a State in the SIP submitted in response to today's action, the new CAIR model SO2 cap and trade program meeting the SO2 emission reduction requirement in today's action that requires use of title IV allowances to comply with the more stringent allowance holding requirement of the new program and retirement under the CAIR SO2 cap and trade program and the Acid Rain Program of title IV allowances used for such compliance. Some commenters claim that EPA's establishment of such a cap and trade program using title IV allowances that sources must hold generally at a ratio of greater than one allowance per ton of SO2 emissions is contrary to title IV. Most of these commenters prefer the approach of allowing States to use a new EPAadministered cap and trade program to meet lawful emission reduction requirements under title I and of allowing ( but not requiring) sources to use title IV allowances in the new program. However, these commenters argue that title IV prohibits requiring sources to use title IV allowances in such a program, whether at the same tonnage authorization ( i. e., one allowance per ton of emissions) established in title IV or at a different tonnage authorization. Other commenters state that title IV does not bar EPA from establishing a new cap and trade program that requires the use of title IV allowances. 637 The EPA maintains that it has the authority under section 110( a)( 2)( D) and title IV to establish a new cap and trade program requiring the use of title IV allowances at a different tonnage authorization than under the Acid Rain Program and the retirement of such allowances for purposes of both programs. First, as discussed in section V above, EPA has the authority under section 110( a)( 2)( D) to establish a new SO2 cap and trade program, administered by EPA if requested in a State's SIP, to prohibit emissions that contribute significantly to nonattainment, or interfere with maintenance, of the PM 2.5 NAAQS. Further, EPA notes that under section 402( 3), a title IV allowance is:

an authorization, allocated to an affected unit by the Administrator under this title [ IV], to emit, during or after a specified calendar year, one ton of sulfur dioxide. 42 U. S. C. 7651( a)( 3).

However, section 403( f) states that:

An allowance allocated under this title is a limited authorization to emit sulfur dioxide in accordance with the provision of this title [ IV]. Such allowance does not constitute a property right. Nothing in this title [ IV] or in any other provision of law shall be construed to limit the authority of the United States to terminate or limit such authorization. Nothing in this section relating to allowances shall be construed as affecting the application of, or compliance with, any other provision of this Act to an affected unit or source, including the provisions related to applicable National Ambient Air Quality Standards and State implementation plans. 42 U. S. C. 7651b( f). 638 1 The EPA's interpretation is based on the language of section 403( f) and the legislative history of the provision. The language in CAA section 403( f) contrasts with language that was in section 503( f) of the House bill  but was excluded from the final version of the Clean Air Act Amendments of 1990  referring to the authority of the " United States" to terminate or limit such authorization " by Act of Congress" and stating that "[ a] llowances under this title may not be extinguished by the Administrator." U. S. Senate Committee on Environment and Public Works, A Legislative History of The Clean Air Act Amendments of 1990 ( Legis. Hist. of CAAA), S. Prt. 38, 103d Cong., 1st Sess., Vol. II at 2224 ( Nov. 1993). Further, unlike CAA section 403( f), the House bill did not state that an allowance did not constitute a property right. Section 403( f) of the Senate bill that was considered, along with the House bill, in conference committee had language different than both CAA section 403( f) and the House bill and stated that " allowances may be limited, revoked or otherwise modified in accordance with the provisions of this title or other authority of the Administrator" and that an allowance " does not constitute a property right." Legis. Hist. of CAAA, Vol. III at 4598. While the scope of the reference to the " United States" in CAA section 403( f) is not clear, EPA maintains that the term is clearly broad enough to include the Administrator. Moreover, even if the term were considered ambiguous with regard to the Administrator, EPA believes that interpreting the term to include the Administrator is reasonable. Specifically, EPA maintains that, by eliminating the explicit House bill language that required Congressional action and including the general reference to the " United States" and the " not a property right" language, CAA section 403( f) essentially adopted the Senate's approach and allows the United States  either through Congressional or administrative ( i. e., EPA) action   to terminate or limit the allowance authorization. See Legis. Hist. of CAAA, Vol. I at 754, 1034, and 1084 ( Oct. EPA interprets the reference in section 403( f) to the authority of the " United States" to terminate or limit the authorization otherwise provided by a title IV allowance to mean that EPA ( acting in accordance with its authority under other provisions of the CAA), as well as Congress, has such authority. 137 Therefore, EPA maintains that it has the 639 27, 2000 floor statements of Sen. Symms, Sen. Baucus, and Sen. McClure indicating EPA has authority to take such action); but see Cong. Rec. at E 3672 ( Nov. 1, 2000)( extension of remarks of Cong. Oxley indicating that only Congress has such authority). authority to establish a new cap and trade program in accordance with section 110( a)( 2)( D) that requires: the holding of title IV allowances under a more limited authorization ( i. e., 2 or 2.86 allowances per ton of emissions) by sources in States participating in the new program; and the termination of the authorization through retirement under the new program and the Acid Rain Program of those title IV allowances used to meet the allowance holding requirement of the new program.

Commenters' arguments based on title IV The commenters claiming that EPA is barred by title IV from requiring use of title IV allowances at a reduced tonnage authorization in a new cap and trade program rely on the above noted provision in section 402( 3) stating that an allowance is an authorization to emit one ton of SO2.

However, this provision does not bar EPA from requiring either: use of title IV allowances in a new cap and trade program under a different title of the CAA at a reduced tonnage authorization; or retirement in this new program and the Acid Rain Program of allowances used in this manner.

At the outset, it should be noted that the CAIR model SO2 cap and trade program does not change the tonnage 640 2 As discussed below, today's action revises the Acid Rain Program regulations to provide for source based, instead of unit based, compliance with the allowance holding requirement. These revisions are adopted for reasons independent of the adoption of the CAIR model SO2 cap and trade program, as well as to facilitate the coordination of these two SO2 trading programs. authorization of individual title IV allowances for purposes of the Acid Rain Program until such an allowance is used to meet the allowance holding requirement of the CAIR SO2 program. The authorization provided by each title IV allowance for a source to emit one ton of SO2 emissions, as well as the requirement that each source hold title IV allowances covering annual SO2 emissions, continue to be in effect in the Acid Rain Program whether or not the source is also covered by the CAIR SO2 program. In fact, the Acid Rain Program regulations continue to reflect both this tonnage authorization and this allowance holding requirement. 138 See final revisions to 40 CFR § 73.35 adopted in today's action.

Moreover, the CAIR model SO2 cap and trade rule coordinates the determinations  made by EPA for sources subject to both title IV and the CAIR  of compliance with the title IV and CAIR allowance holding requirements so that such determinations are made in a multi step, end of year process of comparing allowances held and emissions. First, EPA determines whether the source holds sufficient title IV allowances to comply with the one allowance per ton of 641 3 The commenters' assertion that the sources in a State that does not participate in the CAIR SO2 cap and trade program will be cut off from the Acid Rain cap and trade program is incorrect on its face. Such a source will continue to be subject to the allowance holding requirement and the compliance process in § 73.35 and will not be subject to the allowance holding requirement and the compliance process in the CAIR model SO2 cap and trade rule. emissions requirement in the Acid Rain Program as provided in § 73.35; and subsequently EPA determines whether the source holds the additional title IV allowances that, when added to those held for Acid Rain Program compliance, are sufficient to meet the CAIR allowance holding requirement. Violations of the Acid Rain allowance holding requirement will result in imposition of the penalty for excess emissions ( i. e., the one allowance offset plus $ 2,000 ( inflation adjusted) per ton of excess emissions) under CAA section 411 and § § 73.35( d) and 77.4. See final § 96.254( b)( 1) adopted in today's action.

Thus, the Acid Rain allowance holding requirement continues as a separate requirement and reflects the one allowance

perton of emissions authorization under section 402( 3). 139 In contrast with the one allowance per ton of emissions requirement under the Acid Rain Program, the CAIR SO2 cap and trade program requires each source generally to hold 2 or 2.86 Acid Rain allowances for each ton of SO2 emissions.

Contrary to the commenters' claim, this CAIR allowanceholding requirement is not barred by the definition of the term " allowance" in section 402( 3). While section 402( 3) 642 4 The commenters also seem to argue that the allowance definition itself bars EPA from requiring use of Acid Rain allowances in the CAIR SO2 trading program even on a oneallowance per ton of emissions basis. However, as noted above, the definition is silent on whether title IV allowances may or may not be used outside the Acid Rain Program. defines the term " allowance" as an authorization to emit one ton of SO2, this provision expressly applies the definition to the term "[ a] s used in this title [ IV]" and therefore does not apply to the treatment of title IV allowances in a different program under a different title of the CAA.

Moreover, as noted above, section 403( f) allows EPA to limit ( or terminate) the authorization to emit that an allowance otherwise provides under section 402( 3). Consequently, the allowance definition in section 402( 3) does not bar the treatment of a title IV allowance as authorizing less than one ton of SO2 emissions under the CAIR SO2 cap and trade program established under title I. 140 Once a title IV allowance is used to meet the more stringent allowance holding requirement in the CAIR SO2 program, that allowance is deducted from the source's allowance tracking system account and cannot be used again,

either in the CAIR SO2 program or the Acid Rain Program. As noted above, EPA has the authority under section 403( f) to require this termination of such a title IV allowance's tonnage authorization for purposes of the Acid Rain Program. 643 In addition to referencing section 402( 3) to support claims that EPA is barred from adopting the CAIR model cap and trade program provisions on the use of title IV allowances, the commenters rely on other title IV provisions that they characterize as setting a " title IV cap" on SO2 emissions. Stating that the requirement to use title IV allowances in the CAIR model SO2 cap and trade program has the effect of reducing the " title IV cap," these commenters indicate, with little explanation, that such requirement is unlawful. In mentioning the title IV cap, the commenters are apparently referring to the fact that section 403( a)( 1)

( requiring allowance allocations resulting in emissions not exceeding 8.90 million tons of SO2) and section 405( a)( 3)

( requiring additional allocations of 50,000 allowances)

require EPA to allocate annually, starting in 2010, a total amount of allowances authorizing no more than 8.95 million tons of SO2 emissions. The commenters' argument about how the CAIR model SO2 cap and trade program effectively reduces the " title IV cap" appears to be that elimination of the ability to use, in the Acid Rain Program, title IV allowances that will be used for compliance in the CAIR model SO2 cap and trade program has the effect of reducing the annual 8.95 million ton cap on SO2 emissions. This effective reduction of the " title IV cap" seems to occur when title IV allowances are used in the CAIR SO2 trading program with a reduced 644 5 Similarly, to the extent title IV allowances are used in the CAIR SO2 trading program by non Acid Rain sources, the " title IV cap" seems to be effectively reduced because more allowances are used in the CAIR SO2 trading program and effectively removed from use in the Acid Rain Program. 6 In light of this provision, the statement in the NPR ( particularly as it is interpreted by the commenters) that EPA lacks authority to tighten the requirements of title IV ( 69 FR 4618, col. 1) is overly broad and is not repeated or adopted in today's preamble. tonnage authorization so that more title IV allowances are deducted per ton of emissions than would be deducted for compliance with the Acid Rain Program. 141 The commenters claim that such a reduction in the 8.95 million ton cap is contrary to title IV.

In asserting an overarching principle that EPA is barred from adopting any requirement that would have the effect of reducing the 8.95 million ton cap under title IV, the commenters do not point to any specific statutory provision in support. The EPA maintains that not only are there no such supporting provisions, but also certain title IV provisions contradict this purported principle.

Specifically, while sections 403 and 405 require annual allowance allocations authorizing no more than 8.95 million tons of emissions, section 403( f) provides, as noted above,

that EPA may terminate or limit the one allowance per ton

ofemissions authorization for a title IV allowance. 142 Because any termination or limitation of the tonnage authorization provided by a title IV allowance for purposes of the Acid 645 Rain Program would have the effect of reducing the total tonnage of emissions allowed by the allowance allocations ( i. e., the 8.95 million ton cap) under sections 403 and 405,

the commenters' claim that EPA is barred from adopting any provision that has such an effect is wrong on its face.

Commenters' argument based on Clean Air Markets Group case The commenters also state that the CAIR model SO2 cap and trade program is unlawful under the court's holding in Clean Air Markets Group v. Pataki, 338 F. 3d 82 ( 2d Cir.

2003). According to the commenters, the required use of title IV allowances in the CAIR SO2 program constitutes an unlawful interference with the operation of the interstate title IV SO2 trading program, presumably similar to the unlawful interference found by the court in Clean Air Markets Group. However, the commenters provide little explanation of how such use of title IV allowances ( with or without a reduced tonnage authorization) purportedly interferes with interstate operation of the Acid Rain Program and how the holding in Clean Air Markets Group applies to the CAIR SO2 program.

In Clean Air Markets Group, the Court reviewed a State law that imposed a monetary assessment on any title IV allowance sold by a New York utility to a utility in any of 14 specified States or subsequently transferred to such a 646 utility, with the assessment equaling the proceeds received in the allowance sale. The law also required that each allowance sold include a covenant barring subsequent transfer of the allowance to a utility in any of those States. The Court held that the State law was pre empted by title IV because the State law impermissibly interfered with the method chosen by Congress in title IV to reduce utilities'

SO2 emissions, i. e., the opportunity for nationwide trading of title IV allowances. Id. at 87 88. In particular, the Court found that the assessment of 100 percent of sale proceeds " effectively bans" sales of any allowance by New York utilities to utilities in the specified States and that the restrictive covenant " indisputedly decreases" the value of the allowances. Id. at 88.

The EPA maintains that today's action is distinguishable from the facts and holding in Clean Air Markets Group. In particular, EPA believes that the exercise of its explicit authority under section 403( f) to limit the tonnage authorization of a title IV allowance in the CAIR SO2 cap and trade program and to terminate the tonnage authorization in the Acid Rain Program once the allowance is used in the CAIR SO2 program is consistent with  and necessary to preserve

 the operation of the Acid Rain Program. Therefore, EPA concludes that its approach of limiting and terminating of the tonnage authorization of title IV allowances does not 647 impermissibly interfere with the interstate operation of the Acid Rain Program and is reasonable.

Unlike the circumstances in Clean Air Markets Group,

under EPA's approach in today's action, each title IV allowance is freely transferable nationwide unless and until a source uses the allowance to meet the allowance holding requirements of the CAIR SO2 program, at which time the allowance is deducted from the source's allowance tracking system account and retired for purposes of both the CAIR SO2 program and the Acid Rain Program. Further, EPA expects that the ability to use title IV allowances to meet the more stringent emission limitation under the CAIR SO2 program to maintain or increase ( not decrease) the value of each title IV allowance, until the allowance is used to meet the CAIR SO2 program allowance holding requirement and is retired.

Of course, this retirement of title IV allowances once they are used to meet the CAIR allowance holding requirement means that they cannot thereafter be transferred to any person or be used again, e. g., to meet the Acid Rain Program allowance holding requirement. As noted by the Court in Clean Air Markets Group, section 403( b) provides that title IV allowances " may be transferred among designated representatives of owners or operators of affected sources under [ title IV] and any other person who holds such allowances, as provided by the allowance system regulations" 648 7 While section 403( b)( as well as section 403( d)) refer specifically to the allowance system regulations required to be promulgated by the EPA Administrator within 18 months of November 15, 1990 ( the enactment date of the CAA), the EPA Administrator has authority under section 301 to amend such regulations " as necessary to carry out his functions under [ the CAA]." 42 U. S. C. 7601. promulgated by EPA. 143 42 U. S. C. 7651b( b). Moreover, section 403( d)( 1) requires that the allowance system regulations " specify all necessary procedures and requirements for an orderly and competitive functioning of the allowance system."

42 U. S. C. 7651b( d). In the context of these statutory requirements, EPA maintains that, on balance, the retirement of title IV allowances used for compliance in the CAIR model SO2 cap and trade program does not constitute impermissible interference with the interstate operation of the Acid Rain Program, but rather is consistent with, and necessary to preserve, the operation of the Acid Rain Program.

As noted above, the imposition of an SO2 emission limitation ( such as in today's action) that is significantly more stringent than the one under title IV and covers most of the sources and emissions covered by title IV    but without addressing the impact on the Acid Rain Program  would likely have several adverse consequences. These adverse consequences would be: a significant excess of title IV allowances; a collapse of the price of title IV allowances;

disruption of the title IV allowance market and the title IV SO2 cap and trade system; and potential SO2 emission 649 increases, particularly in States outside the CAIR SO2 region. The EPA modeling indicates that, in 2010, EGU SO2 emissions in States not affected by the CAIR SO2 program would increase by about 260,000 tons ( or about 29 percent of the approximately 0.9 million tons of SO2 emissions projected for the non CAIR SO2 region in 2010) in the absence of an approach for addressing the impact of the CAIR SO2 program on title IV. This is because, with the imposition of the more stringent CAIR SO2 emission limitation in the CAIR SO2 region,

this more stringent limitation becomes the binding limitation for sources in that region. These CAIR SO2 sources must comply with, and cannot use title IV allowances to exceed,

the CAIR SO2 emission limitation. Consequently, the portion of the title IV allowances that equals the difference between the CAIR and the title IV emission limitations is excess and would be available for use only by Acid Rain sources that are outside the CAIR SO2 region.

This excess amount of title IV allowances is potentially very significant. Today's action requires that the States in the CAIR SO2 region achieve an amount of SO2 emission reductions in 2010 and 2015 equal to 50 percent and 65 percent, respectively, of the amount of title IV allowances ( about 7.3 million allowances out of the total nationwide allocation of 8.95 million allowances) allocated to the units in the CAIR SO2 region. If the States achieve all the 650 8 The surpluses for 2010 and 2015 respectively are calculated as: 7.3 million allowances minus (( 100 percent minus the percentage reduction requirement for the year) times 7.3 million allowances).

9 The 4.8 million ton figure is the sum of: 3.65 million tons of emissions ( equal to the tonnage equivalent of the allowance allocations in the CAIR SO2 region); plus about 0.9 million tons of emissions in the non CAIR SO2 region required CAIR SO2 reductions through emission reductions by EGUs ( which are largely the same units that are subject to the Acid Rain Program) and if EGUs held only one title IV allowance for each ton of SO2 emissions as required in the Acid Rain Program, the amount of surplus allowances allocated to the States in the CAIR SO2 region would be about 3.65 million allowances and 4.75 million allowances, respectively in 2010 and 2015.144 Moreover, the vast majority of EGUs nationwide ( about 90 percent) and of EGU SO2 emissions nationwide ( about 90 percent) are covered by the CAIR SO2 program. The net result would be a large surplus of title IV allowances that would not be usable in the CAIR SO2 region and would be usable only by the small subset of EGUs ( about 10 percent) located in non CAIR SO2 region States. Looking at the nation as a whole ( both CAIR and non CAIR SO2 States)

in 2010, there would be total allocations in the Acid Rain Program of 8.95 million title IV allowances but, according to EPA modeling and analysis of the CAIR without a requirement to retire surplus title IV allowances, total projected SO2 emissions for EGUs of only about 4.8 million tons. 145 Based 651 with the retirement of surplus title IV allowances; plus 260,000 tons of increased non CAIR SO2 region emissions if the surplus title IV allowances are not retired. on the principles of supply and demand, EPA concludes that,

with the amount of allowances allocated nation wide exceeding SO2 emissions for EGUs nationwide in 2010 by about 86 percent ( i. e., 8.95 million allowances minus 4.8 million tons divided by 4.8 million tons), the value of title IV allowances would fall to zero, and all but 260,000 of the surplus allowances would have no market and so, as a practical matter, would not be transferable.

The EPA notes that this effect on allowances would occur no matter how the State implements the more stringent SO2 emission limitation required under the CAIR, e. g., whether implementation is through a new cap and trade program ( like in the model rule) or through a fixed ( command and control)

tonnage emission limit imposed on each individual source.

Consequently, the alternatives faced by EPA are either: ( 1)

to establish a CAIR model cap and trade program ( or allow States to use another means of achieving CAIR SO2 emissions reductions) that does not retire the 3.65 million surplus allowances and that results in the devaluation of all title IV allowances to zero and the effective non transferability of all but 260,000 of the 3.65 million surplus allowances in 2010; or, as provided in today's action, ( 2) to adopt a CAIR SO2 model cap and trade program ( or another means of achieving 652 reductions) that retires the 3.65 million surplus allowances and that results in the non transferability of the entire 3.65 million surplus of title IV allowances and ensures the remaining, unused title IV allowances have market value.

Thus, with regard to the impact on the transferability of title IV allowances, EPA's decision to adopt the second alternative of retiring the surplus allowances adversely affects the transferability of only a relatively small amount ( 260,000 out of 8.95 million per year) of allowances, as compared to the amount of allowances whose transferability would be adversely affected under the first alternative.

Moreover, with the total collapse of the title IV allowance price in the Acid Rain Program, the nationwide cap and trade system under title IV  which would be the binding cap and trade system only for sources in the States outside the CAIR SO2 region  would lose all efficacy. The title IV cap and trade system operates by: making owners of sources pay for the authorization to emit SO2 by surrendering, to EPA, allowances that have a market value; and by allowing owners ( e. g., those who choose to reduce emissions) to sell unused allowances. Whether the sources' allowances were originally allocated to the sources or were purchased, the owners must decide the extent to which it is more efficient to give up the market value of such allowances or to reduce emissions. If title IV allowances were to have no market 653 10 See Sen. Rep. No. 101 228, 101st Cong., 1st Sess. at 324 ( Dec. 20, 1989)( stating that "[ a] llowances are intended to function like a currency that is sufficiently valuable to stimulate efforts to acquire it through innovative and aggressive efforts to reduce emissions more than required" and that, in the event of " inflation in the currency," the incentives to " reduce pollution... will be seriously weakened." In the instant case, without a requirement to retire excess title IV allowances, the currency would be inflated to a value of zero. See also Legis. Hist. of CAAA, Vol. I at 1033 ( Oct. 27, 1990 floor statement of Sen. Baucus explaining that "[ s] ince units can gain cash revenues from the sale of allowances they do not use, they will have a financial incentive both to make greater than required reductions and/ or reductions earlier than required" and that " incentives created by the allowance market should stimulate innovations in the technologies and strategies used to reduce emissions" including energy efficiency). value, the title IV cap and trade system would no longer affect the choice of whether to emit or to reduce emissions. 146 The EPA maintains that such a result is contrary to Congressional intent. The purposes of title IV include not only reductions of annual SO2 emissions from 1980 levels, but also the encouragement of " energy conservation, use of renewable and clean alternative technologies, and pollution prevention as a long range strategy, consistent with the provisions of this title, for reducing air pollution and other adverse impacts of energy production and use." 42 U. S. C. 7651( b). Reflecting these purposes, Congress required EPA to promulgate allowance system regulations for the Acid Rain Program that would promote " an orderly and competitive functioning of the allowance system." 42 U. S. C. 7651b( d)( 1). 654 11 While the title IV cap and trade system could be replaced by a new CAIR SO2 cap and trade system that did not address the problems caused by surplus title IV allowance, that new cap and trade system would not be nationwide like the title IV cap and trade system and so would not cover sources outside the CAIR SO2 region. See Sen. Rep. No. 101 228, 101st Cong., 1st Sess. at 320 ( explaining that " the allowance system is intended to maximize the economic efficiency of the program both to minimize costs and to create incentives for aggressive and innovative efforts to control pollution"). As discussed above, if title IV allowances were to have no market value,

the cap and trade system under title IV would no longer affect owners' decisions on whether to emit or to control emissions and so would no longer provide encouragement ( e. g.,

incentives for innovation) for avoidance or reduction of SO2 emissions. 147 In addition, EPA is concerned that such disruption of the title IV allowance market and the title IV SO2 cap and trade system would significantly erode confidence in cap and trade programs in general and the CAIR model cap and trade programs in particular. As noted above, under the Acid Rain Program, companies have made billions of dollars of investments in emission controls in order to be able to sell excess title IV allowances and in purchasing title IV allowances for future compliance ( e. g., under annual, 1 day allowance auctions held by EPA, one as recently as March 22, 655 12 The EPA notes that the potential for increased emissions within the CAIR SO2 region would occur before the implementation of the CAIR SO2 program and is addressed by 2004 when title IV allowances were purchased for about $ 50 million). While in a market based program like the Acid Rain Program, investments are necessarily subject to the vagaries of the market, EPA believes that it should try, to the extent possible consistent with statutory requirements, to avoid taking administrative actions that would cause such extensive disruption of the Acid Rain Program. Allowing such disruption to occur could significantly reduce the willingness of owners of sources in new cap and trade programs to invest in measures that would result in excess allowances for sale or to purchase allowances for compliance.

To the extent owners would ignore the allowance trading option and simply control emissions to the level equal to their source's allocations, this would obviate the incentives for innovation, and hamper realization of the potential for cost savings, that would otherwise be provided by new cap and trade programs ( such as the CAIR model cap and trade programs).

Finally, as noted above, such disruption of the Acid Rain Program would potentially result in significantly increased SO2 emissions ( about 29 percent in 2010) in States covered by the Acid Rain Program but outside the CAIR SO2 region. 148 This would have the effect of reversing, at least 656 allowing pre 2010 banked title IV allowances to be used to meet the CAIR allowance holding requirement beginning in 2010. 13 While the potential for increased emissions outside the CAIR SO2 region supports EPA's conclusion, EPA maintains that, even in the absence of any such increase, the other considerations discussed above are sufficient to justify the conclusion that the retirement of title IV allowances does not impermissibly interfere with the Acid Rain Program and is reasonable. in part, the beneficial effect that the Acid Rain Program has had on SO2 emissions in those States, even though the overall goal of nationwide SO2 emissions reductions would still be met. See 42 U. S. C.( a)( 1) ( Congressional finding that " the presence of acidic compounds and their precursors in the atmosphere and in deposition from the atmosphere represents a threat to natural resources, ecosystems, materials,

visibility, and public health").

In light of these considerations, 149 EPA concludes, on balance, that structuring the CAIR model SO2 cap and trade program in a way that avoids such extensive disruption of the Acid Rain Program ( i. e., by requiring retirement from the Acid Rain Program of title IV allowances used for compliance in the CAIR SO2 program) does not constitute impermissible interference with the interstate operation of the Acid Rain Program. Rather, this approach in the model SO2 cap and trade rule is consistent with, and preserves, such operation  while providing States a tool for imposing the more stringent SO2 emission limitations required under title I  657 and is a reasonable exercise of EPA's authority under section 403( f) to terminate or limit the tonnage authorization of title IV allowances.

2. Legal Authority for Requiring Retirement of Excess Title IV Allowances if State Does Not Use CAIR Model SO2 cap and trade Program.

As discussed above, a State has the additional options of achieving the SO2 emissions reductions required by today's actions through: EGU emission reductions only but without using the model SO2 cap and trade rule; some EGU and some non EGU emissions reductions; or non EGU reductions only.

The requirement to retire excess title IV allowances applies only in the first and second of these three additional options. The State must retire an amount of title IV allowances equal to the total amount of title IV allowances allocated to units in the State minus the amount of allowances equivalent to the tonnage cap set by the State on EGUs' SO2 emissions and can choose what mechanism to use to achieve such retirement. The EPA has the authority to require that the State include in its SIP a mechanism for retiring the excess title IV allowances that will result under these two options.

As discussed above, EPA has the authority under section 403( f) to terminate or limit the authorization to emit otherwise provided by a title IV allowance. Specifically, 658 EPA has the authority to: require that any EGU SO2 emission reduction program, chosen by a State to meet ( in full or in part) the requirements of section 110( a)( 2)( D), include provisions for retiring excess title IV allowances resulting from the implementation of the more stringent emission reduction requirement under the State program; and to require that such retired title IV allowances cannot be used in the Acid Rain Program. As discussed above, the commenters'

claims that such a retirement requirement is barred by title IV ( relying on, e. g., the section 402( 3) definition of " allowance" and on the " title IV cap") lack merit. Also, for the reasons discussed above, the retirement requirement is not unlawful under Clean Air Markets Group and is a reasonable exercise of EPA's authority under section 403( f)

to terminate or limit the tonnage authorization of title IV allowances.

Some commenters also claim that the retirement requirement unlawfully constrains the States' authority to determine in the first instance the control measures to use in meeting emission reduction requirements necessary to comply with section 110( a)( 2)( D). According to the commenters, since only EGUs are subject to title IV, the requirement to retire title IV allowances is in effect a mandate that the State control EGU emissions. 659 However, EPA is imposing the requirement for a State mechanism to retire title IV allowances only if the State decides in the first instance to require any EGU SO2 emissions reductions to meet the emission reduction requirements under today's action. A State that decides not to require any EGU SO2 emissions reductions for this purpose is not required to retire title IV allowances. Further, the amount of the required allowance retirement is limited to the amount of EGU SO2 emissions reductions that the State decides in the first instance to require from EGUs ( i. e., the total title IV allowance allocations in the State minus the tonnage amount of the cap set by the State for EGUs' SO2 emissions). In short, the allowance retirement requirement echoes the State's decision in the first instance concerning the amount of SO2 emissions reductions to require from EGUs in the State. The EPA simply requires the State to implement the State's EGU SO2 emission reduction requirement decision in a manner that avoids the otherwise likely, extreme disruption of the title IV SO2 cap and trade system that is described above. Further, the State may choose what mechanism to include in its SIP revision for achieving the required allowance retirement, and EPA will review the effectiveness of the mechanism in achieving such retirement, and approve and adopt the mechanism if appropriate, in an EPA rulemaking concerning the SIP revision. Therefore, EPA concludes that 660 the allowance retirement requirement is lawful and is a reasonable condition for EPA approval of those State SIPs that require EGU SO2 emission reductions without using the CAIR model SO2 trading program.

The EPA notes that the requirement to retire excess title IV allowances  where a State adopts the CAIR model SO2 trading program or where a State SIP obtains EGU emissions reductions through some other means  is reflected in provisions in both the proposed rules in the SNPR ( i. e.,

in proposed § § 51.124( p) and 96.254( b)) and in the final rules adopted by today's action ( i. e., in final § § 51.124( p) and 96.254( b)). In reviewing the proposed rules in light of the comments received, EPA has concluded that, for consistency and clarity, the Acid Rain Program regulations should also reference this same retirement requirement. Consequently,

today's action adds a new paragraph ( a)( 3) to § 73.35 of the Acid Rain Program regulations that reiterates the requirement  addressed in the preamble and regulations in both the SNPR and today's action  that title IV allowances previously used to meet the allowance holding requirement in the CAIR model trading program in § 96.254( b) or otherwise retired in accordance with § 51.124( p) cannot be used to meet the allowance holding requirement in the Acid Rain Program.

Additional revisions of the Acid Rain Program regulations are discussed below. 661 3. Revisions to Acid Rain Regulations.

In the SNPR, EPA proposed to revise the Acid Rain Program regulations, effective July 1, 2005, to implement the allowance holding requirement on a source by source, rather than on a unit by unit, basis. Instead of requiring each unit to hold an amount of allowances in its Allowance Tracking System account ( as of the allowance transfer deadline) at least equal to the tonnage of SO2 emissions for the unit in the preceding calendar year, the proposal required each source to hold an amount of allowances in its Allowance Tracking System account at least equal to the tonnage of SO2 emissions for all affected units at the source for such calendar year. Because language reflecting or referencing the unit by unit compliance approach is included in many provisions of the Acid Rain Program regulations, a significant number of proposed rule revisions were necessary to implement source by source allowance holding.