1. Acid Rain and NOx Cap and Trade Program Experience Cap and Trade Programs for Air Emissions Presentation for NARUC Winter Meeting 2008 Joint ERE-Electricity Committees Session Clean Air Markets Division U.S. Environmental Protection Agency Office of Air and Radiation February 19, 2008

2. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 2 Overview Cap and trade: An innovative approach Successful U.S. cap and trade programs –Acid Rain Program (ARP) –NO X Budget Trading Program (NBP) Next generation cap and trade programs –Clean Air Interstate Rule (CAIR) –Clean Air Visibility Rule (CAVR) Why has cap and trade worked for U.S. emissions? Key lessons learned Emerging cap and trade issues for greenhouse gas programs

3. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 3 Cap and Trade: An Innovative Approach Government Sets a mandatory cap on aggregate air emissions from a select group of sources or industrial sector(s) Distributes allowances to emit equal to the mandatory cap to the affected sources Allows trading of allowances between sources and others under fairly unrestrictive ground rules Tracks allowance transfers and holdings Compares allowance holdings and emissions to assess compliance and, in the event of noncompliance, levies automatic penalties for each excess ton of emissions Industry Holds sufficient allowances to cover total emissions Develops a compliance strategy to lower emissions –If emissions are below holdings, a source can trade or save (bank) allowances for future use –If emissions are above holdings, a source can purchase allowances Reduces overall costs because sources that have the lowest abatement costs generally sell allowances and sources with high abatement costs generally buy allowances Introduction Government and industry have different but complementary responsibilities to lower air pollution Because of the cap, the government does not need to define how or where emission reductions are made. Government sets the goal, ground rules, and monitors compliance. Industry determines how to comply

4. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 4 Successful Programs Emerged in the 1990s Programs Acid Rain Program (ARP) covers annual sulfur dioxide (SO 2 ) emissions from most fossil fuel electric generation units. Program implemented in two phases: 1995 for largest SO 2 emitters; 2000 for all others. NO x Budget Trading Program (NBP) covers ozone-season (summer) nitrogen oxide (NO X ) emissions in selected eastern states for fossil-fuel electricity generation and other large stationary sources. Program phased in from 2003 to 2007. Programs rely on an emissions cap with air emission allowances that can be traded – cap and trade

5. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 5 Acid Rain Program for SO 2 Program Phases: –1995: Monitoring: Most fossil fuel electric generation units >25 MW Annual cap: Largest 300 emitters –2000: Most fossil-fuel electric generation units over 25 MW under annual cap of ≈ 10 million tons that dropped to 9.5 million tons after that year –2010: New annual cap = 8.95 million tons Programs ARP Units ARP-affected Units’ Annual SO 2 Emissions Currently about 3,500 units covered. Majority of emissions (>90%) from 1,100 coal- fired units (≈420 power plants); units use Continuous Emission Monitors (CEMS) subject to detailed operating and QA requirements Other units often have monitoring that is less costly, but structured to assure emissions are conservatively estimated Quarterly emissions reporting and annual reconciliation of facility emissions and allowances – “true up” SO2 Allowances Transferred under the Acid Rain Program

6. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 6 Programs SO 2 Emissions Have Fallen in Most States Acid Rain Emissions of SO 2 State-by-state SO 2 Emission Levels from Acid Rain Program- affected Sources (1990-2006)

7. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 7 Acid Rain Program Progress Programs Substantial Gains: Reduced “Acid Rain” Improved Air Quality Improved Health (lives extended and ailments reduced) Lowered Regional Haze Provided Other Benefits 2004-2006 Average 1989-1991 Average Annual Mean Wet Sulfate Deposition Water Quality Improvements, 1990-2005 ANC = Acid Neutralizing Capacity

8. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 8 Control Costs: Lower than Predicted Programs Estimated SO 2 Program Costs in 2010 Trends in Electricity Generation, Electric Prices, and SO 2 and NO X Emissions Source: EPA, 2007 2004

9. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 9 NO X Budget Trading Program Programs The NO X Budget Trading Program (NBP) is a market-based cap and trade program created to reduce seasonal NO x emissions from power plants and other large combustion sources in the eastern United States. EPA started NBP in 2003 with phase-in of state groups NBP affected 2,570 units in 2006 Ozone Season NO x Emissions (May 1- September 30) Ozone Season NO x Emissions Eastern Control Area

10. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 10 Ozone Attainment Has Improved Dramatically Programs Changes in 8-Hour Ozone Nonattainment Areas in the East 2001-2003 (Original Designations) Versus 2004-2006 In 2004, EPA designated 104 areas in the East as 8-hour ozone NAAQS nonattainment areas 2004-2006 data show ozone air quality improvements in virtually all of these areas, bringing cleaner air to over 55 million people In 2006, four out of five of the original nonattainment areas met the ozone standard The NO X Budget Trading Program is the most significant contributor (of EPA and state programs) to ozone improvements in the East

11. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 11 Next Generation Programs: Clean Air Interstate and Visibility Rules Next Generation Programs States Covered in Clean Air Interstate Rule (CAIR) and Clean Air Visibility Rule (CAVR) for SO 2 and NO X Note: On February 8, 2008, the U.S. Court of Appeals issued a decision vacating the Clean Air Mercury Rules (CAMR) and thereby suspending the program that allowed mercury emissions trading. EPA is now evaluating the Court’s decision. CAVR Outside of CAIR Region – BART controls or States can create trading programs

12. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 12 Benefits of Acid Rain and CAIR Programs Majority of benefits result from: –Avoidance of premature deaths –Reduced aggravation and incidence of heart and lung ailments Other benefits include increased worker productivity, reduced absences from school and work, and visibility improvement in some parks Benefits not included in estimates: –Acid rain environmental benefits –Mercury co-benefits –Remaining visibility benefits from parks and urban areas –Others Source: EPA 2007 and 2008 Next Generation Programs

13. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 13 Key Elements of Cap and Trade Emissions Cap: Establishes a fixed quantity of allowances for each compliance period (yearly, seasonally, or other) –Cap is the mechanism to achieve and maintain the environmental goal Coverage: Determines sources and/or sector(s) included (existing and new) –Coverage should minimize shifting of production and emissions (“leakage”) that may reduce the environmental effectiveness of the program –Coverage should capture large share of emissions but be administratively feasible Emission Monitoring, Reporting and Verification: Requires complete, accurate measurement and timely reporting of emission assures accountability and provides public access to data – leading to program integrity and confidence Allowance Distribution: Provides initial allowances to regulated community and others (based on political decisions) Allowance Trading: Allows companies to choose (and change) compliance options under modest rules – leads to significant cost savings Stringent, Automatic Penalties: Ensures the environment is made whole and penalizes non- compliance Assessment: Determines achievements of program and whether additional actions needed Elements

14. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 14 Allowance Distribution Considerations: Equity, incentives, certainty, efficiency, revenue impacts, price effects, profitability –Allowance allocation should balance the need for certainty and changing circumstances Experience: The vast majority of allocation approaches that EPA has considered all lead to the same level and distribution of emission reductions; the emission caps and banking drive reductions Approach: Many options, none are perfect –Direct allocation to sources based on historical and/or current emissions, energy use (input), or production (output, e.g. MWH) with the option of set asides for certain sources and/or actions (new sources, renewables, demand side efficiency) –Auction –Hybrid –Auction phase-in starting with direct allocation Elements

15. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 15 Monitoring, Reporting, and Verification Considerations: Equity, incentives, accuracy, timeliness, certainty, transparency, public perception, and confidence in program Experience: EPA collects high-quality SO 2, NO X, and CO 2 data from about 3,500 emission sources in the Acid Rain Program Approach: Focus on complete and accurate emission data –Most accurate methods required of largest emitters with flexibility through alternative, less-costly measurement approaches for other emitters –Built-in incentives for greater accuracy and completeness –Standardized quality assurance tests for every emission value through standardized tests and statistical analyses –Petition process to accommodate unexpected situations –Heart of process is maintenance of CEMS on major emitters (all coal-fired units and others) that monitor emissions (at high reliability and accuracy levels) hourly and report to EPA every quarter Elements

16. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 16 Official record of allowance transfers and holdings Each allowance has a serial number Parties reach agreement, then transfer allowances online, or authorize EPA to transfer allowances CAMD Business System is not a trading platform Allowance Accounting E-government at work… Some Details of Operations… Elements

17. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 17 Some Details continued… EPA just completed major “reengineering” of systems Internet Query Capability Elements Routine Public Access to Emissions and Allowance Data Type of transfer (auction, private) Seller name and account info Buyer name and account info Confirmation date, serial numbers and total allowances transferred

18. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 18 Assessment There are annual program assessments EPA considers results from multiple sources; an urban monitoring network and a rural network developed for ARP Temporary Integrated Monitoring of Ecosystems/ Long Term Monitoring System (Surface Water Monitoring) Measure results through broad monitoring networks –Changes to deposition, water quality, ambient air quality Compare to program goals; assess need for further action Elements

19. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 19 Offers alternative to traditional regulation and credit trading –Not simply a trading feature added to existing regulation Provides certainty that a specific emission level is achieved and maintained Leads to regulatory certainty, compliance flexibility, and lower permitting and transaction costs for emission sources Fewer administrative resources from industry and government (if program keeps a simple design) –Government focused on setting goals & assuring results, not on approving individual compliance actions Creates incentives for innovation and early reductions Compatible with other mechanisms Lower costs makes further improvements feasible Advantages of Cap and Trade Lessons

20. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 20 Why Has Cap and Trade Worked? Cap on emissions –Focuses on environmental goal –Provides certainty to allowance market Full-sector coverage of existing and new emission sources –Focuses on sources with heterogeneous compliance options and costs –Focuses on sources with capability to monitor and report emissions reliably and accurately –Limits ability to shift generation and emissions to non-converted sources –Eliminates need to conduct case-by-case review of emission reductions Complete and accurate emission measurement and reporting –Assures accountability and program credibility Limited restrictions on trading and banking complemented by source-specific limits where needed to protect local air quality –Allows companies to choose compliance options –Addresses “hotspots” through local requirements for direct controls, if necessary –Reduces costs Lessons

21. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 21 Key Lessons Learned Greatest reductions occurred where the highest emissions existed Trading provides regional emissions reductions, which can (and are) augmented with local direct controls Caps protect the environment, not the allowance allocation “Banking” enables early emission reductions that provides early benefits and flexibility for sources that reduces compliance costs Implementation should be kept in mind when designing programs –Setting the goal –Verifying emission data –Administering and enforcing the program –Helping affected sources understand their options and obligations Good legislation makes the job much easier Virtually 100% compliance can result Start and pace of control matters, especially to gain cost advantages Cap and trade can work outside of the power sector Lessons

22. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 22 Key Lessons Learned continued Accountability and transparency essential to program integrity –Require accurate, complete emissions measurement –Provide transparent emission and allowance data –Create predictable and, preferably, automatic consequences for noncompliance Simple and effective design and operation focused on key objectives reduces administrative burden and costs, and improves compliance and timeliness –Establishes a minimal, but effective role for government –Provides industry with compliance flexibility with accountability – this unleashes incentives for better, cost-effective controls –Facilitates market development to maximize flexibility and cost savings –Ensures environmental results through clear objectives, strong monitoring and predictable penalties –Requires a relatively small number of government staff to produce results (especially when advanced information management technology is used) Assessment routinely enables programs to stay environmentally on track Accurate baseline emissions inventory critical to effective design The program’s flexibility with industry responsibility for compliance unleashes innovation and lowers cost and inputs Valuable to program structure that is readily adaptable Lessons

23. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 23 A Better Look at a Lesson Learned: The Biggest Emitters Achieved the Steepest Annual Reductions

24. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 24 Emerging Issues for GHG Programs Levels and timing of control –Cost containment Scope and scale Federal and state roles Technology development and deployment Equity Linkage to cheaper GHG tons –Energy efficiency –International programs –International and domestic offsets Cap and trade vs. tax Emerging Issues

25. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 25 To Learn More….. On emissions trading go to EPA’s Clean Air Markets Division Website at: http://www.epa.gov/airmarkets/

26. IntroductionProgramsNext Generation ProgramsElementsLessonsEmerging Issues 26 To Learn a lot More… Office of Atmospheric Programs: http://epa.gov/air/oap.htmlhttp://epa.gov/air/oap.html –Clean Air Markets Division: http://epa.gov/airmarkets/http://epa.gov/airmarkets/ –Climate Change Division: http://epa.gov/air/ccd.htmlhttp://epa.gov/air/ccd.html –Climate Protection Partnership Division: http://epa.gov/cppd/http://epa.gov/cppd/ –Stratospheric Protection Division: http://epa.gov/ozone/http://epa.gov/ozone/