Cap and Trade in Perspective: Stopping Acid Rain

Aug 10, 2009

At the heart of the Waxman-Markey American Clean Energy and Security (ACES) bill is a national program to cap carbon dioxide emissions, with an accompanying market where polluters can buy and sell an increasingly limited number of pollution allowances.

Over the next few days, we'll look at three cap-and-trade programs already in place – what works about them, what doesn't, and what the U.S. government can learn.

Getting the U.S. Congress to consider a cap-and-trade program to reduce greenhouse gas emissions is no easy feat, but the fact it is even being considered at all owes much to the U.S. Acid Rain Program.

Created under Title IV of the 1990 Clean Air Act Amendments, the Acid Rain Program defied critics who saw it as a costly mistake that would burden the economy and concentrate pollution in regional "hot spots." Instead, emissions of sulfur dioxide (SO2) and nitrous oxide (NOx), which mix with water, oxygen and oxidants in the atmosphere to cause acid rain, have declined dramatically nationwide at far lower costs than expected.

The reductions have had a significant health impact, too: The annual health and welfare benefits of the program are estimated to be $122 billion, in year 2000 dollars, and the prevention of "tens of thousands of premature deaths each year," says Sam Napolitano, director of the U.S. Environmental Protection Agency's Clean Air Markets Division. The annual cost of the program is $3 billion.

The program works because its central purpose is to reduce emissions, analysts say.

Unlike previous clean air laws that considered the rate of pollution coming from individual plants, the ARP created a permanent cap on nationwide SO2 emissions at 8.95 million tons by 2010, which was 50% below 1980 levels, and the program allowed utilities to trade "allowances" to emit SO2, which made reducing those emissions and then selling then unneeded allowances lucrative.

By 2008, SO2 emissions had fallen to 7.6 million tons, according to the EPA, well below the 2010 cap.

"Cap-and-trade is a very efficient way to do things," says Byron Swift, executive director of World Land Trust-US. "It's far better than rate-based standards, which had been the normal way of regulating emissions."

The Acid Rain Program also worked because power plants were given flexibility to figure out the most economical and technologically feasible way to cut emissions given their own particular circumstances.

According to the EPA's Napolitano, companies are still coming up with innovative technologies for cutting emissions at low costs. "They are able to put controls on more cheaply than we thought possible," he says.

EPA Commissioner Lisa Jackson reminded lawmakers in April that "beltway corporate lobbyists" had tried to thwart passage of the ARP by insisting it would be bad for business. Instead,

"Our economy grew by 64 percent even as the program cut acid rain pollution by more than 50 percent," Jackson testified.

The ARP addresses both SO2 and NOx emissions, but in different ways.

The cap-and-trade approach was only for SO2 emissions, which were considered a bigger problem than NOx emissions at the time, Swift says. The SO2 program was implemented in two phases: phase I, begun in 1995, affected mostly coal-burning electric utility plants in eastern and Midwestern states; phase II tightened emission caps on large, high emitting plants and set limits on emissions from smaller plants burning oil, gas and coal.

Meanwhile, NOx emissions from coal-fired electric utility boilers were to be cut two million tons from 1980 levels. Companies were given flexibility in how they reduced NOx emissions and were allowed to meet targets within their fleet of facilities, so emissions from a higher polluting boiler could be offset by one with fewer emissions if the overall goal was met. There was no cap-and-trade provision, however.

From 1995 to 1998, NOx emission levels had fallen 51 percent, or about 3.1 million tons. The ARP contributed to a large amount of these reductions, but NOx was subsequently also regulated through other state and federal programs, including the NOx Budget Program.

At the time it was created, the idea of reducing SO2 emissions by trading emission permits, or "allowances," was a novel approach to environmental policy. Most environmental regulations up until then and been by "command and control": companies were told what to do and how to do it. They also had to go through bureaucratic hoops so the government was sure they were doing it right.

In a 2001 paper for the Environmental Law Journal, Swift detailed how cap-and-trade schemes lead to innovation and greater compliance at a lower cost. Estimates of the compliance cost of the SO2 program from 1995-2000 show that under a regulatory method where specific technologies such as scrubbers are prescribed, the compliance cost would have been about $7 billion a year, while under a cap-and-trade system, compliance costs were only $1.2 billion a year.

"The good news of the SO2 program was monitoring, enforcement and the forces of dynamic capitalism really worked, creating a competitive environment that caused low-cost emission reductions in a way that would not have been realized under the traditional approach of the Clean Air Act," says Dallas Burtraw, a senior fellow at Resources for the Future, a nonpartisan Washington, D.C., think tank.

Burtraw and co-author Karen Palmer, director of the Electricity and Environment Program at Resources for the Future, detail the successes of the Acid Rain Program in a 2003 paper. Among them: Emissions fell well below the initial cap in Phase I of the program because companies were allowed to "bank" allowances for use in future years. A total of 11.6 million allowances were banked by the end of Phase I in 2000, Burtraw and Palmer wrote.

"Once firms had built up a bank of unused allowances, they had a vested interest in maintaining the value of those banked credits, and thus in furthering the program itself," they said.

Another reason for success: The program was popular with industry because the cost of compliance was much less than previous air control programs, Burtraw said in an interview.

"There were these innovations and unanticipated outcomes," Burtraw says. "A more prescriptive approach would have precluded these advantageous changes in the capital markets and fuel markets."

Specifically, the costs of compliance were driven down because of technological advances in coal-scrubber technology, "investment and innovation" in the rail industry that lowered costs for shipping low-sulfur western coal to high coal regions in the east, and individual plant decisions to blend low- and high-sulfur coal, a strategy that wasn't thought feasible before, according to Burtraw and Palmer.

The program also got results because of a flexible, yet rigorous system for monitoring emissions by the hour. Good data, which was readily available to all participants, helped make the market for allowances more efficient. The data also clearly tracked progress toward reducing emissions, according to the EPA's Napolitano and other veteran EPA policymakers and scientists who wrote The U.S. Acid Rain Program: Key Insights from the Design, Operation, and Assessment of a Cap-and-Trade Program, for August-September 2007 issue of the Electricity Journal.

Ultimately, what made the ARP work was its simplicity and transparency: clear emission targets, a good system for monitoring, reporting and verifying emissions, and flexibility for meeting targets.

Many aspects of the acid rain program are being considered by Congress as it crafts greenhouse gas regulation. The American Clean Energy and Security (ACES) bill, which passed the U.S. House of Representatives on June 26, would allow companies to bank allowances for future years. Banking typically gives companies an incentive to over-comply at first so they have a buffer for the future, says the EPA's Napolitano.

Napolitano also believes the very structure of cap-and-trade will lead to the same level of surprising innovation in methods for reducing emissions that has been seen in the SO2 program as well as later federal clean air programs that allow for NOx trading.

"Our expectation is that industry will again figure out (solutions) beyond what we are already aware of what we can do," Napolitano says.

But Burtraw is concerned that ACES, as written now, gives too many allowances away for free instead of selling them in an auction. The ARP also granted allowances for free, but most electric utilities were regulated then and were not allowed to hoard "windfall" profits, he says.

Today, half the electricity industry, representing 40% of carbon dioxide emissions, is deregulated.

"In 1989, regulators were in place and it was their job to make sure firms could not charge consumers for something they had received for free," Burtraw says. "Now, in the electricity sector and in any other sector where there is competitive market forces, you can expect free allocation would lead to windfall profits."

Many of the free allowances are going to regulated local distribution companies in the electric and natural gas sectors, but these companies are overseen by state public utility commissions, which are charged with promoting economic development in their individual states and may be less concerned with achieving national goals, Burtraw says.

The ARP also did not allow companies to meet their obligations by buying "offsets" in emission reduction projects elsewhere, as ACES would allow in prodigious amounts. Burtraw worries offsets will lead to bureaucratic entanglement and market manipulation.

"If the offset market shows the kind of volatility that has occurred in other commodity markets, that could be difficult for CO2," he says. "I'm an environmental economist. All we're asking for is a stable price signal (for carbon) that will incentivize innovation and reductions."

(For Part II of this series, see Cap and Trade in Perspective: Carbon Trading in the Northeast and for Part III see Cap and Trade in Perspective: The European Version.)

See also:

Climate Bill Wins Enough Votes to Pass, But at What Cost?

Memo to Obama: Make Carbon Cap Simple and Unsinkable

Greenpeace Says 'No' to Climate Bill: ACES Is Too Weak

Senate Urged to Protect Clean Air Act from Climate Bill

Letter to Pelosi: 20 Environmental Groups Call for Stronger Climate Bill

(Graphic: env-ngo.wikispaces/arwpthree)

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