ERC Markets Experience Increased Volatility from Stroke-of-the-Pen Events
A complex web of factors impact emissions markets across the country. Informed stakeholders participating in the emission markets, balance in-depth understanding of regulation and policy, technical data, capital project horizon, portfolio optimization, risk tolerance, and transactions.
Emissions markets inherently have “stroke-of-the-pen” risk and are subject to substantial price movements. We have seen this dynamic play out recently in several markets across the country. A ready example is the previously covered D.C. Circuit Court of Appeals Ruling that vacated the ability for companies to rely on interprecursor trading (IPT) to satisfy offsets. Vacating IPT optionality poses substantial challenges to regulated entities like the Houston-Galveston-Brazoria (HGB) Nonattainment Area, which includes a sizable petrochemical and refining industrial complex. Element Markets has seen a run on VOC ERCs in the HGB with this flexibility removed, with petrochemical and refining companies aggressively entering the market to cover their outstanding VOC needs. VOC prices in HGB have increased almost 100% in less than four months, and it would not seem surprising to us if this trend continued in the short-to-medium term.
While a 100% increase in four months sounds extreme, that outcome pales compared to the “stroke-of-the-pen” impacts we see in other markets. For example, the wake of the EPA’s revised Cross State Air Pollution Rule (CSAPR), finalized on March 15, 2021, resulted in a 10x multiplier in pricing for NOx allowances in this seasonal market.
The emission reduction credit market within the San Joaquin Valley Air Pollution Control District (SJVAPCD) was also dramatically impacted by a similar “stroke-of-the-pen” event. Historically, SJVAPCD’s ERC program has been distinct from federal offsetting requirements required by the Clean Air Act. This difference was permitted by the EPA insofar as SJVAPCD’s ERC program was at least as stringent as the federal requirements for criteria pollutants (VOC, NOx, SOx, PM and CO) as it pertains to offset quantity and surplus value.
As of late 2020, SJVAPCD is not able to demonstrate equivalency with offset quantity and surplus value tests for VOC and with surplus value tests for NOx. As a result, all VOC and NOx used for compliance/offset purposes must be surplus at the time of use. SJVAPCD estimates that only around 21% of existing VOCs and 16% of existing NOx in the bank meet federal surplus requirements. This dramatic, ~80%+ reduction in supply has resulted in a 15x increase in VOC prices since December 2020. NOx prices have been slower to react but will likely see large increases unless SJVAPCD can pass federal equivalency tests for surplus value for both pollutants.
HGB Ozone Air Quality Update
It seems fair to characterize Covid-19 and its associated international shutdowns as a “black swan” event in 2020. One secondary effect of Covid-19 having curtailed economic activity is that it appears to have improved air quality in areas such as the HGB area.
As shown in the chart below, the transportation sector was impacted as well.
Based on the data, it seems safe to say that overall emissions into the airshed were reduced, as reflected by the area air monitors. An important metric in this area is the 4th High reading. The 4th High reading for each area air monitor is what is relied upon to determine a three-year average ozone concentration. It is a critical value to determine compliance with the National Ambient Air Quality Standards (NAAQS). The highest 4th High ozone reading in HGB in 2020 was 75 ppb.
Fast forward to 2021, and it appears the area is trending back to pre-Covid-19 levels of activity, including industrial activity and mobility levels, which looks to correspond with pre-Covid-19 levels of emissions. Not surprising is that the HGB area has already registered several data points above the 75 ppb threshold, with the 4th High ozone reading for 2021 (as of July 26, 2021) reported as 78 ppb (see table below).
As of July 20, 2021, the HGB area has missed the deadlines to meet the 75 ppb three-year average, passing the threshold to be “bumped up” to Severe Nonattainment status for the 2008 Ozone Standard. However, areas can request (as TCEQ has done) extensions if in the deadline year the 4th High for that year is at or below the NAAQS threshold. This dynamic may create a potentially tricky scenario for stakeholders, including regulatory agencies, to navigate. For example, questions could center on how an air-quality extension could be granted for a Covid-19 depressed activity year when the current year shows air quality has returned to pre-Covid levels, including ozone levels above the NAAQS standard. Element Markets will continue to monitor the situation as it evolves.