1 The Regional Clean Air Incentive Market (RECLAIM) May 29, 2014May 29, 2014May 29, 2014 David Porter

2 Outline What is RECLAIM? What is RECLAIM? Why tradable permits as policy? Why tradable permits as policy? Policy Design Issue 1: The Property Right Policy Design Issue 1: The Property Right What is an Experiment? What is an Experiment? Policy Design Issue 2: The Market Policy Design Issue 2: The Market

3 RECLAIM SCAQMD was under pressure from EPA to meet clean air standards SCAQMD was under pressure from EPA to meet clean air standards LA Basin had the highest number of high pollution days of any city in US in the early 1990s LA Basin had the highest number of high pollution days of any city in US in the early 1990s Prior to 1994, AQMD used the standard command and control method: Prior to 1994, AQMD used the standard command and control method: BACT – each piece of equipment is regulated BACT – each piece of equipment is regulated R&D firm disincentives and costs ignored (coatings) R&D firm disincentives and costs ignored (coatings) Fails to offer any incentives for firms to cut back emissions any further than mandated percentages Fails to offer any incentives for firms to cut back emissions any further than mandated percentages

4 RECLAIM Rather than attempting to regulate each source, RECLAIM focuses on regulating the net pollution at the facility Rather than attempting to regulate each source, RECLAIM focuses on regulating the net pollution at the facility Each facility is allotted pollution permits and is subject to severe fines if their annual emissions level is not within the fixed limit Each facility is allotted pollution permits and is subject to severe fines if their annual emissions level is not within the fixed limit Businesses which are able to reduce emissions by more that their allotted annual limit are then able to sell their excess reductions to other facilities Businesses which are able to reduce emissions by more that their allotted annual limit are then able to sell their excess reductions to other facilities This creates a significant economic incentive to reduce net emissions, as those emissions credits are a relatively liquid asset This creates a significant economic incentive to reduce net emissions, as those emissions credits are a relatively liquid asset By allowing businesses to interact amongst themselves RECLAIM minimizes the costs associated with emissions reductions By allowing businesses to interact amongst themselves RECLAIM minimizes the costs associated with emissions reductions

5 Policy Design Issue 1: The Property Right Fixed amount of pollution per year in basin Fixed amount of pollution per year in basin NOX, SOX and VOC NOX, SOX and VOC Allocate right to pollute Lbs per year Allocate right to pollute Lbs per year Zones (hot spots) Zones (hot spots) Reduce allocation by fixed percent per year Reduce allocation by fixed percent per year The cap declines annually (8.3% per year on average for NOx and 6.8% per year on average for SOx) from 1994 to The cap declines annually (8.3% per year on average for NOx and 6.8% per year on average for SOx) from 1994 to 2003.

6 Tradable Credit The Process considered had The Process considered had Allocation of credits (pounds designated by year) Allocation of credits (pounds designated by year) Trade credits (swaps, cash, portfolio, etc.) Trade credits (swaps, cash, portfolio, etc.) Monitoring and Reporting (quarterly) Monitoring and Reporting (quarterly) Restrictions – use only current year credits for current year pollution – NO BANKING Restrictions – use only current year credits for current year pollution – NO BANKING Reconciliation Period Created Reconciliation Period Created End of year accounting (delay/uncertainty of use) End of year accounting (delay/uncertainty of use)

7 End of year effect? At year end At year end Long or short Long or short Rational Expectations? Rational Expectations? Proposal to Stagger Credits Proposal to Stagger Credits Jan. 1 to Dec 31 Credits Jul. 1 to Jun 30 Credits

8 Microeconomic Systems as an Experimental Science A Microeconomic system is comprised of: A Microeconomic system is comprised of: The Environment The Environment The Institution The Institution The Environment consists of: The Environment consists of: The list of participants The list of participants The resources to be allocated among participants The resources to be allocated among participants Participant characteristics which are private information Participant characteristics which are private information

9 The Institution: Rules of the Game The Institution consists of: The Institution consists of: Language Language Allocation rule which transforms messages into allocations Allocation rule which transforms messages into allocations Pricing rule transforms messages into sums to be paid or received Pricing rule transforms messages into sums to be paid or received

10 Outcomes: allocations and prices Institutions: language of the market, rules of communication and contract Behavior: rational, bounded, etc. Environment values, costs, information, resources

11 Science of Economics Control environment parameters Control environment parameters Induce value and costs (experimenter knows incentive structure) Induce value and costs (experimenter knows incentive structure) Information can be controlled Information can be controlled The environment can be replicated The environment can be replicated The Institution (rules) can be changed and outcomes observed and measured The Institution (rules) can be changed and outcomes observed and measured Real people Real people Real Incentives Real Incentives Replicable Replicable

12 Outcomes: allocations and prices Institutions: language of the market, rules of communication and contract Behavior: rational, bounded, etc. Environment values, costs, information, resources Controlled by Experimenter Treatments: Change rules Model Predictions

13 Experiments and Public Policy Typically, policy design is based on simple models of behavior or gut-feel Typically, policy design is based on simple models of behavior or gut-feel Models are based on conditions that are not faced in the field application Models are based on conditions that are not faced in the field application Policy impacts can be great if the design is not tested Policy impacts can be great if the design is not tested Lab testing of the system to determine possible flaws are standard in engineering but ignored in public policy design Lab testing of the system to determine possible flaws are standard in engineering but ignored in public policy design Sometimes seeing is believing (details can be important) Sometimes seeing is believing (details can be important)

14 An Experiment with Annual and Staggered Credits Year 1 Year 2 Year 3 Year 4 Year 5

15 Policy Design Issue 2: The Market The general market conditions that will be the focus of our design process are: The general market conditions that will be the focus of our design process are: The RECLAIM market is thin with a small number of participants; The RECLAIM market is thin with a small number of participants; There is a need only to trade at quarterly compliance intervals when facilities can update their emission plans; There is a need only to trade at quarterly compliance intervals when facilities can update their emission plans; There is no history of market trades; and There is no history of market trades; and Buyers and sellers would like to transact by selling whole portfolios of credits (all or nothing trading, economies of scale, complementary pollution emissions requirements, etc.) Buyers and sellers would like to transact by selling whole portfolios of credits (all or nothing trading, economies of scale, complementary pollution emissions requirements, etc.)

16 Order Types A multi-market order for agent i is a vector where: A multi-market order for agent i is a vector where: b i >0 means agent i is willing to pay at most b i for the order, b i >0 means agent i is willing to pay at most b i for the order, b i <0 means agent i is willing to accept at least b i for the order. b i <0 means agent i is willing to accept at least b i for the order. q ij >0 means agent i wants to purchase up to q ij units of j in the order, q ij >0 means agent i wants to purchase up to q ij units of j in the order, q ij <0 means agent i wants to sell up to qij units of j in the order, q ij <0 means agent i wants to sell up to qij units of j in the order, F i is a scale factor (0 where fi [Fi,1]. F i is a scale factor (0 where fi [Fi,1].

17 Experiments/Field When there are complements or minimum fills the mechanism outperforms standard practice When there are complements or minimum fills the mechanism outperforms standard practice Not much harm is done when demands are linear Not much harm is done when demands are linear During the summer of 2000 there was a drastic increase in the demand for power production. During the summer of 2000 there was a drastic increase in the demand for power production. The power industry purchased 67 percent of the available RTCs. Because power-producing facilities only comprise roughly 14 percent of RECLAIM allocations, the increased demand for RTCs led to a decrease in supply. For NOx RTCs in particular, prices increased from approximately $4,284 per ton traded in 1999 to roughly $39,000 per ton traded during the first ten months of The power industry purchased 67 percent of the available RTCs. Because power-producing facilities only comprise roughly 14 percent of RECLAIM allocations, the increased demand for RTCs led to a decrease in supply. For NOx RTCs in particular, prices increased from approximately $4,284 per ton traded in 1999 to roughly $39,000 per ton traded during the first ten months of 2000.

18 Current Condition Energy crisis in California gave the Governor ammunition to let firms (mainly electricity producers) off the hook Energy crisis in California gave the Governor ammunition to let firms (mainly electricity producers) off the hook RECLAIM discontinued RECLAIM discontinued Smog alerts on the rise Smog alerts on the rise