HOGAN & HARTSON L.L.P.

HOGAN & HARTSON L.L.P. LESLIE SUE RITTS PARTNER DIRECT DIAL (202) 637-6573 LSRITTS@HHLAW.COM COLUMBIA SQUARE 555 THIRTEENTH STREET, NW WASHINGTON, DC 20004-1109 TEL (202) 637-5600 FAX (202) 637-5910 WWW.HHLAW.COM M E M O R A N D U M May 31, 2005 To: From: Re: Theresa Pugh, American Public Power Association Leslie Ritts Status of NSR Issues Before EPA and the Courts Introduction At your request, the following discussion provides an update of various New Source Review activities. 1 The topics include the status of the 2002 and 2003 NSR rulemakings, the legal challenges that States and others have filed against EPA s NSR Reform rules in the U.S. Court of Appeals for the District of Columbia, additional NSR reforms that EPA contemplates in the future, and a survey of the settlements of cases related to the 1998 EPA Utility Sector NSR enforcement initiative. As the U.S. House of Representatives appears to be poised anew to consider New Source Review issues for energy industry sources as possible amendments to the Clean Air Act, it should be recognized that few of the NSR reforms promised by the Bush Administration have yet to be realized and considerable uncertainty remains with regard to changes that can be made with respect to boilers without triggering the need for a NSR permits during planned and unplanned outages. A. Federal PSD/NSR Program Rules 2002 NSR Reform Rule EPA issued two sets of revisions to the 1980 PSD/NSR Program Rules in 2002 and 2003. The 2002 NSR Reform 1 New Source Review (NSR) will be used throughout to describe the Prevention of Significant Deterioration (PSD) preconstruction permit requirements in attainment areas as well as NSR rules in nonattainment areas. BERLIN BRUSSELS LONDON PARIS BUDAPEST PRAGUE WARSAW MOSCOW TOKYO NEW YORK BALTIMORE McLEAN MIAMI DENVER BOULDER COLORADO SPRINGS LOS ANGELES

Rule largely affected non-utility sources, although some systems have found the provisions in the rule for streamlined approval of Plantwide Applicability Limits ( PALs ) promising. Importantly, the 2002 rule did not revise or retract the so-called 1992 WEPCO rule adopted by EPA, even though EPA published a supplemental NSR proposal in 1998 that suggested that EPA has no basis for providing a demand growth exclusion to utilities or any other industry as part of the NSR emissions increase test. The other direct effect of the 2002 Reform Rule on the electric utility industry is its recordkeeping requirements to validate that emissions increases attributable to changes at affected sources do not exceed NSR significance thresholds for the 5 years following the changes, or that if such emissions occurs that increases are attributable to growth in demand rather than the change itself. 2003 ERP Rule In contrast, the 2003 NSR rule s equipment replacement provision (ERP) for excluding certain replacements from NSR permitting is critical to all industries, including utilities. Equipment replacement that is automatically exempt from preconstruction permitting under the PSD or NSR regulations is defined as functionally equivalent equipment that does not change fundamental operations of the prior equipment or violate any other applicable requirement and does not exceed 20% of the current replacement value of a process unit. Changes, the cost of which exceed the 20% value, may still be considered exempt Routine Maintenance, Repair and Replacement (RMRR) based on EPA s WEPCO test depending on five factors, including the nature and extent of the change, its purpose, cost, and frequency. Unfortunately, each factor has been subjected to different interpretations by different regulators and the courts. For instance, it remains unclear whether a source should consider the frequency of the type of change across an entire industry or simply at a particular plant, as EPA has argued in various enforcement actions. ERP Rule Stayed and 20% Basis Reconsidered Unfortunately, shortly after the final ERP rule was published on October 27, 2003, the U.S. Court of Appeals for the District of Columbia stayed the ERP rule pending further review of the rule on its merits. Thereafter, EPA also published an administrative action staying in the rule and announced on July 1, 2004 that the Agency had granted Petitions by New York s Attorney General and others to reconsider whether the 20% basis for the rule was appropriate. According to a 2005 EPA Status Report to the Court filed in the ERP challenge, the Agency expects to announce its final action on the Reconsideration Notice by May 31, 2005. B. Federal Court Review of EPA Rules Litigants filed legal challenges to both the 2002 and 2003 EPA NSR rules as soon as the rules were issued. In each instance, environmental groups and a number of states and local jurisdictions principally from the 2

northeast and California argued that EPA both exceeded its legal authority under the Clean Air Act and acted arbitrarily in issuing the NSR reforms. But industry also filed challenges to the 2002 Reform rule. UARG Challenge to the 2002 NSR Reform Rule Even if the 2002 NSR reforms minimally affected utility industry, the challenge filed by the Utility Air Regulatory Group and other industry to the 2002 rule is hugely important to the electric utility industry. The UARG challenge asserts that in the 2002 NSR Reform Rule, EPA departed unlawfully from the 1978-1992 PSD/NSR regulations with respect to how an emission increase that triggers NSR permitting is determined. Not before 2002, industry argues in its brief, had EPA required electric generating systems to ignore whether emissions increased on an hourly basis before determining whether annual emissions exceeded the PSD/NSR rule s significance levels that define when a major modification requires a preconstruction permit. Thus, industry argued that the 2002 NSR Reform rule s methodology for determining when a significant emissions increase occurs as a result of a modification to an existing unit is illegal under the Clean Air Act because it is inconsistent with Section 111(a)(4) of the Clean Air Act, which states that a modification only occurs when there is an increase in the maximum-hourly emissions from a source. Very simply, industry argued, that a PSD/NSR-affected change can only take place if there is a NSPS modification which would result in a significant increase in annual emissions. The Government, and state and environmental groups, argued that industry is wrong and that the 2002 emissions increase test was explicit in the 1980 PSD/NSR rules and is fully consistent with the Clean Air Act because of the different Congressional purposes in enactment of the NSPS and NSR programs. The legal challenges to the 2002 NSR Reform rules now have been fully briefed, and they were argued before a three-judge panel of the U.S. Court of Appeals on January 25, 2005. A decision is expected before summer recess in late August 2005. An opinion may be issued soon now that the Court is no longer hearing argument and has turned to its summer business of preparing opinions in cases it has now heard. Such a decision could also affect decisions in several enforcement cases currently before federal district and appellate court judges (see below). 2003 ERP Challenge In contrast to the legal battle over the 2002 rule, the litigation on the 2003 rule is currently inactive. State and Environmental Petitioners were able to obtain from the Court a rarely granted Emergency Stay of the ERP rule. The Court s order, issued on December 23, 2003, found that the States were likely to succeed on the merits of their challenge. If, as averred in recent filings by the government, EPA finishes its reconsideration of the ERP rule by May 31, 2005, the U.S. Court of Appeals is likely to adopt a joint schedule proposed by the parties which would see 3

briefing in the case completed by early next year, with argument in the spring or early summer, and a decision in the case likely by the end of 2006. C. State Implementation of NSR Reforms and New EPA Reforms As explained above, since the 2003 ERP rule revision was stayed by the federal court (and thereafter by EPA), it cannot be implemented. With respect to the 2002 NSR Reforms, 13 states or portions of the states which never adopted NSR rules in the state implementation plans, operate under the 2002 federal rule. However, nearly all other jurisdictions have chosen to ride it out until the federal appellate court issues a ruling on the legality of the various aspects of the NSR Reform Rule, including the PAL, the clean unit exemption, baseline considerations, and most important, whether it is a comparison of actual emissions before and after a change or an increase in the maximum hourly emission rate that triggers NSR. Several states including Indiana, Colorado, and most recently Ohio, have adopted new NSR programs as amendments to their State Implementation Plans, but EPA has not approved any yet as revisions to the states implementation plans. Indiana s program is largely regarded as the test case, as the state did not adopt regulatory language identical to that in the federal rules, so EPA must determine if the rule is substantially equivalent even though it is much narrower with regard particularly to the clean unit exemption from NSR for BACT/LAER-equipped facilities. Colorado s rule deviates slightly from the federal program, and Ohio s rule is said to be almost identical. Other states, particularly in the southeast, reportedly continue to examine adoption of various options outlined and recommended by the State and Territorial Air Pollution Control Administrators in its Menu of NSR Options. As implementation of the 2002 and 2003 NSR Reforms are stalled, the Agency has announced its plans to go forward with nearly a dozen more NSR changes. These will include: an aggregation rule to define which projects are related for purposes of aggregating emissions increases; a Debottlenecking rule that will explain how emissions from linked upstream and downstream equipment is counted in determining emissions increases from a change; new rules on the inclusion of fugitive emissions in determining whether emissions increases trigger NSR; a definition of significance for certain pollutants such as Ozone Depleting Substances (ODS) (If there is no significance definition in the NSR rules for a pollutant, the significance value is zero.); and 4

rules for implementing the PM-2.5 NAAQS in attainment and nonattainment rules. Current EPA guidance suggests that EPA, but not necessarily the States, will rely on PM-10 as a surrogate for PM-2.5 until this rulemaking is complete. (See attached EPA PM-2.5 Guidance.) D. The EPA 1998 Utility Sector Enforcement Initiative EPA continues to prosecute the cases it brought against a number of investor-owned utilities (IOUs) and the Tennessee Valley Authority (TVA) for NSR violations in 2001, which have not yet been settled. The Agency also continued to file additional NSR cases, not limited to IOUs, albeit on a slower and reportedly more focused basis. While high-ranking EPA officials stated following release of the 2002 and 2003 NSR reform rules that the Agency would only prosecute electrical utilities that made changes that would violate the 2003 ERP 20% replacement definition, clearly certain NSR investigations and cases have been pursued on a basis similar to the original 1998 investigations that resulted in the 2001 EPA complaints. In cases where settlements were agreed to between the parties, as the following table shows, equitable relief in the form of facility pollution control upgrades have been generally costly. Significant Utility/EPA Settlements of NSR Cases Company/Unit s Settlement Date Penalties Pollution Control Cost Environmental Mitigation TECo/10 Feb. 2000 $3.5 mil. ~$1 bil. ~$10-11 mil. PSE & G /4 Jan. 2002 $1.4 mil. ~$337 mil. ~$6 mil. VEPCo/20 April 2003 $5.3 mil. ~$1.2 bil. ~$13.9 mil. WEPCo /23 April 2003 $3.1 mil. ~$600 mil. ~$20-25 mil. SIGECo/3 June 2003 $0.6 mil. ~$22 mil. ~$2.5 mil. Santee June 2004 $2.0 mil. ~$400 mil. ~$4.5 mil. Cooper*/12 Mirant/12 Sept. 2004 $0.5 mil. ~$133 mil. ~$1 mil. Illinois Power March 2005 $9 mil. ~500 mil ~$15 mil. Ohio Edison March 2005 $8.5 mil ~$1.1 bill ~$10 mil * Consent decrees filed but not yet approved. Consent decree stayed by court pending discovery. The Agency s Enforcement office has continued prosecuting remaining cases, but only has pursued one new case against East Kentucky Cooperative, independent of the actions it files in the course of seeking approval of consent decrees to make settlements of actions federally enforceable. A number of original cases proceeded to trial, but two cases that have been reviewed by appellate courts are particularly worthy of mention. In the original action that EPA filed against its sister agency, the Tennessee Valley Authority, the U.S. Court of Appeals for the Eleventh Circuit dismissed the 5

action on the grounds that it was unconstitutional for EPA to issue an EPA Administrative Order to TVA directing retrofit of the system s controls without allowing due process. The Court opened the door to further EPA action against TVA by ruling such enforcement would need to be filed in federal district (trial) court so that TVA could dispute EPA s findings. Some people have read general disapproval of EPA s allegations into the holding, although the written opinion stops far short of discussing EPA s legal theories, on which the Eleventh Circuit heard lengthy arguments. In either situation, EPA has not filed against TVA in district court, though the State of North Carolina has sued EPA as a downwind-affected state. The second significant proceeding is an EPA case against Duke Energy, filed after the initial 9 NSR cases EPA brought in 2001. At the trial court level, a federal district judge agreed with Duke Energy s defense that EPA had not determined that a NSPS modification occurred before it concluded that a PSD permit was required. EPA appealed that holding to the U.S. Court of Appeals for the 4 th Circuit, the case was argued on January 28, 2005, and a decision should be issued in the very near future. E. A NSR Showdown Before the U.S. Supreme Court? The issue on which both the D.C. Circuit Court will rule on the UARG 2002 Reform Rule challenge and the issue before the Fourth Circuit will rule on the Duke Energy case are essentially identical, that is whether an NSPS modification must occur before it is PSD/NSR review is triggered. Whichever federal appeals court issues its opinion first may have an impact on the other court. If the holdings are not the same, they might well provide the basis for an appeal of the basis for PSD/NSR permits to the U.S. Supreme Court. On a writ of certiorari to the high court, it is generally felt that the Supreme Court would accept review of the cases because of the national significance of the NSR program in implementing the Clean Air Act. Conclusion I have not used extensive citations in the summary, but if anyone would like additional information on any of the discussion, they should not hesitate to contact me at 202-637-6573 or LSRitts@HHLaw.com 6