MEMORANDUM TO: Trading/Incentives Banking Group FROM: Joe Belanger, Moderator SUBJECT: Summary of Trading/Incentives Banking Group Conference Call on April 2, 1996 DATE: April 5, 1996 Participants Joseph Belanger, Moderator Vincent Brisini David Damer Lynne Dayton (Walcoff) Norman Fichthorn Joseph Goffman Douglas Grano Thomas Keller Dennis Koepke LeeAnn Kozak James See William Shobe Suzanne Simoni Dean Van Orden Opening Remarks Moderator Joseph Belanger opened the conference call. He commented that although the group had not accomplished as much in its last conference call as he had hoped, the discussion enabled participants to recognize the need to focus on shaping a banking proposal rather than concentrating on the addition of banking to the agenda. Mr. Belanger then asked the group for feedback on the following issues: Is an additional paragraph on banking required to reframe the discussion for the policy paper, or should the group continue to work on the issue and wait until after the meetings on April 11 to present a banking policy paper? Mr. Belanger recommended that the group follow the latter course because additional information regarding the Ozone Transport Commission (OTC) remains outstanding. Dave Damer, who was involved in drafting the 15-percent banking proposal and in helping to prepare the "progressive flow control" plan, agreed with Mr. Belanger. He suggested that the group address the OTC banking proposal at the April 11 Trading/Incentives Workgroup meeting. Mr. Belanger asked the group to allow time during today's call to consider new banking scenarios for ICF Resources to model over the next few weeks. Discussion of Proposals At this point, Vince Brisini, representing Pennsylvania Electric Company, raised the issue of regional effects on individual banks under the proposed OTC plan. He explained that his concern relates to the perception that states can bank allowances that may not be bankable. This uncertainty from state to state causes companies to perceive a loss of control. Companies do not want the regional bank concept to affect their banks. Mr. Brisini then raised the issue of EPA's accounting requirements, suggesting that the agency eliminate the calculation or delay it until later in the year. Mr. Belanger responded that the reporting date could be moved up further in the year, but questioned whether accounting and planning would be done in percentages or actual numbers. Mr. Brisini commented that he does not believe that there is any advantage or disadvantage in terms of the numbers or in actual allowances above the annual allocation. Whether computed on a unit-to-unit or company basis, he sees the plan as providing comfort for the states. Mr. Damer added that some sources do not have banks of more than 10 percent; under these conditions, the total number of allowances that may be withdrawn is artificially limited to those under 10 percent. He explained that the point of progressive flow control was to have the limit set at 10 percent for 1:1 withdrawal; anything above 10 percent would be at 2:1. Mr. Brisini indicated that a 15-percent plan without the 2:1 provision would present fewer restrictions on the number of allowances above the baseline allocations than the OTC progressive flow control plan. One participant asked how Mr. Brisini's proposal handles holders of allowances that may not have an allocation. Mr. Brisini replied that the Pennsylvania Electric Association (PEA) proposal does not consider third parties or opportunities to trade. He added that third parties could act as go- betweens. Tom Keller remarked that he believes the OTC program had been set up so that anyone--whether a source or not--could hold allowances and not be restricted artificially. Mr. Brisini commented that the Pennsylvania companies are troubled by the prospect of having their banks affected by third-party activities. The companies are not concerned with what others do as long as they--the companies--are not affected. He cited examples such as the Massachusetts early RACT and the Virginia and New Jersey emissions reduction credit as examples of such third-party activities. Mr. Belanger disagreed with Mr. Brisini's assertions, adding that if large banks pose a risk, then restrictions should apply to large banks; if companies have only small banks, they should not be affected. At this point, Joe Goffman remarked that banking benefits entire markets and lowers costs for everyone. The measure of these benefits is not how many allowances any individual company has in its bank at a given time, but that these allowances are tradeable. Because of the nature of trading, Mr. Goffman continued, it is artificial to say that this trigger should be based on how much a company has in its bank. There is nothing to stop a company from buying another company's banked allowances. Several participants raised similar concerns about Mr. Brisini's assertions. Mr. Goffman summarized these concerns as follows: "If I transfer an allowance to someone and relinquish control of that allowance, there is at least a theoretical risk that the way that person disposes of that allowance will trigger a restriction that will adversely affect me. If you think that risk is significant, you will price that allowance accordingly when you sell it." Mr. Goffman pointed out that Mr. Brisini's arguments would make sense only if there were no trading and only source-by-source banking. According to Mr. Goffman, the fact that allowances can be traded freely in this market is significant for the following reasons: o Any company is ultimately part of a regional bank because any allowances generated in the region are, in theory, available to everyone in the region. As a result, the costs of compliance options are lowered by what everyone else is doing in the market. o A mechanism puts a screen on the total amount of allowances in one's bank that can come out on a 1:1 basis; one can plan ahead just by ensuring that one has a large bank. He concluded that this trading system allows cost and efficiency benefits. Mr. Brisini disagreed, asserting that the OTC progressive flow control plan offers no incentive to trade with anyone but oneself. He added that the PEA proposal is more conducive to formation of a market. Mr. Belanger commented that the PEA proposal disconnects the real value of banked allowances from those in the marketplace. When the bank is large, the flow control mechanism prices withdrawals of more than 10 percent at a higher rate. That feature is absent in the PEA proposal as a means of protection against higher costs. But, Mr. Belanger noted, the overall economy is still operating with 2:1 pressure. Mr. Brisini then stated that all of this information is public. If a company does not have 1:1 allowances, others will know that this company needs 1:1 allowances and will sell theirs at a higher rate. Mr. Brisini used this example to illustrate his contention that the bottom line is market price. He added that there is no recourse for what different states do. As his example indicated, words and actions are vastly different. Another participant asked whether the OTC progressive flow control proposal would make the system more vulnerable to state deviations and whether the alternative (PEA) proposal offers a better system to address the problems. The group then discussed related issues including states rights, market effects, and various hypothetical situations. At this point, Bill Shobe concluded that the discussion centered on the issue of potential savings in the cost-effectiveness of the program versus the risk that some people's credits will have less value due to the activities of others. In response, Mr. Goffman commented that the question is not whether one approach or the other has an advantage. Under progressive flow control, people will bank as much as they can to get a larger portion of 1:1, within 10 percent. If enough people follow this lead, the result is a larger bank and fewer emissions. He concluded that market-based programs are cheaper because one can go to the cheapest sources and control fewer tons. Comments At this point, one of the participants attempted to clarify and synthesize the various points that had been raised by suggesting that the information be summarized for OTAG. Mr. Brisini reminded the group that his intent is not to change anything about progressive flow control but to establish whether the trigger would be regional or company-specific. One participant asked how the regional concept would be received by the rest of OTAG. Variables include whether states or companies in OTAG prefer the certainty of 10 percent at 1:1, with 2:1 if necessary; or whether they want allowances available at 1:1 to be contingent on everything else. Mr. Belanger raised the issue of the OTAG budget and the question of which system would be more effective at limiting the margin by which any given year's budget can go over 100 percent. Dean Van Orden then joined the discussion. After listening to the various points presented, he concluded that the PEA proposal and the OTC proposal vary only slightly. He suggested that ICF Resources look at the details. Mr. Van Orden commented that the PEA proposal would be easier to sell because it addresses the timely assessment of banks, an issue important to EPA. Jim See suggested that the proponents of each system prepare written summaries of their arguments for the group. Mr. Belanger also reminded the group to consider administrative concerns. Banking Scenarios Doug Grano offered to contact ICF Resources to schedule additional modeling runs for banking scenarios. Norm Fichthorn suggested that the group provide time for additional discussion before submitting new modeling run scenarios. Mr. Fichthorn expressed concern that some of the data used previously by ICF may have been inappropriate. He added that it would not be productive to proceed with ICF before consulting other members of OTAG, particularly the Implementation Strategies and Issues Workgroup. Mr. Belanger suggested inviting Bruce or Sam to the task group meeting on April 10. Mr. Fichthorn recommended that this discussion be held with the entire Trading/Incentives Workgroup and coordinated with the larger OTAG effort. He added that the information must be consistent for all of OTAG if it is to be useful. LeeAnn Kozak agreed with Mr. Fichthorn and emphasized the need for consistency in assumptions. She also requested information on ICF's consideration of other variables, including costs, technology, and options to meet limits. In response to concerns about past ICF modeling, particularly in relation to anticipated growth, Mr. Grano indicated that ICF had considered both growth and controls in its work. ICF also considered factors related to the increasingly competitive nature of the industry. Mr. Grano reminded the group that any changes in assumptions might be difficult for ICF to adopt at this point. Mr. Belanger and Ms. Kozak responded that at least they will know the difference between assumptions used in ICF modeling versus other OTAG modeling work and will consider results accordingly. Closing Remarks and Announcements Mr. Belanger notified Lynne Dayton that he had E-mailed the NERA report to her attention and requested that she forward it to group members in advance of the April 10 meeting. He added that Mr. Damer will present the report during the upcoming meeting. Suzanne Simoni asked Mr. Belanger to set a time and prepare an agenda for the April 10 meeting. Although several people are unable to attend, the group agreed to meet at the Crystal City Doubletree Hotel in Arlington, Virginia, on Wednesday, April 10, at 2:00 p.m. Mr. Belanger suggested the following agenda items:  Presentation on ICF modeling, including methodology, variables, and future adaptation -- Bruce or Sam. o Discussion of the Banking Flow Control Mechanism, including review of OTC and PEA proposals and input from other OTAG groups -- speakers to be determined. o Development of new banking scenarios for ICF, if the group is satisfied with the presentation on ICF modeling. Because Mr. Brisini, Mr. Van Orden, and Mr. Keller are unable to attend the April 10 meeting, Ms. Simoni asked who might be available to present the PEA proposal. Mr. Keller suggested that someone from PEA could stand in and offered to locate an appropriate representative. He will ask that individual to contact Ms. Simoni to make arrangements. In closing, Mr. Belanger thanked the participants for joining today's conference call. The call concluded at approximately 5:15 p.m. Update from Mr. Goffman/April 4, 11:25 a.m. During the call on April 2, a participant asserted that EPA has stated that its Acid Rain Division "cannot implement the progressive flow control provision" of the OTC NOx Model Rule in its current form--with the trigger based on the ratio of the region-wide bank to the region-wide annual allocation. Following the call, Mr. Goffman contacted Claire Schary and Brian McLean of the Acid Rain Division for confirmation or clarification of this issue. He learned that implementing the progressive flow control provision in its current form is completely feasible provided that 1) EPA has sufficient time to instruct the contractor to write the provision into the software that will operate the OTC NOx tracking system, and 2) EPA has more than 30 days after the end of the source's true-up period to complete its--EPA's--true-up of the ATS accounts. Mr. Goffman believes that someone from the Acid Rain Division will be present at the meetings on the afternoon of April 10 and morning of April 11 for additional questions.