White Paper on SO2 and NOx Cap and Trade Programs Under The Clean Air Act
September 2004
By Nancy A. Roberts
The Clean Air Act Amendments of 1990 ushered in a new strategy for reducing air pollution from sulfur dioxide (SO2) emitted by electric generating plants the Environmental Protection Agency calls Cap and Trade. In 1997, based on increasing ozone levels in the eastern U.S. due to nitrogen oxide (NOx) emissions, EPA proposed a rule to limit NOx emissions in 21 eastern states (and DC) using a similar cap and trade strategy. Large electric generating plants, and industrial boilers and turbines located in most of those states have now joined the EPA's NOx emissions trading program. In the future, under the proposed Clean Air Interstate Rule, NOx trading may be extended to a wider region, including Texas and several southern and Midwestern states. Another proposed rule would create a trading program for emissions of Mercury.
A Cap and Trade program represents a market based policy tool for protecting human health and the environment. A cap and trade program first sets an aggressive cap, or maximum limit, on pollutant emissions. Sources covered by the program then receive authorizations to emit in the form of emissions allowances, with the total amount of allowances limited by the emissions cap. One allowance is equal to the right to emit one ton of the designated pollutant: SO2 or NOx.
Under a cap and trade program, each regulated source can design its own compliance strategy to meet the overall reduction requirement, including sale or purchase of allowances, installation of pollution controls, and implementation of efficiency measures. Individual control requirements are not specified under a cap and trade program, but each emissions source must surrender (to a regulatory body) allowances equal to its actual emissions annually in order to comply. Sources must also completely and accurately measure and report all emissions in a timely manner to guarantee that the overall cap is achieved.
Allowance trading is the centerpiece of EPA's acid rain (SO2) and ozone (NOx) reduction programs. Allowances are the currency with which compliance with the SO2 and NOx emissions requirements can be achieved. Through the market-based allowance trading system, utilities and other sources regulated under the programs, rather than a governing agency like EPA, decide the most cost-effective way to use available resources to comply with the requirements of the Clean Air Act. Sources can reduce emissions by employing energy conservation measures, increasing reliance on renewable energy, reducing usage, employing pollution control technologies, switching to lower sulfur fuel, or developing other alternate strategies. Sources that reduce their emissions below the number of allowances they hold may trade excess allowances with other units in their system, sell them to other sources on the open market or through EPA auctions, or bank them to cover emissions in future years. Allowance trading provides incentives for energy conservation and technology innovation that can both lower the cost of compliance and yield pollution prevention benefits.
