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3.2.1. Air Emissions Trading

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Savings from Economic Incentives


EPA's air emissions trading program consists of four separate activities: bubbles, offsets, banking, and netting. The components of the air emission trading program were developed through regulations and policy statements issued by EPA. The programs began independently in the mid to late 1970s and culminated in EPA's Final Emissions Trading Policy Statement, dated December 4, 1986.

Hahn and Hester (1989) estimate that bubbles produced compliance cost savings of $435 million over 6 years (about $70 million per year), offsets yielded negligible savings, banking resulted in very small savings, and netting saved some $525 million to $12 billion over 6 years ($90 million to $2 billion per year).

Foster and Hahn provide the most comprehensive evaluation of the emissions trading program, using data for offset transactions in the Los Angeles area. They obtained data on trading activity from the South Coast Air Quality Management District. The large increase in offset transactions in 1991 and 1992 reflects activity at two special funds created by the SCAQMD in 1991: the Community Bank, which serves small sources producing less than 2 tons per year; and the Priority Reserve, which secures credits for essential public services.

During the period 1985-1992, over 10,000 tons of pollutants were traded in the offset program, with total expenditure on ERCs estimated to be on the order of $2 billion (indicating an average price for traded pollutants of about $200 per ton. Nearly three quarters of the trades involved reactive organic gases (SCAQMD terminology for a subset of volatile organic compounds), but there also were trades in CO, NOx, PM, and SO2.

AER*X, a broker in the Los Angeles offset market, supplied data for prices for over 40 of the trades from 1985 to 1992. All price data are expressed in 1992 dollars. The minimum price per ton in trades of reactive organic gases (ROG) fluctuated in the $40 per ton range over this period, while the minimum value for NOx trades was about $120 per ton. High prices for ROG increased steadily over the period, from $135 to $711 per ton; and high NOx prices increased from about $320 per ton to $655 per ton over the same period. For a variety of reasons, one would not expect all tons of ROG or NOx to be valued identically. First, the markets are imperfect and information on historic trades is not widely disseminated. Second, credits that have been banked involve additional costs to the selling party. Third, offset ratios vary with the distance and location of parties to the transaction. The low end of prices could be determined largely by transactions costs to the seller (thought to be a minimum of $10,000 per transaction). In a few cases, transactions costs apparently exceeded the market value of the credits that were exchanged.

Though the highest and average prices increased over the period, most of the change in 1991 can be attributed to a change in SCAQMD rules the prior year. None of the observed prices remotely approach the typical incremental control costs for ROG and NOx in the Los Angeles area over that period: on the order of $5,000 per ton for ROG and $8,000 per ton for NOx.

Recent prices for emission trades have been higher. The brokerage firm Cantor Fitzgerald regularly posts "representative prices." These numbers are computed as the average of current bid price, current asking price and most recent trade price. In December 1977, the right to emit one pound of ROG per day in perpetuity in the SCAQMD was valued at $754; one pound per day of NOx at $2,908; one pound of PM10 at $1,947; and one pound of SOx at $1,740. The per ton equivalents (discounting at 20% per year) are $826 for ROG, $3,185 for NOx, $2,134 for PM10, and $1,907 for SOx.

Emission trading has not lived up to expectations; trades have been fewer and offset prices lower than many had expected. Several factors seem to have limited the appeal of the emissions trading policy. In order to assure that air quality did not deteriorate, state environ- mental administrators often required expensive air quality modeling prior to accepting proposed trades between geographically separated parties. Deposits to emission banks typically were "taxed" by the air quality management authority to meet state SIP requirements or to generate a surplus the area could offer to attract new firms. Offset ratios greater than unity further depressed the value of ERCs. In many areas it appears that ERCs had an economic value less than the transactions costs of completing a sale to another party.

In other respects, the emission trading program revealed the myriad possibilities for emission trading and many of the features that would be necessary to make trading viable. It served as the foundation for the enormously successful lead credit trading program and the many emission trading features of the 1990 Clean Air Act Amendments. In some respects, however, the 1990 Amendments reduced the scope of trading programs. For example, Section 173(b) restricts the use of growth allowances in State Implementation Plans, limiting the use of offsets. A number of states have redesigned their offset programs as trading programs without emission caps (examples include Delaware, Massachusetts, Michigan, New Jersey, Texas, and Wisconsin as described below). The South Coast Air Quality Management District that has responsibility for the Los Angeles area has developed a much more significant trading initiative known as RECLAIM with an emissions cap and phased reductions in allowable emissions of SO2 and NOx. Illinois expects to have a similar program with an emissions cap in place soon.

A new regional NOx trading program that involves several states in the Northeastern US is described in section 3.2.6. EPA's design builds on a 1993 NESCAUM (Northeast States for Coordinated Air Use Management) Demonstration Project to trade discrete emission reductions (DERs), as well as work by the Ozone Transport Commission (OTC) "cap and trade" model for NOx emission allowances, and Ozone Transport Assessment Group (OTAG) studies regarding a regional trading program for NOx and perhaps also VOC that would cover the eastern one-half of the U.S.

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