Environmental Market Insights: NOx allowance program

Author Argus

This first episode in a new mini-series will take a deep dive into the NOx market and changes coming this summer.

Over the coming weeks we will be discussing growth in the US environmental markets including the new NOx allowance program, expansion of cap-and-trade programs, expansion of LCFS programs, and an update on renewable energy certificates. In this first episode, Jessica Dell and Michael Ball break down the new NOx allowance program including market trends, pricing and more.

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Jessica: Hello and welcome to our new podcast miniseries that focuses on growth in the U.S. environmental markets. In this series, we'll be discussing the new NOx allowance program, the expansion of state cap and trade programs, expansions of low carbon fuel standard programs, and an update on renewable energy certificates.

To get us kicked off, today, we'll be diving into the NOx market and changes coming this summer. This podcast episode is brought to you by Argus Media, which, as many of you know, is a leading independent provider of energy and commodity pricing information. My name is Jessica Dell, and I'm Argus's U.S. West Coast Bureau Chief, and with me today is Mike Ball, editor of our environmental markets publication [Argus] Air Daily.

Mike: Hi. Thanks, Jess.

Jessica: Mike, why don't you start off by telling us just a bit about what the NOx program is, who runs it, and who is regulated under it?

Mike: Sure. So what we're talking about today is a new NOx trading program created by the U.S. Environmental Protection Agency. This is a continuation of a program known as the Cross-State Air Pollution Rule or CSAPR, as many people lovingly call it, that has been up and running for a few years now. And the purpose of it is to reduce power plant emissions of SO2 and NOx across much of the Eastern United States to help downwind areas meet their obligations under federal air quality standards.

Jessica: And what trends have we seen in this market? Have prices been fairly steady in recent years?

Mike: Yeah, for the most part, it has been. So the way the program is structured is there are a couple of different annual programs, that is giving power plants annual obligations for reducing SO2 and NOx emissions, and then there's a separate program, which we'll get into a little bit, that just focuses on what's called the ozone season, or basically, the summertime months.

And for the most part, those markets have been very well oversupplied, which has resulted in low, fairly steady prices, not a whole lot of activity. The annual SO2 and NOx allowances are, basically, at about $2 or $3 a short ton, and have been there for quite a while now, whereas the current Group 2 ozone season programs are about $275 per ton.

And that's a little higher than it has been in recent years but still well below, you know, where previous programs that were doing the same thing that 15, 20 years ago were, like, $2,000, $3,000, or $4,000 a ton.

Jessica: And you touched on the split of the current ozone season NOx program into two separate markets. Can you tell us a bit more about this? When will this new market start? And why did the EPA take this step?

Mike: Yeah, sure. So that's a good question. So what's happening here is EPA is taking...the previous ozone season component of the Cross-State Rule was basically split into two markets. There was one called the Group 1 market, which literally was just the state of Georgia, and not really a whole lot of activity going on there and not one that I think a lot of people focused on too much.

But then the main one at the time was called Group 2, which was something they set up a couple of years ago to help with the 2008 federal ozone standards. And what happened was, through a series of court rulings, a couple of years ago, various states and environmental groups had said, hey, EPA, you're not doing enough to make sure that some of these downwind areas can meet their deadlines because there are concrete deadlines in the Clean Air Act for meeting their obligations under the air quality standards.

And the courts agreed. And they said, EPA, you need to do something more. And so what EPA came back with late last year, and then finalized just a few weeks ago, was this idea of taking the previous Group 2 market and splitting it into two programs. And so what they've come up with now is this new Group 3 market, which takes 12 of the states that were previously part of Group 2 and creates a new separate market with the power plants in those states subject to more aggressive NOx limits than they had previously faced.

Jessica: Thanks for that. And with this new Group 3 market, how is the EPA handling the allocation of allowances for it?

Mike: Sure. So there's a few different steps they're going to be taking over the next several weeks ahead of and after the program launches at the end of June. But one of those is to, basically, recall allowances that have already been issued under the previous program, which is something they're going to do starting in the middle of next month. And then a couple of weeks after that, they're going to start issuing the new Group 3 allowances for power plants to use.

There's also another key step that I think a lot of folks in the market are waiting for, which is they're calling it a bank conversion in mid-August. So what that means is EPA is going to take any of the leftover allowances from the power plants that were previously under Group 2, and will now under...be under Group 3, any allowances they had banked from recent years, and convert those into use under Group 3, which we're going to see what that actually turns out to be. But there's going to be a small bank of allowances that gets carried forward. That's going to happen sometime starting in mid-August.

Jessica: And where have we seen price levels in this new market? Has there been much liquidity so far?

Mike: Not a whole lot so far. It's very quiet. I think people are still waiting to see sort of what happens with some of the various EPA steps coming up next in terms of implementing the program. Like I said, it doesn't really start till the end of June. So it's kind of created this kind of weird kind of gray area, I guess you could say, where the power plants are still having to meet their original Group 2 obligations for at least a couple of months, and then worry about the Group 3 obligations starting at the end of June.

But what we have seen so far is that right now, the market is sort of looking at a price of around $2,700 per ton, which, as I mentioned before, is really not a price level we've seen in about 15 to 16, 17 years. Whether it stays up that high remains to be seen. I think, historically, what you see in a lot of environmental markets is the price gets up to a certain point then kind of comes down a little bit once people get used to the market. And we have heard from a number of market sources who say that they really are waiting on some of these final steps of implementation before they really get into the market and start trading. So I think once that program starts in the next several weeks, we'll start to see a little more trading activity pickup.

Jessica: And across other environmental programs, including cap and trade, clean fuel standard programs, there have been more recent calls for greater stringency just with so much more increased attention on cutting greenhouse gas emissions. For this new NOx market, are these NOx limits set in stone or do you see any potential opportunities down the line? Should market participants expect any kind of review?

Mike: That's a really good question. And I think it's not out of the realm of possibility. I don't think it necessarily means it's going to happen right away. I mean, a good example of that would be the original Group 2 market that I mentioned. That was actually created in 2017 in response to new federal ozone standards. The way the Cross-State Rule had originally been set up several years ago was to deal with standards that had been set by the EPA for ozone and particulate matter as far back as 1997, which kind of depends on which state you're in.

And when they updated the standards in 2008, EPA decided they needed to set more stringent limits on NOx for some of these states. And that ended up leading to the creation of the Group 2 program. And so if in the future, EPA decides that they need to make a...set a more stringent standard for ozone and particulate matter, I think that will increase some pressure on them, at least from environmental groups, to go back and reconsider some of the caps they've set, and to see if there's a way to bring down power plant emissions further.

Whether they will do that, I mean, we'll see. You know, there's a lot of, I think as folks are aware, you know, a lot of retirements in coal-fired power plants, switching to natural gas, switching to...which natural gas is covered by these programs so that wouldn't necessarily exclude the idea of more stringent caps. But you're seeing more renewable energy. So emissions are coming down already. That's really another reason why this Group 3 market ended up getting created is because the emissions are coming down so much that a lot of these previous markets were oversupplied.

And that was sort of discouraging some power plants from running their emissions controls on a full-time basis. And so EPA is sort of hoping to push them in the other direction. Yeah, I mean, it's definitely possible to get more stringent caps in the future if EPA decides that that needs to be done in response to some of these other standards that they've set.

Jessica: Thanks for that. At Argus, the NOx Group 3 assessment isn't the only allowance program we cover. We assess California carbon allowances and RGGI allowances. But these are all regional. There's no federal program at the moment. But with climate being such a key part of Biden's agenda, do you see any potential for any kind of federal cap and trade program? Is there appetite for it? Is it legislatively possible? I'm just curious for your views there.

Mike: That is a great question. I think it's one that a lot of people are keeping an eye on. I guess the way I would put it is, you know, legislatively, there's probably not going to be anything that happens. We've still got a 50/50 split in the Senate. A lot of Republicans are opposed to doing things like cap and trade. And I don't know if there's a lot of appetite from Democrats in Congress to really push the idea. Even with these big climate plans that Democrats in the House and Senate came out with last year, they sort of tiptoed around the idea of doing cap and trade, or any sort of carbon pricing.

That said, I think maybe as soon as folks are aware that the Obama administration, several years ago, put out this thing called the Clean Power Plan, where the idea was to reduce CO2 emissions from existing power plants. And while it didn't require the use of emissions trading, a big component of the program was to encourage states to do that. Since then, there's been...you know, the Trump administration tried to repeal it and replace it with a less aggressive regulation. And earlier this year, the DC Circuit Court of Appeals overturned that regulation and, basically, in the ruling said, EPA can, if it wants to, consider kind of a broad range of tools for reducing power plant emissions, including emissions trading.

So right now EPA is in the process of coming up with a new version of, and what we'll end up calling it, you know, clean power plan two or something else. And so it remains to be seen. That very well could include some sort of trading component, but I think until then, it's going to be largely up to the states to sort of figure out if they want to do that.

Jessica: Thanks, Mike. Sounds like a lot to keep our eyes on. If you enjoyed this podcast episode, please be sure to tune in for the other episodes in this miniseries that will cover cap and trade programs, LCFS programs, and RECs. And for more information on Argus's emissions coverage, please visit [www.argusmedia.com/emissions/argus-air-daily]. Thanks again, Mike.

Mike: Thanks.