Dispelling the myths of the acid rain story

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The program established to deal with the problem of acid rain in the United States is often cited as an example of the success of the "cap and trade" approach now being advanced as a solution to global warming. In July, 1998, Environment magazine published a major critique of "four key assumptions and arguments" of the acid rain debate:

First, that acidification was a new problem or newly discovered environmental problem in North America when it became a major policy question in the late 1970s. Second, that sulfur dioxide controls would necessarily be expensive. Third, that the highly touted allowance trading system created under the U.S. Clean Air Act Amendments of 1990 would reduce control costs. Fourth, that controls would have a serious negative impact, especially on coal and utility companies. Questions raised about each of these assumptions or arguments point to omissions in the acid rain story. As we continue to grapple with this issue, we need to recognize how actual occurrences differed from myth. (The first of these assumptions is examined largely in the context of Canada; the last three largely but not entirely in the context of the United States.)

The article has this to say about the third "myth" -- the efficacy of the allowance trading system:

The successful implementation and low compliance costs of Phase I of the Clean Air Act Amendments have been widely credited to the introduction of an allowance trading system for sulfur dioxide. The now regulated utility companies need one allowance for every ton of sulfur dioxide they emit in any given year. Since they receive from EPA only enough allowances to cover allowable emissions, they have three options (other than limiting power generation) to ensure compliance. The familiar ones are adopting control technology to reduce emissions or switching to low-sulfur coal or natural gas. The new option under the CAAA was buying additional allowances to cover their excess emissions. After reducing its emissions to the required amount, a utility can sell any excess allowances that it may still have.

The allowance trading provision of the 1990 amendments is a variant of the idea, familiar to economists, of tradable pollution permits. Despite its recent press coverage, this system was more refinement than innovation. Its roots go back to EPA's so-called bubble and offsets policies of the 1970s. Under those arrangements, companies could place all their plants in a given region under a hypothetical bubble and cooperate with others to reduce overall emissions at those particular plants where it was least costly to do so, rather than reducing on a uniform plant-by-plant basis. The bubble policy was, in effect, an intrafirm trading scheme without actual allowances. Emissions trading was also a feature of key acid rain related congressional bills debated over the course of the 1980s (albeit not a much-discussed feature) and of many studies done at this time (including the ICF study for the environmental groups noted earlier). In 1980, a senior EPA official made the argument that the most cost-effective acid rain control program would be one in which market forces, including a tradable permit system, determined control strategies. Appropriately enough, the occasion was a flue gas desulfurization conference.(36)

Some utility officials predicted that the value of a sulfur dioxide allowance (i.e., the marginal cost of reducing emissions by one ton) would be $1000 or more, and that it would rise over time.(37) EPA, depending on various sources, estimated a unit cost of $500 to $600, $750, or $400 to $1000. Private, pre-auction transactions in 1992 reportedly took place at around $300-$400 per allowance. Immediately prior to the first official auction in 1993 the average price was about $250 and falling. It then sank over the next four years from around $180 to $159, then to $132 and finally to $68 in 1996. The value of each allowance then rose somewhat during late 1996 and early 1997 and settled into the $90 to $100 range by mid-1997.(38) ([ILLUSTRATION FOR FIGURE 2 OMITTED] on this page.)

Various explanations have been offered to explain the low price of the allowances and the lack of trading, especially prior to 1996. Some suggested it was due to the lack of familiarity on the part of utility executives with this type of mechanism. "You have a lot of really bright engineers who have a preference for technology over financial tools," suggested one, possibly somewhat frustrated, sulfur dioxide allowance broker. Others argued the utility industry was disinterested in profit and averse to risk. Utility planners think that "if you screw up, you get shipped off to count transformers." It is, offered one analyst, a bit like trying to teach an elephant to dance.(39)

All such explanations assume that if these concerns and biases were absent, utilities would naturally be plunging into the allowances market. The simple fact is that many do not have to do so to any significant extent. Even given the prevailing bargain prices for sulfur dioxide allowances, they have other cost-effective options to meet their Clean Air Act obligations, particularly reducing emissions through fuel switching.(40)

Allowance trading should not be equated with market mechanisms. To make this equation, as many do, is to ignore the most important element of Title IV. The 1990 CAAA allowed utilities to choose how they would reduce their emissions. It did not force a technological solution, as the 1977 act had effectively done, or prescribe the emission standards to be met by every smokestack. The new act said, to coin a phrase, "just do it." In this way it brought market forces into the decision calculus of the players. These coal-utility market forces, particularly bargain prices for low-sulfur coals, have been more useful in keeping compliance costs down than the highly touted trading system.

It has been suggested that "the allowance system does not have to work very efficiently to achieve a large proportion of the economic benefits that have been estimated."(41) Indeed, the allowance market does not have to work at all for most of the cost savings to be realized. Trading may well become a more important factor in reducing compliance costs in the future, if more stringent sulfur dioxide controls are legislated. For now, it is more like the icing on an already sweet cake. The cost effectiveness of fuel switching is the main underlying reason why there has been so much compliance at such substantial savings with so little trading.

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