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Six Pillars of a Successful Cap and Trade Program

2010 April 14

There has been a lot of discussion in the news recently about using cap and trade to reduce a variety of pollutants. EPA’s experience with the Acid Rain Program shows that cap and trade can be a very successful way to reduce emissions as long as the program is designed in a certain way and contains a few very important features. In the past few posts of our series on the 20th Anniversary of the Acid Rain Program, we’ve talked about HOW cap and trade works to reduce acid rain. Today, I’m going to talk about WHY cap and trade has been successful for reducing sulfur dioxide (SO2) and nitrogen oxide (NOX) emissions.

In the Clean Air Markets Division where I work, we run three cap and trade programs: the Acid Rain Program (ARP), the NOX Budget Trading Program (NBP) and the Clean Air Interstate Rule (CAIR). All three focus on lowering SO2 and/or NOX from power plants. Results for all three programs have been tremendous and we have seen big reductions of both SO2 and NOX emissions along with cleaner air and a healthier environment.

There are some differences among the three programs, but they all use a cap and trade approach to lower emissions. And they all have six essential features that work together to make these three programs so successful:

  1. The cap – The most important feature of a cap and trade program, the cap is essential to achieving environmental and public health goals. Together, all the facilities in the program have to keep their emissions below this cap even if they expand or new plants are built. The cap also provides certainty and predictability to the trading market because it limits the number of allowances (permission to emit one ton of pollution) available to buy or sell. FIGUREa1
  2. Strong emission monitoring – Accurate, publicly available emissions monitoring data gives the program credibility and helps us make sure that facilities are really reducing emissions. Monitoring also is important for the market because allowances are like currency – so all participants know that a ton of emissions at one power plant is equal to a ton at another power plant.
  3. Full sector coverage – If all facilities of a certain type are in the program, from power plants that already exist to those that could be built in the future, then there can’t be any leakage or shifting of the making of electricity to plants that are not in the program. What’s more, if all facilities are in, then the government doesn’t need to spend lots of time and money reviewing whether one of them should be included on a case-by-case basis. Now that’s government efficiency!
  4. Compliance options – Cap and trade programs work best when facilities have a variety of ways (with a variety of costs) to reduce emissions at their plant. Experience has shown us that more options produce a stronger market because industry has the flexibility to choose the best and most cost-effective way to reduce emissions at their particular facility. That also means the program costs less for the industry and consumers.
  5. Unrestricted trading and banking – Moms, teachers, mentors, and bosses everywhere remind us to KISS – Keep It Simple, Stupid! The same holds true for cap and trade. The simpler a program is, the easier it is to comply with and operate, saving money and time for everyone. Some cap and trade programs have failed simply because they were just too complicated to operate. Many people worry that cap and trade does not address local air quality issues and so they add on all these complex features to try to deal with the local problem. It’s important to remember, however, that a regional cap and trade program can be used alongside other programs that address hotspots or areas where specific emission reductions might be needed to deal with unique air quality issues in certain communities.
  6. Automatic penalties – It’s hard to argue with this one. Like playing tag in the neighborhood, there are rules to the game and if you don’t follow the rules, there are consequences. It’s best if everyone knows the rules ahead of time and if everyone knows the consequences; if the penalty is automatic there is no negotiation or wiggle room. If you get tagged, you’re it.

So there you have it, folks – the six pillars of a successful cap and trade program. We have developed this list based on our own experience with running three successful cap and trade programs. What other features do you think are important to a successful cap and trade program? Why do you think the Acid Rain Program’s cap and trade approach has been so successful?

Erika Wilson works in communication in the Clean Air Markets Division in the Office of Air and Radiation.

Editor's Note: The opinions expressed here are those of the author. They do not reflect EPA policy, endorsement, or action, and EPA does not verify the accuracy or science of the contents of the blog.

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One Response leave one →
  1. April 14, 2010

    Good, concise list, should be common knowledge among policy makers and decision makers. the acid rain program is by all accounts a success for reducing emissions, and though lakes and streams have responded slowly but surely according to enviro monitoring networks, the huge payoff has been human health benefits from air quality improvements. But all this begs further examination, i.e.;

    where does one set the cap? is it based on politics or science? what factors went into setting the cap for the acid rain program, and for other programs? when enviro or health data tell you more is needed, can you lower or adjust the cap without upsetting the balance struck between market forces and the public welfare?

    how are allowances allocated? auction? giveaway? one of the things that isn’t ‘simple’ about the acid rain program is the formula by which emitters received allowances and how many. are they still allocated tradeable allowances even after they may choose to close an emissions-emitting facility? what are the impacts of speculation in the market on what are usually viewed as straightforward incentives to control emissions and costs, esp. in a volatile commodities market as we’ve seen in recent years?

    Can we look back at the same utilities/emission sources that were brought into the ‘experiment’ that was the acid rain cap and trade program, who know the program works and have benefitted from it, and see what they think of cap and trade for carbon?

    None of these questions should detract from the proven achievements of existing cap and trade programs. But the dire projections of a changing climate and the imperative to regulate greenhouse gases should compell us to quickly build on the simple and straightforward to develop something sophisticated and hopefully as successful.

    Happy anniversary to a successful ‘experiment’, and great job promoting dialog, transparency of data and rigorous monitoring!

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