On March 17, 2011, the Center prepared this document to inform EPA’s development of greenhouse gas standards for fossil fuel-fired power plants (Docket ID: EPA-HQ-OAR-2011-0090). This document explores market-oriented approaches for reducing greenhouse gas (GHG) emissions from electricity generation under Section 111 of the Clean Air Act (CAA). This document focuses in particular on how states might adopt market-oriented approaches to achieve the GHG emission reductions required from existing electricity generating units under Section 111(d) of the CAA as well as the implications of different design choices for these market-oriented approaches. This document also highlights policy and legal questions related to state-driven, market-oriented regulations under Section 111(d), describes stances EPA might take toward market-oriented state programs in its emission guidelines, and identifies an opportunity for beneficial interaction between GHG regulations and pending non-climate-related EPA regulations.

NOTE: We prepared this document in consultation with representatives of business and nongovernmental organizations; however, this document is solely a product of the Center and does not represent a consensus position of any coalition or group.

The bullets below summarize key points of the report:

• Market-oriented approaches offer the opportunity to achieve GHG emission reductions more cost-effectively than traditional “command-and-control” regulations.
• EPA could use its authority under Section 111 to create a national emissions trading program for new and existing sources. Such an approach, of course, has not been legally tested and some might argue would be politically contentious.
• Instead, EPA may issue traditional rate-based performance standards for GHG from power plants (for example, lbs of CO₂e per MWh, differentiated by source categories).
• The Clean Air Act appears to allow the flexibility for states who so choose to adopt market-oriented policies to achieve the GHG emission reductions that will be required by EPA’s Section 111(d) emission guidelines.
• States that are already moving forward with market-oriented state or regional emission reduction programs (notably the Regional Greenhouse Gas Initiative and California’s AB 32 cap-and-trade program) ought to be able to use those programs to meet the requirements for emission reductions under Section 111.
• To the extent that additional states would prefer to adopt market-oriented approaches to reduce GHG emissions from power plants, such states should be free to choose such approaches in order to achieve the emission reductions required under Section 111.
• The RGGI states already have an operational cap-and-trade program for CO₂ from power plants, and California is implementing an economy-wide cap-and-trade program. Other states interested in meeting their Section 111 requirements via more cost-effective market-oriented approaches might prefer a flexible emissions standard that allows for rate-based trading rather than a “hard cap” program with allowance trading. States might also be interested in clean energy standards that reduce emissions by requiring increases in lower-carbon generation. The policy approaches have different implications and present different policy design choices.
• Multi-state trading programs involving states that choose to pursue market-oriented regulations can expand the scope of trading and achieve aggregate emission reductions more cost-effectively.  There are steps EPA could take to facilitate multi-state trading.
• There are several questions to be resolved pertaining to state-driven, market-oriented regulation of GHG emissions from power plants—including how best to demonstrate states’ compliance with EPA’s binding emission guidelines if states allow for interstate trading, offsets usage, multi-sector trading, price floors/ceilings, or international trading.
• Lastly, EPA’s NSPS rulemaking is not taking place in a vacuum. Over the next few years, power plant owners will have to make decisions about retrofitting, retiring, and replacing a large number of carbon-intensive coal plants in light of pending non-climate EPA air, water, and waste regulations. EPA and the states should recognize this situation when formulating GHG regulations and evaluate appropriate incentives for power plant owners to retire carbon-intensive units and replace them with low-carbon generation rather than making sub-optimal investments that “lock in” GHG emissions for years to come.