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Looking Back on SO2 Trading: What's Good for the Environment Is Good for the Market

Fortnightly Magazine - August 1997

The overwhelming impression is one of growth (em in volume and in the number of participants.

The early 1990s was an anxious period for advocates of emissions trading. Concerns about whether the sulfur dioxide allowance market would ever develop tempered the heady success of the first national emissions trading program implemented by the Environmental Protection Agency under the Clean Air Act Amendments of 1990, Title IV. These concerns were heightened when in May 1992, Wisconsin Power & Light traded 10,000 allowances to the Tennessee Valley Authority. The response from the media and environmental groups was not good:

• A representative from an environmental group asked a reporter: "What's next, the L.A. Police Department trying to buy civil rights credits from Wisconsin?" %n1%n

• A Tennessee newspaper ran a cartoon of a man trying to arrange his release from hell by making a trade for "a few brownie points." %n2%n

• An op-ed piece in USA Today intoned ominously that because of allowance trading "people will die." %n3%n

The negative public reaction to emissions trading was not the only concern for supporters of market-based environmental programs. Some observers wondered whether long lead times for case-by-case review by government agencies or expensive information requirements that had plagued previous emissions trading programs would also afflict Title IV. %n4%n There were several variations on the "will the government mess it up?" theme. Some questioned whether EPA's stringent requirements for continuous emissions monitors would destroy the market; %n5%n others were convinced that Congress and EPA had destroyed the market by not guaranteeing property rights for emissions allowances. %n6%n The greatest worry, however, was that electric utility industry regulators would interfere with trading through the lack of clear policies on who receives the benefits of trades or through biases against trading within existing cost-recovery rules. %n7%n The

possibility that tax policies surrounding allowances would diminish the incentive to trade also presented concerns. %n8%n

An uncomfortable question hung in the air: Would allowance trading go the way of other well-intended policy initiatives, i.e., good in theory but a failure in practice? Contrary to early fears, the allowance market is alive and well. Using a new framework to categorize transactions in EPA's Allowance Tracking System, a healthy and growing allowance market has developed, particularly in the last two years.

Investigating Allowance Transactions

EPA has developed a new framework to investigate the SO2 allowance market created under the Acid Rain Program. A representative group of utilities, brokers and academics have deemed this classification system credible. %n9%n This system provides substantial insight into the level and type of allowance trading activity under the Acid Rain Program.

ATS began recording transfers in March 1994, and since then has served as a central registry of allowances used for compliance with the Acid Rain Program. Though EPA designed it as an information system for tracking compliance rather than for analyzing market activity, ATS contains details of all private allowance transfers reported. These details allow EPA to distinguish between an allowance transfer that is a "real trade" or one that is simply for administrative or accounting purposes.

One aspect