Economic Instruments - Tradeable Permits
SO2 Cap-and-Trade Program (US)
SO2 Cap-and-Trade Program, US Background The SO2 Trading Program is one of the US emission trading schemes to build upon the experience of earlier emissions trading programmes. The SO2 Program was established as a result of the enactment of the 1990 Clean Air Act Amendments (CAAA) under the authority granted by Title IV, which included other measures to reduce precursor emissions of acid deposition (See Footnote1). Acid rain occurs when sulphur dioxides and nitrogen oxides react in the atmosphere, forming sulphuric and nitric acids respectively. The dominant precursor of acid rain in the US is SO2 from coal-fired and, to a much smaller extent, oil fired power plants. Reports in the 1980's by the National Acid Precipitation Assessment Program (NAPAP) had detailed the environmental and health consequences of acid rain. Prior to this, little had been done to combat the degrading effects acidifying substances were having upon both aquatic and terrestrial systems. The approach adopted in Title IV, often referred to as "cap and trade", establishes an aggregate emissions limit, distributes a limited number of permits to sources more or less in proportion to historical heat input, and lets the individual sources trade the permits with any party or bank them for later use. The only requirement for a source is to have, and to give up, a valid permit, called an allowance, at the end of the year, for each tonne of SO2 emitted during the year. By establishing an emissions cap and allocating tradable emissions permits to individual utilities, utilities are able to seek the least-cost method for meeting the environmental SO2 restrictions. Title IV imposes a 50 per cent nation-wide reduction of acid-rain precursor emissions by electric utility sources, primarily sulphur dioxide (SO2), from 1980 levels. Title IV's cap-and-trade system marked a fundamental departure from the regulatory framework that had governed SO22. It imposed source specific emissions rate limitations on existing (as of the early 1970's) units and effectively mandates flue gas desulphurisation for all new sources, and therefore it could only be described as "command and control." emissions from electric utility sources in the United States. The pre-existing regulatory structure was created by legislation in 1970 and 1978 to eliminate local health and other secondary effects of "criteria pollutants"(See Footnote2), including SO Aims Title IV was advertised as requiring a 10-million-tonnes-per-year reduction in SO2 emissions from 1980 levels by the year 2000. A cap was created on SO2 emissions from electric generating plants of roughly 9 million tonnes per year, effective in the year 2000 and beyond. This emissions cap was to be achieved in two phases. During Phase I (1995-1999), the 263 dirtiest large generating units were required to reduce their emissions by approximately 3.5 million tonnes per year, beginning in 1995. In Phase II (2000 and beyond), almost all fossil-fuelled electric generating plants become subject to the national cap on aggregate annual SO2 emissions (Alaska and Hawaii omitted from the programme). Title IV of the 1990 CAAA also specifies a two-part strategy to reduce NOx emissions in the US by 400,000 tonnes per year between 1996 and 1999 (Phase I) and by approximately 1.2 million tonnes per year beginning in 2000 (Phase 2). It aims to improve the quality of lakes and streams, improve air quality and public health, improve visibility, reduce forest damage and protect buildings from degradation (EPA Progress Report, pp6) Design Coverage The SO2 emission reductions are to be achieved over two phases and affect fossil-fuel burning power plants located in the continental 48 states of the US. These sources account for almost 70 per cent of national SO2 emissions. Phase I took place between 1995-99. During this Phase electric generating units larger than 100MWe in generating capacity with an annual average emission rate in 1985 greater than 2.5 pounds of SO2 per million Btu of heat input (hereafter #SO2/mmBtu) in were required to reduce emissions to a level that would be, on average, no greater than 2.5#SO2/mmBtu. Phase II commenced in the year 2000 and it is expected to run on indefinitely. In Phase II the programme was expanded to include fossil-fuel electricity generating units greater than 25MWe. Essentially this includes all fossil-fuel power stations in the U.S. Trading Programme Classification The SO2 Trading Program is a cap-and-trade programme. Introduced The SO2 Program came into effect in 1995. Units The unit of the SO2 Trading Program is the "SO2 Allowance", which permits its holder to emit one tonne of SO2 emissions. Unit Allocation During Phase I all large generating units with high SO2 emission rates (See Footnote3) were annually issued allowances (an allowance entitles its holder to emit one tonne of SO2 during a certain year), approximately equal to the product of average 1985-87 (baseline) heat input times a target emission rate of 2.5 pounds of SO2 per million Btu (hereafter #/mm Btu). In phase II, all generating units with capacity larger than 25 MWe are issued allowances that will limit aggregate SO2 emissions to approximately 8.9 million tonnes, or the product of baseline heat input times the lesser of the target emission rate of 1.2 #/mm Btu or the unit's actual 1985 emission rate. Allowances can be traded freely with any party participating in the trading programme. Newly constructed facilities do not receive allowances but must obtain them from existing plants. In addition to the private sales and purchases of allowances that continuously occur through the tradable allowance market, the EPA holds an annual auction and a direct sale. The auctions are intended to send a price signal to the allowance market as well as to provide utilities and other parties with an additional avenue for purchasing allowances. The direct sale offers allowances at a fixed price of $1500 (adjusted for inflation) and guarantees Independent Power Producers (IPPs) first priority in purchasing the necessary allowances for building or operating any new units. Monitoring and Enforcement
Within 30 days of the end-of-year, source owners must submit sufficient allowances to the US EPA to cover their SO22 emitted and offset the excess emissions with an equivalent reduction in the following year. The owner or operator of any source subject to the Acid Rain Provisions is required to install, certify and operate a Continuous Emissions Monitoring System (CEMS) on each affected unit at source. The CEMS track hourly emissions that are reported to the US Environmental Protection Agency (EPA) each quarter. Accurate, complete and consistent emissions measurement data are essential for ensuring the integrity of the market-based allowance system and the achievement of the emissions reduction goals. Allowance transactions and the status of allowance accounts are tracked by the EPA's Allowance Tracking System (ATS), an electronic record keeping and notification system. The ATS provides the EPA with the necessary data for determining compliance with the emissions limitations. Any party can open an ATS account, and each account contains the serial number of the traded allowances, the individual unit's account balance, and the name of the account representative. The ATS is intended to expedite the flow of data between the EPA and the utilities and to promote the development of an efficient permit trading system. Banking and Borrowing
Banking of unused allowances for use in future years is permitted. However, allowances cannot be brought forward from a future years allocation in order to meet current compliance obligations. Additional Information
The Acid Rain Program allows for a number of compliance options. Utilities can reduce emissions: - by burning cleaner fuel,
- by reassigning some of its energy production capacity to lower emitting units,
- or by utilising energy conservation measures to reduce total electrical demand.
Because of the wide variety of utility plant types, ages and fuel use, there are large variations in the costs per tonne of SO2 removed. This cost differential provides utilities with substantial opportunity to take advantage of an emissions trading scheme. Generating units with high marginal costs of abatement can achieve emissions reductions by supplementing emissions abatement actions with the purchase of emissions allowances. By reducing emissions below the target level, units with lower marginal costs of control can generate additional revenue through the sale of excess allowances. The SO2 Program is not only the largest domestic programme to incorporate tradable allowances, but it is also the first to include two voluntary compliance programmes, the "substitution" and "opt-in" programmes. Such features are attractive as a further means of lowering programme costs if sources that are excluded from the cap are able to provide cheaper abatement. The substitution programme allowed Phase II affected utility units to voluntarily enter Phase I of the Acid Rain Program whereas the opt-in programme allows non-utility, industrial sources to enter the programme, receive tradable allowances, and trade allowances with other utility and non-utility sources. Performance Environmental Effectiveness
Sceptics of emissions trading as a policy instrument for combating pollution often argue that it is not environmentally effective. The experience with Title IV has provided no grounds for concern about environmental effectiveness and the experience to date would seem to suggest that the environmental performance has been better than that experienced with command-and-control regulation. The largest annual SO2 emissions reduction took place in the first year of the programme (1995). This was when all affected units had to incur a cost for every tonne of emissions for the first time. Given the phased in nature of the requirement facing the Phase I units and the ability to bank, the annual reduction by these units was much greater than required. The annual reduction of emissions in 1995 was 3.9 million tonnes and that quantity of abatement has increased steadily and now stands at 6.3 million tonnes in 2001. Banking implies that emissions in the first years of Phase II will be greater than the allowances issued for the these years, but the appropriate metric is the cumulative emissions reduction since 1995, which has been 33.7 million tonnes, about 29 per cent more than the 26.1 million tonnes that would have been required as of 2001 without banking. By the end of Phase I, the actual cumulative emissions reduction was twice what was required, and that ratio will now decline steadily to 1.0 when the accumulated Phase I bank will be exhausted (this will probably occur in the second half of this decade). The significant and accelerated reduction of emissions implies that the deposition of acidic particles has also fallen. The latest progress report from the US Environmental Protection Agency (USEPA, 2002) reports that all of the conventional indicators relative to SO2 have declined considerably as a result of the SO2 Program. Another aspect of the environmental effectiveness of the Acid Rain Program is the extent of compliance. With the exception of a few very small, new gas units in 2000, all participating generating units have been in compliance with Title IV requirements in all years. This record of virtually 100 per cent compliance is not encountered with command-and-control regulation under which sources frequently receive various forms of dispensation that have the effect of delaying and sometimes permanently relaxing the applicability of the standard. An often grave concern with emissions trading is the development of "hot spots." This phrase refers to the potential in a trading system for emission reductions to be transferred away from areas where emissions cause greater damage to those where the emissions cause less damage. The fear with SO2 trading was that emissions in the Midwest would not be reduced if utilities in this region could pay utilities located in other parts of the country with little impact on the Northeast to reduce on their behalf. This fear has proved to be unfounded (Swift 2000). Sources in the Midwest have provided about 80 per cent of the emissions reduction achieved in Title IV while accounting for about 55 per cent of emissions in 2000. It may be argued that emissions from the Midwest are still too high, but it can hardly be argued that emissions trading has allowed sources in the Midwest to avoid abating. Economic Efficiency The primary evidence for the economic efficiency of the SO2 trading program lies in the early emergence of an allowance market and the significant amount of trading that has occurred since before the programme started. Allowance prices have varied substantially over time - from an all time low of $65 in early 1996 to highs slightly above $200 in 1999 and again in 2001. The earliest reported trades took place at widely disparate prices, which were higher than the clearing price in the first EPA auction, which took place in March 1993. Ellerman (2003) has suggested that while "it is hard to say that an allowance market existed at the time of the first EPA auction, by mid 1994, approximately six months before Phase I entered into effect, a market seems to have formed and the law of one price has prevailed since then". Since allowances are readily substitutable for abatement, this single price provides a signal for all source owners participating in the SO2 program and helps them in deciding whether to abate more or less at any one time and thereby to equalise their marginal cost of abatement. Rising trade volumes during Phase I and the early years of Phase II would seem to suggest that utilities are taking advantage of the cost saving opportunities provided by emissions trading. Since the equalisation of marginal costs presumes a common price and trading among sources facing different costs, the precondition for cost effective abatement are being observed. Further evidence to support the argument for economic efficiency can be observed in the unit-level differences between the volume of allowances that utilities are allocated and the resulting emission levels from these utilities. In his ex-post evaluation of the SO2 Program Ellerman shows the emission rate that would be observed in a no trading scenario and the actual emission rate for Phase I affected units in 1999 and 2000, given the heat input at each unit in these years. The average difference between observed emissions rates and the no-trading rate is about 50 per cent of the mean emission rate: 0.81 #SO2/mmBtu over 1.64 #SO2/mmBtu in 1999 and 0.86#SO2/mmBtu over 1.48#SO2/mmBtu in 2000. A further indication of economic efficiency is given by the relatively small change in average emission rates (-10%) when the allowed emission rate declined by 53 per cent, from 1.85#SO2 in 1999 to 0.87#SO2/mmBtu in 2000, when Phase II began. This smaller change in emission rates could occur with banking; and the 375 participating units went from banking 1.8 million allowances in 1999 to drawing the accumulated bank down by 1.5 million tonnes in 2000. This pattern of aggregate demand over time is characteristic of an optimal banking programme with certainty, in which firms take future required abatement and prices into account when formulating current abatement plans. This behaviour implies that allowance prices rise at the interest rate and abatement increases gradually over the entire banking period. Ellerman observed such a pattern in the transition from Phase I to Phase II among the units affected in both years. Compliance Costs and Savings from SO2 Emission Trading
Only two rigorous ex-post evaluations of the compliance costs of the SO2 Trading Program have been made [Carlson et al., 2000; Ellerman et al, 2000; hereafter, CBCP (for the initials of the authors) and MCA (for Markets for Clean Air)]. The estimates of actual compliance costs of these two studies are approximately the same; they differ concerning the extent of the cost savings in the early years, as well as in their methodologies. CBCP and MCA agree roughly on the cost of compliance in the early years of the Acid Rain Program. The MCA estimates the cost of compliance at $726 million in1995 and about $750 million in1996, while CBCP places the cost at $832 million in 1995 and $910 million in 1996 (these prices are all stated in 1995 dollars). These estimates are not as far apart as they would seem. Complete comparability is not possible because of differences in methodology; however, both treat scrubber expenses in the same manner. Although they largely agree on the fixed cost of scrubbers ($375 million in MCA and $382 million in CBCP), they differ significantly on the variable costs associated with scrubbers ($89 million and $274 million, respectively). CBCP uses scrubber data that reflect pre 1995 estimates of the variable cost of scrubbing, but the actual performance of the Phase I scrubbers has been much better than predicted. Correcting for this better than expected performance of scrubbers largely removes the disparity in the cost estimates between these two ex post evaluations. Ellerman (2003) suggests that an approximate figure of $750 million is probably a good estimate of the annual cost of abatement in the first years of Phase I. CBCP and MCA have both provided current estimates for compliance costs in 2010, both of these estimates reflect current market conditions. CBCP estimate that in 2010 compliance costs will be $1.0 billion with MCA estimating slightly higher compliance costs at $1.4 billion. Ellerman et al. (2000) note that the observed cost of abatement has been on the low side of expectations and much of that lower cost has been due to the much lower than anticipated cost of scrubbing. Whether the reduction in scrubbing cost was induced by emissions trading or has been due instead to the application of exogenous advances in information processing and control technology is a difficult question. They estimate cost savings of 33% to 67% of the Command-and-control alternative. Drawbacks Sceptics of Title IV have attributed the low allowance prices of the early Phase I to defects in allowance markets including (Ellerman et al): The design flaws of EPA auctions Uncertainty regarding the rate-making treatment of allowances traded Barriers to trading. Ellerman et al (2000) attribute the low allowance prices and the gap between allowance prices and observed abatement costs to two factors: 1. There was a general underestimation of the extent to which cost-based shifts to Powder River Basin coal (lower sulphur) after 1990 reduced the amount of abatement necessary to comply with Title IV. 2. Long-lived investments in compliance technology and long-term fuel commitments were made well in advance of compliance deadlines, when future allowance and fuel prices, abatement costs, and electricity prices were all uncertain. Also, emissions trading is not perfect for all environmental problems. If a specific isolated industry is very toxic and puts the environment at a large risk, regulation may be more appropriate. Footnotes - The Clean Air Act Amendments of 1990 set a goal of reducing NOx by 2 million tonnes from 1980 levels by imposing technology-based, maximum average annual NOx emission rates on affected sources - coal-fired electric utility boilers. As with the SO2 emission reduction requirements, the NOx programme was implemented in two phases, beginning in 1996 and 2000. In meeting the standards set out under the NOx Program, utilities were allowed to average emission rates among the units they controlled, but they were permitted to trade NOx emissions among utilities.
- Criteria pollutants are common substances, such as SO2 and hydrocarbons, which create a variety of health effects at high concentrations. These are distinct from hazardous pollutants, such as mercury and radionuclides, which have serious health effects at low concentrations.
- A unit is defined as a "fossil fuel fired combustion device" in section 402 of the CAAA and corresponds to a single generator and associated boiler. Units with a generating capacity greater than 100 MWe and 1985 emission rates greater than 2.5lbs. of SO2 per million Btu of heat input were mandated to be part of Phase I. This gives a total of 263 units at 110 power stations.
References Much of the information contained above on the SO2 trading program is taken from the references listed below; · Ellerman,A.D (2003);Ex-Post Evaluation of Tradable Permits: The US SO2 Cap-and-Trade Program. · Ellerman, Schmalensee, Bailey, Joskow, Montero,(2000);Markets for Clean Air: The US Acid Rain Program. Cambridge University Press Useful Information Sources The websites listed below provide useful information on the SO2 Program and other US emissions trading programmes; US EPA: Acid Rain Program, Allowance Trading - http://www.epa.gov/docs/acidrain/overview.html#trading US EPA: Acid Rain Program, Program Overview - http://www.epa.gov/docs/acidrain/overview.html US EPA: Progress Report on the EPA Acid Rain Program, November 1999 - www.epa.gov/acidrain Information on other cap-and-trade programmes in the US can be obtained from the US EPA website - http://www.epa.gov/airmarkets/trading/index.html
SO2 Cap-and-Trade Program, US Background The SO2 Trading Program is one of the US emission trading schemes to build upon the experience of earlier emissions trading programmes. The SO2 Program was established as a result of the enactment of the 1990 Clean Air Act Amendments (CAAA) under the authority granted by Title IV, which included other measures to reduce precursor emissions of acid deposition (See Footnote1). Acid rain occurs when sulphur dioxides and nitrogen oxides react in the atmosphere, forming sulphuric and nitric acids respectively. The dominant precursor of acid rain in the US is SO2 from coal-fired and, to a much smaller extent, oil fired power plants. Reports in the 1980's by the National Acid Precipitation Assessment Program (NAPAP) had detailed the environmental and health consequences of acid rain. Prior to this, little had been done to combat the degrading effects acidifying substances were having upon both aquatic and terrestrial systems. The approach adopted in Title IV, often referred to as "cap and trade", establishes an aggregate emissions limit, distributes a limited number of permits to sources more or less in proportion to historical heat input, and lets the individual sources trade the permits with any party or bank them for later use. The only requirement for a source is to have, and to give up, a valid permit, called an allowance, at the end of the year, for each tonne of SO2 emitted during the year. By establishing an emissions cap and allocating tradable emissions permits to individual utilities, utilities are able to seek the least-cost method for meeting the environmental SO2 restrictions. Title IV imposes a 50 per cent nation-wide reduction of acid-rain precursor emissions by electric utility sources, primarily sulphur dioxide (SO2), from 1980 levels. Title IV's cap-and-trade system marked a fundamental departure from the regulatory framework that had governed SO22. It imposed source specific emissions rate limitations on existing (as of the early 1970's) units and effectively mandates flue gas desulphurisation for all new sources, and therefore it could only be described as "command and control." emissions from electric utility sources in the United States. The pre-existing regulatory structure was created by legislation in 1970 and 1978 to eliminate local health and other secondary effects of "criteria pollutants"(See Footnote2), including SO Aims Title IV was advertised as requiring a 10-million-tonnes-per-year reduction in SO2 emissions from 1980 levels by the year 2000. A cap was created on SO2 emissions from electric generating plants of roughly 9 million tonnes per year, effective in the year 2000 and beyond. This emissions cap was to be achieved in two phases. During Phase I (1995-1999), the 263 dirtiest large generating units were required to reduce their emissions by approximately 3.5 million tonnes per year, beginning in 1995. In Phase II (2000 and beyond), almost all fossil-fuelled electric generating plants become subject to the national cap on aggregate annual SO2 emissions (Alaska and Hawaii omitted from the programme). Title IV of the 1990 CAAA also specifies a two-part strategy to reduce NOx emissions in the US by 400,000 tonnes per year between 1996 and 1999 (Phase I) and by approximately 1.2 million tonnes per year beginning in 2000 (Phase 2). It aims to improve the quality of lakes and streams, improve air quality and public health, improve visibility, reduce forest damage and protect buildings from degradation (EPA Progress Report, pp6) Design Coverage The SO2 emission reductions are to be achieved over two phases and affect fossil-fuel burning power plants located in the continental 48 states of the US. These sources account for almost 70 per cent of national SO2 emissions. Phase I took place between 1995-99. During this Phase electric generating units larger than 100MWe in generating capacity with an annual average emission rate in 1985 greater than 2.5 pounds of SO2 per million Btu of heat input (hereafter #SO2/mmBtu) in were required to reduce emissions to a level that would be, on average, no greater than 2.5#SO2/mmBtu. Phase II commenced in the year 2000 and it is expected to run on indefinitely. In Phase II the programme was expanded to include fossil-fuel electricity generating units greater than 25MWe. Essentially this includes all fossil-fuel power stations in the U.S. Trading Programme Classification The SO2 Trading Program is a cap-and-trade programme. Introduced The SO2 Program came into effect in 1995. Units The unit of the SO2 Trading Program is the "SO2 Allowance", which permits its holder to emit one tonne of SO2 emissions. Unit Allocation During Phase I all large generating units with high SO2 emission rates (See Footnote3) were annually issued allowances (an allowance entitles its holder to emit one tonne of SO2 during a certain year), approximately equal to the product of average 1985-87 (baseline) heat input times a target emission rate of 2.5 pounds of SO2 per million Btu (hereafter #/mm Btu). In phase II, all generating units with capacity larger than 25 MWe are issued allowances that will limit aggregate SO2 emissions to approximately 8.9 million tonnes, or the product of baseline heat input times the lesser of the target emission rate of 1.2 #/mm Btu or the unit's actual 1985 emission rate. Allowances can be traded freely with any party participating in the trading programme. Newly constructed facilities do not receive allowances but must obtain them from existing plants. In addition to the private sales and purchases of allowances that continuously occur through the tradable allowance market, the EPA holds an annual auction and a direct sale. The auctions are intended to send a price signal to the allowance market as well as to provide utilities and other parties with an additional avenue for purchasing allowances. The direct sale offers allowances at a fixed price of $1500 (adjusted for inflation) and guarantees Independent Power Producers (IPPs) first priority in purchasing the necessary allowances for building or operating any new units. Monitoring and Enforcement
Within 30 days of the end-of-year, source owners must submit sufficient allowances to the US EPA to cover their SO22 emitted and offset the excess emissions with an equivalent reduction in the following year. The owner or operator of any source subject to the Acid Rain Provisions is required to install, certify and operate a Continuous Emissions Monitoring System (CEMS) on each affected unit at source. The CEMS track hourly emissions that are reported to the US Environmental Protection Agency (EPA) each quarter. Accurate, complete and consistent emissions measurement data are essential for ensuring the integrity of the market-based allowance system and the achievement of the emissions reduction goals. Allowance transactions and the status of allowance accounts are tracked by the EPA's Allowance Tracking System (ATS), an electronic record keeping and notification system. The ATS provides the EPA with the necessary data for determining compliance with the emissions limitations. Any party can open an ATS account, and each account contains the serial number of the traded allowances, the individual unit's account balance, and the name of the account representative. The ATS is intended to expedite the flow of data between the EPA and the utilities and to promote the development of an efficient permit trading system. Banking and Borrowing
Banking of unused allowances for use in future years is permitted. However, allowances cannot be brought forward from a future years allocation in order to meet current compliance obligations. Additional Information
The Acid Rain Program allows for a number of compliance options. Utilities can reduce emissions: - by burning cleaner fuel,
- by reassigning some of its energy production capacity to lower emitting units,
- or by utilising energy conservation measures to reduce total electrical demand.
Because of the wide variety of utility plant types, ages and fuel use, there are large variations in the costs per tonne of SO2 removed. This cost differential provides utilities with substantial opportunity to take advantage of an emissions trading scheme. Generating units with high marginal costs of abatement can achieve emissions reductions by supplementing emissions abatement actions with the purchase of emissions allowances. By reducing emissions below the target level, units with lower marginal costs of control can generate additional revenue through the sale of excess allowances. The SO2 Program is not only the largest domestic programme to incorporate tradable allowances, but it is also the first to include two voluntary compliance programmes, the "substitution" and "opt-in" programmes. Such features are attractive as a further means of lowering programme costs if sources that are excluded from the cap are able to provide cheaper abatement. The substitution programme allowed Phase II affected utility units to voluntarily enter Phase I of the Acid Rain Program whereas the opt-in programme allows non-utility, industrial sources to enter the programme, receive tradable allowances, and trade allowances with other utility and non-utility sources. Performance Environmental Effectiveness
Sceptics of emissions trading as a policy instrument for combating pollution often argue that it is not environmentally effective. The experience with Title IV has provided no grounds for concern about environmental effectiveness and the experience to date would seem to suggest that the environmental performance has been better than that experienced with command-and-control regulation. The largest annual SO2 emissions reduction took place in the first year of the programme (1995). This was when all affected units had to incur a cost for every tonne of emissions for the first time. Given the phased in nature of the requirement facing the Phase I units and the ability to bank, the annual reduction by these units was much greater than required. The annual reduction of emissions in 1995 was 3.9 million tonnes and that quantity of abatement has increased steadily and now stands at 6.3 million tonnes in 2001. Banking implies that emissions in the first years of Phase II will be greater than the allowances issued for the these years, but the appropriate metric is the cumulative emissions reduction since 1995, which has been 33.7 million tonnes, about 29 per cent more than the 26.1 million tonnes that would have been required as of 2001 without banking. By the end of Phase I, the actual cumulative emissions reduction was twice what was required, and that ratio will now decline steadily to 1.0 when the accumulated Phase I bank will be exhausted (this will probably occur in the second half of this decade). The significant and accelerated reduction of emissions implies that the deposition of acidic particles has also fallen. The latest progress report from the US Environmental Protection Agency (USEPA, 2002) reports that all of the conventional indicators relative to SO2 have declined considerably as a result of the SO2 Program. Another aspect of the environmental effectiveness of the Acid Rain Program is the extent of compliance. With the exception of a few very small, new gas units in 2000, all participating generating units have been in compliance with Title IV requirements in all years. This record of virtually 100 per cent compliance is not encountered with command-and-control regulation under which sources frequently receive various forms of dispensation that have the effect of delaying and sometimes permanently relaxing the applicability of the standard. An often grave concern with emissions trading is the development of "hot spots." This phrase refers to the potential in a trading system for emission reductions to be transferred away from areas where emissions cause greater damage to those where the emissions cause less damage. The fear with SO2 trading was that emissions in the Midwest would not be reduced if utilities in this region could pay utilities located in other parts of the country with little impact on the Northeast to reduce on their behalf. This fear has proved to be unfounded (Swift 2000). Sources in the Midwest have provided about 80 per cent of the emissions reduction achieved in Title IV while accounting for about 55 per cent of emissions in 2000. It may be argued that emissions from the Midwest are still too high, but it can hardly be argued that emissions trading has allowed sources in the Midwest to avoid abating. Economic Efficiency The primary evidence for the economic efficiency of the SO2 trading program lies in the early emergence of an allowance market and the significant amount of trading that has occurred since before the programme started. Allowance prices have varied substantially over time - from an all time low of $65 in early 1996 to highs slightly above $200 in 1999 and again in 2001. The earliest reported trades took place at widely disparate prices, which were higher than the clearing price in the first EPA auction, which took place in March 1993. Ellerman (2003) has suggested that while "it is hard to say that an allowance market existed at the time of the first EPA auction, by mid 1994, approximately six months before Phase I entered into effect, a market seems to have formed and the law of one price has prevailed since then". Since allowances are readily substitutable for abatement, this single price provides a signal for all source owners participating in the SO2 program and helps them in deciding whether to abate more or less at any one time and thereby to equalise their marginal cost of abatement. Rising trade volumes during Phase I and the early years of Phase II would seem to suggest that utilities are taking advantage of the cost saving opportunities provided by emissions trading. Since the equalisation of marginal costs presumes a common price and trading among sources facing different costs, the precondition for cost effective abatement are being observed. Further evidence to support the argument for economic efficiency can be observed in the unit-level differences between the volume of allowances that utilities are allocated and the resulting emission levels from these utilities. In his ex-post evaluation of the SO2 Program Ellerman shows the emission rate that would be observed in a no trading scenario and the actual emission rate for Phase I affected units in 1999 and 2000, given the heat input at each unit in these years. The average difference between observed emissions rates and the no-trading rate is about 50 per cent of the mean emission rate: 0.81 #SO2/mmBtu over 1.64 #SO2/mmBtu in 1999 and 0.86#SO2/mmBtu over 1.48#SO2/mmBtu in 2000. A further indication of economic efficiency is given by the relatively small change in average emission rates (-10%) when the allowed emission rate declined by 53 per cent, from 1.85#SO2 in 1999 to 0.87#SO2/mmBtu in 2000, when Phase II began. This smaller change in emission rates could occur with banking; and the 375 participating units went from banking 1.8 million allowances in 1999 to drawing the accumulated bank down by 1.5 million tonnes in 2000. This pattern of aggregate demand over time is characteristic of an optimal banking programme with certainty, in which firms take future required abatement and prices into account when formulating current abatement plans. This behaviour implies that allowance prices rise at the interest rate and abatement increases gradually over the entire banking period. Ellerman observed such a pattern in the transition from Phase I to Phase II among the units affected in both years. Compliance Costs and Savings from SO2 Emission Trading
Only two rigorous ex-post evaluations of the compliance costs of the SO2 Trading Program have been made [Carlson et al., 2000; Ellerman et al, 2000; hereafter, CBCP (for the initials of the authors) and MCA (for Markets for Clean Air)]. The estimates of actual compliance costs of these two studies are approximately the same; they differ concerning the extent of the cost savings in the early years, as well as in their methodologies. CBCP and MCA agree roughly on the cost of compliance in the early years of the Acid Rain Program. The MCA estimates the cost of compliance at $726 million in1995 and about $750 million in1996, while CBCP places the cost at $832 million in 1995 and $910 million in 1996 (these prices are all stated in 1995 dollars). These estimates are not as far apart as they would seem. Complete comparability is not possible because of differences in methodology; however, both treat scrubber expenses in the same manner. Although they largely agree on the fixed cost of scrubbers ($375 million in MCA and $382 million in CBCP), they differ significantly on the variable costs associated with scrubbers ($89 million and $274 million, respectively). CBCP uses scrubber data that reflect pre 1995 estimates of the variable cost of scrubbing, but the actual performance of the Phase I scrubbers has been much better than predicted. Correcting for this better than expected performance of scrubbers largely removes the disparity in the cost estimates between these two ex post evaluations. Ellerman (2003) suggests that an approximate figure of $750 million is probably a good estimate of the annual cost of abatement in the first years of Phase I. CBCP and MCA have both provided current estimates for compliance costs in 2010, both of these estimates reflect current market conditions. CBCP estimate that in 2010 compliance costs will be $1.0 billion with MCA estimating slightly higher compliance costs at $1.4 billion. Ellerman et al. (2000) note that the observed cost of abatement has been on the low side of expectations and much of that lower cost has been due to the much lower than anticipated cost of scrubbing. Whether the reduction in scrubbing cost was induced by emissions trading or has been due instead to the application of exogenous advances in information processing and control technology is a difficult question. They estimate cost savings of 33% to 67% of the Command-and-control alternative. Drawbacks Sceptics of Title IV have attributed the low allowance prices of the early Phase I to defects in allowance markets including (Ellerman et al): The design flaws of EPA auctions Uncertainty regarding the rate-making treatment of allowances traded Barriers to trading. Ellerman et al (2000) attribute the low allowance prices and the gap between allowance prices and observed abatement costs to two factors: 1. There was a general underestimation of the extent to which cost-based shifts to Powder River Basin coal (lower sulphur) after 1990 reduced the amount of abatement necessary to comply with Title IV. 2. Long-lived investments in compliance technology and long-term fuel commitments were made well in advance of compliance deadlines, when future allowance and fuel prices, abatement costs, and electricity prices were all uncertain. Also, emissions trading is not perfect for all environmental problems. If a specific isolated industry is very toxic and puts the environment at a large risk, regulation may be more appropriate. Footnotes - The Clean Air Act Amendments of 1990 set a goal of reducing NOx by 2 million tonnes from 1980 levels by imposing technology-based, maximum average annual NOx emission rates on affected sources - coal-fired electric utility boilers. As with the SO2 emission reduction requirements, the NOx programme was implemented in two phases, beginning in 1996 and 2000. In meeting the standards set out under the NOx Program, utilities were allowed to average emission rates among the units they controlled, but they were permitted to trade NOx emissions among utilities.
- Criteria pollutants are common substances, such as SO2 and hydrocarbons, which create a variety of health effects at high concentrations. These are distinct from hazardous pollutants, such as mercury and radionuclides, which have serious health effects at low concentrations.
- A unit is defined as a "fossil fuel fired combustion device" in section 402 of the CAAA and corresponds to a single generator and associated boiler. Units with a generating capacity greater than 100 MWe and 1985 emission rates greater than 2.5lbs. of SO2 per million Btu of heat input were mandated to be part of Phase I. This gives a total of 263 units at 110 power stations.
References Much of the information contained above on the SO2 trading program is taken from the references listed below; · Ellerman,A.D (2003);Ex-Post Evaluation of Tradable Permits: The US SO2 Cap-and-Trade Program. · Ellerman, Schmalensee, Bailey, Joskow, Montero,(2000);Markets for Clean Air: The US Acid Rain Program. Cambridge University Press Useful Information Sources The websites listed below provide useful information on the SO2 Program and other US emissions trading programmes; US EPA: Acid Rain Program, Allowance Trading - http://www.epa.gov/docs/acidrain/overview.html#trading US EPA: Acid Rain Program, Program Overview - http://www.epa.gov/docs/acidrain/overview.html US EPA: Progress Report on the EPA Acid Rain Program, November 1999 - www.epa.gov/acidrain Information on other cap-and-trade programmes in the US can be obtained from the US EPA website - http://www.epa.gov/airmarkets/trading/index.html
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