Program Review and Investigations Committee




<MeetMDY1> May 10, 2007


The<MeetNo2> Program Review and Investigations Committee met on<Day> Thursday,<MeetMDY2> May 10, 2007, at<MeetTime> 10:00 AM, in<Room> Room 131 of the Capitol Annex. Senator Ernie Harris, Chair, called the meeting to order, and the secretary called the roll.


Present were:


Members:<Members> Senator Ernie Harris, Co-Chair; Senators Brett Guthrie, Vernie McGaha, R. J. Palmer II, Joey Pendleton, and Katie Stine; Representatives Dwight D. Butler, Leslie Combs, Charlie Hoffman, Rick G. Nelson, Ruth Ann Palumbo, Rick Rand, and Arnold Simpson.


Guests:  Lona Brewer, Environment and Public Protection Cabinet's Division for Air Quality.


LRC Staff:  Greg Hager, Committee Staff Administrator; Rick Graycarek; Jim Guinn; Christopher Hall; Margaret Hurst; Van Knowles; Perry Papka; Rkia Rhib; Cindy Upton; Colleen Kennedy, Karen Wirth, Committee Assistant; Program Review and Investigations Committee; Mike Clark, LRC Chief Economist.


Upon motion made by Rep. Rand, and seconded by Rep. Combs, Rep. Nelson was nominated for the position of House co-chair.


Upon motion made by Rep. Rand, and seconded by Rep. Combs that nominations cease, Rep. Nelson was elected House co-chair by acclamation; without objection.


Minutes of the December 14, 2006 meeting were approved, without objection, upon motion made by Sen. Pendleton and seconded by Sen. Palmer.


Mike Clark, LRC Chief Economist, presented the report Pollution Cap and Trade Programs in Kentucky.


Mr. Clark stated that the main objective in this study was to determine what impact trading of emissions allowances has on Kentucky's economy.  He explained that a cap and trade program caps the amount of specified types of pollution from a group of sources. Allowances are issued to holders that allow emission of a specified amount of pollution. He gave an example of how permitting allowances to be bought and sold means that firms with higher compliance costs can purchase allowances from firms with lower costs. 


Sen. Harris asked why firms would have different costs to reduce pollution by the same amount.


Mr. Clark responded that one reason for the difference is that a firm can have newer technology than other firms.


Mr. Clark  explained that the first of two main pollutants subject to cap and trade programs is sulfur dioxide (SO2). The federal government's Acid Rain Program limits SO2 emissions from electric power producers. States may participate in the program or develop other strategies. Under the program, the U.S. Environmental Protection Agency (EPA) distributes allowances to firms which can be bought, sold, or banked for future use.


Sen. Harris asked if there was a limit on how long an SO2 allowance could be banked.


Mr. Clark responded that there is not.


Mr. Clark said that allowance prices have stayed relatively consistent, but there was a price spike in 2005. He presented data showing the number of allowances allocated in Kentucky, how many were traded, and how many were used for the years 2001 to 2004. For each year, the number of allowances purchased by Kentucky firms from outside Kentucky was greater than the number they sold out of state. Approximately 500,000 allowances were used in Kentucky each year, with one allowance equal to one ton of SO2 emissions.


Mr. Clark then discussed the nitrogen oxides (NOx) Budget Trading Program. NOx emissions are formed when fuel is burned. The program limits NOx emissions from May 1 through September 30, also known as ozone season. These limits primarily cover electric generating and large industrial units. An allowance represents one ton of NOx emissions and may be bought, sold, or banked, but there are provisions to discourage excessive banking. States may determine how allowances are allocated. Kentucky allocates 98 percent to existing sources of NOx and sells 2 percent through a broker.


Mr. Clark explained that NOx allowance prices have been generally declining in recent years and prices for different vintages (year the allowance can be used) have become more similar. The data collected for 2004 through 2006 shows Kentucky as a net importer of NOx allowances from other states in 2005 and a net exporter in 2004 and 2006.


Allowances benefit the holder and common methods for allocating allowances are distributing at no charge or selling for a price, Mr. Clark stated. Selling the allowances would produce more revenue for the state, however, the amount is unclear  since the price can fluctuate on the market. The benefit of distributing at no charge can lower electric rates, which benefits consumers.


Sen. Harris asked for clarification that the SO2 allowances go directly from EPA to the sources.


Mr. Clark's response was yes.


Mr. Clark stated there are seven counties in Kentucky that are nonattainment areas for the 8-hour ozone standard. Nonattainment areas do not meet the air quality standards  set by EPA. If there is a major increase in emissions from stationary sources, it must be offset by a corresponding reduction within the nonattainment area. The Louisville Air Pollution Control Board administers the offsets in Jefferson County by issuing emission reduction credits for decreasing volatile organic compounds (VOCs). These credits can then be used by the recipient firms or sold to other firms. These credits are typically used only in Jefferson County, but can be used to offset VOC emissions within the nonattainment cluster with approval from the Louisville Air Pollution Control District. If a firm leaves Louisville, credits are returned to a community bank and can be used for other firms.


Sen. Harris asked which firms coming to Jefferson County would need to receive credits.


Mr. Clark responded that only firms with major VOC emissions would need to have credits; some firms are able to keep emissions under the threshold and would not need credits.


Mr. Clark concluded  by saying that cap and trade programs can reduce compliance costs, that the method used to allocate allowances determines who receives the benefits, and that there has been little activity associated with the emission reduction credits in Louisville.


Rep. Hoffman asked if there is a potential for fraud in the trading of allowances.


Mr. Clark responded that the report did not cover that, but trading information is public. He said that potential fraud would depend on the quality of the administration of the program.


Sen. Pendleton asked why a broker is used to sell credits instead of the state doing it.


Mr. Clark said that given the relatively low percentage of allowances sold, it seemed sensible to rely on the expertise of a broker. 


Rep. Butler asked for clarification that there is no limit on banking of SO2 allowances and that limits on NOx banking expire in 2009.


Mr. Clark responded yes.


Sen. Harris asked how SO2 allocations differ from year to year.


Mr. Clark said the allocation is typically similar from year to year.


Sen. Harris wanted to know if there was information on how many SO2 allowances are banked for future use.


Mr. Clark said that he did not know how many allowances are banked.


Sen. Harris asked if other states sell more of their NOx credits than Kentucky, and, if so, whether this increases the costs to consumers.


Mr. Clark did not know of any states that sell a significantly higher percentage than Kentucky; selling a larger share of allowances would increase costs to consumers.


Sen. Harris asked how the number of NOx credits to be allocated were determined.


Mr. Clark responded that the amount is based on past emissions.


Sen. Harris asked if an operation of a firm leaves a nonattainment area, how is it determined whether the firm still has a presence in the area and can keep its credits.


Mr. Clark said that his understanding was that there were standards to define presence, but he could get more specific information.


Sen. MaGaha wanted clarification that the federal government made SO2 allocations to the sources at no cost.


Mr. Clark said that is correct and a small percentage was held back for sale.


Sen. MaGaha asked how selling 2 percent of NOx allowances affects consumers and, if so, how much.


Mr. Clark said that he could not define whether the effect is large.


Sen. MaGaha asked whether existing credits would remain in the new system when the banking limits end.


Colleen Kennedy said that the credits being held now would transfer to the new system.


Sen. MaGaha asked how the cost of an allowance compares to the fine to a firm for going over the number of allowances allocated to it.


Mr. Clark stated that in 2006, the cost was $700 for a NOx allowance compared to a $3000 fine, plus there would be a reduction in future allocation of allowances to the source.


Rep. Palumbo asked if traded credits have to go through a broker.


Mr. Clark said they could be traded between sources without going through a broker.


Sen. Harris asked Lona Brewer, Division for Air Quality, to clarify how allowances are allocated.


Ms. Brewer explained that EPA distributed allowances to existing utilities by looking at tons of emissions between 1984 and 1986 and dividing the total by 2. This was the number of allowances issued. Of the total, 98 percent is allocated and 2 percent is sold each year. She also explained that monitoring emissions has improved greatly and has become very efficient.


Sen. Guthrie asked if a company can cease operations but still technically stay in business in order to maintain control of its allowances.


Ms. Brewer responded that there is more potential of this happening within a nonattainment area.


Sen. Guthrie asked if a company in a nonattainment area can hold credits, which could be sold.


Ms. Brewer said that companies will typically surrender their credits to the bank. She is not sure at what point in time Jefferson County requires business permits to be surrendered.


Sen. Guthrie asked about inclusion of revenues from the sale of NOx allowances in the budget.


Ms. Brewer said that this depends on the percentage of allowances sold, which was 5 percent in the first year of the program and 2 percent thereafter.


Ms. Brewer said that many companies will find ways to decrease their emissions. EPA has proposed reclassifying Bullitt, Jefferson, and Oldham counties as being in attainment and this indicates success for that program. She stated that all areas of the state now meet the 8-hour ozone standard.


Sen. Harris asked if lower sulfur in diesel fuel was included in the Clean Air Interstate Rule program. 


She said it was related but not a part of that program.


The report Pollution Cap and Trade Programs in Kentucky was adopted upon motion by Rep. Simpson and seconded by Rep. Hoffman, without objection by roll call vote.


The meeting was adjourned at 11:30.