Trade in deals

• By Jose A. Diaz
• Mar 01, 2000

Less than one decade ago, the sulfur dioxide (SO₂) emissions trading market was established in response to the U.S. Environmental Protection Agency's (EPA) Acid Rain Program. Since then, regional emissions trading markets have been established for nitrogen oxide (NO_x) and volatile organic compound (VOC) trading. A global market for greenhouse gas emission (GHG) credits, as proposed in the Kyoto Protocol, is also gradually developing. As more pollutants begin to be traded and the number of trades increases, the emissions trading marketplace is becoming more sophisticated, with the potential benefits more tangible.

The concept behind emissions trading is straightforward. Some facilities are able to use air pollution control technology or pollution prevention to "over-control" emissions at a low marginal cost. By doing so, these facilities can generate "emissions credits" that can then be sold. Alternatively, for some facilities, the marginal cost of controlling emissions exceeds the cost of purchasing available emissions credits. By using the emissions trading market to purchase emissions credits, these facilities are able to both meet their environmental obligations and save money.

SO₂ trading

Title IV of the Clean Air Act Amendments of 1990 required EPA to establish a program to reduce emissions of SO₂ and NO_x from certain combustion sources, primarily located at utility plants. Under the program, EPA allocates SO₂ emissions allowances, based on historical fuel usage, to affected sources. An allowance represents authorization to emit one ton of SO₂ during a year. Allowances can be used by sources to cover emissions during that time period or traded. (A national trading program has not yet been established for NO_x emissions, although the regulations allow it.) This type of program is called a cap-and-trade program, because a "cap" on overall emissions is established on a particular source category or categories. Allowances are then allocated to specific sources, authorizing emissions during a particular time period. A "trading" program allows sources to buy and sell emissions allowances to meet their regulatory requirements.

An annual EPA auction of SO₂ allowances is conducted by the Chicago Board of Trade. In addition, a private trading market has developed and is a significant factor in the overall positive results of the Acid Rain Program. The national SO₂ allowance trading program is the largest and most active emissions trading market in the United States and the world, having grown from 200,000 tons transacted in 1992 to nearly 10,000,000 tons transacted in 1998. It is dominated by brokers who trade on behalf of clients, as well as for their own accounts.

Regional ozone trading programs

Another example of a cap-and-trade program is the Northeast Ozone Transport Commission (OTC) NO_x Budget Program, which was established by the OTC under Title I of the Clean Air Act Amendments to address regional ozone non-attainment concerns in the northeast United States. This program creates a pool of NO_x emissions credits that a state can allocate to emissions sources within its boundaries. In 1999, this pool was capped at 219,000 tons, which represented a decrease from the 1990 baseline emissions of 490,000 tons. The cap will decrease in 2003 to 143,000 tons. As part of the plan, companies that reduce NO_x emissions early or more than required can sell their emission reductions to other companies that either cannot meet the deadline or cannot reduce emissions as cost-effectively. Trading in these emissions credits has been active since before actual initiation of the NO_x Budget Program on May 1, 1999.

Other areas of the country with significant ozone non-attainment issues, such as the Gulf Coast region, are also beginning to develop regional programs for controlling ozone precursor emissions, which may include trading programs.

Open market trading

In August 1985, EPA proposed an open market emissions trading rule, dubbed "the model rule." This rule, since withdrawn by EPA and currently held as "guidance," provided the emissions trading framework for states to use in establishing their own open market trading programs. Several states and local regulatory agencies have implemented some form of open market emissions trading to achieve or maintain the National Ambient Air Quality Standards. For instance, the South Coast Air Quality Management District of California, and the states of New Jersey, Connecticut, Michigan, Massachusetts, New Hampshire and Texas, have promulgated emissions trading rules. In contrast to the cap-and-trade concept, open market trading is designed to provide incentives for sources to reduce emissions below regulatory or permit requirements (not based on allowances or allocations), and generate credits for sale on the open market. Other sources could then purchase these credits and perhaps meet regulatory requirements more cost ef fectively than installing control equipment.

Greenhouse gas emission trading

An international credit market for greenhouse gas¹ (GHG) emissions, proposed in the Kyoto Protocol, is still in the infancy stage. Recently, the Sydney Futures Exchange announced that it will begin trading GHG offsets in mid-2000² as it positions itself to dominate GHG trading in Asia. In a related development, Pricewaterhouse Coopers announced an alliance with the Australian office of EcoSecurities³ to provide financial advisory services connected to climate change and GHG mitigation. In the private sector, BP Amoco is taking a proactive approach, launching the first-ever internal company market for GHG emissions using a cap-and-trade approach for its different operating units. Although a handful of greenhouse gas credit trades have occurred, these have generally been highly speculative transactions, as no firm regulatory structure is in place. The potential size of the GHG market, however, dwarfs other emissions trading m arkets, because GHGs are produced by a wide variety of a gricultural and industrial activities affecting industrialized and non-industrialized countries throughout the world, such as combustion of solid waste and fossil fuels, production and transport of natural resources such as coal, oil and natural gas, decomposition of organic wastes in municipal landfills and the raising of livestock.

Potential advantages of emissions trading

There are several potential advantages to participating in emissions trading programs.

Reduced costs. Experience with the Acid Rain Program shows that emissions trading can reduce the overall cost of compliance for facilities.

Operational flexibility. By over-controlling emissions at one facility, an organization can generate allowances for use at another facility. Allowances can also provide an additional safety measure for unplanned equipment failure that might otherwise result in fines or penalties for non-compliance. Similarly, a facility could postpone major capital investments by purchasing allowances to meet emissions limitations.

Revenue source. Allowance prices are trending up and may represent a source of revenue if a facility can generate allowances at a lower marginal cost through such means as alternative fuels, fuel blending, pollution prevention or emissions controls.

Early reduction advantages. Some regulations, such as the Acid Rain Program, may allow facilities to achieve compliance with emissions limitations early to earn bonus allocations. These bonus allocations can then be transferred to another facility within the organization to achieve compliance or sold to another entity.

Sources of information

There are several sources of emissions trading information, including EPA's Acid Rain Program Web page ( www.epa.gov/acidrain), state and local regulatory agencies, consultants and allowance brokers. EPA's Acid Rain Program Web page provides historical price trends, allowance transfer and account data, and general information about trading in SO₂ allowances. Also available on-line are the documents necessary to set up a trading account and to transfer allowances between Acid Rain accounts. State and local regulatory agencies that have established trading programs are also excellent sources of information on the requirements for trading, as well as recent price trends. Consultants and allowance brokers, in addition to assisting in executing transactions, can also provide up-to-the-minute information on pricing and regulatory developments and educate clients about allowance management strategies.

An emissions trading action plan

In order to participate in emissions trading, your facility must be subject to a program (current or anticipated) that establishes regulatory limits on sources of emissions, such as an emissions cap under the Acid Rain or NO_xBudget Programs, or an emissions limit under states' Reasonably Achievable Control Technology (RACT) regulations. Secondly, a regulatory infrastructure or mechanism for tracking and trading of allowances or emissions credits including, for instance, a bank, a tracking system, and quantification and verification procedures, must be in place. Finally, there must be a means of identifying and negotiating with potential trading partners.

Once you've considered the possible benefits of participating in the emissions trading markets and determined that the necessary requirements for emissions trading exist for your facility, follow these steps to identify specific trading opportunities.

Determine regulatory applicability. Evaluate operations to determine if a facility is subject to and qualifies for specific emissions trading programs. Once subject units are identified, determine the regulatory limits for each unit.

Quantify emissions and determine emission reduction needs. Quantify emissions from subject units using accepted emissions quantification procedures. Then, determine the emissions reduction required to meet regulatory requirements.

Determine control strategy. Plan the control strategy to meet regulatory requirements, with the objectives of fully leveraging previous investments and potentially identifying cost-effective control and over-control strategies. Be aware of triggering other regulatory programs such as EPA's Prevention of Significant Deterioration (PSD) rules or New Source Performance Standards (NSPS).

Compare control costs vs. emission credit prices. Evaluate the cost-effectiveness of different control strategies, comparing the incremental costs of control with emissions credit prices. Consider input costs and price pressures, changes in control technology and capital investment timing.

Prepare for trading. Prepare the appropriate documentation, notification, certification and reporting. Develop procedures for ensuring on-going compliance with regulatory requirements and those of the specific trading program. Consider whether to use an allowance broker.

Monitor other trading opportunities. Develop procedures to regularly evaluate other trading opportunities by tracking emissions control costs and emissions credit prices. Monitor regulatory changes for other trading opportunities that potentially provide additional operational flexibility, reduced costs and revenue generation.

Footnotes:

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¹ Greenhouse gases include carbon dioxide, methane and nitrous oxides, among others.

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² A specific date for startup has not yet been established by the Sydney Futures Exchange.

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³ Ecosecurities is an environmental finance and greenhouse gas mitigation services firm.

E-sources

EPA Acid Rain Program — www.epa.gov/acidrain

EPA global warming site — www.epa.gov/globalwarming

South Coast Air Quality Management District — www.deq.state.mi.us/aqd

New Hampshire Department of Environmental Services Air Resources Division — www.des.state.nh.us/ard

Texas Natural Resource Conservation Commission Emission Reduction Credit (ERC) Banking and Trading Program — www.tnrcc.state.tx.us/air/erc/embank.htm

New Jersey Department of Environmental Protection Air Quality Management's Bureau of Regulatory Development — www.state.nj.us/dep/aqm

New Jersey Department of Environmental Protection Open Market Emissions Trading — www.omet.com

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This article appeared in the March 2000 issue of Environmental Protection magazine, Vol. 11, No. 3, p. 69.

This article originally appeared in the 03/01/2000 issue of Environmental Protection.