Several recent developments, including two Circuit Court decisions last week, will have a significant impact on the Nonattainment New Source Review (NNSR) and Prevention of Significant Deterioration (PSD) (collectively NSR) rules, and will affect both permitting strategies and ongoing enforcement actions.

"Modifications" are subject to NSR requirements only if physical or operational changes result in an increase in the hourly emission rate (U.S. v. Duke Energy Corp. (4th Cir. June 15, 2005))

Under US EPA's long-standing NSR rules, a source modification was subject to NSR permitting requirements if a physical change enabled a source to operate more hours per year and would increase future annual emissions, even if the physical or operational change did not increase the hourly emission rate. In U.S. v. Duke Energy Corp., the US Court of Appeals for the Fourth Circuit rejected this rule, finding that US EPA must use the definition of "modification" in the New Source Performance Standard (NSPS), which covers only physical or operational changes that cause an increase in the hourly rate of emissions. The Fourth Circuit reasoned that the Clean Air Act does not permit US EPA to use a different definition for "modification" in the NSPS and NSR rules. Unless and until US EPA goes through rulemaking to change the NSPS definition to be consistent with the NSR definition, the NSPS definition controls.

Although we do not yet know how US EPA will react, we anticipate that the decision will have the following near-term effects:

• The government is expected to petition for a rehearing before the entire Fourth Circuit panel.
• The decision directly affects projects in the Fourth Circuit states (West Virginia, Virginia, Maryland, North Carolina and South Carolina). Although the Court's rationale is not geographically limited, the agency may attempt to limit its application to those states.
• In making NSR applicability decisions or in defending enforcement claims, you will be able to take into account the Court's finding that existing sources should not trigger NSR unless a change increases the hourly rate of emissions.
• According to the Fourth Circuit decision, US EPA could, through rulemaking, revise the NSPS interpretation of "modification" if it wanted to use the previous NSR approach for both programs. In the meantime, the less inclusive NSPS applicability test applies.
• The decision could have a chilling effect on future NSR enforcement actions relying on the Past-Actual-to-Future-Potential Test to show that a change should have triggered NSR. Even if it does not deter US EPA enforcement, defense positions will be strengthened.

US EPA's 2002 NSR Reform Rules are Largely Upheld

On June 24, 2005 the DC Circuit Court of Appeals rejected most of the challenges to US EPA's first round of New Source Review Reform rules in New York, et al. v. U.S. EPA, Case No. 02-1387 (D.C. Cir. 2005).

The Court accepted the primary elements of the NSR reform rule's Actual-to-Projected-Actual Test over the objections of New York and the other state and public interest petitioners. The Court accepted the following NSR Reform Rule components:

• US EPA can allow industry to use a 10-year look back (five years for utilities) to find the 24-month baseline period representing the highest annual utilization rate for establishing past actual emissions.
• US EPA can exclude from the post-change emissions all increases associated with production demand unrelated to the change that the source could have achieved during the baseline period (the so-called "demand growth exclusion").
• US EPA can use the Plantwide Applicability Limit (PAL) procedure in the NSR Reform Rule to give sources greater flexibility to make changes without triggering NSR, provided that they do not exceed a facility-wide emissions cap.

The Court determined that the NSR Reform Rule exceeded US EPA authority in the following ways:

• US EPA cannot excuse a source from recordkeeping based on the mere representation that no reasonable possibility exists for the source to exceed its projected future emissions. This portion of the rule was remanded to US EPA with instructions to revise the provision or improve the justification.
• US EPA cannot excuse Clean Units from NSR based on their previous status as state-of-the-art-controls because the Clean Air Act requires that NSR applicability be triggered based on actual emissions resulting from a change. This provision has been vacated by the Court, which strikes it from the rule.
• US EPA cannot excuse Pollution Control Projects from NSR based on the net environmental benefit of the project because the Clean Air Act requires that NSR applicability be triggered based on actual emissions resulting from a change. This provision has been vacated by the Court, which strikes it from the rule.

This is a national rule affecting all major stationary sources undergoing physical or operational changes. While most states may implement more stringent NSR requirements, states may not be less stringent. Therefore, the Clean Unit and Pollution Control Project exclusions stricken by the Court will not be available under state rules. Some states are expected to develop and implement more stringent NSR requirements, which will further complicate NSR applicability determinations.

The central pieces of the NSR Reform Rule have been affirmed by the DC Circuit. Fewer physical changes are likely to trigger NSR with the 10-year look back for establishing baseline emissions and the ability to use future projected actual emissions instead of future potential emissions to determine whether the project's emission increase is significant. The Court has made clear that the Clean Unit exclusion and the Pollution Control Project exemption will require a legislative change to the Clean Air Act. Recent attempts to revise the Clean Air Act have been stymied by deep divisions in Congress, which are likely to discourage near-term attempts to address these issues.

The Court decisions both clarify and complicate NSR applicability determinations. While these Court decisions address similar territory, the DC Circuit in New York v. US EPA expressly declined to confront the hourly emission rate issue that was before the Fourth Circuit in Duke Energy. As such, the DC Circuit leaves the door open for sources to use Duke Energy to support a determination that NSR is not required for a change that will not increase an hourly emission rate. US EPA will be looking for ways to close that door.

Other NSR Developments

On June 6, 2005 US EPA completed its "reconsideration" of the Routine Replacement Rule and concluded that no substantive changes to the rule are needed. In this rule, US EPA defined for the first time the NSR exemption for routine replacements. A replacement is routine if: (1) the new equipment is functionally equivalent to the equipment that is being replaced; (2) the new equipment does not significantly increase the capacity of the unit, and (3) the fixed capital cost of the replacement is less than 20 percent of the cost of a comparable new emissions unit. This "safe harbor" has been stayed by the DC Circuit until the Court can decide the merits. US EPA's decision on reconsideration clears the way for this NSR Reform provision to be briefed and decided by the Court (projected for 2006).

If you have questions or concerns regarding how these developments will likely affect changes at your facility, contact any of the Squire Sanders lawyers listed in this update.