Types
of
Trading
The United States has pioneered the use of emissions
trading for more than 25 years. Emissions trading can
take different forms and can be used in different sectors
to meet regulatory requirements. There are three general
types of emissions trading programs: cap and trade
programs, project-based or credit programs, and rate-
based or averaging programs.
Cap and Trade Programs
In a cap and trade program, sources are allocated a fixed
number of allowances. Each allowance represents an
authorization to emit a specific quantity of a pollutant
(e.g., one ton). The number of allowances is capped in
order to reduce emissions to the desired level, and sources
are required to meet stringent, comprehensive emission
monitoring requirements. At the end of the compliance
period, emission sources must hold sufficient allowances
to cover their emissions during the period. Sources that
do not have a sufficient number of allowances to cover
emissions must purchase
allowances from sources that
have excess allowances from
reducing emissions.
Cap and trade programs
have been applied to large
electric power and industrial
emissions sources. These
programs do not require case-
by-case review of allowance
trades because of the certainty
provided by the emissions cap,
the fixed number of allowances
available, and the stringent
monitoring and tracking of all
emissions. Examples of cap
and trade programs include:
the Acid Rain SC"2 Program;
the Ozone Transport Commission NOx Budget Trading
Program and the NOx SIP call; as well as proposed
legislation and regulations for additional emission
reductions in the power sector.
CLEANAIR
MARKET PROGRAMS
Project-based, Credit or
Offset Programs
In a project-based program, also referred to as a credit
or offset program, sources earn credit for projects that
reduce emissions more than is required by a pre-existing
conventional regulation or other benchmark. These
credits can then be traded to other facilities where
they can be used for compliance with a conventional
regulatory requirement. The decision to generate these
credits is usually voluntary; however, credits must be
certified through some sort of administrative process.
Credit programs impart flexibility to existing programs,
but do not require reductions (except to the extent
some percentage of credits generated may be retired for
environmental benefit). In the past, the need to determine
whether these types of credits represent real emission
reductions has sometimes been time-consuming, costly
and uncertain. However, credit programs may include a
larger variety of sectors and
source types than do the
other types of trading
programs. Examples of
these types of programs
include offset requirements
for new sources in areas
that do not meet National
Ambient Air Quality
Standards and open
market trading programs
in some states.
All three types of emission trading
programs are meant to work in
conjunction with existing
regulations. Any emission trading
program should be designed and
undertaken to complement basic
safeguards for public health and the
environment under the Clean Air
Act and other environmental laws.
Three Forms of Trading Compared
Cap and Trade
Project-based Trading
Rate-based Trading
Potential to Limit
Total Emissions
High
Low to Medium
Medium
Cost
Minimization
Yes
Yes
Yes
Administrative &
Transaction Costs
Low
High
Low to Medium
Source: "Tools of the Trade: A Guide to DC- d Operating a Cap and Trade Program for Pollution Control, "June 2003 EPA 430-B-03-002
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www.epa.govl airmarkets
Rate-based or Averaging Programs
In rate-based or averaging programs, the regulatory authority sets a
constant or declining emission rate performance standard (e.g. tons
of emissions per megawatt hour). Emission sources with average
emission rates below the performance standard earn credits that they
can sell to other emission sources. Sources with emission rates above
the standard must obtain credits to cover the excess. Rate-based
programs can lower emissions, but emissions can subsequently grow
if activity grows. The successful program to phase-out lead in
gasoline in the early 1980s used this type of trading mechanism to
provide flexibility and cost-savings to oil refineries before the final
ban was implemented. These programs are most easily applied in a
specific sector where facilities have similar emissions characteristics
(such as refineries, mobile sources, and power plants).
For all types of emissions
trading, the basic concept is
similar: trading provides
companies with the flexibility to
develop cost effective emission
reduction strategies.
Comparing Emission Trading Programs
For all types of emissions trading, the basic concept is similar:
trading provides companies with the incentive to develop cost
effective emission reduction strategies. Companies may elect to
control emissions more than required and sell surplus allowances or
credits to other facilities that may face more expensive options to
reduce emissions. All three types of trading can include provisions
to allow companies to save extra allowances or credits for use in
future years (banking).
Each of the three forms of emission trading is appropriate in certain
situations. When achieving and maintaining an absolute emission
goal is important, a cap and trade program provides more certainty
about total emissions from a defined set of sources. Administrative
and transaction costs for cap and trade programs often are lower
than for project-based trading. Project-based trading is burdened by
higher uncertainty and risk and the need for extensive regulating
authority involvement due to the need to assess individual projects.
Offset trading programs have historically evolved from introducing
limited flexibility in traditional command-and-control programs.
Because offset programs usually do not require net emission reductions,
they are not effective as stand-alone programs. However, a well-
designed program may complement a command-and-control
program that establishes emission or concentration limits. It also may
complement a cap and trade program in sectors for which accurate
emission measurement of regulated sources or activities may not be
developed as well.
Cap and Trade
Project-based
Regulated
Non-Regulated
Rate-based
Emissions
Rate
Standard
Emissions
Rate
Source: "Tools of the Trade: A Guide to Designing and
Operating a Cap and Trade Program for Pollution Control,"
June 2003 EPA 430-B-03-002
Rate-based trading can be an effective way to promote efficiency if
circumstances do not require an absolute cap on emissions. The
administrative and transaction costs for rate-based trading programs
are likely to be similar to those for cap and trade. All three types of
emission trading programs are meant to work in conjunction with
existing regulations. Any emission trading program should be
designed and undertaken to complement basic safeguards for public
health and the environment under the Clean Air Act and other
environmental laws.
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