Topic Area: Air Pollution
Geographic Area: United States
Focal Question: How have economic
incentives been applied to the regulation of sulfur dioxide emissions in the
United States?
Sources:
(1) Internet Site - http://www.epa.gov/AIRMARKETS/progsregs/arp/index.html
(2) Kete, N. (1992). The U.S. Acid Rain Control Allowance Trading System. Climate Change: Designing a Tradable Permit
System. T. Jones and J. Corfee-Morlot. Paris, Organization for Economic
Co-operation and Development Publication: 78-108
Reviewer: Nicholas B. Lambert, Colby
College '96
Review:
The environmental impact of acid rain is the acidification of water sources,
which is harmful to wildlife, and damage to trees at high elevations. The
pollutants which comprise acid rain decrease visibility and are damaging to
human health, primarily causing respiratory disease. In addition it accelerates
the decay of man-made structures such as buildings and monuments.
The Clean Air Act Amendments of 1990 were signed into law on November 15 of
that year. Title IV of this legislation was directed at acid rain.
Specifically, it set a goal of reducing sulfur dioxide emissions to 10 million
tons below 1980 levels and set a permanent ceiling on allowable sulfur dioxide
emissions per year.
The Acid Rain Program was designed to be implemented in two phases. Phase I
began on January 1, 1995 and affected 110 electric utilities, the majority of
which being coal-burners, which have historically had high emission levels.
Phase II is scheduled for January 1, 2000, and will both lower allowed emission
levels for Phase I plants and include smaller, cleaner plants which had
previously not been covered by the program. Each phase is expected to lower
total emissions by 5 million tons relative to 1980 levels.
The key feature of the Acid Rain Program is the use of economic incentives
through the SO2 allowance system. Each allowance authorizes the emission of one
ton of SO2. Once allocated, allowances become marketable commodities and may be
bought, sold, or traded. At the end of each year, units included in the program
must hold a quantity of allowances equal to or greater than its annual
emissions.
The Program creates a great deal of flexibility in regulation compliance. The
allowance system allows the least costly units to reduce emissions to a greater
extent than the higher cost units. An individual source could switch fuels,
shift production from dirtier units to cleaner ones, reduce electricity demand
through conservation programs, and so on, depending which would incur the least
cost.
Phase I allocation is based on 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 to 1987). Phase II lowers
allocation to 1.2 pounds of SO2/mmBtu of heat input multiplied by the unit's
baseline and sets a cap on the total number of allowances issued at 8.95
million. Only units in operation before 1996 are eligible for allowance
allocation; others will be required to purchase them through the market system.
To supplement the original allocations, there are several alternative sources
of additional allowances. As incentives for reduced emissions, the EPA offers
allowances to units which install new technology, implement customer-oriented
conservation measures, or invest in renewable energy generation. Additionally,
annual auctions and direct sales are sponsored by the EPA, which help to send
the market price signals.
In an effort to minimize cost in reaching its emissions goals, the EPA
established an opt-in provision to the allowance program. Sources emitting SO2
which are not included in the program have the option to participate on a
voluntary basis. By reducing their emissions at a relatively low cost, their
gained allowances may be transferred to higher cost sources. The industry
minimizes compliance costs, while the voluntary entrant profits as long as revenue
from allowances exceeds emissions reduction and participation costs.
In addition to the annual allocation and collection of allowances, the EPA is
responsible for recording all transfers which take place. This is done through
the Allowance Tracking System (ATS). All parties holding allowances must
register them in an account with the EPA. To accompany the recording of
allowances is the Continuous Emission Monitoring (CEM) system, which provides a
standardized method of measuring and reporting emission levels to the EPA,
which in turn maintains an Emission Tracking System (ETS) to serve as a
repository for emissions data for the industry. Through these control measures,
the program gains credibility and the EPA is able to both monitor the progress
of emission reductions and enforce compliance. Units found to be emitting in
excess of their allowances are fined 2,000 dollars per ton of SO2 and are
forced to supply offsetting allowances, either through reduced allocation or a
emission reduction proposal.
While Phase I officially began in 1995, the EPA implemented a trial program to
cover 1994, including 263 utility units in 21 states. The objective was to
discover any potential problems and facilitate the transition of large
companies into the program.
Each unit began monitoring emissions and submitted the measurements for CEM
certification. The data collected proved to be very reliable. With a few
exceptions which required estimated figures to replace errors in monitoring,
the 1994 data was accurate enough to provide a credible basis for measurement
and error detection for the Phase I systems.
The most important result of the trial program, however, was a decrease in SO2
emission. Over the course of the year, national SO2 emissions dropped to an
estimated level of 7.4 million tons, well below the 1980 baseline level of 9.4
million tons, and was nearly low enough to meet the 1995 allowance target
level. The decrease was attributed to units switching fuel sources and
implementing control measures early in preparation for the 1995 emission
limits. Furthermore, the decrease was spread evenly across the country, with
almost all states experiencing proportional declines from their 1980 baseline
levels.
As the trial program ran its course, and especially as Phase I was implemented
over 1995, use of the allowance system increased dramatically. By the end of
1994, private allowance transfers had reached an estimated 15 million, and
EPA/market transfers 7 million. Private transfers are those within the
industry, while EPA/market transfers are through auction, direct sale,
substitutions, etc. In the first quarter of Phase I, private and EPA/market
transfers increased to an estimated 29 and 9 million, respectively, and by the
fourth quarter were at a level of 36 and 11 million. Of the total trades within
1994 and 1995, 77.6 percent were inter-utility, that is, between separate
companies. This reflects the willingness of the industry as a whole to accept
the program and take advantage of cost minimizing opportunities. The remainder
of the trades were primarily intra-utility and broker to utility. A limited
number of allowances were bought by environmental groups who
"retired" them.
The potential success of the sulfur allowance program is due to its utilization
of market forces through economic incentives. As demonstrated by the
significant volume of trading which has taken place thus far in the program,
use of a command and control approach in this situation would have placed far
greater economic burden on some units than others, increasing the overall cost
imposed upon the industry. By allowing certain units to reduce emissions to a
greater extent than others and not specifying the method by which these
reductions would come about, the regulations provide a great deal of flexibility
in compliance and cost minimization. Accompanying the lower costs of the
industry are lower regulation and enforcement costs faced by the EPA. The
burden of emissions measurement and the development of the technology to reach
the emissions limit is placed on the industry, not the EPA. This is an
additional cost to the industry, but is insignificant in comparison to the
savings. The EPA has the responsibility to organize and periodically check the
emission data and must allocate and track the allowances, but again the overall
costs are greatly reduced when compared to a command and control approach.
The ability of the allowance program to reach the set goal of a 10 million ton
emissions reduction is a benefit compared to the probability that many sources
would not be able to fully comply with an across-the-board limit. It appears
that in this case, the use of economic incentives can benefit all parties
involved.