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Cap & Trade: A Market Approach to Reduce Pollution Brian McLean, Director Office of Atmospheric Programs U.S. Environmental Protection Agency The Sixth.

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Presentation on theme: "Cap & Trade: A Market Approach to Reduce Pollution Brian McLean, Director Office of Atmospheric Programs U.S. Environmental Protection Agency The Sixth."— Presentation transcript:

1 Cap & Trade: A Market Approach to Reduce Pollution Brian McLean, Director Office of Atmospheric Programs U.S. Environmental Protection Agency The Sixth Mansfield Pacific Retreat Unleashing Market Forces to Protect the Environment

2 Traditional Environmental Regulation u Established what needed to be done u Prescribed how and when each source was to do it u Designed to address local impacts u Assured compliance through equipment installations and performance tests, not usually by measuring total emissions u Referred to as “command and control”

3 Bubbles, Offsets and Credits u Assumed command and control infrastructure u Provided some flexibility in how a source could comply, i.e. by getting reductions from another source u Required government approval to prevent: ã “paper credits” ã “anyway tons” ã unacceptable air quality impacts

4 Cap & Trade – A New Experiment u Sets a maximum allowable emission level u Provides incentives for innovation u Refocuses government’s role ã Emphasizes emission reduction and measurement ã Enforces cap (holding sufficient allowances), avoids dictating how sources are to comply ã Reduces administrative burden and cost while promoting greater environmental certainty u Changes government-industry relationship

5 Flexible Approach u Cap & trade provides sources with flexibility to determine appropriate strategy ã How to make reductions ã Where to make reductions ã When to make reductions u For some problems, flexibility may not adequately address problem ã Does it matter where reductions are made? ã Does it matter when reductions are made? u Cap & trade can work with source-specific controls or emission levies

6 Setting the Emission Level u Environmental needs ã Public health ã Lakes, streams and forests ã Buildings and cultural resources u Technical and economic feasibility

7 Allocating Allowances 1990 SO 2 Emissions

8 Operating the Program: U.S. EPA u Collect and verify emission data and make available to public via Internet u Audit and enforce monitoring requirements u Record official allowance transfers and make available to public via Internet u Determine compliance: reconcile annual emissions and allowance holdings u Enforce automatic emission offsets and financial penalties

9 Program Requirements: Sources u Develop compliance strategy u Monitor and report all emissions ã Install and maintain monitors (coal, oil & gas) ã Conduct performance tests ã Report hourly emission data and performance test results u Hold sufficient allowances to cover emissions

10 Acid Rain Program Results u Reductions began on time and on target u Compliance is high (over 99%) u Compliance costs are low (75% below estimate) u Government role is focused u Transaction costs are low u Incentives for innovation are continuous u Health benefits exceed costs by more than 50:1 u Relationship with industry is positive

11 Wet Sulfate Deposition Decreased 1989-19911999-2001

12 SO 2 Concentrations Decreased 1989-19911999-2001

13 NOx Budget Programs u Emission budgets (caps) set for each state by OTC or USEPA u States determine allowance allocations u USEPA (in consultation with States) establishes trading and monitoring rules u USEPA operates allowance and emission tracking systems u States enforce monitoring and allowance holding requirements

14 Benefits of Cap & Trade u More certainty that a specific level of emissions will be achieved and maintained (even with economic growth) u More regulatory certainty for sources u More compliance flexibility and lower compliance costs for sources u Lower transaction costs for trading u Better emission data u Fewer administrative resources needed by industry and government

15 Keys to Successful Cap & Trade u Cap ã Protects the environment ã Provides predictability to market participants u Accountability ã Accurate, complete emission measurement ã Transparent emission and allowance data ã Predictable consequences for noncompliance ã Complete and consistent enforcement u Simplicity of design and operation ã Minimal, but effective government role ã Facilitates market and maximizes cost savings

16 Infrastructure: Measurement u Accurate, consistent measurement methods are essential ã Ensure environmental integrity u Government verification is important ã Ensure environmental integrity ã Encourage equity ã Promote public acceptance

17 Infrastructure: Data Systems u Emission and allowance data must be managed ã Collect data from sources ã QA/QC emission data ã Maintain data ã Disseminate information u Computerized tracking systems provide benefits ã Increase accuracy and consistency ã Reduce time, effort and costs ã Simplify data storage, maintenance, and retrieval ã Improve access to relevant information

18 Infrastructure: Enforcement u Resources for auditing emission measurements and equipment u Resources for determining compliance u Strong enforcement institutions ã Political and institutional support ã Authority to assess and collect penalties

19 For More Information u Visit the clean air markets web site to view ã Emission data and allowance information ã Information on cap and trade programs ã Program rules and guidelines ã Studies and reports ã Information about international cooperation

20 SO 2 Emissions in the U.S. Million Short Tons Great Depression WW II CAA Without the CAA Acid Rain Program

21 SO 2 Emissions Decreased 17.3 16.1 15.7 11.9 12.5 13.0 13.1 12.5

22 Health Benefits Significant Health Benefits in 2010 $50 billion in annual health benefits 10,000 premature deaths avoided

23 Annual Compliance Costs are Low u Reasons for low cost ã Competition across emission reduction options ã Continuous incentive for innovation ã Banking provides timing flexibility ã Allowance price provides benchmark for decision making ã Trading not restricted 2010 Predicted Costs Enactment4 Yrs Later8 Yrs Later

24 Active Allowance Market u Since 1994, over 150 million SO 2 allowances have been transferred. u On-line transfers initiated in 2001. By end of 2002, 80% of transactions conducted on-line. u Approximately 45% of all SO 2 allowances have been transferred between different companies. u In 1990, EPA estimated allowance prices for 2000 at $625* (actual price about $150). * in 2000 dollars

25 Limited Supply of allowances (cap) Economic value for allowances Economic incentives to reduce emissions Demand for allowances Why Cap & Trade Works u Emission Cap ã Limits emissions and maintains reductions ã Provides market value and certainty ã Allows trading without government approval u Trading ã Allows companies to choose compliance options ã Minimizes costs through compliance flexibility

26 RECLAIM u The RECLAIM program is a cap-and trade program that began in 1994 and was expected to be fully implemented in 2003: ã NOx emissions were to be reduced from 105 to 27 tons/day ã SOx emissions were to be reduced from 26 to 10.5 tons/day u Caps all facilities emitting 4 tons or more/year of NOx and/or SOx: ã Initially affected 364 facilities l Included electric utilities, refineries and “other” emitters (cement kilns, diesel engines, process heaters, dryers, etc…,) ã Excluded certain essential public services.

27 Source: White Paper on Stabilization of NOx RTC Prices, SCAQMD Emissions and Credit Supply

28 Cycle 1 Credits Cycle 2 Credits Cycle 1 StartsCycle 2 StartsCycle 1 Ends/Starts Cycle 2 Ends Cycle 1 Credits Trading Under RECLAIM u Two annual cycles: ã Cycle 1: January 1 - December 31, Cycle 2: July 1 - June 30 u Free trading among facilities in different cycles u There is no banking, however, facilities can use another cycle’s credits to offset emissions during the first six months of their cycle.

29 Market Reaction SO 2 and NOx RTC (Compliance Year) Market Price Index Source: Cantor Fitzger ald, EBS NOx Trading continued throughout 2000 despite high prices

30 Reaction to the Price Increase u In response, RECLAIM officials proposed to isolate utilities >50MWe from the NOx market. ã Instead, utilities would pay into an “air quality investment program” $7.50/lb of NOx emitted beyond their initial allocation. u In compliance with abatement orders, 37 air pollution control projects are underway and 29 more are planned ã 17 utility boilers are in the process of installing SCR u Effectively removed utilities from the market

31 Why did NOx RTC prices increase? u Demand increased faster than expected and sources did not reduce their emissions enough to account for the demand increase. u Sources planned to rely on the market for compliance and did not install control technologies that could meet or go beyond the more stringent cap. ã Low RTC prices before 2000, on average < $2000/ton; ã A limited economic incentive to reduce emissions below the required level, ã Absence of banking in the trading program

32 Banking u Banking encourages sources to reduce their emissions sooner and below required levels, ã Allows sources to make extra reductions where and when it is cost-effective to do so; ã Ensures that all reductions will have an economic value in the long-term even if the short term gain is small. u Each banked ton represents a future ton of emissions ã Tradeoff between the short and the long term; ã RECLAIM decided the risk of variability in emissions due to the withdrawal of banked emissions was too great to allow banking.

33 Banking (cont’d) u Other programs resolved the tradeoff differently: ã The Acid Rain Program allows for unlimited, unrestricted banking. ã The OTC NOx Budget Program allows unlimited banking but places an economic disincentive on the use of banked allowances for compliance purposes; l Limits the variability associated the the withdrawal of banked allowances; l Mutes the incentive to generate excess reductions.

34 Implications for future cap-and- trade programs u Program design impacts sources’ ability to meet the cap. ã In RECLAIM, not allowing banking resulted in only a limited incentive for sources to generate excess reductions. ã When demand increased, sources could not reduce their emissions enough to account for the increase ã RECLAIM also has an annually declining cap that (in combination with no banking) may have declined too rapidly given the options and costs for controls. u Need to be aware of the tradeoffs when designing a program

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