United States Washington DC 20460 OPA113/0
Environmental Protection June 1980
Agency
vyEPA Concept Paper:
Emission
Reduction
Banking and
Trading Systems
-------
Contents
Exhibits
Key Concepts of Emission Reduction Banking
and Trading Systems
Analogies and Precedents for Pollution Rights
Banking and Trading
Defining the Commodity. Emission Reductions
and Emission Reduction Credits
The Banking and Trading of Emission Reduction
Credits
Use of the Term "Banking"
Banking and Trading System Components
Component 1 • Creating Emission Reductions
Component 2: Confirmation of Emission
Reductions
Component 3: Certifying Emission Reduction
Credits (ERCs)
Component 4- The Banking and Trading of
ERCs
Component 5 Permit Modification to Use the
ERC
Alternative Banking and Trading Systems
What Are the Relative Merits of Public and
Private Systems?
What Are the Characteristics in General of the
Public Auction System?
What Are the Characteristics of the Public
Monopoly/Monopsony System?
What Are the Characteristics of the Private
Trading System?
Combinations
Exhibit 1: Overview of Components of Banking
and Trading Systems
Exhibit 2: Creation and Use of Emission
Reduction Credits
Exhibit 3: Potential Adjustments to Emission
Reductions and Emission Reduction
Credits
Exhibit 4: Three Alternative Banking and
Trading Systems and Representative
Issues
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2^975
Concept Paper:
Emission Reduction
Banking and Trading
Systems
Preface
This concept paper was
prepared for the U S Environ-
mental Protection Agency by
ICF Incorporated under
contract 68-01-5908 The
purpose of this paper is to
explore the concept of
emission reduction banking
and trading, especially issues
relating to operational.
administrative, and policy
options In addition, under this
same contract. ICF In-
corporated is preparing four
manuals describing how to set
up alternative banking and
trading programs This paper
and the four subsequent
manuals were prepared by a
project team including Paul
Bailey (Project Manager). David
Bruce, and Steve Seidel
The views expressed in this
paper do not necessarily
represent the official policy of
the United States Environ-
mental Protection Agency
Prepared for the
United States Environmental
Protection Agency
by
ICF, Incorporated
1850 K Street, NW
Washington. D C 20006
In conjunction with
EPA's Emission Offsets,
Banking and Trading Team
January, 1980
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Key Concepts
of Emission
Reduction
Banking and
Trading
Systems
Analogies and
Precedents for
Pollution Rights
Banking and Trading
The first section of this paper
highlights key concepts and
terms critical to an
understanding of our approach
to the design of banking and
trading systems Also included
in this section is an overview
of the five components which
comprise a banking and
trading system. Specific topics
examined in this section
include:
• A discussion of analogies
and precedents for banking
and trading systems
• A definition of the
commodity—emission reduc-
tion credits—what is actually
banked and traded, and how it
relates to the initial reduction
of emissions by a source.
• An overview of the five
components in a banking and
trading system
• A comparison of the
different uses of the term
"banking"
Although it is acceptable to
speak colloquially of the
banking and trading of
"Emission Reductions", it is
important to recognize that
what is of marketable value
are the rights connected with
or resulting from an emission
reduction A buyer would want
those rights to use as new
source offsets or for a more
cost-efficient satisfaction of
emission limitations (i e ,
application of the "bubble")
How do we categorize these
rights? Broadly, they are a
right to credit emission
reductions against an emission
limit requirement More
specifically and operationally,
they are the right to have
one's permit adjusted (or
established, in the case of a
new source) The nature and
characteristics of the
commodity or right created by
banking and trading systems
will determine the success of
those systems If the right is
not marketable, the systems
will fail.
While this may sound like
terminological hair-splitting, it
is not Before "investing in"
(e.g., creating) emission
reductions for banking and
trading purposes, potential
sellers will want to know (1)
the expected economic value
they could get for their
investment and (2) possible
legal problems affecting
marketability (and hence, the
return on investment)
Potential buyers will likewise
need engineering and financial
analysis to determine the
value to them, as well as legal
counsel regarding possible
pitfalls The air pollution
control agency will want to
know what effect these
systems will have on their
administrative workload and
their budget, and how these
systems will affect the
achievement of ambient air
quality standards In addition.
speculators, conservationists.
and others may want to
participate in the market All of
these actors will want and
need to know
• What is the nature of the
commodity being traded'
• How does it affect their
rights and obligations'
• What incentives/disin-
centives will result'
Economic literature
describing the concept of a
market for pollution rights
generally discusses the
theoretical merits of such
markets in terms of economic
efficiency (cost-effectiveness
and resource allocation)
However, little attention is
given to more practical issues
In some cases,1 analogies to
the markets for taxi
medallions, offshore oil drilling
rights on federal land, and
liquor licenses are made
Other possible analogies could
include state turnpike
restaurant concessions.
mineral land leases, water
rights in Western states.
transportation route certi-
ficates (CAB, ICC), hospital
certificates of necessity, and
broadcasting licenses In all of
these "public franchise"
situations, there are
government regulations
concerning transferabihty of
rights to other parties and
related issues
These precedents and
analogies can be misleading
In particular, it should be
stressed that the proposed
emission reduction banking
and trading systems differ
from existing precedents and
economic models of
marketable pollution permits m
one very important feature it
is not the administrative
permits themselves that are to
be banked and traded Rather.
the commodity consists of the
"right" to have one's permit
adjusted (or issued, in the case
of new sources) based on a
prior or contemporaneous
emission reduction certified by
the air pollution control
agency
The marketable pollution
permit systems described in
the economic literature
concern (i) the initial
'See. eg.de Lucia. An Evaluation
of Marketable Efficient Permit
Systems (Meta Systems. Inc,
1974)
-------
Defining the
Commodity:
Emission Reductions
and Emission
Reduction Credits
allocation, and (n) rules for
subsequent trading of pollution
permits. Likewise, the official
rules (if any) regulating the
transfer of oil drilling rights,
taxi medallions, liquor
licenses, turnpike concessions,
transportation route certifi-
cates, hospital certificates, and
broadcasting licenses all
concern the transfer of the
entire package of rights
included in the "franchise "
On the other hand, the notion
of marginal cost-effectiveness
underlies the concept of
emission reduction banking
and trading Except where
emission reductions are
created by the complete shut-
down of a source (i e ,
emission elimination), the
seller is transferring—//?
effect—only a part of his
permit to the buyer. Moreover.
the rules of banking and
trading will operate to reduce
somewhat the pollution rights
transferred For example, even
the shutdown of a source
emitting 100 tons of a pollutnt
will not enable the buyer to
increase his emissions by that
full amount Finally, in no
meaningful sense can we
claim that the permit itself is
being traded; emissions
permits are source specific and
non-transferable
In conclusion, it is essential
that a clear idea of the
commodity created for
emission reduction banking
and trading systems be
communicated in the
information manuals and other
marketing and technical
assistance efforts. In the next
section, we describe that
commodity as "emission
reduction credits" and explain
its relationship to pollutant
emission reductions and the
permit process
Exhibit I presents an overview
of the process by which
emission reductions become
amenable to banking and
trading. The process has five
components. (1) creation of an
emissions reduction, (2)
confirmation of the reduction
and permit modification; (3)
certification and registration of
emission reduction credits, (4)
"banking", storage, and
trading; and (5) subsequent
modification of permits. The
five components represented
in the flow chart will be
described in more detail m
Part II of this concept paper.
Here, we want to draw an
important distinction between
two major concepts (1)
emission reductions and (2)
emission reduction credits.
In thinking through how a
banking and trading system
would function operationally,
we found it necessary to
distinguish between the
physical reduction of
emissions by a source and the
commodity that is to be banked
and/or traded The two are not
identical As we discuss below
in Part II, the use of "taxes" to
either finance the system or
create a public reserve,
"discounts" to reflect changes
in SIP's, or other
"adjustments", as well as the
offset ratio which may be
required to satisfy the
"demonstration of attainment"
requirement, means that while
actual source emissions-may
be reduced, for example. 100
tons of a pollutant, only 80
of these tons may be available
for banking and trading In
order to avoid confusion
between the physical pollution
units and the intangible
pollution "rights" which are
banked and traded, we call the
latter "emission reduction
credits "
The permit system is the
administrative mechanism
through which emission
reduction credits can be
created and used This is
shown in Exhibit 2 Emission
reduction credits may be
created by a source through
the use of the permit system
A source may apply to change
its permits in the direction of
lower emission limits by
installing controls, altering
operating parameters and
inputs, suspending operations,
etc., so as to reduce emissions
below the existing baseline
level of emissions Reductions
of emissions below the
baseline amount are eligible
for conversion into emission
reduction credits. Once
emission reductions below the
baseline are documented, the
Exhibit 1
Overview of Components of Banking and Trading Systems
Emission
Reduction
Creation
7
Confirmation
of
ERs
\
)
Certification
and Registration
of Emission
Reduction Credits
N
Banking
Storage and
Trading
Systems
.)
Use
in
Permits
-------
The Banking and
Trading of Emission
Reduction Credits
source is bound to the new.
lower baseline, but is free to
"bank", use. or trade the
emission reduction credits in a
manner consistent with
applicable rules. Emission
reduction credits may be used
by being converted back into
physical pollution units
through the permit system in a
manner consistent with other
requirements (e g , new
sources, bubble) Conversion of
the ERC's into an emissions
allowance in a permit
extinguishes the emission
reduction credits Thus, while
there is a close relationship
between emission reductions
and emission reduction credits,
the two are different in
function and amount
Conversion must take place by
using the permit and
certification system
Exhibit 2
(I) How Emission Reductions (ERs) Can Be Converted into Emission Reduction Credits (ERCs)
Emission
Reduction
Baseline
\
/
AIR POLLUTION
CONTROL AGENCY
Confirm Ers
Change Permit
Certify ERC
Register ERC
)
/
\.
X
Emission
Reduction
Credits
-1-
New Lower
Emissions
V
^
<
/
BANK .
USE .
TRADE.
(II) How Emission Reduction Credits Can Be Converted Back into Allowable Emissions
Emission
Reduction
Credits
X
/
AIR POLLUTION
(TNTROL AGENCY
• Confirm ERCs
• Change SIPs
• Change or
Issue Permit
• Extinguish ERC
• Debit ERC
Register
•s
/
Emissions
Allowance
From Use
of ERCs
It is helpful to distinguish the
five components of this
process displayed in the
Exhibit 1 flowchart The first
component represents the
physical reduction of pollutant
emissions from a source The
source always has the option
of using controls and other
means of voluntarily emitting
lower levels of pollution than
currently allowed under its
permit This preserves the
right of that source to return,
at any time, to the higher
actual levels of emissions
authorized by its permit This
can be done without the
approval or even knowledge of
pollution control authorities
However, the transfer or
reallocation of pollution rights
between and among sources
(i e , banking and trading)
requires
• the confirmation of the
emission reductions by the air
pollution control agency and
the modification of source
permits,
• the certification and
registration of emission
reduction credits;
• "banking" and trading
according to the rules of the
system established, and
• modification of the permits
of transferee and transferor
and the extinguishment of the
credit
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Use of the Term
"Banking"
These requirements are
described in detail in the
following parts of this paper
In conclusion, the
commodity which can be sold
or transferred by a source is
an "emission reduction credit"
which entitles the owner to
the modification of emission
permits The permit documents
themselves are not the
commodity '
The term "emission reduction
credit" is useful and
descriptive Moreover, the term
signals the fact that the
commodity traded—a "credit"
—is embedded in the context
of the permit process of a SIP
The term also suggests that
the "credit" necessarily is
based on a definable emission
reduction and it sounds more
positive than "pollution rights"
(a very misleading expression).
'This distinguishes the proposed
system from other "marketable
pollution permit" ideas, eg.de
Lucia. An Evaluation of Marketable
Effluent Permit Systems. (Meta
Systems, Inc, 1974)
Throughout the development
of this paper, we have been
concerned with the "correct"
use of the term "banking". In
general, we use the phrase
"banking and trading system"
to describe the mechanism by
which aspects of the offset
and bubble policies can be
effectuated. However, we
recognize that these terms are
not always used consistently
in the literature and that
confusion—both conceptual
and terminological—cannot'be
eliminated by fiat. Neverthe-
less, it is important that we
distinguish and be aware of
several possible uses of the
term
Four broad usages of the
term can be distinguished:
• the activity of "banking" an
emission reduction,
• the status of emission
reductions as "banked",
• the collection of emission
reductions in a "bank
repository", and
• the agency and body
involved, the "bank".
These uses are relatively
easy to describe in the
abstract
The activity of "banking"
emission reductions: In our
formulation, this is equivalent
to the activity of applying for a
permit change and an
emissions reduction credit The
use of the term "credit"
suggests the commonly
understood notion of having
deposits in a commercial
financial bank Synonyms
could include "storing" and
"depositing"
The status of emission
reductions as "banked":
Again, this suggests the
common idea of demand
deposits in commercial
financial institutions. While
the depositor retains
ownership of the banked
emission reductions, custody
and control are out of his
hands
The collection of certificated
emission reductions: In this
usage, the bank comprises the
store or pool or stock of
emission reductions that have
been certificated and
registered. The registry serves
as an index of what is in the
bank The certificate is the
evidence of deposit ownership
and may be traded or
transferred as allowed
The agency or body that
issues emission reduction
credits: In this usage, the term
bank refers to an institution
and the procedures used for
making sure the system works
We have avoided this use by
employing such terms as
"public authority", "public
body", and the like
Complications enter during
the banking and trading phase
Because the systems (e g ,
public auction, monopoly/
monopsony, private trade) have
different critical features, the
four common usages of the
"banking" concept undergo
changes in the context of each
system
Consider, for example, the
public auction option As the
agency or body conducting the
auction, the "bank" can either
buy emission reduction credits
outright or accept them for
auction on consignment In the
former instance, it owns the
credits, in the latter instances,
it acts as a selling agent for
the actual owners of the
credits In both instances, the
emission reductions seem to
be "banked". However, the
producer cannot "withdraw"
any emission reduction credits
that the b3nk has purchased
outright. The emission
reduction credits consigned to
the public body are analagous
to bank deposits, but the ones
sold directly to the public body
have a different status.
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Banking and
Trading
System
Components
Component 1: Creating
Emission Reductions
Similarly, calling the public
body a "bank" does not
distinguish its possible
different roles as (1) repository,
(2) consignee for sales, (3)
purchaser for later disposition,
(4) sole sales outlet under the
monopoly/monopsony option,
and (5) clearinghouse or
broker We have tried to use
these more explicit terms in
the body of this paper.
One final point should be
raised The focus of this paper
is on banking and trading
systems It is the trading
aspect that will be particularly
difficult to implement What
we mean by "trading" is the
transfer of emission reduction
credits from one legal person
to another We have not
explicitly addressed the case
where one person wishes to
create and transfer emission
reduction credits among its
sources; in this instance, there
is no trading per se, but there
is banking for future use and
the modification of source
permits. For example, in the
Louisville emission reduction
bank to date, withdrawals have
been limited to firms drawing
against their own deposits If
this is expected to be the more
common pattern, it may be
preferable to develop one
manual concerning banking
and three separate manuals
concerning banking and
trading.
In this section, we describe
five components of an
emissions reduction banking
and trading system and the
issues raised in each
component.
Creating Emission Reduc-
tions (ERs)
• What are the different ways
of producing an ER?
• What restrictions should be
placed on producer eligibility?
Confirmation and Permitting
of Emission Reductions
• How can ERs be confirmed?
• How can the permanency of
ERs be assured?
• How should administrative
costs be financed?
Certifying Emission Reduc-
tion Credits (ERCs)
• How should producers of
ERCs be classified?
• How should sources be
classified?
• By what process are ERs
converted into ERCs?
• How are ERCs to be
accounted for?
The Holding, Sale, or Transfer
of ERCs
• How should buyers be
classified?
• What requirements should
guide the actual transfer
process?
Permit Modification After
Sale
• How should ownership of
ERCs be confirmed?
• In what regulatory contexts
may ERCs be applied?
• Are the ERCs of the
appropriate characteristics for
the source seeking to use
them?
• What permit modifications
are necessary?
These issues are discussed
in the following sections In
Part III of this paper, we focus
on the components and
structures of alternate models
of banking and trading
exclusively.
The initial component of a
banking and trading system
involves the creation of
emission reductions (ERs) It is
the first step in the production
of the commodity—emission
reduction credits (ERCs)—
which ultimately will be
banked and traded
The principal goal in setting
up rules for this component of
the process is to maximize
production of emission
reductions At the same time,
other factors including equity,
administrative necessity, and
economic efficiency must also
be considered to ensure the
viability of a banking and
trading system and the
achievement of its desired
goals Specific issues which
arise in the context of this
initial component include1
• What are the different ways
of producing an ER?
• What restrictions should be
placed on producer eligibility?
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What Are the Different Ways
of Producing an ER?
A source creates an ER by
lowering its emissions below a
definite baseline (e g , the
amount actually emitted) This
reduction can be accomplished
in a number of ways A plant
could shutdown existing
facilities, cutback its
operations, alter its production
processes, or add abatement
equipment For each source
seeking to create an emission
reduction, there must be a
definite baseline against which
to measure the reduction
Absent such a baseline,
enforcement problems arise
because there is no way to tell
whether the current "reduced"
emission level is sufficiently
below the previous unspecified
higher level to accurately
account for the ER allegedly
created In some situations, a
source may not be subject to a
permit (e.g, a minor source or
a source in a state without a
permitting system) or the
terms of the permit may not
specify a definite level of
emissions (e g., the permit
specifies operating procedures,
work practices, operation of
equipment, etc ) or the permit
may not reflect existing
emissions at the time the SIP
design value was calculated
To determine the baseline in
these situations, some form of
engineering analysis,
monitoring, or other form of
audit is required Because
emission reductions must be
real, permanent, and
enforceable, the establishment
of before and after baselines is
an important function
In terms of improved air
quality, the origin of the ER is
of little concern. Although a
banking and trading system
will lead to emission reductions
that improve air quality, at
least temporarily, it may also
take mto account effects on
employment and economic
development in the area For
this reason, it may be
desirable to differentiate
among the various ways in
which an ER is produced
Operationally, differing
incentives to reduce emissions
could be incorporated into the
system by varying the
percentage of ERCs awarded
for the production of ERs on
the basis of the method in
which they were created For
example.
• Awarding ERCs for a plant
or source shutdown would
create an incentive (i e , profit
from the sale of the ERC) for
this action, the award of ERCs
for reductions produced in this
manner could be restricted Of
course, prohibiting such
reductions could create
perverse incentives to continue
use of polluting facilities rather
than shutting them down
• It may be desirable to create
an incentive for the use of
innovative technologies as the
means of producing an ER
Bonus ERCs could be issued to
encourage this method of
reducing pollution
The use of ERC certification as
an incentive device to affect
the manner in which actual
emissions are reduced will be
discussed in greater detail in
Component 3, "Certifying
Emission Reduction Credits".
From the standpoint of
a state or local air pollution
control agency, it may be
desirable to first adopt a
straightforward banking and
trading system with relatively
few complicated rules or
exceptions Refinements such
as those discussed throughout
this paper may be added later
at the discretion of the
controlling agency
An additional method of
discouraging the creation of
certain types of ERs would be
to limit the context (e g , new
vs expanding source) in which
they can be used on the basis
of the manner in which the ER
was created For example, ERs
created by a plant or source
shutdown would be limited to
use by the same firm in
opening a new facility Limits
on user (buyer) eligibility will
be discussed in "The Holding.
Sale, or Transfer of ERCs "
One final point related to the
creation of ERs is that many
sources may now have actual
emission levels which are
below that specified in their
permits, if any This situation
may exist because pollution
control equipment operates in
a step-wise (and not
incremental) manner to control
emissions or because of the
costs of inputs (e g , in the
West, low sulfur coal is
relatively inexpensive) In
effect, these sources may have
"paper" ERs, the question is
can they have them certified m
order to bank and trade them?
If this is allowed, and their ERs
are ultimately bought and
used, air quality could actually
deteriorate To guard against
this occurrence, states must
be sure that credits are given
only for sources that make real
reductions that have not
already been accounted for in
a demonstration of attainment
If the SIPs were developed in
such a way that allowing pre-
existing ERs to be credited
would interfere with
"reasonable further progress"
or attainment, it will be
necessary to limit a source's
ability to cash-in on "pre-
existing" ERs This could be
accomplished by limiting the
award of ERCs only to
reductions in "actual" and not
"allowable" emissions.
-------
Component 2:
Confirmation of
Emission Reductions
What Restrictions Should Be
Placed On Producer
Eligibility?
Any source can create an
emission reduction. As
suggested earlier, there may
be legitimate reasons for
restricting which sources can
participate in a banking and
trading system. This would be
accomplished by not certifying
a source's ER or by only
certifying a percentage of them
as ERCs. Situations in which
restrictions may be placed on
producer eligibility include:
• where a source is
purchased for the purpose of
obtaining ERs by closing the
facility;
• where a source is marginal
or where it is obsolete and
likely to be shutdown for
economic reasons in the near
future; and
• where the source seeking to
create ERs owns other
facilities which are not in
compliance
The actual restrictions
placed on sources would occur
at the time a source goes
before the governing body to
have the ERs certified as
ERCs. This process will be
discussed in detail in
"Certifying Emission Reduction
Credits". At this juncture.
it is important that all sources
are aware that restrictions
may be placed on having their
ERs certified as ERCs. This could
be accomplished by making
available to all sources explicit
guidelines describing the
conditions and restrictions on
certification of emission
reductions.
After an ER is created, but
before it can be banked or
traded, it must be entered in
the records of the air pollution
control agency (APCA). The
creation and magnitude of the
ER must be confirmed, and the
source's permit and the SIP
must be altered to reflect this
change.
To the extent practicable,
these administrative steps
should be incorporated into
on-going agency activities
Some states have developed
inventories of existing sources
and currently have under
permit most, if not all, major
stationary sources. States have
also developed approved SIPs
which include emissions
limitations for each major
stationary source, and most
importantly, have programs to
enforce these requirements
The effectiveness of state and
local APCAs in implementing
these existing programs (e g .
the reliability of data in
inventories and permits, the
certainty of enforcement, etc.)
vanes considerably across
states. These administrative
systems may have to be
strengthened in order to insure
the integrity of the banking
and trading system. Where
sources are not under permits,
the APCA will have greater
difficulty in determining the
appropriate baseline against
which emission reductions can
be evaluated.
The primary function of the
confirmation and permitting
component of a banking and
trading system is to officially
incorporate newly created ERs
into the SIP through the
permitting system The change
in a permit would also provide
an administrative record which
would clearly identify the
ownership, quantity, and
characteristics of emission
reductions The principal issue
which must be addressed in
designing this component
include
• How can ERs be confirmed?
• How can the permanency of
ERs be assured?
• How should administrative
costs be financed?
How Can ERs
be Confirmed?
As part of the process to
develop and implement their
SIPs, most states have
compiled an inventory of the
major sources of emissions
located within their
jurisdiction These inventories
typically list the facility, point
sources within the facility,
applicable emission standards
for each point source, and the
pounds of pollutant each
emits
Most sources in an inventory
are also included within the
state's permitting system.
Pollution control permits have,
within the past decade, been
issued by some states for all
new major sources of
pollution Existing sources
have also been brought within
the permitting system at the
time they installed pollution
control equipment or when
complaints or inspections
brought them to the attention
of the APCA
Permits typically include
more detailed information
about a source than that found
on an inventory (e g.,
compliance method and
timetable ar d ooerat-ng
characteristics) They also tend
to be more up to date than the
inventory, but may not be as
comprehensive in the number
of sources recorded
The existing inventory and
permitting systems provide an
excellent starting point for
determining the types of ERs
which should be certified
Emissions found on the
inventory and specified in a
permit go into developing the
SIP and therefore are included
as part of the state's strategy
to comply with ambient air
quality standards Any real
reduction below the existing
emissions would represent an
improvement in air quality and
thus qualify as an ER
However, reductions that
affect permitted or allowable
levels but not actual emissions
would not be an improvement
in air quality Consequently,
their acceptance as ERCs and
use in permit applications
would be in conflict with
maintaining the SIPs
approvability Consequently,
while a useful starting point,
relying on state inventory and
permitting systems as the
basis for certifying ERs has its
limits There are several
potentially significant
problems.
Nonconventional Sources: A
large quantity of certain
pollutants (e g , participates.
hydrocarbons) are the result of
nonpomt sources including
roadways, construction sites,
etc. These pollutants are
difficult to control, but more
importantly from the
standpoint of an agency
confirming a reduction in
emissions, they '-.re difficult to
measure Frarii .nai forms of
measurement •;• rli as
-------
engineering analysis and stack
tests are inapplicable. Without
the ability to clearly measure
current emissions and the
level of proposed abatement,
any award of ERCs to the
source would be arbitrary Yet
reductions from these sources
clearly do result in improved
air quality, may be relatively
cost effective to achieve, and
may be essential to achieving
ambient air quality standards
Because it may be desirable
to incorporate this form of
abatement into the banking
and trading system some
technique to confirm the
creation and amount of a
reduction should be developed.
Possible methods to treat
nonconventional sources
include1 only ERs which result
from permanent changes
would be permitted, the
quantity of ERs would be
determined by engineering
analysis or ambient air
monitoring at the property line
before and after improvements
ere made, or to offset the
uncertainty inherent in the
creation of this type of ER,
only a percentage of the ERs
claimed would be certified as
ERCs or the use of this form of
ER could be limited to similar
circumstances at the facility of
Jhe buyer.
In treating non-conventional
sources and minor sources
it may be useful to apply an
incremental approach to these
sources' incorporation into the
banking and trading system
For example, as the banking
and trading system is being
established, it may be more
practical and realistic to focus
on major, conventional
sources. Once the program
has been successfully
implemented for major,
conventional sources, the
banking and trading system
can be expanded to include the
more difficult problems posed
by non-conventional and minor
sources
Minor Sources: Minor sources
are those stationary sources
which emit less than 100 tons
per year of pollution 2 This
category includes small
industrial sources, commercial
sources, and household
boilers. They are excluded
from the new source
permitting primarily because of
administrative necessity. This
is not to suggest, however,
that they may not be
significant and potentially
attractive sources of ERs As
was discussed previously in
reference to nonconventional
sources, it may also be more
cost effective to reduce
pollution from these sources
than to attempt to obtain
additional abatement from
large stationary sources
Inaccuracy of Data: Since
reductions must take place in
actual emissions, air pollution
control agencies may have to
establish definite procedures
for estimating historical or
existing emissions baselines.
To do this, air pollution control
agencies must develop
reasonable, consistent, and
reliable procedures for
determining baselines which
preclude opportunistic
behavior on the part of
sources. Significant problems
exist even for those major
sources on the inventory or
^Alabama Power Company vs
Costle(DC Cir 1979) (No 78-
10006), Initial ruling reported in
13ERC 1225
under permit for which data on
current emissions exist The
accuracy of emissions data
derived from both monitoring
and engineering analysis, the
most commonly used methods
of estimating emissions, has
been found to be of
questionable reliability. (In
some situations, however,
engineering estimates may be
the most effective tool
available.) This problem is
heightened over time, in part
because a source alters its
operating characteristics and
employs uncertain operation
and maintenance practices A
potentially attractive al-
ternative would be to monitor
key operating parameters.
How Can Permanent
Enforceability of ERs
Be Assured?
In addition to the requirements
that an ER be confirmed and
the level of abatement be
accurately assessed, an
additional requirement is that
the source producing the
reduction must permanently
maintain that reduced level of
emissions While this
requirement will be written
into a revised permit, current
practices suggest this action
by no means ensures the
continued compliance of that
source with the terms of the
permit. One alternative is to
limit the certification of ERs to
those which are clearly
permanent, e g.. the closing of
a facility, the shutting down of
a boiler unit, a change in
process equipment. But this
restriction would unnecessarily
limit the production of ERs
Instead, the potential benefit
from the sale of an ERC could
be used as leverage to
implement potentially useful
measures to ensure continued
compliance Another al-
ternative would be to require
sources seeking to have an ER
certified to include monitoring
measures such as installing
stack monitoring equipment,
installing parameter moni-
toring devices, or periodically
sampling ambient air quality at
the property line Alternatively,
instead of requiring some form
of continuous monitoring,
sources which fail to provide
such measures could have
only a percentage of their ERs
confirmed for sale as ERCs
Assuring the permanency of
ERs through continuous
compliance is as critical to the
integrity of any banking and
trading system as it is to
attainment Providing
incentives for the adoption of
monitoring measures would be
a significant boon to state and
local APCA efforts to improve
the effectiveness of their air
quality programs A banking
and trading system does not
present any enforcement
problems different from those
currently encountered by state
and local agencies. It does,
however, provide a mechanism
which could be used to create
an incentive which would
facilitate future, enforcement
activities
How Should Administrative
Costs Be Financed?
The administration of the
certification process will
necessarily place an added
burden on state and local
APCAs. To the extent possible,
this burden can be minimized
and the possibility of delay
reduced by utilizing existing
administrative systems. As
-------
Component 3:
Certifying Emission
Reduction Credits
(ERC)
discussed earlier, the
documentation of ERs can
readily be incorporated into
existing permitting and SIP
systems, although exact
estimation of actual emission
reductions will be difficult.
Possible additional ad-
ministrative costs associated
with the confirmation and
permitting of ERs may include1
• Engineering analysis of
proposed plans performed by
the APCA staff to determine
the magnitude of the ER
created,
• Site visits by APCA staff to
examine the nature of the
change, e.g., installation of the
control equipment, change in
process equipment, shutdown
of facility, and
• Monitoring of emissions
before and after the proposed
change to determine the
magnitude of the ER created
The costs of these
requirements should probably
be born by the source
producing the emission
reduction and applying for an
ERC. The APCA could perform
most of the tests and be
reimbursed for costs by the
source, or the burden could be
placed directly on the source
to provide specified
documentation of the results
of required emissions tests
which would then be reviewed
by the ACPA's staff
A possible financing
alternative would be to assess
a charge on the source in the
form of a specified number or
percent of ERCs created In
this way, a "public bank"
would be created for
discretionary allocation, sale,
or to offset a future revision in
the SIP. in addition to paying
for the administrative
expenses incurred in the
creation of an ER However, a
direct fee charge for permit
change application, processing,
and compliance monitoring of
ER's has the important
advantage of administrative
simplicity—and would not
operate to complicate the rules
of banking and trading
systems.
As emphasized in earlier
sections, an ERC is not the
same thing as an ER The ERC
is an outgrowth of the ER; this
section describes the issues
surrounding the ERC's
emergence from an ER This
discussion concerns four
issues.
• How should producers of
ERCs be classified?
• How should sources be
classified?
• By what process are ERs
and ERCs adjusted?
• How are ERCs to be
accounted for?
There is a strong supporting
rationale for introducing
classification schemes
Although allowing economic
growth is one goal of a
banking and trading system.
growth is only to be allowed if
air quality can be
simultaneously maintained
Thus, reducing the emissions
of current sources is used to
create "room" (in terms of air
quality) for economic growth
However, as discussed above,
the science of measuring and
monitoring emission per-
formance is, at best, an
inexact one In this climate of
technical uncertainty and
administrative constraints, the
responsible public authority
must move cautiously both in
allowing participation in the
banking and trading system
and in the degree to which
emission reductions can be
converted into allowances for
economic growth A carelessly
structured and administered
banking and trading system
will encourage economic
growth at the expense of air
quality, the Congress has
made the policy decision that
this is not an acceptable
tradeoff.
Thus far, we have discussed
the banking and trading
system to the point where ERs
have been confirmed It now
remains for ERCs to be
fashioned from the ERs The
ERC emerges only after the
producer of the ER has met
the eligibility requirements for
converting its ERs into ERCs.
the source from which the ER
comes is taken into
consideration as are the
characteristics of the ER, and
any "adjustment" measures
are taken Thereafter, the
administrative steps of
certifying the ERC are taken
How Should Producers of
ERCs Be Classified?
The banking authority should
find it useful and necessary to
regulate who can produce and
trade ERCs However, the
eligibility criteria for producing
ERs should-not create
unnecessary disincentives to
their production There are two
reasons for this
• It is in the interest of air
quality to encourage the
production of as many ERCs as
possible—it obviously leads to
cleaner air, at least
temporarily The appropriate
regulatory body should
welcome the decrease in
emissions, whether or not it is
produced by a source that in
the past has been cooperative
with clean air goals (Note that
a source cannot produce ERCs
until it has reduced emissions
10
-------
below the relevant baseline
thus, by the time of ERC
production, the emissions
requirements at that source
will, by definition, be
satisfied.)
• Buyers warrant closer
scrutiny because they seek
ERCs for the purpose of
increasing pollutant emissions
—thus degrading air quality in
an absolute sense In this
situation, more so than with
producers, there should be
concern about past behavior
This is consistent with Clean
Air Act provisions which
require that all of a source's
facilities in a state be in
compliance before it can use
an offset
The producer of ERCs and
the seller of ERCs, while
frequently the same, are not
always synonymous In a
system which has some kind
of middleman, producer or
seller may be different and
eligibility criteria will have to
be met by both entities. Two
eligibility criteria seem most
relevant
• The current status of the
producer and its past activities
in relation to clean air goals—
even though the producer's
record is not as crucial as that
of the buyer, it still is relevant
Past activity is more important
jf the seller is different (i e., a
middleman) from the producer
Unscrupulous dealings in the
past should put a regulatory
body on notice that a particular
seller may bring more trouble
than efficiency to the banking
system. In addition, when
considering whether a
producer source can/will
maintain an emission
reduction, past performance is
relevant However, use of past
performance as a qualifier can
not be left entirely to the
discretion of the public body.
Rather, explicit criteria must
be set and measures taken to
assure that producers have
prior knowledge of these
cntera
• The method by which the
ER is obtained—This is a
relevant consideration in
deciding whether a producer
may participate in the banking
system. For example, certain
reduction activities may be
encouraged (e g , installation -
of innovative control
technology) while others are
discouraged (e g., buying a
plant for the purpose of closing
it—while this produces the
emission reduction, it also
costs local jobs and may,
therefore, be considered an
undesirable method of
production) In such a
situation, an ER created in an
unfavored manner might not
qualify for conversion to an
ERC. or might qualify for an
unfavorable conversion ratio. It
is obvious that in very few
instances will an ER be
produced if the producer is
aware that it cannot be
converted into an ERC (except
where ERs are created
"inadvertently").
How Should Sources Be
Classified?
It will be useful to classify
sources creating ERs so that
the participation of their
owners in converting ERs to
ERCs can be regulated
effectively. Several criteria
characteristics could be used
to classify sources for
differential treatment. Five are
mentioned below.
• The type and characteristic
of pollutant. This basis for
classification is probably the
most obvious. Different
pollutants have different
properties, they affect health
and welfare differently, they
are not equally susceptible to
measurement or controli/and
so on It seems clear that
sources, if classified on the
basis of nothing else, must be
classified on the basis of,the
kind (type, size, and source) of
pollutant emitted.
• The size of the source- It
may be helpful to classify
sources according to whether
or not a source is major or
minor Minor sources should
not be excluded from
producing emission reductions,
since air quality is
substantially affected by
unregulated minor sources, it
is worthwhile to seek minor
source participation, especially
since many major sources are
already well controlled
However, minor source
participation raises difficult
questions about permanence
and will have to pass rigorous
tests to assure permanence
This is particularly true since
ERCs used as offsets allow
major new sources to
permanently increase
emissions, while minor
sources are not subject to new
source review at all Since
major sources provide a single
location with greater potential
for ERC production, and since
these sources are currently the
subject of new source
regulation, it might be easier
to treat them separately from
minor sources
• Current Compliance Status
Sources have one of three
compliance statuses. (1) in
compliance, (2) not in
compliance, but on an
approved compliance schedule,
and (3) not in compliance and
not on an approved compliance
schedule This is strictly a
factual determination and does
not address motive or intent A
11
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source which is in compliance
with the appropriate emission
limits should qualify for
participation without any
restraint based on compliance
status. A source not in
compliance but on an approved
schedule could simultaneously
come into compliance and
obtain credit for any reductions
beyond that required for its
compliance, and it might be
permitted to purchase credits
for expansion purposes A
source in the third category
could not produce credits, and
serious questions should be
raised about its participation in
any phase of the banking and
trading system f
• Presence on Inventory A
state or locale's inventory is a
touchstone for determining (at
least m a first cut) what is a
legitimate source Appearance
on the inventory suggests a
relatively established source
for which emissions may have
been catalogued previously, so
that a reasonably accurate
measure of reductions can be
made The past performance of
a source not on the inventory
is difficult to track Sources not
on the inventory probably tend
to be minor or nonconven-
ttonal sources. As such, it is
not as easy to keep track of or
to verify their continued
compliance It is also important
to note that emission reduction
credits cannot be given for
sources not included in the
inventory until the SIP is
revised to include them.
• Impending Change in
Standards: There may be
various industrial processes
that, from time to time, are the
subject of new or revised
regulations—presumably a
further "tightening" of
permissible emissions In such
a situation, it may be desirable
for the public body to place a
temporary prohibition on the
granting of ERCs for these
process changes so that the
new, lower limits cannot be
avoided by a last-minute
"voluntary" reduction thai
would soon thereafter be
required anyhow. Such a
prohibition would necessarily
be publicized in advance
By What Process Are
Emission Reductions and
Emission Reduction Credits
"Adjusted"?
During the trading and banking
process, there are three points
at which either ERs or ERCs
may be adjusted downward for
valid policy reasons The
discussion of the adjustment
process is in three parts
• To put the adjustment
points in perspective, a brief
outline of the banking and
trading system is provided and
the points at which adjustment
may occur are identified;
• The rationales for
adjustment are discussed in
detail; and
• Three varieties of
adjustment are described.
Identification of the Points At
Which Adjustment May
Occur
Within the five basic
components of a banking and
trading system, there are five
points at which adjustment
may occur This is shown in
Exhibit 3, and is discussed
below.
Component 1. The ER is
created;
Component 2. The ER is
confirmed;
• Adjustment point 1 After
the ER is confirmed (i.e., the
producing source's permit is
changed to reflect a lower
level of permissible emissions),
the ERs may be adjusted
downward for two reasons. (1)
uncertainty concerning the
creation, magnitude, and
permanency of an ER, and (2)
producer or source classifica-
tion Thus, the producer may
be required to maintain
emission levels that are lower
than the reduction level on
which its ERCs are based
Component 3. The remaining
ERs become ERCs and are
entered and stored in a central
registry;
• Adjustment point 2. The
ERCs just created from
adjusted ERs may themselves
be adjusted for two possible
reasons (1) to help finance the
administration of the banking
and trading system, (2) to '
create a public reserve or help
drive attainment.
Component 4. The ERC is
banked and/or traded, and
• Adjustment Point 3 While
the ERC is banked, and prior to
its use, ERCs may be adjusted
to reflect a change in the SIP
or national ambient air quality
standards.
• Adjustment point 4 At the
time of sale, the buyer should
be aware of what the precise
"loss" is that it will suffer
from this adjustment The
adjustment may be made for
two possible reasons- (1) to
help finance the banking and
trading system, and (2) to
create a public reserve or to
help drive attainment
Component 5. The ERCs are
used up in permits The
buyer's permit is issued or
revised to reflect compliance
through the use of the ERCs
• Adjustment point 5 When
the ERCs are used to satisfy a
new or changed permit, it may
be necessary to adjust the
ERCs to satisfy the
"demonstration of attainment"
test An ERC is a type of
contingent "procedural"
property right which entitles
users to have permits adjusted
'or issued according to the
requirements of the Clean Air
Act and incorporating an
emissions allowance based on
a confirmed and permanently
enforceable preceding
emissions reduction. Thus, the
ERC is clearly not an absolute
license to pollute.
12
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Exhibits
Potential Adjustments to Emission Reductions and Emission Reduction Credits
Components
of
System
Points at Which
Adjustments May
Be Necessary
Creation of
Emission
Reduction
Confirmation of
Emission
Reduction
Certification of
ERCs
1 When the permit
is changed to
confirm the
emission
reduction
Potential Reasons
for Adjustments
Banking of ERCs
Trading of ERCs
2 When the
emission reduction
credit is certified &
registered
A Because of
uncertainty (i e.
magnitude/
permanency)
of emission
reduction
B Because of
producer or source
classes
3 Prior to use of
the credits
A In order to
finance the
administrative
costs
B To create a
public reserve
C To help drive
attainment
Use of ERCs in
Permit
Modification
4. When the credit
is transferred
A In order to
comply with e
change in the SIP
or ambient air
quality standards
5 When the ERCs
are used to satisfy
e new or changed
permit
A To finance
administrative
costs
B To create a
public reserve
C To help drive
attainment
A. To satisfy
demonstration of
attainment test
13
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The Reasons
for Adjustment
Six reasons for adjusting ERs
and ERCs were noted above
They are discussed below in
terms of legal, political.
administrative, and incentive
issues
Reason 1. ERs may be
adjusted to compensate for
uncertainty in the technology
used to create and measure
the ER. The underlying
purpose is to assure that
credit granted corresponds to
emission reductions which
were actually created
• Legal Issues There should
be no legal problems related to
this reason Uncertainty should
be relatively constant for types
of industries and pollutants,
and the adjustment should be
relatively uniform (thereby
avoiding any equal protection
problems)
• Political Issues This reason
for adjustment should not
cause significant political
difficulties Given the state-of-
the-art in emission control and
measurement technology, the
need for a downward revision
to compensate for uncertainty
is readily apparent Uniform
handling of this downward
revision (e g , a flat percentage
adjustment for a particular
pollutant emission) enhances
its acceptability
• Administrative Issues There
are significant administrative
problems raised by this reason.
Initially, there will be technical
debate to determine what
levels of imprecision exist and
what the proper response to
such imprecision should be
Subsequently, as the state of
the art improves, the means of
compensating for uncertainty
will have to be altered The
administrative burden of
resolving technical debate and
keeping abreast of technical
developments could be
substantial.
• Incentive Issues This
reason for adjustment should
not create any perverse
incentives if the reduction in
ER is reasonable in light of the
level of uncertainty It may,
however, have the negative
impact of encouraging the use
of existing technology
Reason 2. ERs may be
adjusted because the producer
or the source falls within a
particular classification This is
an attempt to assure that, if
the source or producer fall
within a defined class, the ERs
are revised downward for valid
policy reasons.(see the
preceding discussion on
producer and source
classification)
• Legal Issues Equal
protection issues probably
would arise due to the
differential credit allowed
based on source classification
However, as long as the
classification is reasonable and
shown to be related to the
regulatory purpose, the equal
protection claim would not
stand
• Political Issues. The political
repercussions from this
method are sure to be strong
Source classification will
cause significant discrimi-
nation in credit allowed
Although no source should be
classified without sub-
stantiating evidence, documen-
tation, and explanation, it still
may be difficult for a source
owner in a valley to
understand why the reduction
credit allowed is only 60%,
whereas the same kind of
source on a plain is allowed
80% credit Some effort will be
required to make difficult
technical issues compre-
hensible to the public
• Administrative Issues The
adjustment imposes great
difficulties on an adminis-
trative system For example,
different sources could be
subject to different downward
adjustments depending on age,
past performance, and a host
of other variables To keep
track of these variables would
be a difficult and time-
consuming task (assuming that
a banking region has enough
sources to constitute a viable
market)
• Incentive Issues Treating
producers and sources
differently may have the effect
of encouraging more ER
production and more economic
growth in those industries for
which the adjustment is less
severe. A significant incentive
problem would also be posed
by the consideration of past
performance. This is sure to
provide a disincentive to the
"bad actor" unless it is
carefully fashioned While past
behavior seems relevant, it
should not obscure the
purpose of a banking and
trading system—to produce as
much ERs (and ERCs) as
possible
Reason 3. ERCs may be
adjusted to help finance the
banking and trading system
The public authority could take
some of the ERCs from both
the producer and the buyer for
it to sell on its own account
Proceeds from the sale of
these ERCs would help the
public authority to finance the
banking and trading system's
costs An alternative, of
course, is to charge the
producer or buyer a flat fee in
the nature of a brokerage fee
or user charge (i e., for using
the banking and trading
system) This latter alternative
is preferable because it avoids
undue complication of the
system
• Legal Issues. Adjusting to
finance the banking and
trading system should qualify
as a valid exercise of the
police power To be a valid
exercise of the police power,
courts generally require that
the amount of the fee (here, it
would be some amount of
ERCs) bear some relationship
to the costs of regulation,
inspection, or monitoring
necessitated If the fee greatly
exceeds these costs, it is
generally held to be either a
tax or an illegal exercise of the
police power Many states
recognize an exception to this
rule where the fees are also
based on the indirect (e g ,
social) costs to the public
suffered as a consequence of
the activities listed In addition,
another exception appears to
be recognized by most courts
and allows police power fees
to be set high enough to effect
a reasonable restriction or
restraint of business activities
deemed harmful to public
morals, productive of disorder,
or injurious to the public
• Political Issues Initial
opposition would come from
the producers and buyers of
the credits They probably
would argue that the costs of
14
-------
running the banking and
trading system were too high.
If economic gains are
sacrificed because of this
adjustment, subsequent
opposition might arise from
community leaders and from
the workforce. When the
economic tradeoffs become
apparent, many individuals and
politicians may be willing to
compromise environmental
values.
• Administrative Issues:
Adjusting to finance, at least
in part, the operating expenses
of the banking and trading
system does add a significant
administrative burden. More is
required than just a few
additional lines in a ledger.
The ERCs used for financing
purposes must be managed or
disposed of—this is not a self-
executing task.
• Incentive Issues: This
adjustment will affect the
incentive to produce ERCs If
the "payment" to the public
authority is too high, it will
cost the producer more to
produce its "net" ERCs than
some buyers may decide to
pay. The practical result will be
that ERC production will cease,
defeating both purposes of the
banking and trading system
(enhancing economic growth
and improving air quality).
Reason 4. ERCs may be
adjusted to help create a
public reserve. The ERCs taken
from producers and/or buyers
could be set aside for public
use—whether to maintain
clean air or to promote certain
types of economic growth.
• Legal Issues: The public
.reserve purpose for adjusting
seems, like the financing
purpose, to fall within the valid
exercise of the police power.
• Political Issues: Opponents
to this aspect of adjusting
(initially producers and buyers
would object, but others would
join if the economic <
consequences become more
widespread) probably will
argue that the public reserve is
too large. The adjustment level
must be set prudently, so that
its use is not unreasonably
burdensome.
• Administrative Issues: The
public reserve will create
management requirements
and undoubtedly will induce
controversy over its use—
should it be set aside (like a
national park) to be used only
for clean air purposes, or can
the public authority use it to
encourage or direct economic
growth in the locale or state.
Other possible uses will be
suggested, and strong opinions
are sure to arise in favor of the
several possible uses.
• Incentive Issues: This
adjustment can either reduce
the supply of ERCs (if the
public reserve is" used solely
for clean air maintenance) or
increase the public authority's
stance as a competitor with
producers of ERCs (if the
public reserve is used to
encourage economic growth).
In the former instance, the
price for ERCs should respond
to the supply (i.e., if ERCs are
"retired" in the public reserve,
ERCs will be more scarce and
consequently should bring a
higher price per unit), but it is
not clear how elastic the
demand is. Response to the
expected higher price might
offset the producer's reduced
supply. In the latter instance.
however, the public reserve
competes with the private
supply, and care must be taken
that such competition does not
result in a significant lowering
of ERC production or price.
Reason 5. ERCs may be
adjusted when an SIP is
altered to further restrict
allowable emissions. In such a
situation, the ERCs might be
subjected to a pro rata
reduction or to some other
form of downward adjustment.
This adjustment is removed in
time from the other
adjustments. It affects all ERCs
that have been certified, but
not used. This adjustment
would diminish outstanding
ERCs to the point that if they
were used immediately, the
new SIP standard would not
be violated. This can occur
only after the ERC has been
certified and before it is used
by either the producer or a
later purchaser. Thus, if a
buyer purchases the ERC and
holds it without using it (i e.,
without having its permit
altered), the ERCs so held
would be subject to downward
'revision to accommodate a
SIP change
• Legal Issues: There should
be no legal difficulty with this
use of adjustment. However, it
would be prudent to advise the
holder of the ERC at the time
the ERC is obtained (either
through creation or purchase)
that until it is used, the value
of the ERC is subject to certain
contingencies, including a
reduction in its quantitative
worth.
• Political Issues: If
adjustment is done on a pro
rata basis, there seems to be
little difficulty from the political
standpoint. However, if some
differential reduction is
applied, substantial political
problems may appear.
• Administrative Issues:
Applying this adjustment
should be relatively easy from
an administrative standpoint.
In terms of an SIP change, the
discount can be made on the
credit ledger and the holder
can be notified (this assumes
that there is some central
registry).
• Incentive Issues- If
uncertainty exists about the
actual ERC quantity a source
has (after having either
created or purchased it), there
may be some reluctance to
participate in the process.
What actually may occur is
that the ERCs will be
purchased only as the need
arises, instead of for future
expansion plans This should
not have too adverse an effect
on the production of ERs
(assuming the price adjusts
with any changes in supply).
Speculation, if permitted, may
occur. In fact, the prospect of
diminishing supply at a higher
price may be incentive to
purchase early against future
shortages, thus assuring that
some ERCs will be available if
needed In the final analysis,
ER production will continue as
long as if pays the producer to
do so—i e., as long as the
marginal cost of production is
less than the marginal price
the producer can obtain, the
production will continue. This
assumes, of course, that the
particular market is operating
efficiently, especially in terms
of information flow.
15
-------
Note that Reason 5 risks
both in delaying ER production
and in proceeding with ER
production. Delay may result in
a lost opportunity to create
ERs (i.e., if the SIP is altered to
further restrict allowable
emissions, a producer probably
will have less room for
improvement after meeting the
amended SIP) Alternatively.
proceeding with ER production
at an early date does expose
the ERC to possible
discounting. However,
something is better than
nothing, especially since those
somethings—bankable emis-
sion reduction credits—will be
significantly more valuable
after a major SIP revision.
Reason 6. ERCs may be
implicitly adjusted during a
permit application to satisfy
the requirement in non-
attainment areas that any use
of an ERC as an emission
offset must satisfy the
"demonstration of attainment"
test The relative location and
pollutant characteristics of the
'buyer and producer of the ERC
will determine the ERCs
required for a transaction
between two particular parties.
• Legal Issues- There seems
to be no legal difficulty with
this use of adjustment It is
merely an application of
existing policy interpreting the
Clean Air Act's requirement
that m non-attainment areas
"reasonable further progress"
be made in achieving ambient
air quality standards
• Political Issues There may
be some political difficulty in
adjusting for this reason—
offsets should not necessarily
be used to "drive" attainment
If the adjustment is more than
necessary to sustain
reasonable further progress
(RFP). it could run into
significant resistance Explicit
criteria should exist for
determining the offsets
required to satisfy the
demonstration of attainment
test
• Administrative Issues: The
major difficulty will be
determining the ratio of ERCs
to new emissions required for
an offset If general guidelines
showing the affect of location,
plume rise, etc., cannot be
devised, some degree of
emission dispersion modeling
may be necessary to determine
that the reasonable further
progress requirement is being
satisfied
• Incentive Issues: Incentives
should not be adversely
affected if requirements are
not excessive. It is a policy
currently in effect and requires
only a small "discount" as
currently interpreted
Three Concepts of
Adjustment
There are three concepts
around which downward
revision of ERs and ERCs may
be organized.
• Tax: The means of adjusting
ERs and ERCs could be called
a tax. If "tax" is used,
however, special legal and
political problems are created
that otherwise could be
avoided. "Tax" is a term which
flags everyone's attention and
evokes strong reactions It may
be prudent to apply some other
term to the adjusting process.
especially for those kinds of
adjustment which m no way
are taxes.
• Adjustment The term
"adjustment", used above as a
generic term, is accurate for
reductions not intended to
raise "emission reduction
revenue" for use by the state.
"Adjustment" aptly describes
the fine-tuning necessary to
bring the idea of ERCs into
harmony with reality.
• Discount. Discounting
accurately describes the
process of reducing the
quantitative value of ERs and
ERCs when the total set of
emissions allowed must be
reduced to bring an area into
attainment. Again, this term is
not as evocative a term as
"tax"
Any of these three (or other)
terms could be used to
describe the downward
revision of ERs and ERCs.
However, though substantively
they accomplish the same
result, careful consideration
should be given before a short-
hand term is selected for the
different contexts in which
adjustment may occur.
How Are ERCs
To Be Accounted For?
To maintain order in the
creation and transfer of ERCs,
some accounting process must
be used This will impede
fraudulent use of ERCs,
carelessness in transferring
ERCs. and generally will
enable the public authority
operating/overseeing the
banking and trading system to
keep a tighter rein on banking
and trading activities The ERC
accounting system should
coincide with the permitting
and SIP systems in order to
achieve maximum efficiency
and accuracy Administratively,
it should be relatively easy to
establish one set of books
which would include
information on permit
limitations, including their
quantity, their characteristics.
and any downward revisions
which have been assessed
against ERs These records
should also include the
conversion ratio applied to
create ERCs, the number of
ERCs (their characteristics
should be the same as those
of the ERs from which they are
derived), and any assessments
against ERCs. The registry
would denote creator, chain of
ownership, etc —in sum. a
running tally of the ERC's
history until it is extinguished
by use (i e., the buyer has its
permit changed) The registry
should contain all information
necessary for a potential buyer
to make an initial
16
-------
Component 4:
The Banking and
Trading of ERCs
determination of the potential
utility of the ER for the buyer's
particular use. Available ERs
should be indexed by pollutant
type and location and. if
feasible, be recorded on a
computerized system. General
guidelines concerning
geographical limitations on the
use of ERCs should also be
readily accessible*
Because the banking and
trading system is very
sensitive to misuse, this
careful "tracking" is
necessary. The final registry
might be analogous to the
system of recording
requirements for real estate'
and its transfer. A registration
system for ERCs should be
centrally compiled so errors
can be minimized and more
easily located and resolved.
For information purposes.
duplicate sets could be placed
in key locations throughout the
banking region. Presence on
the registry should be an
invariable requirement for the
transfer and use of an ERC.
Once the ERC is created, it is
transferable according to the
rules of the particular banking
and trading system. These
rules will deal with two
primary issues:
• What buyer eligibility
criteria should be established
for participation in the banking
and trading system?
• What requirements does the
banking and trading system
place on the actual mechanics
of the transfer process?
The first issue is discussed
here in some detail, and the
second issue is overviewed. A
full treatment of the second
issue is presented in Part III
which discusses in detail three
alternative banking and trading
systems.
How Should Buyers
Be Classified?
This is a crucial issue because
buyers are a key point of
control and enforcement. The
banking and trading system
cannot succeed if ERCs are
misused. It is reasonable.
therefore, to impose some
, restrictions or requirements on
those who wish to purchase
ERCs. Several criteria seem
especially relevant.
• Current Status—The
question posed is whether the
buyer owns or controls other
sources which are not in
compliance with relevant
ambient air quality standards?
The public authority could
require a buyer to be in
compliance with emissions
limitations at all sources it
owns or controls.
• Benefits of Trade—The
public body may want to limit
participation of buyers who
will obtain the most economic
"mileage" from the ERCs. This
could be in terms of jobs.
gross products, etc.
• Reason for Purchase—this
issue goes to the nature of the
buyer: Is speculation
permitted? Can environ-
mentalists participate and buy
credits that will be withdrawn
and not used for economic
growth? And so on. The
underlying question is whether
the buyer will use the credit to
fuel additional economic
growth This can be a difficult
question to answer since there
is no objective test to
determine whether a purchase
is to be made for purposes of
economic growth. In addition,
there would be strong
sentiment both to permit
purchase for non-economic
reasons and to forbid such
purchases. Whether or not
other users (i.e.. environ-
mentalists, speculators, etc.)
are permitted is a policy
decision to be made by the
appropriate public authority.
However, the legal and
administrative realities may
limit actual policy choices.
*
• Government Subdivision as
Purchaser—\l is possible to
permit intervention by the
public body in the purchase of
ERCs (e.g., by tightening
standards on existing sources
to obtain ERCs). This
intervention could supplement
an economic development role,
and also could be used to
effect other desirable goals
(e.g., countering market
dominance).
• Past Performance—While
not central to producer
eligibility, past performance is
crucial to buyer eligibility. The
question is whether the buyer,
if not cooperative in the past,
should be permitted to benefit
under this system which
facilitates economic growth It
is reasonable to suggest that
such buyers be required, as a
"gesture of good will, to meet
some higher standard for
participation (e.g , they may be
required to contribute more to
a public reserve of ERCs).
However, it should be
remembered that the central
purpose of the banking system
is to permit economic growth
and not to punish past
misdeeds.
• Market Dominance—This
issue has two facets. The first
regards a potential buyer that
has a market dominant
position in the banking region.
The public body may want to
limit such a buyer's
opportunity to solidify its
dominant position by obtaining
ERCs necessary to economic
growth. The other facet goes
to intent and is very difficult to
determine—is the buyer trying
to attain or maintain a market
dominant position by
'purchasing ERCs so that
competitors will be excluded
from expanding or locating in
the banking and trading
region. The public authority
will have to determine, first, is
it possible to deal with this
issue and, second, if it wants
to deal with this issue. (Note
that anti-trust law could inhibit
the market dominance strategy
described above. However,
there would be a lag time
before anti-trust enforcement
action "caught up" with such
a ploy) There are means of
17
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Component 5:
Permit Modification to
Use the ERC
dealing with the market
dominance issue. For example,
there could be limits on how
much of the bank any person
or firm could control. Another
possibility is to limit
participation to persons or
firms who have less than a
specified percentage of the
market.
What Requirements Guide
the Actual Transfer Process?
The final part of this paper
discusses at length three
alternative banking and trading
systems. The three are
summarized below with
special emphasis on the sales
process.
• The public auction system:
The public authority collects.
either by purchasing outright
or by taking consignments,
ERCs for sale at a public
auction. The form of the
auction may vary (see the
discussion below on the
differences of the "Dutch".
"English", and 'Traditional"
options), but the public
authority controls who may
bid, whether or not minimum
bids are required,
frequency of auctions, and the
block size of ERCs offered. *
9 The public monopoly/
monopsony system: The 'public
body could act as the sole
purchaser from producers/
sellers and the sole supplier to
buyers. ERCs are collected
only through purchases from
the producers of ERCs. The
public body determines to
whom it will sell, what the
conditions of the sale are. and
what price will be charged.
However, there probably will
be some room for limited
negotiation between the public
body (monopolist) and the
buyers. It is not necessary that
the monopoly or monopsony
organization be publicly
owned. For example, the public
body could grant the monopoly
to some private organization—
perhaps along the lines of a
turnpike concessionaire who
bids for the right to operate
the monopoly. In addition, the
public body could retain
control of this system, but
rather than sell the ERCs, it
would give them away to new
sources as a means of
promoting economic growth.
Where the market does not
generate enough capital to
support one of the other
banking and trading options,
the monopoly/monopsony
option can generate the
desired level of activity.
Instead of funding the
purchase of ERCs through the
proceeds of sales, the public
body could assess a tax
against all existing sources
and provide ERCs to new
sources free of charge.
• The private trading system:
There are many variations of
this system, but all must
involve some degree of public
intervention. At a minimum,
the public authority will have
to direct the process of
certifying/registering ERs and
ERCs, and monitoring/
enforcing their proper use.
Additional public involvement
ranges from no control over
ERC price and market
participation to stringent
guidelines regarding prices
and market entry. However,
negotiation and sale
consummation will be
accomplished through the
private parties involved in each
transaction.
Once a transaction has
occurred, the emission
reduction credit can be applied
toward compliance with the
emission standard faced by its
new owner. This last step in
the trading and banking
system incorporates the _
transfer of an ERC into the
permitting system at which
time the ERC is extinguished.
It attempts to ensure that
ERCs are properly used and
recorded. Issues arising in the
design of this component
include:
• How should ownership of
ERCs be confirmed?
• In what regulatory contexts
may ERCs be applied?
• Are the ERCs of the
appropriate characteristics for
the source seeking to use
them?
• What permit changes are
necessary?
How Should
Ownership of ERCs
Be Confirmed?
Before approving a new source
permit or altering an existing '
permit which includes the
application of an ERC, the
state or local APCA would first
want to confirm that the
prescribed ERC is genuine, and
that the source is the
legitimate owner. Because
notification of the registry
would be a requirement of any
transaction, this information
should be readily available
from a central registry
(discussed earlier). Thus, the
registry serves the dual
function of providing
information concerning the
9V.J!3t:.*i.'v of ERCs and
documentation relating to
ownership. In the context of »
the latter function, the registry
should reduce the likelihood of
an ERC being sold twice or
being fraudulently created, and
therefore should provide the
level of certainty critical to
creating an effective market
for this commodity.
In What Regulatory
Contexts May ERCs Be
Applied?
There are several possible
regulatory requirements to
which ERCs may be applicable.
The use of internal and
external offset arrangements
has been proposed and
adopted in a number of
contexts and has resulted in
considerable litigation.
At this time, ERCs could be
applied to:
• a new source wanting to
locate in a non attainment
area;
• an existing source wanting
to expand in a non attainment
"area;
• a new source wanting to
locate in a PSD area but with
emissions which would bump
the allowable increment; and
• internally within an existing
source seeking a less costly
mens of satisfying an SIP w
requirement (i.e., the bubble).
-------
Alternative
Banking
and Trading
Systems
The APCA creating the
banking system may decide to
limit the use of ERCs to one or
more of these contexts.
Alternatively, it could decide to
provide different requirements
for each. This decision would
be determined by air quality
characteristics (What class:
PSD? Non attainment?) and by
the exact nature' of the
incentive sought by the APCA.
It should be noted, however,
that broader application of the
banking and trading system
would increase the number of
potential buyers and sellers
and therefore would be
somewhat more advantageous.
Are the Emission Reduction
Credits "Appropriate" for the
Proposed Use?
Before a permit can be
changed to reflect the
application of an ERG, the
APCA will first have to make a
final determination that the
magnitude of the ERC offered
and its pollutant character-
istics (e.g.. pollutant type, size
of particles, source) are
appropriate for the proposed
use.
Presumably, the source
seeking to apply the ERC to its
permit had performed the
required analysis and had
discussed the matter with the
APCA authority at a pre-
application conference. At the
time the owner came into
possession of the ERC (either
having created the ER itself or
purchased the credit), it should
be clear what is permissible
and what requirements will be
imposed on the use of the
ERC. Unless a potential owner
of an ERC can be reasonably
certain of these factors before
actually taking ownership of
the ERC, the uncertainty
surrounding future use would
severely impede the efficient
functioning of a market. If
these precautions are taken,
final approval of the particular
use of an ERC and
documentation of this use
through its recordation in a
permit should be little more
than a perfunctory adminis-
trative step.
What Permit Changes
Are Necessary?
If deemed suitable to be used
to satisfy the required
emission standard, the ERC
would be "extinguished" as a
credit in the registry. At the
same time, use of the credit
would be entered as part of
the permit for the source to be
applied against the source's
actual emissions. The registry
would document the creation
and eventual use of the ERCs.
• It should be noted that the
magnitude of the emissions
offset by the ERC will not
necessarily be equivalent to
the certified amount of the
credit. The APCA may require
a more than one-for-one offset
to ensure the achievement of
reasonable further progress, or
it may assess a charge in
order to pay administrative
costs, or to establish a public
bank. This is discussed at
length in a previous section on
adjustments.
At the time the source's
permit is changed or issued
(for a new source), it is also
necessary to change the SIP to
reflect the rearrangement of
emissions. In addition, in those
situations where a greater
than one-for-one offset was
required, the total amount of
emissions would be reduced
and should be reflected in the
SIP. Because of trading and
banking, changes in the SIP
may become more frequent
and it may be desirable to
reduce some of the
administrative steps currently
required. It may be possible to
exempt SIP changes related to
banking from some of these
requirements or to develop a
more effective means of
satisfying the goals of these
procedures. One possibility
might be to include ERCs in a
state protected "growth"
margin.
Three alternative banking and
trading systems (two "public"
systems and one "private"
system—see Exhibit 2) will be
the subject of three "manuals"
to be prepared by the ICF
project team. In this section of
the initial concept paper, the
following issues are discussed:
• What are the relative merits
of public and private systems?
• What are the characteristics
of a public auction system?
• What are the characteristics
of a public monopoly/
monopsony system? and
• What are the characteristics
of a private trading system?
Each system will be
described, including its
advantages and disadvantages.
In addition to these three
systems, hybrid alternatives
are possible and are briefly
discussed to show the
flexibility available to states
and locales in developing a
system suited to their unique
requirements.
-------
Exhibit 4
Three Alternative Banking and Iradlng Systems and Representative bsues
Public Auction System
Producer/
Seller of
ERC
Consigns
or
Qalle
ERC \
Publicly
Assessibte
Entity
Auctions
ERC
\
7
Buyer/
User
of
ERC
• Does the public body buy the ERC. or take it on
consignment?
• What units of ERCs are offered for sate?
• By what process do buyers establish their
qualification to bid for the ERCs being offered?
Public Monopoly/Monopsony
Producer/
Seller of
ERC
Sells
ERC
>
/
Publicly
Assessible
Entity
Sells
N
/
Buyer/
User
of
ERC
• How are prices determined?
-WOI differential pricing be used?
— Win^rice negotiation occur?
• How many ERCs with what characteristics should
the public body buy?
Private Trading System
Producer/
Seller of
ERC
consigns
or
SeDs
ERC \
s
Private
Middle-
man
broker
Sells
ERC
V
Buyer/
User
of
• Is the brokerage function regulated'
• Us speculation permitted?
• How can the achievement of public goals be
ensured?
• How will trade restraint practices be policed'
• In general what are the relative merits of e public and a private system?
• Who qualifies to produce/sell/buy ERCs d.e. how is market entry regulated)?
• How will the system be financed?
• What incentives ere Greeted for each participant?
20
-------
What are the Relative
Merits of Public and
Private Systems?
Selecting between some kind
of public or private system
"requires consideration of the
relative advantages and
disadvantages of each.
Although there is not always a
one-for-one comparison
between an advantage in the
public system and a
disadvantage in the private
system (and vice versa), this
frequently is the case. Some of
the most important advantages
and disadvantages are
discussed topically, below.
• Market Certainty—Initial
success of a banking system
may hinge to a large degree on
Jiow certain the emission
Teduction credit (ERC) market
is. The public alternatives
provide more assurance for
potential buyers and sellers
(because of government
control of prices, supply,
market entry, etc.) than do
private alternatives.
• Socially Desirable Goals—A
banking system can take
account of a broad range of
goals in addition to economic
efficiency. For example,
considerations of equity may
lead to exclusion from or
limiting of participation in the
banking system by a particular
source owner. A private
System, concerned primarily
with economic efficiency,
might not respond to this kind
of concern. It is possible.
Viowever, to design a private
system so that social goals are
~ adequately considered. Yet in
the prototypical private model
{i.c . one with very Itmitad
government intervention),
those goals may not be
achieved. The public
alternative would be able to
control this situation It would
also be more effective in
preventing the creation of
private monopolies achieved *
through purchase of available
ERCs. In addition, it could
encourage entry of new
sources by adjusting the price
of ERCs.
• Transaction Costs—Both
public and private systems
create transaction costs that
are avoided by the other
system. The public systems
introduce more "red tape"
than the private system simply
because a public body is
involved as the middleman.
Although there may be less
red tape in a private system,
more time will be required to
locate buyers and sellers, to
negotiate sale prices, and
other elements of the ERC
transfer transaction It also will
be necessary to closely
coordinate the activities of the
private system with the local
APCA.
• Market Stability—This refers
not to the initial certainty
discussed above, but to the
market's long-term stability.
The public system should be
able to avoid much of the
fluctuation which a private
system may exhibit—especially
in terms of ERC price. This
greater stability of price may
reduce the potential for
opportunistic prices which
could result where buyers are
not fully aware of prices.
However, certainty may be
achieved at the expense of
econom'c efficiency.
• Incentives to Produce
ERCs—The private system may
provide greater opportunity for
the profit incentive to operate
in encouraging the production
of ERCs. When prices are
manipulated/set by the public
body, they may be lower than
a market-determined price. In
such a situation, fewer ERCs
will be produced than if there
were no publicly-set price.
(Note that "publicly-set" prices
can also refer to prices
determined publicly, not just
prices set by a public body.
Thus, an open auction could
result in "publicly-set prices")
Such "public" prices would
provide a tremendous
incentive for the production of
ERCs, acting as market signals
to potential producers.
"Private" negotiations would
often deprive the market of
this important information.
Alternatively, it may be
possible for an artificially high
price to be set by a public body
purchasing the ERCs from the
producer. There is precedent
for this kind of government-
induced production incentive.
• Duplication of Effort—To
keep the prices for ERCs at a
level which will encourage
activity, the public body would
have to keep abreast of
developments in the business
and technological community.
This attempt to keep current in
the demand and supply levels
for credits is extremely difficult
to do and may duplicate
existing private efforts to
maintain awareness of these
same developments.
The "public" advantages are
that the regulatory body is able
to control the system enough
to ensure that all public policy
goals are taken into
consideration and to avoid the
ill effects perceived to occur
when only economic efficiency
and market allocation goals
"drive" the system. Thus, in a
"public" system, economic
growth can be encouraged in
situations or locales where it
would be discouraged by a
"private" system; private
monopoly situations can be
avoided; recalcitrant sources
can be prevented from
profiting through their past
uncooperative behavior; and so
on. While a purely private
market system does not
provide these advantages, it
does provide a simple and
efficient mechanism for
achieving the primary goal of a
banking system—permitting
economic growth while
safeguarding air quality. What
is required in this situation is a
policy decision about what is
expected from a banking
system—is it to be a system
which promotes economic
growth and safeguards air
quality without regard to
collateral issues and concerns,
or is it to be a system which
sacrifices some efficiency in
promoting environmentally
safe economic growth in order
to protect other societal
values.
21
-------
What are the
Characteristics in
General of the Public
Auction System?
This system is operated
entirely by some banking and
trading authority—already
existing or created
specifically—to administer the
banking and trading system.
The banking and trading
authority does not have to be a
public (i.e., government) body,
but'the auction must be
publicly conducted. (Note that
"public" in this sense differs
from "public" in the monopoly
and monopsony option.) The
gist of an auction system is
that a responsible banking and
trading authority governs the
transfer of ERCs by conducting
auction sales of credits to
qualified bidders. The banking
and trading authority acts as a
middleman or sales agent in
bringing the buyer and seller
together. However, it should
be emphasized that a public
body (e.g., the Air Pollution
Control Agency) may be
involved to the extent that it
regulates who may create, sell,
and purchase reduction credits
as well as other related issues.
Description. The auction
alternative encompasses a
number of options, including
three discussed below:
• The "Dutch" auction;
• The "English" auction; and
• The 'Traditional" auction.
In each of these three, the
actual auction is conducted
differently, but some common
issues exist. These issues
relate primarily to adminis-
tration of the auction system
and to other support activities.
These issues are discussed
briefly, and then the three
auctions are described in
detail.
Issues. The administrative
and other support functions
are framed in terms of
options—i.e., there are several
means to achieve a particular
end, and a decision must be
made about which of those
means to use.
• Publicity: The auction must
be publicized, and there are
several means of doing this—
advertisement in local
newspapers, mailouts to
sources on the inventory,
personal contacts, and
publication in trade/industry
journals are possible ways to
accomplish this. In addition to
the medium of publicity, a
decision must be made about
the content of publicity—it can
be very brief with a contact-
person listed for further
information, or it can be quite
comprehensive in listing
number and characteristics of
the ERCs that will be offered
for sale.
• Transfer to the Trading and
Banking Authority. The trading
and banking authority can
obtain the ERCs for the
auction in two basic fashions:
it can purchase them outright
or it can accept the ERCs on
consignment. The purchase
option contains inherent risks
and benefits—the trading and
banking authority may not be
able to sell ERCs at the price it
paid (to avoid this it might set
minimum bids) or it may be
able to turn a "profit" (thereby
financing at least a portion of
the system). On the other
hand, the consignment option
is safer, and the banking and
trading authority does not run
the risk of losing money in the
transaction (or being left with
a supofv of unsold ERCs) nor
wouio it have the opportunity
of turning a "profit". (However,
the consignment option may
provide less incentive to the
public body to "move" the
ERCs.) In subsequent
discussion, the banking and
trading authority will be
described as "collecting" the
ERCs for sale—this term
includes both the purchase
and consignment options.
• Reserves: When an
auctioneer has items on
consignment, the consignor
may establish a price below
which it does not want to sell.
This is referred to as a
"reserve". In the ERC auction,
the banking and trading
authority may or may not want
to permit this practice.
However, the use of it does
give the producer/seller some
certainty, and this certainty
will strengthen the incentive to
produce ERCs. The banking
and trading authority also may
use a version of the reserve by
setting minimum bids.
• Pre-auction Conference. It
may be advisable to hold a
pre-auction conference to
explain to bidders the rules to
be used in the conduct of the
auction (The same conference
might include producers/
sellers, but logistically it seems
that they will have to have
been familiarized with the
system before they
sell/consign ERCs to the
banking and trading authority.)
Instead of a conference, it may
be possible to prepare an
information packet which will
detail the information for
bidders.
• Credentials for Use of
ERCs: There may have to be
some process whereby bidders
establish their qualification to
use the ERCs being offered
(especially if participation in
the banking and trading
system is limited to those who
are using ERCs for economic
growth). This can be done on a
personal one-on-one basis—
representatives of the banking
and trading authority and the
public body will meet with a
representative of the potential
bidder to evaluate the potential
bidder's qualifications.
Alternatively, the potential
bidder can submit documenta-
tion for review and verification.
There also could be a
combination of these two
alternatives For example,
private firms could be licensed
to perform this analysis and
certify appropriate trades
• "No Sells": It is possible, in
some of the auction options, to
have items offered for sale
which are not purchased. (In
the "Dutch" system, this is not
a problem as will become
evident in the description of
that system ) A decision must
be made whether to hold on to
the no sells (until the next
auction) or whether to try to
dispose of them by a direct
sale. Of course, if the public
body takes the ERCs on
consignment, this is not a
problem—the "no sells" are
merely returned to the
producer (or retained for the
next sale). However, if this
occurs too often, it will be a
disincentive for the creation of
ERCs; in such a situation, the
public authority may want to
consider "buying in" the
unsold lots, with the price
established by some formula
based on the successful bids
on the ERCs which were sold
at the auction.
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• Unit of Sale: There are a
rjumber of options for the unit
of sale. Once the method of
quantifying the ERCs (an issue
discussed elsewhere in this
concept paper) is determined,
there will presumably be a
single unit which can be
identified (for example, one
ton/year). Three options'are
possible for the number to be
offered for sale:
• they can be sold singly (i.e..
one unit);
• they can be sold in uniform
blocks (e g , 10 ERCs/block);
and
• they can be sold as they are
created by the producer/seller
(i.e.. if a producer/seller
created 9 ERCs, they would be
sold as a block—there would
not be uniformity amongst the
blocks offered for sale).
There are advantages and dis-
advantages to each of these
options. The single unit sale
enables each source to buy
only the amount it needs—
thereby facilitating maximum
economic growth. However.
units would not be created on
a single unit basis, and
permitting single unit purchase
would involve additional
Administrative effort to keep
track of how much of a
particular "lot" had been sold
and for how much. The
uniform block approach
imposes a rigid framework
which may require buyers to
over-buy in substantial
amounts. Not only does this
r?H.jce economic growth
potential, but it drives up the
s^rtive price for a buyer to
expand to the degree planned.
For example, if a buyer needs
only 10 ERCs. but only 15
unit-blocks are available, the
cost of expansion will be 15
ERC units and not 10 ERC
units The adverse effect
created by this situation may
be modified if the excess 5
ERCs are viewed as an
investment; but m terms of
Immediate cash outlay, the
cost remains at 15 ERC units.
This may not be a significant
deterrent to large firms, but it
may prevent smaller firms
from entering the ERC
market—thus contributing to
market dominance. The sell-
as-created option imposes little
administrative burden and
facilitates accounting require-
ments. However, it also suffers
the drawbacks of non-flexibility
exhibited by uniform blocks.
• Classification of Bidders:
This is a difficult issue. For
example, a particular ERC in
particulate emissions may be
worth more to a facility near
the producer of the ERC than
to a similar plant further away
The reason related to the
diffusion of emissions and
their effect on ambient air
quality. An ERC represents an
improvement in air quality that
is being used to offset a
degradation in air quality.1 An
ERC will represent a greater
improvement in nearby air
quality than in the air quality
'EPA's Emission Offset
Interpretative Order states that to
achieve reasonable further
progress (a requirement for each
offset trade), a higher ratio of
offsets (ERCs) will be required the
further away a facility is from
where the offset was created.
Each trade must satisfy the
"demonstration of attainment"
rule
at a dista'nt site. Consequently.
the ERC may be worth more
(i.e., will permit more pollution
to be offset) to a source near
the producer than to a source
. further removed. An example
illustrates the point. Source A
installs technology which leads
to the creation of 10 ERCs.
Source B is one mile from A,
and Source C is 100 miles
from A. The reduced emissions
have a greater impact on
ambient air quality closer to A
than further from A (at least in
the simplistic world of this
example). Because B and C are
differently situated, their
respective uses of A's ERCs
would probably differ. It may
be useful, in dealing with such
situations, to develop a matrix
indicating what differently
situated sources can do with
the same ERC. The matrix
should be geared to a
demonstratipn of attainment
by the purchasing source. In
this example, such a
matrix probably would require
that C buy more of A's ERCs
than B in order for C to
increase its emissions by an
amount equal to B's increase.
It will be necessary to clearly
inform buyers of how many
ERCs are needed to satisfy the
"demonstration of attainment"
rule.
The discussion of these
issues indicates that many
options exist concerning the
structure of the administration
and support of a particular
auction system The three
alternative auction systems2
are next described and
H'he discussion of the "Dutch"
and "English" systems is based on
de Lucia, An Evaluation of
Marketable Effluent Permit
Systems, pp 17-20(1974)
critiqued in terms of their
advantages and disadvantages.
The "Dutch" Auction System
The "Dutch" auction system is
a method for determining the
market clearing price of the
ERCs. The public body
conducting the auction collects
enough ERCs from interested
producers to justify holding an
auction. The public body
publicizes the auction and
what is being offered as well
as the conditions of sale. It
then announces an initial
(relatively high) price per unit
for the ERCs, and invites
orders at that price. If a full
subscription is not obtained, all
the orders are returned, a new
lower price is announced, and
the process of receiving bids is
begun anew. The process is
repeated until a full
subscription is obtained. It is
possible to avoid multiple steps
by using a schedule-of-
payment order—the bidders
indicate how many ERCs they
want at each of several
alternative prices, and the first
price for which all ERCs are
ordered is the overall unit
sales price.
The "English"
Auction System
This alternative is similar to
that used for the sale of U.S.
Treasury bills. Blocks of ERCs
would be auctioned serially
until all were gone, The blocks
, would be uniform (e.g., 10
ERCs per block), but the price
would not. The first block sold
would probably bring a higher
price (from a bidder who needs
them more than bidders at
lower prices) th^n the last
block sold. One difficulty-
involved is the meaning of a
23
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"uniform block". As noted
above, because the ratio of
offsets required to ensure
reasonable further progress
may vary, B's purchase of 10
ERCs created by A may not
enable B to increase its
emissions as much as if C had
purchased, the same 10 ERCs.
Therefore, uniform block can
have two meanings:
• Uniformity, as determined at
the producing source (i.e . if
the block is to be 10 ERCs.
then regardless of bidders'
characteristics, they will have
to buy 10 ERCs as measured
at the producing source); and
• Uniformity, as determined at
the buying source (i.e., if the
block is to be 10 ERCs. then
buyers must buy in blocks of
ERCs that are commensurate
to an increase of 10 emission
units at the buying source—
this may require the purchase
of fewer than 10, more than
10, or 10 ERCs as measured at
the producing source).
The latter option presents
some substantial adminis-
trative hurdles which,
practically, require that only
the same class of bidders be
permitted to participate in any
one auction.
The "Traditional" Auction
System
This system responds more to
the specific character of an
ERC as a commodity, i.e., each
block of emission reductions
has relatively unique
characteristics (e.g., pollutant
size and location) and because
of dispersion factors, will
affect potential buyers
differently. What is offered for
sale is the ERC as created by
any one producer. The
"blocks" in the traditional
auction are individual "lots" of
ERCs either consigned or
bought outright, and therefore
would not be uniform. This
system would be similar to
that used in auctioning oil
leases. Oil lease tracts are not
uniform in size, and may vary
in value from bidder-to-bidder
based on considerations such
as proximity to other otl lease
tracts held by the particular
bidder. In an ERC auction, a
particular block might be worth
more to a buyer source close
to a producer source than to a
buyer located further away.
Thus, ERCs would be offered
"as is", and the bidder would
have to buy enough blocks to
cover its needs. (This suggests
that a bidder will sometimes
have to buy more ERCs than it
actually needs simply because
no one block had the exact
amount of ERCs needed by the
buyer source.) In this system,
two considerations will
dominate bid decision:
• how close is a particular
ERC block to the number
required by the bidJer? (The
possibility exists that the bid
for a block which is relatively
close to the number required
will represent a high per unit
price than a bid for a block
which has many more ERCs
than required. For example, if
a bidder needs 19, it might
offer more per unit for a bloc
of 20 than for a block of 25.);
and
• how much value the ERC
has for the bidder (i.e.. Is it a
block which can be usert
almost one-for-one to allow
increased emissions? As
discussed above, the closer the
producer/seller source is to
the buyer source, the more
likely is the one-for-one
correspondence).
Advantages. There are a
number of advantages in using
some form of the auction. They
are detailed below:
• Administrative Efficiency:
The auction is a convenient
method of handling the sale of
ERCs. Instead of proceeding in
a piecemeal, transaction-by-
transaction fashion, the sale
effort can be focused on
relatively few points in time.
The administrative burden is
thereby reduced.
• Transaction Costs: The
parties involved (producer/
seller, public authority, and
buyer) will have minimal
transaction costs. There is
little, if any, negotiation
required Information is easy to
obtain, and the actual sale
normally will not be a
protracted event. (However, in
the "Dutch" system, if a
schedule-of-payment variation
is not used, the actual sale
could be a very time-
consuming transaction.
Avoiding such delay is a strong
advantage of the schedule-of-
payment variation.)
• Market-Clearing Price. This
price is easy to determine in
the auction program, whether
available ERCs are sold
simultaneously (as in the
"Dutch" system) or whether
ERCs are sold serially (as in
the other two variations). The
market is defined as that group
of potential bidders who are
actually qualified/certified to
participate in the auction
(rather than defining it as the
group of bidders who would
participate if there were no
barriers to entry). The auction
system also focuses the
bidders' attention on the
demand for ERCs. This helps
bidders to assess not just what
they want to pay for the ERCs,
but what they will have to pay
in order to win the bidding
competition for these scarce
ERCs.
• Promoting Clean Air. It is
possible that an auction
system may inadvertently
result in additional
improvement in clean air. If a
buyer must bid on blocks of
ERCs. it may end up buying
more than it wants—this
means some ERCs will exist.
at least for a while, which may
not be used. This maintains
cleaner air than would be
required. Of course, the source
which bought too many would
try to sell the excess through
the auction system, but that
source would then have to
meet the seller qualifications
set by the public authority.
Even if the buyer of too many
ERCs would resell them
through the auction system,
there would be that temporary
cushion of excess ERCs—and
this "temporary" cushion
might remain fairly constant
from auction-to-auction with
the only change being the
identity of the source providing
the cushion.
Disadvantages. There are
also disadvantages in selecting
one of the variations of the
auction system. These are
noted below along with some
possible remedial'measures.
-------
What are the
Characteristics of the
Public Monopoly
Monopsony System?
• Time Inflexibility. To be
efficient (one of its major
advantages), an auction of
ERCs probably will not be held
with great frequency. It is not
impossible for an auction
system to operate with
frequency (for example, the
auction of Treasury bills is
held weekly), but the demand
and supply must be sufficiently
high to justify frequency. This
may not be true of the market
for ERCs. This time inflexibility
inhibits immediate purchase to
satisfy ERC needs as they
arise However, this
disadvantage probably is not
great since the technical
preparation and planning for
the purchase and use of an
ERC ordinarily will require
lengthy periods of time during
which it is likely that an
auction will occur. The
frequency of auctions will in
part be determined by the
thinness of the market for
ERCs
• Block Inflexibility. If a buyer
source must buy blocks of
ERCs, it will often be forced to
buy more ERCs than it needs.
While beneficial from a clean
air standpoint, this will inhibit
economic growth (by
unnecessarily limiting the
supply of ERCs) This can be
avoided in both the "Dutch"
and "English" systems (but not
in the "Traditional" system) by
defining "block" to be one unit
of ERC.
•
• Classes of Buyers When
there are different classes of
buyers, it is more difficult to
establish their credentials than
wlien there is only one class
It should be noted, however.
that multiple classes of buyers
detract from the administrative
efficiency advantages noted
above In a banking and
trading system, however, this
disadvantage seems unavoid-
able—and it is a disadvantage
for all three banking and
trading alternatives being
considered.
• Sell-out Requirements. If
the ERCs on auction are
required to be sold out,
significant delays in the sale of
ERCs occur The "Dutch"
system is the only auction
variation which has this
requirement, and it is a
significant deterrent for
selecting that variation. Not
only are time delays
encountered, but such a policy
could lead to a short-term
price that did not reflect the
value of the credit over the
long-term It is possible to
modify the "Dutch" system to
include a minimum bid which,
if reached without attaining
full subscription, would be the
final price acceptable—those
orders at that price would be
filled and the unsold portion
would be kept until the next
auction.
Summary. The systems
described offer flexible
opportunities to provide the
means of using the auction
concept to allocate ERCs. The
three variations presented
above are not rigid, and it
would be possible for an
entirely new variation to be
created by combining different
aspects of the three. In
addition to the specific
advantages and disadvantages
of the auction, per se, the
variations also exhibit the
advantages and disadvantages
of the public option, discussed
generally at the beginning of
this part of the paper.
This second public option gives
the banking and trading
authority (as noted above, this
is not necessarily a public
body) extensive control over
the sale and purchase of
emission reduction credits. In
essence, the banking and
trading authority exercised
great influence over the entire
process of banking and trading
emission reductions—from
production to final sale.
Production is influenced by the
price at which the public
authority purchases the ERCs,
and the sale (and subsequent
economic growth) also is
influenced by the price which
the banking and trading
authority charges the buying
sources This is not to say,
however, that the banking and
trading authority is the sole
motivating force to production
and sale of ERCs Control
technologies are not so precise
that a source will invariably
comply precisely with its
permit requirements As a
result of its compliance efforts.
a source might "inadvertently"
create ERCs which it then
would try to sell to the banking
and trading authority.
Similarly, a buyer's need for
ERCs might be of such a
nature that the price is not
much of an object In both
these situations, the activities
of the banking and trading
authority in setting sale and
purchase prices would not
affect the sources' incentive to
create or purchase ERCs. As in
the public auction system, the
public body will have a role
that extends, at least, to
regulating who may produce.
sell, and purchase ERCs as
well as other related issues.
Description. A banking and
trading authority would serve
as the sole purchaser of ERCs
from producers and the sole
supplier of ERCs to buyers.
Both the banking and trading
authority and the public body
(if different) would engage (to
varying degrees) in several
administrative duties. Included
in these duties are the
following:
• Publicity—the banking and
trading authority and the
public body would disseminate
information about the ERC
trading system. Possible
mediums of communication
include special information
packets, advertising in
newspapers, advertising in
trade/industry journals,
conducting seminars, and so
on.
• Explaining the mechanics of
the trading system—this could
be covered in the publicity, but
it seems more effective to
direct these explanatory efforts
to sources which express an
interest in participating in this
trading system. The
explanation could be on a
large scale (e.g., by using a
packet of information and
conducting outreach seminars
and meetings on the topic) or
on a one-on-one basis (i.e.. in
dealing with producer/sellers
and buyers, one of the first
things done would be some
kind of conference during
which the rules and
regulations of the trading
system were explained). These
efforts could be coordinated
with the APCA. Chamber of
Commerce, economic develop-
ment agency, or could be
undertaken independently by
the banking and trading entity.
25
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• Determining the eligibility of
producer/sellers and buyers—
this is another administrative
task which must be taken care
of early in the trading
transaction. As noted in the
discussion of auctions,
establishing the eligibility of
participants can be quite
complicated. It can be
executed in at least two
different ways—the potential
participant can submit
documentation prior to
beginning the trading process,
and eligibility and demon-
stration of attainment require-
ments can be determined
before the process continues;
or an eligibility and
demonstration of attainment
determination can be made on
a one-on-one basis during the
initial stages of the trading
process. This latter alternative
involves personal communica-
tion, technical evaluations,
documentation, and the like.
Of course, a combination of
the two alternatives is
possible.
The banking and trading
authority determines at what
price it will buy ERCs and at
what price it will sell ERCs. In
this sense, then, the authority
is the sole buyer (monopsonist)
and the s&le seller
(monopolist). Although the
authority's position suggests
that it can dictate these two
prices (purchase and sale), its
actual power to do so is
constrained. The authority
cannot dictate the behavior of
the market. Quite simply, if it
is paying too little for ERCs,
sources will not go to the
expense of creating them, or if
a source does reduce
emissions, it will not go
through the process of
converting those reductions
into ERCs. Presumably, a
producing source can back out
of the process anytime before
its permit is changed to reflect
the emission reductions on
which its ERCs are based. In
such an instance, the source
could maintain the documen-
tation of its reduction and wait
to convert into ERCs until the
ERC market appears more
favorable, or until the
producing source decides it
must usejor dispose of the
Emission reductions. Alterna-
tively, if the selling price is too
high, sources wishing to
expand or build simply will
decide to cancel or postpone
their plans, or to seek a
different location. Thus, the
banking and trading authority's
power is constrained by
market considerations.
The banking and trading
authority also needs some
mechanism for determining
what is to be chargedjn each
1 sale and what is to be paid for
each purchase. A major issue
is whether or not these prices
should be uniform It is
possible to use differential
pricing as a means to regulate
entry and participation in the
system. For example, the
authority might pay reduced
prices for ERCs which result
from plant shutdowns or from
plants just now coming into
compliance. Differential
pricing, however, could
present serious legal
difficulties,1 and it would
certainly place a substantial
administrative strain on the
authority's controlling the
banking and trading system. In
determining the price charged
or asked, there may be room
for negotiation between the
authority and the buyers and
sellers. The extent of this
negotiation is set at the
discretion of the banking and
trading authority Negotiation
is attractive in that it may
permit some transactions to
occur which would not have
been consumated otherwise.
However, it also .can introduce
delay, added administrative
cost, and unbridled
administrative discretion to
this banking and trading
system.
'Differential pricing raises the
issue of equal protection Unless
there is a rational relationship
between the action taken and the
regulatory purpose, the action cah_
be successfully attacked. If it is
shown that a differential price is
used as a punitive measure for
past behavior, it also is subject to
attack. No attempt is made in this
paper to explore or resolve these
potential legal issues
Advantages. There are
several attractive advantages
to this public option, which are
discussed as follows.
• Time flexibility. The
monopoly/monopsony (M/M)
alternative provides a
continuous opportunity for
buyer sources to obtain ERCs.
Instead of waiting for a
periodic opportunity to
purchase ERCs, the buyer
source can obtain them as
necessary. This also benefits
the banking and trading
authority which does not have
to concern itself with selling
out an entire subscription or
with what to do with ERCs in
the interim between sales.
• Achievement of social goals.
Although this is an advantage
of all public banking and
trading options, the M/M
system is particularly
adaptable m order to achieve
these goals. By manipulating
prices paid and asked, the
banking and trading authority
administering the system has
a quick and efficient tool for
achieving societal policies—
i e., rather than issuing flat
prohibitions to sources which
have not cooperated in the
past, the authority can merely
place an appropriate premium
on that source's participation.
This does not preclude the
current participation/coopera-
tion of the source, but does
force it (as the price of
participation) to demonstrate
good faith in light of its past
misdeeds.
26
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• Efficiency in the transaction.
.This advantage encompasses
reduced transaction costs, but
goes beyond that. Buyers and
sellers save time and effort in
selling and seeking ERCs
because there is only one
purchaser and one supplier—
the banking and trading
authority. In addition to this,
the banking and trading
authority system avoids the
need for oversight and
regulation of many private
brokers Although such
regulation is not a sine qua
non of the private system, it is
a probably outgrowth of such a
system. Since in the M/M
system, there is only one
broker, this oversight/
regulatory duty is diminished
substantially and public
resources are conserved
• Market certainty. The
certainty imparted to the
market by the M/M system
goes beyond mere stability
The M/M does provide
stability, but it also assures the
producer/seller that there will
be a buyer. Since the ERC
created by the producer is sold
to the banking and trading
authority, the producer does
not have to be concerned with
the possibility of a no-sale.
*» Block flexibility It is possible
in the M/M system to sell to
the buying source that exact
^amount of ERCs it needs. The
banking and trading authority
can tailor the blocks available
to a buying source to reflect
any discounts to be imposed
on the buyer
• Allocation of attainment
burden: The M/M system can
be used to alfocate the cost of
achieving attainment. Instead
of placing the full burden on
new sources, the M/M system
could arrange to give ERCs to
new sources. ERCs could be
financed through a tax levied
proportionately on all major
sources of pollution or they
could be acquired by imposing
further reductions on existing
sources.
Disadvantages. Some of the
disadvantages of selecting an
M/M banking and trading
system are described as follows.
• The nature of monopoly and
monopsony to producing and
buying sources. In the M/M
system, the various sources
must deal with the banking
and trading authority, or else
abstain from participation in
the banking and trading
system. If the authority
appears intransigent to a
producer/seller or buyer, there
is no other purchaser or
supplier with whom to deal.
This dominant position of the
authority can lead to a certain
insensitivity about the
concerns of producer/sellers
and buyers. Although this is
not inevitable, it is a possible
development to guard against.
As noted in the description,
though, the authority's power
is not unconstrained, and the
purpose of a trading and
banking system (to permit
economic growth while
improving air quality) should
mitigate against the tendency
of the authority to become
isolated from the needs of the
it serves.
• Non-market price. It will be
difficult for the banking and
trading authority to determine
the market clearing price.
There is no easy mechanism
for determining the price as
there was in the auction
alternative. The authority can
proceed in an iterative fashion
to adjust the price charged
until it is able to sell all ERCs,
but this is an inexact and time-
consuming process. On the
other hand, the authority may
not be overly concerned with
finding and charging the
market price, and may
concentrate instead on other
goals. The issue is whether
the authority can determine
the price of ERCs so that both
economic efficiency and
related goals of trading and
banking are promoted.
• Administrative burdens. The
use of discriminatory pricing
(and payment), aside from
difficult legal issues, would
create tremendous administra-
tive problems. When a
transaction deviates from the
payment/charge usually made,
special attention will have to
be given to the transaction—to
determine if such a deviation
is justified, to decide what the
difference in payment/charge
should be, and to document
the decision. If such instances
are relatively rare, the M/M
system will be able to absorb
the disruption caused much
more readily than if they occur
as a matter of course.
• Classes of buyers.
Classifying buyers according to
the effect a particular ERC has
on the air quality in the
buyer's area is another
substantial administrative
burden. However, in order for
the trading and banking
system to operate in ajrashion
that ensures The achievement
'of reasonable further progress,
this is an essential
requirement to comply with
the Clean Air Act, and one
which, in one way or another,
must be performed in all three
of the alternative systems.
• Administrative inefficiency.
Since the sales process is
continuous, it is necessay to
maintain constantly the
administrative apparatus to
conduct the sales transactions.
This could be avoided in the
auction system since sales
occurred only at specified
intervals. This disadvantage
does not apply to the purchase
of ERCs since all three
systems contemplate con-
tinuous or open-ended
purchasing (or consignment) of
ERCs
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What are the
Characteristics of the
Private Trading
System?
• Unbridled discretion. The
M/M system raises the
possibility that the banking and
trading authority will be given
too much power. Failure to
hold it accountable for its
activities fosters a climate
conducive to favoritism, or
even corruption.
Summary. The M/M system
provides greater flexibility than
the auction system, but
introduces some elements
which create greater
administrative burdens.
Although greater flexibility
exists for the banking and
trading authority producer/
seller and buyer sources may
face greater constraints in
disposing of and purchasing
ERCs.
The alternative to a "public"
system is a "private" system—
one in which government
participation is kept to a
minimum. In an area such as
emissions control, it is
impossible and undesirable to
bar all government
involvement, but a private
trading system would limit the
govenment to its current
responsibilities (e.g., setting
emission standards in the
SIPs, monitoring and enforce-
ment activities). In addition,
the APCA would be required to
certify the creation and use of
emission reductions and
ensure that all transactions
satisfied the demonstration of
attainment rule.
Description. The private
trading system encompasses a
variety of options which all
share the characteristics of
being dominated by private
parties and concerns rather
than government regulatory
bodies. Two major design
options dominate this system:
• The direction transaction in
which the buyer and seller
deal face-to-face; and
• The middleman transaction
m which the transfer of ERCs
is accomplished through the
office of some private
middleman or brokering
organization.
The most likely scenario
would involve a source that
wished to expand or locate in
an area. That source, needing
ERCs to accomplish its
planned expansion, would turn
to some middleman which had
ERCs to sell. If there were not
enough ERCs on hand, the
middleman would try to
negotiate a price for ERCs
which would induce their
production by some existing
source. Assuming that the
market was big enough, a
middleman would probably
find it worthwhile to develop a
stock of ERCs—whether
through purchase or
"consignment"—so that a
buyer could be readily
accommodated This develop-
ment would, of necessity,
involve speculation. As the
incentive for middleman
participation, there must be
the expectation of a
reasonable profit.
The concept of a middleman,
however, suggests that a
market is fairly well developed
In the initial stages of a
banking and trading system,
this would not necessarily be
the case. As a result, there
may be more direct
transactions in the early
stages of the banking and
trading system. In fact, under
the existing emissions offset
policy, the overwhelming
number of completed offset
arrangements were produced
internally at facilities owned by
the same source seeking to
expand.
The size of the market does
not necessarily dictate
whether or not a middleman
can operate m it. There may
develop several regional or
national middlemen firms who
maintain local market
information and therefore can
efficiently service a small
market that could not provide
enough activity to support a
permanent local middleman
organization.
A private trading system can
involve varying degrees of
government involvement.
Access to the ERC market
could be unregulated, except
insofar as existing laws (e.g.,
antitrust laws) restricted the
sources which would
participate. On the other hand,
eligibility requirements could
be set which limited the
sources which could
participate in the creation,
sale, and purchase of ERCs. In
a very real sense, this power
to control market entry is
inherent in the public
authority's power over
verification of emission
reductions and changes in
source permits and the SIP.
Similarly, the public body could
exercise varying degrees of
control over any middleman
organization. Such control
could range from a laissez
faire attitude, to simple
registration requirements, to
strict licensing, reporting, and
oversight activities. Insofar as
discounts, adjustments, and
taxes have to be assessed,
government involvement is
unavoidable.
28
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There is one area which
probably will be left entirely to
the private parties—price. The
prices for ERCs will be
determined by the parties
involved, with no minimum
and no maximum Yet. it is an
option for the public body to
set price guidelines which
would establish ceilings and
floors for prices However, if
government involvement
became so detailed that it
determined the price,
controlled access to the
market, and exercised strict
oversight of each transaction,
much, if not all, of the
rationale for a private system
would have been preempted
In such a situation, it is better
to conclude the de facto nature
of the system, and call it a
"public" rather than "private"
system
Advantages. The private
system's advantages are
• Limited government
resources required Limited
activity on the part of the
public authority will conserve
public resources relative to the
resources which must be
expended in the two "public"
alternatives, the private
system, to a great extent, runs
«pn its own fuel
• Limited administrative
burdens Since government
regulation is kept to a
minimum, resource-consuming
efforts to satisfy the
administrative burden usually
generated by such regulation
would be avoided The effect of
this advantage may not be
great, because there will be
strict government control over
the documentation, verifica-
tion, and maintenance of
recorded emission reductions
The administrative burdens
imposed by this control cannot
be avoided
• Market price If government
intervention in price setting is
avoided, the price charged for
ERCs should reflect a relatively
accurate market price
• Incentive to produce and
trade ERCs The pnvate'system
allows the appropriate
economic signals to be sent m
encouraging or discouraging
the production and trading of
ERCs If the demand is low.
the price will drop as will
production The system will
not produce {at least ideally it
will not) ERCs that cannot be
justified from an economic
standpoint
• Timing of Availability ERCs
will be available without any
time restriction That is, the
on-hand supply may not
always satisfy the current
demand, but there is no
waiting period once the ERCs
are created Of course, there
will be the delays experienced
in every system—having
changes made in the SIP and
source permits
• Block flexibility The buying
source will be able to
negotiate for precisely the
amount of ERCs it needs. This
permits efficient use and
allocation of ERCs so that the
maximum allowable economic
growth can occur
The extent of these
advantages is heavily
dependent on the degree of
government involvement in the
private system Many of the
advantages mentioned are
predicated on relatively little
involvement by the public
authority (i e , the public body
would perform only those
activities which must be
performed by the government)
As the degree of government
involvement rises, these
advantages diminish
Disadvantages. The private
system has several drawbacks
which are discussed, below
• High transaction costs The
private transaction, whether
through a middleman or direct,
may require fairly substantial
transaction costs as compared
with the "public" alternatives
The purchaser/supplier of
ERCs must be sought, and
negotiated with instead of
being readily apparent and
available. This search requires
the participating firm to
expend its own resources in a
direct transaction, and to pay a
middleman in the non-direct
transactions
• Abuse potential When
there are primarily private
actors participating in the
transaction process, the
potential for abuse rises
When the government holds
the reins of the actual
transaction process, it is much
easier to guard against abuse
than when it exercises an
oversight function of many
different private sectors
29
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Combinations
• Duplication of effort If the
private system requires
substantial government
involvement, it might be more
efficient to allow the public
authority to operate the
banking and trading system
There either will be overlap in
function, or the public body
will be performing most of the
essential tasks In either case,
it probably should be asked
whether a "public" system
would be a more efficient use
of resources
• Uncertainty There is an
element of uncertainty in the
private system that is not
present in the public systems
Especially during the initial
stage of a market's operation,
the private system will have to
"feel" its way to stability
Because the public systems
have governmental under-
pinning, much of this
instability is avoided Of
course, in a private market,
there are more risks involved
than m a publicly controlled
market (as evidenced by the
presence of speculators in the
private market), but that is
merely a characteristic of the
private market place
• Market Imperfections The
private system will exhibit
some market imperfections
which realistically affect any
private market and keep it
from responding precisely in
accord with economic theory
A good example of this is
imperfect information In a
public system, all the
information about prices is
readily available from the
public authority (actually, the
issue is somewhat meaning-
less in those situations where
the public body sets the
price)—the buyer source
knows what is available and
what its own needs are and
can make an informal decision
on what to pay However, in
the private system, there is no
guarantee that the buyer
source will bo aware of the full
supply picture, and an
improper decision about what
price to pay for ERCs might
ensue
Summary. The private
system provides greater
freedom and flexibility in
satisfying a source's needs for
ERCs However, it offers less
certainty to the participant,
posing risks avoided by the
public systems
It is possible for states or
locales to decide that there are
characteristics of each of these
options that are desirable, and
that a combination of these
three options is preferrable to
selecting only one of the three
For example, it is possible to
use the private trading system.
but limit to some degree who
may participate Or, use the
monopsony portion of the
public option for collecting
ERCs for sale, but use the
auction system to dispose of
the ERCs The intent of com-
binations is to fashion an
alternative that is suited to the
needs of a particular banking
and trading locale—since local
and state conditions vary
considerably, it is reasonable
to assume that the
combinations selected would
also exhibit variation
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