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In 1980, rising public concern about the
extensive health and environmental impacts of
acid rain prompted Congress to commission a
ten-year study on its causes and effects. After
years of debate and extensive research under the
study, Congress established the Acid Rain Program
under Title IV of the 1990 Clean Air Act
Amendments. The program called for major
reductions in electric-generating facilities'
emissions of sulfur dioxide (SO2) and nitrogen
oxides (NOX)—the key components of acid rain—
while establishing a new approach to
environmental protection through the use of
market incentives.
The Acid Rain Program's centerpiece is a market-
based system for capping and trading SO2
emissions. (The program's NOX control component
is more traditional and not the focus of this
brochure.) The SO2 requirements are structured in
two phases. Phase I, which began in 1995, limited
emissions from the largest, highest-emitting
electric-generating facilities. Phase II, which began
in 2000, tightened the annual limits on the large
plants, and set restrictions on smaller, cleaner
plants and all new plants. As of 2001, the program
encompassed nearly 2,300 units at 1,000 plants.
The significant environmental progress and cost
savings resulting from this nationwide experiment
in capping and trading SO2 emissions have
attracted worldwide attention. This brochure
explains how and why this system works, clears
up some common misunderstandings, and
presents the outlook for future programs based
on this model.
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Capping and Trading Emissions:
The Concept
BEFORE THE PROGRAM
20,000
With no reductions required, Unit 1 and Unit 2 each emits
20,000 tons a year.
THE "CAP"
The cap requires a 50 percent cut in emissions—e.g., from
20,000 to 10,000 tons.
EMISSIONS TRADING UNDER THE CAP
5,000 Surplus
I 15,000
10,000
If Unit 1 can efficiently reduce 15,000 tons of emissions
and Unit 2 can only efficiently reduce 5,000 tons, trading
allows each unit to act optimally while ensuring achieve-
ment of the overall environmental goal. Unit 1 can hold on
to (and "bank") its excess allowances or can sell them to
Unit 2, whereas Unit 2 must acquire allowances from Unit 1
or from another source in the program.
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How It Works
The "Cap" Puts a Ceiling on Emissions
The Acid Rain Program sets a nationwide cap on SO2 emissions from electric-generating facilities. Already, emissions have
been reduced by more than 6.5 million tons from 1980 levels, measuring approximately 10.6 million tons in 2001. By 2010,
the program will lower the cap to 8.95 million tons—a 50 percent reduction from 1980 SO2 emissions.
Emission Allowances Reinforce the Cap
Each allowance authorizes one ton of SO2 emissions. Limiting the number of available allowances ensures the cap's integrity.
Allowances are allocated among sources based on emission performance standards and representative fuel use. At the end of
each year, every source must have enough allowances to cover its emissions for that year. Unused allowances may be sold,
traded, or saved (banked) for future use.
Sources Have Many Options for Reducing Emissions
Sources may choose from many alternatives that best meet their needs,
including installing pollution control equipment; switching from high-sulfur
coal to medium- or low-sulfur coal, fuel blends, or natural gas; employing
energy-efficiency measures and/or renewable generation; buying excess
allowances from other sources that have reduced their emissions; or using a
combination of these and other options.
Monitoring and Penalties Ensure Compliance
An EPA-certified monitoring system at each source continuously
measures and records mass emissions of SO2 to account for every ton of SO2
emitted. Sources must then retire one allowance for each ton emitted. Those
that don't have enough allowances to cover their annual emissions are auto-
matically fined and must surrender future year allowances to cover any short-
fall.
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Why It Works
The Cap Provides Environmental Certainty
Even in the case of high growth in the electricity industry, the cap restricts total emissions. This provides a distinct
advantage over traditional command-and-control regulatory methods that establish source-specific emission rates and
can't ensure that aggregate emissions don't rise as new sources come on line or as existing sources are used more.
Limiting Allowances Creates Economic Value
A limit on allowances creates scarcity; scarcity ensures economic value for allowances; and value provides
incentive to reduce emissions.
Lower Compliance Costs Raise the Environmental Bar
Because a cap-and-trade system allows companies to choose the lowest-cost compliance option, regulators can pursue
more ambitious environmental goals for a given expenditure. For example, before Congress agreed to a 10-million-
ton reduction goal under the Acid Rain Program, most alternative proposals sought only an 8-million-ton reduction
using conventional approaches.
Banking Encourages Early Reductions
By allowing companies to save unused allowances for future use, banking creates a tangible, quantifiable, economic
incentive to decrease emissions beyond allowable levels. Early emission reductions result in earlier human health and
environmental benefits.
Accurate Monitoring Improves Accountability
Accurate monitoring of all emissions and timely reporting ensure that a ton from one source is equal to a ton from
any other source and that the integrity of the cap is maintained. Participating sources must fully account for each
ton of emissions according to stringent protocols. The resulting compliance information is unprecedented in its accu-
racy and comprehensiveness. All data are publicly available on the Internet, providing complete transparency
State and Local Authorities Retain Flexibility
States and localities may impose stricter limits on sources to address specific local air quality concerns. These limits
must be met regardless of a source's accumulated allowances.
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Because the Acid Rain Program's cap-and-trade system has achieved greater SO2 reductions muc
trolling other environmental problems. For example, northeastern states began implementing ;
Midwest and Southeast will also use this model to address a broader area of ozone transport be
using a trading system. Despite the successes and growing use of cap-and-trade programs, the public
tions and answers should help clarify these common misunderstandings.
Question Answer
Aren't sources just
shifting their emis-
sions around instead
of reducing them?
Does the Acid Rain
Program really
address human
health risks?
Doesn't trading
result in hot spots
(areas of heavy,
localized emissions)
and higher health
risks?
20
15
O
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;h earlier than expected and at lower cost to society, it is increasingly seen as a superior option for con-
i cap-and-trade program to address regional ozone problems in 1999; numerous additional states in the
:ginning in 2004; and dozens of countries around the world have agreed to reduce greenhouse gases by
debate reveals that some aspects of emissions trading are not fully understood. The following ques-
Question Answer
Isn't the real pur-
pose of emissions
trading to save
sources money?
Isn't trading
increasing acidity in
acid-sensitive lakes?
Aren't older, dirtier
sources exempt—or
"grandfathered"—
from the Clean
Air Act?
Won't the future use
of banked allow-
ances undo much
of the progress
achieved by early
reductions?
While a cap-and-trade system reduces compliance costs, it also creates incentives to
reduce emissions below allowable levels, spurring technological innovation and ener-
gy efficiency. In the 1990s, scrubber costs dropped by 40 percent, and the sulfur
removal efficiencies of scrubbers improved from 90 to 95 percent. Additionally, the
cap provides environmental certainty, which is absent in other regulatory programs.
S04 deposition
(kg/ha)
1989-1991
In fact, the early SO2 reductions that sources chose to
make are resulting in faster removal of sulfur from sen-
sitive ecosystems. The delay in recovery of acid-sensitive
lakes is more likely due to decades of very high levels of
nitrogen deposition.
There are no "grandfathered" sources in the Acid Rain
Program. The source of this misconception is the 1977
Clean Air Act, which imposed new-source performance
standards on sources built after the Act's passage.
Although sources built before 1977 are grandfathered
from these standards, these sources are subject to the
Acid Rain Program's emission reduction requirements.
Large, older sources are among those that have reduced
their emissions by the greatest amounts.
On average, the Acid Rain Program's Phase I sources emitted about 28 percent less
than the allowances allocated to them. During Phase II, which has more stringent
emission limits, many utilities seeking low-cost compliance options may turn to their
bank of unused allowances. While this may delay the achievement of an annual
emission reduction target, the cumulative reductions over the first fifteen years of the
program will be identical.
Since the Acid Rain Program began, the acidity of
rain has decreased by an unprecedented 25 percent.
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Question Answer
Is restricting
emissions trading to
within a state's
border the only way
to protect vulner-
able ecosystems?
Are all emission
trading programs
the same?
Actually, from 1995 to 1998 under the Acid Rain
Program, more than 80 percent of allowances used
for compliance originated from other in-state sources.
Additionally, because the wind carries emissions
across state borders, preventing sources from trading
outside of their states doesn't appear to have any
measurable environmental benefit. In fact, it could
harm the competitiveness and profitability of in-state
sources, which could result in higher compliance
costs and higher consumer utility bills. Preventing
sources from trading at all would remove any incen-
tive for earlier or deeper in-state reductions. The
most effective way to protect sensitive ecosystems is
to further reduce cap levels.
Not all emission trading programs have the same fea-
tures. Critical features are the cap, accurate and com-
plete measurement of emissions, and substantial and
automatic penalties for noncompliance. Although a
trading program cannot work in every circumstance,
one with these features can be a very effective tool.
D1980
S1990
1995-99 Avg.
Mosf of the SO2 trading has occurred
within the Ohio Valley, where the highest-
emitting sources have made the largest
reductions.
See www.epa.gov/airmarkets
. for more information on the
Acid Rain Program and other
capped trading programs.
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Moving Forward
During the first phase of the Acid Rain Program, SO2 emissions were reduced further, faster, and cheaper than expec-
tations, resulting in significant human health and environmental benefits over large areas of the country. However,
while the program is achieving the goals of the 1990 Clean Air Act Amendments, air pollution continues to
degrade human health and the environment, compelling additional reductions.
Additional Emission Reductions Are Necessary
The Acid Rain Program has enjoyed an unusually high level of emission reductions and near-perfect compliance.
However, it is becoming increasingly clear that the program's emission targets may not be sufficient to achieve its
environmental goal of ecosystem recovery. For example, some Adirondack and other sensitive ecosystems remain
acidic, and visibility in the East, including the Great Smokies, remains impaired. Scientists believe that emissions
from electric generating facilities that cause acid rain must be reduced by two-thirds or more beyond current
requirements to allow ecosystems to recover. Also, the relative contribution of sources outside the power sector is
increasing as emissions from power generation are decreasing.
Cap and Trade Will Be Important to Future Cost-Effective Reductions
The success of the Acid Rain Program has spurred the development of numerous cap-and-trade programs based on
this model, from the regional to the international level. In addition to the domestic programs already planned or in
progress, Congress is considering broader application of cap-and-trade programs. The flexibility and cost savings
associated with cap-and-trade programs enable policymakers to consider approaches that will more expeditiously
and cost-effectively address the human health and environmental problems caused by air pollution.
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"We should build on the successes of the past ten years, particularly the Add Rain Program's
cap-and-trade approach, which—through cost-effective, market-based approaches—has
shown that environmental and economic interests can be aligned, rather than at odds."
—Ken Colburn, New Hampshire Department of Environmental Services
"Cap-and-trade programs...-will tend to create incentives for the dirtiest plants to clean up
the most, as theper-ton cost of emission reductions may be expected to be the least....[The]
data show that, if anything, trading may be expected to cool hot spots and not create them."
—Environmental Law Institute
"The superior environmental and economic results of... the SO2 program are precisely what
should have been expected of a program that matched an explicit emissions limit -with a mar-
feet that turned pollution reductions into marketable assets." —Environmental Defense
"The flexibility of the trading program has encouraged utilities to capitalize on advantageous
trends, such as changing fuel prices and technological innovation, that might have been
delayed or discouraged by traditional regulatory approaches." —Resources for the Future
"Market-based incentives also clarify the environmental debate for the general public because
they focus on environmental goals...." —Robert Stavins et al., Harvard University
"EPA deserves significant credit for resisting opportunities to review and approve compliance
and trading decisions by private parties and for focusing instead on the integrity of emissions
monitoring and on a strict, no-excuse, banlter-type accountability for emissions and
allowances." —Denny Ellerman et al., Massachusetts Institute of Technology
Office of Air and Radiation
Clean Air Markets Division (6204N)
EPA-430F-02-009
www.epa.gov/airmarkets
May 2002
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