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The Functional Interrelatedness Test: Is the End in Sight?

September 30, 2013

By Richard Alonso and Sandra Snyder

In March 2013, a not-for profit coalition of manufacturing companies filed a petition for review in the D.C. Circuit challenging whether the Environmental Protection Agency (EPA) can use different air permitting criteria in different parts of the country.  Nat'l Envtl. Dev. Assoc.'s Clean Air Project (NEDA) v. U.S. EPA, No. 13-1035 (D.C. Cir. filed Mar. 25, 2013). This challenge arises from a memorandum issued by EPA in December 2012 in response to a decision issued by the U.S. Court of Appeals for the Sixth Circuit.  In Summit Petroleum Corporation v. EPA, No. 09-4348 (6th Cir. Aug. 7, 2012), the Sixth Circuit held that EPA's decades-long policy of determining whether sources are adjacent by looking at whether the sources are functionally related was unreasonable and contrary to the plain meaning of the term adjacent. The decision initially seemed to create a formidable barrier to EPA using aggregation principles to require oil and gas wells and other sources that are not physically located next to each other to obtain Title V and major New Source Review (NSR) permits. It also appeared to reverse approximately 30 years of EPA's interpretation and implementation of NSR regulations.

EPA sought but was denied rehearing en banc.  Undeterred, EPA issued a memorandum in December 2012 instructing the regional offices that Summit only applies in the Sixth Circuit. Thus, in the Sixth Circuit states of Ohio, Michigan, Kentucky, and Tennessee, permitting authorities should not consider whether sources are functionally related when assessing whether to aggregate emissions. However, in all other states, permitting authorities should continue to assess the functional relationship between emission sources.  The NEDA petitioners have challenged whether EPA is authorized to use different permitting criteria based on the location of the emission source.

Aggregation Law Background
Whether different facilities are treated as a major source depends upon the stationary sources' potential to emit certain pollutants. Federal prevention of significant deterioration (PSD) regulations define stationary source as any building, structure, facility, or installation which emits or may emit any regulated air pollutant. 40 C.F.R. § 51.166(b)(5). In 1979, the D.C. Circuit held that EPA cannot treat contiguous and commonly owned units as a single source unless they fit within the four statutory terms that comprise a stationary source (i.e., structure, building, facility, or installation). Alabama Power Co. v. Costle, 636 F.2d 323, 397 (D.C. Cir. 1979). Accordingly, the Alabama Power court directed EPA to promulgate regulatory definitions of the term's structure, building, facility, and installation to provide for the aggregation, where appropriate, of industrial activities according to considerations such as proximity and ownership. Id. EPA responded by amending its PSD regulations:

In EPA's view, Alabama Power sets the following boundaries on the definition for PSD purposes of the component terms of source: (1) it must carry out reasonably the purposes of PSD; (2) it must approximate a common sense notion of plant; and (3) it must avoid aggregating pollutant-emitting activities that as a group would not fit within the ordinary meaning of building, structure, facility, or installation.

45 Fed. Reg. 52,676, 52,694-95 (Aug. 7, 1980). In other words, when defining a "stationary source" under the CAA, permitting agencies must focus on whether the purported "source" "approximate[s] a common sense notion of plant."  Id.

Consequently, EPA devised a three-factor test allowing aggregation of emissions only from pollutant-emitting activities that collectively satisfy the common sense notion of plant. Based on that test, permitting agencies can aggregate emissions from separate oil and natural gas units only if each of three criteria is established. The separate units must:

  1. Belong to the same industrial grouping; and
  2. Be under the control of the same person (or persons under common control); and
  3. Be located on one or more contiguous or adjacent properties.

40 C.F.R. § 51.166(b)(6).

The first criterion in the three-part test requires that the units belong to the same industrial grouping. The 1980 PSD Regulations established the use of two-digit major Standard Industrial Classification (SIC) codes for analyzing this factor in lieu of analyzing the functional interdependence of separate units. An analysis of SIC Codes enables permitting authorities to determine whether separate activities belong to the same industrial grouping in a manner that adds objectivity and relative simplicity to the process. 45 Fed. Reg. at 52,695.

The second criterion is that the units must be under common control. EPA has historically presumed that two companies are under common control when one entity has as much as 50% voting interest in both. Definition of Source – Arizona Chemical Co., Memorandum from Edward E. Reich to Region 6 (Mar. 16, 1979). EPA also relies on the U.S. Securities and Exchange Commission's definition of control (i.e., the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person (or organization or association) whether through ownership of voting shares, contract, or otherwise.). See 45 Fed. Reg. at 59,878.

Finally, the third criterion is that the units must sit on contiguous or adjacent properties. EPA's recent precedent has been that whether two noncontiguous units are adjacent could depend on whether they are (1) proximate or (2) exclusively interdependent. See, e.g., Order Denying Petition for Objection to Permit, Permit No. 95OPWE035, Pet. No. VIII- 2010-4, at 11 (Feb. 2, 2011) (EPA Frederick Order). EPA lost its way in implementing this third prong.

Source Aggregation in the Oil and Natural Gas Industry
Determining the scope and extent of a source for air permitting purposes becomes complex when regulators try to assess the interrelationships between sources in the oil and natural gas industry. In using these interrelationships, EPA moved away from the common sense notion of a plant and turned a simple case-by-case analysis into a complex analysis that led to a lot of litigation and uncertainty for the regulated community over the past 30 years. Assessing the interrelationships of plants has been problematic because EPA refused to specify a distance in its regulations beyond which plants cannot be considered adjacent. As a result, EPA issued some applicability determinations aggregating sources that were up to 40 miles apart. In 2007, EPA issued guidance on aggregation of oil and natural gas operations which emphasized the importance of proximity, noting that several states used a presumption that units located outside a quarter-mile radius were not adjacent. See William L. Wehrum, Source Determinations for Oil and Gas Industries (Jan. 12, 2007) (Wehrum Memo). But, in 2009, EPA withdrew (without proper public notice and comment) the Wehrum Memo, stating that proximity was not a sufficient endpoint for the analysis and emphasizing that anything other than a case-by-case evaluation was unworkable. See Gina McCarthy, Withdrawal of Source Determinations for Oil and Gas Industries at 1-2 (Sept. 22, 2009) (McCarthy Memo). In fact, as the Summit Court found, EPA's reinstated case-by-case evaluation was unworkable, subjective, and impermissibly deviated from the plain English text of the aggregation test.

When trying to apply the interdependency test to sources in the oil and gas industry, the results have been understandably inconsistent. The problem with applying the interdependency test to this industry is that the presence of pipelines connecting separate oil and natural gas operations is not particularly useful to a source aggregation determination. Essentially, the entire natural gas production, gathering, processing, and transportation system is interconnected through an elaborate network of pipes extending from the wellhead to the ultimate end-users. Supporting this interstate system is an untold number of local gathering and processing facilities. Therefore, "[t]he simple fact that a pipe connects two physically separate oil and gas facilities or emission units does not, by itself, imply that these two facilities or units should be considered to be a part of the same emission source." In re Anadarko Petroleum Corp., Frederick Compressor Station, Pet. No. VIII-2010-4 (Resp. of Colo. Dept of Pub. Health and Envt, Air Pollution Control Div., to Order Granting Pet. for Objection to Permit) at 5 (July 14, 2010).

EPA's Summit Aggregation Determination
Summit Petroleum Corporation owns and operates a natural gas sweetening plant located in Rosebush, Michigan. The Rosebush plant receives natural gas from over 100 production wells located across a 43-square-mile area with some wells as close as 500 feet from the plant, while others are located up to eight miles away. The Rosebush plant emits slightly less than 100 tons per year of sulfur dioxides (SO2) and nitrous oxides (NOx). Because the Rosebush plant's emissions are under the 100 tons per year threshold, the facility would not need to obtain a Title V operating permit unless the emissions from some or all of the wells were aggregated with the emissions from the plant. See 42 U.S.C. § 7602(j).

In January 2005, Summit submitted a request to EPA to determine whether the Rosebush plant was a major source that required a Title V operating permit. After providing information to EPA over the course of several years, Summit finally received EPA's source determination in September 2009 that concluded that the Rosebush plant and the associated production wells were a single stationary source; therefore, according to EPA, Summit needed a Title V operating permit for this major source. EPA argued that its finding was correct because the Rosebush plant and the associated production wells were interdependent and thus adjacent under the three-part aggregation test.

Errors in the EPA Aggregation Determination
Summit challenged this determination, but agreed with EPA that the Rosebush plant and its production wells were under common control and belonged to the same major industrial grouping. Therefore, the parties only disagreed about whether the Rosebush plant and the production wells were contiguous or adjacent. In particular, EPA argued that the term "adjacent" is ambiguous and the agency's determination of physical distance should be replaced by an interdependency analysis, especially in light of the agency's longstanding policy of assessing the functional relationship between multiple emissions activities. Summit argued that the term "adjacent" is exactly what it says and means to common people – adjacent means adjacent.

Citing Webster's dictionary, the Sixth Circuit concluded that the plain meaning of the term "adjacent" is unambiguous. In particular, the court rejected EPA's suggestion that the term "adjacent" requires undertaking an analysis of the functional relationship between the two plants. The court determined that asking the purpose of an activity's existence at each plant was an "impermissible and illogical stretch." The Sixth Circuit was not persuaded that EPA's interpretation should be entitled to deference merely because the agency had a longstanding policy – documented throughout the years in formal applicability determinations – of requiring an assessment of the interrelatedness of the activities. Instead, the court chastised EPA by saying that "[a]n agency may not insulate itself from correction merely because it has not been corrected soon enough, for a longstanding error is still an error."

The NEDA Challenge
The Summit decision was a helpful step towards clarifying what has become an unnecessarily complicated and unpredictable issue for industry over the last several years. However, until the D.C. Circuit issues a decision in NEDA v. U.S. EPA, the impact of the Summit decision is unclear.

Petitioners in NEDA argue that EPA's December 2012 memo must be struck down for two reasons.  First, the memo is contrary to law because the Clean Air Act (CAA) and EPA regulations require uniformity in permitting criteria.  Nat'l Envtl. Dev. Assoc.'s Clean Air Project v. U.S. EPA, No. 13-1035 (D.C. Cir. filed June 21, 2013).  Petitioners claim that the "non-acquiescence doctrine," which allows the government to relitigate issues in multiple circuits, has been displaced by Congress's directive in the CAA to "assure fairness and uniformity in the criteria, procedures and policies applied by the various regions in implementing and enforcing" the CAA.  Id. at 3 (citing 42 U.S.C. § 7601(a)(2)).  To carry out this uniformity requirement, EPA adopted a "Regional Consistency" requirement to ensure "fair and uniform application by all EPA Regional Offices of the criteria, procedures, and policies employed in implementing and enforcing" the CAA.  Id. (citing 40 C.F.R. § 56.3). According to Petitioners, EPA's December 2012 memo advises the regional offices and state and local agencies to depart from the Regional Consistency requirement.  Second, Petitioners claim that EPA's action is arbitrary, capricious, and contrary to law.  Petitioners argue that EPA cannot disregard the Regional Consistency requirement just because considering functional interrelatedness has been a "longstanding" policy.  Id. at 4. According to Petitioners, EPA's policy is also arbitrary and capricious because EPA failed to articulate a rationale for ignoring the Summit decision, failed to consider alternatives, and the December 2012 memo is overall unsound because it fails to explain what EPA believes "adjacent" and "functionally interrelated" mean and how those terms should be practically applied.  Id. at 30-31. 

With briefing expected to conclude in November 2013, by spring 2014, the regulated community may finally know whether the functional relatedness test is truly a thing of the past or if they will have to suffer with the uncertainty it creates until other jurisdictions rule that it is unlawful.

Originally published in Environmental Enforcement and Crimes Committee Newsletter, American Bar Association Section of Environment, Energy, and Resources, Volume 14, Number 1, August 2013.