Summary: A number of NSR enforcement actions against electric generating companies are still pending, with the courts split on two of the issues central to a determination of when a "modification" occurs. One involves the exemption for routine maintenance, repair and replacement activities; the other involves the appropriate test for whether or not an emissions increase occurs. A split among the appeals courts on either of these issues could elevate one or more of these cases to the Supreme Court. Meanwhile, EPA has proposed another NSR rule that represents a 180 degree shift from its consistent position in the enforcement cases. Although the outcome of challenges to this rule is difficult to predict, it is a sure thing that there will be challenges. Also, if the proposed new rule survives, many fewer cases will be subject to NSR, making the outcome of litigation involving the routine maintenance rule far less consequential. Meanwhile, EPA has also announced a shift in its enforcement priorities (away from NSR).

In 1999, EPA and the Department of Justice (DOJ) initiated the most far-reaching environmental enforcement initiative the government had ever undertaken, aimed at alleged violations of EPA's New Source Review (NSR) regulations at coal-fired power plants. Several of the largest electric generating companies in the country, including American Electric Power (AEP), Cinergy, Duke Energy and Southern Company were among the first targets. States and environmental groups have joined many of the federal actions, and have even initiated a few cases independently. In this article, we focus on the history and status of the federal NSR enforcement actions and on the recently proposed NSR rule. We refer readers to the Clean Energy Group website, at www.mjbradley.net/_sis/cegdocs.asp, for a number of earlier Environmental Energy Insights articles on the topic.

The cases are in different stages, in courts across the country. Some have settled without significant court rulings, and some are still very much works in progress. Among the cases in which there have been final or otherwise significant substantive rulings, the courts have split as follows:

• The government prevailed on pre-trial motions in its case against Southern Indiana Gas & Electric Company (SIGECO), in the U.S. District Court for the Southern District of Indiana. The case subsequently settled.



• The same judge who ruled for the government in the SIGECO case did so again on pre-trial motions in the case against Cinergy, which is now on appeal to the Seventh Circuit Court of Appeals.



• The government likewise scored a victory against Ohio Edison in the U.S. District Court for the Southern District of Ohio. That case settled after the trial on liability.



• Duke Energy won in June of 2005 when the U.S. Court of Appeals Court for the Fourth Circuit ruled in its favor (as did the district court), becoming the first federal appeals court to rule on the substantive NSR issues. (The Eleventh Circuit ruled in favor of the Tennessee Valley Authority in 2003 on other grounds.)



• A preliminary ruling by a federal district court judge in the case against Alabama Power, a Southern Company subsidiary, tracked the ruling in the Duke case. The judge subsequently ordered the parties to mediation.

Meanwhile:

• The AEP liability trial took place in July before the same judge who ruled against Ohio Edison.



• The case against East Kentucky Power Cooperative is scheduled to go to trial in March 2006.



• The case against Southern Company subsidiaries Georgia Power and Savannah Electric remains on hold.

Companies have raised numerous defenses in the NSR enforcement cases, including the statute of limitations and lack of "fair notice" of alleged changes in EPA's interpretations of the NSR rules. The courts have largely rejected most of the defenses, but remain divided on two fundamental issues:

1. whether the "routine maintenance, repair and replacement" ("RMR&R") exemption from the definition of "modification" for NSR purposes should be viewed in the context of what is routine in the industry or what is routine for a particular unit; and



2. whether or not the same test for determining an emissions increase under EPA's New Source Performance Standards (NSPS) regulations, the "hourly emission rate test," must be used for determining an emissions increase for NSR purposes as well.

Although we encourage the reader to look back to the trail of Insights articles on NSR, some background information is in order here. All of the federal NSR enforcement cases involve alleged violations of NSR at existing coal-fired power plants arising out of plant modifications. When Congress adopted the NSR program in amendments to the Clean Air Act, it adopted by cross-reference the same definition for “modification” as existed in the NSPS provisions of the Act, which is:

any physical change in, or change in the method of operation of, a stationary source which increases the amount of any air pollutant emitted by such source or which results in the emission of any air pollutant not previously emitted.

In promulgating its regulations implementing the NSPS and NSR provisions of the Act over the years, EPA has established a two-prong test for determining if an activity at a source qualifies as a "modification." First, the activity must be a physical change or change in the method of operation and, second, it must result in an increase in emissions.

Historically, there has been no distinction between the NSPS and NSR programs in treatment of the first prong: both sets of regulations exempted activities that qualify as RMR&R from the definition of physical change, with a multi-factor test for determining what constitutes RMR&R. However, whether by intent or oversight, EPA's recent RMR&R rule for electric generating facilities imposes a different RMR&R standard for NSPS and NSR purposes: the new rule applies to NSR, but not NSPS. This may be of largely academic interest, since the rule was promptly stayed by the D.C. Circuit (and, in any event, did not apply to past violations).

With respect to the second prong, EPA has established different methodologies under its NSPS and NSR regulations for determining if an emissions increase will occur as the result of a proposed modification, in recognition of the different purposes of the programs. Since the NSPS program has a technology focus, EPA's regulations compare the hourly emission rate of the unit prior to the change to the projected hourly emission rate after the change to determine whether an emissions increase will occur and, thus, trigger NSPS applicability.

In contrast to NSPS, the NSR program focuses on air quality rather than on technology. Therefore, for NSR purposes an emissions increase has involved a comparison of pre- and post-modification annual emissions, in tons. If annual emissions are projected to increase above certain threshold regulatory levels, then the proposed activity triggers NSR.

Plant modifications that qualify as RMR&R avoid NSR. In the enforcement cases, companies have argued that activities that are routine in the electric generating industry are RMR&R, regardless of whether they are routine-or, indeed, have ever occurred before-at the particular source in question. In contrast, the government has argued that routine refers to the particular source.

The courts have split on this issue. In the SIGECO and Ohio Edison cases, federal district courts have ruled in favor of the government. In SIGECO, the U.S. District Court for the Southern District of Indiana ruled that EPA's current interpretation of the RMR&R exemption is reasonable and consistent with past formulations of the test based on a case-by-case weighing of multiple factors-the nature, extent, purpose, frequency and cost of the activity. The court ruled that "the exemption does not turn on whether the activity is prevalent within the industry as a whole."

In Ohio Edison, the U.S. District Court for the Southern District of Ohio ruled that EPA's analysis is reasonable, saying:

The Court finds that the plain language of the CAA, read together with the routine maintenance exemption, make it clear that the exemption must have a narrow interpretation so as not to swallow the general rule requiring CAA compliance when a modification is made.

On the other side of the ledger, in the Duke Energy case, the U.S. District Court for the Middle District of North Carolina granted summary judgment in favor of Duke on the NSR emissions increase determination test (discussed below). It further noted that although it agreed with Duke's interpretation of the RMR&R issue, there was insufficient evidence to grant the company summary judgment on this claim. In June 2005 the Fourth Circuit Court of Appeals affirmed the decision of the district court on the emissions increase test, thereby also side-stepping the RMR&R issue.

Following the Duke Energy decision, the U.S. District Court for the Northern District of Alabama issued pre-trial determinations in the Alabama Power case (and later in a case against TVA brought by private parties) that track the Duke case. In the Alabama Power case, the court ruled that:

The RMRR exclusion applies to projects that are routine within the industry, by which is meant work of a type performed commonly within the industry, although perhaps infrequently at any specific one or more of...[the company's] particular plants.

The electric generating company defendants in the NSR enforcement cases have argued that the test for determining if an emissions increase has occurred for NSR purposes should be the same as the test used in the NSPS regulations, which looks to the hourly emissions rate of the unit before and after the proposed change. The government has argued that the NSR test compares the actual annual tons of emissions prior to the proposed change, with the projected annual tons of emissions after the proposed change (the so-called "actual-to-projected-future-actual" methodology). Again, the courts have split.

On one side, the federal district courts in the SIGECO, Ohio Edison and, most recently, the Cinergy case (the same judge as in SIGECO) have ruled for the government. The Cinergy case is of particular significance in that the court had an opportunity to evaluate the views of the Fourth Circuit Court of Appeals (discussed below)-and rejected them. According to the court in the Cinergy case: "Nothing in the Congressional history indicates Congress intended to incorporate the [NSPS] regulatory definition." The court's ruling on summary judgment on the issue is now on appeal to the Seventh Circuit Court of Appeals. As we discuss at greater length below, the D.C. Circuit comes down on the same side of the argument, although not in the context of an enforcement case.

In contrast, the Fourth Circuit Court of Appeals embraced Duke Energy's position on this issue, and the court in both the Alabama Power and TVA cases has sided with the Fourth Circuit. The Fourth Circuit's view is based on the fact that "modification" is defined only once in the Clean Air Act—in the NSPS section of the Act, with reference to the "amount" of pollutant emitted. When the NSR provisions of the Act refer to modification they do so only by cross-reference to the NSPS section. On this basis, the court held that the term must be defined identically for both NSPS and NSR purposes.

As we discussed at some length in the July-August issue of Environmental Energy Insights, the D.C. Circuit Court of Appeals (viewed as the first appeals court among 12 "equals") has a distinctly different view. In State of New York v. EPA, the D.C. Circuit ruled on numerous challenges to the highly technical 2002 NSR rule (aka "the New Year's Eve rule"). The court declined to take head-on the question of whether the definition of modification by cross-reference requires that the term be defined identically for NSPS and NSR purposes because of its view that industry petitioners waived the argument by failing to raise it in their opening briefs. However, it observed that EPA had defined modification differently at different points in time for NSPS purposes (and for NSR purposes, as well), and gave short shrift to the Fourth Circuit's views:

Given the two quite differently worded regulatory definitions of "modification" within the NSPS program at the time of the 1977 amendments, it would take a rather pointed indication from Congress to support the idea that it expressly adopted one of them for NSR. No such indication exists.

On October 13, 2005, EPA proposed changes to NSR that would establish a uniform test nationally for measuring an emissions increase under the NSPS and NSR programs for existing EGUs. EPA proposes to allow existing EGUs to use the same maximum achievable hourly emissions test that applies under the NSPS rules to determine whether a physical or operational change results in an emissions increase under NSR. Although EPA claims that this change would apply only prospectively (more on this below), application of the hourly rate test is exactly what EPA and DOJ have argued is impermissible in the NSR enforcement cases. Instead, it reflects the industry defendants' longstanding position as to the proper measure of an emissions increase.

EPA sets forth a number of policy reasons for this dramatic about-face. First, the Agency maintains that several air quality programs adopted since the inception of the NSR program (e.g., the Acid Rain Program, the Clean Air Interstate Rule) obviate the need to address air pollution through NSR. Second, EPA argues that the existing test for determining applicability under NSR has discouraged the pursuit of efficiency upgrades at existing power plants. Third, the proposed regulations would establish a uniform emissions test nationally under the NSPS and NSR programs for existing EGUs, expanding throughout the country the rule on emissions increases that the Fourth Circuit has laid down in the Duke Energy case. (One might think that EPA could wait until the time has elapsed to seek Supreme Court review of the Duke case before pursuing the goal of national uniformity….)

EPA struggles mightily in the preamble to the proposed rule to reconcile positions that are difficult to reconcile, maintaining both that the Fourth Circuit's decision that an emissions increase must be measured with respect to hourly rate was incorrect, and that its proposed rule adopting the Fourth Circuit’s ruling is advisable.

EPA Administrator Steven Johnson announced on October 13 that the Agency would "re-prioritize resources in other areas" rather than pursuing violations of NSR rules.

A recent EPA memo to regional administrators announces that EPA will pursue electric generating company cases that have been filed in court, but that the Agency should in the future file enforcement actions only against sources that have violated the new proposed rule. Note that this is an unusual interpretation of "prospective" application of a new rule, since any violation that has occurred in the past would, in fact, be a violation of the old rule. A leaked memo from EPA's enforcement division director complains that under the proposed rule "NSR would never be triggered."

The policy change appears likely to halt up to 17 NSR cases that EPA and DOJ have reportedly prepared to file but have not yet actually filed. Reports are that EPA has about 75 investigations in progress that will not proceed.

Despite assurances that EPA will pursue pending cases, environmental stakeholders have already argued that the proposed rule and change in enforcement priority will allow defendants in these cases to argue that it would be unfair to impose major penalties in these cases.

Several important events are in the offing. First, Cinergy has taken the adverse summary judgment ruling against it on the issue of hourly rate versus tons to the Seventh Circuit Court of Appeals. If the Seventh Circuit agrees to review the Cinergy case and the company prevails, that will line up two appeals courts (the Seventh and the Fourth) against the government on the issue, with the D.C. Circuit having indicated its disagreement. (Saying that the D.C. Circuit went the other way would be a bit-but only a bit-strong.) On the other hand, if the Seventh Circuit rules for the government, there will be a clear split in the circuits, increasing the chances of Supreme Court review.

Second, after closing briefs and final arguments-and assuming no settlement intervenes-the district court (with the same judge who ruled for EPA in the Ohio Edison case) will issue a decision in the liability phase of the AEP case. If AEP loses, the case goes to trial on damages, although a direct appeal of the liability decision to the Sixth Circuit Court of Appeals is a possibility. If the government loses, it could appeal—in light of the rule changes, whether or not it will is anybody's bet.

Third, a number of states and environmental groups will undoubtedly challenge EPA's recent NSR proposal, with the outcome highly uncertain. What effect the proposed rule will have on the outcome of the pending NSR cases remains to be seen. Many observers believe that the shift in policy reflected in the proposed rule revisions will affect the outcome of these cases, particularly at the remedy phase (assuming any of them reach that stage). Courts have a good deal of discretion at that juncture, and may well feel that it is unfair to impose costly remedies when others in the industry will be subject to more lenient regulations.

Fourth, with oral argument scheduled for February 2006, the D.C. Circuit will almost certainly rule on the challenge to the RMR&R rule next year-and EPA will almost certainly lose. At that point the government could try for Supreme Court review, but more likely it will go back to the drawing board and draft a new rule-a lengthy process. But it is important to understand the link between the RMR&R rule and the proposed hourly emission rate test. If the court upholds that proposal, many fewer source modifications will trigger NSR, regardless of the status of the RMR&R provision.

If the October 2005 rule survives, importing the NSPS hourly emissions rate test into the definition of modification for NSR purposes, very few modifications will trigger NSR-even if the D.C. Circuit strikes down the RMR&R rule.

Between the pending NSR enforcement cases, the ongoing litigation surrounding EPA's New Year's Eve and RMR&R rules, and the anticipated litigation facing the rule proposed in October 2005, the electric generating sector can expect uncertainty for some time to come as to how proposed modifications at power plants are treated for NSR purposes.

A split on NSR issues between the appeals courts could make Supreme Court review of an NSR enforcement case more likely-although by no means inevitable. The Fourth Circuit has already ruled for Duke Energy on the emissions increase test for NSR. Conflicting decisions in the Cinergy case by the Seventh Circuit, or by the Sixth Circuit if the AEP case finds its way there, or by the Eleventh Circuit if Alabama Power is appealed, are possibilities.

EPA may have compromised its position in the pending NSR enforcement cases with its October proposal. Notwithstanding the agency's position that the rule will operate only prospectively, out of a sense of fairness judges in the pending enforcement cases may be less likely to impose stiff penalties and burdensome remedies if the rule is finalized and survives challenge.

Given EPA's rush to impose national consistency with respect to the emissions increase test (with the time for the government to appeal to the Supreme Court not yet expired), it is curious that the new RMR&R rule currently being litigated applies only to the NSR, and not to the NSPS, program.