State Of California The Resources Agency Of California


M e m o r a n d u m
      Date: August 5, 1998
      Telephone: (916) 653-1614

To: Jananne Sharpless, Presiding Member    
        Robert A. Laurie, Associate Member
    


From:   California Energy Commission   - RICHARD K. BUELL
                                                                          Siting Project Manager



Subject: High Desert Power Project (HDPP) ~ Staff's Response to the HDPP Committee's
            July 20, 1998 Order Directing Clarification (97-AFC-1)


On July 8, 1998, Allan J. Thompson, counsel for the High Desert Power Project, LLC (the applicant), filed with the Energy Facility Siting Committee a "Request for Commission Staff Guidance-Docket No. 97-AFC-1", regarding staff's position on Emission Reduction Credits (ERCs) in the HDPP case. On July 20, 1998, the HDPP Committee issued an "Order Directing Clarification". This Order directed staff to answer a series of questions regarding the provision of ERCs in the HDPP case. The following are our responses to the questions raised in the July 20, 1998 Order, and a brief discussion of our position on the policy issues raised by the Applicant's July 8, 1998 request:


A. What is Staff's position concerning identifying and securing ERCs in the High Desert case?
  1. Specifically, does Staff contend that ERCs must actually be purchased prior to preparation of the air quality portion of the FSA?
    1. If so, and on what basis?
    2. Are there other arrangements other than actual purchase, which in Staff's view, would indicate that ERCs have been identified and secured?
    3. If there are such other arrangements, indicate what these arrangements are and define what is meant by each (e.g. options, binding contracts, letters of intent, etc.).
    4. Explain any differences which may exist between each of these other arrangements and the actual purchase of ERCs.

Answer: Our position is that 45 days prior to the preparation of the FSA, the applicant must provide evidence of the likely amount and location of ERCs that the project will use.{ 1 } This can best be accomplished by demonstrating that: (1) sufficient ERCs exist; (2) the ERC owner has indicated a willingness to sell the ERCs to the applicant; and (3) a preliminary understanding of the contract terms has been reached between the parties. The latter two elements can be demonstrated by any of the following: a) a letter of intent (which is not a binding contract in that it does not create any legal obligations of performance, but does indicate both an intent to enter into a contract and the parties' preliminary understanding of the contract); b) a statement under oath at a Committee hearing by both parties that they intend to enter into a sales or option agreement and have reached a preliminary understanding of the contract terms; or c) any other means that demonstrates that specific ERCs are likely to be obtained for the project. Although a binding contract{ 2 } would also satisfy the later two elements, we do not believe that binding contracts are necessary to demonstrate that elements (2) and (3) have been satisfied. We believe that the applicant has not provided sufficient evidence of any of the three required elements thus far in the proceeding.


B. Does Staff contend that ERCs must be purchased prior to conclusion of the Commission's licensing process (e.g. pre-FSA, pre-Final Determination of Compliance, pre-evidentiary hearing, pre-Final Decision, etc.)?
  1. If so, specify at what point and the authority supporting this position.
  2. If not, at what point must ERCs be purchased (e.g. pre-Authority to Construct, pre-construction, pre-operation, etc.)?

Answer: We contend that the applicant must obtain ERCs (either under an option contract or a sales contract) any time prior to the Energy Commission's decision on the project. The authority for this position is found in Public Resource Code section 25523 which specifies the contents of the Energy Commission's decision on an application. Subsection (d)(2) states that "the commission shall not find that the proposed facility conforms with applicable air quality standards . . . unless the applicable air pollution control district or air quality management district certifies that complete emission offsets for the proposed facility have been identified and will be obtained by the applicant prior to the commission's licensing of the project. . . " District certification and evidence that the applicant has in fact purchased ERCs must be sponsored by a witness into the evidentiary record at a hearing prior to issuance of the Presiding Members Proposed Decision.

The applicant may choose to provide evidence that it could purchase more ERCs than required order to provide flexibility to negotiate a better price or conditions for obtaining ERCs. In cases where the purchase contract or the option contract provide for contingencies, making the purchase of the ERCs uncertain, staff may recommend that the Commission require evidence of purchase of additional ERCs in order to ensure that sufficient ERCs are obtained prior to the Energy Commission's license. In either case, the advantage of providing evidence of the additional ERCs is that the district and staff will be able to analyze the acceptability of these additional ERCs prior to the Energy Commission certification. If the applicant were to delay consideration of alternative ERCs until after certification, this could require analysis in a potentially time critical amendment process and undermine the Commission's policy of resolving all significant issues in the case prior to certification.


C. Is Staff's position in the High Desert case consistent with the requirements imposed by the Commission in previous recent Application for Certification decisions? In responding, verify the requirements imposed in the cases mentioned in the July 8, 1998 Status Report Number 6, among others.

Answer: Our position is consistent with the requirements imposed in other recent AFC decisions. As discussed in our Status Report Number 6, evidence of sales contracts or options contracts for all offsets was included in the evidentiary record in the San Francisco Energy Company (SFEC), Procter & Gamble Cogeneration, Campbell Cogeneration, and Crockett application for certification (AFC) proceedings.

In the Campbel Cogeneration case, for example, the actual completion of the District's banking process, and the surrendering of ERC certificates to the District, was not required until prior to construction. Thus, the Commission decision contained both the mandatory finding that the ERCs would be obtained prior to the decision, which was based on the District certification and evidence of sales or option contracts, and Conditions of Certification requiring the completion of the banking process prior to either operation or construction.


D. What criteria are Staff using to implement the existing Commission policies concerning ERCs in this case?

Answer: We are unaware of any existing Energy Commission policies concerning ERCs, other than the policy of implementing Public Resources Code (Pub. Resources Code) section 25523(d)(2) by making a finding in the decision on the case that the required district determination was provided, and making a finding in the decision on the case about the conformity of the project with applicable air standards and other relevant laws pursuant to Pub. Resources Code section 25523 (d)(1).


E. What is the United Stated Environmental Protection Agency's (USEPA) current interpretation of federal law as it pertains to the timing of obtaining ERCs and the nature of the arrangement by which ERCs are identified and secured?

Answer: The U.S. Environmental Protection Agency (EPA) indicated that it would provide a clarification of their June 19, 1998 comments on the Mojave Desert Air Quality Management District's preliminary Determination of Compliance on August 3, 1998. On August 4, 1998, EPA requested additional time to provide clarification, and indicated it expected to have a response the week of August 10, 1998. Pending receipt of EPA’s response, we reserve our response to the Committee's question.


F. Are Commission requirements consistent with federal requirements as interpreted by USEPA?

  1. If so, explain.
  2. If not, explain the nature of any differences and the reasons therefor.

Answer: EPA will provide a statement explaining when federal requirements mandate that ERCs be obtained. However, we note that federal law does not prohibit a state from requiring ERCs be obtained earlier in the process. Thus, while the federal requirements may be different from state requirements, which direct that offsets be obtained prior to an Energy Commission decision, they are in no way inconsistent with state law.

DISCUSSION

INTRODUCTION

This discussion provides context for the specific answers provided above. It summarizes the informational requirements relating to ERCs at the different stages of the Energy Commission's licensing process, and explains the rationale for each set of requirements. We believe it is appropriate that different requirements for ERC information be imposed at different stages of the AFC process, and we agree that all parties will benefit from resolution of any confusion that may exist about these requirements.

DATA ADEQUACY

For purposes of data adequacy, the Energy Commission's regulations require that the applicant provide an estimate of the quantity of offsets needed, an identification of potential offset sources including location and quantity, and identification of the method of emission reduction. (Appendix B(g)(8)(J)) In simple terms, the applicant must indicate how many ERCs will be required, and how and from what source those ERCs may be provided. This provides staff, interested agencies, and the public with a basic understanding of the applicant's proposed offset strategy.

DISCOVERY - REQUIRED INFORMATION

During discovery, additional information about the proposed ERCs is needed. Specifically, in order to provide a complete assessment of the project, its impacts, and the effectiveness of any proposed mitigation, we need to be able to assure the Energy Commission and the public that the proposal outlined in the application is likely to be implemented. Thus, at least 45 days prior to the FSA, we require the applicant to demonstrate that 1) sufficient ERCs exist; 2) the ERC owner(s) has indicated a willingness to sell sufficient ERCs to the applicant; and 3) a preliminary understanding of the contract terms have been reached between the parties.

Thus, the first element of our analysis is to determine whether sufficient ERCs exist. We begin with the ERC requirements established by the local air pollution control district. In this case, the Mojave Air Quality Management District (District) has identified an ERC liability of 464 tons of nitrogen oxide (NOx), 229 tons of volatile organic compounds (VOC), and 139 tons of particulate matter less than 10 microns (PM10). We believe that the applicant has demonstrated that sufficient VOC and PM10 ERCs are likely to be available. However, there is a serious issue about the availability of NOx offsets. The District bank currently contains no NOx offsets, and the District's proposed decision to issue 165 tons of NOx offsets to PG&E in the first of four pending banking applications has been questioned by staff, Air Resources Board (ARB), and EPA, none of whom support the District's proposed decision.{ 3 } We do not know the current status of the other three applications, but are concerned that they could raise the same issues.

Once we determine that sufficient ERCs have been identified, we assess whether the applicant has demonstrated that they are likely to be available for the project. As stated above, we consider whether the owner of the identified ERCs has indicated a willingness to sell sufficient ERCs to the applicant and whether the parties have reached a preliminary understanding of the contract terms. The existence of these two elements provides sufficient assurances that the ERCs will be used as described for staff to draw conclusions in its FSA about the environmental consequences of the project. Finally, although the actual provision of offsets through a sales or option contract is not required for staff's environmental analysis, we assess the likelihood that the applicant will provide such contracts prior to the final Energy Commission decision, as required by Public Resources Code section 25523(d)(2).

As noted above, we believe that there are several ways an applicant can establish the necessary assurances that the identified offsets will be used for the project. Obviously, sales contracts or option contracts would provide more than the required level of certainty. Letters of Intent may also be sufficient for purposes of completing the FSA, if they indicate that serious negotiations have been undertaken and that the parties are confident that they will be able to arrive at mutually agreeable contract terms in time for the applicant to obtain the offsets prior to the Energy Commission's decision. In response to the Committee's questions, we identified several types of arrangements that the applicant and ERC source could enter into, including options, binding contracts, and letters of intent. The Committee also requested that staff explain the differences between these arrangements and actual purchase. In short, an option is a bilateral contract in which the buyer has the absolute right to buy property at a specified price within a specified period of time. A binding contract is any contract under which the parties have legal obligations of performance; it includes an option contract and a sales contract. A letter of intent is not a binding contract in that it does not create any legal obligations of performance, but merely indicates the preliminary understanding of the parties who intend to enter into a contract. A sales contract is a contract under which title to the property passes upon the performance of the buyer, which is usually the payment of the sales price.

However, staff cautions the Committee that it may be unproductive to focus solely on the types of arrangements between the owner of ERCs and the applicant that are required for preparation of the FSA. A more fundamental issue exists in this case -- the applicant has not demonstrated that there are sufficient NOx ERCs available. The inability of the District to successfully process any banking applications for NOx ERCs that have been identified by the applicant raises serious doubts about both the availability and amount of offsets, and the applicant's ability to demonstrate that it can obtain and use them. As a result, it would be appropriate for the Committee to address whether there are sufficient NOx ERCs available for the project as well the adequacy of the letters of intent provided by the applicant on June 15, 1998. It would be unfortunate if staff based its analysis on letters of intent or option contracts to purchase ERCs that are not valid under state and federal law. Not only must we know the location and methods used to achieve emission reductions for the proposed ERCs, we must also have some reasonable level of certainty that a sufficient amount of valid offsets exist, and that the applicant will obtain them. None of these elements has been provided in the High Desert Power Project.

DISCOVERY - ANALYSIS

After the required information is obtained, we conduct our analysis. We consider two issues related to ERCs. The first issue concerns the location of the ERCs. In evaluating a project's impact and the effectiveness of mitigation, we determine where the project impacts will occur and assess whether the proposed ERCs will ameliorate that impact.{ 4 } (Pub. Resources Code section 21100; Cal. Code Regs., tit. 20, section 1742.5; Cal. Code Regs., tit. 14, section 15126) We acknowledge that this assessment is difficult, in part because determining the extent and location of impacts attributable to either the project or the mitigation (ERCs) is imprecise at best. Moreover, the Energy Commission has long supported the use of market-based regulatory mechanisms as providing a more economically efficient way of controlling environmental impacts associated with energy projects. A properly-functioning banking rule is just such a mechanism, and allows Districts to impose emission reduction requirements at a lower cost than would otherwise be possible. However, a bank can allow project emissions to be offset with ERCs that have no correlation to the impacts created by the project. In this situation, it is not clear that the ERCs constitute "mitigation" as defined in CEQA, thereby raising the question of whether the project's emissions are a potentially significant impact. (Cal. Code Regs., tit. 20, section 15370)

We balance the two objectives of supporting market-based mechanisms, such as emission banks, and encouraging the use of ERCs that actually minimize project impacts by recommending selection of ERCs that can be shown to create ambient air quality benefits in the same general location of project impacts. This demonstration requires staff to consider the actual location of the offsets, as well as the trends in ambient air quality in the District (which provides an indication of the effectiveness of the District's attainment efforts), and the level of trading activity that occurs (which provides an indication of whether the District banking mechanism has created a robust market throughout the district, accommodating any discrepancies between the location of offsets and location of projects for which offsets are acquired). Thus, we need to know at least 45 days prior to the FSA where the offset sources for the project will be located. In the High Desert Power Project, all of the NOx ERCs identified by the applicant are in the same general vicinity as the project. Staff will provide a final determination as to whether the location is acceptable in the FSA.

The second issue concerns secondary impacts. Under CEQA, when a project creates secondary impacts, those impacts must be analyzed in the Lead Agency's environmental review of the project. (Pub. Resources Code § 21083) For example, if the road-paving actions of the applicant, taken to mitigate project PM10 emissions, could create secondary effects by exposing the public to excessive noise or dust, the Energy Commission would need to consider those impacts in its environmental analysis. In the High Desert Power Project, the only secondary impacts that staff is aware of are those that may be created by the proposal to offset the project with NOx ERCs created by substituting coal with tires as a fuel at a cement facility. However, as those ERCs are created under the District's banking rule, staff believes that the District will be required to evaluate that issue in its review of the ERC application. We plan to participate in that process to ensure that the issue is fully addressed. Proper consideration of the issue by the District will preclude the necessity of Energy Commission review of the same issue.

ENERGY COMMISSION DECISION

Public Resources Code section 25523 (d)(2) states that "the commission shall not find that the proposed facility conforms with applicable air quality standards . . . unless the applicable air pollution control district or air quality management district certifies that complete emission offsets for the proposed facility have been identified and will be obtained by the applicant prior to the Commission's licensing of the project." Thus, the Mojave Air Quality Management District (District) must make a finding that the applicant will obtain ERCs prior to the final Energy Commission decision on the project, which requires the applicant to purchase ERCs (either under an option contract or a sales contract) prior to the Energy Commission decision on the project. Moreover, as this section requires that the Energy Commission receive this certification prior to writing its proposed decision, the Energy Commission must hold a hearing prior to the proposed decision's release in order to properly receive the determination into the record of the proceeding. At that same hearing, the Energy Commission confirms the District certification by receiving evidence that the applicant has entered into either a sales contract or an option contract for the necessary ERCs. We believe that the Committee is best able to determine the appropriate schedule for that hearing, as the Committee, and not staff, has the responsibility of preparing the proposed decision. In any event, it can be subsequent to the issuance of the FSA and the start of evidentiary hearings on the project, but before issuance of the proposed decision.

As stated above, staff advises the Committee in its FSA on the likelihood that the District certification and evidence of contracts will be provided prior to the final Energy Commission decision. Staff performs this task because in past siting cases, the Energy Commission has expressed concern about the wisdom of continuing to commit public resources on a project which faces significant difficulties in obtaining sufficient offsets and may not be able to meet these requirements.{ 5 }

If you have any additional questions regarding staff's position or past practice regarding ERCs, we can provide additional information.

cc: Proof of Service
Ray Menebroker, ARB
Chuck Fryxell, APCO Mojave Desert AQMD
Robert G. Zeller, Mojave Desert AQMD
Matt Haber, U.S. EPA
Doug Nguyen, U.S. EPA



FOOTNOTES************************************

  1. One statement in the May 15, 1998 Draft PSA, referring to obtaining offsets prior to the FSA, was inaccurate and does not reflect the position we have asserted in the other portions of the air quality section of the PSA, written status reports, and at status conferences and hearings. We apologize for any confusion created by this one sentence.

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  2. A binding contract is any contract under which the parties have legal obligations of performance. It includes an option contract, in which the buyer has an unconditional right to purchase for a limited period of time, and a sales contract, under which the ERCs actually pass from seller to buyer.

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  3. Moreover, even were these issues to be resolved in PG&E's favor, the applicant is apparently not negotiating with PG&E for purchase of these ERCs, as PG&E is not identified in any of the letters of intent the applicant filed with the Energy Commission on June 15, 1998.

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  4. In addition to ERCs, staff also considers whether other methods of lessening project impacts are feasible, including use of alternative control technologies, specifying turbine options, and operational controls.

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  5. In several past cases, including the Irwindale Resource Recovery Facility and the Santa Maria Aggregate Project AFCs, the Energy Commission suspended, and ultimately terminated, AFC proceedings in the face of the applicants' inability to obtain sufficient offsets during the course of the AFC proceedings.

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