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21
4
11
1
EXECUTIVE OFFICE OF THE PRESIDENT
COUNCIL OF ECONOMIC ADVISERS
WASHINGTON, D.C. 20502
May 10, 1999
Manuel Betancourt
Secretaria de Energia
Subsecretaria de Politica y
Desarrollo de Energeticos
Direccion General de Politica y
Desarrollo Energeticos
Insurgentes Sur No. 890, Piso 14
Col. Del Valle C.P. 03100
Mexico, D.F.
Dear Lic. Betancourt:
Please find enclosed a set of papers describing the U.S. sulfur dioxide emissions trading
program. These papers are from the U.S. Environmental Protection Agency, Resources for the
Future (a non-partisan think-tank focused on environmental and natural resource issues), and
academic journals. I hope that you will find these papers useful in understanding the design and
performance of our emissions trading system. If you would like to follow-up with more
discussion of this program, please don't hesitate to contact me. I would be more than happy to
speak with you and your colleagues about the program. In addition, please feel free to contact
Stephanie Benkovic of the U.S. Environmental Protection Agency at 202-564-9142 and
[email protected]. I will also compile some papers that may provide insights on the
potential design of a greenhouse gas emissions trading system and send them to you in the near
future.
We look forward to continued work with you and your secretariat on sustainable energy,
climate change, and other related issues.
Sincerely,
7.4l Joe Aldy
Senior Adviser
enclosures
cc:
Stephanie Benkovic, U.S. Environmental Protection Agency
Mark Mazur, U.S. Department of Energy
United States
Office of Air and Radiation
EPA
Revised August 1998
Environmental Protection Agency
Acid Rain Division (6204])
Emissions Trading of Sulfur Dioxide:
ACID
RAIN
PROGRAM
The U.S. Experience
Introduction
mandatory ceiling, on total SO₂ emissions
from utilities. After full implementation of
The overall goal of the United States' Acid
the program, annual emissions will be
Rain Program is to achieve significant
capped at 8.95 million tons, which
environmental and public health benefits
represents a 50 percent decrease in SO₂
through reductions in emissions of sulfur
emissions from electric utilities from 1980
dioxide (SO₂) and nitrogen oxides (NOx),
levels. Enforcing this cap is a rigorous
the primary causes of acid rain. To achieve
monitoring system that allows EPA to
this goal at the lowest cost to society, the
ensure accuracy and verifiable emissions
program employs both traditional and
reductions.
innovative, market-based approaches for
controlling air pollution.
In a dramatic departure from traditional
command and control regulatory
At the core of the SO₂ program is a cap, or
structures, this program utilizes a market-
based system of
tradeable emissions
8.95 Million Tons; 49% below
allowances. The system
allows regulated utilities
1980 level
flexibility in how they
30
attain compliance, so
that they can select the
25
most cost effective
Without Acid Rain Program
strategy for their
20
particular facilities.
Million tons
15
Allowable Emissions
The program was
10
established in the 1990
amendments to the
With Acid Rain Program
5
Clean Air Act, the
nation's air pollution
0
control law. As stated
1980
1985
1990
1995
2000
2005
2010
in Title IV of the Clean
Air Act, the primary
goal of the Acid Rain
Figure 3 The Clean Air Act will result in a 10 million ton reduction
Program is to reduce
in SO₂ emissions from 1980 levels by the year 2010.
annual SO₂ emissions by
10 million tons below 1980 levels. To
year.
achieve these reductions, the law requires a
two-phase tightening of restrictions placed
The allowance trading system gives utilities
on fossil fuel-fired power plants, which
flexibility in devising compliance strategies.
accounted for two thirds of national SO₂
This flexibility is a result of the fact that a
emissions in 1980.
regulated unit need only to hold enough
allowances at year end to account for its
Phase I began in 1995. It affects 263
emissions. Unlike traditional regulatory
boilers, or "units," at 110 mostly coal-
programs, EPA does not dictate the
burning electric utility plants that were
compliance options. Options might
identified in the law as the largest SO₂
include employing energy conservation
emitters. Additional units may voluntarily
measures, increasing reliance on renewable
join Phase I of the program early as
energy, reducing usage, employing
substitution or compensating units. In 1997
pollution control technologies, switching
there were a total of 423 affected units.
to lower sulfur fuel, or developing other
alternate strategies to reduce emissions.
Phase II, which begins in the year 2000,
tightens the annual emissions limits
Because allowances have a value and can be
imposed on these large, higher emitting
purchased and owned, they are sometimes
plants. In addition, restrictions come into
misconstrued as "rights" to a certain
effect on smaller, cleaner plants fired by
amount of pollution. However, the law
coal, oil, and gas. This phase affects
makes clear that allowances are merely
existing utility units serving generators
authorizations to emit, since at all times
with an output capacity of greater than 25
the government retains the authority to
megawatts and all new utility units.
require affected sources to comply with the
Clean Air Act limits. The concept of
The Clean Air Act also calls for a 2 million
authorizing sources to emit is common to
ton reduction in NOx emissions by the
all air pollution regulations; no regulations
year 2000 through a more conventional
dictate zero air emissions. With more
regulatory program. A significant portion
traditional forms of regulations, sources
of this reduction will be achieved by coal-
are authorized to emit through emissions
fired utility boilers that will be required to
limits or through requirements to install
install low NOx burner technologies and
specific technologies.
to meet new emissions standards.
The financial value and enduring validity
The Allowance System
of excess allowances encourage SO₂
reductions beyond what is required by the
Allowance trading is the innovative tool
present year's allotment. Allowances are
for achieving SO₂ emissions reductions
fully marketable commodities: units that
required by the cap. Allowances are the
reduce their emissions below the number
currency with which compliance with the
of allowances they hold may trade their
SO₂ emissions requirements is achieved;
excess allowances with other units in their
one allowance authorizes a regulated unit
system, sell them on the open market to
to emit one ton of SO₂ during a specific
other utilities or through EPA auctions, or
year or any year thereafter. At the end of
bank them to cover emissions in future
each year, the unit must hold an equal or
years.
greater number of allowances as the tons of
SO₂ emitted that year, i.e., a unit that emits
Banking
5,000 tons of SO₂ must hold at least 5,000
Banking encourages early emissions
allowances that are eligible to be used that
reductions by allowing participants to store
their excess allowances and by assuring that
existing rates greater than 2.5
those allowances will retain their
pounds/mmBtu and was multiplied by the
compliance value in future years. Utilities
unit's average fuel use from 1985 through
may use banked allowances to help comply
1987. These allocations are listed in the
in later years, or they may sell them. In
Clean Air Act and are codified in the
the first year of the Program's
Allowance System Regulations.
implementation, Phase I affected units
collectively achieved 40 percent greater
In Phase II, the limits imposed on Phase I
emissions reductions than was required by
plants will be tightened, and emissions
law. This dramatic result demonstrates
limits will be imposed on smaller, cleaner
that banking leads to SO₂ reductions earlier
units that were not included in Phase I.
than if banking were not permitted. These
EPA allocated allowances to each unit at
extra reductions result in environmental
the lesser of its existing emission rate or 1.2
and health benefits that begin sooner.
pounds of SO₂/mmBtu, multiplied by the
unit's baseline fuel consumption.
Banking also reduces compliance costs by
allowing utilities more flexibility in the
Equity issues in allowance allocations
timing of their pollution control
In addition to the standard formulas for
investments.
allocating emission allowances, the Clean
Air Act Amendments set forth special
Phase I affected sources are likely to be
provisions to address equity concerns
banking allowances in anticipation of the
raised by some states. For example, in
more stringent emission limits and higher
some cases, states that had already reduced
costs in Phase II. It is expected that rather
the emissions of their electric utilities to
than a sharp drop in emissions at the start
levels well below the national average were
of Phase II, reductions will move toward
given extra allowances. Similarly, a state
the ultimate cap more gradually as banked
with high population growth in the 1980s
allowances from previous years are used for
was given bonus allowances for its electric
compliance. Although the reduction rate
utilities to compensate for this growth. In
may slow down after Phase II, the
all cases, these redistributions of allowances
environmental and health benefits sparked
were done without increasing the overall
by the initial overcompliance will have
level of national emissions. In other
been accruing for several years.
words, increases in allowance allocations in
certain states or at certain electric utilities
Regardless of how many allowances a unit
were offset by decreases in the allowance
holds, it is never entitled to exceed the
allocations to other states or emissions
source-specific limits set under Title I of
sources.
the Clean Air Act to protect public health.
Permits
Allocations
Permitting under the Acid Rain Program is
EPA allots allowances to each affected unit
simple and flexible. For example, the Phase
for each year, beginning with Phase I units
II permitting form consists primarily of a
in 1995. These allocations were
statement of standard legal requirements in
determined prior to the start of the trading
the Clean Air Act that companies certify
program, based on selected emission rates
they will meet. Utilities may select from
and each unit's representative fuel
several compliance options, devise the most
utilization level. In Phase I, the specified
cost-effective compliance plan, and revise
emission rate was 2.5 pounds of
plans easily without needing government
SO₂/mmBtu (million British thermal
review or approval. The standard permit
units). This rate was applied to units with
forms ensure consistency on a nationwide
basis.
Source makes
Then mail trade
Allowance
allowance trade
information to EPA
with brokers,
Transfers
environmental
EPA is responsible
groups,or other
for recording the
sources
transfer of
allowances that are
used for
compliance and for
confirming that
utilities hold at
ATS
least as many
allowances as tons
of SO₂ emitted by
EPA sends a
the end of the year.
transfer
EPA enters trade
confirmation
information into the
To fulfil this role,
report to each of
Allowance Tracking
the traders
System
EPA designed and
maintains the
Figure 4 The allowance transfer process
Allowance
Tracking System (ATS), a computer
program that is the official record of
ATS also makes the movement of allowances
allowance holdings and transfers. Every
easy to track. ATS records the issuance of all
utility unit, corporation, group, or
allowances, the holdings of allowances in
individual holding allowances has an account
accounts, the deduction of allowances for
with ATS, held in the name of a designated
compliance purposes, the transfer of
individual. EPA established accounts for
allowances between accounts, and the
utility units affected by both Phase I and
number of allowances held in EPA reserves.
Phase II. In addition, any person or group
Information on ATS accounts and
wishing to purchase allowances may open an
transactions are available to the public via
ATS account.
the Internet.
The structure of the Acid Rain Program
Determining Compliance
simplifies the transfer of allowances, thereby
At the end of the year, units must hold in
lowering the cost of transactions. The
that year's compliance subaccount an
transfer process is comprised of four steps for
amount of allowances equal to or greater
utilities. A utility makes an allowance trade
than the amount of SO₂ emitted during that
with another utility, a broker, or
year. By January 30 following the
environmental group. They enter
compliance year, units must finalize and
information about the trade on a one-page
report to EPA allowance transactions that
form and mail it to EPA. Next, EPA enters
were used in attaining quantities of
this information into ATS and then sends a
allowances necessary for compliance. The
transfer confirmation report to each of the
amount of emissions is contained in the
traders. Because there is no need for case-by-
Emission Tracking System (ETS), which is
case approval of trades, allowance transfers
operated by the Acid Rain Program and
are straightforward and fast. Only transfers
records each hour of each unit's hourly
of allowances to be used for compliance
emissions throughout the year.
require EPA notification; notification of
other transfers is voluntary.
After the January 30 deadline, EPA deducts
Rain Program has witnessed large reductions
effects of the program. Industry's role is to
in SO₂ emissions. Since the start of the
reduce emissions in the most cost effective
program in 1995, all Phase I affected units
manner. Brokers provide information on
have been in compliance, and utilities
the market and facilitate allowance transfers
reduced emissions significantly more than
for utilities and other parties, thus reducing
required by the cap. Annual emissions from
transaction costs. Finally, environmental
these Phase I units dropped by more than
organizations monitor the overall
half between 1980 and 1995, from 10.9
performance through access to emissions and
million tons to 5.3 million tons.
allowance data. In addition, these groups
may purchase and retire allowances, a small
Environmental effects corresponding to
but direct action individuals can take to
these early reductions are starting to emerge.
reduce pollution.
A United States Geological Survey study
determined that 1995 wet sulfate deposition
Just as each participant has a role in ensuring
declined in the eastern United States by 10 to
the integrity of the Program, each element of
25 percent. Other anticipated benefits
the Program works in concert to bring about
include avoided health costs of $12 to $40
efficient emissions reductions. The allowance
billion per year by 2010; improvements in
trading system capitalizes on the power of
visibility amounting to $3.5 billion by 2010;
the marketplace to reduce SO₂ emissions in
fewer acidic lakes and streams; and reduced
the most cost effective manner possible. The
damage to buildings and outdoor cultural
permitting program allows sources the
artifacts.
flexibility to tailor and update their
compliance strategy based on their individual
At the same time, the Acid Rain program
circumstances. The continuous emissions
has cost significantly less than the benefits,
monitoring and reporting systems provide
and estimates for the program's long term
the accurate and standardized accounting of
costs continue to drop. As of 1994, the
emissions necessary to make the program
estimated cost of the program was $2 to $2.5
work, and the excess emissions penalties
billion per year by 2010. This cost is half of
provide strong incentives for compliance.
what a command and control regulatory
Each of these separate components
program would cost.
contributes to the effective working of an
integrated program that harnesses market
The cost of reducing a ton of SO₂ from the
incentives for the benefit of the
utility sector has been much lower than
environment.
expected: scrubber costs have dropped,
removal efficiencies have improved, and
For More Information
expected increases in costs associated with
the increased use of low sulfur coal have not
For more information on the Acid Rain
materialized. These reductions in cost have
Program, please visit the Acid Rain
been reflected in allowance prices. In just
Program's web site at
two years, allowance prices have dropped
www.epa.gov/acidrain or call the Acid
from $150/ton to less than $100/ton.
Rain Hotline at 202-564-9620.
Important Roles Played by Participants
Successful implementation of the Acid Rain
Program hinges on straightforward and well-
defined roles for each participant. EPA
monitors utilities' emissions to ensure
compliance, and measures the environmental
allowances from each unit's compliance
Strong enforcement measures deter
subaccount in an amount equal to its SO₂
noncompliance. If annual emissions exceed
emissions for that year. If the unit's
the number of allowances held, the owners
emissions do not exceed its allowances, the
or operators of delinquent units must pay a
remaining allowances are carried forward, or
penalty of $2,000 (adjusted for inflation) per
banked, into the next year's subaccount.
excess ton of SO₂ or NOx emissions. This
fee is substantially higher than the cost of
Ensuring Environmental and Health
compliance, e.g., an allowance. In addition,
Benefits through Stringent Monitoring
the number of exceeded allowances is
deducted from the violating utility's account
Tradable allowances are intended to achieve
for the next year to fully offset the
environmental goals at the lowest cost to
environmental impact.
society. However, even if no trades were to
occur, these environmental goals would still
The emissions monitoring and reporting
be met by the Acid Rain Program. The
systems are critical to the program.
Program uses several mechanisms to ensure
Monitoring ensures, through stringent
that its environmental and health goals are
accounting, that the SO₂ and NOx emissions
met. During Phase II, the Clean Air Act
reduction goals are met. They also instill
places a cap of 8.95 million on the total
confidence in allowance transactions by
number of allowances issued to units each
certifying the existence and quantity of the
year. This effectively caps emissions at 8.95
commodity being traded.
million tons annually and ensures that the
mandated emissions reductions are
Emissions data is available to the public in
maintained over time. This reduction
several formats, including over the Internet.
represents a 50 percent decrease in SO₂
Such public access provides the program
emissions from 1980 levels.
transparency that assures integrity and public
trust in the system.
To enforce the integrity of the emissions
limit, EPA tracks on a continuous basis each
Results
unit's emissions of SO2, NOx and CO2, as
well as volumetric flow and opacity. In most
The Acid Rain Program's environmental
cases, a continuous emission monitoring
goals are already starting to be met. After
(CEM) system must be installed. Through
the first year of implementation, the Acid
the CEM system, units
report their hourly
SO2 Emissions from
emissions data to EPA
263 Phase I Units
on a quarterly basis.
The reporting process is
12
evolving from the
10
9.4
9.3
submittal of diskettes to
8.7
Allowable Emissions
the use of modems,
8
7.4
7.1
which has greatly
6.0
increased the efficiency
6
of reporting. The data
SO2 (million tons)
4.5
4.8
4.8
is then recorded in the
4
Emissions Tracking
System, which serves as
2
a repository of
0
emissions data for the
utility industry.
1980
1985
1990
1995
1996
1997
United States
Office of \ir and Radiation
Revised February 1999
EPA
Environmental Protection Agency
Acid Rain Division 62041)
EPA 430-F-92-015
Environmental Benefits
ACID
RAIN
of the Acid Rain Program
PROGRAM
Introduction
enjoyment of scenic vistas across our country,
particularly in National Parks. Stress to our
Acidic deposition, or acid rain as it IS
forests that populate the ridges of mountains
commonly known, occurs when emissions of
from Maine to Georgia will be reduced.
sulfur dioxide (SO₂) and oxides of nitrogen
Deterioration of our historic buildings and
(NOx) react in the atmosphere with water,
monuments will be slowed. Finally, reductions in
oxygen, and oxidants to form various acidic
SO₂ and NOx will reduce sulfates, nitrates, and
compounds. These compounds then fall to
ground level ozone (smog), leading to
the earth in either drv form (such as gas and
improvements in public health.
particles) or wet form (such as rain, snow, and
fog). Prevailing winds transport the
compounds, sometimes hundreds of miles,
Surface Waters
across state and national borders.
Acid rain primarily affects sensitive bodies of
Electric unlity plants account for about 70
water, that is, those that rest atop soil with a
percent of annual SO₂ emissions and 30
limited ability to neutralize acidic compounds
percent of NOx emissions in the United
(called "buffering capacity"). Many lakes and
States. Mobile sources (transportation) also
streams examined in a National Surface Water
contribute significantly to NOx emissions.
Survey (NSWS) suffer from chronic acidity, a
Overall. over 20 million tons of SO₂ and
condition in which water has a constant low pH
NOx are emitted into the atmosphere each
level. The survey investigated the effects of acidic
year.
deposition in over 1,000 lakes larger than 10 acres
and in thousands of miles of streams believed to
Acid rain causes acidification of lakes and
be sensitive to acidification. Of the lakes and
streams and contributes to damage of trees at
streams surveved in the NSWS, acid rain has
high elevations (for example, red spruce trees
been determined to cause acidity in 75 percent
above 2,000 feet in elevation). In addition,
of the acidic lakes and about 50 percent of the
acid rain accelerates the decav of building
acidic streams. Several regions in the U.S. were
materials and paints, including irreplaceable
identified as containing many of the surface
buildings, statues, and sculptures that are part
waters sensitive to acidification. They include,
of our nation's cultural heritage. Prior to
but are not limited to, the Adirondacks, the
falling to the earth, SO₂ and NOx gases and
mid-Appalachian highlands, the upper Midwest
their particulate matter derivatives, sulfates
and the high elevation West.
and nitrates, contribute to visibility
degradation and impact public health.
In some sensitive lakes and streams, acidification
has completely eradicated fish species, such as the
Implementation of the Acid Rain Program
brook trout, leaving these bodies of water barren.
under the 1990 Clean Air Act Amendments
In fact, hundreds of the lakes in the Adirondacks
will confer significant benefits on the nation.
surveved in the NSWS have acidity levels
By reducing SO₂ and NOx, many acidified
indicative of chemical conditions unsuitable for
lakes and streams will improve substantially
the survival of sensitive fish species.
so that they can once again support fish life.
lisibility will improve, allowing for increased
Critical pH Levels for Selected Aquatic Organisms
65
6.0
55
5.0
45
40
Yeilcw Perch
Brook Trout
Lake Trout
Smailmouth Bass
Rainbow Trout
Common Shiner
American Toad*
Wood Frog*
Leopard Frog*
Spotted Salamander*
Crayfish**
Mayfly**
Clam**
Snall**
"embryonic life stages
"selected species
Note: Solid symbols for each type of organism are placed in favorable pH ranges. Shaded symbols are placed
in less favorable ranges. No symbol is placed in pH ranges that generally do not support populations of a particular type of organism.
Source: National Acid Precipitation Assessment Program 1990 Integrated Assessment Report, November 1991
Emissions from U.S. sources also contribute
Acidification is also a problem in surface water
to acidic deposition in eastern Canada, where
populations that were not surveyed in federal
the soil is very similar to the soil of the
research projects. For example, although lakes
Adirondack Mountains, and the lakes are
smaller than 10 acres were not included in the
consequently extremely vulnerable to chronic
NSWS, there are from one to four times as many
acidification problems. The Canadian
of these small lakes as there are larger lakes. In
government has estimated that 14,000 lakes in
the Adirondacks, the percentage of acidic lakes is
eastern Canada are acidic.
significantly higher when it includes smaller lakes
(26 percent) than when it includes only the target
Streams flowing over soil with low buffering
size lakes (14 percent).
capacity are equally as susceptible to damage
from acid rain as lakes are. Approximately
The acidification problem in both the United
580 of the streams in the Mid-Atlantic Coastal
States and Canada grows in magnitude if
Plain are acidic primarily due to acidic
"episodic acidification" (brief periods of low pH
deposition. The New Jersey Pine Barrens
levels from snowmelt or heavy downpours) is
area endures the highest rate of acidic streams
taken into account. Lakes and streams
in the nation with over 90 percent of the
throughout the United States, including high
streams acidic. Over 1,350 of the streams in
elevation western lakes, are sensitive to episodic
the Mid-Atlantic Highlands (mid-Appalachia)
acidification. In the Mid-Appalachians, the
are acidic, primarily due to acidic deposition.
Mid-Atlantic Coastal Plain, and the Adirondack
Many streams. in that area have already
Mountains, many additional lakes and streams
experienced trout losses due to the rising
become temporarily acidic during storms and
acidity.
snowmelt. Episodic acidification can cause large
scale "fish kills."
2
Approximately 70 percent of sensitive lakes in
in several ways; for example, acidic cloud water at
the Adirondacks are at risk of episodic
high elevations may increase the susceptibility of
acidification. This amount is over three times
the red spruce to winter injury.
the amount of chronically acidic lakes. In the
mid- Appalachians, approximately 30 percent
There also is a concern about the impact of acid
of sensitive streams are likely to become
rain on forest soils. There is good reason to
acidic during an episode. This level is seven
believe that long-term changes in the chemistry of
times the number of chronically acidic
some sensitive soils may have alreadv occurred as
streams in that area.
a result of acid rain. As acid rain moves through
the soils, it can strip away vital plant nutrients
Acid rain control will produce significant
through chemical reactions, thus posing a
benefits in terms of lowered surface water
potential threat to future forest productivity.
acidity. If acidic deposition levels were to
remain constant over the next 50 years (the
time frame used for projection models), the
Visibility
acidification rate of lakes in the Adirondacks
that are larger than 10 acres would rise by 50
Sulfur dioxide emissions lead to the formation of
percent or more. Scientists predict, however,
sulfate particles in the atmosphere. Sulfate
that the decrease in SO₂ emissions required
particles account for more than 50 percent of the
by the Acid Rain Program will significantly
visibility reduction in the eastern part of the
reduce acidification due to atmospheric
United States, affecting our enjoyment of national
sulfur. Without the reductions in SO₂
parks, such as the Shenandoah and the Great
emissions, the proportions of acidic aquatic
Smokv Mountains. The Acid Rain Program is
systems in sensitive ecosystems would remain
expected to improve the visual range in the
high or dramatically worsen.
eastern U.S. by 30 percent. Based on a study of
the value national park visitors place on visibility,
The impact of nitrogen on surface waters is
the visual range improvements expected at
also critical. Nitrogen plays a significant role
national parks of the eastern United States due to
in episodic acidification. and new research
the Acid Rain Program's SO₂ reductions will be
recognizes the importance of nitrogen in
worth a billion dollars by the year 2010. In the
long-term chronic acidification as well.
western part of the United States, nitrogen and
Furthermore, the adverse impact of
carbon also play roles, but sulfur has been
atmospheric nitrogen deposition on estuaries
implicated as an important source of visibility
and other large water bodies may be
impairment in many of the Colorado River
significant. For example, 30 to 40 percent of
Plateau national parks, including the Grand
the nitrogen in the Chesapeake Bav comes
Canvon, Canvonlands, and Bryce Canyon.
from atmospheric deposition. Nitrogen is an
important factor in causing eutrophication
(oxygen depletion) of water bodies.
Materials
Acid rain and the dry deposition of acidic
Forests
particles are known to contribute to the
corrosion of metals and deterioration of stone
Acid rain has been implicated in contributing
and paint on buildings, cultural objects, and cars.
to forest degradation, especially in
The corrosion seriously depreciates the objects'
high-elevation spruce trees that populate the
value to society. Dry deposition of acidic
ridges of the Appalachian Mountains from
compounds can also dirty buildings and other
Maine to Georgia, including national park
structures, leading to increased maintenance costs.
areas such as the Shenandoah and Great
To reduce damage to automotive paint caused by
Smokev Mountain national parks. Acidic
acid rain and acidic dry deposition, some
deposition seems to impair the trees' growth
manufacturers use acid-resistant paints, at an
3
average cost of $5 for each new vehicle (or a
Clean Air for Better Life
total of $61 million per year for all new cars
and trucks sold in the U.S.) The Acid Rain
Bv significantly reducing SO₂ emissions, the
Program will reduce damage to materials by
Clean Air Act will confer numerous benefits on
limiting SO, emissions. The benefits of the
the nation. Scientists project that the 10
Acid Rain Program are measured, in part, by
million-ton reduction in SO₂ emissions required
the costs now paid to repair or prevent
by the Acid Rain Program should significantly
damage--the costs of repairing buildings.
decrease or slow down the acidification of water
using acid-resistant paints on new vehicles,
bodies and will reduce stress to forests. In fact, a
plus the value that society places on the
United States Geological Survey study determined
details of a statue lost forever to acid rain.
that after the first year of the Acid Rain Program's
implementation, 1995 wet sulfate deposition in
the eastern United States declined bv 10 to 25
Health
percent. Anticipated benefits also include
significantly improved visibility and longer life
Based on health concerns, SO, has
spans of building materials and structures of
historically been regulated under the Clean
cultural importance. Finally, the reductions in
Air Act. Sulfur dioxide interacts in the
emissions will help to protect public health.
atmosphere to form sulfate aerosols, which
may be transported long distances through
the air. Most sulfate aerosols are particles that
For More Information
can be inhaled. In the eastern United States,
sulfate aerosols make up about 25 percent of
For more information, please visit the Acid Rain
the inhalable particles. According to recent
Program's World Wide Web site at
studies at Harvard and New York
www.epa.gov/acidrain, or contact the Acid Rain
Universities, higher levels of sulfate aerosols
Hotline at 202-564-9620.
are associated with increased morbidity
(sickness) and mortality from lung disorders
such as asthma and bronchitis. By lowering
sulfate aerosol levels, the Acid Rain Program
will reduce the incidence and the severity of
asthma and bronchitis. When fully
implemented by the year 2010 the public
health benefits of the Acid Rain Program will
be significant due to decreased mortality,
hospital admissions, and emergency room
visits.
Decreases in nitrogen oxide emissions are
also expected to have a beneficial impact on
health effects by reducing the nitrate
component of inhalable particulates and
reducing the nitrogen oxides available to react
with volatile organic compounds and form
ozone. Ozone impacts on human health
include a number of morbidity and mortality
risks associated with lung disorders.
4
EPA
United States
Office of Air and Radiation
Revised February 1999
Environmental Protection Agency
Acid Rain Division (6204J)
The Environmental Impacts
ACID
RAIN
PROGRAM
of SO₂ Allowance Trading
SO2 allowance trading allows utilities flexibility in the timing and location of their
emissions reductions. EPA is assessing how trading affects emission patterns around
the country. The first three years of the program have produced extra SO2
reductions in almost every affected state. Most allowances were used in the same
state as they were allocated, indicating little geographic shifting of emissions due to
Introduction
Existing utility units were allocated allowances
The Environmental Protection Agency's Acid
for each future compliance year. At the end of
Rain Program, established under Title IV of the
each year, each unit must surrender, or "retire,"
1990 Clean Air Act Amendments, calls for major
as many allowances as tons of SO2 emitted that
reductions of sulfur dioxide (SO2) and nitrogen
year. Allowances have a specific use year,
oxides (NOx), the pollutants that cause acid rain.
making them valid for surrender that year or any
In an innovative approach to environmental
year thereafter.
protection, the program uses market incentives
to achieve a nationwide limit on SO2 emissions
How does EPA verify compliance?
more cost effectively than traditional regulatory
In the year-end compliance process, EPA
methods. The Acid Rain Program requires a two-
reconciles its data on allowance holdings and
phase tightening of restrictions on fossil fuel-
utility emissions. Accurate accounting of utility
fired power plants, resulting in a permanent cap
emissions is essential to the trading system's
on SO2 of 8.95 million tons nationwide, which
integrity. EPA tracks on a continuous basis each
is half the amount emitted by utilities in 1980.
unit's allowance holdings and emissions of SO2,
Phase I runs from 1995 through 1999 and affects
NOX, and CO2, and other parameters. In most
roughly 440 of the larger, higher-emitting utility
cases, units install a continuous emissions
boilers, or units, in the country. Phase II begins
monitoring (CEM) system that reports their
in 2000 and extends to over 2,000 units.
hourly emissions data to EPA.
This market-based program uses a system of
Because stringent monitoring and reporting
tradable emissions allowances. Each SO2
certifies that environmental requirements are
allowance is an authorization to emit one ton of
being met, EPA can give utilities flexibility in
SO2 in a given year. Allowances may be bought,
the methods and timing by which they achieve
sold, or banked by utilities, brokers, or anyone
compliance. This flexibility allows utilities to
else interested in holding them. The creation of
pursue their most cost effective strategies, which
a market for emissions allowances attaches a
could include installing flue gas desulfurization
clear monetary value to emissions reductions,
("scrubbers"), switching to lower sulfur fuels,
thereby providing utilities an economic incentive
incorporating more renewable energy, or
to cut their SO2 emissions. Unneeded
purchasing allowances.
allowances can be sold for profit.
Results
Utility SO2 Emissions
In 1997, Phase I affected units emitted well under
30
their collective emissions limit. These units were
allocated 7.1 million allowances for the 1997
25
compliance year and only emitted a total of 5.5
million tons of SO2.¹
20
Without Acid Rain Program
Environmental data reflect improvements
begun in 1995. Large areas of the eastern U.S. saw
SO2 Emissions (million tons)
15
Allowances Allocated
accompanying the downward emissions trend
10
With Acid Rain Program
up to a 25 percent decrease in sulfur concentration
in rain in 1995 and 1996. Sulfur concentration in
5
dry deposition decreased by 30 percent in the
eastern U.S. between 1989 and 1995. Ambient, or
0
airborne, concentrations of sulfur dioxide also
1980
1985
1990
1995
2000
2005
2010
declined by 17 percent nationally between 1994
and 1995 and remained flat from 1995 to 1996.
Figure 1: By 2010, utility SO2 emissions will decrease by 8.5
million tons from 1980 levels. Banking encourages early
reductions, but gives utilities flexibility in timing these cuts.
What role does banking play?
These dramatic emissions reductions help
Even so,
Illinois, Kentucky, and New
demonstrate that banking leads to SO2 reductions
Hampshire emitted 29, 31, and 36 percent less,
earlier than if banking of allowances were not
respectively, than their 1990 emissions levels.
permitted. Banking encourages early reductions by
allowing participants to garner the benefits of over
Moreover, there have been significant emission
control through the storage of unused allowances
reductions in some of the highest emitting areas
and by assuring that those allowances will retain
of the country. For example, electric utilities in
their compliance value in future years. Phase I units
Ohio and Indiana reduced SO2 emissions by 44
are likely to be banking allowances in anticipation of
percent and 50 percent respectively from 1990
the more stringent emissions limits and higher costs
levels. This outcome is important because
of Phase II. Although banked allowances will delay
emissions reductions in these high emitting states
the full effect of the emissions cap on SO2 until 2010,
support a fundamental premise of Title IV's
the early reductions of emissions may provide greater
market based approach, i.e., that the highest
health and environmental benefits than would have
emitting plants have an incentive to make
occurred without banking (see Figure 1).
substantial reductions in emissions because they
Where did extra S02 reductions occur?
Allowance Utilization, Relative to 1997 Allocation
Nearly every state containing Phase I affected
150000
units enjoyed overall emissions reductions.
100000
Figure 2 illustrates the tons of sulfur dioxide
50000
each state emitted below or in excess of its initial
0
NH KY IL
allocation. In all but three states, utilities
Allowances
-50000
IA
KS
MS
MA
MD
MN
FL
MI
100000
AL
emitted less SO2 than originally provided for in
OH
WI
150000
NY
their allowance allocation. Only Illinois,
PA
-200000
TN
W
Kentucky, and New Hampshire emitted more
-250000
MO/
than originally allocated, but in amounts
-300000
350000
GA
overshadowed by large, extra reductions in the
other states.
Figure 2: The differences between allowances initially allocated
and allowances retired show that almost every state (IL, KY, NH
excepted) made greater SO₂ reductions than required.
can achieve these reductions at lower cost per ton
than most lower-emitting plants. Concerns that
Real and Potential SO2 Emissions
the biggest emitters of SO2 would simply buy
in Ohio, 1997
allowances and continue to emit at their historical
2,500,000
2,099,653
levels have thus far proven to be unwarranted.
2,000,000
Tons S02
1,500,000
1,288,197
1,184,641
Is trading shifting the location of emissions?
1,000,000
Other
An analysis of the allowances retired in 1996 and
allowances
500,000
Ohio
1997 reveals that the overwhelming majority of
allowances
0
allowances were retired in the same state in which
1990
1997
1997
they were initially allocated (see figure 3). For
Emissions
Allocation
missions
example, affected units in Ohio were allocated
1,288,197 allowances, in aggregate, for the 1997
Figure 3: Typical of Phase I states, Ohio retired mostly its
own allowances. The band represents out-of-state allowances
compliance year. At year end, these units emitted
retired in 1997.
1,184,641 tons of emissions. The figure depicts the
difference: affected utilities in Ohio emitted
103,556 fewer tons of SO2 than allowed by their
allowances were obtained from other units
allocation. This pattern of retiring same-state
within their own companies. This trend is
allowances shows that allowance trading has not led
illustrated by a geographic information system
to emissions shifting from one state to another in
(GIS) analysis of utility units that retired more
any significant amount. The extra emissions
allowances than initially allocated in 1996. The
reductions achieved in almost every affected state
analysis covered only the allowances retired by
further confirms that trading has not led to major
these units since the units' environmental impact
inflows of emissions into the vast majority of states.
was greater than provided for in the 1996
allocations.
From where have utilities obtained "extra"
allowances needed for compliance?
The locations of both the units that retired more
In cases where electric utility units required more
allowances than allocated and the units to which
allowances than their allocation, most of these
those allowances were initially allocated were
GEOGRAPHIC CENTERS OF TRADING, 1996
Buying Activity
Selling Activity
Mean Center of Buying Activity.
Mean Center of Selling Activity.
Weighted by Allowances Bought
Weighted by Allowances Sold
Figure 4: Our study revealed that allowance transfer activity was highest in the Midwest.
3
mapped (figure 4). For each map, the geographic
are not expected to impact sensitive ecosystems.
mean was calculated to determine the center of
In fact, in many sensitive areas such as the
trading activity. The means were weighted by the
Adirondacks and mid-Appalachians, there is
number of allowances bought or sold.
projected to be virtually no change in deposition
due to trading. EPA will continue to analyze the
The geographic centers were very close. This
impacts of allowance trading to assess how this
proximity indicates that there was no significant flow
innovative market-based program affects
of allowances from one region to another among
environmental results.
these units. In addition, the analysis reveals that the
high emitters were more concentrated in the
For More Information
Midwest, as were the units that sold them the excess
For more information on the Acid Rain
allowances. The tight geographic correlation
Program, please visit the Acid Rain Program's
corroborates EPA's observations that units tended to
web site at www.epa.gov/acidrain, or call the
acquire their excess allowances from within their
Acid Rain Hotline at 202-564-9620.
own company.
1. U.S. EPA, Acid Rain Program Compliance
When will utilities use the allowances they
Report 1997, EPA 430/R-98-012, August 1998.
buy?
Many utilities will acquire allowances now to ensure
their ability to comply later. Thus, even though a
utility is buying allowances, it does not necessarily
intend to use the allowances immediately. In some
cases allowances being traded today bear vintages
that make them valid only in future years.
Furthermore, allowances often pass through several
owners before being retired. The most important
transfer in an allowance's life, from the
environmental perspective, is the retirement of the
allowance, because only then does the allowance
correspond with one ton of real pollution. Where an
allowance is held today does not necessarily indicate
where it will be retired. In spite of these
uncertainties surrounding how much and when
utilities will emit, the emissions cap ensures that
pollution reduction goals will be met.
For now, utilities will continue to adapt their trading
strategies as the Acid Rain Program matures.
Currently almost all of the allowances used for
compliance come from sources within the same
utility company and by extension, the same
geographic region. In the future, companies are likely
to use more allowances acquired from other
companies across greater geographic distances.
However, even if all economically advantageous
trades are made, EPA models project that trading
will lead to only small changes in deposition which
4
Acid Deposition
Sulfur and nitrogen oxides are emit-
ranges from 20 to 60 percent of total
meteorological measurements that
ted into the atmosphere primarily
deposition.
are used to estimate rate of the actual
from the burning of fossil fuels.
The United States Environmen-
deposition, or "flux." Data representing
These emissions react in the atmo-
tal Protection agency (EPA) is required
total deposition loadings (e.g., total
sphere to form compounds that are
by several Congressional and other
sulfate or nitrate) are what many envi-
transported long distances and are
mandates to assess the effectiveness
ronmental scientists use for integrated
subsequently deposited in the form of
of air pollution control efforts. These
ecological assessments.
pollutants such as particulate matter
mandates include Title IX of the Clean
(sulfates and nitrates), SO₂, NO₂,
Air Act Amendments (CAAA), the
PRIMARY ATMOSPHERIC
nitric acid and when reacted with
National Acid Precipitation Assess-
DEPOSITION MONITORING
volatile organic compounds (VOCs)
ment Program (NAPAP), the Govern-
NETWORKS
form ozone. The effects of atmo-
ment Performance and Results Act,
spheric deposition include acidifica-
and the U.S. Canada Air Qualitv
The National Atmospheric Deposi-
ion of lakes and streams, nutrient
Agreement. One measure of effective-
tion Program (NADP) and the Clean
enrichment of coastal waters and
ness of these efforts is whether sus-
Air Status and Trends Network
large river basins, soil nutrient deple-
tained reductions in the amount of
(CASTNet), described in detail below,
tion and decline of sensitive forests,
atmospheric deposition over broad
were developed to monitor wet and
agricultural crop damage, and im-
geographic regions are occurring.
dry acid deposition, respectively.
pacts on ecosystem biodiversity.
However, changes in the atmosphere
Monitoring site locations are pre-
Toxic pollutants and metals also can
happen very slowly and trends are
dominantly rural by design to assess
be transported and deposited through
often obscured by the wide variability
the relationship between regional
atmospheric processes. (See Chapter
of measurements and climate. Nu-
pollution and changes in regional
5: Air Toxics.)
merous years of continuous and con-
patterns in deposition. CASTNet also
Both local and long-range
sistent data are required to overcome
includes measurements of rural
emission sources contribute to atmo-
this variability, making long-term
ozone and the chemical constituents
spheric deposition. Total atmospheric
monitoring networks especially critical
of PM₂ Rural monitoring sites of
deposition is determined using both
for characterizing deposition levels
NADP and CASTNet provide data
wet and dry deposition measure-
and identifying relationships among
where sensitive ecosystems are lo-
ments. Wet deposition is the portion
emissions, atmospheric loadings, and
cated and provide insight into natural
dissolved in cloud droplets and is
effects on human health and the envi-
background levels of pollutants
deposited during rain or other forms
ronment.
where urban influences are minimal.
of precipitation. Drv deposition is the
For wet and dry deposition,
These data provide needed informa-
portion deposited on dry surfaces
these studies typically include mea-
tion to scientists and policy analysts
during periods of no precipitation as
surement of concentration levels of
to studv and evaluate numerous
particles or in a gaseous form. Al-
key chemical components as well as
environmental effects, particularly
though the term "acid rain" is widely
precipitation amounts. For drv depo-
those caused by regional sources of
recognized, the dry deposition portion
sition, analyses also must include
emissions for which long range trans-
CHAPTER 7: ACID DEPOSITION 101
NATIONAL AIR QUALITY AND EMISSIONS TRENDS REPORT, 1997
Figure 7-1. The NADP/NTN Network.
port plays an important role. Mea-
that time, the network became known
TRENDS ANALYSES FOR SULFATE
surements from these networks are
as the NADP/NTN (National Trends
AND NITRATE CONCENTRATIONS IN
also important for understanding
Network). By the mid-1980s, the NADP
WET DEPOSITION
non-ecological impacts of air pollu-
had grown to nearly 200 sites where it
tion such as visibility impairment
stands today as the longest running
Sulfate concentrations in precipita-
and damage to materials, particu-
national deposition monitoring net-
tion have decreased over the past
two decades.¹ The reductions were
larly those of cultural and historical
work (see Figure 7-1).
importance.
The NADP analyzes the constitu-
relatively large in the early 1980s
ents important in precipitation chem-
followed by more moderate declines
National Atmospheric Deposition
istry, including those affecting rainfall
until 1995. These reductions in sul-
Network
acidity and those that may have eco-
fates are similar to changes in SO₂
The NADP was initiated in the late
logical effects. The Network measures
emissions. In 1995, however, con-
centrations of sulfates in precipita-
1970s as a cooperative program be-
sulfate, nitrate, hydrogen ion (measure
tween federal and state agencies,
of acidity), ammonia, chloride, and
tion over a large area of the Eastern
United States exhibited a dramatic
universities, electric utilities, and other
base cations (calcium, magnesium,
industries to determine geographical
potassium). To ensure comparability
and unprecedented reduction.² In
of results, laboratory analyses for all
1995 and continued in 1996, sul-
patterns and trends in precipitation
chemistry in the United States. Col-
samples are conducted by the NADP's
fates have been estimated to be 10-
Central Analytical Lab at the Illinois
25 percent lower than levels ex-
lection of weekly wet deposition
State Water Survev. A new subnet-
pected with a continuation of
samples began in 1978. The size of
work of the NADP, the Mercurv Deposi-
1983-1994 trends (see Figure 7-2).
the NADP Network grew rapidly in the
tion Network (MDN) measures mer-
This important reduction in acid pre-
early 1980s when the major research
effort by the NAPAP called for charac-
cury in precipitation. The MDN is
cipitation is directly related to the
terization of acid deposition levels. At
discussed in Chapter 5 of this report.
large regional decreases in SO₂ emis-
102 CHAPTER 7: ACID DEPOSITION
NATIONAL AIR QUALITY AND EMISSIONS TRENDS REPORT. 1997
Figure 7-2. Percent differences in mean annual measured sulfate concentrations as compared to projected concentrations for
1995-1996 for the Eastern United States (from NADP/NTN).
Small squares on the map show
locations of electric utility plants
affected under Phase I of the acid rain
program. Areas on the map depicting
higher sulfate concentrations (e.g.,
south and east of Lake Michigan and
the southwestern portion of map)
appear to be due to below average
precipitation volumes, which are
associated with higher concentrations
of sulfate. In addition, these results
may have been affected by SO₂
emission increases at some Phase II
emissions sources that will not be
controlled by the acid rain program
until the year 2000.
-20
-15
-12
-b
5
10
20
sions resulting from Phase [ of the
The dense network of NADP/
it also can contribute to higher lev-
acid rain program (see the SO₂ sec-
NTN sites facilitate the development
els of wet deposition. Figures 7-5
tion in Chapter 2). The largest re-
of concentration and wet deposition
and 7-6 present estimates for total
ductions in sulfate concentrations
maps to describe the trends and
wet deposition of sulfates and ni-
occurred along the Ohio River Val-
spatial patterns in the constituents
trates respectively, by multiplying
ley and in states immediately down-
of acid precipitation. Figures 7-3
concentration by the total amount of
wind of this region. For example,
and 7-4 show sulfate and nitrate
precipitation. During 1997, the
the average reduction in sulfate
concentrations in precipitation lev-
highest sulfate wet deposition oc-
concentrations in Ohio was approxi-
els for 1997. Sulfate concentrations
curred in western New York State
mately 21 percent, in Marvland, 27
in precipitation are highest in the
extending southward through the
percent, and in Pennsvlvania, 15 per-
Great Lake States and areas extend-
Ohio Valley and along the Appala-
cent. The largest decrease (32 per-
ing eastward. Nitrates in precipita-
chian ridge. Nitrate deposition
cent) occurred in the northern portion
tion are more regionally uniform.
shows a similar pattern.
of West Virginia. Reductions in hvdro-
The highest nitrate levels in precipi-
gen ion concentrations (H1) in the
tation are in the vicinity of the Great
Clean Air Status and Trends
East. the primary indicator of precipi-
Lakes, with relatively high concen-
Network
tation acidity, were very similar to
trations extending from the Plains
The CASTNet provides atmospheric
those of sulfate concentrations, both
States to the Northeast.
data on the dry deposition compo-
in magnitude and location. Nitrate
Reported concentrations and
nent of total acid deposition, ground-
concentrations at NADP/NTN sites
total wet deposition are both depen-
level ozone and other forms of atmos-
were not appreciably different in
dent on the amount of precipitation in
pheric pollution. CASTNet is
1995-1996 from historical levels.³
a particular year. While larger
considered the nation's primary
Analyses based on the 1997 data are
amounts of precipitation can dilute
source for atmospheric data to esti-
not yet available.
the measured pollutant concentration,
mate dry acidic deposition and to
CHAPTER 7: ACID DEPOSITION 103
NATIONAL AIR QUALITY AND EMISSIONS TRENDS REPORT. 1997
Figure 7-3. Sulfate concentration in precipitation. 1997.
e0.2
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606
0.3
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2.
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0.8
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$10
#0.8
&
$1.2
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et.1%
1.4
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-1.1
a0.7
Figure 7-4. Nitrate concentration in precipitation. 1997.
a0.3
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=0.3
e0.8
607
-0.4
08
ORDER
*1.0
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0.4
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on
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1.3
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0.0
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0.0
>1.8
-0.7
-0.5
104 CHAPTER 7: ACID DEPOSITION
NATIONAL AIR QUALITY AND EMISSIONS TRENDS REPORT. 1997
Figure 7-5. Wet deposition of sulfate. 1997.
&
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CHAPTER 7: ACID DEPOSITION 105
NATIONAL AIR QUALITY AND EMISSIONS TRENDS REPORT. 1997
Figure 7-7. The CASTNet Network.
provide data on rural ozone levels.
weekly average atmospheric
databases provide the necessary
Used in conjunction with other na-
concentrations of sulfate, nitrate,
data to estimate trends and spatial
tional monitoring networks,
ammonium, sulfur dioxide, and
patterns in total atmospheric deposi-
CASTNet is used to determine the
nitric acid.
tion. National Oceanic and Atmo-
effectiveness of national emission
hourly concentrations of ambient
spheric Administration (NOAA) also
control programs. Established in
ozone levels.
operates a smaller dry deposition
1987, CASTNet now comprises 72
meteorological conditions required
network called Atmospheric Inte-
monitoring stations across the United
for calculating dry deposition
grated Assessment Monitoring Net-
States, as shown in Figure 7-7. The
rates.
work (AIRMoN) focused on ad-
longest data records are primarily at
dressing research issues specifically
eastern sites. The majority of the
Dry Deposition
related to dry deposition measure-
monitoring stations are operated by
Dry deposition rates are calculated
ment.
EPA's Office of Air and Radiation;
using atmospheric concentrations,
however, 19 stations are operated by
Concentration Trends Analysis at
meteorological data, and information
the National Park Service in coopera-
CASTNet Sites
on land use, vegetation, and surface
tion with EPA. Of the total number of
conditions. CASTNet complements
CASTNet data were analyzed for the
sites, 67 measure dry-deposition; 18
the database compiled by NADP.
period 1989-1995. During this 7-year
measure wet-deposition; 68 measure
Because of the interdependence of
period, atmospheric concentrations of
ozone; and 8 measure aerosols for
wet and dry deposition, CASTNet
sulfur dioxide and sulfate at 34 east-
visibility assessment.
also collects wet deposition data at
ern CASTNet sites showed statisti-
Each CASTNet dry deposition
the 18 sites where there are no
cally-significant declining trends.
station measures:
NADP/NTN stations within a 50 km
The average reduction in sulfur diox-
radius. Together, these two long-term
ide concentrations for all sites was 35
106 CHAPTER 7: ACID DEPOSITION
NATIONAL AIR QUALITY AND EMISSIONS TRENDS REPORT. 1997
Figure 7-8. Trends in annual mean aerosol sulfate concentrations at Whiteface
Monitoring Stations (NAMS) net-
Mountain and Mayville, 1978-1996.
works. Most air quality samples at
SLAMS/NAMS sites are located in
urban areas, while CASTNet sites
SO₂ metric tons)
11
Midwest emissions
are in rural locations. Hourly ozone
measurements are taken at each of
9
the 50 sites operated by EPA. Data
from these sites provide information
7
to help characterize ozone transport
issues and ozone exposure levels.
5
Future trend reports will present
information on rural O3 concentra-
tions measured at CASTNet sites.
SO4 (µg/m³)
5
Mayville
References
3
1. Lynch, J.A., Grim, J.W., and
Bowersox, V.C. 1995 Trends in
Whiteface Mt.
Precipitation Chemistry in the United
1
States: A National Perspective, 1980-
1978
1981
1984
1987
1990
1993
1996
1992. Atmospheric Environment Vol
Also shown are annual SO₂ emissions for the Midwest as explained in the text. Lines
29, No. 11.
through the points are the result of multiple regression and smoothing and are only
2. Lynch, J.A., Bowersox, V.C., and
added to aid the eye.
Grim, J.W. 1996. Trends in Precipita-
tion Chemistry in the United States.
percent and in sulfate concentra-
air quality fluctuates from year to
An Analysis of the Effects in 1995 of
tions was 26 percent. Trends in
year, the underlying trend in annual
Phase I of the Clean Air Act Amend
total nitrate concentrations (nitrates
sulfate concentrations tracks emis-
ments of 1990, Title IV. U.S. Geologi
plus nitric acid) were not as pro-
sions with both trends exhibiting a
cal Survey. Open-file Report 96-0346.
nounced, with an average reduction
small decrease. Then, sulfates de-
3. Lynch, J.A., Bowersox, V.C., and Grim,
of S percent. A regional estimate for
clined sharply in 1995, correspond-
J.W. Acid Rain Reduced in Eastern U.S.A.
a cluster of sites in the Ohio River
ing to a 36 percent reduction in re-
Submitted to Environmental Science
Valley showed a close correspon-
gional emissions. During 1995,
Technology. In Review.
dence between declining sulfur
emissions from this region ac-
4. Holland, D. M., Principe, P., and
dioxide concentration (35 percent)
counted for 38 percent of the na-
Sickles, J.E., II. Trends in Atmospher-
and declining sulfur dioxide emis-
tional emission inventory. The air
ic Concentration of Sulfur and Nitro-
sions (32 percent) in this region.4
quality improvement (~1 µg/m²) was
gen Species in the Eastern United
The relationship between re-
approximately 30 percent for Mavville
States. Atmospheric Environment, Vol.
33, 37-49
gional SO₂ emissions and sulfate air
and an impressive 47 percent for the
quality is graphically illustrated in
more distant Whiteface Mountain
5. Husain, L., Dutkiewicz, V.A., and
Figure 7-8. This recently published
location.
4
Dass, M. 1998. Evidence for Decrease
graph compares long-term trends
in Atmospheric Sulfer Burden in the
(1978-1996) in annual mean aerosol
Rural Ozone
Eastern United States Caused by Re-
sulfate concentrations at two rural
duction in SO, Emissions. Geophysical
Ozone data collected by CASTNet
Research Letters Vol. 25 No. 7.
locations in New York State with up-
are complementary to the larger
wind SO₂ emissions for the Midwest
ozone data sets gathered by the
region (MN, WI, IL, MI, IN, OH, WV, KY
State and Local Air Monitoring Sta-
and Western PA). Although average
tions (SLAMS) and National Air
CHAPTER 7: ACID DEPOSITION 107
EPA
United States
Office of Air and Radiation
Updated September 1998
Environmental Protection Agency
Acid Rain Division (62041)
EPA +30-1-92-019
Overview of the
ACID
RAIN
PROGRAM
Acid Rain Program
Introduction
in 1997 there were a total of 423 Phase I
affected units.
The overall goal of the Acid Rain Program is to
achieve significant environmental and public
Phase II, which begins in the year 2000, tightens
health benefits through reductions in emissions
the annual emissions limits imposed on these
of sulfur dioxide (SO₂) and nitrogen oxides
large, higher emitting plants and also sets
(NOx), the primary causes of acid rain. To
restrictions on smaller, cleaner plants fired by
achieve this goal at the lowest cost to society,
coal, oil, and gas. The program affects existing
the program employs both traditional and
utility units serving generators with an output
innovative, market-based approaches for
capacity of greater than 25 megawatts and all
controlling air pollution. In addition, the
new utility units.
program encourages energy efficiency and
pollution prevention.
The Act also calls for a 2 million ton reduction
in NOx emissions by the year 2000. A
Title IV of the Clean Air Act sets as its primary
significant portion of this reduction will be
goal the reduction of annual SO₂ emissions by
achieved by coal-fired utility boilers that will be
10 million tons below 1980 levels. To achieve
required to install low NOx burner technologies
these reductions, the law requires a two-phase
and to meet new emissions standards.
tightening of the restrictions placed on fossil
fuel-fired power plants.
Operating Principles: Feasible, Flexible,
Accountable
Phase I began in 1995 and affects 263 units at
110 mostly coal-burning electric utility plants
The Acid Rain Program is implemented
located in 21 eastern and midwestern states.
through an integrated set of rules and guidance
Additional units may join Phase I of the
designed to accomplish three primary
program as substitution or compensating units;
objectives:
Achieve environmental benefits through
reductions in SO2 and NOx emissions
S02 Allowance Program
Facilitate active trading of allowances and
Emission Reductions
use of other compliance options to
30
minimize compliance costs, maximize
Utility SO2 Emissions (million tons)
25
Without Acid Rain Program
economic efficiency, and permit strong
economic growth
20
Promote pollution prevention and energy
15
efficient strategies and technologies
10
Each individual component fulfills a vital
5
With Acid Rain Program
function in the larger program:
the allowance trading system creates
0
low-cost rules of exchange that minimize
1980 1985 1990 1995 2000 2005 2010
government intrusion and make allowance
trading a viable compliance strategy for
Figure I The Acid Rain Program will result in a 10
reducing SO₂;
million ton reduction in SO2 emissions from 1980
the opt-in program allows nonaffected
levels by the year 2010.
industrial and small utility units to
rain accelerates the decay of building materials,
Acid Rain Formation
paints, and cultural artifacts, including
irreplaceable buildings, statues, and sculptures
that are part of our nation's cultural heritage.
Prior to falling to the earth, SO₂ and NOx
SO₂
NOx
Acid Rain
gases and their particulate matter derivatives,
sulfates and nitrates, contribute to visibility
degradation and impact public health.
Implementation of the Acid Rain Program
under the 1990 Clean Air Act Amendments
will confer significant benefits on the nation.
Coal-fired electric utilities
By reducing SO₂ and NOx, many acidified
and other sources that
burn fossil fuels smit
lakes and streams will significantly improve so
sulfur dioxide and nitrogen exides
that they can once again support fish life.
Visibility will improve, allowing for increased
Figure 2 Sulfur dioxide and nitrogen oxide emissions react
enjoyment of scenic vistas across our country,
with water vapor and oxidants in the atmosphere and are
particularly in National Parks.
chemically transformed into acid compounds. These
compounds are deposited in rain or snow (wet deposition);
Stress to our forests that populate the ridges of
the compounds also join airborne particles and fall to the
earth as dry deposition.
mountains from Maine to Georgia will be
reduced. Deterioration of our historic
buildings and monuments will be slowed.
participate in allowance trading;
Finally, reductions in SO₂ and NOx will reduce
the NOx emissions reduction rule sets new
sulfates, nitrates, and ground level ozone
NOx emissions standards for existing
(smog), leading to improvements in public
coal-fired utility boilers and allows
health.
emissions averaging to reduce costs;
the permitting process affords sources
Allowance Trading
maximum flexibility in selecting the most
cost-effective approach to reducing
The Acid Rain Program represents a dramatic
emissions;
departure from traditional command and
the continuous emission monitoring (CEM)
control regulatory methods that establish
requirements provide credible accounting
specific, inflexible emissions limitations with
of emissions to ensure the integrity of the
which all affected sources must comply.
market-based allowance system and the
Instead, the program introduces an allowance
achievement of the reduction goals;
trading system that harnesses the incentives of
the free market to reduce pollution.
the excess emissions provision provides
incentives to ensure self-enforcement,
Under this system, affected utility units were
greatly reducing the need for government
allocated allowances based on their historic fuel
intervention; and, finally,
consumption and a specific emissions rate.
the appeals procedures allow the regulated
Each allowance permits a unit to emit 1 ton of
community to appeal decisions with which
SO₂ during or after a specified year. For each
it may disagree.
ton of SO₂ discharged in a given year, one
allowance is retired, that is, it can no longer be
Together these measures ensure the
used.
achievement of environmental benefits at the
least cost to society.
Allowances may be bought, sold, or banked.
Any person may acquire allowances and
Environmental Benefits
participate in the trading system. However,
regardless of the number of allowances a source
Acid rain causes acidification of lakes and
holds, it may not emit at levels that would
streams and contributes to damage of trees at
violate federal or state limits set under Title I of
high elevations (for example, red spruce trees
the Clean Air Act to protect public health.
above 2,000 feet in elevation). In addition, acid
2
National SO2 Emissions by Source
National NOx Emissions by Source
Non-Road Engines
Metals Processing
and Vehicles
2%
3%
On-Road Vehicles
Fuel Combustion-
13%
17%
Fuel Combustion-
30%
Industrial
Industrial
Fuel Combustion-
5%
4%
Fuel Combustion-
Other
Other
5% All Other
7%
All Other
Fuel Combustion
Fuel Combustion-
Electric Utility
Non-Road Engines
Electric Utility
67%
28%
and Vehicles
19%
Figure 3 Electric utilities contribute 67 percent of SO2 emissions and 28 percent of NOx emissions nationally.
Source: National Air Pollutant Emission Trends, 1900-1996, US EPA, Office of Air Quality Planning and Standards,
December 1997 (EPA-454/R-97-011).
During Phase II of the program, the Act sets a
by which EPA determines compliance with the
permanent ceiling (or cap) of 8.95 million
emissions limitations. Any party interested in
allowances for total annual allowance
participating in the trading system may open an
allocations to utilities. This cap firmly restricts
ATS account by submitting an application to
emissions and ensures that environmental
EPA. Accounts contain information on unit
benefits will be achieved and maintained.
account balances, account representatives
(which must be appointed by each trading
Annual Reconciliation
party), and serial numbers for each allowance.
ATS is computerized to expedite the flow of
Annual Reconciliation refers to EPA's task of
data and to assist in the development of a viable
reconciling the annual emissions of a unit with
market for allowances.
its allowance holdings. At the end of the year,
utilities are granted a 30-day true-up or grace
Auctions
period, during which SO₂ allowances may be
purchased, if necessary, to cover each unit's
Because the availability of allowances is crucial
emissions for the year. At the end of the grace
to ensure both the economic efficiency of the
period, the allowances a unit holds in its
emissions limitation program and the addition
compliance account must equal or exceed the
of new electric-generating capacity, Title IV of
annual SO₂ emissions recorded by the unit's
the Clean Air Act Amendments mandates that
monitoring system. Any remaining allowances
EPA hold or sponsor yearly auctions of
may be sold or banked for use in future years.
allowances for a small portion of the total
allowances allocated each year. The auctions
The EPA must consider a number of issues
help ensure that units have a public source of
related to the operation of the unit over the past
allowances beyond those allocated initially to
year, including the unit's SO₂ emissions,
existing units. Moreover, the auctions provided
whether or not the unit was "underutilized,"
price information to the allowance market early
and whether the unit is subject to special
in the regulatory program.
provisions (e.g., a state law limiting emissions
on an system-wide basis).
Voluntary Entry: The Opt-in Program
The Allowance Tracking System
The Opt-in Program expands EPA's Acid Rain
Program to include additional SO₂-emitting
EPA has instituted an electronic record keeping
sources. Recognizing that there are additional
and notification system called the Allowance
emission reduction opportunities in the
Tracking System (ATS) to track allowance
industrial sector, Congress established the
transactions and the status of allowance
Opt-in Program under section 410 of the Clean
accounts. ATS is the official tally of allowances
Air Act Amendments of 1990. The Opt-in
3
Program allows sources that are not required to
The NOx program embodies many of the same
participate in the Acid Rain Program the
principles of the SO₂ trading program in its
opportunity to enter the program on a
design: a results-orientation, flexibility in the
voluntary basis, reduce their SO₂ emissions, and
method to achieve emission reductions, and
receive their own acid rain allowances.
program integrity through measurement of the
emissions. However, it does not "cap" NOx
The participation of these additional sources
emissions as the SO₂ program does, nor does it
will reduce the cost of achieving the 10 million
utilize an allowance trading system.
ton reduction in SO₂ emissions mandated under
the Clean Air Act. As participating sources
Emission limitations for the NOx boilers
reduce their SO₂ emissions at a relatively low
provide flexibility for utilities by focusing on the
cost, their reductions -- in the form of
emission rate to be achieved (expressed in
allowances -- can be transferred to electric
pounds of NOx per million Btu of heat input).
utilities where emission reductions are more
Two options for compliance with the emission
expensive.
limitations are provided: compliance with an
individual emission rate for a boiler or
The Opt-in Program offers a combustion
averaging of emission rates over two or more
source a financial incentive to voluntarily
units to meet an overall emission rate limitation.
reduce its SO₂ emissions. By reducing
(In the latter case, units must have the same
emissions below its allowance allocation, an
owner or operator.)
opt-in source will create unused allowances,
which it can sell in the SO₂ allowance market.
These options give utilities flexibility to meet
Opting in will be profitable if the revenue from
the emission limitations in the most
allowances exceeds the combined cost of the
cost-effective way and allow for the further
emissions reduction and the cost of
development of technologies to reduce the cost
participating in the Opt-in Program.
of compliance.
Pollution Prevention
If a utility properly installs and maintains the
appropriate control equipment designed to
The allowance trading system contains an
meet the emission limitation established in the
inherent incentive for utilities to prevent
regulations, but is still unable to meet the
pollution, since for each ton of SO₂ that a utility
limitation, the NOx program allows the utility
avoids emitting, one fewer allowance must be
to apply for an alternative emission limitation
retired. Utilities that reduce emissions through
(AEL) that corresponds to the level that the
energy efficiency and renewable energy are able
utility demonstrates is achievable.
to sell, use, or bank their surplus allowances.
As also provided in the Act, EPA has set aside
Phase I of the program, which was delayed a
a reserve of 300,000 allowances to stimulate
year due to litigation, began on January 1, 1996,
energy efficiency and renewable energy
and affects two types of boilers (which are
generation. Those utilities that either implement
among those already targeted for Phase I SO₂
demand-side energy conservation programs to
reductions): dry-bottom wall-fired boilers and
curtail emissions or install renewable energy
tangentially fired boilers. Dry-bottom wall-fired
generation facilities may be eligible to receive
boilers must meet a limitation of 0.50 lbs of
extra allowances from this reserve.
NOx per mmBtu averaged over the year, and
tangentially fired boilers must achieve a
The NOx Program
limitation of 0.45 lbs of NOx per mmBtu,
again, averaged over the year. Approximately
The Clean Air Act Amendments of 1990 set a
170 boilers must comply with these NOx
goal of reducing NOx by 2 million tons from
performance standards during Phase I.
1980 levels. The Acid Rain program focuses on
one set of sources that emit NOx, coal-fired
The regulations to govern the Phase II portion
electric utility boilers. As with the SO₂ emission
of the program, which begins in 2000, were
reduction requirements, the NOx program is
published in December 1996. These
implemented in two phases, beginning in 1996
regulations set lower emission limits for Group
and 2000.
1 boilers first subject to regulations in Phase II.
In addition, these regulations would establish
4
initial NOx emission limitations for Group 2
Representative, to represent the owners and
boilers, which include boilers applying
operators of the source in all matters relating to
cell-burner technology, cyclone boilers, wet
the holding and disposal of allowances for its
bottom boilers, and other types of coal-fired
units that are affected by the Clean Air Act. The
boilers.
Designated Representative is also responsible
for all submissions pertaining to permits,
Emissions Monitoring and Reporting
compliance plans, emission monitoring reports,
offset plans, compliance certification, and other
Under the Acid Rain Program, each unit must
necessary information. A source may appoint
continuously measure and record its emissions
an Alternate Designated Representative to act
of SO₂, NOx, and CO2, as well as volumetric
on behalf of the Designated Representative.
flow and opacity. In most cases, a continuous
emission monitoring (CEM) system must be
Permitting
used. There are provisions for initial equipment
certification procedures, periodic quality
The Designated Representative for each source
assurance and quality control procedures,
is required to file a permit application for the
record keeping and reporting, and procedures
source and a compliance plan for each affected
for filling in missing data periods. Units report
unit at the source. The Acid Rain permits and
hourly emissions data to EPA on a quarterly
compliance plans are simple, allow sources to
basis. This data is then recorded in the
fashion a compliance strategy tailored to their
Emissions Tracking System, which serves as a
individual needs, and foster trading. For
repository of emissions data for the utility
example, they allow sources to make real-time
industry. The emissions monitoring and
allowance trading decisions through the use of
reporting systems are critical to the program.
automatic permit amendments.
They instill confidence in allowance
transactions by certifying the existence and
The permits stipulate the initial allowance
quantity of the commodity being traded. They
allocation for each affected unit at a source.
ensure that NOx averaging plans are working.
Monitoring also ensures, through
accurate accounting, that the SO₂
and NOx emissions reduction
Phase 1 Sources
goals are met.
Excess Emissions
The owners or operators of
delinquent units must pay a
penalty of $2,000, adjusted for
inflation, per excess ton of SO₂ (if
annual emissions exceed the
number of allowances held) or
NOx emissions. In addition,
Phase II Sources
violating utilities must offset the
excess SO₂ emissions with
allowances in an amount
equivalent to the excess. A utility
may either have allowances
deducted immediately or submit
an excess emissions offset plan to
EPA that outlines how these
cutbacks will be achieved.
Designated Representatives
Figure 4 Phase I and Phase II affected units. In Phase II the number of
Each source appoints one
affected units will increase to 2,220 as smaller, cleaner plants are included in
individual, the Designated
the regulatory network.
5
Permit applications must certify that each
SO2 Emissions from
unit account will hold a sufficient number
of allowances to cover the unit's SO₂
263 Phase I Units
emissions for the year, will comply with
12
the applicable NOx limit, and will
10
9.4
9.3
monitor and report emissions. Permits
8.7
Allowable Emissions
are subject to public comment before
8
7.4
7.1
approval.
6.0
6
SO2 (million tons)
4.5
4.8
.8.4.
4.8
4
Compliance Options: Freedom to
Choose
2
0
The Acid Rain Program allows sources to
select their own compliance strategy. For
1980
1985
1990
1995
1996
1997
example, to reduce SO₂ an affected
source may repower its units, use cleaner
Figure 5 Emissions at the 263 Phase I units have been well below
burning fuel, or reassign some of its
their required level.
energy production capacity from dirtier
units to cleaner ones. Sources also may decide
effects of the program through economic and
to reduce electricity generation by adopting
environmental studies.
conservation or efficiency measures. Some of
the options afford the unit special treatment,
The Acid Rain Program is already being viewed
such as a compliance extension or extra
around the world as a prototype for tackling
allowances. Most options, like fuel switching,
emerging environmental issues. The allowance
require no special prior approval, allowing the
trading system capitalizes on the power of the
source to respond quickly to market conditions
marketplace to reduce SO₂ emissions in the
without needing government approval. For
most cost-effective manner possible. The
NOx, the source may meet the performance
permitting program allows sources the flexibility
standard on a utility-unit basis, enter into an
to tailor and update their compliance strategy
emissions averaging plan, or apply for an
based on their individual circumstances. The
alternative emissions limitation.
continuous emissions monitoring and reporting
systems provide the accurate accounting of
In either case, the program allows affected
emissions necessary to make the program work,
utilities to combine these and other options in
and the excess emissions penalties provide
ways they fit in order to tailor their compliance
strong incentives for self-enforcement. Each of
plans to the unique needs of each unit or
these separate components contributes to the
system.
effective working of an integrated program that
lets market incentives do the work to achieve
A Model Program
cost-effective emissions reductions. The
General Accounting Office confirmed the
EPA gained broad input into the development
benefits of this approach, projecting that the
of the Acid Rain Program by consulting with
allowance trading system could save as much as
representatives from various stakeholder
$3 billion per year over 50 percent
groups, including utilities, coal and gas
compared with a command and control
companies, emissions control equipment
approach typical of previous environmental
vendors, labor, academia, Public Utility
protection programs.
Commissions, state pollution control agencies,
and environmental groups.
For More Information
EPA is maintaining this open door policy as it
implements the program, and it continues to
For more information on the Acid Rain
solicit ideas from the numerous and diverse
Program, please visit the Acid Rain Program's
individuals, and groups interested in acid rain
World Wide Web site at http://
control. Inaddition, EPA is collaborating with
www.epa.gov/acidrain or contact the Acid
groups who wish to evaluate the benefits and
Rain Hotline at 202-564-9620.
6
Allowance Trading System Fact Sheet
http://www.epa.gov/acidrain/allsys.html
EPA
United States
Environmental Protection Agency
Acid Rain Program
Overview
Effects
SO2 Program
NOx Program
Emissions
Conservation
Allowance Trading System Fact Sheet
The innovative, market-based SO2 allowance trading component of the Acid Rain Program
allows utilities to adopt the most cost-effective strategy to reduce SO2 emissions at units in
their systems. The Acid Rain Program operating permit outlines the specific program
requirements and compliance options chosen by each source. Affected utilities are also required
to install systems that continuously monitor emissions of SO2, NOx, and other related
pollutants in order to track progress, ensure compliance, and provide credibility to the trading
component of the program. In any year that compliance is not achieved, excess emissions
penalties will apply, and sources either will have allowances deducted immediately from their
accounts or may submit a plan to EPA that specifies how the excess SO2 emissions will be
offset.
Introduction
Allowance trading is the centerpiece of EPA's Acid Rain Program, and allowances are the
currency with which compliance with the SO2 emissions requirements is achieved. Through the
market-based allowance trading system, utilities regulated under the program, rather than a
governing agency, decide the most cost-effective way to use available resources to comply
with the acid rain requirements of the Clean Air Act. Utilities can reduce emissions by
employing energy conservation measures, increasing reliance on renewable energy, reducing
usage, employing pollution control technologies, switching to lower sulfur fuel, or developing
other alternate strategies. Units that reduce their emissions below the number of allowances
they hold may trade allowances with other units in their system, sell them to other utilities on
the open market or through EPA auctions, or bank them to cover emissions in future years.
Allowance trading provides incentives for energy conservation and technology innovation that
can both lower the cost of compliance and yield pollution prevention benefits.
The market-based allowance trading system capitalizes on the power of the marketplace to
reduce SO2 emissions cost-effectively and uses economic incentives to promote conservation
and the development of innovative technology. The Acid Rain Program may establish a
precedent for solving other environmental problems in a way that minimizes the costs to
society and promotes new technologies.
Frequently Asked Questions About the Allowance System
1. What Are Allowances?
2. How Are Allowances Allocated?
3. How Else Can Allowances Be Obtained?
4. Who May Participate in Allowance Trading?
5. What Is the System for Keeping Track of Allowances?
6. What Information is Contained in ATS Accounts?
7. How Are Allowance Transfers Submitted?
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Allowance Trading System Fact Sheet
http://www.epa.gov/acidrain/allsys.html
8. How Will Compliance Be Determined?
9. How Can Allowance Allocation, Transfer, Sale, or Deduction Decisions Be Appealed?
What Are Allowances?
An allowance authorizes a unit within a utility or industrial source to emit one ton of SO2
during a given year or any year thereafter. At the end of each year, the unit must hold an
amount of allowances at least equal to its annual emissions, i.e., a unit that emits 5,000 tons of
S02 must hold at least 5,000 allowances that are usable in that year. However, regardless of
how many allowances a unit holds, it is never entitled to exceed the limits set under Title I of
the Act to protect public health.
Allowances are fully marketable commodities. Once allocated, allowances may be bought, sold,
traded, or banked for use in future years. Allowances may not be used for compliance prior to
the calendar year for which they are allocated.
How Are Allowances Allocated?
Allowances are allocated for each year beginning in 1995. In Phase I, EPA allocates allowances
to each unit at an emission rate of 2.5 pounds of SO2/mmBtu (million British thermal units) of
heat input, multiplied by the unit's baseline mmBtu (the average fossil fuel consumed from
1985 through 1987). These allowance allocations are listed in Table A of the Clean Air Act and
codified in the Allowance System Regulations (Part 73, Table 1). Alternative or additional
allowance allocations are made for various units, including affected units in Illinois, Indiana,
and Ohio, which will be allocated a pro rata share of 200,000 additional allowances each year
from 1995 to 1999.
In Phase II, which begins in the year 2000, the limits imposed on Phase I plants are tightened,
and emissions limits are also imposed on smaller, cleaner units. Allowance allocation
calculations are made for various types of units, such as coal- and gas-fired units with low and
high emissions rates or low fuel consumption. EPA allocates allowances to each unit at an
emission rate of 1.2 pounds of SO2/mmBtu of heat input, multiplied by the unit's baseline.
During Phase II, the Act places a cap at 8.95 million on the number of allowances issued to
units each year. This effectively caps emissions at 8.95 million tons annually and ensures that
the mandated emissions reductions are maintained over time.
How Else Can Allowances Be Obtained?
In addition to annual allocations, allowances are also available upon aplication to three EPA
reserves. In Phase I, units can apply for and receive additional allowances by installing
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Allowance Trading System Fact Sheet
http://www.epa.gov/acidrain/allsys.html
qualifying Phase I technology (a technology that can be demonstrated to remove at least 90
percent of the unit's SO2 emissions) or by reassigning their reduction requirements among
other units employing such technology. A second reserve provides allowances as incentives for
units achieving SO2 emissions reductions through customer-oriented conservation measures or
renewable energy generation. The third reserve contains allowances set aside for auctions,
which are sponsored yearly by EPA. In addition, allowances are given as incentives for utilities
that replace boilers with new, cleaner and more efficient technologies. The incentives also
apply to small diesel fuel refiners that have exceeded the Clean Air Act requirements to remove
sulfur from fuels.
Units that began operating in 1996 or later will not be allocated allowances. Instead, they will
have to purchase allowances from the market or from the EPA auctions and direct sales to
cover their SO2 emissions.
Who May Participate in Allowance Trading?
Allowances may be bought, sold, and traded by any individual, corporation, or governing body,
including brokers, municipalities, environmental groups, and private citizens. The primary
participants in allowance trading are officials designated and authorized to represent the
owners and operators of electric utility plants that emit SO2. Other potential participants are
utility power pools, or groups of units choosing to aggregate some or all of the allowances
held by the individual units within the pool. The parties involved in the pool determine the
details of these allowance-pooling arrangements.
What Is the System for Keeping Track of Allowances?
EPA's role in allowance trading is to record allowance transfers that are used for compliance
and to ensure at the end of the year that a unit's emissions do not exceed the number of
allowances it holds. To accomplish this, EPA maintains an Allowance Tracking System (ATS).
Each affected utility unit, corporation, group, or individual holding allowances has an account
in the ATS. Parties must notify EPA to have transfers recorded in their ATS account, but it is
not necessary to record all transfers with EPA until such time that the allowances are to be
used to meet a unit's SO2 emissions limitation requirement. ATS accounts are, however, the
official records for allowance holdings and transfers used for compliance purposes. To
facilitate tracking and recording, EPA assigns every account an identification number and every
allowance a serial number.
EPA established accounts for utility units affected by both Phase I and Phase II. Each unit
account consists of a compliance subaccount for allowances that may be used for compliance in
the current year and future year subaccounts for allowances to be used in years to come.
Any person or group, including brokers and investors, wishing to purchase allowances may
open an ATS account. To open a general ATS account, the interested party submits the
Account Information Form to EPA.
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Allowance Trading System Fact Sheet
http://www.epa.gov/acidrain/allsys.html
What Information is Contained in ATS Accounts?
ATS accounts tracks the issuance of all allowances; the holdings of allowances in accounts; the
holdings of allowances in various allowance reserves, such as the EPA Auction and Sale
Reserve and the Conservation and Renewable Energy Reserve; the deduction of allowances for
compliance purposes; and the transfer of allowances between accounts. Information in the ATS
accounts is available to the public.
How Are Allowance Transfers Submitted?
Allowance transfer requests and all correspondence with EPA concerning compliance with the
Acid Rain Program must be performed by authorized account representatives. For a unit
account, the Designated Representative, who represents the owners and operators of that unit,
performs this function. For a general account, the Authorized Account Representative is the
person who represents the parties with an ownership interest in the allowances, and who signs
the Account Information Form to open the account.
To request the transfer of allowances from one account to another, the Authorized Account
Representative submits to EPA an Allowance Transfer Form. The Authorized Account
Representatives of both the transferor and transferee must sign the form.
How Will Compliance Be Determined?
At the end of the year, units must hold in their compliance subaccounts a quantity of
allowances equal to or greater than the amount of SO2 emitted during that year. To cover their
emissions for the previous year, units must finalize allowance transactions and submit them to
EPA by January 30 to be recorded in their unit accounts. The amount of emissions is
determined in accordance with the monitoring and reporting requirements described in the
Continuous Emission Monitoring Rule.
After the Januarv 30 deadline and the final submitted transfers are recorded, EPA deducts
allowances from each unit's compliance subaccount in an amount equal to its SO2 emissions
for that year. If the unit's emissions do not exceed its allowances, the remaining allowances are
carried forward, or banked, into the next year's subaccount, which then becomes the current
compliance subaccount. If a unit's emissions exceed its allowances, the unit must pay a penalty
and surrender allowances for the following year to EPA as excess emission offsets. Unless
otherwise provided in an offset plan, EPA deducts allowances from the compliance subaccount
in an amount equal to the excess emissions.
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Allowance Trading System Fact Sheet
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How Can Allowance Allocation, Transfer, Sale or Deduction Decisions Be
Appealed?
A person challenging an allowance, transfer, sale, or deduction decision may file a petition for
review with the Environmental Appeals Board. Only the authorized account representative or
certifying official involved may appeal such a decision. If EPA makes an error in the
recordation of an allowance transfer, the authorized account representative may file a claim of
error requesting EPA to correct the mistake. Where the claim of error procedure is applicable,
the decision may not be appealed to the Environmental Appeals Board if a claim of error
notification was not first submitted. Final agency actions may be appealed to the federal courts.
Acid Rain Program Home | Trading and Trends I Contact Us
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Last Modified October 1997
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Trading Activity Breakdown
http://www.epa.gov/acidrain/ats/qlyupd.html
EPA
United States
Environmental Protection Agency
Acid Rain Program
Overview
Effects
SO2 Program
NOx Program
Emissions
Conservation
Trading Activity Breakdown:
Cumulative Graphics
Definitions for all of the trading categories listed in the charts below are available.
Through December of 1998, over 4,900 transfers moving 62.8 million allowances were reporte
the Allowance Tracking System. Approximately 60 percent of these allowances (38.1 million) W
transferred within organizations, as delineated in Figure 1. The remaining 24.7 million allowance
transferred through December 1998 were transferred between organizations. Figure 2 displays t
breakdown of these transfers between distinct entities, which represent "true" market activity to
observers of the program. The growing magnitude of trades between organizations is depicted i
Figure 3.
FIGURE 1
Allowances Transferred Within Organizations 3/94 - 12/98
38.1 Million Allowances
Reallocations
91.3%
Intra-utility transfers
8.7%
FIGURE 2
Allowances Transferred Between Organizations 3/94 - 12/
24.7 Million Allowances
Between Utilities
Between Utilities
and Brokers
13.8%
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Trading Activity Breakdown
http://www.epa.gov/acidrain/ats/qlyupd.html
66.8%
Other* (betweenb rokers,
indep endent investors, etc.)
15.3%
Between Utilities
4.0%
and Fuel Cos.
*This category is prim arily composed of transfers between and am ong allow ance
brokers
FIGURE 3
Allowances Transferred Between Organizations, by categ
12,000,000
Util to Fuel
Fuel to Util
10,000,000
Other
Util to Broke
Broker to Ut:
8,000,000
Inter-utility
6,000,000
4,000,000
2,000,000
0
1994
1995
1996
1997
1998
Acid Rain Program Home I Trading and Trends I Contact Us
http://www.epa.gov/acidrain/ats/qlyupd.html
Last Modified March 1999
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Private Allowance Transfers Reported to ATS
http://www.epa.gov/acidrain/ats/defs.html
EPA
United States
Environmental Protection Agency
Acid Rain Program
Overview
Effects
SO2 Program
NOx Program
Emissions
Conservation
EPA's Classification Methodology
for Private Allowance Transfers
Reported to ATS
EPA has produced a straightforward classification methodology and applied it to all trades
reported to the Allowance Tracking System through the conclusion of the most recent quarter.
This represents EPA's effort to provide a general indicator of market activity to interested
parties.
Definition
Examples (1st
Category
and 2nd quarter, 1996)
Any transfer of allowances
from one utility operating
Inter-Utility
company's account to a
different utility operating
company's account, provided
LILCO General Account to
the operating companies are
Detroit Edison Unit Account
not controlled by the same
parent company. Both
transferor and transferee
accounts can be either general
or unit accounts.
Any transfer from one unit
account to another unit
account within the same
Intra-Utility
operating company.
- Within one operating
Within operating company-
NYSEG Unit Account to
company
Any transfer from one
different NYSEG Unit
operating company's unit
Account
- Between operating
account to another's unit
companies within the same
account within the same parent
Between operating
parent company
company.
companies within same parent
Allowances transferred from
company - Ohio Power Unit
the general account of one
Account to Appalachian
Power Unit Account (both
operating company to a unit
are within AEP)
account of the same operating
company or parent company
may also be intra-utility
trades.
*
Any transfer from a unit or
general account of one
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Private Allowance Transfers Reported to ATS
http://www.epa.gov/acidrain/ats/defs.html
operating company to a general
Unit to general account
Reallocation
account of the same operating
within same company -
company or parent company
Wisconsin Public Service
(some may become intra-utility
Unit Account to Wisconsin
in the future), any pooling
Public Service General
activity (e.g. Phase I extension
Account
redistributions), or any transfer
in which the transferor is a
Pooling - Phase I Extension
partial owner of the transferee
General Account to Georgia
account, or vice versa.
Power Unit Account
Allowances transferred from
Among co-owners -
the general account of one
Jacksonville Electric Unit
operating company to a unit
Account to Florida Power
account of the same operating
and Light General Account
company or parent company
(FP&L is a co-owner of
may also be reallocations.*
Jacksonville's Unit Account)
Cantor Fitzgerald to Big
Any transfer from an allowance
Broker/Trader to Utility
Rivers Electric Corp General
broker or trader to a utility.
Account
Any transfer from a utility to
PG&E Unit Account to
Utility to Broker/Trader
an allowance broker or trader.
Enron Power Marketing
Any transfer from a fuel
Peabody Coal Company to
Fuel Company to Utility
supplier (e.g., coal, gas) to a
PSI General Account
utility.
PECO Energy Company Unit
Any transfer from a utility to a
Utility to Fuel Company
Account to Canterbury Coal
fuel supplier.
Co.
Any transfer that does not fit
into any of the above
categories. This includes
Emissions Trading, LLC to
transfers involving
AIG Trading
Other
environmental groups,
non-utility accounts, or
Paramount Petroleum to
individuals. Also included are
Cantor Fitzgerald
broker to broker transfers, fuel
supplier to broker transfers,
etc.
*Each of these transactions from a general account to a unit account in the same operating company or parent
company is investigated to determine the prior location of the allowances traded from the general account. If the
allowances originated from a different unit account of the same operating or parent company, the transaction is
classified as intra-utility. If the allowances originated from the same unit account of the same operating or parent
company into which they are now being transferred, the transaction is classified as a reallocation. If the allowances
originated from a unit or general account of a different operating or parent company, the transaction is classified a
reallocation (because the transaction into the general account would have already been classified as inter-utility, and
the latter trade in question here involves only a reallocation of allowances among accounts).
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Private Allowance Transfers Reported to ATS
http://www.epa.gov/acidrain/ats/defs.html
Acid Rain Program Home I Trading and Trends I Contact Us
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rading Activity Summary Table
http://www.epa.gov/acidrain/ats/cumchart.html
EPA
United States
Environmental Protection Agency
Acid Rain Program
Overview Effects SO2 Program NOx Program Emissions Conservation
Cumulative Trading Activity Table
Total Private Transfer Activity
Second
Fourth
First Quarter
Third Quarter
Annual Total
Quarter
Quarter
1994
NA
48 transactions
15 transactions
152 transactions
215 transactions
1.8 M
1.7 M
5.8 M
9.2 M
NA
allowances
allowances
allowances
allowances
1995
181 transactions
118 transactions
137 transactions
177 transactions
613 transactions
10.6 M
2.2 M
0.8 M
3.1M
16.7 M
allowances
allowances
allowances
allowances
allowances
1996
1,074
447 transactions
112 transactions
196 transactions
319 transactions
transactions
3.4 M
0.5 M
1.1 M
3.2 M
8.2 M
allowances
allowances
allowances
allowances
allowances
1997
1,429
514 transactions
263 transactions
253 transactions
399 transactions
transactions
4.1 M
4.2 M
2.0 M
4.9 M
15.2 M
allowances
allowances
allowances
allowances
allowances
1998
1,584
624 transactions
264 transactions
275 transactions
421 transactions
transactions
4.6 M
2.8 M
3.4 M
2.7 M
13.5 M
allowances
allowances
allowances
allowances
allowances
Private Transfers Between Economically Distinct Organizations
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Trading Activity Summary Table
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Second
Fourth
First Quarter
Third Quarter
Annual Total
Quarter
Quarter
1994
NA
41 transactions
5 transactions
20 transactions
66 transactions
0.8 M
7,000
90,000
0.9 M
NA
allowances
allowances
allowances
allowances
1995
55 transactions
88 transactions
90 transactions
96 transactions
329 transactions
0.5 M
0.2 M
0.4 M
0.8 M
1.9 M
allowances
allowances
allowances
allowances
allowances
1996
148 transactions
98 transactions
137 transactions
195 transactions
578 transactions
0.9 M
0.5 M
0.9 M
2.1M
4.4 M
allowances
allowances
allowances
allowances
allowances
1997
166 transactions
208 transactions
174 transactions
262 transactions
810 transactions
1.7M
1.9 M
1.6 M
2.7M
7.9 M
allowances
allowances
allowances
allowances
allowances
1998
188 transactions
218 transactions
200 transactions
336 transactions
942 transactions
2.0 M
2.3 M
2.7 M
2.5 M
9.5 M
allowances
allowances
allowances
allowances
allowances
Acid Rain Program Home I Trading and Trends I Contact Us
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Allowance Prices
http://www.epa.gov/acidrain/ats/prices.html
EPA
United States
Environmental Protection Agency
Acid Rain Program
Overview Effects I SO2 Program 1 NOx Program Emissions Conservation
Monthly Average Price of Sulfur Dioxide Allowances
Under the Acid Rain Program
Cantor Fitzgerald
Allowance Price in dollars
Fieldston Pub lications
250
250
200
200
150
150
100
100
50
50
9/94
12/94
3/95
6/95
9/95
12/95
3/96
6/96
9/96
12/96
3/97
6/97
9/97
12/97
3/98
6/98
9/98
12/98
Month / Year
Though the EPA does not officially track allowance prices, the monthly average price of a
current vintage year allowance, as reported by a brokerage firm and Fieldston Publications'
market survey, is recorded here for informational purposes.
View table with supporting price data.
Acid Rain Program Home I Trading and Trends I Contact Us
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Last Modified March 1999
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Allowance Price Data Table
http://www.epa.gov/acidrain/ats/pricetbl.html
EPA
United States
Environmental Protection Agency
Acid Rain Program
Overview Effects SO2 Program NOx Program Emissions Conservation
The table below displays the supporting data for the SO2 Allowance Price Chart. Prices
reported by the brokerage firms and the Fieldston Publications' market survey are rounded to
the nearest whole dollar.
Allowance Price in Dollars
Month/Year
Emissions Exchange
Cantor Fitzgerald EBS
Fieldston Publications
8/94
150
145
150
9/94
150
147
150
10/94
145
145
150
11/94
145
144
145
12/94
142
135
140
1/95
141
138
137
2/95
136
135
135
3/95
133
133
133
4/95
132
132
132
5/95
132
132
132
6/95
132
131
130
7/95
130
130
130
8/95
130
130
130
9/95
127
126
128
10/95
125
122
128
11/95
119
117
120
12/95
105
109
111
1/96
92
95
98
2/96
74
79
81
3/96
70
69
83
4/96
81
76
85
5/96
79
79
84
6/96
81
80
83
7/96
82
81
82
8/96
83
82
82
9/96
88
87
86
10/96
92
90
86
11/96
91
92
92
12/96
91
90
94
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Allowance Price Data Table
http://www.epa.gov/acidrain/ats/pricetbl.html
1/97
97
97
96
2/97
106
102
99
3/97
115
110
111
4/97
113
115
115
5/97
94
98
100
6/97
89
90
93
7/97
87
88
90
8/97
89
91
91
9/97
101
104
92
10/97
105
104
102
11/97
104
107
110
12/97
98
100
102
1/98
96
98
98
2/98
101
101
101
3/98
104
113
105
4/98
133
139
134
5/98
140
148
138
6/98
--
189
193
7/98
--
197
188
8/98
--
189
208
9/98
--
169
177
Acid Rain Program Home I Price Chart I Contact Us
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Cumulative Allowance Transfers in the Allowance Tracking System
http://www.epa.gov/acidrain/ats/cumtrans.html
EPA
United States
Environmental Protection Agency
Acid Rain Program
Overview Effects SO2 Program NOx Program Emissions Conservation
Cumulative Allowances Transferred
Under the Acid Rain Program
Allowances (in Millions)
100
90
$0
70
EPA Transfers
60
50
40
30
20
Private
10
0
3/94
9/94
3/95
9/95
3/96
9/96
3/97
9/97
3/98
9/98
Quarter (cumulative)
*
These numbers represent only those transfers of allowances which are reported to the Allowance Tracking System.
Additional transfers may be taking place in the allowance market.
Private Transfers
These transfers were submitted by authorized account representatives for market
accounts. (EPA does not attempt to determine what constitutes an actual trade where
money is exchanged).
EPA / Market Transfers
Most of these transfers involved movement of allowances from EPA accounts to market
accounts (e.g., auctions, Phase I extension allowances, substitution allowances, etc.)
Acid Rain Program Home I Trading and Trends I Contact Us
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Last Modified March 1999
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The Allowance Tracking System
http://www.epa.gov/acidrain/ats/atsintro.html
EPA
United States
Environmental Protection Agency
Acid Rain Program
Overview
Effects
SO2 Program
NOx Program
Emissions
Conservation
The Allowance Tracking System:
Accounting for SO2 Allowances Under the Acid Rain
Program
What is the Allowance Tracking System?
What is the Role of the ATS in the Allowance Market?
How is the ATS Organized?
Who is Authorized to Manage a Unit or General Account?
How Should AARs Report Allowance Transfers to the ATS?
Reporting Allowance Transfers Electronically NEW
What is the Allowance Tracking System?
Functioning much like a bank, the ATS is an automated system used to track the allowances
held by utilities, other affected companies, and other organizations or individuals. These
allowances may be bought, sold, or transferred at any time. Specifically, the ATS tracks:
The issuance of all allowances.
The holdings of allowances in accounts.
The holdings of allowances in various allowance reserves, such as the EPA Auction and
Sale Reserve and the Conservation and Renewable Energy Reserve.
The deduction of allowances for compliance purposes.
The transfer of allowances between accounts.
Each allowance within the ATS is identified by a 12-digit serial number consisting of 4 digits
signifying the first year in which the allowance can be used for compliance and a unique 8-digit
identifier. For example, an allowance that becomes eligible for use in compliance during 1995
could be numbered 1995-04875234. Only EPA can create emission allowances, and the ATS is
the only official record of their creation, transfer, and use for compliance purposes.
What is the role of ATS in the allowance market?
The primary role of the ATS is to provide an efficient, automated means of monitoring
compliance with the Acid Rain Program. The ATS also provides the allowance market with a
record of who is holding allowances, the date of allowance transfers, and the allowances
transferred. ATS information is available on the Internet. The ATS does not, however, record
the price or other terms associated with allowance trades; such information is better collected
and reported by the private sector through established exchanges or other trade information
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The Allowance Tracking System
http://www.epa.gov/acidrain/ats/atsintro.html
brokers. Transfers to be executed at some future date also are not recorded in the ATS.
Although submitting allowance transfers to EPA is voluntary, EPA expects most transfers to
be recorded in the ATS.
How is the ATS organized?
The ATS contains two types of accounts: unit accounts and general accounts. As part of the
implementation of the Acid Rain Program, EPA established unit accounts for all utilities
governed by the Acid Rain Program. EPA uses unit accounts in determining compliance with
the Acid Rain Program.
General accounts are used to hold or trade allowances but are not subject to allowance
deductions to cover emissions. Any individual or group, including a utility, can open a general
account by submitting an Allowance Account Information form. General accounts can be used
for a variety of purposes:
Utilities may pool their emission allowances in general accounts.
Brokers may use general accounts to hold allowances that they buy or sell for customers.
Investors may use general accounts to hold allowances they have acquired for eventual
resale.
Public interest groups wishing to remove a portion of the available allowances from the
market may purchase allowances and place them in general accounts.
Who is authorized to manage a unit or general account?
Whenever a unit or general account is opened, the owners or operators of the affected utility
unit, or persons or companies that have an ownership interest in the allowances held in a
general account, must select an authorized account representative (AAR) to act on their
behalf. Designated representatives that are responsible for a utility's permitting and monitoring
requirements automatically become AARs for unit accounts within the ATS. AARs and their
appointed alternates are the official contact persons for EPA's Acid Rain Program. They are
the only persons able to authorize the transfer of allowances, surrender allowances for
compliance purposes, and change information associated with their particular unit or general
accounts. AARs may represent more than one account, including both unit and general
accounts.
How should AARs report allowance transfers to the ATS?
Allowance transfers are reported to the ATS through the submittal of an Allowance Transfer
form. This form must list the serial numbers of the allowances to be transferred and include the
signatures of both the transferor (the party selling or transferring the allowances) and the
transferee (the party buying or receiving the allowances). EPA will record the trade within 5
business days of receiving the form and will notify both AARs of the transaction within 5
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The Allowance Tracking System
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business days of recording the trade.
Note: see the rule revision of December 11, 1998 regarding single signature requirement.
Electronic transfers of allowances
The Acid Rain Division has introduced the option of submitting transfer information via
Electronic Data Interchange (EDI). Details
Acid Rain Program Home I SO2 Emissions Trading I Contact Us
http://www.epa.gov/acidrain/ats/atsintro.html
Last Modified December 1998
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Auctions Fact Sheet
http://www.epa.gov/acidrain/auctions/auctions.html
EPA
United States
Environmental Protection Agency
Acid Rain Program
Overview
Effects
SO2 Program
NOx Program
Emissions
Conservation
Allowance Auctions Factsheet
Because the availability of allowances is crucial to ensure both the economic efficiency of the
emissions limitation program and the addition of new electric-generating capacity, Title IV of
the Clean Air Act Amendments mandates that EPA hold or sponsor yearly auctions of
allowances for a small portion of the total allowances allocated each year. The auctions help
ensure that new units with a public source of allowances beyond those allocated initially to
existing units. Moreover, the auctions help to signal price information to the allowance market
in the early stages of the regulatory program.
Frequently Asked Questions on Allowance Auctions
1. Where Do Allowances Come From?
2. Who Administers the EPA Auctions?
3. How are the Auctions Conducted?
Where Do Allowances Come From?
To supply the auctions with allowances, EPA set aside a Special Allowance Reserve of
approximately 2.8 percent of the total annual allowances allocated to all units. During Phase I,
when the allocated allowances total 5.7 million allowances annually, 150,000 allowances are
available every year for auctions. During Phase II, when allowance allocations total 8.95
million allowances annually, 250,000 allowances are earmarked annually for auctions.
Private allowance holders (such as utilities or brokers) also may offer their allowances for sale
at the EPA auctions, provided that the allowances are dated for the year in which they are
offered, for any previous year, or for 7 years in the future. Authorized account representatives
must notify the administrator of the EPA auctions of their intent to sell at least 15 business
days prior to the auctions. The account representatives must specify the number of allowances
they are offering and their minimum price requirements.
Table: Allowances Offered at Auctions
Year of Auction
Spot Auction
Advance Auction*
1998
150,000
125,000
1999
150,000
125,000
2000 and after
125,000
125,000
* Not useable until 7 years after purchase.
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Auctions Fact Sheet
http://www.epa.gov/acidrain/auctions/auctions.html
Who Administers the EPA Auctions?
The auctions are currently conducted for EPA by the Chicago Board of Trade (CBOT). This
authorization is made possible by the Clean Air Act Amendments that gave EPA the authority
to delegate the administration of the auctions. After an objective selection process, EPA chose
CBOT to run the auctions because of its demonstrated ability in handling and processing
financial instruments and using transactional information systems.
Because EPA delegates to CBOT (as opposed to contracting with CBOT) to administer the
auctions, CBOT is not compensated by EPA for its services nor allowed to charge fees. CBOT
is not allowed to bid for allowances in the auctions nor transfer allowances in the EPA
Allowance Tracking System. Only the administrative functions of the auction program have
been delegated to CBOT; all other aspects of the auctions remain with EPA, as do all
allowance transfer functions.
How Are the Auctions Conducted?
The auctions began in 1993 and are held annually, usually on the last Monday of March.
Auctions are divided into two segments: (1) a spot allowance auction, in which allowances are
sold that can be used in that same year for compliance purposes, and (2) an advance auction
for the sale of allowances that will become usable for compliance 7 years after the transaction
date, although they can be traded earlier. Bidders must send sealed offers containing
information on the number and type (spot or advance) of allowances desired and the purchase
price to CBOT, no later than 3 business days prior to the auctions. Each bid must also include
a certified check or letter of credit for the total bid cost. (Other forms of payment may be
permitted by EPA upon public notice.)
The auctions sell allowances from the Special Allowance Reserve on the basis of bid price,
starting with the highest priced bid and continuing until all allowances have been sold or the
number of bids is exhausted. EPA may not set a minimum price for allowances from the
Special Allowance Reserve.
Allowances are sold from the Special Allowance Reserve before allowances offered by private
holders are sold. Offered allowances are sold in ascending order, starting with the allowances
for which private holders have set the lowest minimum price requirements. Offered allowances
are sold until the allowance supply is depleted, bids are used up, or the minimum price for the
next set of offered allowances exceeds the purchase price of the next bid.
EPA returns proceeds and unsold allowances from the auctioning of reserve allowances on a
pro rata basis to those units from which EPA originally withheld allowances to create the
Special Allowance Reserve. Proceeds from the sale of offered allowances are returned to
private allowance holders that contributed the allowances to the auctions. EPA likewise returns
payment from unsuccessful bids and allowances from unsuccessful offers.
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Auetions Fact Sheet
http://www.epa.gov/acidrain/auctions/auctions.html
Acid Rain Program Home I Auctions I Contact Us
http://www.epa.gov/acidrain/auctions/auction.html
Last Modified February 1998
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1999 Acid Rain Ailowance Auction
http://www.epa.gov/acidrain/auctions/99result.htm
EPA
United States
Environmental Protection Agency
Acid Rain Program
Overview Effects SO2 Program NOx Program Emissions Conservation
1999 Acid Rain Allowance Auction Results
I. Allowances Available for Auction
Apot Auction
7 Year Advance Auction
Origin of Allowances
(First Usable in 1999)
(First Usable in 2006)
EPA
150,000
125,000
Privately Offered
2,510
0
Total
152,510
125,000
II. Spot Auction Results
Allowances
Number of Bids
Number of Bidders
Bid Price
Bid For: 500,567
Successful: 27
Successful: 11
Highest: $230.00
Sold: 150,010
Unsuccessful: 50
Unsuccessful: 12
Clearing: $200.55
Total: 77
Total: 23
Lowest: $41.16
Average (weighted): $207.03
III. 7-Year Advance Auction Results
Allowances
Number of Bids
Number of Bidders
Bid Price
Bid For: 253,055
Successful: 21
Successful: 11
Highest: $220.51
Sold: 125,000
Unsuccessful: 11
Unsuccessful: 1
Clearing: $167.55
Total: 32
Total: 12
Lowest: $110.31
Average (weighted): $179.79
Spot Auction Winners
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1999 Acid Rain Allowance Auction
http://www.epa.gov/acidrain/auctions/99result.htm
Percentage of
Bidder's Name
Quantity
Amount Paid
Total Allowances
American Electric Power
74,424
49.61%
$15,100,733.20
Cinergy Services, Inc.
30,000
20.00%
$6,466,050.00
Cantor Fitzgerald EBS
21,250
14.17%
$4,402,812.50
Potomac Electric Power Company
10,000
6.67%
$2,120,100.00
Milton R. Young Station
7,467
4.98%
$1,553,210.67
Wisconsin Electric Power Company
5,000
3.33%
$1,016,980.00
Baltimore Gas and Electric Company
1,804
1.20%
$382,448.00
Sacramento Municipal Utility District
40
0.03%
$8,700.00
Acid Rain Retirement Fund
13
0.01%
$2,990.00
Maryland Environmental Law Society
11
0.01%
$2,436.00
K-Marx Capital
1
<0.01%
$225.00
TOTAL
150,010
100%
$31,056,685.37
7 Year Advance Auction Winners
Bidder's Name
Percentage of
Quantity
Amount Paid
Total Allowances
American Electric Power
121,945
97.56%
$21,869,384.75
Cantor Fitzgerald EBS
3,000
2.40%
$592,530.00
The Clean Air Conservancy
40
0.03%
$8,420.40
St. Edmonds Academy, Delaware
6
<0.01%
$1,278.00
Birney Elementary
2
<0.01%
$441.02
Democrats of Amherst, NH
2
<0.01%
$425.02
Summit Academy North
1
<0.01%
$220.51
Snape/Bower Clean Air Preserve
1
<0.01%
$212.51
Combined Schools Clean Air Preserve
1
<0.01%
$210.51
Pepperdine Environmental Law Society
1
<0.01%
$200.00
Matthew L. Floyd
1
<0.01%
$185.00
TOTAL
125,000
100%
$22,473,507.72
TOTAL AUCTION PROCEEDS: $53,530,193.09
Acid Rain Program Home
I
Auctions
I
Contact Us
http://www.epa.gov/acidrain/auctions/99result.htm
March 24, 1999
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1997 Allowances Available for Auction
http://www.epa.gov/acidrain/auctions/98result.htm
EPA
United States
Environmental Protection Agency
Acid Rain Program
Overview Effects SO2 Program NOx Program Emissions Conservation
1998 EPA SO2 Allowance Auction Results
I. Allowances Available for Auction
Spot Auction
7 Year Advance Auction
Origin of Allowances
(first usable in 1998)
(first usable in 2005)
EPA
150,000
125,000
II. Spot Auction Results
Allowances
Number of Bids
Number of Bidders
Bid Price
Bid For: 767,097
Successful: 21
Successful: 11
Highest: $228.92
Sold: 150,000
Unsuccessful: 88
Unsuccessful: 25
Clearing: $115.01
Total: 109
Total: 36
Lowest: $56.91
Average (weighted): $116.96
III. 7 Year AdvanceAuction Results
Allowances
Number of Bids
Number of Bidders
Bid Price
Bid For: 509,009
Successful: 20
Successful: 3
Highest: $115.01
Sold: 125,000
Unsuccessful: 34
Unsuccessful: 9
Clearing: $108.30
Total: 54
Total: 12
Lowest: $87.00
Average (weighted): $111.05
IV. Spot Auction Winners
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1997 Allowances Available for Auction
http://www.epa.gov/acidrain/auctions/98result.htm
Percentage of Total
Bidder's Name
Quantity
Amount Paid
Allowances
Cantor Fitzgerald
110,000
73.33
$12,943,200.00
Allowance Holdings Corporation
39,978
26.65
$4,597,869.78
Vermont Center
10
0.01
$1,155.00
Drake Environmental Law Society
3
<0.1
$346.53
CUNY Environmental Law Students
2
<0.1
$250.00
Association
McGeorge Environmental Law
2
<0.1
$250.00
Forum
Michael J. Walsh
1
<0.1
$228.92
Carolina Clean Skies
1
<0.1
$150.00
Maria Damon/ Cornell Univ.
1
<0.1
$131.51
Catholic Univ. Environmental Law
1
<0.1
$126.90
Society
Univ. of Wisconsin- Madison
1
<0.1
$120.00
Total
150,000
100
$17,543,828.64
V.7 Year Advance Auction Winners
Percentage of Total
Bidder's Name
Quantity
Amount Paid
Allowances
Cantor Fitzgerald
124,995
99.9
$13,880,908.50
Maryland Environmental Law
4
<0.1
$446.08
Society
Hatena Environmental Network
1
<0.1
$110.00
Japan
Total
125,000
100
$13,881,464.58
Total Auction Proceeds: $31,425,293.22
Acid Rain Program Home I Auctions I Contact Us
http://www.epa.gov/acidrain/auctions/98result.htm
March 25, 1998
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Opt-in Program Fact Sheet
http://www.epa.gov/acidrain/optin/optin.html
EPA
United States
Environmental Protection Agency
Acid Rain Program
Overview
Effects
SO2 Program
NOx Program
Emissions
Conservation
Opt-in Program Fact Sheet
The Opt-in Program expands EPA's Acid Rain Program to include additional sulfur dioxide
(SO2) emitting sources. Recognizing that there are additional emission reduction opportunities i
the industrial sector, Congress established the Opt-in Program under section 410 of the Clean A
Act Amendments of 1990. The Opt-in Program allows sources not required to participate in the
Acid Rain Program the opportunity to enter the program on a voluntary basis, reduce their SO2
emissions, and receive their own acid rain allowances.
The participation of these additional sources will reduce the cost of achieving the 10 million ton
reduction in SO2 emissions mandated under the Clean Air Act. As participating sources reduce
their SO2 emissions at a relatively low cost, their reductions -- in the form of allowances -- can
be transferred to electric utilities where emission reductions are more expensive.
The Opt-in Program offers a combustion source a financial incentive to voluntarily reduce its
SO2 emissions. By reducing emissions below its allowance allocation, an opt-in source will crea
unused allowances, which it can sell in the SO2 allowance market. Opting in will be profitable if
the revenue from allowances exceeds the combined cost of the emissions reduction and the cost
of participating in the Opt-in Program.
An opt-in source must comply with the same or similar provisions as utility units affected under
the mandatory Acid Rain Program. These provisions relate to allowance trading, permitting,
excess emissions, monitoring, end-of-year compliance and enforcement. Most basic to the
program is the requirement that each year the opt-in source must hold enough allowances to
cover its annual SO2 emissions.
Frequently Asked Questions about the Opt-in Program
1. Who Can Opt-in?
2. How Does a Source Opt-in?
3. How Is the Number of Opt-in Allowances Calculated?
4. Are There Restrictions on Opt-in Allowances?
5. Why is EPA Concerned with Reductions in Utilitization?
6. Questions About the Thermal Energy Exception
What is the Thermal Energy Exception?
What is a Thermal Energy Plan?
How are Allowances Transferred Under a Thermal Energy Plan?
Must a Thermal Energy Plan Be Renewed?
May a Retiring Source Participate Under the Thermal Energy Exception?
7. May a Source Withdraw From the Opt-in Program?
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Opt-in Program Fact Sheet
http://www.epa.gov/acidrain/optin/optin.html
Who Can Opt-in?
All operating stationary combustion sources that emit SO2 but are not otherwise required to me
the mandatory SO2 emissions limitations of Title IV are eligible to opt into the Acid Rain
Program. Combustion sources are defined as fossil fuel-fired boilers, turbines or internal
combustion engines.
Examples of Eligible Combustion Sources
Existing utility units serving generators less than 25 megawatts
Simple combustion turbines built before November, 1990
Industrial boilers
Non-affected municipal waste combustors burning some amount of fossil fuel
Examples of Ineligible Sources
Utility units affected under 40 CFR part 72.6
New units exempt under 40 CFR part 72.7
Retired units exempt under 40 CFR part 72.8
Mobile sources
The Acid Rain Division has published a guidance document to help sources determine whether
not they are affected by the mandatory utility program (see "Do the Acid Rain SO2 Regulations
Apply to You?" EPA 430-R-94-002).
How Does A Source Opt-in?
In order to enter the Opt-in Program, a combustion source must submit an opt-in permit
application and monitoring plan to its permitting authority, receive an opt-in permit, and install
and certify its emission monitors.
After receipt of a complete opt-in permit application and after the monitoring plan is determined
to be sufficient, the permitting authority will issue a draft opt-in permit for the source to review.
The draft permit is then made available for public comment and eventually issued or denied with
12 or 18 months of receipt of a complete application 12 months if the EPA is the permitting
authority or 18 months if the State is the permitting authority. The opt-in source must renew the
opt-in permit before it expires, and, in most cases, the permit will last for 5 years.
The opt-in permit application must clearly identify the combustion source and contain all of the
information needed to calculate the combustion source's allowance allocation, including its fuel
input and emissions data as well as historic and current emission limits.
The certification of monitoring systems for the combustion source will follow the same
procedures and requirements as for affected units in the mandatory utility program (see 40 CFR
part 75 for more specific requirements). However, there will be no provisional nor automatic
certification of monitoring systems for combustion sources. In addition, an approved opt-in
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Opt-in Program Fact Sheet
http://www.epa.gov/acidrain/optin/optin.html
permit for an applying combustion source will expire if the combustion source fails to complete
the certification of its monitoring systems within 180 days after the permit's approval.
EPA expects combustion sources to pursue the resolution of the permitting process towards a
final opt-in permit and the certification of the combustion source's monitors simultaneously. The
renewal for an opt-in permit must be requested at least 6 months prior to the expiration of an
existing opt-in permit, if EPA is the permitting authority, and at least 18 months prior to the
expiration of the existing opt-in permit, if the State is the permitting authority. The renewal,
however, should be much more straightforward than the initial opt-in permit application, becaus
the allowance allocation, once established, cannot be altered in the renewal.
How is the Number of Opt-in Allowances Calculated?
Opt-in allowances are allocated upon entry into the Opt-in Program. The number of allowances
an opt-in source receives is based on the product of its average heat input for all fuel consumed
during 1985 - 1987 (known as its "baseline") and the lesser of three emissions rates: its 1985
actual emissions rate, its 1985 allowable emissions rate, and its allowable emissions rate at the
time the combustion source submits an opt-in permit application.
If the source began operating after 1985, then EPA will accept an "alternative baseline" which is
the average heat input for all fuel consumed during the first three consecutive calendar years for
which the combustion source operated after December 31, 1985. The emissions rates used for t
allowance calculation will be the actual and allowable emissions rate for the first year of this thr
year period as well as the combustion source's current allowable SO2 emissions rate.
ANNUAL
THE 955 ACTUAL 502 EMISSIONS RATE
OPT-IN
=
[EASELINE
X
THE LESSER OF
THE 1985 ALLOWABLE 502 EMISSIONS RATE
THE UPPENT ALLCA&BLE 502 EMISSIONS PATE
ALLOWANCES
Are There Restrictions on Opt-in Allowances?
There are restrictions on opt-in allowances that do not apply to allowances allocated to affected
units under the mandatory utility program. They are:
1. Only opt-in allowances dated for the current or previous years can be transferred to other
accounts in the Allowance Tracking System.
2. Only opt-in allowances for past years may be offered for sale in the spot auction, and no
opt-in allowances may be offered for sale in the advance auction.
3. Opt-in allowances must be surrendered to the EPA if the opt-in source experiences reduc
utilization relative to its baseline. The number of allowances surrendered will be
proportional to the reduction in the opt-in source's historic operations (i.e., its baseline).
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Opt-in Prograin Fact Sheet
http://www.epa.gov/acidrain/optin/optin.html
The only exception to the surrender of allowances for reduced utilization is known as the
thermal energy exception.
Why is EPA Concerned with Reductions in Utilization?
Because participation in the opt-in program is voluntary and does not include all sources, the
statute recognized that shifts in utilization from opt-in sources to sources not participating in the
program would free up allowances without reducing emissions. EPA, in accordance with sectio
410(f)of the Act, will deduct allowances from an opt-in source when it shuts down or reduces
utilization.
For most years, utilization is calculated as the three year rolling average of heat input for the
opt-in source. An opt-in source is considered to have reduced its utilization if its average
utilization is below its baseline (i.e., its average historic fuel input). If an opt-in source has
reduced its utilization, EPA will deduct allowances from the opt-in source as described in the
equation below.
EPA will consider documented claims of demand side efficiency improvements as well as
improvements in the efficiency of electricity or steam production at the opt-in source when
determining reduced utilization. EPA will give credit and not deduct allowances for any portion
of the opt-in source's reduced utilization provided by efficiency improvements.
ALLOWANCES
DEDUCTED
AVERAGE UTILIZATION
II
ANNUAL OFT-IN ALLOWANCES
X
FOR REDUCED
EASELINE
UTILIZATION
Questions About the Thermal Energy Exception
1.
2. What is the Thermal Energy Exception? Title IV allows for the transfer of allowances tha
otherwise must be deducted to account for reduced utilization or shutdown, but the
transfer may only be made to a unit that is replacing the thermal energy previously supplie
by the opt-in source. Thermal energy is the thermal output or steam produced by a
combustion source that is used directly as part of a manufacturing process, but not used t
produce electricity. A replacement unit must be an affected unit under the Acid Rain
Program and prove that it actually replaces the opt-in source's thermal energy.
3. What is a Thermal Energy Plan? In order for an opt-in source to transfer allowances to a
replacement unit under the thermal energy exception, the opt-in source must submit a
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Opt-in Program Fact Sheet
http://www.epa.gov/acidrain/optin/optin.html
thermal energy plan and amend its opt-in permit accordingly.
A thermal energy plan is entered into jointly by the opt-in source and its replacement units
The plan estimates the amount of thermal energy replaced and requires additional
information on the operations of both the opt-in source and its replacement units while
governed by the plan.
A thermal energy plan has a fixed duration and must be renewed. The term of the plan
extends over full calendar years, so interested opt-in sources and replacement units could
have a plan last as many as five years, if the opt-in permit is on a calendar year basis, or
three years, if the opt-in permit begins on a date other than January 1.
4. How Are Allowances Transferred Under a Thermal Energy Plan? The number of
allowances transferred from the opt-in source to the replacement unit is calculated using
the following equation:
The allowance transfer from the opt-in source to the replacement unit will take place
annually. Such transfer will follow EPA's deduction of allowances to offset emissions for
the previous compliance year and before any other allowance transfers are recorded in the
Allowance Tracking System for that year. Since the number of allowances that will be
transferred each year is contained in the approved thermal energy plan, the opt-in source
and each replacement unit will know exactly how many allowances will be transferred.
At the end of each year, EPA will adjust this allowance transfer to reflect the actual therm
energy replaced. In the event that the amount of replacement is altered by an opt-in
source's confirmation report, a report submitted after allowance reconciliation that
documents efficiency improvements, the EPA will make adjustments in the following
manner: EPA will consider the number of allowances transferred to replacement units fixe
after the reconciliation process has ended. The Agency will rely on the opt-in source to
surrender any additional allowances needed to make the accounting consistent with both
the confirmed efficiency estimates and the number of opt-in allowances available for
transfer.
When a thermal energy plan is terminated, the allowance transfer for the current year
would be reversed, essentially restoring the opt-in source's original allocation for the
current year. Future year opt-in source allowances would remain unchanged.
THERMAL ENERGY
X ALLOWABLE EMISSIONS RATE AT REPLACEMENT UNI
ALLOWANCES
EFFICIENCY CONSTANT
TRANSFERRED
2000
5. Must A Thermal Energy Plan Be Renewed? A thermal energy plan will, in most
circumstances, be renewed along with the renewal of the opt-in permit. At other times, th
renewal of the plan will be considered a revision of the opt-in permit and will follow the
procedures established for all Acid Rain permit revisions. One important aspect of
renewing a thermal energy plan is the possible change in the allowable emissions rates at
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Opt-in Program Fact Sheet
http://www.epa.gov/acidrain/optin/optin.html
the replacement units. The Agency will rely on the current allowable rate in effect at the
time of renewal for the allowance transfer under the thermal energy plan.
6. May a Retiring Source Participate Under the Thermal Energy Exception? A retiring
source may enter the Opt-in Program and participate in a thermal energy plan, but must b
operating at the time it submits its opt-in permit application. Operating is defined for this
purpose as having documented fuel consumption for more than 876 hours in the 6 months
immediately preceding application (i.e., operating at 20 percent capacity factor or greater)
EPA places this requirement on retiring combustion sources, to prevent sources shut dow
long ago from claiming allowances and increasing overall emissions.
Retiring combustion sources seeking to become opt-in sources can receive an exemption
from the Opt-in Program's monitoring requirements, consistent with 40 CFR part 75.67.
The designated representative of such a source must petition the Administrator for such a
exemption.
May a Source Withdraw From the Opt-In Program?
An opt-in source can withdraw from the program provided it meets certain conditions:
1. The opt-in source must submit its annual compliance certification report by January 30 of
the first calendar year in which the withdrawal is to be effective (rather than March 1);
2. The opt-in source must immediately provide additional allowances if it has excess
emissions;
3. The opt-in source must surrender all allowances allocated to it for the year in which the
withdrawal is to take effect and for all years thereafter.
If the opt-in source does not meet these conditions to withdraw, the opt-in source shall remain i
the Opt-in Program and remain subject to all requirements of the program.
Withdrawal will take effect on January 1. For opt-in sources that withdraw from the program,
they cannot reapply to opt in until the year before the original opt-in permit needed to be
renewed.
Additional Details
A monitoring plan is sufficient if the plan appears to contain information demonstrating
that all emissions are monitored and reported in accordance with 40 CFR part 75. A
determination of sufficiency shall not be construed as the approval or disapproval of the
combustion source's monitoring systems.
The term "permitting authority" is used to designate the entity responsible for issuing and
administering permits. Initially, the EPA is the permitting authority. As states, and in som
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Opt-in Program Fact Sheet
http://www.epa.gov/acidrain/optin/optin.html
cases, local air pollution control agencies are authorized to issue permits under Titles IV
and V, they would become the permitting authority.
The 1985 allowable emissions rate is the most stringent federally enforceable limitation f
SO2 (in lb/mmBtu) applicable to the combustion source for 1985.
The allowable emissions rate at the time of application if it exists, is a new lower
emissions limit that is finalized but not yet in effect for the applying opt-in source. EPA W
consider this new limit (known as "the current promulgated SO2 emissions rate") and will
adjust the combustion source's allowance allocation for the year and all years after such
limit takes effect.
The Allowance Tracking System (ATS) is an automated system operated by EPA's Acid
Rain Division and used to track the allowances held by utilities, opt-in sources and other
organizations and individuals. More on the Allowance Tracking System.
EPA holds annual auctions from a special allowance reserve and from offers of allowanc
from private holders. There are two types of auctions: (1) a spot allowance auction, in
which allowances are sold that can be used in that same year for compliance purposes, an
(2) an advance auction for the sale of allowances that will become usable in the future.
More on Auctions.
Demand side efficiency improvements include demand side measures that improve the
efficiency of electricity or steam consumption. Qualified demand side measures applicable
to the calculation of utilization for opt-in sources are listed in Appendix A, Section 1 of 4
CFR part 73. More on energy efficiency improvements under the Clean Air Act.
Acid Rain Program Home I SO2 Emissions Trading Contact Us
http://www.epa.gov/acidrain/optin/optin.html
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Early Reduction Credits
http://www.epa.gov/acidrain/erc.html
EPA
United States
Environmental Protection Agency
Acid Rain Program
Overview
Effects
SO2 Program
NOx Program
Emissions
Conservation
Early Reduction Credits
Units may receive additional allowances under Section 404(e) for SO2 emissions reductions
accomplished in years prior to the implementation of the Acid Rain Title. Only a few Phase I
and Phase II utility systems are eligible for these early reduction credits. Eligible Phase I units
receive allowances for voluntary emissions reductions made after enactment and before January
1, 1995. Eligible Phase II units receive allowances for voluntary SO2 emissions reductions
made between January 1, 1995 and January 1, 2000.
Acid Rain Program Home I SO2 Emissions Trading I Contact Us
http://www.epa.gov/acidrain/erc.html
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Cost Savings, Market Performance, and
Economic Benefits of the U.S. Acid Rain
Program
Dallas Burtraw
Discussion Paper 98-28-REV
Revised September 1998
RESOURCES
FOR THE FUTURE
1616 P Street, NW
Washington, DC 20036
Telephone 202-328-5000
Fax 202-939-3460
© 1998 Resources for the Future. All rights reserved.
No portion of this paper may be reproduced without
permission of the author.
Discussion papers are research materials circulated by their
authors for purposes of information and discussion. They
have not undergone formal peer review or the editorial
treatment accorded RFF books and other publications.
Cost Savings, Market Performance, and Economic Benefits
of the U.S. Acid Rain Program
Dallas Burtraw
Abstract
This paper reports on four areas of research concerning Title IV of the 1990 Clean Air
Act Amendments that regulates emissions of SO₂ from electricity generation. The first is the
costs of the program over the long-run as estimated from the current perspective taking into
account recent changes in fuel markets and technology. We compare projected costs with
potential cost savings that can be attributable to formal trading of emission allowances. The
second area is an evaluation of how well allowance trading has worked to date. The third area
is the relationship between compliance costs and economic costs from a general equilibrium
perspective. The fourth area is a comparison of benefits and costs for the program.
Key Words: acid rain, benefit-cost analysis, air pollution, permit trading, Clean Air Act
JEL Classification Numbers: H43, Q2, Q4
ii
Table of Contents
Introduction
1
Costs of the SO₂ Program and Cost Savings from Allowance Trading
2
Performance of the Program to Date
7
Compliance Costs versus Economic Costs
10
Comparing Benefits and Costs
13
Conclusion
15
References
17
List of Figures and Tables
Figure 1. Annual 90 Percent Confidence Intervals for Total Health Benefits Compared
with Expected Annualized Costs
15
Table 1.
Estimates of Long-run (2010) Annual and Marginal Cost
3
Table 2.
The Contribution of Price and Technological Change to Compliance Costs
5
Table 3.
Cost Estimates for Compliance in 1995
8
Table 4.
Benefits and Costs Expressed as "Per Affected Capita" in 2010
13
iii
C
Dallas Burtraw*
Title IV of the 1990 US Clean Air Act Amendments regulates emissions of SO₂ from
electric utility facilities and instituted two important innovations in US environmental policy.
The more widely acknowledged of these is the SO₂ emission trading program, which is
designed to encourage the electricity industry to minimize the cost of reducing emissions.
The industry is allocated a fixed number of total allowances and firms are required to hold
one allowance for each ton of sulfur dioxide they emit. 1 Firms are allowed to transfer
allowances among facilities or to other firms, or to bank them for use in future years. This
approach enables firms operating at high marginal pollution abatement costs to purchase SO₂
emission allowances from firms operating at low marginal abatement costs, thereby lowering
the cost of compliance.
The second and less widely acknowledged innovation is the annual cap on average
aggregate emissions by electric utilities, set at about one-half of the amount emitted in 1980.
The cap accommodates an allowance bank, so that in any one year aggregate industry
emissions must be less than the number of allowances allocated for that year plus the surplus
that has accrued from previous years. Unlike most previous regulations in the US, including
technology standards or emission rate standards, the emissions cap represents a guarantee that
emissions will not increase with economic growth. 2
This paper begins with a summary of recent projections of the
costs of
compliance when the program is fully implemented in the next decade, and estimates of
stemming from the trading program in the long run. Second, I evaluate how well the
allowance trading has worked to date, and what one can expect to happen in the future.
*
Fellow, Quality of the Environment Division, Resources for the Future. An earlier version of this paper was
presented April 9, 1997 at the Institute of Development Studies, University of Sussex. The paper will appear in
, S. Sorrell and J. Skea, eds., forthcoming (1998)
from Edward Elgar Publishing.
1 Allowances are allocated to individual facilities in proportion to fuel consumption multiplied by an emission
factor during the 1985-1987 period. About 2.8 percent of the annual allowance allocations are withheld by the
EPA and distributed to buyers through an annual auction run by the Chicago Board of Trade. The revenues are
returned to the utilities that were the original owners of the allowances.
2 Title IV also used a more traditional approach in setting NOₓ emission rate limitations for coal-fired electric
utility units, although this approach has been modified to allow emission rate averaging among commonly
owned and operated facilities. Hence, there is no cap on NOₓ emissions, but Title IV is expected to result in a
27 percent reduction from 1990 emissions for electric utilities.
1
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Most attention has been focused on the reduction in "out-of-pocket" compliance costs
that may result from allowance trading. However, compliance costs are not the same thing as
economic costs. A third focus of this paper is to explain how hidden economic costs inflate
the total cost of the program in an important way, and how recognition of these costs provides
an important lesson for the design of future programs. Fourth, I return to the primary purpose
of the program, which after all is to reduce acidification of the environment and associated
effects on human well-being. An economic assessment of benefits, though extremely
uncertain, indicates that benefits are an order of magnitude greater than costs under the
program. An important component of this favorable assessment rests with the design of the
tradable permit program which has helped to reduce costs substantially.
To make sense of the wide variety of claims about the costs of the SO₂ program one
has to put these claims in historic perspective. In the 1980s there were over seventy proposed
pieces of legislation that suggested a variety of regulatory approaches aimed at the problem of
acidification.
One prominent proposal was the Sikorski/Waxman bill in 1983 that sought to rollback
emissions, by about the same amount as eventually required under Title IV, by requiring the
installation of scrubbers (flue gas desulfurization equipment) at the fifty dirtiest plants. 3 The
estimated levelized cost of this proposal ranged from about $7.9 billion per year according to
government studies (OTA, 1983) to $11.5 billion per year according to an industry study
(TBS, 1983; 1995 dollars).
Another bill (H.R. 4567) in 1986 was aimed at similar environmental gains but
promoted cost reductions by applying a target average emission rate for each utility company.
Taking account of changes in fuel and other input prices between 1983 and 1986, an industry
study (TBS, 1986) found costs would be $7.5 billion per year compared with estimates of
$3.5 to $6.2 billion by ICF in a study for the EPA, and $3.4 to $4.3 billion by the OTA (1995
dollars). 4 Though ultimate regulation did not involve either of these approaches the estimates
provide an indication of what the program might have cost under alternative regulatory
approaches, and have often been used as a basis for comparison.
One of the earliest studies of the cost under an allowance trading system was Elman
et al. (1990) who estimated the marginal cost of compliance and inferred this would be the
3 These plants represented 89 percent of the nation's pre-New Source Performance Standard coal-fired capacity.
Fuel switching to low-sulfur fuel and other facility improvements would have been required at other facilities.
Scrubbing would have been applied to about half of the affected capacity and accounted for 70 percent of the
SO₂ reduction.
4 It is noteworthy that an industry study (TBS, 1986) suggested the costs would be higher as a result because
although "intra-firm trading" would reduce the need for scrubbing, it would increase reliance on low sulfur coals
resulting in an increased premium on low sulfur coal that would raise costs for units already using low sulfur
coal. This prediction is contradicted by the turn of events under Title IV, when the cost of lost sulfur coal fell
with its expanded use.
2
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value of emission allowances. Under a perfect trading market, this study predicted marginal
costs (presumed to equal allowance prices under perfect trading) of $742-1032 (1995 dollars)
and costs of $1935 for imperfect trading, ranging up to $2580 or $5160 at a number of
utilities. However, for evaluation of the program compared to prior expectations, the most
useful study is ICF (1990), which was done for the EPA and available prior to enactment of
the legislation. This study captured more accurately the ultimate design of the regulation, and
projected marginal costs of $579-760 (1995 dollars) for full compliance under the program.
This and a number of other studies are summarized in Table 1.5
(billion 1995 dollars)
(1995 dollars)
(1995 dollars)
1.0
291
174
0.9
239
[EPRI]
436
[EPA]
2.3
532
252
[EPRI]
1.4-2.9
543
286-334
2.2-3.3
230-374
[EPRI]
2.4-3.3
520
314-405
[EPA]
1.9-5.5
579-760
280-467
An important feature of the studies summarized in Table 1 is that, as a group, they
have successively estimated a sequence of declining projections of annual and marginal costs
of compliance. There are several contributing reasons for this. One is that the trading
program ignited a search for ways to reduce emissions at less cost, as theory suggests is likely
to occur with this type of regulation, and the fruitful results of this enterprise are measured by
latter studies (Burtraw, 1996).
It is also the case that advantageous trends in fuel markets contributed to a decline in
emission rates, making it easier for utilities to attain the goals of the program thereby reducing
program costs (Ellerman and Montero, 1998; Burtraw, 1996). Indeed, the right-hand column
in Table 1 reporting average cost per ton estimated by the various studies reflects this decline.
The differences in average cost estimates are due to differences in annual cost reported in the
5 These estimates describe long-run costs expected to obtain when the allowance bank, which is expected to
build up to about 11 million tons by the end of Phase 1 (in the year 2000), is drawn down and net contributions
to the bank are zero.
3
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first column, but also they are due to differences in the estimate of tons reduced under the
program compared to various specified baseline projections of emissions that would occur in
the absence of the program. To the extent these emission reductions would have occurred even
in the absence of the SO₂ program then the program should not be given credit; however, it
appears the trading program encouraged utilities to capitalize on these advantageous trends
while other regulatory approaches might not have.
A third reason for declining projections of cost is that the market structure for
industries offering compliance services to utilities was dramatically changed under the trading
program. What were previously independent factor markets supplying services to utilities
(coal mining, rail transport, and scrubber manufacturing) were thrown into a competition with
each other by the program's flexible implementation. This unleashed competitive pressure to
find ways to reduce costs in all these markets.
All of the explanations listed appear to contribute to some degree to the decline in
estimates of compliance costs. The Carlson et al. (1998) model can help to sort out these
factors because it provides a framework in which we can vary factors one at a time and
explore their significance. While most of the studies in Table 1 rely on engineering-based
models of compliance options and their costs, Carlson et al. uses a simulation model based on
marginal abatement cost functions derived from an econometrically estimated long-run total
cost function for electricity generation for a sample of over 800 generating units over the
period 1985-1994.⁶ From an economist's perspective, this study is superior because it takes
into account behavioral responses to changes in relative input prices. These behavioral
responses generally take the form of substitution among inputs to reduce jointly the costs of
generating electricity and of complying with emission reduction requirements. The
econometric approach also affords a method for measuring the role of technological change in
reducing the costs of SO₂ abatement over time, and to develop forecasts of future compliance
costs and gains from trade that implicitly incorporate future behavioral changes including
future responses to changes in technology.
Table 2 presents several estimates using this model, varying assumptions about fuel
prices and technological change. The columns in the table represent the annual cost of a
command and control approach (uniform emission rate standard), the annual cost of efficient
trading, its associated marginal abatement cost and finally the estimated gains from trade that
are available from efficient trading.
6 The cost function they estimate treats fuel type (high-sulfur and low-sulfur coal), labor and generating capital
as fully variable inputs. The econometric model consists of the cost function plus two share equations that
specify the share of total costs attributed to capital and labor, and an equation for the firm's mean annual
emission rate. The study uses a translog form for the cost function, adding dummy variables for each plant in the
database to measure fixed effects that vary among the plants. Costs for units with scrubbers are taken directly
from reported data. The model does not investigate whether early commitments to build scrubbers was
economical, but several studies have suggested that several of these investments were not.
4
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(million 1995
(million 1995
(1995
(million 1995
dollars)
dollars)
dollars)
dollars)
The first row in Table 2 reports numbers for a benchmark scenario that uses
assumptions comparable to those in previous studies, including assumptions that relative fuel
prices remain stable at 1995 levels, technology including the utilization rate of scrubbers is
characterized at 1995 levels and the historic method for measuring emissions based on
sampling of coals and engineering formulas remains in effect. The retirement rates for coal
facilities, and replacement with scrubbed coal technology, is taken from projections by the
Energy Information Administration (EIA, 1996). The estimates assume that no additional
retrofit scrubbers are constructed after Phase I.
This benchmark predicts long-run marginal abatement costs will be $436 (1995
dollars). The second row presents an estimate under most benchmark assumptions but with
prices held to their 1989 level (implying a higher price for low sulfur coal relative to high
sulfur coal than obtained in 1995) and the time trend for technological change (factor
productivity) also held at 1989 levels.⁷ From this vantage point, marginal abatement costs
rise to $560, or 28 percent greater. One should note that this is not far from that offered by
ICF (1990) calculated with comparable information reported in Table 1.
The last row in Table 2 presents the Carlson et al. (1998) preferred estimate,
reproduced for convenience from Table 1. Compared to the benchmark, this scenario adopts
1995 prices and 2010 technology. It assumes utilization rates and performance of in-place
scrubbers continues to improve. It assumes a slower retirement rate of coal-fired facilities, and
half of retired facilities are replaced by gas. Also it assumes that the use of continuous
emission monitoring systems in place of the historic measure of emissions will raise emission
7 Technological change here captures both exogenous efficiency improvements at the power plant and
improvements induced by the program, but it does not capture improvements in scrubber technology and
performance.
5
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estimates and necessitate a greater level of control. 8 Explicitly missing from consideration in
all of these studies is the influence of other potential regulatory actions, such as further
control on particulates or NOₓ emissions or actions to meet global warming goals.
Based on this information and model, the savings from allowance trading that are
expected from an efficient allowance market are about $780 million annually, or about 42
percent of the costs under command and control. Previous studies (Van Horn Consulting
et al., 1993; GAO, 1994) suggested an efficient allowance market would result in cost savings
of about twice this much in percentage terms. In all these studies, the command and control
approach that is modeled is "enlightened" in that it is a performance standard (emission rate or
emission tonnage standard) applied to each facility, calibrated to achieve the same level of
total emissions.⁹ This approach already encompasses many of the beneficial incentives of the
SO₂ trading program compared to a technology forcing approach by providing individual
facilities with flexibility in achieving the standard. Other command and control approaches
that were seriously considered in the US, such as forced scrubbing at larger facilities, could
have cost substantially more. Forced scrubbing is also the approach embodied in the New
Source Performance Standards for SO₂ from power plants. 10
In summary, estimates of both a command and control approach and allowance trading
have fallen over time due to a number of factors. Allowance trading is expected to result in cost
savings relative to a command and control approach, but the absolute magnitude of these savings
is expected to be somewhat less than previously envisioned due to changes in fuel markets.
However, a more rigid approach that forced firms to adopt specified technologies would have
precluded them from taking advantage of some of these trends in the industry. Compared to this,
allowance trading could be argued to constitute a greater savings than we estimate.
Though they are substantial by any accounting, cost savings have been exaggerated in
many accounts of the program. Advocates of ambitious climate change policies have
suggested that SO₂ allowance prices are "so low" and that economists and engineers got it "so
wrong" that policy makers should virtually ignore cost projections when developing new
regulations such as a carbon permit trading program (or trading of nitrogen oxide (NOx)
permits). These exaggerated comparisons have often used inconsistent estimates of cost,
8 In 1995 the continuous emission monitors estimated seven percent higher emissions than did the historic
approach on average, although there was considerable variability among facilities.
9 In their command and control scenario, Carlson et al. (1998) apply a uniform emission rate standard to all
facilities. GAO (1994) and Van Horn Consulting et al. (1993) allow intra-utility trading, but no trading between
utilities. GAO (1994) also models a scenario that requires each facility to achieve its SO₂ allowance allocation
without trading, and finds cost savings more than double that in the case in which internal-trading is allowed in
the command and control baseline.
10 1978 Clean Air Act regulation of sulfur emissions from newly constructed fossil fuel-fired electricity
generating facilities imposes a rate-based standard that requires a 90 percent reduction in a smokestack's SO₂
emissions, or 70 percent if the facility used low-sulfur coal. Although nominally a performance standard, it
effectively dictates technological choices and precludes compliance through the use of process changes or
demand reduction. The only available technology to achieve such reductions is scrubbing, and the use of low-
sulfur coal is not a permissible way to avoid the threshold for the strict standard.
6
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leading to erroneous conclusions (Bohi and Burtraw, 1997). The most obvious of these errors
is to compare allowance prices today directly with long-run marginal cost estimates. This is
erroneous because long-run marginal cost estimates describe costs that will not be incurred
until late in the next decade, when the allowance bank is drawn down and net contributions to
the bank are zero. Allowance prices today should be proximate to short-run marginal cost and
these are related to long-run marginal costs by the rate of interest. Discounting long-run
marginal costs for the year 2010 to the present reduces them by about two-thirds!
A proper comparison of program costs indicates they are expected to be less by almost
one-half that indicated in information available to legislators in 1990. Further, program costs
are perhaps half again the cost of an inflexible technology standard. However, they are not
reduced by fifteen fold, as some have claimed. 11 Furthermore, as described previously, a
significant portion of the actual decline is due to factors exogenous to the program.
Nonetheless, after accounting for these factors the remaining decline in costs is impressive,
and in general it points toward success for the program.
The previous section reported on estimates of the cost of compliance when the program
is fully implemented. The second phase of the program begins in the year 2000, when an
expanded set of facilities will be brought into the program and the average emission rate for all
facilities will reduce to about 1.2 lb. per million Btu. In the first phase of the program, which
began in 1995, firms have been over-complying in order to save allowances in the bank and to
ease the transition into Phase II. In the second phase, utilities will begin to draw down their
allowance banks until net contributions to the bank are zero and annual emissions equal annual
allocations for an average year. This is projected to occur by the year 2010.
A specific economic relationship is expected to govern use of banked allowances, and
the magnitude of the marginal costs in a given year. As previously mentioned, allowance
prices in a given year should reflect marginal abatement costs in that year. To appreciate why
this is so, imagine instead that allowance prices were less than a firm's marginal costs. Then
the firm could decrease its compliance activities and purchase allowances in the market as an
alternative means of compliance, earning positive net revenues.
A similar reasoning governs the relationship between marginal costs at different points
in time. Marginal costs in any given year should equal the present discounted value of
marginal abatement costs in the future. Imagine instead that allowance prices were less than
the present discounted value of marginal costs in the future. Then again the firm could
purchase allowances in the current year and "bank them" for use in place of compliance
11 For instance, March 10, 1997 EPA Administrator Carol Browner argued: During the 1990 debate on the
acid rain program, industry initially projected the cost of an emission allowance to be $1500 per ton of sulfur
dioxide.
Today, those allowances are selling for less than $100." ("New Initiatives in Environmental
Protection,"
(newsletter), March 31, 1997, Commonwealth Club of California. See also
"Economists" Cold Forecast; Assumptions: Expect their dire predictions about the impact of the global warming
treaty on the United States. Ignore all of them," by Elaine Karmarck,
, December 28, 1997.
7
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activities in the future, generating net revenues. Of course, the converse would hold as well,
if allowance prices were greater than these respective measures of marginal costs. Hence, the
banking provision in the allowance market serves an intertemporal arbitrage function that
allows firms to identify the least cost means of compliance over time just as allowance trading
allows firms to identify the least cost means of compliance over geography.
Using this relationship from economic theory provides one way to check on the
performance of the market and the likely accuracy of estimated costs. If cost estimates for the
long-run are correct, and using a discount rate of 8 percent reflecting the opportunity cost of
capital for firms in the industry, current allowance prices should be about one-third of projected
long-run costs. The present discounted value of long-run marginal costs of $291 in 2010 should
be about $95 in 1997. Allowance prices hovered between $100 and $110 for most of 1997,
suggesting that the model is roughly consistent with current activities, and that intertemporal
arbitrage is working to an important degree. The explicit omission of other potential regulatory
actions (NOx, CO₂) in the models may explain much of the remaining difference.
Another way to measure the performance of the market to date is to look at the
allocation of compliance activities among firms in the current period. Economic theory
suggests that the marginal cost of compliance activities should be the same at all facilities
(except as may be constrained by local ambient air quality restrictions).
To investigate this Carlson et al. (1998) evaluated their estimated marginal abatement
cost functions at the level of emissions in the industry in 1995. These results are reported in
Table 3. The cost of efficient trading is projected to be $552 million, with a marginal cost for
fuel switching activities of $101. This compares with a cost under a command and control
emission rate standard of $802 million, representing a savings of 30 percent. 12 Further, the
projected marginal cost of $101 is remarkably close to allowance prices in this period (around
$90 in 1995), reinforcing the notion that intertemporal arbitrage is working as it should.
(million 1995 dollars)
(1995 dollars)
(1995 dollars)
552
101
194
832
180
291
726
153
210
*
Includes scrubbing costs
12 As noted previously, in their command and control scenario, Carlson et al. (1998) apply a uniform emission
rate standard to all facilities.
8
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However, the second row of the table reports the estimated actual cost of compliance
when the estimated abatement cost functions are evaluated using observed emissions at
individual facilities. The
cost to the industry in 1995 is estimated to be $832 million,
or 50 percent more expensive than a least cost solution (reported in row 1) according to the
model. The only other estimate for 1995 that we are aware of is Ellerman et al. (1997) who
found costs in 1995 to be $726 million.
The notion of an industry marginal cost does not apply in this context, since costs
presumably differed among firms. However, Carlson et al. calculate the marginal cost at each
facility weighted by that facilities portion of total generation and summed for the industry
results in an estimate of $180. Ellerman et al. do not report marginal cost but they find an
average cost from fuel switching activities of $153. Both of these figures compare poorly with
observed allowance prices in 1995. We consider the proximity of the Carlson et al. econometric
estimates to the Ellerman et al. survey estimates of actual costs, and the distinction between
these estimates and the estimated cost of efficient compliance as evidence that in the first year
of the program there were unrealized potential gains from trade suggesting that important
imperfections characterized the allowance market in the first year of the program. Moreover,
the difference between the observed price of allowances (approximately $90 in 1995) and both
Ellerman et al. and Carlson et al. estimates of actual compliance cost provides further evidence
that the new program of allowance trading was not yet a mature institution in 1995.
What appears to have occurred in 1995 is that different patterns of compliance
behavior co-existed in the industry. Many utilities appear to have taken advantage of the
flexibility afforded by the allowance program to find ways to reduce costs of compliance,
including taking advantage of allowance trading per se However, many other utilities appear
to have pursued a solitary strategy, rationalizing to some degree the cost of emission
reductions within the firm, but not taking advantage of the allowance market to rationalize
costs with other firms in the industry (Bohi and Burtraw, 1997).
This glance at the first year of performance in the market is disconcerting, but it may
be a poor indicator of the rich long-run prospects for the program. One should expect that an
industry that has heretofore been subject to cost recovery rules in a regulated setting would
take some time in adjusting to a new incentive-based approach to environmental regulation.
In fact, one can be relatively confident that the future holds better things in store for the
program. One reason is that trading activity is increasing. Trades can be recorded with the
EPA at any time prior to the use of an allowance for compliance, and recorded trades are
monitored in the EPA's electronic, on-line Allowance Tracking System (ATS). The EPA has
developed an algorithm for classifying trades as "economically significant" if they are
transfers between independent firms, and the majority of trades that are recorded have been
transfers for accounting convenience or other reasons within firms. However, the number of
economically significant trades has virtually doubled each year through 1997.
A second reason for optimism about the efficiency of the market is that the industry-
wide level of emissions increased slightly in 1996. An adjustment was necessary because the
weighted average costs in 1995 were greater than the present discounted value of marginal
9
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costs in the future and greater than allowance prices that reflect the latter measure. Behavior
at the outset of the program appears to have been risk averse, with firms making sure they
could achieve compliance through a "go-it-alone" strategy. Subsequently, there appears to be
a growing level of comfort with the use of the market as a way to ensure compliance.
A third reason for optimism has to do with over-arching trends in the electric utility
industry in the US. The industry is in a fundamental period of realignment as competition at
the wholesale level, and perhaps ultimately at the retail level, is beginning to emerge. This
type of competition is placing pressure on the industry to find ways to reduce costs in all
segments of its business. One should not expect the industry to absorb $300 million in
unnecessary costs in the future when allowance trading provides a fairly simple means of
reducing those costs.
Though widely known, it is not often acknowledged that compliance costs and
economic costs are not the same thing. Compliance costs describe the out-of-pocket expenses
by a firm or industry to comply with regulations. Economic costs describe the value of goods
and services that were lost to the economy due to the regulation. This can include so-called
hidden costs or benefits, such as costs incurred but not reported as compliance costs or
indirect productivity changes that result from environmental compliance.
One type of important hidden cost stems from the interaction of the program with the
pre-existing tax system. Important distortions away from economic efficiency stem from pre-
existing taxes. Labor income taxes are particularly important because of their magnitude in
the economy. Labor taxes impose a difference between the before-tax wage (or the value of
the marginal product of labor to firms) and the after-tax wage (or the opportunity cost of labor
from the worker's perspective). This difference causes workers to substitute away from labor
to leisure compared to an efficient outcome were these two measures equal.
Any regulation that raises product prices potentially imposes a hidden cost on the
economy by lowering the real wage of workers. This can be viewed as a "virtual tax"
magnifying the significance of previous taxes, with losses in productivity as a consequence.
If there were no pre-existing distortions in the economy, the impact of regulatory costs would
be of little concern. However, the cost of distortions associated with taxes grow more than
proportionally with the size of the tax, and hence the hidden cost of regulation can be of great
importance when pre-existing taxes are taken into account.
This hidden cost has been termed the tax-interaction effect (Parry, 1995) and it tends
to erode the usual efficiency benefits identified with setting prices to include external costs.
The tax interaction effect is particularly important in the allowance trading system, relative to
a command and control approach, because the price of the final product in a competitive
market should reflect not only compliance cost for emission reductions but also the
opportunity cost (or price) of allowances used for compliance. As the electric utility industry
in the US moves toward competition, this effect of allowances on electricity prices is expected
to emerge. The trading program is expected to result in significant savings in compliance
10
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costs, but commensurately it internalizes additional costs in the way of allowance prices into
electricity prices. 13
Goulder et al. (1997) have investigated the magnitude of the tax-interaction effect in
the context of the SO₂ program using both analytical and numerical general equilibrium
models. They find that this effect will cost the economy about $1.06 billion per year (1995
dollars) in Phase II of the program, adding an additional 70 percent to their estimated
compliance costs for the program.
There are important lessons here for the design of other environmental programs that
may refer to the SO₂ program as a model. First Goulder et al. (1997) find that the tax
interaction effect is more significant, relative to the magnitude of compliance costs, for
programs that are aimed at small emission reductions such as may describe possible policies
for CO₂ reductions. 14 Further, since the tax-interaction effect is positive even for a small
emission reduction, then it is possible for the economic costs of regulation to be greater than
the benefits even when compliance costs start at zero.
Second, the cost of the tax-interaction effect can be largely (but not entirely) offset by
policies that raise revenues for the government, because these revenues can (in principle) be
used to offset preexisting taxes and correct distortions in the labor market resulting from these
taxes. The authors find that over half of the economic cost of the tax interaction effect, or
$622 million, could be avoided if emission allowances were auctioned rather than
grandfathered and the revenue was used to reduce the marginal tax rate on labor income.
Unfortunately, the SO₂ program does not raise revenues since allowances are distributed for
zero cost. Consequently, the current program design imposes a hidden cost on the economy
that could be avoided if allowances were auctioned instead of allocated without charge.
The recommendation that allowances be auctioned comes with significant political
liability. The endowment of allowances without charge, so-called "grandfathering" of
allowances, is an important form of compensation to the electric utility industry. The
industry's attitude toward the SO₂ program would have been considerably more negative had
this compensation not existed. Hence policy makers face a trade-off between efficiency and
compensation in the design of the program.
There is an equity aspect to this issue that counter-balances the concerns of industry as
well. At the time legislators adopted the SO₂ program in 1990, state public utility
commissions were in the business of regulating the industry and setting electricity prices, and
they were the safeguard to ensure utilities could not charge customers for something the
utilities received for free. Hence, endowing allowances at zero cost was not controversial to
13 The effect on product prices should occur without regard to how the firm acquired allowances originally, if
prices reflect marginal costs and allowances are valued at their opportunity cost.
14 Small emission reductions require small compliance expenditures, leaving a larger quantity of emissions to be
included in a permit trading scheme. Allowance prices would be low, relative to a case with greater emission
reductions, but they apply to a larger quantity of emissions. Hence, the portion of costs associated with permit
use relative to the portion of costs associated with compliance cost is greater.
11
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the design of the SO₂ program. However, in the near future we expect regulators to exit the
business of setting prices, at least with respect to electricity generation, and electricity prices
will be set in a competitive market. 15 In the textbook and presumably in the market, SO₂
allowances take on the value of their opportunity cost, and this will be passed on through
marginal cost pricing in a competitive electricity market, regardless of how the utility
acquired the allowances originally. The value of this endowment, coming out of the hides of
electricity consumers and accruing to the industry, is potentially very large.
A potentially important qualification concerns whether coal-fired electric generating
facilities which are the source of SO₂ emissions are likely to be the marginal unit that is the
highest cost unit that is operated to meet electricity demand and hence will be determining
electricity price. For example, at times when a gas-fired unit is the marginal unit, the price of
electricity should reflect the marginal costs of that unit and will not reflect allowance costs for
coal-fired generation that may be running at costs below the margin. On the other hand, when
coal-fired units are the marginal unit then all infra-marginal technologies that operate at less
cost than the marginal unit will receive the same price of electricity, which reflects the costs
of allowances.
To investigate this issue, we exercised an electricity dispatch model aggregated by
season, time block and region, that is maintained at Resources for the Future. The model is
intended to characterize the industry under competitive conditions expected to prevail after
deregulation. We find that coal-fired facilities can be expected to generate about one-half of
all electricity generated in the US, just as they do under current regulatory practice. Further,
we find that about one-half of all electricity would be generated when a coal facility is the
marginal unit. Hence, on a per kilowatt-hour basis, the effect on electricity prices from
emission allowances appears to be about the same as it would be if we were to assume
generation from coal-fired units always occurred when these were the only units operating
and their marginal costs were to determine electricity prices when they were in operation.
Under the assumption that the program works efficiently and firms value SO₂
allowances at their opportunity cost (the price of an allowance, equal to the marginal abatement
cost) then the magnitude of the compensation under the program (the grandfathering of
allowances valued at their opportunity cost) far outweighs the compliance cost incurred by
firms. I estimate that the present discounted value of this difference is between $10 and $20
billion (1995 dollars). This represents a tremendous transfer of wealth from electric utility
customers to the industry, and this transfer should be of interest in the design of other programs.
In particular, the design of a CO₂ permit program would involve smaller emission
reductions in percentage terms and therefore a much greater transfer of wealth relative to the
cost of compliance and also in absolute terms. Both the equity and the efficiency aspects of
15 This will occur if state or federal policy-makers move to retail competition. At the time of this writing,
fifteen states have committed to retail competition to be implemented at some future date, and virtually all states
are actively considering doing so (Ando and Palmer, 1998). Even if retail competition is slow to develop,
wholesale competition is likely to emerge in the near future.
12
Burtraw
RFF 98-28-REV
the tax-interaction effect can be largely remedied by a carbon tax or auctioned carbon permits.
Recognizing that there may political obstacles to a revenue-raising carbon policy, a hybrid
system involving an auction of some portion of the permits and grandfathering the remaining
may be a useful compromise.
The primary measure of success of the SO₂ program, from the perspective of economics,
is the comparison of benefits and costs. Burtraw et al. (1997) describe an integrated assessment
of the of benefits and costs through the year 2030, with benefits quantified for health, visibility
and aquatics. 16 The accounting of benefits is incomplete because several environmental
pathways could not be modeled completely. The cost estimate and estimate of health benefits
are calculated for the entire nation, but visibility and aquatic benefits are calculated only
to illustrate the potential relative magnitude of these benefits; and, the estimates
do not necessarily apply to the entire nation. Midpoint estimates of the benefits and costs per
affected capita for the year 2010 are summarized in Table 4.
(1995 dollars)
4.09
69.25
0.72
3.90
6.79
6.19
Source: Burtraw et al. (1997)
The study finds that benefits of the SO₂ program are an order of magnitude greater
than costs, a result that contrasts sharply with estimates in 1990 that pegged benefits about
equal to costs (Portney, 1990). What explains the difference between the earlier and recent
estimates?
16 The integrated assessment involved nearly thirty researchers at a dozen institutions The assessment is based
on reduced-form models that were calibrated to several larger models of utility emissions and costs, atmospheric
transport of pollution, visibility impairment, effects on aquatic systems and human health, and valuation of
effects. Economic assessment of costs are calculated with an engineering model constructed for the assessment.
Economic valuation of damage to aquatic systems relied on random utility models of recreational use. Health
mortality valuation relied on compensating wage and contingent valuation studies and morbidity valuation relied
on a number of studies and methods. Valuation of visibility effects at national parks used contingent valuation
methods, and valuation of visibility in residential areas used a combination of contingent valuation combined
with hedonic property value studies.
13
Burtraw
RFF 98-28-REV
The lion's share of benefits result from reduced risk of premature mortality, especially
through reduced exposure to sulfates, and these expected benefits measure several times the
expected costs of the program. Significant benefits are also estimated for improvements in
health morbidity, recreational visibility and residential visibility, each of which measures
approximately equal to costs. These areas, namely human health and visibility, were not the
focus of acid rain research in the 1980s, and new information suggests these benefits are
greater than were previously anticipated.
In contrast, areas that were the focus of attention in the 1980s including effects to
soils, forests and aquatic systems still have not been modeled comprehensively, but evidence
suggests benefits in these areas to be relatively small, at least with respect to "use values" for
the environmental assets that are affected.
In the 1980s public attention to air pollution from SO₂ and NOₓ emissions largely
centered on the problem of acidification ("acid rain"), with particular concern for its affect on
water and soil chemistry and ultimately ecological systems. It is surprising to many that
relatively low benefits are estimated by economists for effects on aquatics (in Burtraw et al.,
1997) or are expected to result from effects on forests and agriculture. One reason is that
willingness to pay for environmental improvement depends on the availability of substitute
assets. Economists would not expect changes in quality at one site to elicit large benefits if
there are many sites available for comparable recreational opportunities. In contrast,
individuals do not have the same kind of substitution possibilities with respect to health and
visibility, which may help explain the relatively larger benefit estimates for these endpoints.
Furthermore, one should note that the low values for aquatics stem from an assessment of
values, or
values in the case of agriculture. Environmental changes may also yield
values, and estimates for nonuse values are not available. Nonetheless, the evidence,
based on a small number of relatively narrow studies, suggests these values may be significant.
On the cost side, compliance has cost one-half or less what it was anticipated to cost in
1990. Trends in both directions, that is, increased appreciation of benefits and decreased
estimate of costs have qualified the program as a tremendous success from an economic
perspective.
There are huge uncertainties, especially on the benefits side of the ledger, especially in
valuation of mortality. Recent economic critiques have argued that the use of the value of a
statistical life as the basis for valuing health risks from air pollution, instead of a more
appropriate measure of quality adjusted life years lost, could grossly overestimate mortality
benefits. In addition, economists have questioned the appropriateness of using labor studies
of prime age men to value changes in life expectancy that occur among an older population.
On the other hand, we note that because environmental exposures are involuntary, compared
with studies of labor market behavior, the latter may underestimate willingness to pay to
avoid environmental exposures. Burtraw et al. (1997) used Monte Carlo analysis and a
parametric one-sided sensitivity analysis to investigate some of these sources of uncertainties.
Their analysis finds that there is no year in which health benefits alone at the 5 percent
confidence interval are less than the levelized expected costs. These results are illustrated in
14
Burtraw
RFF 98-28-REV
Figure 1, with millions of (1990) dollars on the vertical axis and years of the program on the
horizontal axis. As noted, significant benefits are also estimated for improvements in health
morbidity, recreational visibility and residential visibility, each of which measures
approximately equal to costs. Despite tremendous uncertainties about benefits and costs, the
main conclusion that benefits soundly outweigh costs appears to be robust.
45,000
40,000
35,000
30,000
25,000
Benefits
20,000
Cost
15,000
10,000
5,000
1995
2000
2005
2010
2015
2020
2025
2030
Source: Burtraw et al. (1997)
Although tremendous attention has been addressed to the innovative design of the SO₂
emission allowance trading program, an economic approach to policy analysis should perhaps
focus first on the comparison of benefits and costs of the program. Evidence to date suggests
that benefits are expected to greatly outweigh the costs of the program. Surprises on the
benefits side that contribute to this favorable assessment are in benefit categories of human
health and visibility that were not the primary focus of research on acid rain in the 1980s.
Favorable events on the cost side have to do with the expected successful
implementation of the allowance trading program, and with advantageous trends in markets
that supply the electric utility sector. Developments in these input markets, which include
scrubber manufacturing, coal mining and rail transport of coal, are at least partially related to
the SO₂ program. Due to advantageous trends in the industry leading to increased use of low
sulfur coal, the quantity of emissions that had to be reduced is less than anticipated. This led
to lower costs than many envisioned, and commensurately SO₂ trading could provide a
smaller measure of cost savings. However, the SO₂ program deserves considerable credit for
15
Burtraw
RFF 98-28-REV
providing firms with the flexibility to capitalize on these advantageous trends as they
strategize their compliance activities.
There is some reason for concern about the ability of the SO₂ market to function
efficiently and for firms to capture possible cost savings based on evidence for 1995, the first
year in which the program was binding. However, there are several reasons one can expect
the market to become more efficient over time and the long-run prospects for the program are
bright.
As scholars and policy analysts attempt to draw lessons from the SO₂ program, one
area that should receive significant attention is the manner in which emission allowances are
allocated to the industry. Evidence suggests that grandfathering of allowances can impose
significant efficiency costs. Furthermore, this approach represents a tremendous transfer of
wealth that raises equity issues as well. Rarely in economics do efficiency and equity issues
point in the same direction, but in this case they do. The recommendation that follows is that
emission allowances should be auctioned or allocated in some means that raises revenue for
government that can be used to reduce other distortionary taxes. If the allocation of
allowances is to serve as compensation for industry, this function should be weighed carefully
against the benefits of raising revenue. A hybrid program, in which some portion of
allowances are grandfathered and the rest auctioned by the government could offer a
compromise that would improve programs of this type in future applications.
16
Burtraw
RFF 98-28-REV
Ando, Amy, and Karen Palmer. 1998.
, Discussion Paper 98-19, Resources for the Future,
Washington, D.C., March.
Bohi, Douglas R., and Dallas Burtraw. 1997. "SO₂ Allowance Trading: How Do
Expectations and Experience Measure Up?,"
, vol. 10, no. 7,
pp. 67-77.
Burtraw, Dallas. 1996. "The SO₂ Emissions Trading Program: Cost Savings Without
Allowance Trades,"
, xiv (April), pp. 79-94.
Burtraw, Dallas, Alan J. Krupnick, Erin Mansur, David Austin, and Deirdre Farrell. 1997.
, Discussion Paper 97-31-REV, Resources
for the Future, Washington, D.C., September.
Carlson, Curtis, Dallas Burtraw, Maureen Cropper, and Karen Palmer. 1998.
, Discussion Paper 98-44,
Resources for the Future, Washington, D.C., July.
Ellerman, A. Denny, and Juan Pablo Montero. 1998. "Why Are Allowance Prices so Low?
An Analysis of SO₂ Emissions Trading Program,"
(forthcoming).
Ellerman, A. Denny, Richard Schmalensee, Paul L. Joskow, Juan Pablo Montero, and
Elizabeth M. Bailey. 1997.
(Cambridge, Mass.:
MIT Center for Energy and Environmental Policy Research).
Elman, Barry, Bruce Braine, and Richard Stuebi. 1990. "Acid Rain Emission Allowances
and Future Capacity Growth in the Electric Utility Industry,"
, vol. 40, no. 7, pp. 979-986.
Goulder, Lawrence H., Ian W.H. Parry, and Dallas Burtraw. 1997. "Revenue-Raising vs.
Other Approaches to Environmental Protection: The Critical Significance of Pre-Existing
Tax Distortions,"
, vol. 28, no. 4 (Winter), pp. 708-731.
ICF Resources Incorporated (ICF). 1990.
, prepared for
U.S. Environmental Protection Agency, Washington, D.C., July.
ICF. 1995.
,
prepared for the U.S. Environmental Protection Agency, September.
Parry, Ian W.H. 1995. "Pollution Taxes and Revenue Recycling,"
, vol. 29, no. 3 (supplement), pp. S-64-S-77.
Portney, Paul R. 1990. "Economics and the Clean Air Act,"
, vol. 4, no. 4, pp. 173-181.
17
Burtraw
RFF 98-28-REV
Temple, Barker, and Sloane, Inc. (TBS). 1983.
, prepared for the Edison Electric
Institute, September 20.
Temple, Barker, and Sloane, Inc. (TBS). 1986.
prepared for the Edison Electric Institute, April 14.
U.S. Energy Information Administration (EIA). 1996.
DOE/EIA-0383(97), Washington, D.C., December.
U.S. Government Accounting Office (GAO). 1994.
, GAO/RCED-95-30, Washington, D.C.
U.S. Office of Technology Assessment (OTA). 1983.
, Staff Memorandum (revised July 12).
Van Horn Consulting, Energy Ventures Analysis, Inc., and Keith D. White. 1993.
, prepared for the Electric
Power Research Institute, EPRI TR-102510 (August).
White, Keith. 1997.
prepared for the Electric Power Research Institute (EPRI), EPRI TR-107897 (April).
White, Keith, Energy Ventures Analysis, Inc., and Van Horn Consulting. 1995.
prepared for the Electric Power Research Institute (EPRI), TR-105490,
Palo Alto, Calif. (Final Report: September).
18
The Costs and Benefits of Reducing
Acid Rain
Dallas Burtraw, Alan Krupnick, Erin Mansur,
David Austin, and Deirdre Farrell
Discussion Paper 97-31-REV
Revised September 1997
Original paper issued July 1997
RESOURCES
FOR THE FUTURE
1616 P Street, NW
Washington, DC 20036
Telephone 202-328-5000
Fax 202-939-3460
© 1997 Resources for the Future. All rights reserved.
No portion of this paper may be reproduced without
permission of the authors.
Discussion papers are research materials circulated by their
authors for purposes of information and discussion. They
have not undergone formal peer review or the editorial
treatment accorded RFF books and other publications.
The Costs and Benefits of Reducing Acid Rain
Dallas Burtraw, Alan Krupnick, Erin Mansur,
David Austin, and Deirdre Farrell*
Abstract
Title IV of the 1990 Clean Air Act Amendments initiated a dramatic reduction in
emissions of sulfur dioxide and nitrogen oxides by electric power plants. This paper presents
the results of an integrated assessment of the benefits and costs of the program, using the
Tracking and Analysis Framework (TAF) developed for the National Acid Precipitation
Assessment Program (NAPAP). Although dramatic uncertainties characterize our estimates
especially with respect to the benefits of the program, many of which we have modeled
explicitly, we find that the benefits can be expected to substantially outweigh the costs of the
emission reductions. The lion's share of benefits result from reduced risk of premature
mortality, especially through reduced exposure to sulfates, and these expected benefits
measure several times the expected costs of the program. Significant benefits are also
estimated for improvements in health morbidity, recreational visibility and residential
visibility, each of which measures approximately equal to costs. In contrast, areas that were
the focus of attention in the 1980s including effects to soils, forests and aquatic systems still
have not been modeled comprehensively, but evidence suggests benefits in these areas to be
relatively small, at least with respect to "use values" for the environmental assets that are
affected.
Key Words: acid rain, sulfur dioxide, nitrogen oxides, cost-benefit analysis, Clean Air Act,
Title IV
JEL Classification Nos.: H43, Q2, Q4
*
Resources for the Future, 1616 P Street, Washington DC, 20036; [email protected]. The authors acknowledge
the contribution of over 30 researchers at nearly a dozen research institutions around the country who helped
develop the Tracking and Analysis Framework, and especially the intellectual contribution of Cary Bloyd, Max
Henrion, John Molburg, Jack Shannon and Rich Sonnenblick, Mitch Small, Tim Sullivan and many others, and
the members of the model peer review panel organized by Oak Ridge National Laboratory. We also
acknowledge the financial and intellectual contribution of NAPAP and its member agencies, especially the
Department of Energy, the Environmental Protection Agency, and the National Oceanic and Atmospheric
Administration. We appreciate comments from Jane Hall on a previous version of this paper.
ii
Table of Contents
I.
Introduction
1
II.
Description of TAF
2
The Benefits Valuation Module
4
Health Effects
4
Visibility
6
Recreational Lake Fishing
7
Costs and Emissions
8
Other Effects Not Modeled
8
III. Baselines and Scenarios
9
The Hagler Bailly Study of Health Benefits from Sulfate Reductions
12
The EPA's Regulatory Impact Assessment for Particulates
12
Alternative Cost and Emission Estimates
12
IV. Results
13
Comparison with HB Study
19
Comparison with the RIA
22
Cost Comparisons
22
Unmodeled Pathways and Research Priorities
24
V.
Conclusions
26
References
30
List of Tables and Figures
Table 1.
Options for Assessing Mortality Effects
6
Table 2.
Per Capita Benefits in 2010 for Affected Population
13
Table 3.
Expected Total Health Benefits for 2010 and Percent of National SO2 Emission
Reductions by State
19
Table 4.
Comparison of HB and TAF Mortality Sulfate Benefits for Eastern U.S. with
Percent Changes over Previous Scenario, Year 2010
20
Table 5.
Long-run (Phase II, year 2010) Cost Estimates for SO2 Reduction
23
Table 6.
Long-run (Phase II, year 2010) Cost Estimates for NOx Reduction
24
Table 7.
Qualitative Evaluation of Expected Benefits and Value of Additional Information for
Modeled and Nonmodeled Pathways
25
Table 8.
Major Uncertainties and Omissions and Direction of Bias in TAF
28
Figure 1.
Costs and Benefits for Modeled Pathways for Affected Populations
14
Figure 2.
Benefit-cost Ratio for Health Benefits under Alternative Assumptions about
Electricity Industry
16
Figure 3.
Annual Mean Total Health Benefits with 90% Confidence Intervals Compared
with Expected Annualized Costs
17
Figure 4.
Annual Mean Total Health Benefits and Levelized Costs by Scenario
18
iii
The Costs and Benefits of Reducing Acid Rain
Dallas Burtraw, Alan Krupnick, Erin Mansur,
David Austin, and Deirdre Farrell*
I. INTRODUCTION
This paper presents the first contemporary analysis of the prospective benefits and the
costs of Title IV's Allowance Trading System for reducing sulfur dioxide (SO₂) emissions
and Title IV's mandated reductions in emissions of nitrogen oxides (NOx). 1 This benefit-cost
assessment is conducted using the Tracking Analysis Framework (TAF) that was developed
to support the activities of the National Acid Precipitation Assessment Program (NAPAP).
Control of SO₂ emissions under the 1990 Clean Air Act Amendments instituted two
important innovations in U.S. environmental policy. The more widely acknowledged of these
is the SO₂ emissions trading program. Firms are allowed to transfer allowances among
facilities, or to bank them for use in future years. Less widely acknowledged is the average
annual cap on aggregate emissions by electric utilities, set at about one-half of the amount
emitted in 1980. The emissions cap represents a guarantee that emissions will not increase
with economic growth. Title IV also used a more traditional approach in setting NOx
emission rate limitations for coal-fired electric utility units, although this approach has been
modified to allow emission rate averaging among commonly owned and operated facilities.
Hence, there is no cap on NOx emissions, but Title IV is expected to result in a 27 percent
reduction from their 1990 emissions.
Below, we describe TAF and its components, and then turn to the development and
description of baseline assumptions, and default and sensitivity case scenarios. Next we report
the results for our default scenario. Then, three sets of sensitivity analyses are reported. One
set uses assumptions other than our default assumptions. We explore the sensitivity of results
to changes in baselines and compare levelized costs with expected health mortality benefits
only. Confidence intervals are constructed out of the statistical uncertainties associated with
the health effects and monetary values. Subsequently we compare the TAF mortality benefits
with estimates developed by Hagler Bailly (HB, 1995) for EPA's Acid Rain Division, and the
*
Resources for the Future, 1616 P Street, Washington DC, 20036; [email protected]. The authors acknowledge
the contribution of over 30 researchers at nearly a dozen research institutions around the country who helped
develop the Tracking and Analysis Framework, and especially the intellectual contribution of Cary Bloyd, Max
Henrion, John Molburg, Jack Shannon and Rich Sonnenblick, and many others, and the members of the model
peer review panel organized by Oak Ridge National Laboratory. We also acknowledge the financial and
intellectual contribution of NAPAP and its member agencies, especially the Department of Energy, the
Environmental Protection Agency, and the National Oceanic and Atmospheric Administration. We appreciate
comments from Jane Hall on a previous version of this paper.
1 There exist analyses of benefits and analyses of the costs, some of which we describe below. This is the first
analysis to compare benefits and costs under uniform assumptions.
1
Burtraw, Krupnick, Mansur, Austin, and Farrell
RFF 97-31-REV
EPA's Regulatory Impact Analysis (RIA) for the proposed new particulate standard (USEPA,
1996). Finally we compare cost estimates in TAF with other recent studies.
We find that expected health mortality benefits alone far exceed expected costs in all
but one of the variations in assumptions we tried, and that even 5th percentile estimates of
benefits do not dip below costs for any of these scenarios (but one) in any years after 2010.
Our mortality benefits estimates are substantially lower than HB's, though we predict larger
changes in sulfate concentrations for a given change in emissions. Our lower mortality benefit
estimates can be attributed primarily to our estimates of smaller emission reductions (lower
emissions in the baseline against which we compare the policy), and smaller reductions in
mortality risks for a given change in sulfates and a smaller value of statistical life.
In addition, we find that mean values for three other modeled pathways--health
morbidity, recreational visibility, and residential visibility--each approximately equal mean
levelized costs of the program. Recreational lake fishing benefits appear to be of much lower
magnitude. We compare these estimates in a qualitative and relative ranking with our
informed conjecture about the likely magnitude and uncertainty of several other benefit
categories that are not modeled quantitatively.
We compare the TAF default cost estimate with other scenarios and other recent
estimates within TAF. The TAF default estimate is on the low end of other estimates with
respect to SO₂. In part, this reflects a downward trend in the estimates and secular trends in
the industries that affect compliance. The TAF estimate as well as these others assumes that a
well-functioning SO₂ allowance market will allow the industry to achieve emission reductions
at minimum feasible cost. This is not strictly evident in the first two years of compliance with
the program, and so the short-run cost estimates may be low. However, we expect least cost
compliance to be a reasonable characterization of the future, as the electricity industry
becomes increasingly competitive. The estimates of NOₓ control costs are proximate to those
of other recent estimates; however, the estimates do not reflect the opportunity for emission
rate averaging which are expected to lower costs. At the same time, the TAF default estimate
and all other estimates are low because they fail to account for the costs of the regulation
within a general equilibrium framework with pre-existing taxes and distortions away from
efficiency. Nonetheless, with all the omissions, caveats and uncertainties taken into account,
we find the benefits of Title IV exceed the costs by a significant margin.
II. DESCRIPTION OF TAF
The Tracking and Analysis Framework (TAF) is an integrated assessment model of
acid precipitation damages and the effects of Title IV of the 1990 Clean Air Act
Amendments. 2 TAF integrates models of electric utility emissions and costs, pollutant
transport and deposition (including formation of secondary particulates but excluding ozone),
visibility effects, effects on recreational lake fishing through changes in soil and aquatic
2 TAF is documented in Bloyd et al. 1996.
2
Burtraw, Krupnick, Mansur, Austin, and Farrell
RFF 97-31-REV
chemistry, human health effects, and valuation of benefits. The model also can be readily
extended to include other benefit pathways as modeling capability is developed. To ensure
that each component represented the state of the science in its respective modeling domain,
each module was constructed and refined by a group of experts in that field, and draws
primarily on peer reviewed literature to construct the integrated model. Thus, TAF is the
work of a team of over 30 modelers and scientists from institutions all over the country. As
the framework integrating these literatures, TAF itself was subject to an extensive peer review
in December 1995, which concluded that "TAF represent(s) a major advancement in our
ability to perform integrated assessments" and that the model was ready for use by NAPAP.³
Considerable uncertainty in parameter and model form exists in each of our modeled
domains and in the underlying scientific and economic literature. We selected Analytica™ as
the modeling platform for TAF in part because of its capability to propagate model
uncertainties, and we adopted a process designed to identify and characterize those
uncertainties. We chose an integrated assessment framework, as opposed to a suite of related
but unlinked models, because it met the following needs of the TAF project:
To provide comparable results across a variety of effects (visibility, recreational lake
fishing, human health), for a common region (continental US), and over a single time
horizon (1995-2030);
To provide an integrated analysis of costs and benefits based on common assumptions, and
to provide insight about model assumptions and components which contribute significantly
to overall results;
To suggest productive areas for future research and additional modeling based on an
assessment of the current model's critical uncertainties and omissions.
TAF characterizes emissions, emission transport, atmospheric concentrations of
pollutants and health effects at the state level. This level of aggregation introduces some
uncertainty into the analysis, but it is not evident that a bias is introduced. The estimation of
effects also is amenable to modeling at a less centralized level, and we use probabilistic
methods to represent variations in sources of emissions, geography and population density
within states. TAF omits benefits that occur in Canada and Mexico. Recreational lake effects
are characterized for a distribution of lakes in the Adirondacks. Recreational visibility effects
are characterized at two parks and valued nationally, and residential visibility effects are
characterized and valued for five metropolitan areas. These results are most usefully
considered on a per capita basis. In this paper we do not try to assess regional issues in a
thorough way, but we do display the regional pattern of health benefits.
3 ORNL, 1995. TAF is being used to provide supplementary analysis to NAPAP in drafting their 1996
Integrated Assessment, but it is not a centerpiece.
3
Burtraw, Krupnick, Mansur, Austin, and Farrell
RFF 97-31-REV
The Benefits Valuation Module
Benefit valuation is essential for comparison of various physical effects with each
other and with costs. From an economic perspective, values are measured by how much of
one asset or service individuals in society are willing to sacrifice in order to obtain or preserve
another. Economics refers to this as an "opportunity cost approach" to valuation. Values are
expressed in monetary terms, although, in principle, they can be expressed in other metrics.
The value or opportunity cost of goods and services that are readily traded in markets is
reflected in their prices. For goods that are not traded in markets, the economics literature on
monetizing benefits and costs is more developed in certain areas than in others, which is
reflected in the characterization of uncertainty in the benefit models.
The Benefits Valuation Module provides an accounting of pathways and benefit
endpoints considered in TAF. The module values effects on visibility (recreational and
residential), Adirondack lake sport fish populations, and human health. These effects are
valued only where physical effects have been modeled in TAF, so comprehensive geographic
coverage is not provided. Other kinds of effects, such as forest, stream, and material
damages, are not valued at this time, but they are represented in TAF in a qualitative manner.
Health Effects
The Health Effects Module is designed to estimate the health impacts of changes in air
pollution concentrations. Impacts are expressed in terms of the number of days of acute
morbidity effects of various types, the number of chronic disease cases, and the number of
statistical lives lost to premature death. The change in the annual number of impacts of each
health endpoint is the output of this module. Inputs consist of changes in ambient
concentrations of SO₂ and NOₓ, demographic information on the population of interest, and
miscellaneous additional information such as background PM₁₀ levels for analysis of thresholds.
The module is based on concentration-response (C-R) functions found in the peer-
reviewed literature. The C-R functions are taken, for the most part, from articles reviewed in
the U.S. Environmental Protection Agency (EPA) Criteria Documents (see, for example,
USEPA 1995). These documents are outcomes of a recurring comprehensive process initiated
by the Clean Air Act and its Amendments for reviewing what is known about the health
effects of the so-called "criteria" air pollutants.4 Such information, and judgments about its
quality, eventually help the Administrator of the EPA make decisions about National Ambient
Air Quality Standards (NAAQS) that would "protect the public against adverse health effects
with a margin of safety." These Criteria Documents contain thousands of pages evaluating
toxicological, clinical, and epidemiological studies that relate particular criteria pollutants to a
variety of health endpoints, including primarily acute cardiopulmonary and respiratory
effects, chronic effects and prevalence of chronic illness, and premature mortality. The TAF
4 The Criteria Pollutants include ozone [O₃], nitrogen dioxide [NO₂], sulfur dioxide [SO2], particulate matter
less than 10 microns in diameter [PM₁₀], lead [Pb], and carbon monoxide [CO].
4
Burtraw, Krupnick, Mansur, Austin, and Farrell
RFF 97-31-REV
Health Effects Module contains C-R functions for PM₁₀, total suspended particulates (TSP),
SO₂, sulfates (SO₄), NO₂, and nitrates (NO3). 5
The Health Effects Module calculates morbidity impacts resulting from sulfates and
nitrates, which are particulates created from emissions of SO₂ and NOx, respectively, and
SO₂ and NOx as gases. Mortality impacts are only represented as resulting from the
particulates. The C-R functions found in the literature for these endpoints are documented
within the software model.
The top level of the Health Effects Module is structured according to an influence
diagram that visually depicts the fact that, in a C-R function, concentration changes and
demographic data determine the number of morbidity and mortality impacts experienced in a
population. Within the morbidity and mortality submodules there is great flexibility to
structure the model so as to test a range of assumptions about the relationship between
pollutant concentrations and health effects.
For both the morbidity and mortality endpoints, the Health Effects Module contains a
comprehensive library of C-R functions found in the peer reviewed literature, in total
consisting of more than fifty studies linking air pollution to premature death, chronic disease,
hospitalizations and other symptoms. The user may select from among any of the studies in
the library available for a given health endpoint, or may decide to weight coefficients from a
number of studies.
For the mortality endpoint, in addition to the choice of a C-R function, the user may
decide to treat the various components of particulate matter separately. For example, some
evidence suggests that the fine fraction of the mass may have more of an effect than the
coarser components. Four plausible interpretations of the evidence on this subject are offered
to the user as options (Table 1). Within each of these options, the user may choose from
among the available studies in the library for each pollutant and endpoint, or use a
combination of other C-R functions weighted to reflect the user's judgment. Options 1 and 2
assume that sulfates and nitrates have the equivalent potency in causing health effects as any
other particle 10 microns or less in diameter (PM₁₀), but option 2 allows the user to look at
the age-disaggregated effects of air pollution on mortality. These reflect the fact that the over
65 population is more likely to die as a result of high particulate levels than is the under 65
population. Option 3 treats sulfates as distinct and associates them with relatively greater
potency than other constituents of PM10. Option 4 treats both sulfates and nitrates as
relatively more potent than other components of PM₁₀. We focus on the third option as most
plausibly representing the evidence at the time the work was completed.
The morbidity submodule allows the user a choice of either aggregating SO₂, PM₁₀
and sulfate effects according to a scheme designed to avoid double-counting, such as
symptom days and restricted activity days, or of using SO₄ effects as a proxy for particulate
and SO₂ effects. NOx is included for eye irritation and phlegm days. As with the mortality
5 Since nitrates are particulates, and no independent effect of nitrates on health has been established, they are
treated as a component of PM₁₀.
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submodule, default studies have been identified for each endpoint, but where other studies
exist in the literature they may be substituted for the defaults.
Table 1. Options for Assessing Mortality Effects
Option 1
Sulfates and nitrates treated as PM10
Option 2
Sulfates and nitrates treated as PM10, disaggregated by age
Option 3 (default)
Nitrates treated as PM10, sulfates distinct and more potent
Option 4
Sulfates and nitrates treated as sulfates
The Health Valuation Submodule of the Benefits Valuation Module assigns monetary
values taken from the environmental economics literature (e.g., Lee et al., 1994) to the health
effects estimates produced by the Health Effects Module. The benefits are totaled to obtain
annual health benefits for each year modeled. The Health Valuation Submodule also contains
a comprehensive library, based on the environmental economics literature, of values
associated with morbidity and mortality endpoints. As with the Morbidity and Mortality
Submodules, defaults have been selected, but the user may test the effects of assigning
alternative values to the various health endpoints, consistent with the valuation literature.
Visibility
The Visibility Effects module calculates changes in visual range for five cities
(Albany, NY; Atlantic City, NJ; Charlottesville, VA; Knoxville, TN; and Washington, DC),
and two national parks (the Grand Canyon, and Shenandoah). Seasonal distributions of mid-
day visual range are based on estimated atmospheric sulfate and nitrate concentrations from
the Atmospheric Pathways module a reduced-form model of the Advanced Statistical
Trajectory Regional Air Pollution (ASTRAP) model. Calculation of change in visual range is
based on the Visibility Assessment Scoping Model (VASM), which uses Monte Carlo
techniques to produce short-term variations of visual impairment based on seasonal lognormal
distribution parameters of the six important particulate species (sulfate, nitrate, elemental
carbon, organic carbon, fine-particle dust, and coarse-particle dust), relative humidity
distribution statistics from climatology, and modeled changes in the seasonal means of the
sulfate and nitrate concentrations.
The Visibility Valuation submodules examine both recreational and residential benefits.
Chestnut and Rowe (1990) proposed a functional form to value both recreational and
residential visibility that takes into account the nonlinearity of willingness to pay (WTP) for a
given change in visual range (i.e., the diminishing marginal utility for visibility enhancement).
WTP for improvements in recreational visibility were drawn from contingent valuation (CV)
studies and involve both use and nonuse values for residents living in either park's state or
another state ("out-of-state" residents). To value residential visibility improvements we
employ a range of WTP coefficients from the Brookshire et al. (1979) Los Angeles study, and
the McClelland et al. (1991) study of Atlanta and Chicago. We assume residential WTP is
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positive only for local residents (e.g. only use values matter), so we adjust values for "in-state"
recreational visibility to avoid double counting with improvements in residential visibility.
Recreational Lake Fishing
The Recreational Lake Fishing module predicts changes in lake chemistry and soil
chemistry caused by acid deposition. Using a set of "acid stress indexes" (ASIs) that describe
the responses of specific species of fish to varying levels of acidity (pH) in the water, the
module estimates economic benefits resulting from improvements in recreational fishing due to
decreased acidification. Future surface-water and soil chemistry conditions in the watersheds
are projected by reduced-form models based on the Model of Acidification of Groundwater in
Catchments (MAGIC). MAGIC is a lumped-parameter model that uses chemical equilibrium
and mass balance equations to predict changes in lake and soil chemistry. The reduced-form
models have been applied to lakes in New York's Adirondack region, using a set of 33 lakes
chosen to be representative of the target population of lakes in the region.
The Recreational Lake Fishing Benefits module allows the user to specify whether
benefits are to be estimated on the basis of benefits to recreational anglers, or alternatively as
avoided lake liming costs. The Recreational Lake Fishing submodule estimates changes in
the catch rates (catch per unit effort, or CPUE) of anglers fishing for three species of fish in
Adirondack Park. Values are assigned to these changes through the use of a "random utility"
travel cost model. Benefits are calculated for the change in value of a single-day fishing trip
(as opposed to an overnight or multi-day outing) as a result of changes in CPUE. The
submodule also estimates the change in the annual number of single-day fishing trips the
average Adirondack Park angler will take in the park, as a function of changes in CPUEs and
other factors. 6
The submodule does not attempt to account for benefits enjoyed by new anglers
attracted by improved conditions, or for angler benefits other than improvements in catch
rates.⁷ There are two reasons for this simplification. First, no more than 10 percent of the
population fishes for recreation, and the use benefits enjoyed by non-anglers are probably of
second order to the anglers' values for improved catch rates. Second, there are no reliable
estimates on which to base valuations of non-fishing uses--in part because relative aesthetic
effects are much smaller than the effects on fish populations. TAF does not include estimates
of the nonuse or existence benefits that may be enjoyed by persons not visiting the affected
lakes. Other parts of the country are not modeled currently. However, we use the effects in
6 The aquatics valuation literature focuses on single-day trips because it is thought that valuations for multi-day
trips, of which there are far fewer, are intrinsically different. For instance, it would be necessary to better control
for lake amenities such as lodging and camping facilities, which would presumably be important determinants of
lake choice. These "use values", for multi-day trips, are not represented in the TAF analysis.
7 Changes in fish populations could be correlated with changes in lake amenities such as the health of the
lakeside flora and fauna.
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the Adirondack region to illustrate the potential magnitude of benefits on a broader scale by
presenting benefits in per capita terms for the affected population.
Costs and Emissions
Embedded in TAF are estimates of costs and an algorithm for determining compliance
activities at different facilities, developed by Argonne National Laboratory, and based on their
unit inventory called GECOT. Compliance options for SO₂ reductions include scrubbing,
fuel switching (including plant modifications), retirement and replacement of plants.
Decisions by utilities to install retrofit desulfurization equipment (scrubbers) at 21 units for
compliance in Phase I of the SO₂ trading program are taken as given. The module ranks
further compliance options on a unit cost ($/ton reduction) basis, with the most-cost-effective
units being implemented first, until the emission reduction requirements are satisfied.
Many units are found to achieve cost savings through fuel switching and/or blending,
consistent with other studies (Burtraw, 1996; Ellerman and Montero, 1996). In these cases
the emission reductions are not included in the analysis of benefits because we assume the
baseline (without Title IV) scenario also should reflect these emission reductions. However,
we observe that the flexibility of the emission allowance trading program has allowed firms to
take advantage of advantageous trends in fuel markets and to realize cost savings, while
conventional regulatory approaches such as technology standards may have prohibited firms
from doing so. Emission allowance trading is modeled implicitly by allocating compliance in
a cost-effective way. NOx compliance is modeled to achieve emission rate reductions
sufficient to meet the emission reduction goals of the program. Emission rates and costs are
equivalent to low NOₓ burners absent further flexibility for compliance that characterizes the
SO₂ program. This description differs somewhat from actual implementation which has
allowed firms to average emission rates among commonly owned and operated facilities, and
hence our estimate of costs can be viewed as conservative (high). The total cost of
compliance is calculated as the present value of revenue requirements to cover compliance
costs summed over all units, and this quantity is levelized (equal annual costs spread over the
lesser of 35 years or the remaining life of the facility) for comparison with benefits.
For SO₂ reductions, the module predicts the industry will rely on fuel switching and
blending as the primary means of compliance, and that much of this switching will be
implemented at low cost or cost savings to the affected firms. Scrubbing is also implemented,
to a limited degree. This scenario appears robust to recent developments in the coal industry,
and hence we use these estimates as a benchmark for compliance costs over the long-run. We
explore the robustness of the module through scenario analysis about plant lifetimes and
future electricity demand, and through comparison with other recent studies.
Other Effects Not Modeled
There are numerous other effects of Title IV that TAF does not model quantitatively
because of a lack of proper scientific and/or economic data and models. These include effects
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to material and cultural resources, nonuse of ecosystem health, recreational forests, agriculture
and commercial forestry, and radiative forcing. Material and cultural resource valuation lacks a
complete inventory of affected assets, data about the economic lives of affected assets, and
information on behavioral responses. While nonuse values of ecosystem health are expected to
be large, there is no characterization of ecosystem changes associated with Title IV or of a
valuation framework for assessing benefits from improvements in ecological indicators,
especially given the temporal aspects of ecological dynamics. Similarly, the link between
primary pollutants and forest recreation effects that people care most about is not established.
Exposure to ambient ozone is likely to be the most significant air pollutant causing significant
effects on crops, but the studies examining these effects fail to account for behavioral responses
in an adequate way, and the data on changes in ozone as a result of Title IV are not currently
available. Lastly, atmospheric models predict changes in particulates and their effect on
radiative forcing, but the economic methods for modeling damages of climate change are very
uncertain, and data for valuation of local effects are not available.
III. BASELINES AND SCENARIOS
The analysis requires an estimate of the time path of emissions of SO₂ and NOx (plus
associated abatement costs) from 1995 to 2030 in the absence of Title IV--termed the
baseline--and estimates of the emissions (and costs) associated with Title IV. Subtracting the
emissions for the scenario from the baseline emissions provides emissions changes (which are
fed into the atmospheric transport module) to estimate benefits of Title IV. These benefit
estimates are compared with costs under a consistent set of assumptions, as well as "off-line"
comparisons with alternative cost estimates.
We developed three baselines and picked one as the default. The baselines differ
according to an estimate of plant lifetimes (60 versus 70 years) and the growth in electricity
demand over the period (3 percent, termed "high growth", and 1 percent, termed "low
growth"). Growth rates in electricity demand are weighted by state population growth. We
think that the 70 year-low growth baseline is the most likely, but also examine the effects of a
60 year-low growth and 70 year-high growth baseline.
The scenarios all involve Title IV with SO₂ trading and NOₓ reductions mandates.
Specifically, the first phase of SO₂ reductions implemented in 1995 require average emission
rates to be about 2.5 lb. sulfur per million Btu heat input. This rate applies to 431 units,
including nearly 200 so-called "substitution and compensation" units that were voluntarily
brought into Phase I to ease the cost of compliance on average. The second phase, taking
effect in 2000, will lower the average emission rates to about 1.2, and will affect over 2,000
units. The first phase of NOx controls took effect in 1996 and reduced emission rates to .45
or .50 lb. per million Btu, affecting 239 units, all but 16 of which were also affected by Phase
I SO₂ rules. The second phase of NOx controls expand the set of affected facilities and go
into effect in 2000 and are not yet final, but are expected to take effect in 2000.
Since health benefits emerge as by far the most important of the benefits we quantify,
we focus several analyses toward an exploration of the sensitivity of those benefits to various
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sets of assumptions. First we test the sensitivity of health benefits to two alternative baseline
scenarios involving different life expectancies for power plants and different projections for
growth in electricity demand.
Next, under our default baseline for power plant life expectancy and growth in
electricity demand, we explore four scenarios involving different assumptions involved in
estimating health benefits, which we compare with our default assumptions for the health
benefits case.
The default case health benefits estimates resulted from our best judgment about the
epidemiological and valuation literature at the time the work was completed. Our most
important choice concerns the C-R functions for the mortality effects of reductions in sulfates
and nitrates. For sulfates we use a weighted mean of the coefficient estimate of two benefit
studies, giving both studies equal weight. This coefficient predicts the change in the number
of incidents of mortality annually resulting from changes in total PM₁₀ (sulfate and nitrate)
concentrations. The low estimate (0.1 percent), based on Plagiannakos and Parker (1988),
assumes that sulfates are equally as potent as any PM₁₀ particle class, and estimates only daily
mortality. The high estimate (0.7 percent), based on Pope et al. (1995), addresses the effects
of cumulative exposure to fine particles, and probably captures much of the daily mortality
risk. The high estimate implies that sulfates, which fall into the fine fraction of the particulate
mass, are a relatively potent constituent of PM₁₀.
We depart from some of the benefit literature (Hagler Bailly, 1995) by ignoring the
higher estimates of the particulate mortality coefficient (1.4 percent) found in the Dockery
et al. (1993) study because it only examines mortality effects in 6 cities and a sample of 8,111
people versus the 151 cities and 552,000 people covered by the Pope et al. (1995) study.⁸
For nitrates, we assume that they are no different in potency from any constituent of
PM₁₀ based on Schwartz and Dockery (1992). Taken together, these choices imply that
nitrates are, overall, less potent than sulfates, an assumption that reasonably reflects the state
of the literature. For both functions we assume that there are no thresholds, meaning health
benefits from emissions reductions can be expected to occur irrespective of the baseline
concentration of particulates.
The other key choice is the estimate of WTP for mortality risk reductions. In the base
case, we use a lognormal distribution with mean of $3.1 million per statistical life (in $1990),
and a 90 percent confidence interval of $1.6 and $6 million. This distribution generally
accords with the valuation literature, but is somewhat on the low side because we give less
weight to the labor market studies relative to the contingent valuation studies, the latter being
marginally more appropriate for valuing mortality risks in the environmental health context
and also capture age effects, based on Jones-Lee et al. (1985). The Jones-Lee study finds that
8 A fourth study, Evans et al. (1984), with a mid-range particulate mortality coefficient (0.3 percent) was also
considered by Hagler Bailly (1995). We implicitly endorse use of this study as it falls within the range of low
and high estimates we use in the TAF default case.
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the value of a statistical life for the 65 years and older group is about 75 percent of that of the
average (40 year old) participant in their study.
As seen below, for the default case, benefits of reduced risk of health mortality alone far
exceed the costs of emission reductions. For this reason, we only explore downside sensitivities
of the health benefits estimates which are designed to test whether there are plausible
assumptions under which benefits no longer exceed costs. We explore three options and
compare them each individually to the default assumptions. Then we explore a combined case.
Impose threshold for PM₁₀. In this case we assume that there is a threshold in effects at a
24-hour average concentration of 30 µg/m³ PM₁₀ (Lee, et al., 1995). Days in which the
baseline concentration of PM₁₀ in a county is below this amount will not register benefits
of sulfate or nitrate reductions.
Treat sulfates as PM₁₀. In this case we assume that nitrates have no effect on mortality
rates, in line with the lack of any direct epidemiological evidence linking nitrates with such
effects. We assume that sulfates are no more potent than any other PM₁₀ constituent and
use the daily mortality studies only (equivalent to applying the base case mortality
assumptions for nitrates to sulfates).
Mortality Risk Valuation. Even using the Jones-Lee et al. study to adjust the value of a
statistical life (VSL) estimates for age probably overestimates benefits of mortality risk
reductions from PM₁₀ because this study (and the rest of the VSL literature) provides
estimates for reducing risks of accidental and immediate death, such as in a car accident.
Particulate matter exposure, on the other hand, may lead to higher probabilities of death for
individuals only when they are already quite old. For most of the population, then, the
mortality benefits of today's PM₁₀ reduction may be zero or very small. It may contribute
to a higher probability of developing chronic respiratory disease which, in turn, may reduce
life expectancy. Said another way, the WTP for a risk reduction realized in the future is
likely to be much lower if one has to pay today versus in the future. Unfortunately, we
cannot take this effect into account directly in the sensitivity analysis. Instead we use an
approach to adjust the VSL downwards, based on life-years remaining, that probably
provides a lower bound to the VSL. 9-10
9 This age disaggregated estimate, which is based on a procedure that assumes each year of life is worth the default
VSL divided by the life expectancy of a 40 year old, and that those over 65 are willing only to pay by the year for
the number of years they can be expected to live, results in the assignment of a VSL to the over 65 population of
$0.9 million, about 1/3 that of the under 65 population, for which the VSL is assumed to be the default.
10 It is worth noting that there are additional reasons why WTP estimates in the "auto-death"-type context may
over or underestimate risks in the PM-mortality context. The former may overestimate the latter if the older
people at risk from PM have compromised health. The former may underestimate the latter if air pollution is
thought to be an involuntary risk and auto-death risk is thought to be voluntary.
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Combined Case. In this case we assume that there is a 30 µg/m³ PM₁₀ threshold and that
sulfates only have the potency of the average PM₁₀ particle.
The Hagler Bailly Study of Health Benefits from Sulfate Reductions
EPA commissioned a study by Hagler Bailly (HB, 1995) of the health benefits of
reductions in emissions associated with Title IV reductions in SO₂ emissions. This study
began with estimates of emissions changes made by ICF Resources using their Coal and
Electric Utilities Model (CEUM) on behalf of the EPA's Acid Rain Division. The EPA tied
those changes in emissions to their Regional Acid Deposition Model (RADM) to obtain
changes in sulfate (fine particle) concentrations in the Eastern U.S., and used a particular set
of health concentration-response and valuation functions to estimate the monetized health
benefits of the emissions changes. The HB study places an expected value of a statistical life
at $3.2 million (1990$) compared to an expected value of $3.1 in TAF. Expected benefits are
higher from the HB study than under our default health benefit estimates.
To reconcile the differences between these results, we incorporated the HB study into
TAF to compare results for 2010. Since EPA population estimates could not be easily obtained,
TAF population projections were used in all scenarios. 11 We calculated mortality benefits per
ton for SO₂ emission reduction. We did not have access to RADM for direct comparison with
ASTRAP in TAF. However, by explicitly comparing the state-aggregated emission reductions
forecast by TAF and HB, and the predicted health effects and valuation functions, we were
able to impute the influence that the different atmospheric models had on benefit estimates.
The EPA's Regulatory Impact Assessment for Particulates
As part of the Regulatory Impact Assessment (RIA) for the new proposed standards
for particulates, the EPA has developed new health effect and valuation functions. The RIA
examines mortality effects from PM₂.5 (which includes both sulfates and nitrates), using a
value of a statistical life of $4.8 million. We incorporate, these new functions as an option in
TAF and compare them with our default assumptions.
Alternative Cost and Emission Estimates
To examine the sensitivity of our findings to changes in costs, we compare our default
cost estimates for SO₂ reductions with several others from the literature including White et al.
(1995), compiled for the Electric Power Research Institute, ICF (1995), compiled for the
EPA, and GAO (1994). Burtraw et al. (1997) provides econometric estimates of short-run
11 HB used different population estimates than are modeled in TAF. The estimates for 2010 differ from TAF both
by state and nationally, with average difference leaving HB estimate about 3.6 percent above that of TAF, though
most of the difference is in areas without a large change in SO4 in the benefits module. Hence, their benefits
estimate increase only 1.5 percent as a result of population differences. We adjust HB's population estimates to fit
ours; i.e., all results presented in this paper for HB reflect a small downward population adjustment.
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and long-run costs. We compare TAF default estimates of the cost of NOx control with an
ICF (1996) and E.H. Pechan (1996).
With respect to emissions, our default estimates lead to emission estimates that are
proximate to empirical measures based on the first two years of the program. In reporting our
results, we focus primarily on long-term estimates for the year 2010 and beyond, when the
program will be in full swing. To consider an alternative emission scenario and its effects on
benefits, we compare the Argonne model with emissions and forecast by HB.
IV. RESULTS
Figure 1 and Table 2 summarize the mean expected costs and benefits in per capita
terms for the included benefit pathways, for our main run of 50 realizations of the Monte
Carlo simulation model. We emphasize that the exact same results will not obtain in running
the model two different times because of random aspects of the sampling procedure, and
because we may vary the choice of sampling procedure. The virtue of this approach is that it
avoids a false sense of precision in the estimates, and allows us to focus on the likely
distribution of outcomes and identify qualitative results.
Table 2: Per Capita Benefits in 2010 for Affected Population.
Effect
Benefits per Capita (1990$)
Morbidity
3.50
Mortality
59.29
Aquatic
0.62
Rec. Visibility
3.34
Resid. Visibility
5.81
Costs
5.30
Estimates in Table 2 are projected for the year 2010, when the second phase of the
SO₂ program and the NOx programs are expected to be in full effect. (Note the vertical axis
in Figure 1 is a log scale.) The dominant source of benefits is reduced human mortality risk,
and taken singularly it results in a mean benefit estimate in 2010 that is nearly an order of
magnitude greater than costs. Expected benefits from human morbidity, recreational visibility
and residential visibility each individually are approximately equal to the annualized expected
cost per capita in 2010.
Health and recreational visibility benefits are presented as the average per capita benefits
for all U.S. residents. Recreational visibility represents an estimate of average willingness-to-
pay for modeled visibility improvements at just two parks--Grand Canyon and Shenandoah.
Although there would be improvements at other park locations, problems of embedding benefit
endpoints in the application of contingent valuation techniques to estimation of nonuse benefits
suggest that measures of WTP at other locations would not be additive to these, and indeed we
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may capture most of the WTP for improvements across the entire nation with these locations
(Chestnut and Rowe, 1990).
Costs and Benefits per Capita
$100.00
$10.00
Mortality
Resid. Visibility
Costs
Rec. Visibility
Morbidity
$1.00
Rec. Lake Fishing
$0.10
1995
2000
2005
2010
2015
2020
2025
2030
Year
Figure 1: Costs and Benefits for Modeled Pathways for Affected Populations (Log-scale)
A virtue of a per capita comparison is that we can include benefit pathways that are
not modeled for the entire U.S. The residential visibility benefits are those benefits that
obtain for all residents in the five modeled cities of Washington, Atlantic City, Knoxville,
Charlottesville, and Albany. The aquatic benefits are those that obtain for the portion of the
population that is engaged in recreational fishing in Adirondack lakes. We express these
benefits in per capita terms for each affected population in order to obtain a measure of the
potential magnitude of such benefits at a national level. In the case of residential visibility, an
extrapolation to the national level would likely overstate benefits because changes in sulfate
and nitrate concentrations would be less in other parts of the country. In the case of aquatic
effects, an extrapolation to the national level also would likely overstate benefits because a
large portion of the population does not pursue recreational fishing, and again because the
changes in lake chemistry would be less in most, if not all other parts of the country.
A potential point of confusion is the measure of tons reduced under the program, which
depends importantly on the characterization of what would have happened to emissions in the
absence of the program. To avoid confusion over the baseline emissions (we discuss the issue
again below), we draw attention to benefits calculated per ton of emission reductions. The
location of emission reductions still matters importantly to the calculation of benefits per ton,
and this is modeled explicitly in TAF. Measured in this way, health still plays a dominant role
in the assessment of benefits. Median mortality benefits for the entire U.S. per ton SO₂
reduction under TAF's default scenario are $3,102. We find the 90 percent confidence interval
around TAF's reference case estimate for SO₂ mortality benefits to range from $1743 to
$9,649. The median value of human morbidity effects for TAF are $193 per ton of SO₂
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reduction. The median estimate of benefits resulting from changes in NOx emissions in 2010
are $463 per ton for mortality (through the change in nitrate concentrations) and $137 for
morbidity. These do not include the effects from changes in ozone concentrations. In contrast,
annualized costs in 2010 are estimated to average $271 per ton of SO₂ emission reduction, and
$382 per ton for NOx emission reduction.
Figure 2 displays the benefit-cost ratio, using health benefits only, under alternative
baseline assumptions about plant lifetimes and growth in electricity demand. In the year
2020, when the benefit-cost ratio is greatest, annual costs (1990$) are $1.56 billion in the
default case (low growth-70 year retirements), while benefits are $19.9 billion. Costs drop to
$1.19 billion in the low growth-60 year retirements case, while benefits drop to $13.2 billion.
Costs are $1.63 billion in the high growth-70 year retirements case, while benefits are $21
billion. For the high growth-70 year retirement case, the benefit-cost ratio of Title IV is even
larger than for the default case. The reasons are that changes in assumptions affect both
benefits and costs in the same direction but to differing degrees. For instance, lower growth
in electricity demand implies that there is a lower opportunity cost to retiring older plants. It
also suggests that emissions in the baseline would be lower, and hence emission reductions
and program benefits would be lower. It is also interesting that benefits in the low growth-60
year retirement case are less than or equal to the default case in every year. The benefit-cost
ratios are not much different among the cases.
Perhaps the most interesting aspect of this figure is that the benefit-cost ratio does not
vary by a huge amount under the different assumptions, even though the measure of benefits
or the measure of costs taken separately does vary significantly. This points out a virtue of
TAF in that it allows us to explore benefits and costs under a consistent set of assumptions
and sensitivity cases.
Because of the dominant role of health, we devote a considerable part of our sensitivity
analysis to whether the mortality and morbidity benefit estimates are robust. Figure 3 displays
the annual health benefits alone for the default scenario, with associated uncertainty bars, in
comparison with our default annualized expected cost estimates, in millions of dollars.
Annualized costs for SO₂ and NOx reductions are about $761 million per year in 1995,
increasing to $1.51 billion in 2000 and $1.56 billion in 2020. Expected benefits in the default
scenario rise from $5.1 billion in 1995 to $19.9 billion in 2020, dropping back to $15.5 billion
by 2030. The ramp up of benefits is attributable to meeting Title IV year 2000 goals as well as
to population and income growth, while the drop after 2020 is attributable to plant retirements
that occur in the baseline.
Our main observation in Figure 3 is that the uncertainty bounds around the benefit
estimates show that there is no year in which benefits (at the 5 percent confidence level) are
less than expected annualized costs. Uncertainty in the cost estimates is explored through the
three scenarios involving alternative assumptions about plant lifetimes and electricity demand
growth described in Figure 2. However, these alternatives generate such a small range in costs,
compared to uncertainty in benefits, that it does not display in Figure 3. About 94 percent of
total health benefits result from mortality benefits in 2010. Only about 11 percent of total
15
Benefit (Health only): Cost Ratio Under
Alternative Assumptions about Electricity Industry
15.0
13.0
11.0
70 high
9.0
70 low
60 low
7.0
5.0
3.0
1995
2000
2005
2010
2015
2020
2025
2030
Year
Figure 2: Benefit-cost ratio for health benefits under alternative assumptions about electricity industry
16
45,000
40,000
35,000
30,000
25,000
Benefits
20,000
Cost
15,000
10,000
5,000
1995
2000
2005
2010
2015
2020
2025
2030
Year
Figure 3: Annual mean total health benefits with 90% confidence intervals compared with expected annualized costs
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benefits are attributable to NOₓ reductions (the rest are attributable to sulfate reductions). Of
morbidity benefits, NOₓ reductions account for closer to 27 percent of the benefits, according
to our analysis.
Figure 4 reports the annual mean total health benefits and annualized costs for the TAF
default case, the HB case for sulfates only, each of the three separate sensitivity analyses which
are designed to reduce benefits, and for the combination case. The three separate analyses do
not eliminate the gap between expected benefits and levelized costs in any year when taken
separately. The most dramatic reduction in benefits occurs when we use very conservative
assumptions to value statistical life. For instance, in 2020, expected total health benefits are
$19.9 billion in the default scenario, but only $5.4 billion in this sensitivity case. Uncertainty
analysis on the three sensitivity cases reveals that 5th percentile benefits are less than
annualized costs up to, but not beyond, either 2000 or 2005, depending on the case, but that in
no case do total costs exceed total health benefits. Only when we do a combined sensitivity
analysis--where we assume that sulfates affect mortality with the potency of the average
component of PM₁₀ and that there is an effects threshold of 30 µg/m³ PM₁₀--do we find total
expected costs proximate to total expected benefits, though it is still less than benefits.
Annual Mean Total Health Benefits and Annualized Costs by Scenario
100,000
10,000
HB (Sulfates)
Default
Threshold
PM10
Age Disag
Cost
PM10 and Threshold
1,000
100
1995
2000
2005
2010
2015
2020
2025
2030
Year
Figure 4: Annual mean total health benefits and levelized costs (log scale) by scenario
Legislative debates about acid rain in the 1980s had a sharp regional character. Since
acid deposition typically occurs far from the source of emissions, which were largely
concentrated in the Ohio Valley, many observers claimed that emissions from these power plants
were contributing to environmental degradation in the Northeast. The regional decomposition of
health benefits from reduced emissions is less parochial because atmospheric concentrations are
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affected closer to the source of emissions. Table 3 illustrates that, expressed in per capita terms,
the greatest health benefits accrue to the regions with the greatest changes in emissions.
Table 3: Expected total health benefits for 2010 and percent of
national SO₂ emission reductions by state
Per Capita
Health Benefits
Percent of National
Percent of National SO₂
State
(1990$)
Health Benefits
Emission Reductions
WV
$171.38
1.8%
12.0%
OH
$159.85
10.2%
23.3%
DC
$158.81
0.5%
0.0%
PA
$157.84
11.0%
9.8%
KY
$148,29
3.3%
11.0%
VA
$135.41
5.5%
0.4%
MD
$131.77
4.1%
0.4%
IN
$131.46
4.4%
16.0%
DE
$131.21
0.6%
0.0%
NJ
$130.70
6.2%
0.4%
NY
$115.42
11.6%
2.2%
Other
$36.93
40.8%
24.5%
Comparison with HB study
Table 4 provides sulfate mortality benefit estimates comparing the HB model and our
default values in TAF. This comparison was obtained through a different run of the model
than the results reported previously and consequently the results for our default assumptions
vary due to use of a different sample drawn with a different sampling procedure. A common
sample was drawn for all examples in this comparison, however.
Because we use identical census population projections for both estimates, there are
three margins along which TAF and HB estimates may differ: (i) the quantities and locations
of emissions changes differ; (ii) the "source-receptor matrices" linking emissions to
concentrations over space differ; and (iii) the concentration-mortality risk estimates and the
estimates of the value of a statistical life differ. Each scenario in Table 4 is identified by the
source for emission changes (EPA for the HB study, or TAF's default values), the
atmospheric model (RADM for HB, or ASTRAP for TAF) and the health effects and
valuation functions (HB or TAF).
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Table 4: Comparison of HB and TAF Mortality Sulfate Benefits (billions $1990) for
Eastern U.S. with percent changes over previous scenario, Year 2010
New Health
Scenario:
EPA/HB
New Transport
New Emissions
TAF
Emissions
EPA
EPA
TAF
TAF
Transport
RADM
ASTRAP-TAF
ASTRAP-TAF
ASTRAP-TAF
Model
Health/
HB
HB
HB
TAF
Valuation
Mean
Benefits
30.3
56.9
25.1
15.4
(billion $)
Percent
+87.8%
-55.9%
-38.6%
Change
Benefits ($)
3,289
6,179
6,296
3,852
per ton
Median Benefits
(billion $)
19.0
34.5
15.3
12.64
Percent
+81.6%
-55.7%
-17.4%
Change
Benefits ($)
2,061
3,749
3,828
3,153
per ton
Expected (mean) mortality benefits are higher from HB than TAF. Before any
adjustments, HB found sulfate mortality health benefits of $31 billion in 2010 (1990$) in the
Eastern U.S. while TAF estimates benefits of $15.4 billion in this region. 12 We reconcile
differences in population estimates by using TAF's estimates in both scenarios. Under these
assumptions, adjusted HB estimates are $30.3 billion as reported in Table 4.
Although we do not focus on uncertainty in this reconciliation, we note that the
adjusted HB estimates range from $5 to $67 billion for the 20th and 80th percentiles around
the mean. TAF has tighter uncertainty bands, at $7.6 to $24 billion for the same confidence
interval. This uncertainty difference is driven primarily by our use of a narrower range of
PM-mortality studies than those used by Hagler Bailly.
12 When including morbidity, total health benefits for HB are $35.5 billion, and for TAF they are $17.8 billion.
Benefits in the Eastern U.S. make up the 98% of the benefits in TAF for the entire U.S. Also note that in using
RADM for atmospheric modeling, HB is using the median of several runs of the model rather than the mean.
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To reveal the effect of each of these differences in underlying assumptions, we begin
with the HB analysis, and gradually replace HB assumptions with default assumptions in
TAF. We begin by substituting the ASTRAP source-receptor coefficients used in the TAF
analysis for RADM, which results in a large (87.8 percent) increase in the benefit estimates
(from $30.3 billion to $56.9 billion). Viewing the results state-by-state explains what is
happening. The HB version with RADM shows a highly variable pattern of benefits, ranging
from $360 per capita in Tennessee to $13 per capita in Minnesota. The highest benefits are in
the south (particularly the southeast and southern Appalachians); Mid-Atlantic and New
England states have very low benefits per capita. In contrast, the TAF-ASTRAP version
yields larger benefits that are also less variable. Further, ASTRAP shows much larger effects
in the northeast, followed by the Mid-Atlantic states, and then some southern states, with
smaller benefits in several others. These differences translate to per capita benefits with
ASTRAP that are highest in the Mid-Atlantic, about equal in the Midwest and Northeast, and
smallest in the South.
What could account for such differences between ASTRAP and RADM? Shannon,
et al. (1997) found the two models' predictions reasonably in agreement for predicting
atmospheric sulfate concentrations in the eastern U.S., though RADM actually predicts
greater sulfate reductions in the more populated regions including the mid-Atlantic. Weather
patterns appear to be handled differently by RADM and ASTRAP in a way that could account
for much of the difference in benefits. In the HB application, the median episode taken over
30 episodes is used rather than a weighted average of episodes. In contrast, ASTRAP uses 11
years of daily meteorology to develop its source-receptor (S-R) matrices, which are
constructed to represent average meteorology for each season. Given the lognormal
distribution of meteorology, the median could be far below the mean.
Substituting EPA emissions forecasts with the TAF emissions forecasts decreases
mortality benefits (which drop 56 percent from $56.9 billion to $25.1 billion). Although
approximately equal average annual emissions should obtain in the long run, the EPA forecast
suggests a higher baseline level of emissions and hence greater emission reductions under the
program. EPA's higher baseline projects fewer units switching to coals with lower sulfur
content than does the TAF model.
We complete the reconciliation by substituting TAF mortality coefficients and values
of a statistical life for those in HB (recall that we are only considering mortality effects). This
switch decreases our mean benefit estimate by 38.6 percent (from $25.1 to $15.4 billion).
This change is primarily a consequence of the inclusion by HB of the Dockery et al. (1993)
"six city" study relating annual PM2.5 concentrations to the probability an individual in the
cities will die during the study period. While HB assigns this study a weight of 25 percent,
we give it no weight because it is dominated, in our opinion, by the Pope et al. (1995) study,
which uses a similar approach but is applied to 552,000 individuals over 151 cities. HB also
uses somewhat higher values of a statistical life than we do (they use an estimate with a
expected value of $3.2 million, the expected value of the TAF estimate is $3.1 million).
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Comparison with the RIA
For further analysis of heath effects we substitute coefficients from the EPA's draft
Regulatory Impact Assessment (RIA) for particulates into the health effects and health
valuation modules. Compared with the EPA/HB analysis in Table 4, which reported mean
annual mortality benefits from sulfate reductions in 2010 of $30.3 billion in the Eastern U.S.,
the RIA (using EPA emissions and RADM for atmospheric modeling) approach yields $25.6
billion. The RIA uses a higher value of a statistical life ($4.8 million) than HB, but predicts a
smaller change in mortality for the same change in sulfate concentrations, despite including
long-term mortality effects. The EPA/RADM/RIA analysis estimates are still larger than the
mean estimates for TAF of $15.4 billion. When we substitute the RIA for TAF in measuring
health effects and valuation (TAF/ASTRAP/RIA), the expected benefits fall to $21.3 billion.
Cost Comparisons
The costs of SO₂ reductions under Title IV have attracted considerable attention
because of the innovative allowance trading program. Cost projections from the middle
1980s based on command and control approaches, and projections of marginal costs under a
market with an inadequate level of trading, ranged as high as $1500 per ton (Bohi and
Burtraw, 1997). At the time of Title IV's enactment the EPA projected costs in 2010 of $450-
$620 per ton (ICF, 1990). Cost estimates have continued to decline, in large part because the
program gives utilities the flexibility to exploit advantageous trends in coal markets and the
cost of rail transport that have led to a drop in the cost of switching to lower sulfur coal.
Table 5 reports a series of estimates for average costs (which are expected to be lower
than marginal costs in Phase II), illustrating that various projections have continued to decrease
as allowance trading has taken hold. Nonetheless, the TAF default costs are on the low end of
this range. The ICF (1995) estimates are the final in a series of declining estimates provided
for the EPA by ICF since 1989. ICF (1995) estimates were reported in the EPA's Regulatory
Impact Assessment for Title IV. These estimates describe a considerably greater emissions
reduction because of higher projected emissions in the baseline than assumed in TAF. The
greater annual costs spread over greater emission reductions yield comparable average costs. It
makes sense that the average costs per ton are greater in the TAF estimates since it assumes
more switching to low sulfur coal for economic reasons in the baseline; a greater portion of this
switching is accounted for as part of Title IV by ICF and this brings down the average cost per
ton in that study. Based on recent econometric estimates (Burtraw et al., 1997) and the recent
trend in fuel markets, and also due to current trends toward increasing competition in the
electric utility industry, we believe the TAF estimates can be taken as central estimates. ICF
(1995) suggests annual costs about 2.5 times those included in the TAF default case; however,
the estimated cost per ton reduction is just about equal to that for TAF.
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Table 5: Long run (Phase II, year 2010) cost estimates for SO2 reduction
Annual Cost
Average Cost per Ton SO2
Study
(billion 1990 dollars)
(1990 dollars)
TAF Default
0.8
205
ICF (1995)
2.0
216
White, et al. (1995)
1.2-2.5
245-286
GAO (1994)
1.8-2.9
197-320
Van Horn
Consulting et al. (1993)
2.0-3.2
289-373
Other reported estimates include White et al. (1995) and Van Horn Consulting et al.
(1993) which were compiled for the Electric Power Research Institute. The range of estimates
in White et al. is associated with the level of plant utilization, comparable to TAF's low and
high electricity demand cases. Van Horn Consulting was also the contractor for the GAO
(1994) estimates. The range of estimates for GAO pertain to variations in the liquidity of the
allowance market, and the range in the Van Horn Consulting estimates cover a mix of scenarios.
Another aspect of regulatory costs that has only recently been investigated and
estimated is the hidden social cost of imposing additional regulations in a second-best setting
characterized by pre-existing regulations and taxes that already distort the economy away from
economic efficiency. This issue has ignited colorful debate with respect to policies to address
climate change. Goulder et al. (1997) addressed this issue in an analytical and computable
general equilibrium model of the SO₂ program to estimate hidden social costs due to the
second-best setting for Title IV. They estimated that the social costs stemming from
interactions between the trading program and pre-existing taxes in the economy were $533
million per year. This social cost stems from the fact that the SO₂ program, like any
regulation, imposes a cost that reduces the real wage of workers. This cost can be viewed as a
virtual tax, and when imposed on top of pre-existing taxes, has large consequences for
economic efficiency. Unfortunately, as far as this issue is concerned, the SO₂ trading program
imposes particularly large costs because it encourages firms to internalize not only their
abatement costs, but also the cost of residual emissions through the opportunity cost of SO₂
allowances. Were the program to raise revenues through the auction of permits, it could use
these revenues to offset this tax-interaction effect by reducing other distortionary taxes.
However, the SO₂ allowances are allocated without charge, so there is no revenue available for
this purpose, and consequently the tax-interaction effect and resulting social cost is substantial.
Table 6 reports alternative cost estimates for the NOx portion of Title IV. The E.H.
Pechan (1996) estimate may be high because it reflects average costs for 3.7 million tons per
year in NOx emission reductions. This is greater than the other estimates, and reflect
reductions as a result of Title IV requirements coupled with requirements on electric utilities
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stemming from other parts of the Clean Air Act Amendments. Also, like the TAF estimates,
E.H. Pechan does not allow for averaging of emission rates among commonly owned and
operated facilities, which is a feature in the actual implementation of the regulation. In
contrast, the TAF emission reductions are 1.97 million tons per year and the ICF (1996)
reductions are forecast to be 2.06 million tons per year, both reflecting only the specific
requirements of Title IV. Among these three sets of estimates, only ICF reflects the reduction
in costs that can be expected through emissions averaging, which helps explain why it is
lower than the others.
Table 6: Long run (Phase II, year 2010) cost estimates for NOx reduction
Annual Cost
Average Cost per Ton NOx
Study
(billion 1990 dollars)
(1990 dollars)
TAF Default
0.8
382
ICF (1996)
0.5
229
E.H. Pechan (1996)
1.6
438
Considering the alternative cost estimates, and also recognizing that costs stemming
from the second-best setting of environmental regulation are excluded, we argue that TAF's
more conservative default estimate is a reasonable midpoint. We feel especially justified in
this view because of the apparent magnitude of benefits compared to costs. If one were to
double TAF's estimate, this difference would have an important effect on the benefit-cost
comparisons illustrated in our previous examples; however, it would not by itself change the
qualitative finding that benefits appear to outweigh costs by a significant margin.
Unmodeled Pathways and Research Priorities
To varying degrees, members of the team of scientists and economists that contributed
to construction of TAF initiated review and modeling of environmental pathways that were
not part of our quantitative analysis. Based in part on these efforts, we have constructed a
qualitative review of pathways that are not modeled, including a relative ranking of their
expected magnitude, and a prioritization for further research according to our assessment of
the value of additional information for each. This evaluation is reported in Table 7.
Short run and long run research needs vary among the modeled and unmodeled
pathways. Estimates of health and visibility benefits remain uncertain; however, the cost of
reducing uncertainty appears to be relatively lessithan many other areas. To evaluate Title IV
on the basis of a comparison of benefits and costs, it may be sufficient to focus efforts at
assessing benefits from health and visibility, because these benefits alone appear to outweigh
the costs. Environmental areas including aquatics and forests stand to benefit in addition.
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Table 7: Qualitative evaluation of expected benefits and value of additional
information for modeled and nonmodeled pathways
Categories
Expected Benefit:
Value of Additional
Information:
high
high-mid
Are expected benefits large?
With the goal of improving
mid
benefit estimates, what is
low-mid
the relative short-term
low
return on investment?
Health: Mortality
Health: Morbidity
Visibility
Materials and Cultural
Resources
Nonuse Values: Ecosystem
Health
Aquatics: Recreation
Forests: Recreation
Agriculture and
Commercial Forestry
Radiative Forcing
While there are many issues facing the health scientists and epidemiologists,
economists should work to improve the basis for the valuation of small risks to mortality
health due to environmental changes. Also, economists need to develop estimates for WTP to
avoid these risks that depend on the age and health status of the affected individual. For
visibility, valuation needs to be more precise with respect to the endpoints that are important
for assessment of benefits, and particular attention should be paid to the nature of preferences
for changes in visibility, such as the trade-off between changes in the mean and extreme
values of visual range. Benefits to materials and cultural resources is another area where
benefits may be sizable. Rapid progress could be made through further work on the valuation
of cultural resources, which should concentrate on the identification of the resources and the
attributes of those resources that are meaningful endpoints to individuals. Assessment of
benefits to commercial materials requires an improved inventory of affected materials, and
improved estimates of their economically useful lives.
Over the longer time frame, we suggest assessment of nonuse values for ecosystem
health should be afforded high priority. However, a research emphasis in this area would
require sustained levels of funding over several years to yield results that would be reliable.
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Also, agriculture and commercial forestry would receive a somewhat higher ranking in Table 7
were a sustained level of funding to be committed. One reason sustained funding over time
would be necessary is that agriculture is undergoing structural change due to reforms passed by
Congress in 1996 that may not be fully attained until the next decade. In addition, estimating
rural ozone effects may be costly and time consuming, though such modeling would also
contribute to an understanding of human health benefits and forest recreation.
The most important of the uncertainties and omissions in this analysis are summarized
in Table 8 which appears as an appendix to this paper. In this table we indicate our qualitative
assessment of the direction of the bias for each of these shortcomings. A plus sign (+) indicates
the uncertainty or omission imposes an upward bias in our benefit or cost estimate; a negative
sign (-) indicates otherwise. Additional information about the uncertainties and limitations at
each step in the TAF model is provided in the documentation for TAF (Bloyd et al., 1996).
V. CONCLUSIONS
Although important limitations, caveats, and major uncertainties inhibit the
comprehensiveness of this benefit-cost analysis, the clear conclusion that emerges from the
array of scenarios we explore is that the benefits of Title IV exceed the costs by a substantial
margin. This assessment differs from the information that was available to policy makers at the
time the program was enacted in 1990. At that time, Portney (1990) ventured to offer a
comprehensive assessment of the Clean Air Act Amendments. Portney wrote that the expected
benefits and costs appeared to be about equal for Title IV, in part because of the cost savings
that were expected to result from the innovative allowance trading program. Since that time it
appears that costs have fallen significantly compared to prior expectations, and benefits are now
thought to be greater than expected.
Expected benefits tend to be high in some areas that were not a primary focus of
benefits assessment in the 1980s, particularly health and visibility. The dominant category of
benefits is mortality, which we expect to be several times the costs of the program. We find
mortality values that are less than previous estimates for the EPA. Still, in our analysis there is
no year in which health benefits alone at the 5 percent confidence level are less than the
levelized expected costs. About 89 percent of the total health benefits are attributable to
changes in SO₂ and 11 percent attributable to changes in NOx emissions.
We emphasize that there are tremendous uncertainties in measuring and valuing
mortality. Recent economic critiques have argued that the use of the value of a statistical life
as the basis for valuing health risks from air pollution, instead of a more appropriate measure
of quality adjusted life years lost, could grossly overestimate mortality benefits. In addition,
economists have questioned the appropriateness of using labor studies of prime age men to
value changes in life expectancy that occur among an older population. In the future we
expect these critiques to gain in credibility as more is learned about how to measure benefits.
On the other hand, we note that because environmental exposures are involuntary, compared
with studies of labor market behavior, the latter may underestimate willingness to pay to
avoid environmental exposures.
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Morbidity, recreational visibility, and residential visibility benefits each separately
appear to measure at comparable magnitude with costs. About 73 percent of morbidity effects
are attributable to SO₂, and 27 percent are attributable to NOx. (We do not model the
contribution of NOₓ to ozone.) The visibility estimates illustrate their potential magnitude,
but we note that the literature is narrow and should be subject to closer scrutiny.
Public attention in the 1980s to air pollution from SO₂ and NOx emissions largely
centered on the problem of acidification ("acid rain"), with particular concern for its affect on
water and soil chemistry and ultimately ecological systems. It is surprising to many that
relatively low benefits are estimated by economists for effects on aquatics (in this study) or
are expected to result from effects on forests and agriculture. One reason is that willingness
to pay for environmental improvement depends on the availability of substitute assets.
Economists would not expect changes in quality at one site to elicit large benefits if there are
many sites available for comparable recreational opportunities. In contrast, individuals do not
have the same kind of substitution possibilities with respect to health and visibility, which
may help explain the relatively larger benefit estimates for these endpoints. Furthermore, one
should note that the low values for aquatics stem from an assessment of use values, or
commodity values in the case of agriculture. Environmental changes may also yield nonuse
values, and estimates for nonuse values are not available. Nonetheless, the evidence, based
on a small number of relatively narrow studies, suggests these values may be significant.
The costs of compliance under Title IV have attracted attention because of the
innovative allowance trading program. Many recent estimates find costs to be lower than
anticipated for SO₂ emission reductions, in large part because of the flexibility the program
gives firms to find least-cost ways to reduce emissions and to take advantage of advantageous
trends in fuel and factor markets. Nonetheless, the TAF default costs are on the low end of
previous estimates for SO₂ and somewhat high for NOx control, and they do not take into
account hidden social costs stemming from the second-best setting for environmental policy.
These factors impart uncertainty around estimates of costs in this study.
The strength of this analysis using TAF is the flexibility it gives us to explore
uncertainties in the measurement of benefits and costs, and to employ consistent assumptions
in the comparison of benefits and costs. We acknowledge important gaps and uncertainties in
this analysis. Nonetheless, in spite of, and in some cases because of these important caveats,
our exploration of the relevant uncertainties leads us to find compelling evidence that benefits
of Title IV substantially exceed costs.
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Table 8: Major uncertainties and omissions and direction of bias in TAF
Uncertainties and Omissions
Bias
Description
BENEFITS
AGGREGATION TO STATE LEVEL
?
Emissions, atmospheric transport and effects are
modeled at state level. Probability distributions are
used to represent variability within states in the
simulations.
ATMOSPHERIC MODEL DOES NOT
+
Ammonia may be a limiting factor in formation of
CAPTURE ROLE OF AMMONIA
secondary particulates. Reductions in one (e.g.
sulfates) may allow increases in the other (e.g.
nitrates).
AQUATIC EFFECTS CAPTURE ONLY
-
The measure does not capture effects on other
LIMITED RECREATIONAL USE,
recreational uses.
ONLY AT LAKES
AQUATIC EFFECTS LIMITED TO
+/?
The Adirondack region has high participation rates
ADIRONDACKS
compared to nation. Calculation of effects on "per
affected capita" basis yields inflated values when
extrapolated to nation.
RECREATIONAL VISIBILITY
+/?
Only two parks included, but this may capture
majority of benefits. Contingent valuation
methods uncertain. Valuation is not precise with
respect to the distribution of visibility
improvements over time.
RESIDENTIAL VISIBILITY
?
Only five cities evaluated; benefits represented on
"affected per capita" basis.
MORBIDITY MEASURES
-
Reduced workplace productivity for small effects
not captured.
MORTALITY COEFFICIENT
+
Use of mortality coefficients treats all mortality
effects equally. A preferable approach would be
life-years lost.
VALUE OF STATISTICAL LIFE
+/?
The VOSL approach does not value appropriately
small changes in life expectancy realized late in
life (+). Health status is not included. (+) However,
VOSL ignores involuntary nature of exposure (-).
OMITTED ENVIRONMENTAL
-
Magnitude of use values for omitted pathways may
ENDPOINTS AND NONUSE VALUES
be small as indicated by included aquatic endpoint.
LISTED IN TABLE 6
However, nonuse measures are not explored and
may be significant.
BENEFITS OUTSIDE U.S. EXCLUDED
-
The analysis is limited to the continental U.S.
COSTS
SO₂ PROGRAM MODELED AS PERFECT
-
Regulatory incentives may hamper allowance
TRADING
trading.
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Table 8: Major uncertainties and omissions and direction of bias in TAF (continued)
Uncertainties and Omissions
Bias
Description
NOx ABATEMENT MODEL DOES NOT
+
Implementation of NOx rules allows emission rate
REFLECT EMISSIONS AVERAGING
averaging among commonly owned and operated
units which lowers costs.
ELECTRICITY DEMAND GROWTH
-
Previous analysis has indicated electricity demand
growth and plant lifetime to be the most important
variables in costs. Both variables explored in
sensitivity analysis. Our analysis is conservative
(low) on projected demand growth.
PLANT LIFETIME
?
Plant lifetime is treated parametrically.
PARTIAL EQUILIBRIUM ANALYSIS
-
General equilibrium effects indicate hidden
efficiency costs from regulations that raise product
costs. Also, failure of program to raise revenue.
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Dockery, D. W., C. A. Pope III, X. Xu, John D. Spengler, James H. Ware, Martha E. Fay,
Benjamin G. Ferris, Jr., and Frank E. Speizer. 1993. "An Association between Air
Pollution and Mortality in Six U.S. Cities," The New England Journal of Medicine,
vol. 329, no. 24, pp. 1753-1759.
E. H. Pechan and Associates. 1996. "Emission Reduction and Cost Analysis Model for NOx
(ERCAM-NOX)," Report No. 96.09.002/1763, September.
Ellerman, A. Denny, and Juan-Pablo Montero. 1996. "Why are Allowance Prices so Low?
An Analysis of the SO2 Emissions Trading Program," MIT-CEEPR Working paper 96-
001 (February), Massachusetts Institute of Technology.
Evans, J. S., T. Tosteson, and P. L. Kinney. 1984. "Cross-Sectional Mortality Studies and
Air Pollution Risk Assessment," Environment International, 10, pp. 55-83.
Goulder, Lawrence H., Ian W.H. Parry and Dallas Burtraw. 1997. "Revenue-Raising VS.
Other Approaches to Environmental Protection: The Critical Significance of Pre-Existing
Tax Distortions," RAND Journal of Economics, forthcoming.
30
Burtraw, Krupnick, Mansur, Austin, and Farrell
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Government Accounting Office (GAO). 1994. "Air Pollution: Allowance Trading Offers an
Opportunity to Reduce Emissions at Less Cost," GAO/RCED-95-30, Washington, D.C.
Hagler Bailly. 1995. Human Health Benefits Assessment of the Acid Rain Provisions of the
1990 Clean Air Act Amendments. Final report prepared by Hagler Bailly Consulting,
Inc., Boulder, Colorado, under subcontract to ICF Incorporated, Fairfax, Virginia, for
U.S. Environmental Protection Agency, Acid Rain Division.
ICF. 1990. "Comparison of the Economic Impacts of the Acid Rain Provisions of the Senate
Bill (S.1630) and the House Bill (S.1630)," prepared for the U.S. Environmental
Protection Agency (July).
ICF. 1995. "Economic Analysis of Title IV Requirements of the 1990 Clean Air Act
Amendments," prepared for the U.S. Environmental Protection Agency (September).
ICF. 1996. "Regulatory Impact Analysis of NOₓ Regulations," prepared for the U.S.
Environmental Protection Agency (October 24).
Jones-Lee, M. W., M. Hammerton, and P. R. Philips. 1985. "The Value of Safety: Results of
a National Sample Survey," The Economic Journal, 95 (March), pp. 49-72.
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Cycles: Analytical Methods and Issues, and Estimating Externalities of Coal Fuel Cycles
(Washington, D.C., McGraw-Hill/Utility Data Institute).
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Valuation, draft, U.S. Environmental Protection Agency, Washington, D.C.
Oak Ridge National Laboratory. 1995. "Peer Review Of The Tracking And Analysis
Framework (TAF) For Use In The 1996 NAPAP Integrated Assessment," Oak Ridge,
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Plagiannakos, T., and J. Parker. 1988. "An Assessment of Air Pollution Effects on Human
Health in Ontario," Ontario Hydro, March.
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and C. W. Heath, Jr. 1995. "Particulate Air Pollution as a Predictor of Mortality in a
Prospective Study of U.S. Adults," American Journal of Respiratory and Critical Care
Medicine, 151, pp. 669-674.
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Perspectives, vol. 4, no. 4, pp. 173-181.
Schwartz, J., and D. W. Dockery. 1992. "Increased Mortality in Philadelphia Associated
with Daily Air Pollution Concentrations," American Review of Respiratory Disease, 145,
pp. 600-604.
Shannon, J. D., E. C. Trexler, and R. Sonnenblick. 1997. "Modeling Visibility for
Assessment," Atmospheric Environment, forthcoming.
31
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U.S. Environmental Protection Agency (USEPA). 1995. "Air Quality Criteria for Particulate
Matter (Draft)," Environmental Criteria and Assessments Office, Research Triangle Park,
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Proposed Particulate Matter National Ambient Air Quality Standard (Draft)," prepared by
Innovative Strategies and Economics Group, Office of Air Quality Planning and
Standards, USEPA, Research Triangle Park, N.C. (December.)
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Analysis of Fuel, Technology and Emission Allowance Markets, prepared for the Electric
Power Research Institute, EPRI TR-102510 (August).
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Emission Allowance Market and Electric Utility SO2 Compliance in a Competitive and
Uncertain Future, prepared for the Electric Power Research Institute, EPRI TR-105490s
(September).
32
RESOURCES
FOR THE FUTURE
SO₂ Allowance Trading: How
Experience and Expectations
Measure Up
Douglas R. Bohi
Dallas Burtraw
Discussion Paper 97-24
February 1997
Resources for the Future
1616 P Street, NW
Washington, DC 20036
Telephone 202-328-5000
Fax 202-939-3460
© 1997 Resources for the Future. All rights reserved.
No portion of this paper may be reproduced without
permission of the authors.
Discussion papers are research materials circulated
by their authors for purposes of information and
discussion. They have not undergone formal peer
review or the editorial treatment accorded RFF books
and other publications.
SO₂ Allowance Trading: How Experience and Expectations Measure Up
Douglas R. Bohi and Dallas Burtraw
Abstract
The SO2 trading program has achieved reductions in emissions ahead of schedule, with
allowance prices below the marginal costs that were anticipated for the program. This paper
explores the experience with the program and proposes a taxonomy of reasons why allowance
prices are low. The overarching reason is that the most costly investments to accommodate
full emission reductions have been successfully delayed. Application of a discount rate to these
long run marginal costs yields an estimate of allowance price close to that observed today.
Several factors have contributed to the delay in bearing these costs, and helped to reduce their
magnitude. One group of factors stems from market fundamentals, especially the cost of rail
transport of low sulfur coal. A second group includes the influences of state and federal
regulators. A third group includes distinctions from the "imagined" program compared to that
which was actually been enacted.
-ii-
SO₂ Allowance Trading: How Experience and Expectations Measure Up
Douglas R. Bohi and Dallas Burtraw¹
1. INTRODUCTION
The sulfur dioxide (SO2) emission allowance trading program enacted through Title IV
of the 1990 Clean Air Act Amendments (CAAA) ushered in the first nationwide effort to use a
market in tradable "emission allowances" as the way to encourage the electricity industry to
minimize the cost of reducing emissions. The electricity industry is allocated a fixed number of
total allowances and firms are required to hold one allowance for each ton of sulfur dioxide
they emit. Firms may choose to buy allowances to meet their requirement rather than reduce
emissions, or to sell excess allowances not required for compliance.
Since the first phase of the program began in January, 1995, the experience has been
full of pleasant surprises. Firms are reducing emissions in excess of statutory requirements in
Phase I and accumulating an unexpectedly large bank of allowances for use in the second phase
of the program that begins in January 2000. Probably the most surprising development has
been the decline in the price for allowances, compared with the expectations of many analysts
at the inception of the program. Also the cost of emission reductions using low sulfur coal or
flue gas scrubbing equipment has been lower than expected. At the same time, it appears that
the volume of allowance trading to date, while substantial, has been less than analysts had first
believed necessary to take full advantage of allowance trading. Hence, there is an apparent
puzzle: greater than expected cost savings have been achieved under the allowance trading
program with a lower than expected level of trading (Conrad and Kohn, 1996, offer another
perspective on a similar question).
1 Douglas R. Bohi, Charles River Associates, Inc.; Dallas Burtraw, Quality of the Environment Division,
Resources for the Future. The authors are grateful for research assistance from Brian Kropp, Ron Lile and Erin
Mansur, and comments from Curtis Carlson.
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An explanation for these observations is called for not only for evaluation of the current
program, but also to arrive at lessons that might guide the use of tradable permit programs in
other applications in the future. This is especially important with respect to the differences
between expectations of allowance prices and their current value, because some analysts assert
that engineers and economists so overstated the cost of meeting SO2 reductions that their cost
projections for future environmental regulations such as carbon dioxide controls should be
discounted significantly.
This paper will evaluate the experience with the emission trading program to date and
explain why the surprises indicated above came to pass. We offer a taxonomy of reasons why
allowance prices are below the expectations of some. The lesson is not so much that prior
estimates were wrong (at least the more sophisticated and unbiased ones) but that they were
static snapshots taken in a dynamic policy environment. We argue the program should be
given credit for the attainment of cost savings in emissions reductions because it has provided
incentives for firms to innovate and to exploit advantageous trends in fuel markets and in the
industry. Nonetheless, there have been impediments to trading allowances and other
idiosyncrasies in program design that have promoted uneconomic investments and prevented
firms from realizing additional savings. The experience to date illustrates that the potential
savings from incentive based environmental policies such as the allowance trading program are
enormous. However, improvements in trading behavior will be increasingly important for the
industry to capture these savings as it approaches the more stringent second phase of the
program. Due to increasingly competitive pressures to reduce costs in electricity generation,
we are optimistic that a boost in allowance trading will be realized, but this is far from certain.
2. AN EXPERIMENT IN REGULATORY REFORM
In contrast to traditional command and control environmental regulation, where firms
typically adopt a common technology to reduce emissions by a specific amount, the emission
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trading program allows each firm to choose its own individual emission rate and the means to
achieve that rate. This flexibility allows firms to identify the cheapest way to reduce its
compliance costs. Allowance trading takes advantage of the fact that emission control costs
vary across different generating plants, and encourages firms with the cheapest control costs to
undertake the most emission reduction.
To work in this idealized way, however, each firm must have the incentive to minimize
its costs. One should be careful in assuming that electric utilities will seek to, or even will be
allowed to, minimize the cost of reducing emissions. The problem is that electric utilities are
not allowed to maximize their profits. Instead, their prices and profits are regulated by the
states in which they operate. The state regulators allow the firms to charge prices for electricity
that will recover only those costs of production that are deemed to be prudently incurred.
In fact, many state public utility regulators have imposed cost recovery rules that
distort the firms' incentive to minimize costs (see Rose, 1997; Bohi, 1994; Rose, 1992; and
Bohi and Burtraw, 1992). For example, regulators typically allow more favorable cost
recovery on scrubbing and fuel switching than on allowance purchases. Several states have
granted preapproval for the recovery of scrubber costs. Investments in capital costs such as
scrubbers or fuel handling equipment in the case of fuel switching can be depreciated or
expensed beginning as soon as facilities are in operation, and in some states scrubber costs can
be recovered even before the units are in operation. Fuel cost increases are typically passed
through to customers in the year the expense is incurred. In contrast, though allowance
acquisitions may be necessary for investment and planning purposes years in advance of their
use, their cost cannot be recovered until after the allowances are used for compliance. If the
price of an allowance falls over the period of time between acquisition and use the state
regulator may deny full recovery of cost on the grounds that a particular transaction was
imprudent. If the price rises and the utility decides to sell the allowances and adopt a different
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compliance strategy, the utility is unlikely to be able to capture the capital gains. Hence, the
utility faces a downside risk for which there is no upside compensation.
In summary, the potential savings from allowance trading are tremendous but for a
variety of reasons firms may have an incentive to pursue abatement options over allowances
transactions even when they appear to be more expensive. Several studies have estimated a
high cost associated with impediments to trading (Fullerton et al., 1996; Winnebrake et al.,
1995; USGAO, 1994). For a dissenting view on whether state regulators have impeded
trading, see Bailey (1996).
In the last year, apparently despite these impediments, there has been a tremendous
boost in allowance trading (Dean and Kruger, 1997). One reason may be that regulators have
corrected the early signals given to utilities, but evidence of this is lacking. It is more likely the
case that the potentially achievable cost savings from trading overwhelm the restrictive signals
issued by some regulators, especially as utilities come to recognize the oncoming pressures of
competition set in motion by the 1992 Energy Policy Act. While many have complained that
regulators stopped paying attention to emission trading in 1992 (Rose, 1997), it may turn out
to be a good thing.²
3. OBSERVATIONS OF THE EARLY PERFORMANCE
Four interrelated aspects of the experience with the emission trading program deserve
to be highlighted and they are listed in Table 1. First, the volume of sulfur dioxide actually
emitted since the law was passed in 1990, and before it took effect in 1995, is significantly
lower than expected.³ Utilities have been aggressive in taking advantage of the opportunity to
2 One utility employee told us that the utility had stopped filing the burdensome paperwork that the public
utility commission required to be filed for every allowance transaction. So far, he reported, the regulators did
not notice or care.
3 Projections by both ICF (1989), p. 24, and Molburg et al. (1991) Table 5.1, p. 47, showed emissions rising
steadily from 1985 to 1995 when the new Clean Air Act requirements went into effect. Instead, emissions rose
only to 1990, the year the Clean Air Act was enacted, and dropped steadily thereafter. For a comparison of
these studies see Reid, Bohi and Burtraw (1994).
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save allowances earned through emission reduction actions, and the volume of "banked"
allowances that will be available for use in Phase II of the program is larger than expected.
The bank represents a "win-win" outcome for the environment and for industry. The early
reductions provide an opportunity for environmental recovery and improved public health at an
earlier point in time than would occur otherwise, while the bank provides an opportunity for
industry to lower its overall costs of compliance and the ability to ease into the more stringent
Phase II. Estimates of the volume of banked allowances expected to accumulate during Phase
I range between 7 and 15 million. White et al. (1995) estimate the allowance bank will reach
9.4 million tons in the year 2000. RDI (1995) estimates the bank will reach 12-15 million. In
1991 the estimate of total Phase I banked allowances made for the Department of Energy
(DOE) was only 4.35 million (Molburg et al., 1991, Table 4.10, p. 44). The more recent
estimates of the Phase I bank are equivalent to 25% to 50% of the allocation of allowances
during the first five-year phase of the program.
Table 1: Four observations of SO2 allowance trading to date.
1. Over-compliance in Phase I will lead to a substantial bank for Phase II.
2. The volume of allowance trading has been less than anticipated.
3. The price of allowances is low.
4. The cost of emission reductions is low.
A second observation is that the volume of allowance trading has been less than many
anticipated. The overwhelming portion of the approximately 53 million private allowances
transferred in 3,300 transactions that have been recorded through the EPA's Allowance
Tracking System were accounting transfers within firms. A relatively small percentage,
roughly about six to ten percent, were economic transfers between independent parties. The
actual number of economic transfers is not easily deciphered from the allowance data. Three
efforts to identify economic transfers that reach somewhat different conclusions are reported in
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Table 1. As of the middle of 1995, White et al. (1995) find less than 1.6 million allowances
have been traded among utilities. Joskow et al. (1996) find that as of the first quarter of 1996
about 6.5 million allowances have been traded among utilities, between utilities and third
parties and between non-utility parties. In addition, 775,000 allowances have been purchased
at EPA auctions (excluding allowances offered for sale by private parties through the auction).
Dean and Kruger (1997) report that economically meaningful transactions (defined as
allowances acquisitions by utilities) involving 4.8 million allowances had occurred as of the end
of 1996. Lile et al. (1996) review the issues involved in these assessments and promote the
perspective developed in Dean and Kruger. Montero, Ellerman and Schmalensee (1996) find
that for compliance in 1995, "spatial" trading (as opposed to "inter-temporal" trading, or
banking) account for about 500,000 out of 5.3 million tons from facilities covered by the
program in Phase I. About two-thirds of this trading was intra-utility, and only one-third
(involving primarily six utilities) was inter-utility, representing about 3% of allowances used for
compliance.
The data suggest that a good number of utilities have failed to take advantage of the
allowance market to reduce their costs of compliance, though most have taken advantage of
the flexibility in the allowance trading program to bank allowances for Phase II, and to pursue
fuel switching.
Eighty-five percent of the base allowances issued in the first phase (excluding facilities in
the Substitution and Compensation Program) go to utilities located in only eleven states (see
columns 1 and 2 of Table 2). All of the states may be said to actively reduce the incentive to
trade. For example, all of the states proscribe that the benefits that may result from allowance
trading will be passed on to customers. The State of Connecticut provides the one exception to
this rule, wherein it allowed a utility to retain 15% of the revenue from the sale of allowances
(Rose, 1997). In addition, six states provide a regulatory bias in favor of scrubbers as a
compliance option (column 3). All six states have significant indigenous coal industries and
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have acted to protect their markets against encroachment from lower sulfur coal. Out of 110
affected generation facilities, 26 generating units at 14 facilities opted for scrubbing and all of
these units are located in states with a regulatory bias in favor of scrubbing.
Table 2: Allowance trading and compliance plans by state.
(1)
(2)
(3)
(4)
(5)
(6)
State
% of Phase I
Regulatory Bias For
Plans to
Expected
Phase I
Allowances
"Other" Compliance
Trade
Status Toward
Compliance
Options
Allowances
Allowances
Plans
Mainly
Ohio
16.9
Yes
Intrafirm
Buy
Switching;
Scrub Gavin
Mainly
Indiana
12.6
Yes
Sell
Buy
Switching;
Scrub 7 Units
Bank or
Georgia
10.2
No
Intrafirm
Sell
Switching Only
Scrub 5 Units;
Penns
9.4
Yes
Buy
Sell
Switching
Scrub 4 units;
West Va
8.7
Yes
Intrastate
Sell
Switching
Intrastate
Switching and
Illinois
6.9
Yes
and Buy
Sell
Buying
Allowances
Missouri
6.2
No
No
Sell
Switching Only
Kentucky
4.9
Yes
Intrastate
Buy
Mainly
and Sell
Switching;
Scrub 6 Units
Alabama
4.1
No
Intrafirm
Sell
Switching Only
New York
2.7
No
No
Sell
Switching;
Scrub 2 units
Florida
2.4
No
No
Buy
Switching Only
TOTAL
85.0
SOURCES: Column (3) and (4) from interviews with public utility commission staff; Column (5) from ICF model
with "Low-Flexible" assumptions, reported in National Acid Precipitation Assessment Program, 1990 Integrated
Assessment Report, p. 425; and Column (6) from U.S. Environmental Protection Agency, "SO2 Phase I and II Boiler
Compliance Methods," Office of Air and Radiation, June 14, 1993.
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One indication of the unexpected nature of the amount of allowance trading so far is
reflected in the discrepancies between the expected status of the utilities in each state as a buyer
or seller of allowances (column 5) and the actual compliance plans (column 4). The lack of
correspondence between plans and estimates is of interest because the ICF optimization model
was the primary source of estimates of the efficiency gains from a system of allowance trading
that was used in the political debate over the acid rain provisions in the CAAA. Though the
costs of the program have been low, experience so far suggests that the promised benefits of
allowance trading are not being realized in the way they were initially expected.
Another indication of the amount of trading is illustrated in Figure 1. Arrayed along the
horizontal axis of this figure are utilities (at the holding company level) according to the number
of total allowances allocations they are to receive between 1995 and 2026. The vertical axis is a
ratio of the amount of "economically distinct" transactions each utility has been involved in to
their total allowance allocation. We include intra-utility trades, which could be more important
for the larger firms and holding companies. The ratio captures our intuition that utilities with
more allowances should be more involved in trading, so one might expect the ratios across firms
to be approximately equal if all firms attempted to take equal advantage of the market. The
variation in these ratios suggests that utilities vary greatly in the amount of activity in the market,
even when we control for their size and allowance allocations.
A third and particularly important observation is that the price of allowances has been
lower than expected. Table 3 reports expected and actual allowance prices and the volume of
inter-utility trades. Prior to the enactment of the Clean Air Act Amendments in 1990, the
estimated price of allowances ran as high as $1500, a number that was enshrined in the Act as
the fixed price of direct sales by EPA. During 1990, the EPA cited a price estimate of $750 as
the best guess of what allowances (and emission reductions at the margin) would cost.
-8-
0.0000%
0.2000%
0.4000%
0.6000%
0.8000%
1.0000%
1.2000%
1.4000%
1.6000%
Southern Company
American Electric Power
Tennessee Valley Authority
TU Electric*
Cinergy Corp.
GPU Generation
Allegheny Power System
Detroit Edison Company*
-9-
Illinois Power
Ohio Edison Company
Pennsylvania Power & Light
as % of Initial Allowances
Commonwealth Edison
Virginia Power
Total Number of Economically Distinct Allowances Bought/Sold
Duke Power Company*
Central & South West Services*
Carolina Power & Light*
PacifiCorp*
Union Electric Company
Florida Power & Light*
ENTERGY*
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Instead, actual prices for inter-utility trades have been considerably lower, starting out in the
range of $250-300 in 1992, they fell steadily to $110-140 in 1995, and to around $70 in 1996
before rebounding to the low $90s at the time of this writing.
Table 3: Allowance prices and volumes.
Allowance
EPA Auction
Quantity of Inter-Utility Trades
Price
Clearing Price
(thousands)
(Spot)
White et al.*
Joskow et al.**
Dean & Kruger
Expected
1989
$1500
1990
$750
Actual
1992
$250-$300
70
130
1993
$130-$300
$157
639
226
1994
$130-$140
$159
562
1,467
1995
$110-$140
$132
320***
4,918
1996
$90
$66
4,800****
Notes: The expected price in 1989 is from ICF (1989), and in 1990 it is from White et al. (1995). Actual prices and
trading volumes are from White et al. (1995), Joskow et al. (1996) and the industry press. White et al. (1995) report
inter-utlity trades.
Joskow et al. (1996) report trades between April and March of the subsequent year, and include
inter-utility trades, trades between utilities and third parties, and trades between two non-utility parties.
Data for
1995 is for first half of year only.
Dean and Kruger (1997) report all allowance acquisitions by utilities through
the end of 1996.
Table 4: Projected annual costs under alternative implementations for Phase II.
Command and
Constrainted trading
Flexible interutility
billion dollars
control baseline
(internal transfers)
trading
ICF (1989)
3.3 4.7
2.7 4.0
Van Horn Consulting
et al. (1993)
5.1
3.4
2.2
GAO (1994)
4.3
2.5
1.4
Burtraw, et al. (1997)
2.5
1.0
A fourth observation, also related to the price of allowances, is that the cost of
emission reductions has been dramatically less than industry projections before adoption of the
program. Table 4 presents four sets of estimates compiled at various times of the relative
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annual costs in Phase II for three implementation scenarios: command and control,
constrained trading (only among facilities within a firm), and interutility trading.
The estimates pertain to annual cost when the net contributions to the allowance bank
are zero sometime in Phase II. The estimates illustrate an evolution as utility compliance plans
have become known and set into motion, and new information has surfaced about compliance
options and their costs. According to estimates made by ICF (1989) for the U.S. Environmental
Protection Agency (EPA) before the CAAA was enacted, the levelized annual cost of the
program was expected to be $2.7 - 4.0 billion. These costs reflect a cost savings of 40% over a
command and control approach. The GAO study in 1994 also estimated that compliance costs
in the year 2001 would be almost 40 percent less than they would have been under a command
and control approach of emission rate limits applied to specific facilities, but costs in both cases
were less than forecast in 1989. Specific technology requirements, which were also considered
in various proposals in the 1980s, would have been even more expensive. The Burtraw et al.
(1997) study differs from the others, which were primarily engineering based studies, by
employing an econometric analysis. They find that permit trading would reduce the costs of the
program by 60% compared with a command and control approach.
4. WHY ARE ALLOWANCE PRICES so LOW?
In this section we reconcile the most widely discussed of the discrepancies between
experience and expectations: Why allowance prices are so low? The answer, in this case at
least, is not that the experts are wrong. In fact, the explanations for the divergence between
expectations and observed allowance prices are several, and can be organized into three
groups, as listed in Table 5. First are market fundamentals, which is analogous to the term
used in financial economics that describe changes that have driven down marginal costs of
compliance. Second are regulatory influences that also work to reduce observed allowance
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prices to date. Third are the distinctions between the imagined program that was the subject of
many analyses, and the actual program as set forth in the Clean Air Act.
Table 5: Nine reasons why allowance prices are so low.
Market Fundamentals:
1. Discounting of future costs.
2. Widespread availability of low sulfur coal.
3. Competition and innovation.
4. General equilibrium effects.
Regulatory Influences:
5. Sunk "uneconomic" investments in scrubbers.
6. Annual auction invites strategic under-bidding.
The Imagined versus Real Program:
7. Bonus allowances subsidies for scrubbing delay future costs.
8. Two phases of program segregate sellers and buyers.
9. Substitution and Compensation units delay future costs.
Market Fundamentals
1. Marginal cost estimates that will be incurred in the future should be discounted to the present
to be relevant for current allowance prices.
The single most important factor in comparing the marginal costs of the program with
observed allowance prices to date is the role of discounting. An investment of $126 that is to
be made in the year 2000 for the purpose of compliance has a present value of (1-d)³ 128 in
1997, where d represents a discount rate. For instance if d=.08, then the investment in the
year 2000 has a present value in 1997 of $100. Furthermore, anything that happens to delay
this investment beyond the year 2000 serves to lower its present value.
Most analyses of long run marginal costs which were used for allowance price
projections were built on models that accommodated full implementation of Phase II of Title
IV, which will be felt when the bank from Phase I is drawn down and net contributions to the
bank are zero. The bank is expected to be exhausted toward the end of the next decade.
Table 6 reports several estimates along with the net present value (NPV) of the long run
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marginal costs obtained by discounting these estimates at a rate of 8% per year (real),
assuming these marginal costs were incurred in the year 2010. White et al. (1995) suggest an
8% real discount rate as a benchmark, above the after-tax weighted average cost of capital
(5% real), to account for increased risk as the industry enters a more competitive era, and
uncertainty around the allowance market. White et al. (1995) and ICF (1995) are engineering
studies of marginal costs. The RDI (1995) estimates are projections of allowance prices,
rather than marginal costs per se, so the comparison with the engineering estimates is
somewhat misleading. Several of the complementary explanations we discuss below have
helped to delay the time at which these investments would be needed, thereby lowering the
price of allowances in the present.
Table 6. Estimates of the long run marginal cost of emission reductions, and the role of
discounting future costs for present allowance transactions.
Long Run Marginal Cost
Estimates
Net Present Value
White et al. (1995)
$528
$179
($335-$614)
($114-$209)
ICF (1995)
$516
$175
RDI (1995)*
$220
$75
($100-$360)
($34-$122)
Burtraw et al. (1997)
$284
$97
Notes: * RDI (1995) estimates are for allowance prices rather than marginal costs.
2. Low price and widespread availability of low sulfur coal.
Low sulfur fuel appears to account for about half of the emission reductions in Phase I,
but more importantly it accounts for emission reductions at the margin, serving to set marginal
costs and allowance prices. The most important aspect in the trend toward lower compliance
costs is that, while the demand for low sulfur coal has gone up, the price has gone down due to
dynamic changes in coal markets. Also, there is roughly equal access to low-priced coal to all
utilities affected by Phase I regardless of their location.
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The relevant factor for determining the marginal cost of fuel switching or blending as a
compliance option is the difference between low and high sulfur fuel, termed the "sulfur premium."
This premium widened in 1990, but then stabilized and narrowed in most states since then.
Surprisingly, the shift in demand toward low sulfur coal did not cause the price of low sulfur coal
or the sulfur premium to rise. Thus, switching to low sulfur coal did not entail a major economic
burden, as some analysts for electricity industry had predicted it would in the 1980s.⁴
After Phase II requirements are in place in 2000, the range of sulfur content in coal that
achieves compliance is cut to about half that in Phase I. Focusing demand on this narrower
range of coals will test the capability of the supply system to deliver low sulfur coal at stable
prices. Two questions are central to the determination of future compliance costs. Is it
possible to further increase the infrastructure and efficiency in transporting coal from Wyoming
to the east? Is the low sulfur coal resource base east of the Mississippi large enough to
continue to be an important source of supply to eastern utilities?
Scrubbers may be more important for meeting compliance requirements in the future.
For example, plants that were able to meet Phase I requirements by blending low and high
sulfur coals are likely to be faced with a choice between a switch to low sulfur coal or the
installation of a scrubber. The capital costs associated with switching from high to low sulfur
coal is about 35% of the capital costs of a scrubber per kW of capacity. In addition, if the
answer to either of the two questions raised above about the supply of low sulfur coal turns
out negative, and low sulfur coal is not as competitive in Phase II, scrubbers may be the
cheapest option for meeting the emissions cap.
4 In fact, one industry study suggested the costs of sulfur abatement would be higher if fuel switching played an
important role, because although "intra-firm trading" would reduce expensive scrubbing it would increase
reliance on low sulfur coals resulting in an increased sulfur premium that would raise costs for units already
using low sulfur coal. (TBS, 1986).
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3. Competition and innovation.
The minemouth price of low sulfur coal located in the Powder River Basin has always
been cheaper than eastern alternatives, but the geographic extent of the market has been limited
by transportation costs. As noted by Ellerman and Montero (1996), Fieldston Company (1996)
and Burtraw (1996), the cost of rail transportation from the Powder River Basin to delivery
points east has fallen recently. Because of competition created by the Staggers Rail Act of
1980, the cost of transportation from the Powder River Basin has declined from a rate of over
two mills per ton-mile in the early to mid 1980s to less than one mill per ton-mile today
(Ellerman and Montero, 1996), p 5). Railroad competition has also reduced rail rates for
central Appalachian and midwestern coals, but by less than the reduction in Powder River Basin
rates for delivery to the midwest. As reported by Burtraw (1996, p. 13), transportation rates
dropped from 20-26 mills per ton mile to 10-14 mills over the same period.
Another area of innovation has been coal-blending at the power plant. The blending of
fuels with different sulfur contents was thought difficult before 1990. Since that time engineers
have learned they can blend up to 40% low sulfur subbituminous coals with higher sulfur
bituminous coal, without incurring major capital expense or a decline in performance.
Yet another leading compliance option is scrubbing. The cost of installing and
operating scrubbers has fallen in recent years, no doubt in response to competition from lower
sulfur coal while removal efficiencies have improved. In addition, the fact that "a ton of
emissions saved is an allowance earned" gives an incentive for utilities and scrubber suppliers
to find ways to improve the efficiency of existing scrubbers.
4. General equilibrium effects
One source of systematic bias in engineering models and many economic models is the
failure to take into account all the opportunities that individuals in the economy have to alter the
investment and consumption behavior in response to changes in prices. For instance, since
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electricity prices are affected by the SO2 program, consumers may decide to switch to other
sources of energy services at less cost. Goulder et al. (1996) embed a ballpark estimate of
marginal technological abatement cost within a computable general equilibrium model. This
model allows producers and consumers to substitute among alternatives as the price of electricity
changes reflecting expenditures on technological abatement. These substitutions tend to amplify
emission reductions in their model; consequently, the environmental goal of a 10 million ton
reduction is achieved with less investment in technological abatement than would be anticipated
without such opportunities to substitute, and at a lower cost. They find the general equilibrium
context to lower the private marginal abatement costs by 5 to 15 percent.
Regulatory Influences
5. Regulatory incentives promoted "uneconomic" scrubber investments that, once in place,
have low marginal cost.
Scrubbing accounts for about 50 percent of the emissions reductions in Phase I. This
compliance option has been heavily promoted in some states by the legislatures and state public
utility commissions. Scrubbing involves large up-front capital costs, an anathema in an
industry already burdened by excess generating capacity and facing the prospect that a
significant part of their capital costs cannot be fully recovered in a more competitive market.⁵
Although scrubbers have been installed on 14 plants (26 generating units) to meet Phase I
compliance requirements, their choice may not reflect an underlying economic advantage as
much as favorable regulatory treatment, as described previously. In addition, 19 units qualified
for a significant bonus of emission allowances (3.5 million tons, or over 10 percent of the
allocation in the five years of Phase I) awarded by the CAAA to utilities that add scrubbers in
Phase I. Even with these bonuses, these investments appear uneconomic ex post. Although
from the current perspective capital cost of investments in retrofit scrubbers appear
5 Chao and Wilson (1993) estimate that the option value provided by holding allowances rather than scrubbing
is worth $85 per ton, although their calculations assume that the price of allowances is $400 per ton and the
elasticity of low sulfur coal is very low.
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uneconomic, once in place their operating costs are low, perhaps $60-$90 per ton removed, so
they will be run to full capacity. The operating costs of scrubbing do not determine the
marginal abatement cost, since they are fully utilized. However, they reduce the need and
lower the marginal cost for other compliance options, thereby affecting allowance prices.
6. The annual auction provides incentives for buyers and sellers to understate their opportunity
costs, which may have an influence on allowance prices.
The auction design set forth in the statute is a discriminating price, sealed bid auction
that provides strategic incentives for bidders and sellers to understate their reservation prices
(Cason, 1993, 1995). Whether this incentive has led to average auction prices that are biased
relative to opportunity costs is an open question. Joskow, Schmalensee and Bailey (1996)
argue that the auction has been unimportant with regard to the performance of the allowance
trading program generally. Furthermore, some utilities have argued that they could do better if
they were allowed to retain ownership of allowances that are allocated through the auction.
Ellerman and Montero (1996) suggest, however, that the auction played a useful role in the
early stages of the program in signaling the relatively low compliance costs that faced many
utilities. Further, some brokers and utilities report that future allowance transactions are
hinged to the auction price, so that any change in the auction would disrupt the evolution of
the market. Whether or not the auction design is amended in the future, evidence is consistent
with the notion that the annual auction is poorly designed and provides a price signal below
true opportunity costs. Whether the influence of the auction is or is not important has not been
determined convincingly
The Imagined versus Real Program
7. Bonus allowances add to the surplus of allowances in the early stage of the program, with
downward pressure on price.
One aspect of Title IV that was not included in many early models of the program is
the role of bonus allowances for utilities that chose to meet emission reductions through
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scrubbing. These allowances expand the amount of Phase I allowances available by 3.5
million, over 10 percent of allocations in Phase I. This increase in supply in the near term
places downward pressure on costs and on allowance prices by delaying the necessity of
abatement expenditures.
8. The two phases of the program segregate most potential allowance sellers into Phase I and
buyers into Phase II, resulting in a near term downward trend in the price of allowances.
Burtraw et al. (1997) estimate the mean marginal abatement cost weighted by emissions
at various facilities in 1994. They find the cost for Phase I facilities in 1994 to be $60, and for
Phase II facilities to be $384. This difference suggests that a substantial bank would accumulate
to delay the relatively more expensive abatement efforts that otherwise would be required from
Phase II facilities after 2000. If the allowance market performed perfectly, the accumulation of
an allowance bank would not necessarily have an impact on the relationship between observable
allowance prices and marginal costs. However, to the extent there are market imperfections,
less than perfectly rational planning, or regulatory intervention, the asymmetry between Phase I
and Phase II may exacerbate trends in the allowance market that are unrelated to technological
costs pushing down current allowance prices.
9. The opportunity to rely on Substitution and Compensation units further reduces the costs of
complying with Phase I emission reductions.
Substitution and Compensation units voluntarily brought into Phase I typically have the
lowest marginal costs of units affected in Phase II. By opting into Phase I, managers at these
units can begin emission reductions at these units and delay reductions at other units by
building up their allowance bank. Hence, to the extent that the surplus of allowances in
Phase I leads allowance prices to diverge from naive estimates of marginal abatement cost, this
trend would be exacerbated by the opportunity to use Substitution and Compensation units in
Phase I.
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5. CONCLUSION
The puzzle that has emerged from the early experience with the SO2 allowance trading
program is: Why are allowance prices so low, especially when trading volume appears to be
lower than expected? This paper offers several answers to this question. The conclusion that
emerges is that the institution of allowance trading and the flexibility it gives to firms has
enabled electric utilities to achieve environmental goal at dramatic reductions in costs,
compared to previous regulatory experience. However, one must also consider the particular
aspects of this program that delay significantly the time at which future investments will be
incurred. This often overlooked factor also contributes significantly to the low allowance
prices that have been observed in the first years of the program.
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REFERENCES
Bailey, E. M. 1996. Allowance Trading Activity and State Regulatory Rulings: Evidence
from the U.S. Acid Rain Program, MIT-CEEPR 96-002WP, Massachusetts Institute of
Technology.
Bohi, D. R. 1994. The Electricity Journal, 7, pp. 20-27.
Bohi, D. R., and D. Burtraw. 1992. Resources and Energy, 14, pp. 129-153.
Burtraw, D. 1996. Contemporary Economic Policy, 14, pp. 79-94.
Burtraw, D., C. Carlson, M. Cropper, and K. Palmer. 1997. "Econometric Estimates of SO2
Abatement Costs Under Title IV," in Proceedings of AWMA/Acid Rain Electric Utilities
Conference.
Cason, T.N. 1993. Journal of Environmental Economics and Management, 25, pp. 177-
195.
Cason, T.N. 1995. American Economic Review, 85, pp. 905-922.
Chao, H.-P., and R. Wilson. 1993. Journal of Regulatory Economics, 5, pp. 233-249.
Conrad, K., and R. E. Kohn. 1996. Energy Policy, 24, pp. 1051-1059.
Dean, M., and J. Kruger. 1997. "Using EPA's Allowance Tracking System to Assess the
Allowance Market," in Proceedings of AWMA/Acid Rain Electric Utilities Conference.
Ellerman, A. D., and Juan-Pablo Montero. 1996. "Why are Allowance Prices so Low? An
Analysis of the SO2 Emissions Trading Program," MIT-CEEPR working paper.
Fieldston Company, Inc. 1996. Coal Supply and Transportation Markets During Phase One:
Change, Risk and Opportunity, prepared for Electric Power Research Institute, TR-
105916.
Fullerton, D., S.P. McDermott, and J.P. Caulkinset. 1996. Sulfur Dioxide Compliance of a
Regulated Utility (Austin, Texas, University of Texas at Austin, Department of
Economics).
Goulder, L. H., I. W.H. Parry, and D. Burtraw. 1996. Revenue-Raising VS. Other
Approaches to Environmental Protection: The Critical Significance of Pre-Existing Tax
Distortions, Discussion Paper 96-14, Resources for the Future, Washington D.C., April.
ICF. 1989. Economic Analysis of Title V (sic) (Acid Rain Provision) of the Administration's
Proposed Clean Air Act Amendments (HR 3030/S 1490), prepared for the U.S.
Environmental Protection Agency.
ICF. 1995. Economic Analysis of Title IV Requirements of the 1990 Clean Air Act
Amendments, prepared for the U.S. Environmental Protection Agency.
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Joskow, P.L., R. Schmalensee, and E. M. Bailey. 1996. "Auction Design and the Market for
Sulfur Dioxide Emissions," mimeo, MIT Center for Energy and Environmental Policy
Research.
Lile, R. D., D. R. Bohi, and D. Burtraw. 1996. An Assessment of the EPA's SO₂ Emission
Allowance Tracking System (Washington, D.C., Resources for the Future).
Molburg, J. C., J. A. Fox, G. Pandola, and C. M. Cilek. 1991. Analysis of the Clean Air Act
Amendments of 1990: A Forecast of the Electric Utility Industry Response to Title IV,
Acid Deposition Control, ANL/EAIS/TM-81, Argonne National Laboratory.
Montero, J-P., A. D. Ellerman, and R. Schmalensee. 1996. "The U.S. Allowance Trading
Program for Sulfur Dioxide: An Update After the First Year of Compliance," unpublished
mimeo (draft), Massachusetts Institute of Technology.
Reid, J., D. R. Bohi, and D. Burtraw. 1994. Recommendations to NAPAP Regarding SO2
Emission Projections (Washington, D.C., Resources for the Future).
Resource Data International, Inc. (RDI). 1995. RDI's Phase I 1995 Databook (Boulder,
Colorado, RDI).
Rose, K. 1992. Public Utility Commission Implementation of the Clean Air Act's Allowance
Trading Program (The National Regulatory Research Institute, Ohio State University).
Rose, K. 1997. Market Based Approaches to Environmental Policy: Regulatory Innovations
to the Fore, R. F. Kosobud and J. M. Zimmerman, eds. (New York, N.Y., Van Nostrand
Reinhold), forthcoming.
Temple, B., and Sloane, Inc. 1986. Evaluation of H.R. 4567: The 'Acid Deposition Control
Act of 1986', prepared for the Edison Electric Institute.
U.S. General Accounting Office (USGAO). 1994. Air Pollution: Allowance Trading Offers
an Opportunity to Reduce Emissions at Less Cost, GAO/RCED-95-30.
U.S. National Acid Precipitation Assessment Program (NAPAP). 1991. 1990 Integrated
Assessment Report, Washington D.C.
Van Horn Consulting, Energy Ventures Analysis, Inc., and K. D. White. 1993. Integrated
Analysis of Fuel, Technology and Emission Allowance Markets, EPRI TR-102510,
prepared for the Electric Power Research Institute.
White, K. D., Energy Ventures Analysis, Inc., and Van Horn Consulting. 1995. The Emission
Allowance Market and Electric Utility SO₂ Compliance in a Competitive and Uncertain
Future, prepared for the Electric Power Research Institute, EPRI TR-105490s.
Winebrake, J., M. A. Bernstein, and A. E. Farrell. 1995. The Electricity Journal, 8, pp. 50-54.
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RESOURCES
FOR THE FUTURE
An Assessment of the EPA's SO₂
Emission Allowance Tracking System
Ronald D. Lile
Douglas R. Bohi
Dallas Burtraw
Discussion Paper 97-21
November 1996
Resources for the Future
1616 P Street, NW
Washington, DC 20036
Telephone 202-328-5000
Fax 202-939-3460
© 1997 Resources for the Future. All rights reserved.
No portion of this paper may be reproduced without
permission of the authors.
Discussion papers are research materials circulated by their
authors for purposes of information and discussion. They
have not undergone formal peer review or the editorial
treatment accorded RFF books and other publications.
An Assessment of the EPA's SO₂ Emission Allowance Tracking System
Ronald D. Lile, Douglas R. Bohi, and Dallas Burtraw
Abstract
On November 8, 1996, various Environmental Protection Agency (EPA) officials, scholars
and industry representatives gathered at Resources for the Future (RFF) to examine the EPA's
method for classifying private SO₂ allowance transactions by the Allowance Tracking System
(ATS). The one-day workshop at RFF was designed to evaluate how well the EPA's classification
scheme within the ATS currently meets the needs of constituencies with a vested interest in the
allowance trading system, and to determine if other classifications would be more beneficial. The
EPA has limited its collection of information to that which is necessary to ensure compliance with
environmental goals. In particular, the EPA has interpreted its mission to be one of minimal
interference in guiding the development of the allowance market and that its primary purpose is
emission compliance and not the monitoring of transactions. Therefore, the goal of the ATS is to
provide a central registry of recorded allowance transfers for the purpose of emission compliance.
As a result, the ATS is unusual as a mechanism for monitoring market activity because it provides
information about the buyer and seller of an allowance but does not provide price information.
Furthermore, the EPA has limited its role so as not to exercise approval of individual allowance
trades, and has excluded from consideration options for expanding the EPA's data collection effort.
However, the EPA recognizes that the interests of Congress and the public extend beyond
compliance with the environmental goals to include the development of allowance trading to help
achieve these goals at the lowest possible cost. In addition, there is widespread interest in the
development of SO₂ emission allowance trading as a prototype for other potential trading
programs, and the ATS provides a potential template for the oversight role of the environmental
regulator in programs such as these. Therefore, another goal of the workshop at RFF was to
assess how well the ATS performs in promoting the development of allowance trading in general,
and with respect to the interests and needs of each of the constituencies interested in the SO₂
allowance trading program. This discussion paper incorporates observations, suggestions and
concerns expressed during this workshop. Furthermore, this discussion paper concludes with
recommendations regarding the EPA's current classification methodology.
Key Words: transaction costs, regulated industries, electric utilities, emissions
JEL Classification Nos.: D23, D49, H70, K23, L94, Q25
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Table of Contents
Introduction
1
The Organization of ATS
3
Classifying Allowance Transactions and Capturing Transactions Costs
5
Inter-utility
7
Reallocation
7
Intra-utility
9
Broker to utility, utility to broker/trader, fuel company to utility and utility to
fuel company
10
Other
10
An Illustration of the Current Taxonomy
10
Strategic Behavior in Trading Activity
13
What Needs to be Done to Improve the Market, and Is There a Role for ATS in
Doing So?
14
Observations About the Future
15
Summary and Recommendations
16
List of Participants at the November 8 Meeting
18
List of Figures and Tables
Figure 1. Current methodology
6
Figure 2. Previous methodology
6
Table 1.
Examples of Inter-Utility and Intra-Utility Trades
11
Table 2.
Examples of Reallocations and Intra-Utility Trades
11
Table 3.
Examples of Trades Involving Co-owners
12
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An Assessment of the EPA's SO₂ Emission Allowance Tracking System
Ronald D. Lile, Douglas R. Bohi, and Dallas Burtraw¹
INTRODUCTION
Allowance trading is an innovative feature of Title IV of the 1990 Clean Air Act
Amendments, intended to reduce the costs of compliance with the goals of the statute. Title
IV is a precedent-setting approach to environmental legislation that places government in the
role of setting standards of performance, while leaving to the private sector the task of finding
the best way to meet these standards. This approach provides the firm with the flexibility to
find the most cost effective way of achieving the standard. The allowance trading program has
the potential of dramatically lowering the costs of attaining the environmental goal of a
national average cap on SO₂ emissions.
Title IV requires the Environmental Protection Agency (EPA) to establish a system for
the collection of information on allowance transfers, primarily for the purpose of monitoring
compliance. The system that has been established is known as the Allowance Tracking System
(ATS). Although its primary function is to facilitate regulatory oversight of compliance, the
information that is available in the ATS is of interest to a number of constituencies for various
purposes. Allowance brokers and electric utilities potentially could rely on the ATS to provide
information about trading activity. Regulators could rely on the ATS to provide information
that may be relevant to oversight of utility compliance activities and cost recovery. Policy
analysts and Congress could rely on the ATS to provide an indication of the performance of
the market and its effect on the costs of implementing emission reductions under Title IV. In
1
The authors are, respectively: Research Assistant, Energy and Natural Resources Division, Resources for the
Future; Senior Fellow and Division Director, Energy and Natural Resources Division, Resources for the Future;
and Fellow, Quality of the Environment Division, Resources for the Future. This research was supported in
part by funding from the EPA. We would like to thank the participants at RFF's November 8, 1996 workshop
on the EPA's Allowance Tracking System for their constructive contributions to this report. Furthermore, we
received helpful comments from EPRI's Keith White. In addition, we are especially grateful to Melanie Dean,
Joe Kruger and Alex Salpeter of the EPA's Acid Rain Office for their generous assistance. All remaining errors
are the responsibility of the authors.
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addition, environmental advocates are interested in the ATS for information on the influence of
allowance trading on the geographic or temporal pattern of emissions.
On November 8, 1996, various EPA officials, scholars and industry representatives
gathered at Resources for the Future (RFF) to examine the EPA's method for classifying
private SO₂ allowance transactions by the Allowance Tracking System (ATS). The one-day
workshop at RFF was designed to evaluate how well the EPA's classification scheme utilizes
information in ATS to meet the needs of constituencies with a vested interest in the allowance
trading system, and to determine if other classifications would be more beneficial.
The EPA has limited its collection of information to that which is necessary to ensure
compliance with environmental goals. In particular, the EPA has interpreted its mission to be
one of minimal interference in guiding the development of the allowance market and that its
primary purpose is emission compliance and not the monitoring of transactions. Therefore, the
goal of the ATS is to provide a central registry of recorded allowance transfers for the purpose
of emission compliance. As a result, the ATS is unusual as a mechanism for monitoring market
activity because it provides information about the buyer and seller of an allowance but does not
provide price information. Furthermore, the EPA has limited its role so as not to exercise
approval of individual allowance trades, and has excluded from consideration options for
expanding the EPA's data collection effort. It is the EPA's contention that the private sector
should fill the information void, to the extent that the market needs a clear indication of
allowance prices in order to be able to function. Such information is widely available from
several sources and is reasonably accurate.
However, the EPA recognizes that the interests of Congress and the public extend
beyond compliance with the environmental goals to include the development of allowance
trading to help achieve these goals at the lowest possible cost. In addition, there is widespread
interest in the development of SO₂ emission allowance trading as a prototype for other
potential trading programs, and the ATS provides a potential template for the oversight role of
the environmental regulator in programs such as these. Therefore, another goal of the
workshop at RFF was to assess how well the ATS performs as an evaluation mechanism for
allowance trading activity, with respect to the interests and needs of each of the constituencies
interested in the SO₂ allowance trading program. This paper is an assessment of the ATS in
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this regard. Observations, suggestions and concerns expressed during the workshop have been
incorporated into this assessment.
THE ORGANIZATION OF ATS
The ATS is a database operated and maintained on EPA's National Computer Center.
While ATS itself cannot currently be directly accessed, EPA provides weekly extracts of the most
relevant information. These extracts, i.e., electronic files, can be assessed electronically by the
public through the World Wide Web (address: http://www.epa.gov/acidrain/atsdata.html). As
discussed below, expanded capabilities that will allow the public interactive access to these data
files are in development at the EPA and are expected to be available in the summer of 1998. The
following files derivable from ATS are the most relevant to the trading analysis:
ACCOUNT -- contains information such Account Number, Account Name, Account
Rep ID, Alternate Rep ID, Plant ID/ORISPL, Unit/Boiler ID and various flags
denoting type of account.
REPRESENTATIVES -- contains information such Account Rep/Alternate ID,
Name, Address, Phone Number.
OWNERS -- contains Account Number, Owner ID, Owner Name, Binding Parties.
TRANSACTIONS -- contains information such Transaction Number, Transaction
Type, Date Received, Date Recorded, Transferee Account, Transferor Account,
Account Rep for Transferee, Account Rep for Transferor, Amount of Allowances
Transferred.
ALLOW_IN_TRANSACT -- contains information on allowances involved in a given
transaction such as Transaction Number, Starting Serial Number, Ending Serial Number.
ALLOW_HELD_BY_ACCOUNT: contains information on Account, Allowance
Use Year, and Serial Number.
UTILITY -- information on the utility company that operates (responsible for
dispatching) a given plant.
PLANT -- contains information on the State where Plant Located.
PLANT_UTILITY_XREF -- a file combining the PLANT and UTILITY
information, for effective retrieval/query.
These files provide various ways to view current allowance data. These are very large
files. For example, the TRANSACTION file includes over 9,500 transactions involving over
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41 million allowances. The TRANSACTIONS file may include transactions among unit
accounts, which are accounts associated with generating units, and general accounts, which
can be set up by any person, group or corporation.² The general account differs from the unit
account because it is not associated with an individual generating unit. There are a variety of
reasons that the data in these files may not provide information in a form that is useful to
potential users. For instance, a transfer from a unit account to a general account and another
transfer back to the original unit account would show up as two separate transactions that
actually cancel each other out. Such a sequence of transactions is not unusual. To understand
the data, the user needs to conduct some analysis. However, the website does not offer the
option of merging files or conducting searches yet. However, files can easily be downloaded
and manipulated by interested parties.³
To facilitate monitoring of the allowance market for the various purposes suggested
above, the EPA's Acid Rain Division has devised a routine to categorize allowance transfers.
EPA runs several queries on ATS data to produce a file with most of the information necessary
to classify a trade. Using this consolidated information, the EPA can organize allowance
transfers according to various categories that are viewed as meaningful for economic and
environmental measures of the program. The EPA places allowance transactions in the
following categories: Intra-Utility, Inter-Utility, Utility to Broker, Broker to Utility, Utility to
Fuel Company, Fuel Company to Utility, Reallocation and "Other." These categories represent
all private trades reported to ATS. Since the ultimate goal is emissions compliance by utilities,
allowance transfers viewed as meaningful for economic and environmental measures of the
program involve those allowances acquired by utilities. As noted, the Acid Rain Division is in
the process of converting the ATS from a mainframe system to a Windows based system. The
new windows based system should allow for interactive data filtering and manipulation.
Currently, users must rely on analysis already conducted and posted by the EPA, or download
the entire database to another computer to perform independent analysis. In addition, the Acid
2 A unit may be owned by more than one operating company. A transfer from a unit account to a general
account of any of the owners is classified a reallocation. For further explanation, see the discussion of
Reallocations in the text.
3 Another feature utilizing the above ATS data, but not available on the website, is a "history search." This
feature enables the EPA to track the entire history of an allowance by its serial number.
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Rain Division is in the process of developing an electronic transfer program, which converts
the ATS into a paper-less system. A pilot program is planned for next year with the Southern
Company. However, there are some obstacles that will need to be resolved before the
electronic transfer program is fully implemented, such as an amendment to the current
requirement that a transfer include both the seller's and buyer's signature.
CLASSIFYING ALLOWANCE TRANSACTIONS AND CAPTURING TRANSACTIONS COSTS
The primary interest of most users of the ATS involves a measure of "meaningful
transactions." A transfer between units owned by the same utility might be meaningful for
analysis of the environmental effects of sulfur dioxide emissions. Such a transfer also may be
meaningful for an assessment of cost savings from flexibility resulting from transfers within a
firm. However, the greatest interest among users of the ATS hinges around economically
meaningful transfers between economically separate organizations, which provides evidence of
the role of allowance trading for compliance. It also provides information about the value and
availability of allowances that are of direct interest to utilities and brokers.
The Acid Rain Division's current taxonomy for categorizing allowance transactions
and its previous taxonomy concentrate on organizing transactions to identify economically
meaningful transfers among separate organizations. The main distinction between the previous
classification scheme and the current scheme is the definition of inter-utility transactions.
These approaches to the classification are presented in full in Dean and Kruger (1997).4 The
categories that are used to organize transfers along with observations and potential problems
are listed below. Although the categories themselves are stable, the categorizations of a
transaction between two particular entities may become dated due to mergers and acquisitions.
4 "Using EPA's Allowance Tracking System to Assess the Allowance Market," Melanie Dean and Joe Kruger,
Proceedings of AWMA/Acid Rain Electric Utilities Conference, January 1997.
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Figure 1. Current methodology:
1,918,979 Allowances Acquired by Utilities through Private Transactions Reported to ATS from 1/96
through 9/96
Broker to Utility
27.0%
Intra-Utility 51.8%
Fuel Co to Utility
1.9%
Within Operating Co. 65%
Within Holding Co. 35%
Inter-Utility
19.4%
Figure 2. Previous
1,895,061 Allowances Acquired by Utilties through Private Transactions Reported to ATS from 1/96
through 9/96
Broker to Utility
19.6%
Intra-Utility
34.2%
Fuel Co to
1.6%
Inter-Utility
44.7%
"Two Main distinctions from the current methodology - No breakdowns within the Intra-Utility trades and
trades between two different operating companies are classified as Inter-utility trades (even if they are
within the same holding co.)
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Inter-utility⁵
The current scheme defines inter-utility transfers as any transfer of allowances from
one utility operating company's account to a different operating company's account, provided
the operating companies are not controlled by the same holding company. These are viewed as
economically distinct transactions. If the transaction involves a trade between two units
affiliated with the same holding company, it is classified as an intra-utility transaction under the
current scheme.
The previous scheme classified all transactions between operating companies as inter-
utility transactions, without a clear differentiation about their status with regard to a holding
company. As a result, this scheme overstated inter-utility transactions compared to the current
approach. Figures 1 and 2 illustrate the overstatement for the period of 1 January 1996
through 31 October 1996, although the magnitude of the overstatement is inflated in this
example because January had the largest number of intra-utility transfers in the history of the
trading program. To improve the accuracy of the classification, the current classification
algorithm determines the unit's holding company affiliation before classifying the transaction. 6
One reason for emphasizing the difference among these type of trades in the current scheme is
that these type of trades have different transactions costs.
Reallocation
Reallocation transfers are defined as any transfer from a unit account to a general
account of the same operating company or holding company (and, in given circumstances, vice
versa), any pooling activity, or any transfer in which the transferor is the partial owner of the
transferee account (and vice versa).
Since the statute requires each unit (not plant) to be in compliance at the end of each
year, the initial allocation of allowances goes to the generating unit account. Firms may want
to aggregate allowances from various unit accounts into one or more general accounts to more
5 At the workshop, the EPA presented two sub-categories for the Inter-utility classification: economically
distinct and "among co-owners." As a result of the workshop, the EPA has moved the "among co-owners"
distinction to the Reallocation classification.
6 Holding company information is not part of the ATS, but can be found in publicly available sources such as
The Electrical World's Directory of Electric Power Producers.
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easily assess allowance holdings and needs for the future, and potentially to facilitate allowance
transactions with other firms. However, when an allowance is used for compliance at a
specific generating unit, the allowances must first be reallocated to the unit account associated
with that generating unit.
Furthermore, when a generating unit is owned jointly by multiple operating companies,
the allocation of allowances to that unit also goes to the unit's account which, as in all cases,
has an authorized account representative. That representative is responsible for reallocating
the allowances among co-owners according to mutually agreed upon guidelines. Some co-
owners view the allowances as assets and these owners want it reflected on their books, which
provides one of many possible motivations for reallocation among co-owners. The transfer of
allowances to a general account obfuscates the question of compliance at a unit until the time
for truing up comes at the end of the year.
Although the ATS data indicates when there are co-owners of a unit, the ATS does not
indicate how an account for that unit will be managed among co-owners. Some state PUCs
prevent automatic separation of allowances among co-owners. Consequently it is not possible
for the EPA to employ a consistent algorithm for categorizing allowance reallocations among
co-owners. One possibility would be for the agency to gather information from the manager of
the unit account about the rules for reallocation, but this takes the agency in a direction other
than its principle mission which concerns compliance activities. The goal of the EPA's
categorization algorithm is to indicate these as reallocations rather than economically
meaningful inter-utility transfers.⁷
The EPA currently evaluates the "ownership" on both sides of each transfer. This is
done by determining the binding parties of both the transferee and transferor of allowances. If
there is overlap of any degree, the EPA classifies this transaction as a Reallocation. As a result,
this approach captures all transfers among co-owners as reallocations. This approach would be
imperfect because in some cases a co-owner may reallocate an allowance originally allocated to
a different unit to the co-owned generating unit for compliance purposes, while allocating
allowances from the co-owned unit to other purposes. This reallocation may in fact be an Intra-
utility transfer. However, for the sake of the methodology's validity, the EPA has decided to err
7 At the workshop, the EPA presented transactions among co-owners as Inter-utility transfers. However, as a
result of the workshop, the EPA now considers all transactions among co-owners as Reallocations.
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on the conservative side by under reporting transactions that may be economically significant.
Although the EPA has acknowledged that this methodology will underestimate Intra-utility
transfers, this methodology is the best plan that has been suggested to date.
Intra-utility
Within the intra-utility transactions, there are two sub-categories: transactions between
units within the same operating company (we label these "Intra-utility Class 1") and
transactions between units owned by different operating companies within the same holding
company (we label these "Intra-utility Class 2"). The sub-category distinction is useful because
each sub-category has different transactions costs. An Intra-utility Class 1 transaction is
defined as either a transfer from one unit account to another unit account within the same
operating company or, in some cases, a transfer from a general account of one operating
company to a unit account of the same operating company. An Intra-utility Class 2 transaction
is defined as either a transfer from a unit account of one operating company to another unit
account of a different operating company within the same holding company or, in some cases,
a transfer from a general account of one operating company to a unit account of a different
operating unit within the same operating company.
Trades within the same operating company are likely to have lower transaction costs
than trades between operating companies within the same holding company. In some cases
trades among operating companies within the same holding company can have transaction
costs that are higher than inter-utility trades. One reason is that the Public Utilities Holding
Company Act (PUHCA) requires special reporting requirements for holding companies (Parent
companies that are not holding companies under PUHCA are not required to follow these
requirements.). These reporting requirements have an impact on transactions costs. 8 Any kind
of reallocation or transaction between operating companies (under the PUHCA) must be
documented at the market price. Since it is difficult to adhere to these reporting requirements,
utilities turn to the market. This is one of the reasons for treating these trades differently.
8
Transaction costs for trades among operating companies within the same holding company may have be large
when the operating companies are in different states and thus have different regulatory rules.
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Broker/trader to utility, utility to broker/trader, fuel company to utility and utility to fuel company
These classifications are relatively self-explanatory. The EPA created these categories
specifically to report on the data and to limit its interpretive role. However, there is the
possibility of confusion in the case where some companies perform dual roles. To clarify the
role of these "dual role" market participants, EPA determines from the participant its
predominant role, and then EPA classifies them accordingly.
One important concern in registering trading activity involving brokers is the desire to
avoid double-counting brokered transactions. This could occur if a broker took possession of
an allowance and registered its possession with the ATS. If this was the vehicle for managing a
transfer between utilities, two transactions would be reported when only one meaningful
transaction really occurred.
An important factor concerns the type of brokers involved in a trade, and there are
basically two types of brokers. One type takes title to an allowance and the other that doesn't
take title. As a result, it is difficult to determine the incremental transaction costs associated
with brokered transactions. Transactions involving brokers that do not take title will not be
captured by the ATS, so double-counting will be avoided.
Other
All transactions that do not fall into the previous categories are classified as "other."
So far the "other" category involves an insignificant number of transactions and allowances.
AN ILLUSTRATION OF THE CURRENT TAXONOMY
The current taxonomy will successfully organize the majority of private allowance
transfers registered with the EPA into useful and descriptive categories. Tables 1 and 2
illustrate the distinction between reallocations, inter-utility and intra-utility trades. However, as
the previous section indicates, there are still ample opportunities to mis-classify market activity.
As noted above, the intra-utility trades involve two sub-categories in which we have
called "Intra-utility Class 1" and "Intra-utility Class 2" trades. Furthermore, each sub-category
had two possibilities: one strictly involving unit accounts and the other involving general
accounts. Table 1 illustrates Intra-utility trades, both Class 1 and Class 2, involving only unit
accounts. Table 1 also includes an example of an inter-utility trade. In contrast, Table 2
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illustrates Intra-utility trades, both Class 1 and Class 2, involving general accounts.
Furthermore, Table 2 combines intra-utility trades with reallocations to illustrate the similarity
between these types of trades.
Table 1. Examples of Inter-Utility and Intra-Utility Trades
Inter-Utility
unit account
unit account
operating company A
operating company B
Intra-Utility
Class 1
unit 1 account
unit 2 account
operating company A
operating company A
Intra-Utility
Class 2
unit 1 account
unit 2 account
operating company A
operating company B
subsidiary of holding company
subsidiary of holding company
Z
Z
Table 2. Examples of Reallocations and Intra-Utility Trades
Reallocation
Reallocation
unit 1 account
general account
unit 1 account
operating company
operating company A
operating company A
A
Reallocation
Intra-Utility
Class 1
unit 1 account
general account
unit 2 account
operating company A
operating company A
operating company A
Reallocation
Intra-utility
Class 2
unit 1 account,
general account,
unit 2 account,
operating company A
operating company A
operating company B
subsidiary of holding
subsidiary of holding
subsidiary of holding
company Z
company Z
company Z
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Table 3. Examples of Trades involving Co-owners
Reallocation
Inter-Utility
unit 1 account
general account
unit account
co-owned by
operating company A
operating company
operating companies
D
A, B, C
Reallocation
Reallocation*
unit 1 account
general account
unit 2 account
co-owned by
operating company A
co-owned by
operating companies
operating companies
A, B, C
A, B, C
Reallocation
Reallocation*
unit 1 account
general account
unit 2 account
co-owned by
operating company A
co-owned by
operating companies
operating companies
A, B
C,D
A: subsidiary of
C: subsidiary of
holding company Z
holding company Z
B: subsidiary of
D: subsidiary of
holding company Y
holding company X
Reallocation
Reallocation
unit 1 account
general account
unit 1 account
co-owned by
operating company A
co-owned by
operating companies
operating companies
A, B, C
A, B, C
Inter-Utility
unit account
unit account
co-owned by
operating company C
operating companies A, B
Reallocation*
unit 1 account
unit 2 account
co-owned by
co-owned by
operating companies A,B
operating companies A,C,D
Reallocation*
unit 1 account
unit 2 account
co-owned by
operating company c
operating companies A, B
subsidiary of
A: subsidiary of holding company Z
holding company Z
B: subsidiary of holding company Y
*
This is an example that could be classified as an Intra-utility Class 1 transfer and as a result would not be
captured as such by the ATS.
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Table 3 captures the issues involving co-ownership of generating units. There is the
possibility of confusion in classifying Reallocations, Intra-utility or Inter-utility where a unit has
multiple owners. As explained above, the EPA's categorization algorithm is to determine the
binding parties (co-owners of generating unit accounts or general accounts) of both the
transferee and the transferor of a transaction. If there is any degree of overlap the trade is
classified as a Reallocation.⁹ If ownership differs on both sides of the trade, the trade is
considered an Inter-utility trade. This approach is imperfect because in some cases a co-owner
may reallocate an allowance originally allocated to a different unit to the co-owned generating
unit for compliance purposes, while allocating allowances from the co-owned unit to other
purposes. This reallocation may in fact be an Intra-utility Class 1 transfer.
Due to this classification methodology, the EPA's current taxonomy will underestimate
Intra-utility transfers. Nonetheless, since the Reallocation methodology errs in a conservative
manner, this categorization algorithm is the best option short of expanding the EPA's data
collection. It is evident that, as the number of co-owners increase, it is more difficult to
categorize the trades. Furthermore, as noted before, as operating companies merge, this
problem is exacerbated.
STRATEGIC BEHAVIOR IN TRADING ACTIVITY
Several hypothetical or imagined behaviors by participants in the allowance market have
led to questions about whether there is strategic behavior that will obscure important allowance
trading activities. One suggestion is that brokers or utility companies might "churn" the market
in order to register a false level of trading activity. However, according to participants at the
RFF workshop, brokers do not perform extra transactions just to "show" activity. Furthermore,
the ATS does not capture transactions unless they are reported to the ATS, which involves a
further level of accounting effort that would discourage "churning" the market.
An obvious motivation for strategic behavior stems from the current regulated nature
of the utility industry, both for purposes of environmental compliance and for cost recovery.
There are numerous interested parties including environmental groups and rate payers who
would like to have a say in the decisions of utilities. In this light, maneuvers to obfuscate
9 As noted before, this categorization algorithm may miss some economically distinct transactions.
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trading activity might be viewed as a fundamental contradiction between the interests of the
public and the private. Some observers have suggested that utilities have occasionally used
forward contracts to postpone taking possession of allowances and thereby avoid or postpone
either regulatory interference or the attention of environmental watchdog groups.
The impending restructuring of the electricity industry, accompanied by some degree of
deregulation or "re-regulation," also has strategic implications for participants in the allowance
market. Allowance trading activity can be a signal of future investment plans. Further, since
allowances constitute a sizable asset themselves, a utility may want to veil its activity in the
allowance market, for competitive reasons. Since trades do not have to be recorded with the
ATS until they become relevant for compliance, there may be less information content about
actual trading volume in the ATS in the future than there has been to date. In the future, the
motivation for the use of instruments such as forward contracts may follow from the
competitive pressures of the industry.
For these reasons there is an apparent conflict between the interests of analysts who
wish to obtain detailed information about the market, presumably through the ATS, and the
interests of participants in the market who wish to keep information about their own plans and
operations private. The paradox is that to the extent the interest for public disclosure prevails,
providing a better measure of market performance, the market may do less well, as participants
retreat from public scrutiny or the scrutiny of their competitors. The advice from many
participants seems to be that the market will work best if it is left alone. However, if the SO₂
trading program and the ATS are to serve as a basis for other regulatory experiments at the
national or state level, there will have to be some meaningful way to gauge the performance of
these institutions and to garner lessons for the design of new ones.
WHAT NEEDS TO BE DONE TO IMPROVE THE MARKET, AND IS THERE A ROLE FOR ATS IN DOING SO?
This question invoked opposing views from participants at the RFF workshop. One
view argued there is nothing wrong with the ATS or the market. The market is currently thin
and in time will become more active. Furthermore, the only existing problem is "bad"
information. From this perspective, when the EPA puts out incomplete information it leads to
confusion. Moreover, the market doesn't need the EPA to analyze the data because private
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market analysts can do it. Private sources are supplying market information that is valued
higher than that supplied by EPA.
A contrasting view is there are inadequacies in the market and that private sources of
market information that may cause confusion. In particular, private sources of information
may not be reliable for policy evaluation purposes. The EPA can provide a source of
information that in principle would be free of any bias. This view prompted the following
rejoinder: "What makes the EPA's interpretation right and all of the others wrong?"
If the information that EPA supplied was transparent and objective, then there would
be no opposition to the EPA supplying it. However, if the information was transparent and
objective, then why would the market need it? However, one might answer that the EPA is the
primary institution with perspective, incentive and responsibility to identify shortcomings in the
market if they exist. The organization of data in the ATS is the way such potential
shortcomings can be identified. In many cases, the proprietary interests of the private parties
may limit their disclosure of data or it may render data too expensive for "public interest"
groups seeking access.
There is also a difference of opinion over how well the market is working. Many
market observers note that some potentially important traders have yet to get into the market,
with the result that sizable potential cost savings are unrealized. The ATS is the source of
information that would allow an analysis of this issue. Nonetheless, to say the market is partly
broken is not to say that it needs to be fixed, but indeed the infant market may do well if left
alone, especially under increasing competitive pressures in the industry to find ways to reduce
costs. In any event, there is little to suggest that manipulation of information in the ATS or
changes in the collection of data are ways to get players in the market.
OBSERVATIONS ABOUT THE FUTURE
Several changes are occurring that signal a maturation of the allowance market. One is
in the public attitude with respect to the role of allowance trading as a means to reduce the
cost of pollution control. Many observers suggest that environmental advocacy groups are no
longer interested in looking at each trade from an environmental perspective. These groups
have finally moved over to the EPA's stance that, for environmental purposes, aggregate trades
and emissions are important, not individual trades and emissions. This shift in attitude seems
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to indicate that one constraint on active participation in the market that has deterred some
potential trading activity, the harsh scrutiny of advocacy groups and negative characterizations
in the media, may be of diminished importance in the future.
The second trend that bodes well for the allowance market is increasing competition in
the electric industry and the resulting pressure to reduce costs. In the future this pressure may
override other obstacles that may have hindered the allowance trading activities of some utilities
to date. Ironically, though, the move toward a more competitive industry environment will also
make it harder for analysts to gather information from market participants, as it will be in the
interests of those participants to veil their activities for strategic competitive purposes.
In Phase I of the SO2 trading program, which began in 1995, the goal of most utilities
has been to over-comply with necessary emission reductions in order to bank allowances for
Phase II. In doing so, utilities have been able to put off capital costs as long as possible,
including installing scrubbers. Since there is an abundant supply of Powder River Basin (PRB)
coal (low sulfur coal) at relatively low prices, compared to the costs of capital investments for
compliance, there may be further delays in the capital investments compared to what was
expected when the program was adopted in 1990. The opportunity to delay large investments
is consistent with the value of waiting in making capital investments in an uncertainty
environment. The implication is that the flexibility implicit in the allowance trading program
will be put to great use.
One area where market participants may desire greater information concerns a timely
report of emissions data. Although the brokers and the utilities in general currently do not
look at the emissions data, but improved access to emissions data would be useful in
determining what companies are actually doing, such as, for example, a decision to burn low or
high sulfur coal.
SUMMARY AND RECOMMENDATIONS
The fundamental test for the EPA's current taxonomy is whether it provides
information that is potentially "wrong" or easily "misinterpreted." Workshop participants
agree that the current classification scheme passed this test and offer widespread support for
the EPA's current methodology for categorizing allowance trading activity. In summary, the
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current classification provides information that is of widespread interest and runs little risk of
providing false information.
Our analysis and the discussion at the workshop lead us to recommend the EPA
proceed with its current classification methodology. However, we offer the following
suggestions to clarify the methodology.
1. Documentation of the definition and limitation for the methodologies should be
available with the data.
2. Replace all references to "holding company" with "parent company." In addition,
it is suggested that a footnote describing why the term "holding company" was
avoided (i.e., Public Utility Holding Company Act) be incorporated into the online
documentation.
3. The documentation should incorporate visual examples to delineate the differences
between a Reallocation, an Inter-utility trade and an Intra-utility trade.
4. The documentation should incorporate a general note indicating that the ATS is
designed primarily for compliance purposes and has limitations when used for
evaluation purposes. Further, this note should indicate the ATS only captures
trade activity that is recorded with the EPA. Some trades may not be captured by
the ATS until those allowances are used for compliance. Hence, the ATS
transaction date may not be the actual trade date. Other limitations on the ATS
data as a measure of allowance trading activity should be made explicit.
5. The EPA should provide its data in an interactive file format. The interactive
format should allow the user to conduct various searches such as the number of
inter-utility transactions, number of interstate transactions, number of transactions
within a state, transaction type, history search (as indicated above) and so on.
6. Due to the concerns regarding transactions costs and market analysis, it is
recommended that the EPA incorporate titles for the Intra-utility sub-categories.
We utilized "Intra-utility Class 1" and "Intra-utility Class 2" as titles to make the
discussion regarding intra-utility trades as transparent as possible.
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Participants at the November 8 meeting included:
Carlton W. Bartels, Director of the Environmental Brokerage at Cantor Fitzgerald;
Elizabeth M. Bailey and A. Denny Ellerman, from MIT's Center for Energy and Economic
Policy Research;
Doug Bohi, Dallas Burtraw and Ron Lile, from Resources for the Future;
Daniel Chartier, Manager of Emissions Trading at Wisconsin Electric Power Company;
Melanie Dean, Joe Kruger, Brian McLean, Sharon Saile, Alex Salpeter, Claire Schary, Mary
Shellabarger, Janice Wagner, all from the EPA's Acid Rain Division;
Andrew Ertel, Manager of the Emissions Brokerage Desk at Natural Resources Group, Inc.;
Gary Hart of Southern Company Services, Inc.;
Ken Rose, from the National Regulatory Research Institute at Ohio State University;
George Spencer, Editor of the Air Daily.
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