Summary: Connecticut, Delaware, Maine, New Hampshire, New Jersey, New York, and Vermont made history in December 2005 with the launch of the Regional Greenhouse Gas Initiative (RGGI), the country's first mandatory carbon dioxide (CO2) cap-and-trade program. The RGGI memorandum of understanding (MOU), which will govern further development of the trading regime, aims to reduce electric sector CO2 emissions by ten percent from 2009 levels by 2018. After two years of immersion in its development, Massachusetts and Rhode Island withdrew from the program just before execution of the MOU. Meanwhile, Massachusetts has proposed rules to address power plant CO2 emissions that provide substantially more leeway than RGGI in the use of offset credits. Legislation is also pending in Massachusetts that could require the entry of the state into the RGGI program. Although Maryland, with observer status, was never a full participant in RGGI's development, there is a move in its legislature as well to require the state to join RGGI, and regulatory and legislative proposals to limit emissions of other pollutants from power plants are pending.

On December 20, 2005, seven states: Connecticut, Delaware, Maine, New Hampshire, New Jersey, New York, and Vermont—launched the country's first mandatory carbon dioxide (CO2) cap-and-trade program, known as the Regional Greenhouse Gas Initiative (RGGI). RGGI has spurred activity outside the seven-state region, as well. Massachusetts and Rhode Island were participants in the birthing of the program until virtually the end of the multi-state negotiations, and state legislation—or the next gubernatorial election—could actually inject Massachusetts back into the program. Although most of the RGGI states may conclude that they do not need authorizing legislation in order to participate, Vermont already has a bill pending. Maryland, the District of Columbia, Pennsylvania, the Eastern Canadian Provinces Secretariat, and New Brunswick were observers in the process; like Massachusetts, Maryland is struggling with RGGI-related issues on the home front.

The seven RGGI states have signed a memorandum of understanding (MOU) committing themselves to proposing a CO2 trading program for legislative and/or regulatory approval. The MOU sets a year 2018 target for reducing electric sector emissions from 2009 levels by ten percent. The MOU explicitly recognizes (in numerous “whereas” clauses) a growing scientific consensus on the contribution of anthropogenic emissions of greenhouse gases to climate change; serious risks to human health and ecosystems; risks of sea level rise and saltwater contamination of drinking water; and the utility of a carbon constraint on electricity generation in creating incentives for the development and deployment of new technologies, renewables, and efficiency.

The authorizing legislation or regulations are to be in place no later than December 31, 2008. The program, which is to start on January 1, 2009, applies to fossil fuel-fired electricity generating units 25 megawatts and larger. Under the MOU, the signatory states must aim to draft a model rule for public comment by late March 2006, to serve as the framework for each state's program.

The regional base annual CO2 emissions budget is 121,253,550 short tons, apportioned to each state in an amount that the MOU specifies. Each state's budget is to remain unchanged from 2009 through 2014. Beginning with the annual allocations for 2015, each state's budget declines by 2.5 percent per year, so that each state's annual emissions budget for 2018 is ten percent below its initial budget.

States may allocate allowances from their budgets as they choose, except that 25 percent of the allowances must be allocated for a consumer benefit or strategic energy purpose, as the MOU defines those terms:

to promote energy efficiency, to directly mitigate electricity ratepayer impacts, to promote renewable or non-carbon-emitting energy technologies, to stimulate or reward investment in the development of innovative carbon emissions abatement technologies with significant carbon reduction potential, and/or to fund administration of [the RGGI program].

States may grant early reduction credits for projects undertaken at affected facilities after the MOU was signed but before January 1, 2009. There is no limitation on the use of early reduction credits or banking.

Affected facilities must have enough allowances at the end of each compliance period to cover their emissions during that period. The compliance period is a minimum of three years unless a “safety valve trigger event” occurs as follows:

If, after the Market Settling Period [the first 14 months of each compliance period], the average regional spot price for CO2 allowances equals or exceeds the Safety Valve Threshold [$10, as adjusted] for a period of twelve months on a rolling average (a "Safety Valve Trigger Event"), then the compliance period may be extended by up to 3 one-year periods.

The MOU provides for award of offset allowances to approved greenhouse gas reduction projects for reductions that take place after the date of the MOU, and specifies the key components of the offsets program:

• Offsets must consist of actions that are real, surplus, verifiable, permanent, and enforceable.



• Offset types that are initially approvable are specified: landfill gas capture and combustion; sulfur hexafluoride (SF6) capture and recycling; afforestion; end-use efficiency for natural gas, propane and heating oil; methane capture from farming operations; and projects to reduce fugitive methane emissions from natural gas transmission and distribution. The states agree to develop additional offset categories.



• Allowances for projects located inside a signatory state are awarded on a one-to-one basis (i.e., one allowance for each CO2-equivalent ton of reductions); for projects elsewhere in the U.S., the ratio is one-to-two. But if an "Offsets Trigger Event" occurs (an average regional spot price for CO2 allowances of $7.00 per ton or more for a period of 12 months on a rolling average basis), offset allowances may be awarded to projects located anywhere in North America on a one-to-one basis until the start of the next compliance period.



• In each compliance period, a source may cover up to 3.3 percent of its emissions with offset allowances (but up to five percent if an Offsets Trigger Event occurs, until the start of the next compliance period).



• If a Safety Valve Trigger Event occurs twice in two consecutive 12-month periods, offset allowances may be awarded to projects anywhere in North America, and allowances from international trading programs may be used, both on a one-to-one basis. In this situation, the percentage of a source's emissions that may be covered with offset allowances is adjusted as specified in the MOU. Once again, the program is reset at the start of the next compliance period.

The MOU explicitly states that expansion of the program to other states is a goal. It also provides for the addition of Massachusetts and Rhode Island with specified emissions budgets at any time before January 1, 2008, without any amendment to the terms of the MOU (other than the automatic adjustment of the regional budget to reflect the addition of these two states).

The signatory states commit to monitoring the progress of the program on an ongoing basis, including impacts on the reliability of the regional electric system and the appropriateness of additional reductions after 2018. The states also anticipate a federal program, pledging to advocate for a federal approach that rewards first-mover states and to transition to a federal program if it is comparable to RGGI.

Finally, the MOU addresses the "L" word: leakage, which refers to the possibility that RGGI will increase the price of electricity generated within the region, leading to increased electricity imports from outside the region and an associated increase in emissions. To address this issue, the MOU commits the signatory states to establishing a multi-state working group by April 1, 2006 to consider the options for mitigating leakage if it occurs, to issuing findings and conclusions by December 2007, and to implementing appropriate measures if necessary.

After engaging Massachusetts deeply in the development of RGGI, Governor Romney withdrew the state from the multi-state negotiations just prior to the signing of the MOU, purportedly as a result of disagreements over the mechanisms in the program that address price certainty. Since then, on March 8, 2006, a bill has been filed in the state legislature to require the state to adopt a trading program to reduce CO2 emissions from electric generating facilities. The program must be consistent with RGGI and allow affected Massachusetts plants to trade allowances in the RGGI market. Additionally, at least 50 percent of all Massachusetts allowances must be auctioned, with the proceeds used for “consumer benefit or strategic energy purposes.”

Regardless of whether the bill passes, the next gubernatorial election could bring Massachusetts into RGGI. Governor Romney is not running for reelection, and although the Republican candidate for governor has sided with Romney on RGGI, she is running well behind in the polls. Both Democratic candidates for governor have indicated their support for RGGI.

There is a related piece to this. The Department of Environmental Protection (DEP) promulgated the state's "Filthy Five" regulations (actually applicable to six plants) in April 2001, governing power plant emissions of sulfur dioxide (SO2), nitrogen oxides (NOx), mercury, and CO2. The provisions governing SO2, NOx, and mercury emissions became effective earlier, but the CO2 portions of the rules just went into effect, on January 1, 2006.

The CO2 provisions impose an emissions cap, applicable as of January 1, 2006, on each of the six facilities; and a rate limitation that will be applicable as of January 1, 2008. The April 2001 CO2 provisions provide for the use of off-site reductions and sequestration for the purpose of compliance with both the cap and the rate limit. Note that although the rules provide for compliance through the use of offset credits, they do not provide for compliance by means of trading with other facilities that have over-complied. In other words, the rules impose a cap (as well as a rate), but do not create a cap-and-trade program.

The April 2001 rules anticipated additional regulations that would flesh out the program. During the period of the state's involvement in the design of RGGI, the assumption was that the state's obligations under RGGI would provide the eventual framework for its approach to CO2 offset creation. However, when Governor Romney withdrew the state from RGGI, the possibility of a RGGI framework for the CO2 program came off the table, at least in the absence of legislation that would require the state's participation or the election of a governor with different views.

The new regulatory proposal, which emerged on December 7, 2005, addresses the creation and use of offset credits. Although changes could emerge as a result of comments, the proposal's provisions include the following:

• Like the April 2001 rules, the proposal provides that over-compliance with the cap and rate requirements cannot create credits (nor can nuclear generation), and that only affected facilities can submit applications for credits.



• Examples of eligible projects are: reductions in landfill gas emissions that are not already required, sulfurhexafluoride (SF6) capture and recycling, afforestation, and various end-use energy efficiency projects.



• The requirement that reductions be "real, surplus, verifiable, permanent, and enforceable" is changed. The modification proposes that reductions be "permanent to the maximum extent feasible," and "enforceable as a practical matter."



• Only activities in the Northeast can generate credits—but this is the case only if the price of allowances remains below the "Offset Trigger Price," initially set at $6.50 per ton of CO2-equivalent. If the average annual price of greenhouse gas credits hits this mark, activities anywhere in the world can generate credits. Moreover, the rule is once triggered, always triggered: even if the credit price falls, projects anywhere can qualify.



• Should average annual credit prices rise to $10 per ton of CO2 equivalent, which is the "Trust Trigger Price," facilities may make payments into the GHG (greenhouse gas) Expendable Trust. Here, the rule is not once triggered, always triggered. Trust funds will be used to fund CO2 reduction projects or to purchase greenhouse gas credits, with a preference for reductions that take place within the state.



• A so-called "Circuit Breaker Mechanism" is provided: if DEP determines at any time that the price of credits has substantially exceeded either the Offset or Trust Trigger Price, or if there are insufficient applications for credits, then after an opportunity for public comment DEP may expand the geographical scope available for offset projects, or may allow payments into the GHG Expendable Trust.

Release of the proposed rules has turned up the volume on criticism of the governor's withdrawal of the state from RGGI. The concerns center on the price control mechanisms and on the inability of a resource-strapped Massachusetts agency to monitor far distant greenhouse gas reduction projects.

As noted, the RGGI MOU commits the signatory states to developing a regulatory program to implement the program, and to seeking legislative authority if the state's regulatory authority is in question. Several signatory states are apparently of the view that they have sufficient regulatory authority without additional legislation. Of the signatories, only Vermont has legislation pending. However, there is significant related legislative and regulatory activity in Maryland, which is not a signatory to the MOU.

With no coal-fired power plants, Vermont is unlike other states in the RGGI region. A bill that passed the House in late February but has not yet been taken up by the Senate provides the state's natural resources agency and public service board with the legal authority to implement RGGI. The bill also requires the proceeds from the sale of all of the allowances allocated to Vermont to be used to accomplish the goals specified in the bill—generally speaking, to maximize the benefit to Vermont's electric consumers through investments in energy efficiency and low-emitting resources.

Governor Ehrlich and the state legislature have been engaged in a lengthy tug of war involving multi-pollutant regulation of power plants. On March 13, 2006, Maryland released its proposed Clean Power Rule, which would require emissions reductions of SO2, NOx, and mercury from six coal-fired plants. The proposed rule amends an earlier draft by, among other things, removing an exemption for smaller units from certain provisions.

Meanwhile, on March 20, the state Senate passed the Healthy Air Act. Unlike the Clean Power Rule, the bill would target CO2 emissions in addition to emissions of the other three pollutants, requiring Maryland to join RGGI by June of 2007 or adopt regulations to require a ten percent reduction of CO2 emissions from affected facilities by 2018. A separate CO2-only bill addressed to the electric sector is also pending in the state legislature.

As an effort to establish the country's first mandatory limits on CO2 emissions from power plants, RGGI has already made a mark. Additional states that choose to participate will have to adopt provisions that are comparable in most respects. If other states regulate CO2 emissions, they will likely opt for programs that will allow for trading with RGGI sources.

Other potential RGGI states are already in the wings. The Massachusetts gubernatorial election later this year is likely to result in the state's participation in the program; pending legislation could have the same effect. Two separate bills in Maryland's legislature would require the state to join RGGI or otherwise limit the stat's power plant emissions.

However, legal challenges to RGGI are likely. Some signatory states will almost certainly promulgate regulations to implement the program, without seeking additional legislative authority. These rules may be challenged, with the outcome entirely dependent on the scope of the particular state's environmental regulatory authority.

Various implementation issues remain to be resolved. Depending on whether leakage occurs and on whether the states put in place measures to address it, there could well be challenges based on the Commerce Clause of the U.S. Constitution. There are too many "ifs" here—including the design of any mechanism to address leakage—to enable a guess at the outcome of any such litigation.