Court Case Against EPA’s Clean Air Interstate Rule Offers Sulfur Allowance Opportunity

Implications:     The EPA is currently being challenged in the courts by both the states and industry over various aspects of the Clean Air Interstate Rule (CAIR).  The outcome of the case could provide an opportunity for those trading SO2 allowances.

Analysis:     EPA’s program to control SO2 and NOx through CAIR is being challenged by both the states and industry over five main points.  The litigation has been consolidated in State of North Carolina, et al v. United States Environmental Protection Agency and is at the DC Circuit Court of Appeals.

    One of the five points in the legal challenge comes from industry groups that argue that the EPA does not have the right to change the law passed by Congress in the Clean Air Act Amendment regarding the surrender rate of one SO2 allowance for each ton of SO2 emissions.  Specifically, the EPA in the CAIR states requires the surrender of 2 SO2 allowances for every 1 tons of SO2 emissions starting in 2010; lowering to 2.86 starting in 2015.  Pre-2010 SO2 allowances that have not been used for emissions requirements may continue to be banked and used at the 1-to-1 surrender rate after 2010.
 
     If the Court were to rule that EPA did not have the authority to reduce the SO2 allowance surrender ratio in the CAIR states, the value of the 2010 SO2 allowance would increase because it would no longer be at a 50% value because of the 2-to-1 surrender rate; instead it would revert back to the 1-to-1 surrender rate.

    The SO2 market has priced in some of the potential for the Courts to strike down the EPA’s change of a 1-to-1 surrender rate in the Clean Air Act Amendment to a 2:1 surrender rate under CAIR.  The forward curve for 2010 SO2 allowances should trade at ½ the price of 2009 allowances less the cost of money for one year.  Currently, 2010 SO2 allowances trade at $218 versus 2009 SO2 allowances at $350.  In a market without a Court challenge, 2010 SO2 allowances should trade at slightly less than $175 each ($350/2); reflecting the halving of value of an allowance in 2010 versus 2009 and a discount for the time value of money.

    If the Court were to rule EPA did not have the authority to change the SO2 allowance surrender rate, the likely outcome would be for Congress to revisit and reduce SO2 emissions and other pollutants through a more comprehensive Law.  This comprehensive reduction would likely go into effect after 2010, with the surrender value of the 2010 allowance reverting back to a 1-to-1 surrender rate and being priced near the 2009 allowance value.  This provides an opportunity for those in the SO2 allowance marketplace.