State Law Impacts on Allowance Trading Programs in Eight Southeastern States

Mass-Based Clean Power Plan Compliance: State Law Impacts on Allowance Trading Programs in Eight Southeastern States Principal Authors: Katherine Lee Clinical Fellow, Turner Environmental Law Clinic Stephanie Cook, Allison Gleditsch, Blake Meadows, and Laura Snider Student Attorneys, Turner Environmental Law Clinic June 2016

Prepared by: The Turner Environmental Law Clinic provides important pro bono legal representation to individuals, community groups, and nonprofit organizations that seek to protect and restore the natural environment for the benefit of the public. Through its work, the clinic offers students an intense, hands-on introduction to environmental law and trains the next generation of environmental attorneys. Each year, the Turner Environmental Law Clinic provides over 4,000 hours of pro bono legal representation. The key matters occupying our current docket fighting for clean and sustainable energy; promoting sustainable agriculture and urban farming; and protecting our water, natural resources, and coastal communities are among the most critical issues for our state, region, and nation, especially in light of climate change s effects. For more information about the clinic or our current work, please contact: Mindy Goldstein Director, Turner Environmental Law Clinic 404-727-3432 mindy.goldstein@emory.edu Emory University School of Law 1301 Clifton Road Atlanta, GA 30322

TABLE OF CONTENTS PART I Scope and Purpose 1 PART II Background 2 PART III Guide to State-by-State Analysis 7 PART IV Legal Trends in the Southeast 13 PART V State-by-State Analysis Alabama 15 Florida 21 Georgia 27 Kentucky 35 Mississippi 42 North Carolina 50 South Carolina 57 Tennessee 64 PART VI Conclusion 72

PART I SCOPE AND PURPOSE The Clean Power Plan (CPP), released in August 2015, has been widely praised by environmental advocates and many others as an important step in the United States response to climate change. Still, the rule has met a substantial amount of legal and political controversy. Twenty-seven states, along with trade groups and companies, are currently challenging the legality of the CPP in the D.C. Circuit Court of Appeals, and in February 2016, the Supreme Court stayed the effectiveness of the rule pending the outcome of this litigation. Nevertheless, many stakeholders across the country are still assessing different state compliance options to ensure that they are prepared if the CPP or a similar rule ultimately goes into effect. One area of particular interest is how state law could constrain which compliance options are available to any particular state. The goal of this paper is to provide information on one such compliance option allowance trading under a mass-based plan and assess how existing state laws could affect the design and implementation of state plans in eight Southeastern states: Alabama, Florida, Georgia, Kentucky, Mississippi, North Carolina, South Carolina, and Tennessee. The paper will not discuss the legality of the CPP or advocate for any particular compliance mechanism over another. As such, the analysis in this paper is limited to the eight states assessed, and relies on several assumptions: 1. The CPP will go into effect in substantially its current form; 2. The eight states assessed in this paper will choose mass-based plans; and 3. These states will choose to incorporate carbon allowance trading into their state plans. These assumptions are made purely for the purpose of conducting this analysis and are not predictions of what will ultimately occur. In addition, many aspects of how the CPP will be implemented are still uncertain. Thus, while we believe this paper is an important first step, it does not purport to address all potential legal issues that could arise. 1

PART II BACKGROUND Basics of the Clean Power Plan On August 3, 2015, the U.S. Environmental Protection Agency (EPA) finalized the Clean Power Plan, establishing the nation s first-ever limits on carbon dioxide (CO 2 ) emissions from existing fossil fuel-fired power plants. 1 Under the CPP, EPA has established CO 2 emissions goals for each state in the country, and in turn, states must develop state plans that detail how they will achieve those goals. 2 Each state must meet its final emissions goal by 2030, and demonstrate incremental progress towards their goal over the 2022 2029 interim compliance period. 3 If a state does not submit a plan, or if the plan is insufficient, EPA will implement a federal plan in the state. 4 A key feature of the CPP is its emphasis on state flexibility. Each state can meet its emissions targets using any regulatory approach it sees fit. In keeping with this flexible approach, EPA established state emissions goals in two general forms an emissions rate (expressed in pounds of CO 2 /megawatt-hour) and a mass-based goal (expressed in total short tons of CO 2 ). 5 States may choose either of these goals to form the basis of their state plans. While the massand rate-based goals are intended to be equivalent, some emission reduction measures may be better suited to one type of goal versus the other. Allowing states to choose the form of their emissions goals, and the suite of policies to meet it, gives states the ability to tailor their compliance approaches to their states particular circumstances and policy objectives. 6 Mass-Based Trading and Emissions Allowances For states that choose a mass-based approach, one compliance option is a mass-based trading program (also commonly known as cap-and-trade). 7 Mass-based trading is a long-established means of reducing air pollution and has been used by EPA in past Clean Air Act regulatory programs, including the Acid Rain Program, NO X Budget Trading Program, and the Cross-State Air Pollution Rule. 8 Two CO 2 cap-and-trade programs, the Regional Greenhouse Gas Initiative and the AB 32 program in California, currently operate in ten U.S. states. 9 The basics of mass-based trading programs under the CPP are simple. In states that choose a mass-based trading approach, state regulators will issue a number of tradable emissions allowances, each representing one ton of CO 2, that equals their mass-based emissions goal for the given compliance period. Regulated power plants either buy or are given allowances, and must surrender one allowance for each ton of CO 2 emitted. 10 Unused or excess allowances may be banked for future use or sold at market. 11 As an allowance market develops, regulated entities begin to factor allowance value into their planning decisions. As an example, a power company may base its decision on whether to close a power plant by weighing the cost of closing the plant with the value of allowances required to operate it. Ideally, allowance trading is a flexible compliance mechanism that drives regulated entities to find the least-cost opportunities to reduce emissions. 12 2

Important Design Choices for Mass-Based Trading Programs The CPP limits the number of allowances that states may issue, but otherwise allows states to choose how to design and administer their trading programs. There are many different ways that states can tailor trading programs to meet their individual needs. For instance, various policies can help to mitigate rate increases for electricity consumers, incentivize energy efficiency, or subsidize renewable energy sources. 13 This subsection will briefly discuss several of the most fundamental questions that states must answer when designing a mass-based trading program. Allowance Distribution One of the most important threshold issues that states must decide is how they will make their initial distribution of allowances. Generally, states have three options: giving them away for free (free allocation), auctioning, or a combination of the two. 14 Because allowances can be bought and sold, they represent a significant source of value to their holders. 15 Thus, how states distribute their allowances, and to whom, can be used as a way to incentivize certain activities or entities, and disincentivize others. Free Allocation Free allocation is when regulators choose to give allowances away for free. If free allocation is used, regulators must determine who will receive the allowances and on what basis. For instance, states may choose to allocate allowances only to regulated emitters, or they may include all energy producers in the initial allocation. The latter could incentivize clean energy, because by freely allocating allowances to renewable sources that do not need to use them, the allowance basically acts as a cash subsidy. 16 In addition, states must choose the criteria for how many allowances a recipient is entitled. States may grant allowances based on historical or projected generation, based on environmental performance, or based on some other criteria of their choosing. 17 The method that a state chooses for allocation is a key decision, as it can affect how program costs and benefits are distributed among regulated sources, other electricity providers, and ratepayers. 18 Auctioning of Allowances An alternative approach is for states to auction all of their allowances upfront. States may choose to do so for a number of reasons, such as administrative simplicity, to raise revenue, to ensure access to all energy producers, or to set an immediate price signal for carbon. 19 If allowances are auctioned, the revenue can theoretically be used to promote certain policy objectives, such as developing renewable energy, reducing electricity costs for low- and moderate-income consumers, or promoting other needs in the state. 20 However, as discussed in Parts III and V of this paper, existing state law may limit the extent to which auction revenue can be directed to a particular purpose. Part II: Background 3

Combination of Free Allocation and Auction As a final option, states may choose to use some combination of both free allocation and auction. One example of this is straightforward: states freely allocate a portion of their allowance budget, then auction the remainder. Another example is a consignment auction, where states freely allocate allowances to regulated entities, but then require those entities to consign some portion of their allowances to an auction. 21 A combination of both free allocation and auction can have many of the benefits of both types of approaches, both preventing rate spikes that could occur if large utilities were required to purchase all their allowances at auction, but also setting an early price signal for carbon and allowing nonregulated entities access into the market. 22 Inclusion of New Sources (Addressing Leakage ) The CPP itself only applies to existing sources, as new sources are covered under a different part of the Clean Air Act. 23 However, because emissions from new sources have no mass-based cap, there is a possibility for regulated entities in mass-based states to avoid making any actual reductions by shifting generation from existing to new sources. This is called leakage, and to prevent it from occurring, states with mass-based plans are required to demonstrate how their state plan will address the issue. In its final rule, EPA proposed several ways that states could do this. To counteract leakage, state may choose to regulate new sources under their massbased program, or could use an updating allowance allocation system that helps to mitigate the incentive to shift generation to new sources. 24 Interstate Trading States must also decide whether to allow for interstate trading. Generally, because it allows for access to a broader market, interstate trading is viewed as more cost-effective than single-state trading, though it also requires increased coordination between states. EPA has offered two options for states who want to participate in interstate trading. First, they can coordinate with other states to submit a multi-state plan. Second, they can submit a trading-ready plan that allows regulated entities to use allowances obtained from out of state for compliance. 25 In some states, interstate trading may require approval from the state legislature, a new statute, or a constitutional amendment. Roadmap for This Paper Many states, including several in the Southeast, have expressed interest in a mass-based trading approach to comply with the CPP. 26 How and if they ultimately implement such a program may depend significantly on the ways their plan designs may be constrained by state law. This paper addresses how existing state laws could affect the design of mass-based state plans in eight states: Alabama, Florida, Georgia, Kentucky, Mississippi, North Carolina, South Carolina, and Tennessee. To do so, the remainder of the paper is organized into three main parts. Part III provides a guide to the state analyses in the paper, including a synopsis of the legal issues addressed. Part IV lists common legal trends seen across the eight states we assessed. Part V includes all eight state-specific analyses, ordered alphabetically by state. Finally, the conclusion to the paper is found in Part VI. Part II: Background 4

1 Carbon Pollution Emission Guidelines for Existing Stationary Sources: Electric Utility Generating Units; Final Rule, 80 Fed. Reg. 64,662 (Oct. 23, 2015) (to be codified at 40 C.F.R. pt. 60) [hereinafter Final Rule]. 2 EPA established standards for all states except Alaska, Hawaii, and Vermont. U.S. Envt l Prot. Agency, Clean Power Plan State-Specific Fact Sheets, https://www.epa.gov/cleanpowerplantoolbox/clean-power-planstate-specific-fact-sheets. 3 State plans must include a glide path that shows the reductions each state will make over the 2022-2029 interim compliance period. Each state may choose its own glide path based on which emission reduction policies it plans to deploy over the course of the compliance period. Final Rule, supra note 1, at 64,876. 4 EPA proposed its Federal Implementation Plan on October 23, 2015. Federal Plan Requirements for Greenhouse Gas Emissions From Electric Utility Generating Units Constructed on or Before January 8, 2014, 80 Fed. Reg. 64,966 (proposed Oct. 23, 2015), available at https://www.gpo.gov/fdsys/pkg/fr-2015-10-23/pdf/2015-22848.pdf. 5 Rate- and mass-based standards are designed to be equivalent. For more information on the methodology that EPA used to translate rate-based goals to a mass-based equivalent, see Final Rule, supra note 1, at 64,821 64,825. 6 For a discussion on the relative merits of mass-based or rate-based plans, see Karen Palmer & Anthony Paul, Res. for the Future, A Primer on Comprehensive Policy Options for States to Comply with the Clean Power Plan 6 (2015), http://www.rff.org/files/sharepoint/workimages/download/rff-dp-15-15.pdf. 7 States that choose a rate-based goal may also implement a trading program, though generally, a massbased compliance approach is viewed as simpler and more advantageous, particularly for trading. Jeffrey Tomich, State Regulators, Utilities See Advantages in Mass-Based Approach to EPA Rule, ENERGYWIRE, ENV T & ENERGY PUBL G (Oct. 20, 2015), http://www.eenews.net/stories/1060026570 (subscription required). Note that states will only be able to trade with other states choosing the same form of emissions goal; in other words, mass may only trade with mass, and rate with rate. 8 U.S. Envtl. Prot. Agency, Clean Air Markets, https://www.epa.gov/airmarkets. 9 Ctr. for Climate & Energy Solutions, California Cap and Trade, http://www.c2es.org/us-states-regions/keylegislation/california-cap-trade; Cal. Air Res. Bd., Cap-and-Trade Program, http://www.arb.ca.gov/cc/ capandtrade/capandtrade.htm; REG L GREENHOUSE GAS INITIATIVE, https://www.rggi.org/. 10 Nat l Comm n on Energy Pol y, Allocating Allowances in a Greenhouse Gas Trading System 3 (2005), http://bipartisanpolicy.org/wp-content/uploads/sites/default/files/allocating Allowances in a Greenhouse Gas Trading System.pdf [hereinafter NCEP Report]. 11 Id. 12 Ari Peskoe, Designing Emission Budget Trading Programs Under State Law, Harv. Envt l Pol y Init. 1-2 (Jan. 27, 2016), http://environment.law.harvard.edu/wp-content/uploads/2014/08/designing-emission-budget- Trading-Programs-Under-Existing-State-Law.pdf. 13 The design of a state plan can significantly impact who bears the greatest costs, or gains the most benefit, from a mass-based trading program. As such, there are many economic and political considerations that states must consider in choosing the specific design of their plans. For a thorough discussion of these issues in the context of allowance allocation, see Understanding Allowance Allocation Options Under the Clean Power Plan, BIPARTISAN POL Y CTR. (Jan. 11, 2016), http://bipartisanpolicy.org /events/understanding-allowance-allocation-options-under-the-clean-power-plan/ [hereinafter BPC Webcast]. 14 Greenhouse Gas Emissions Allowance Allocation, PEW CTR. FOR GLOBAL CLIMATE CHANGE 1, http://www. c2es.org/docuploads/ddcf-allowanceallocation.pdf [hereinafter Pew Center Report]. 15 NCEP Report, supra note 10, at VI. 16 For a thorough discussion of how these allocation decisions can affect policy, see Pew Center Report, supra note 14. 17 Peskoe, supra note 12, at 3. 18 BPC Webcast, supra note 13. 19 Peskoe, supra note 12, at 4. Part II: Background 5

20 Pew Center Report, supra note 14, at 6-7. 21 Peskoe, supra note 12, at 4-5. 22 Id. 23 Under the CPP, new sources are those that commence construction after January 8, 2014. Id. at 12. 24 Id. at 5. 25 Final Rule, supra note 1, at 64,892. 26 See Jeannine Anderson, Mass- vs. Rate-Based Models Debated at Clean Power Plan Workshop, PUB. POWER DAILY (Oct. 21, 2015), http://www.publicpower.org/ media/daily/articledetail.cfm?itemnumber=44685. Of the eight states assessed in this paper, three Georgia, South Carolina, and Tennessee indicated in October (before the Supreme Court stay) that they may be leaning towards a rate-based approach. Id. However, no Southeastern state has actually decided which approach to take, and indeed, most have halted their planning efforts in the wake of the stay. E&E s Power Plan Hub, ENV T & ENERGY PUBL G, http://www.eenews.n et / interactive/clean_power_plan (subscription required). Part II: Background 6

PART III GUIDE TO STATE-BY-STATE ANALYSIS For EPA to approve a state plan, the state must be able to demonstrate that its plan not only complies with the CPP, but is enforceable under state law. As a result, state law is likely to have a substantial impact on how the CPP is ultimately implemented. For instance, if a state wants to incorporate any particular compliance mechanism into its plan an allowance auction, for example the state must ensure that the responsible regulatory agency already has the authority to conduct an auction, or the state must enact a law or constitutional amendment to give the agency that authority. Thus, state law could affect which body of government, the state legislature or state regulatory agencies, will play the biggest role in designing state plans. As discussed in Parts I and II, this paper assesses how existing state laws could affect massbased allowance trading programs in eight Southeastern states: Alabama, Florida, Georgia, Kentucky, Mississippi, North Carolina, South Carolina, and Tennessee. Each of these states is analyzed separately in Part V. This synopsis will clarify the legal issues addressed in these statespecific analyses and provide guidance on how the state sections are organized. General Legal Questions Being Addressed Under the CPP, there are many ways that state law could affect the design of a mass-based trading plan. This paper assesses some of the design mechanisms that states may wish to employ and then assesses whether those mechanisms would be permitted under state law. In particular, each state analysis seeks to address three main issues: 1. Agency Charged With Distribution of Allowances: Which entities within the state government agencies, quasi-governmental organizations, or otherwise may be charged with either the creation or distribution of carbon allowances? 2. Method and Criteria for Allowance Distribution: Does state law constrict whether a state may auction or freely allocate allowances, the criteria for allowance distribution, or who the state distributes allowances to? May a state agency develops a trading program by rulemaking, or is legislation required? 3. Use of Allowance Auction Revenue: May the state agency direct the auction revenue for a particular purpose, such as supporting renewable energy sources or energy efficiency, or would this require legislation or a constitutional amendment under state law? For most of the states we assessed, many of these questions had no clear answer. Very few of these states had any laws addressing emissions trading, so there often was little (or no) law that directly applied. Thus, the analysis in Part V often discusses issues of state law that are not strictly related to emissions trading, but that have analogous characteristics to legal issues that may arise in the context of trading under the CPP. 7

Step-by-Step Guide to State Analyses This guide will walk step-by-step through the state-by-state analyses of Part V. Each section will discuss the question being addressed and how the legal analysis was conducted. 1. State At-a-Glance Table Each state analysis begins with an overview of the findings for the state in table form. The table serves two purposes: (1) to identify the state environmental agency and the state air quality statute; and (2) to quickly summarize the conclusions reached in the analysis. In particular, the table lays out a number of regulatory actions that a state could take when designing its state plan, and then provides a conclusion about how likely it is that such actions will be permissible under existing state law. The possible legality of each action is ranked on a five part scale, color coded as shown in the legend below. This color scheme applies to all tables in this document. Allowed (or Yes): There appears to be no legal limitations on a state s ability to undertake the specified action (or auction infrastructure is in place). Probably Allowed: This activity is probably permitted, but there are possible limitations. Maybe Allowed: There is not enough applicable state law to predict whether the action is allowed or not. Probably Not Allowed: The action is probably prohibited under state law, but it is not entirely certain. Prohibited (or No): State law appears to prohibit the activity; statutory or constitutional changes may be required. 2. General Issues Next, each state analysis discusses two general issues: legislative approval and judicial review of agency rulemakings. Legislative Approval of Agency Rulemakings The extent that the legislature can control agency rulemaking is important for the purposes of this paper. Even where legislation is not required for an agency to act, the legislature may nevertheless exercise some degree of control over what the agency does. In particular, some states require that agency regulations undergo review by a legislative committee, though the influence of this review process over agency rulemaking varies from state to state. Sometimes, the legislative committee is required to review regulations, but has no ability to prevent the rule from going into effect, aside from introducing and passing legislation. In other states, the committee can veto the regulation, though sometimes the governor must also approve a veto. 1 Part III: Guide to State-by-State Analysis 8

Judicial Review of Agency Decisionmaking The purpose of this paper is to assess the possible legality of future agency actions (state plans) to comply with the CPP. In particular, it is largely assessing whether, if an agency took a particular action, it would be within the scope of authority granted to the agency by statute. Thus, it is important to understand the standard of review that courts apply when reviewing an agency s interpretation of its own statutory authority. Generally, courts give deference to an agency s interpretation of the statute(s) that it is charged with enforcing or administering. 2 However, such an interpretation is not binding on the courts, which have the ultimate authority to construe statutes. 3 Typically, administrative decisions will be upheld by courts if the agency s interpretation correctly reflects the plain language of the statute and comports with the intent of the legislature. 4 This general standard of review applies in all eight of the states assessed. 3. Authority to Create a Mass-Based Allowance Trading Program The third section in each state analysis discusses whether the state environmental agency has the authority to create a mass-based allowance trading program within the state. State agencies get their authority from statutes, and in this case, from state air quality statutes. One way that a statute can vest an agency with authority over a certain matter is by expressly stating as much in the statute itself. For instance, some state air quality statutes explicitly allow for emissions trading, market-based mechanisms, or flexible or alternative regulatory schemes. Ultimately, if a state air quality statute expressly authorizes the state environmental agency to do any of the above, the agency likely could establish a mass-based trading program under the CPP, without the need for additional legislation. The converse is also true; if a statute prohibits the agency from using trading, the agency may not do so without legislation. However, even if emissions trading is not specifically authorized by statute, a state agency may nevertheless have broad enough authority under its air quality statute to set up a trading program. Often, state air quality statutes give agencies very broad rulemaking authority to ensure state compliance with the state Clean Air Act. State agencies could rely on these general powers to set up an allowance trading program. To determine if this is the case in a particular state, one thing to look for is how the state agency dealt with emissions allowances under other Clean Air Act programs. For instance, both the Clean Air Interstate Rule (CAIR) and the Clean Air Mercury Rule (CAMR) required states to issue emission allowances. If a state agency implemented those programs without requiring additional legislation, it likely could set up an allowance scheme under the CPP as well. 4. Free Allocation of Allowances The fourth section in each state analysis turns to the more specific questions associated with free allocation of allowances. As noted in Part II, a state can freely allocate allowances in many different ways, depending on the state s policy objectives. The analysis of free allocation in this paper focuses on three questions: (1) whether the state agency has the authority under state law to freely allocate allowances; (2) whether it has the authority to choose to whom it allocates (i.e. allocation to non-regulated entities); and (3) whether it can choose how it allocates allowances (i.e. based on historical generation, on an updating basis). Part III: Guide to State-by-State Analysis 9

Authority to Choose Free Allocation This question focuses on whether the state s choice between free allocation and auction is limited in any way. Generally speaking, if a state environmental agency has the authority to create an allowance trading system, it likely also has the authority to freely allocate allowances. As such, the analysis for this section largely tracks that in the Authority to Create a Mass-Based Allowance Trading Program section, discussed above. Allocation to Non-Regulated Entities The analysis then turns to whether the state agency can allocate allowances to non-regulated entities, such as renewable energy providers or new sources. For the former, an agency s ability to allocate to renewable providers likely relies on the same considerations assessed above; where an agency has broad powers under its air quality statute, it is more likely to be able to exercise discretion in choosing what entities will receive allowances. For instance, under other Clean Air Act trading programs, agencies in several states (though none of the eight assessed here) allocated portions of their allowance budgets to renewables or energy efficiency providers. Most of those state agencies acted without state legislation, relying instead on the broad powers granted to them under their state air quality statutes. 5 Thus, absent any specific statute to the contrary, an agency s ability to allocate allowances to renewable sources is closely tied to how broad its regulatory powers are under its state air quality statute. For allocation to new sources, the analysis is generally very similar. However, in some states, environmental agencies are prohibited from adopting regulations more stringent than federal law requires. Because the CPP does not regulate new sources, some have argued that it may be unlawful for regulators in these states to require new sources to hold allowances, as this would be more stringent than federal law requires. The merits of this argument are debatable; while the CPP does not regulate new sources, it does requires mass-based states to address leakage, and including new sources is one way to do so. 6 Under this view, including new sources may be entirely necessary to satisfy the requirements of the CPP, and thus would not be considered more stringent than federal law requires. However, this issue has never been addressed by any court, and could be raised in the future. Thus, the state-specific analyses in this paper will note when a state has such a stringency limitation in place. Criteria for Allowance Distribution State laws could also potentially constrain the criteria a state agency uses as its basis for allocating allowances. However, unless a statute prohibits them from doing so, if a state agency has the authority to allocate allowances, it probably can choose the criteria by which it allocates those allowances. For example, many states under the CAIR program customized the criteria they used to allocate allowances, generally without state legislation. 7 5. Authority to Auction Allowances Next, each state analysis addresses the state environmental agency s authority to auction allowances. As with the issues discussed above, a state agency could have the authority to conduct an emissions auction either under its general authority to administer the state air Part III: Guide to State-by-State Analysis 10

quality statute, or because auctions are expressly authorized in the statute. However, of the twelve U.S. states that have auctioned or sold emission allowances in the past, most have done so under specific statutory authorization. 8 As such, the analysis in this section is cautious as to any agency s authority to auction allowances without additional legislation. 6. Use of Auction Revenue If a state chooses to conduct an emissions auction, it must determine how to invest the proceeds. As noted in Part II, one way to invest the proceeds is to direct them towards a renewable or energy efficiency energy program, or to direct them back into the state air program. However, several state law factors could affect an agency s ability to direct auction revenue to a particular purpose. First, the agency may be prohibited from collecting auction revenue because it is considered a tax. Second, state law could already dictate how the funds may be spent. Finally, if there is no statute to direct the funds, the agency may not have the authority to direct funds on its own, without legislative authorization. The fifth section of each state analysis will discuss each of these issues, to the extent they are relevant in the state. Authority to Collect Auction Revenue: Fee v. Tax Under the law of some states, auction revenue could be construed as a tax requiring legislative authorization. Unlike regulatory fees, which state agencies generally have the ability to collect, some states require legislative approval to institute a new tax. This issue was raised in California after the institution of its cap-and-trade program, which uses an allowance auction. Challengers to the program argued that the price of an allowance was a tax, which would require approval by two-thirds of the California legislature. Ultimately, California courts held that the allowance price was a regulatory fee, but the issue could potentially arise in other states. While this paper assesses the fee vs. tax issue for each state, it does not appear that this issue will be consequential in most of the eight states assessed. Only two of these states require a legislative supermajority to raise taxes, and in any event, the law in all eight states strongly suggests that auction revenue would be considered a fee rather than a tax. Existing Funds It is possible that a state agency is already required by state law to direct revenue into a particular fund. For example, many state air agencies are required to invest certain fees that they collect into particular dedicated or special funds, which agencies are only authorized to expend for certain purposes. Whether auction revenue could be directed to a clean energy program would depend on (1) whether auction revenue was the type of fee that was required to go into the fund; and (2) if so, whether a clean energy program would fall within the scope of purposes for which the fund may be used. Authority to Direct Revenue Without Statutory Authorization In many states, agency revenue that is not already dedicated to a particular fund is required to go into the state general fund. If revenue is required to go into the general fund, those funds Part III: Guide to State-by-State Analysis 11

are pooled with other general fund sources, and may only be spent through the appropriations process in the state legislature. 7. Role of Third-Party Entities In some circumstances, the state environmental agency may not be the entity that is bestsuited to administer an allowance distribution program in the state. Some states, for example, have dedicated governmental or quasi-governmental agencies that regularly administer environmental financing programs, and thus may have the infrastructure and expertise necessary to administer an allowance system as well. In states where utilities are highly regulated, a state public utilities commission may be well-equipped to determine which electricity providers should receive allowances, and in what amount. As such, this final section of each state analysis looks at, first, whether the state environmental agency could contract with other entities to assist with allowance distribution, and if so, which entities may be potential candidates. It may also be possible for state environmental agencies to contract with private companies to run aspects of an allowance-based program, such as a tracking service. However, because it would be difficult to identify private companies that may be able to provide such services, only governmental or quasi-governmental agencies are discussed in this paper. 1 See Nat l League of Cities, Separation of Powers Legislative Oversight, http://www.ncsl.org/research/ about-state-legislatures/separation-of-powers-legislative-oversight.aspx. 2 See, e.g., Handel v. Powell, 284 Ga. 550, 553 (2008); State Bd. of Trustees v. Day Cruise Ass'n, Inc., 794 So. 2d 696, 700 (Fla. Dist. Ct. App. 2001); McCullar v. Universal Underwriters Life Ins. Co., 687 So. 2d 156, 163 (Ala. 1996). 3 See, e.g., Handel v. Powell, 284 Ga. 550, 553 (2008). 4 Id. 5 Ari Peskoe, Designing Emission Budget Trading Programs Under State Law, Harv. Envt l Pol y Init. 7-8 (Jan. 27, 2016), http://environment.law.harvard.edu/wp-content/uploads/2014/08/designing-emission-budget- Trading-Programs-Under-Existing-State-Law.pdf. 6 See id. at 12 for a more thorough discussion of this issue. 7 Id. at 7-8. 8 Id. at 9. Part III: Guide to State-by-State Analysis 12

PART IV LEGAL TRENDS IN THE SOUTHEAST This paper allows for each of the eight states in the Southeast to be reviewed in isolation, for the purpose of helping government officials, non-governmental organizations, utilities, and others make decisions regarding the implementation of the CPP in their state. However, when these state analyses are viewed in the aggregate, several trends arise: In seven of the states we assessed (all but Kentucky), the state environmental agency most likely could establish an allowance trading system in the state through rulemaking, without the need for state legislation. In most of these states, this authority stems from the broad rulemaking powers that their environmental agencies are granted under their respective state air quality statutes. Georgia and North Carolina s air quality statutes expressly allow for trading mechanisms. Seven states (again, all but Kentucky) could possibly choose auction as a means to distribute allowances. In Georgia, the air quality statute expressly allows for allowance auctions. For the six other states, the environmental agency s authority to conduct an auction would have to stem from their broad rulemaking powers, rather than an express statutory authorization. However, most states that have auctioned allowances have done so with specific statutory authorization. As such, it is possible that these states may require additional legislation to conduct an auction. Seven of the state environmental agencies assessed also appear to have the authority to choose what criteria to use in a free allocation system. Four of these states, for example, customized the criteria they used to allocate allowances under the CAMR or CAIR programs, and did so by regulation alone. While the other three states have not created their own allowance allocation criteria yet, they appear to have broad enough rulemaking authority under their state air quality statutes to be able to do so in the future. In the seven states that could choose to auction allowances, there is no significant trend among states in terms of how they can invest the auction proceeds. Each state differs in terms of where the money is required to go and how it can be invested. Still, it does appear that in several states, auction revenue could arguably be invested into a renewable or energy efficiency program. In all of the states assessed, the state environmental agency would probably be required to create the state plan through rulemaking, and could not do so through a less formal process. This is important because in six of the states we assessed, agency rulemakings must go through some sort of approval process by a committee of the state legislature. The degree of legislative oversight varies by state. More specific details are discussed in each state analysis. Finally, it is worth noting that Kentucky is likely the only state of those we assessed that may not be able to establish a mass-based trading plan at all. In 2014, the Kentucky legislature passed a law that requires the state agency to set plant-specific emission standards, and 13

prohibits the agency from using any outside the fenceline mechanisms for CPP compliance, such as mandated fuel switching. While it may be possible for Kentucky to implement a mass-based plan under these constrictions, it is unclear what such a plan would look like. Nevertheless, the section for Kentucky does contain an analysis of what powers the state environmental agency would have if this legislation were to be repealed in the future. Part IV: Legal Trends in the Southeast 14

PART V STATE ANALYSIS: ALABAMA Alabama At-a-Glance Air Agency Air Quality Statute Topic Alabama Department of Environmental Management (ADEM) Alabama Air Pollution Control Act (Alabama APCA), Ala. Code 1975 22-28 Action and Explanation General Free Allocation Auctioning Establishing a Mass-Based Trading Program Using Third Parties for Allowance Distribution Choosing Free Allocation Generally Choosing the Criteria for Allocation Allocating to Non-Regulated Entities Allocating to New Sources Auctioning Allowances Generally Directing Auction Revenue Allowed. ADEM has previously administered mass-based trading programs in the state through rulemaking alone. Legislative approval is required for rulemaking in Alabama. Allowed. ADEM likely may contract with either governmental or non-governmental third parties to conduct allowance-related services. Two possible entities in Alabama are the Alabama Department of Economic and Community Affairs (ADECA) and the Alabama Public Service Commission (Alabama PSC). Allowed. ADEM has freely allocated emissions allowances in the past under several other air regulatory programs. State legislation was not required for any of these past programs. Probably Allowed. The Alabama APCA does not appear to limit ADEM s ability to choose what criteria it uses to distribute allowances. However, ADEM has never established its own allowance distribution criteria; in past regulatory programs, it adopted EPA s recommended criteria entirely. Probably Allowed. The Alabama APCA does not appear to limit ADEM s ability to allocate allowances to non-regulated entities, though ADEM has never done so in the past. Probably Allowed. The Alabama APCA does not restrict ADEM s ability to pass regulations more stringent than federal law, and there do not appear to be any other state laws that would limit ADEM s ability to include new sources in an allowance allocation scheme. Maybe Allowed. In Alabama, auction revenue would likely be considered a fee, not a tax, and thus could be collected by ADEM. While there do not appear to be any state laws that would limit ADEM s ability to conduct an auction, it has never done so in the past. Probably Allowed. Auction revenue would likely be required to go into the state s Environmental Management Fund, which must be used to further the purposes of the Alabama APCA and the Clean Air Act; this could potentially include supporting renewable energy sources. 15

General Issues Legislative Approval of Agency Rulemakings In Alabama, the state legislature can disapprove agency rulemakings. Under the Alabama Administrative Procedure Act, the legislature s Joint Committee on Administrative Regulation Review must review all agency rulemakings. 1 The committee has 45 days to disapprove a rule, and an agency may appeal the disapproval to the Lieutenant Governor. Based on the Lieutenant Governor s decision, the rule either becomes effective at the end of the next legislative session, or is returned to the agency. The state legislature may, by joint resolution, overturn the Lieutenant Governor s decision to approve the rule. 2 Judicial Review of Agency Decisionmaking In Alabama, [t]he interpretation placed on a statute by the executive or administrative agency charged with its enforcement is given great weight and deference by a reviewing court. 3 However, the agency s interpretation must be consistent with the plain language of the statute and its legislative intent. 4 Authority to Create a Mass-Based Allowance Trading Program Alabama s Clean Air Act program is governed by the Alabama APCA. The APCA gives two entities responsibility for its implementation: Alabama Department of Environmental Management (ADEM): ADEM is responsible for the administration and enforcement of the Alabama APCA. 5 ADEM proposes regulations to implement the statute, which must be presented to the Environmental Management Commission for consideration and final approval. Environmental Management Commission (Commission): The Commission has final authority over all rulemakings to implement the Alabama APCA. 6 The Commission, which consists of seven members appointed by the state Senate, 7 is responsible for approving ADEM regulations and enacting them into law. The purpose of the Alabama APCA is to achieve and maintain such levels of air quality as will protect human health and safety and, to the greatest degree practicable, prevent injury to plant and animal life and property, foster the comfort and convenience of the people, promote the social development of [Alabama] and facilitate the enjoyment of the natural attractions of [the] state. 8 To achieve these ends, the Alabama APCA provides for a coordinated statewide program of air pollution prevention, abatement and control, and establishes a framework within which all values may be balanced in the public interest. 9 Under the Alabama APCA, ADEM has quite broad authority to adopt regulations as necessary to prevent, abate, or control air pollution. 10 Though the Alabama APCA does not mention trading in the list of enumerated powers it grants, the APCA provides that those listed powers should not be read to limit the authority granted to the Commission and ADEM. 11 In two circumstances, ADEM has used this broad authority to allocate allowances. ADEM allocated NO X Part V: State-by-State Analysis Alabama 16

allowances in accordance with the Clean Air Interstate Rule (CAIR), 12 and similarly, before the Clean Air Mercury Rule (CAMR) was repealed, ADEM allocated allowances under the CAMR framework as well. 13 Legislation was not required in either circumstance. Under this broad authority, it is likely that ADEM could establish a mass-based allowance trading program as a means of complying with the CPP. Such a program would have to comply with the general purposes and requirements set forth in the Alabama APCA. 14 Any such program would have to be established by rulemaking, approved and adopted by the Commission, and included in the state implementation plan submitted to EPA. To be approvable by EPA, the rules must detail how ADEM will implement and enforce its state program. Free Allocation of Allowances Authority to Choose Free Allocation ADEM could likely choose to freely allocate emissions allowances through regulation alone. As noted above, ADEM has freely allocated allowances in the past under several Clean Air Act programs, relying on its broad powers under the Alabama APCA. Thus, ADEM likely could opt to freely allocate emission allowances under the CPP as well. Allocation to Non-Regulated Entities The Alabama APCA does not address specifically whether ADEM could issue emission allowances to non-regulated entities, such as renewable energy sources or new power plants. Under the CAIR and CAMR structures, ADEM only allocated emissions allowances to regulated sources. However, as stated above, ADEM s powers under the Alabama APCA are broad. The APCA grants ADEM with the authority to establish such emission control requirements, by rule or regulation, as in its judgment may be necessary to prevent, abate, or control air pollution. 15 ADEM could reasonably conclude that subsidizing renewables through allowance allocation may be an appropriate way to abate air pollution and comply with the CPP. Similarly, allocating to new power plants is a way to prevent leakage and thus to control emissions. Thus, while ADEM has never allocated allowances to non-regulated entities, it may nevertheless already have the authority to do so under state law. Criteria for Allowance Allocation Other than the general requirements set forth in the Alabama APCA, the statute does not prescribe what criteria ADEM must use when allocating allowances. Alabama did not customize its allowance allocation criteria under either CAIR or the CAMR. However, this does not necessarily mean that ADEM does not have the authority to develop its own criteria. The Alabama APCA does not require ADEM s regulations to match federal Clean Air Act regulations, and again, ADEM has broad authority under the Alabama APCA. It seems probable that selecting the criteria for allowance distribution would fall under the scope of powers that ADEM is granted under the Alabama APCA. Part V: State-by-State Analysis Alabama 17

Authority to Auction Allowances Neither the Alabama APCA nor ADEM s regulations address how or whether ADEM could auction emission allowances. However, as stated before, ADEM has allocated NO X allowances in the past under its CAIR program, and did so without authorizing state legislation. This suggests that ADEM likely has quite broad powers under the Alabama APCA and therefore, could potentially opt to auction rather than freely allocate allowances to comply with the CPP. Still, the Alabama APCA does not expressly authorize ADEM to conduct an auction or to collect revenue for allowances, and most states that have auctioned allowances under a cap-and-trade scheme have done so by legislation; this may also be necessary in Alabama. 16 Use of Auction Revenue Categorization of Auction Revenue: Fee v. Tax In Alabama, auction revenue would most likely be considered a regulatory fee rather than a tax. Under Alabama law, taxes must originate in the state house of representatives. 17 However, a tax is generally a revenue raising measure, imposed by a legislative body, that allocates revenue to a general fund, and is spent for the benefit of the entire community. 18 In contrast, a user fee is a payment given in return for a government provided benefit and is tied in some fashion to the payor s use of the service. 19 In an allowance auction, entities pay the government in order to receive a government-provided benefit the right to emit one ton of CO 2. The payment is directly related to the benefit that the recipient obtains, and is directly related to the service provided by ADEM air quality protection. As such, because ADEM has the authority to collect regulatory fees, there appear to be no limitations on ADEM s ability to collect auction revenue. Existing Funds Alabama law requires ADEM to place all moneys that it receives through appropriations, grants, fees, or from any other source whatsoever, into a dedicated fund called the Alabama Department of Environmental Management Fund (ADEM Fund). 20 ADEM is required to use all monies within the Fund to further the provisions of the statutes it is charged with administering. 21 Given the broad scope of funding streams directed to the ADEM Fund, ADEM would almost certainly be required to direct revenue from allowance auctions into the Fund. ADEM clearly is permitted to use this Fund to support the costs of the state air program. Arguably, ADEM could also use money from the ADEM Fund for a state clean energy program. Renewable energy can be used to replace CO 2 -emitting sources and improve the state s ability to meet its goals under the Clean Air Act and the Alabama APCA. As such, a renewables program could improve the state s performance in administering its regulatory functions, and thus fall under the permissible uses of the Fund. It is important to note, however, that without a constitutional amendment, the state legislature is authorized to divert money from the ADEM Fund back into the general fund of the state. 22 Part V: State-by-State Analysis Alabama 18