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Smokestacks Bill Helped Utilities

State law protected Duke from lawsuit, penalties and fines — Part 1

RALEIGH—Contrary to the stated objectives of its supporters, the 2002 North Carolina Clean Smokestacks law — based on controversial environmental assumptions used to espouse questionable health benefits — may have been crafted to help protect the state’s two largest electricity suppliers from federal lawsuits and fines.

The plan, signed into law June 2002, was developed by the liberal group Environmental Defense, which had joined the federal Environmental Protection Agency in a lawsuit against Duke Energy for alleged emissions violations at seven coal-fired power plants.

After EPA filed its lawsuit against Duke for its violations, the company entered into settlement negotiations with the agency.

“We explained the details of what EPA and the (U.S.) Department of Justice were looking for,” said Bruce Buckheit, former director of the EPA’s Air Enforcement Division, “then Duke broke off settlement discussions while they looked into the Smokestacks legislation.”

George Givens, a General Assembly analyst who helps write legislation, acknowledged that the Smokestacks law helped Duke with its federal difficulties.

“The work required under, and thus the cost of compliance with, any federally required upgrade would, at least for the most part, overlap the work required under, and thus the cost of compliance with [Smokestacks],” Givens wrote in a memo June 8, 2002, just before the bill became law.

A last-minute change in the law said that if the EPA required stronger controls than the Smokestacks bill, which was highly unlikely, then the costs wouldn’t be recoverable under the new state law.

“The intent of this change is to encourage rather than discourage settlement of any litigation,” Givens wrote, “ensure that the utilities get the ‘benefit of their bargain’ under [Smokestacks], and ensure that any costs that may be incurred beyond [Smokestacks] for a violation of federal law will not be covered by [Smokestacks].”

Asked whether the pending EPA lawsuit influenced Duke’s decision to support the Smokestacks bill, company spokesman Thomas Williams said, “Not a bit.” When informed of Buckheit’s comments, Williams said, “We’re not going to comment on settlement discussions that were going on at some point.”

Also, as the Smokestacks bill was passed, Duke was under scrutiny from auditors working for utilities regulators in North Carolina and South Carolina.

The Charlotte-based power supplier had been exposed by one of its own accountants for under-reporting its earnings, because Duke was allowed only a 12.5 percent return on its equity by the North Carolina Utilities Commission. The audit found that Duke officials made illegal accounting adjustments in order to hide their excessive earnings.

What Duke got, as well as Progress Energy, out of the Smokestacks law was a promised five-year “rate freeze” from state lawmakers and regulators, which funded the costs of the expected $2.3 billion pollution controls. Duke’s excessive earnings were also preserved. Without the Smokestacks law, Duke and Progress Energy would have been subject to a N.C. Utilities Commission rate review that would have scrutinized all their expenses, including any new emissions controls. Had a freeze not been implemented, rates for North Carolinians almost certainly would have gone down, perhaps significantly.

“We believe that the goal of the Clean Smokestacks Act should be to protect the citizens and the environment, not the excessive profits of Duke,” said Sharon Miller, executive director of the Carolina Utility Customers Association, which represents industrial and other customers in the state.

EPA files lawsuits

In November 1999 the EPA and the U.S. Department of Justice announced a new enforcement initiative against some Southern and Midwestern electric utilities. Attorney General Janet Reno filed seven lawsuits on behalf of the EPA against the utilities because of their failure to properly upgrade emissions technology on the smokestacks of some of their coal-fired power plants. EPA also filed an administrative order against the federally owned Tennessee Valley Authority for its violations.

Ensuing months and years saw some of the utilities enter settlement agreements with EPA and the USDOJ. The first to reach an agreement was Tampa Electric Company, which was forced to spend $1 billion to install stronger emissions controls on its coal-fired power plants. The company also agreed to pay a $3.5 million civil penalty and to spend $10 million to $11 million on mitigation projects for its emissions.

Other companies later reached costly settlements with the EPA. In April 2003 Virginia Electric and Power Company agreed to spend $1.2 billion on emissions controls and to pay a $5.3 million civil penalty and at least $13.9 million on mitigation projects. Cinergy Corp. of Ohio also agreed to add $1 billion worth of pollution controls.

In May 2000 EPA issued to Duke Power a Notice of Violations letter for eight of its coal-fired plants, and the following December added the North Carolina utility to its list of lawsuit defendants. The litigation was based on a section of the federal Clean Air Act called New Source Review, which required utilities to implement the best available emissions reduction technology during certain types of upgrades to their plants.

Progress Energy (then called Carolina Power & Light) was also under scrutiny by the EPA, and in 1999 and 2000 received requests for information by the federal agency about eight of its power plants. Company spokeswoman Dana Yeganian said the EPA’s pending litigation against the other utilities did not drive Progress to support the Smokestacks bill.

Reduce mountain haze

Concurrently North Carolina residents, especially in the mountains, and environmentalist groups pressured lawmakers and utilities to address their complaints about increasingly poor air quality. Throughout 2000 the groups campaigned for stronger emissions controls on the smokestacks of the 14 coal-fired power plants in the state owned by CP&L and Duke, and crafted an effective postcard campaign from citizens who begged for the controls.

The utilities, which acknowledged partial responsibility for the state’s ozone levels, pushed for less-stringent controls on its plants than environmentalists wanted. CP&L and Duke realized the equipment, called Selective Catalytic Reduction and “scrubbers,” would cost hundreds of millions of dollars and require rate increases. The utilities even started a counter-campaign to the environmentalists, asking supporters to write state regulators. According to an October 2000 News & Observer of Raleigh article, former CP&L employee W.G. Bowers of Raleigh wrote that “the company shouldn’t have to spend millions without any guarantee it will solve the problem.”

By March 2001 a dozen liberal activist groups, led by Environmental Defense, backed the North Carolina Clean Smokestacks Plan. The conservationists worked with two Western Democratic legislators from Asheville, Sen. Steve Metcalf (now retired from office) and Rep. Martin Nesbitt (now a state senator), to pressure the utilities and to sponsor the Smokestacks bill in the General Assembly. Nesbitt did not return phone messages seeking comment for this article.

“[Nesbitt and Metcalf] kind of played hardball with the utilities,” Michael Shore, Southeast air quality manager for Environmental Defense, told The News & Observer in April 2001. Shore authored the N.C. Smokestacks Plan, which served as the basis for the bill.

But the Smokestacks bill did not provide any new meaningful authority for the state to force utilities to reduce their emissions. The EPA’s pending litigation and settlement negotiations with Duke would have effectively forced the company to install equipment to reduce its emissions of sulfur dioxide and oxides of nitrogen.

Nor would the bill have improved visibility in the mountains (although on several occasions supporters would promote the bill as doing so), since pollution sources west of North Carolina were primarily responsible for that problem. Provisions in the Smokestacks bill for the state attorney general to pursue legal action against other states already existed in federal law.

State senators from both political parties were brought quickly on board, and even signed a letter April 4 (the date the bill was filed in the General Assembly) to President Bush pleading for the TVA to be investigated about its emissions. The letter revealed that the lawmakers understood that the Smokestacks bill would do little, if anything, to improve the visibility problem.

“Even with [the pending Smokestacks bill] the air quality in the western part of our state will not be improved,” they wrote. “Until we address TVA, we cannot begin to recover.”

Selling Smokestacks at DENR

Shore, who left employment at North Carolina’s Department of Natural Resources in 2000, was back meeting with his colleagues in the Division of Air Quality in April 2001. His goal: persuade them to support the bill and get their boss, Gov. Mike Easley, to commit to its passage as well.

Shore’s plan — much of it based on questionable data and controversial assumptions — was received by DENR Secretary Bill Ross without much scrutiny of the plan’s details. Among Shore’s claims was that Duke and CP&L’s cost of compliance with the new emissions standards would be only a combined $449 million. Actually, the two utilities will be writing off $2.3 billion for the equipment in the next seven years.

Shore and Environmental Defense public information officials did not respond to several e-mails and phone messages seeking comment.

Still, air-quality officials, after a meeting April 3 about the Smokestacks bill near Metcalf’s office, began deliberating about how to garner support for it from Easley and the House. In response to a request from Ross, Shore e-mailed a list of points for Ross to use “as you encourage Gov. Easley to support the N.C. Clean Smokestacks Bill.” Among Shore’s reasons were:
• “Protect public health and the environment… enumerated in the (Smokestacks Plan). This bill is possibly the most significant piece of air quality legislation in North Carolina in decades.”
• “The bill is endorsed by both the environmental community and utilities… also quite politically safe consider[ing] that both sides endorse it.”
• “Strong support in Senate….”
• “Easley support is critical to passage in the House. If he supports the bill early, he can take credit for this clean air initiative.”
• “Easley can… make the Clean Smokestacks his issue, get significant points with the environmental community and the general public, and fulfill a campaign promise.”
• “Credit by the press… If he waits for editorials to come out, he will seem like a laggard, even if he eventually supports the bill.”
• “Be a leader among governors in the Southeast.”

Shore also argued that the bill would be good for economic development, but acknowledged that “this bill could put N.C. at a competitive disadvantage because of marginally higher energy prices.”

Health benefits an afterthought?

Documents obtained by Carolina Journal largely paint a picture of a bill presented by an environmental group, not the state agencies that address environmental issues. Statements show that support was given based on political considerations rather than real changes in air quality in the state. Only after the bill moved through the Senate and governor’s office did DENR officials search for data to validate the bill’s presumed virtues. In other words, no study or modeling of ambient effects were conducted before the widespread backing for the Smokestacks bill.

“I spoke to Robin Smith (an air quality analyst) at DENR and she told me: This is an [Environmental Defense] initiative,” wrote Phil Telfer of the Department of Justice in an e-mail to two colleagues April 17, 2001. “It is not a DENR bill, but the gov(ernor) has said if it passes in its current form he will sign it.”

Communications among DENR and DAQ officials in the early days of the bill indicate that real data and health benefits were not a prerequisite for support of the Smokestacks bill. On April 6, a day after the bill was filed in the Senate, air quality director Alan Klimek e-mailed his subordinates seeking information.

“Bill Ross has indicated… that it would be great if we could get some ‘back of the envelope’ number on what a reduction from utilities of 500,000 tons [per year of sulfur dioxide] to 130,000 tons [per year] might do for our future [fine particle pollution] concerns,” Klimek wrote. “I realize we haven’t even started really thinking about this, but it would be a healthy (excuse the pun) reduction.”

Another Klimek e-mail, on April 11, showed that DAQ officials were scrambling in anticipation of having to answer questions from legislators about the bill.

“On the question of how much good this could do for [air quality], do we have a handle on what our annual [sulfur dioxide] emissions are and therefore what [percentage] reduction this means…?”

Other communications among DAQ officials indicate that some sulfur dioxide comes from North Carolina sources, but that “much sulfate is likely transport(ed).”

The Smokestacks bill required that Duke Power and CP&L reduce nitrogen oxides and sulfur dioxide beyond what federal law requires. But the state was already meeting federal air quality standards for those pollutants, and further reductions in emissions would not improve the air where concerns were greatest — in the mountains.

Still, proponents were pushing the bill as a solution for the cleansing of mountain air. According to an April 24, 2001 report in the N&O, state Sen. Steve Metcalf argued that Smokestacks would improve air quality in western North Carolina.

“I have never supported a bill… that I think is more for the children than this bill,” Metcalf said during Senate debate.

Metcalf was a signee to the April 4 Senate letter to the president claiming the Smokestacks bill would do little to clear mountain air.

Finding ‘a unified message’

Even after the bill passed the Senate DENR officials had trouble promoting it.

“Bill Ross discussed with me the fact that the proponents of this bill were not able to make a strong case on its benefits when it was being debated in the Senate,” Klimek wrote in an e-mail April 27 to Shore and representatives of the two utilities. “He would like us to see if we can get a one-pager together summarizing these benefits. The idea would be to have a unified message to counter the increasing concerns over costs.”

In the following month Shore and officials from DAQ and from the utilities discussed the development of “talking points” to be used to support the Smokestacks bill. DENR officials discussed the revision of a memo that they would deliver to Easley’s chief legislative lobbyists, Franklin Freeman and Kevin Howell, presumably for them to make the case for the Smokestacks bill to House members.

While DAQ officials wanted to tout air quality improvements and Shore wanted to promote the Smokestacks bill’s health benefits, George Everett, Duke’s vice president for environmental and public policy, objected to both points.

“The assessments of the impacts of our emissions included in the Clean Smokestacks Plan do not have a sound basis in my opinion,” Everett wrote in an e-mail to Klimek on May 1, 2001.

By summertime, environmental groups had increased their lobbying efforts for the bill. They wrote to Easley asking for him to increase his efforts lobbying House members to pass the Smokestacks bill, after he had participated in a Southern regional governors’ summit on mountain air quality.

Also, environmentalists began making a case for year-round reductions in nitrogen oxides, which are a primary factor in the formation of ground-level ozone. However, the ozone season runs from May to October, because warm weather is usually needed for constituent elements to form ozone. The state doesn’t even monitor ozone levels in the state outside those months.

Discussions between DAQ Deputy Director Brock Nicholson and Marc Bernstein of the attorney general’s office illustrated further doubt about year-round nitrogen oxide reductions. After Nicholson sent out “fact sheets” in support of the Smokestacks bill, Bernstein asked, “Should we include in the… sheet the fact that ozone in NC is not necessarily from NC? This of course is important in the long term when dealing with [Georgia and Tennessee]. But (it) may hurt in the short term for [Smokestacks] so (it) would have to be worded carefully.”

Bernstein further questioned Nicholson.

“You’ve mentioned that ozone is formed in greater quantities on hot, sunny days,” he wrote. “This supports the argument that year-round controls are not necessary. Can you provide any support for year-round controls?”

As justification for year-round nitrogen oxide reductions, Shore wrote a memo arguing that reduced pollution of soil and water would result, as well as visibility in the mountains, which was refuted by other sources. Still, those requirements ended up in the Smokestacks law, and both utilities accepted it as long as their costs were recovered.

Ratepayers’ opposition

But two major groups representing large industrial ratepayers — the Manufacturers and Chemical Industry Council of North Carolina, and the Carolina Utility Customers Association — opposed the bill. Many of their members were enduring difficult economic times and laying off a lot of their employees.

“It was a surprise to us,” said Preston Howard, president of MCIC. “We worked hard to keep the bill from coming to the floor of the House.”

Howard said his group didn’t object to the emissions requirements of the Smokestacks bill, but did oppose the surcharge.

“As you know, both utilities are experiencing record earnings,” Howard wrote in December 2001 to Alan Hirsch in Easley’s office, “while most North Carolina companies and many employees are simply trying to survive in the current economy.”

Howard, as well as CUCA, argued that North Carolina customers, under the Smokestacks bill, would pay the total costs of the emissions controls while Duke’s and Progress’ South Carolina and wholesale customers would pay nothing. He also said the N.C. Utilities Commission could allow both companies to recover their costs under a general rate review, without need for a special surcharge that the Smokestacks bill would call for.

“Governor Easley should ask the two utilities to ‘step up,’” Howard wrote to Hirsch, “they can afford it.”

In the late fall proponents made one last “push” for the bill before the legislature adjourned. Ross wrote to House Speaker Jim Black, arguing that the Smokestacks bill would reduce “asthma attacks among our people” and “haze in our mountains,” despite contrary arguments from his own subordinates and from state senators.

But because the concept of a surcharge to recover costs for the utilities was so objectionable to ratepayer groups, the Smokestacks bill was left in limbo at the end of the 2001 General Assembly session.

Return of Smokestacks in 2002

By February 2002 proponents in Easley’s office, in DENR, and in Attorney General Roy Cooper’s office were discussing the Smokestacks bill again. Cost recovery for Duke and Progress was the main remaining holdup. One e-mail between Department of Justice officials said Ross was “anxious to try to move this bill and wants our assistance in finding a way around the impasse.”

Compounding the problem was the fact that CUCA wanted the Utilities Commission to initiate a general rate case review for Duke, because they believed the utility had repeatedly exceeded its 12.5 percent allowed rate of return on its equity.

CUCA believed a rate review for Duke, even with new emissions controls, would result in an overall rate decrease for customers.

Contributing to suspicions about Duke’s earnings was that the company hid excessive earnings from utilities regulators in North Carolina and South Carolina. An audit by accounting firm Grant Thornton LLP determined that Duke management “met and developed a plan to identify expense and revenue items which could serve as a basis for accounting adjustments which could be made to ‘avoid reporting over-earnings to regulators.’” Duke vehemently denied any intentional wrongdoing, and a federal investigation produced no indictments.

While the audit continued and Duke’s EPA lawsuit was still unsettled, Smokestacks negotiators discussed the concept of a five-year rate freeze for both utilities in exchange for accelerating writeoffs for the costs of the new emissions controls.

The N.C. Utilities Commission, despite Duke’s suspected under-reporting, agreed to allow a rate freeze to become part of the bill. The idea broke the deadlock over cost recovery, bringing Howard in support, but still leaving CUCA in opposition.

However, that was good enough to get the bill passed in the House, where only four members voted against it. Easley signed it into law on June 20, 2002.

Duke wins in review and in court

After winning passage of the Smokestacks bill, the Grant Thornton audit report was completed a month later and was released in October 2002. CUCA sought a rate review for Duke from the N.C. Utilities Commission, but the rate freeze contained in the Smokestacks bill prevented that.

According to a report in the Oct. 3, 2003 Charlotte Business Journal, Duke’s return on equity was 14.43 percent during the year ending June 30, 2003, and had overrun its permitted rate of return for three consecutive quarters. Each percentage point represents about $55 million, meaning Duke’s profit exceeded its permitted rate by more than $100 million.

Meanwhile Duke, like several other utilities that had been targeted by the EPA that had worked toward settlements while still defending themselves in the lawsuits, obtained a favorable court decision in August 2003. U.S. District Judge Frank W. Bullock Jr., in contrast to rulings by other courts, ruled that the basis for the EPA’s actions against Duke were unlawful. The case is now under appeal.

But in the early days of the EPA’s enforcement action, Duke, like many other utilities, sought to negotiate with federal authorities.

“We set out our demands,” said Bruce Buckheit, former EPA director of air enforcement, “and Duke took off for about six months to a year, and popped up with a bill that very nearly met our demands and had a mechanism where the pollution controls would be paid for.”

Buckheit, who retired from the EPA in December 2003, said Bullock’s surprise ruling delayed a settlement. Meanwhile Duke officials think the company’s legal position is strong in the case and that the Smokestacks bill benefited all who participated in its negotiation.

“We’re happy because we got very healthy cost recovery,” said Duke spokesman Thomas Williams. “We think it’s excellent legislation.”

Part 2: Smokestacks Built on Dubious Data
Part 3: Duke Challenged Merits of Smokestacks
Part 4: Rate Freeze Allowed Despite Audit

Paul Chesser is associate editor of Carolina Journal. Contact him at [email protected].