U.S Experience with SO2 and NOx Trading

November, 2004

Brian McLeanU.S. EPA

Cap and Trade

• An alternative to traditional regulation and credit trading—not simply a trading feature added to existing regulation

• Certainty that a specific regional emissions level is achieved and maintained

• More regulatory certainty, compliance flexibility and lower permitting and transaction costs for sources

• Fewer administrative resources needed by industry and government – Government focused on setting goals & assuring results

• Incentives for innovation and early reductions• Can be compatible with other mechanisms• Lower costs make further improvements feasible

Limited Supply of allowances (cap)

Economic valuefor allowances

Economic incentivesto reduce emissions

Demand forallowances

Why Cap & Trade Works

• Emissions cap– Limits emissions to achieve &

maintain environmental goal– Provides market value and certainty

• Monitoring– Establishes integrity of currency– Assures accountability & results

• Trading– Allows companies to choose

compliance options– Minimizes costs through compliance

flexibility• With the cap, allowances

allocated, and monitoring, government approval of compliance choices and trades is not required

SO2 Emissions

(million tons)

0

5

10

15

20

25

30

19

80

19

85

19

90

19

95

20

00

20

05

20

10

Allowable Emissions

ActualEmissions

Without Acid Rain Program

National SO2 Trading Program

• Goal: Reduce acid deposition

• Target: Reduce SO2 emissions from electric generators by 8.5 million tons (50% below 1980 levels)

• Flexibility: Trading and banking of allowances

Multi-State NOx Programs

• Goal: Reduce summer ozone/smog levels

• Target: Reduce NOx emissions from electric generators and industrial boilers by 1 million tons (70% below 1990 levels)

• Federal government sets state caps, states allocate allowances

• Trading and bankingOTR Trading States

Additional NOx SIP Call States

OTR State dropped in NOx SIP Call

Federal and State Roles Under NOx Programs

Design Element SO2 Program NOx ProgramNational/State Emissions Budgets Federal FederalSource Allowance Allocations Federal StatesRegistry Operation Federal FederalEmissions Measurement Standards Federal FederalEmissions Reporting Standards Federal FederalEmissions Verification Federal FederalCompliance Determination Federal FederalExcess Emissions Penalties Federal FederalCriminal and Civil Penalties Federal Federal/StatesEnforcement Actions Federal States

Allocating Allowances

• Many ways, none perfect– auction or free (size, emissions, or utilization; input or

output; historic or future; permanent or updating)

– set asides (new sources, renewables, demand side efficiency)

• Considerations: environmental, economic (macro, equity), allowance market

• Provide as much certainty as possible– allocate several years into the future

Emissions Measurement Goals for SO2 and NOx Programs

• Complete accounting with no underestimation• Simplicity, consistency and transparency• Incentives for accuracy and improvement• Cost effectiveness • Flexibility for small sources

– 36% of units must use Continuous Emissions Monitors (CEMS)

– Accounts for 96% of total SO2 emissions

• Electronic reporting, feedback, and auditing• Public access to data

Quality Assurance and Verification by EPA

• Certification of emissions monitoring systems• Stringent daily, quarterly and annual QA checks

and tests • Conservative data substitution for missing data

– Provides incentive for monitoring– Monitors running over 99% of the time

• Near 100% electronic auditing of emissions data• Random on-site field audits and witnessing of QA

tests

Public Access to Hourly Emissions Data

Allowance Registry

• Official record of allowance transfers

• Each allowance has a serial number

• Parties reach agreement, then authorise EPA to transfer allowances or transfer online

• Registry is not a trading platform

Public Access to Allowance Data

Type of transfer(auction, private)

Seller name andaccount info

Buyer name andaccount info

Confirmation date, serial numbers and

total allowancestransferred

Internet query capability

Compliance & Enforcement

• Annual reconciliation: Compare emissions with allowances • Penalties for non-compliance

– SO2 Program: • Automatic offset (deduct allowance from next year’s allocation)• Automatic financial penalty ($2,900/ton of SO2 )• Possible civil and criminal penalties

– NOx Program• 3 allowances surrendered for each ton from next year’s account (no

automatic monetary penalty)• Possible civil and criminal penalties

• 99.9% compliance rate for both SO2 and NOx programs– penalties have ranged from $3,000 to $1,500,000

Environmental Accountability

TIME/LTM (Surface Water Monitoring)

• Measuring Results– Changes to deposition and water quality

• Comparing to Goals– Are additional actions needed?

0

5

10

15

20

1980 1990 1995 2000 2002 2003 2010

Major Reductions in SO2 and Acid Rain

SO2 emissions from power plants down by 5.1 million tons

since 1990

Acid rain reduced by

25 – 40%

Wet Sulfate DepositionAverage 1989 - 1991

Wet Sulfate DepositionAverage 2000 – 2002

11.9

Mil

lion

Ton

s of

SO

2 Actual EmissionsFinal Cap

15.7

10.2

17.3

89.011.2 10.6

Low Compliance Costs

Compliance Costs - 2010

0

0.5

1

1.5

2

2.5

3

Commandand

Control

EmissionRate

Standard

Cap &Trade

Bill

ion

US

$

Source: Carlson, Burtraw, Cropper, Palmer

• Competition among emission reduction options

• Continuous incentive for innovation

• Banking provides timing flexibility

• Allowance price provides benchmark for decision making

• Trading not restricted

Active Allowance Market

• Over 165 million allowances transferred through almost 27,000 transactions since 1994

• Approximately 45% of transfers are arms length trades

• Over 80% of transfers are handled online

• Low transaction costs

SO2 Allowances Transfered Under the Acid Rain Program

0

5

10

15

20

25

30

35

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003M

illi

on

s

Between Economically Related Organizations

Between Economically Unrelated Organizations

SO2 Allowance Prices

0

50

100

150

200

250

Jan-94

Jan-95

Jan-96

Jan-97

Jan-98

Jan-99

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

US

$

Fieldston Publications Price IndexCantor Fitzgerald Market Price Index

NOx Program Results

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

2,000,000

OTC States Non-OTC States Total

1990 Baseline 2000 Baseline 2003 Emissions Budgets

·OTC states reduced emissions:

–70% from 1990 levels,

–33% from 2000 levels.

• Over 1.5 million allowances transferred through almost 8600 transactions since 1998

Ozone Season NOx Emissions

Largest Reductions Occurred at Plants with Highest 1990 Emissions

Plant-Level 1990 SO2 Emissions and SO2 Emissions Changes by 2001-03

-350,000

-300,000

-250,000

-200,000

-150,000

-100,000

-50,000

0

50,000

0 50,000 100,000 150,000 200,000 250,000 300,000 350,000 400,000

1990 SO2 Emissions (tons)

Ch

an

ge

in

SO

2 (

ton

s)

fro

m 1

99

0 t

o 2

00

1-0

3

Change in Em is s ions if All PlantsReduce Sam e Am ount

Actual Change in Em is s ions

The red line represents the expected change in SO2 from 1990 levels if each plant achieved the same percent reduction as the entire universe of affected sources did in aggregate (32.6% reduction). This assumes that there are no new plants with emissions since 1990.

Decreases tended to be large, while increases tended to be small (and smaller plants) 353 facilities decreased emissions by 6.5 million tons 274 facilities increased by 1.2 million tons).*

* This only includes facilities with emissions in 1990. It does not include new sources or sources that did not operate in 1990.

Spatial Distribution of Emission Changes

– Blue circles: sources that reduced emissions more than 1,000 tons.– Orange squares: sources that increased emissions more than 1,000 tons.– Size of symbols proportional to magnitude of change in emissions.– Hollow circles: emissions did not change more than 1,000 tons.

SO2 Emissions Changes Between 1990 and 2001-03 (Acid Rain Sources)

Lesson: To Trade or Not to Trade…

• Can the problem be addressed with a flexible approach?– Local or regional problem?– Episodic or cumulative problem?

• Can emissions be measured accurately and consistently?

• Do abatement costs differ among facilities?• Is there an appropriate number of sources?• Do the necessary governmental and market

institutions exist?

Lesson: Program Compatibility

• Cap & trade programs should complement, not contradict, existing environmental regulations

• An unambiguous legal framework defining the relationship between cap & trade programs and other policy instruments should be established before a trading program begins

• Hybrid approaches may be appropriate• Programs are less confusing, less expensive, and

more likely to succeed if they are simple

Lesson: Government Focus

• Achieving a specific environmental objective

• Supporting the allowance market by– Ensuring the integrity of the allowance, i.e., the

authorization to emit– Minimizing administrative costs

Recent Policy Trends

• Trend #1: From experiment to mainstream• Trend #2: Increased public acceptance• Trend #3: Increased activity at the State level• Trend #4: Looking beyond U.S. borders

Trend #2: Increased Public Acceptance

• Media’s reaction to trading in 1992– “Why not set up a national Murder Inc. as a murder-rights

clearinghouse? Time to subject random violence to free-market discipline.” (editorial in The Nation)

– “What’s next, the L.A. Police Department trying to buy civil rights credits in Wisconsin?” (quote from A.P. wire story)

– “Why applaud a deal that lets companies buy pollution rights? People will die.” (op. ed. In USA Today)

• Situation in 2004– Acclaimed by “policy elite”– More positive media coverage– More NGO’s support (but not all)

Trend #3: Increased Activity at the State and Municipal Level

• Southern California (RECLAIM) program for SO2 and NOx• Western States (WRAP) using cap and trade as backstop for

regional haze• Chicago VOC cap and trade program• New Hampshire NOx program• Connecticut and New York non-ozone season NOx

programs• Massachusetts and New Hampshire have power sector caps

on CO2• Regional GHG cap and trade initiative (RGGI) in

Northeastern States

Trend #4: Looking Beyond U.S. Borders

• U.S.- Canada Feasibility Study announced in July 2003– Evaluate impacts of cross border trading (SO2 and NOx)

– Assess differences in key design elements (e.g., monitoring, registries)

– Describe legal and regulatory infrastructure

• U.S. – Mexico at earlier stage of cooperation– Joint workshops on emissions trading

– Capacity building on inventories, economic modeling

– Experimental project-based trades along border region

• Supporting efforts in other countries

For More Information

• Visit the clean air markets web site to view– Emissions data

– Allowance transfers

– Information on the acid rain program and ozone transport programs

– Program rules and guidelines

– Studies and reports

http://www.epa.gov/airmarkets/