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Washington Breaks New Ground with Greenhouse Gas Regulation

November 2, 2016

On September 15, 2016, the Washington State Department of Ecology (“Ecology”) adopted its final Clean Air Rule (“Rule”) after months of stakeholder meetings and public comment and over a decade of climate policy discussion.1 This rule limits greenhouse gas emissions from the largest producers in the state and represents a unique approach at the state level. The rulemaking is a compromise after comprehensive cap-and-trade legislation failed to gain traction in the legislature. When coupled with a possible state carbon tax, on the ballot in November 2016, Washington’s approach could become a model for other states hoping to address climate change in lieu of federal action.

Washington Clean Air Rule

Overview

The Clean Air Rule applies only to covered parties, which the Rule defines as: 1) the owners or operators of stationary sources located in Washington, 2) petroleum product producers in Washington or importers to Washington, and 3) natural gas distributers in Washington.2 Once a covered party exceeds a threshold level of greenhouse gas emissions, it is regulated under the Rule and must reduce its emissions.

The greenhouse gas (“GHG”) emissions regulated under the Rule are carbon dioxide (“CO2”), nitrous oxide (“N2O”), methane (“CH4”), hydro fluorocarbons (“HFCs”), perfluorinated compounds (“PFCs”), sulfur hexafluoride (“SF6”), and nitrogen trifluoride (“NF3”).3 The GHGs are measured in metric tons of CO2 or its equivalent, and reductions are measured in emission reduction units (“ERUs”). One ERU equates to one metric ton of CO2 equivalent.4

There are two categories of covered parties under the Rule: Category 1 and Category 2. All covered parties with GHG emissions averaging at least 70,000 metric tons per year between 2012 and 2016 are Category 1 parties under the Rule5 and must notify Ecology of their status as Category 1 parties by January 1, 2017.6 Category 1 parties that emitted a three calendar year rolling average of at least 100,000 metric tons of GHG emissions beginning in 2012 must achieve an annual average GHG reduction of 1.7% of their baseline level of emissions between 2017 and 2019.7 This compliance threshold of 100,000 metric tons of GHG emissions lowers by 5,000 metric tons CO2 every three years, eventually requiring reductions from all Category 1 parties by 2035.8 Reductions are based on each party’s baseline. The baseline for Category 1 parties is calculated by using the average emissions between 2012 and 2016, but may be based on an average calculated with as few as three years if a particular calendar year’s emissions were calculated with a different methodology.9

Category 2 parties include: covered parties that emitted on average less than 70,000 metric tons of GHGs per year between 2012 and 2016; covered parties that did not operate between 2012 and 2016; voluntary participants; and petroleum product importers.10 Once a Category 2 party emits an average of at least 70,000 metric tons of GHGs per year for three consecutive years after 2012 or requests to become a voluntary participant under the Rule, Ecology must calculate a baseline emissions value using the average of three years of emissions from the party’s required annual GHG reports.11 If the operation is modified or new, the baseline is set using a benchmarking process that entails studying the facility and its operating processes, as well as using recent emissions data from similar operations.12
Businesses and organizations that emit 10,000 metric tons of GHGs per year have been required to report to Ecology annually since 2012.13 Consequently, Ecology knows the parties likely to be regulated by the Rule and has compiled a list of potentially eligible parties based on that data.14 This list includes nearly 70 potentially eligible parties, including natural gas distributors; petroleum product producers (i.e. refineries and importers); metal, cement, pulp and paper, and glass manufacturers; power plants; and waste facilities.

While many operations will be required to reduce their GHG emissions under this Rule, especially as the threshold for required reductions lowers, there are many exemptions from regulation, including GHG emissions from: suppliers of coal-based liquid fuels; the industrial combustion of fuel wood; coal-fired baseload electric generation facilities in Washington that emitted more than 1 million metric tons of GHGs in any year prior to 2008; and the combustion of certain products by petroleum producers, petroleum importers, and natural gas distributors.15 Stationary sources included in EPA’s Clean Power Plan will be considered compliant with the Rule for the first compliance period (2017-2019) provided that EPA approves Washington’s implementation plan and the approved plan requires greater GHG emissions than otherwise required under the Clean Power Plan.16

In addition to these exemptions, covered parties identified in the Rule as energy intensive and trade exposed (EITE) are not considered Category 1 parties, even if otherwise qualified, until 2020, with GHG reductions first due in 2023.17 In addition, EITE parties go through a different baseline and reduction calculation process.18 Examples of EITE parties include frozen fruit, juice, and vegetable manufacturers; animal (except poultry) slaughterers; pulp mills; nitrogenous fertilizer manufacturers; lime manufacturers; iron and steel mills; aircraft manufacturers; and petroleum product importers, among several others.19

Achieving Compliance

The covered parties that emit GHGs above the threshold for regulation must achieve an annual average GHG reduction of 1.7% of their baseline level of emissions and submit a compliance report demonstrating reductions every three years. There are several ways covered parties can make the required reductions. First, a party could simply reduce its GHG emissions. While this may be possible for some, the Rule gives covered parties the option to use emission reduction units (“ERUs”) instead of requiring GHG reduction. ERUs work as currency under the Rule and can be generated, recorded, banked, and exchanged by covered parties.

ERUs are generated by a covered party, including a voluntary party under the Rule, when that party emits fewer GHGs than allowed.20 ERUs can also be generated by emission reduction projects, programs, or activities.21 The emission reductions from these projects must be real, specific, identifiable, quantifiable, permanent, and located in Washington.22 The programs must also be enforceable and verifiable, and not double-counting emission reductions with other legal requirements (except the EPA Clean Power Plan and two Washington GHG standards).23 Emission reduction projects include increasing transportation efficiency, implementing energy efficiency measures and demand side management (including renewable energy credits), reducing the use of nitrogen fertilizer in agricultural operations, and reducing GHG emissions from industrial processes.24 To qualify, each of these programs must meet specific requirements detailed in the Rule.

Finally, ERUs can be generated through GHG markets outside of Washington if 1) the allowances are issued by an established multisector GHG reduction market; 2) the covered party may purchase allowances from that market; and 3) the allowances are calculated with similar methodologies to those used under Washington rules.25 Initially covered parties may use out-of-state allowances to account for 100% of their required reduction; however, by 2023 this reduces to 50% and by 2035 the maximum amount of reduction that can be achieved through out-of-state allowances is 5%.26 There are also requirements related to the “vintage year” of out-of-state allowances, meaning that all allowances used for compliance in a particular year cannot have that same vintage year (generally the year the allowance was recorded, assigned by the program supplying the allowance).27

Once ERUs are generated, they must be recorded in Ecology’s registry, which tracks each ERU from generation, transfer between parties, and ultimately, once used for compliance, retirement.28 Each covered party must also keep a record of all ERUs generated or obtained for ten years.29 A covered party may bank ERUs for up to ten years, and when withdrawing an ERU, it must withdraw the oldest vintage year first.30 Once an ERU is generated and registered, it may be transferred between covered parties. While only covered parties, voluntary parties, and Ecology can hold ERUs, other entities such as brokers can facilitate ERU transactions.31

To demonstrate compliance, covered parties over the reduction threshold must submit a compliance report every three years demonstrating the party met the required reduction. This report includes the amount of GHG emitted as well as ERUs generated, ERUs banked, and ERU transactions.32 The report must also include documentation that a third party verified that the actions described in the report were permanent, enforceable, and sufficient to meet the Rule’s obligations.33 If the report shows that the reduction requirement was not met, the covered party will be required to purchase ERUs equal to the required reduction amount.34

Finally, if a covered party operating over the threshold level and complying with reduction and reporting requirements emits less than 50,000 metric tons of GHGs per year for three consecutive years it does not have to continue complying with the Rule.35

Ecology’s Management Role

To effectively manage the ERU market, Ecology must establish an account of reserve ERUs. Ecology may retire ERUs from the reserve: a) to ensure consistency with the aggregate cap limit, b) to account for GHG emissions by covered parties that do not yet have to make reductions, and c) to promote the viability of voluntary renewable energy programs.36 Ecology may also withdraw the ERUs from reserve, assigning them to a stationary source restarting operations or to programs that reduce GHG emissions and are consistent with environmental justice principles.37

Carbon Tax Ballot Initiative

This rulemaking is a compromise for Washington Governor Jay Inslee after his comprehensive cap-and-trade legislation failed to gain traction in the legislature in 2015. That legislation would have created a market-based system that limited carbon emissions and charged fees on GHG emissions, raising approximately $1 billion in revenue for the state.38 The final Clean Air Rule does not charge fees on emissions or generate revenue for the state, but this November, Washington voters will decide if carbon emissions in the state should be taxed. If it passes, Initiative Measure No. 732 (“Initiative”) would implement the nation’s first carbon tax.

The Initiative proposes a carbon tax applicable to fossil fuels sold or used within the state and electricity consumed in the state, including imported electricity and that purchased from Bonneville Power Administration. The Initiative excludes from taxation fossil fuel brought into Washington in vehicle tanks. The Department of Revenue must develop through rulemaking the “carbon calculation” for both fossil fuels and electricity, which involves calculating the amount of CO2 emissions in the taxed fossil fuels and electricity. The Initiative sets the tax rate at $15 per metric ton of CO2 starting July 1, 2017, increasing to $25 per metric ton on July 1, 2018. Thereafter, the tax would increase 3.5% plus inflation every year, not to exceed a rate of $100/metric ton in 2016 dollars.

Some fossil fuel usage is phased into the taxation scheme, including fossil fuels for agricultural uses, public transportation, nonprofit transportation providers, the Washington state ferry system, and school buses. Fossil fuels for these uses is initially taxed at 5% of the normal rate, which is equal to $0.75 per metric ton of CO2. In 2018 the rate increases to 10% of the normal rate, which is equal to $2.50 per metric ton of CO2. The rate for these phased-in fossil fuel uses increases 5% every two years until it reaches the regular tax rate in 2055.

The Initiative is a revenue-neutral proposal, meaning that all revenue obtained from taxing CO2 is used to reduce taxes such that the Initiative results in no net change in the state’s revenue stream. In addition to implementing the tax on carbon, the Initiative reduces the state sales tax by 1% by July 1, 2018; significantly reduces business and occupation taxes on manufacturing; and increases the working families’ sales tax exemption for qualifying low income people.

Implications

The outcomes of both the greenhouse gas reduction rule and the carbon tax ballot initiative are uncertain. Although the Rule is final and took effect October 17, 2016, industry groups have already filed lawsuits challenging the Rule. A group of natural gas utilities filed a lawsuit in the U.S. District Court for the Eastern District of Washington alleging that Ecology unduly burdened interstate commerce and regulated extraterritorially in violation of the interstate commerce clause by restricting how emissions credits and offsets can be transferred to and from other states.39 That same group of natural gas utilities and eight other industry groups—including pulp and paper mills, truckers, and food processors—filed two separate suits in Thurston County Superior Court, challenging Ecology’s authority to impose the Rule without the approval of the legislature, in addition to procedural claims.40

The Initiative’s fate at the ballot box is unpredictable. An August 2016 poll showed 34% in favor of the carbon tax, 37% against, and 30% undecided.41 Initiative advocates have failed to garner support from many progressive and environmental groups, including the Sierra Club, Climate Solutions, and Puget Sound Sage. These groups claim that the revenue-neutral nature of the tax prevents investment in renewable energy, public transportation, and green job creation and burdens low income families with increased gas and electricity costs.42

Finally, if the Initiative passes, it is unclear how it will interact with the greenhouse gas regulation rule. As Chris Best, lead climate policy adviser to Governor Inslee said, “No one started this process thinking about how to design these things to interact with each other,”43 and industry groups may view the combination of mandated reductions and a tax without additional incentives as overly burdensome. After the Rule was finalized in September 2016, Sarah Rees, Ecology’s special assistant on climate change policy said, “Right now, [the carbon tax] isn’t on the books…In the event it would pass, we would evaluate where we are in the rule. Theoretically our rule could continue in parallel, but I think we would want to take a look to see how it would interact and what would make sense for Washington State in terms of impacts on folks and getting emissions reductions.”44 If the Initiative passes in November, the outlook for the Rule may look very different.

Ultimately, both the greenhouse gas reduction rule and the proposed carbon tax are unique policies to address climate change. If Washington passes the Initiative, it would have the only carbon tax in the nation, and the Rule represents a distinctive policy for requiring greenhouse gas reduction for the highest emitters without a complete cap-and-trade program like California. This ad hoc strategy has emerged from Washington’s own legislative failure to pass a comprehensive cap-and-trade program. Nevertheless, its implementation will certainly provide lessons for other states hoping to address climate change as federal regulation in the Clean Power Plan remains uncertain and federal climate legislation seems improbable.

For more information, please contact Sarah Wightman or one of the other attorneys in the Firm’s Climate Change, Energy, or Alternative Energy practice groups.

1 Split in Washington State Climate Workgroup Recommendations Shows Challenges in Moving Climate Policy Forward, Marten Law Environmental News (January 27, 2014).

2 WAC 173-442-020(1)(k).

3 WAC 173-441-020(1)(g).

4 WAC 173-442-020(1)(n).

5 WAC 173-442-050(1)(a).

6 WAC 173-442-020(1)(m)(ii)(A).

7 WAC 173-442-030(1); WAC 173-442-060(1)(b)(i).

8 WAC 173-442-030(3).

9 WAC 173-442-050(2) and (3).

10 WAC 173-442-050(1)(b).

11 WAC 173-442-050(4).

12 WAC 173-442-050(5).

13 See WAC 173-441.

14 Washington Dep’t of Ecology, Clean Air Rule: Potentially Eligible Parties (June 2016).

15 WAC 173-442-040.

16 WAC 173-442-040(4).

17 WAC 173-442-030(2).

18 See WAC 173-442-070.

19 WAC 173-442-020(1)(m).

20 WAC 173-442-110(1).

21 WAC 173-442-110(2).

22 WAC 173-442-150(1).

23 WAC 173-442-150(1).

24 See WAC 173-442-160.

25 WAC 173-442-170(1).

26 WAC 173-442-170(2)(a).

27 WAC 173-442-170(2)(b).

28 WAC 173-442-230.

29 WAC 173-442-120(2).

30 WAC 173-442-130.

31 WAC 173-442-140(3).

32 WAC 173-442-210.

33 WAC 173-442-210(3)(d) and WAC 173-442-220.

34 WAC 173-442-200(3).

35 WAC 173-442-210(7).

36 WAC 173-442-240(2).

37 WAC 173-442-240(3).

38 See Carbon Pollution Accountability Act, available at http://www.governor.wa.gov/issues/issues/energy-and-climate/2015-carbon-pollution-reduction-legislative-proposals (last visited October 13, 2016).

39 Tom Banse, Industry Lawsuits Mount Against Washington State’s New Carbon Cap, Northwest News Network (September 30, 2016).

40 Id.

41 Jim Camden, Elway poll: Voters split on November initiatives, The Spokesman-Review (August 18, 2016).

42 Ashley Ahearn, Should Carbon Emissions Be Taxed? Washington Voters Will Decide, Oregon Public Broadcasting (October 7, 2016).

43 Id.

44 Samantha Larson, State unveils new rules to combat climate change, Crosscut (September 15, 2016).

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