oversight

Air Pollution: Overview and Issues on Emissions Allowance Trading Programs

Published by the Government Accountability Office on 1997-07-09.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                    United States General Accounting Office

GAO                 Testimony
                    Before the Joint Economic Committee
                    Congress of the United States




For Release
on Delivery
Expected at
                    AIR POLLUTION
10 a.m. EDT
Wednesday
July 9, 1997
                    Overview and Issues on
                    Emissions Allowance
                    Trading Programs
                    Statement of Peter F. Guerrero, Director,
                    Environmental Protection Issues,
                    Resources, Community, and Economic
                    Development Division




GAO/T-RCED-97-183
    Mr. Chairman and Members of the Committee:

    We are pleased to be here today to testify on the work we have done on
    the allowance trading program to control acid rain, which was set forth
    under the Clean Air Act, and to provide some observations on the
    feasibility of applying a similar trading approach to control other types of
    air pollution. Under emissions trading programs, pollution sources that
    reduce their emissions below the required levels can sell their extra
    allowances to other sources of pollution to help them meet their
    requirements. Trading of emissions allowances can be a less costly means
    to achieve pollution reductions than traditional regulatory approaches.

    Our testimony today specifically focuses on (1) cost savings and pollution
    reductions from EPA’s acid rain—or sulfur dioxide (SO2)—allowance
    trading program, which are based largely on our December 1994 report1 as
    updated to reflect current program data, (2) experiences with trading
    programs designed to control other air pollutants, and (3) issues that need
    to be considered in expanding trading programs. In summary, we found
    the following:

•   In 1994, we reported that trading and increased flexibility provided under
    the act could reduce compliance costs by $3.1 billion per year as
    compared to conventional regulatory approaches.2 We also estimated that
    SO2 emissions could be reduced by approximately 2 million tons below the
    level specified in the act. Currently, there is more trading of allowances
    between utilities than we reported in 1994 and prices being paid for
    allowances have fallen through 1996, suggesting large cost savings. In
    addition, EPA’s 1996 compliance report indicates that emissions of SO2
    were 2.9 million tons, or 35 percent, below the emissions cap.
•   To date, there has been limited experience in applying trading programs to
    other types of air pollutants. In one example of a trading program, the
    South Coast Air Quality Management District has implemented a trading
    program in the Los Angeles area to reduce air pollutants that contribute to
    the area not meeting national air quality standards. District officials
    believe the program will be more cost-effective than traditional regulatory
    approaches. EPA plans to issue additional guidance for states to follow in
    establishing various types of trading programs that the agency believes



    1
     Air Pollution: Allowance Trading Offers an Opportunity to Reduce Emissions at Less Cost
    (GAO/RCED-95-30, Dec. 16, 1994).
    2
     This estimate is for the year 2002 and assumes that utilities trade with one another until all cost
    savings opportunities are realized.



    Page 1                                                                             GAO/T-RCED-97-183
                 will provide states with more flexibility to decide the most cost-effective
                 way to reduce emissions.
             •   Several key issues need to be considered in expanding emissions trading
                 programs to other pollutants. These issues include the need for reliable
                 emissions data, penalties to discourage noncompliance, the allocation of
                 emissions allowances, and the development of trading boundaries, to
                 ensure that actual emissions reductions are achieved.


                 Emissions allowance trading differs from the traditional approach to
Background       environmental protection, commonly referred to as
                 “command-and-control.” Under a command-and-control approach, sources
                 of pollution are required to install control technologies or meet
                 plant-specific reductions of emissions for all sources. According to critics
                 of this regulatory approach, command and control is needlessly costly
                 because it imposes similar reduction requirements on sources that
                 sometimes incur very different control costs, rather than concentrating
                 reductions at those sources with the lowest control costs.

                 Recognizing the economic and environmental benefits of emissions
                 trading, the Congress adopted a new regulatory approach to deal with the
                 issue of acid rain by reducing SO2 emissions, a major cause of the
                 problem. Specifically, title IV of the Clean Air Act allows electric utilities,
                 the major source of SO2 emissions, to trade allowances to emit SO2 with
                 other utilities. After setting the overall reductions in SO2 emissions to be
                 achieved, the Congress defined each source’s specific emissions limits and
                 directed the administration to allocate allowances to sources in amounts
                 equal to the emissions limits. These emissions limits for all sources
                 combined to meet a total emissions cap. Sources that emit SO2 must install
                 continuous emissions monitors and regularly report their actual emissions
                 to EPA. Utilities that reduce their emissions below the required levels can
                 sell their extra allowances to other utilities to help them meet their
                 requirements. Utilities that exceed their emissions allowances forfeit
                 allowances to cover the excess emissions and must pay fines that are set
                 at several times the estimated average cost of complying with SO2
                 emissions limits.

                 The use of market approaches to address environmental problems is not
                 new. EPA introduced limited forms of trading emissions into its regulations
                 in the late 1970s.3 More recently, the Clean Air Act Amendments of 1990

                 3
                 For more details on these earlier approaches to trading, see A Market Approach to Air Pollution
                 Control Could Reduce Compliance Costs Without Jeopardizing Clean Air Goals (GAO/PAD-82-15,
                 Mar. 23, 1982).



                 Page 2                                                                        GAO/T-RCED-97-183
                       also addressed the use of market-based approaches to attain and maintain
                       the National Ambient Air Quality Standards (NAAQS) for other air
                       pollutants, particularly ozone. Section 110(a)(2)(A) of title I of the act
                       describes general requirements for state implementation plans to meet the
                       NAAQS and clarifies that states can use “economic incentives such as fees,
                       marketable permits, and auctions of emission rights” to meet the act’s
                       requirements.

                       The 1990 amendments to the act also recognize that the long-range
                       transport of ground-level ozone is a regional problem that states and
                       localities cannot be expected to fully address by themselves. Therefore,
                       the amendments provided for the creation of interstate transport regions
                       to deal with the ozone problem on a regional basis. The trading of
                       emissions allowances can be a particularly useful approach to address
                       regional problems with ozone in a cost-effective manner.


                       In December 1994, we reported that the acid rain program would result in
Acid Rain Program      significant cost savings as compared to a traditional command-and-control
Has Reduced            regulatory approach. Thus far, reports of SO2 emissions have indicated
Compliance Costs and   that the acid rain program has also been successful in achieving greater
                       than planned reductions in emissions.
Emissions
Cost Savings           As we reported previously, utilities have taken advantage of the regulatory
                       flexibility under title IV to choose less costly ways to reduce emissions. As
                       vendors have competed to fulfill utilities’ compliance needs, utilities’
                       ability to choose among various compliance measures has lowered prices
                       for low-sulfur coal, scrubbers, and allowances. For individual utilities, we
                       reported that the cost savings were large. For example, the Central Illinois
                       Public Service expected to save $225 million as a result of allowance
                       trading and the act’s flexibility to choose among control options. Illinois
                       Power reported saving $91 million by purchasing allowances instead of
                       installing scrubbers. Similarly, Duke Power projected savings of
                       $300 million, and Wisconsin Electric Power Company estimated saving
                       almost $90 million by avoiding the installation of scrubbers. Carolina
                       Power and Light expected to reduce its future compliance costs by
                       two-thirds as a result of purchasing allowances.

                       Projected cost savings through the acid rain program are substantial and
                       depend on the level of trading. In 1992, EPA estimated that the costs of
                       achieving compliance could be up to 50 percent lower than the costs




                       Page 3                                                      GAO/T-RCED-97-183
under a traditional command-and-control approach, depending on how
much trading occurred between utilities. We also estimated large potential
savings. According to our 1994 estimates, emission reductions would cost
as much as $4.5 billion per year by 2002 if utilities were forced to use the
types of controls typically prescribed under more traditional regulations.
Under the act’s more flexible approach, we estimated that utilities would
spend about $2.6 billion per year if they restricted themselves to internal
trading, resulting in annual savings of $1.9 billion.4 Finally, we estimated
that costs could be reduced an additional $1.2 billion per year by 2002 if
utilities traded with one another until all cost-savings opportunities were
realized, resulting in annual cost savings of $3.1 billion. However, at the
time we made these estimates, there was very little trading of allowances
occurring between different utility companies and, thus, little evidence
that this additional $1.2 billion per year in cost savings would be realized.

In 1994, we reported that various factors were causing the low level of
allowance trading at that time. Among them, phasing in emissions
reductions over several years had reduced the urgency to buy and sell
allowances. We also reported a major barrier to trading was that state
utility commissions and the Federal Energy Regulatory Commission had
provided limited guidance on whether utilities could recover allowance
trading costs. Without this guidance, many utilities may have avoided
trading and instead installed scrubbers or fuel-switching equipment.

Recent data from EPA indicate that the amount of actual trading between
utilities has been increasing since the time of our report. The number of
allowances traded between utilities, or between utilities and other entities
(e.g., brokers), has increased about 400 percent, from 881,852 in 1994 to
4,407,302 in 1996 (see fig. 1 for quarterly trading data).5 EPA’s data suggest
that utilities are making substantial efforts to achieve potential cost
savings.




4
 Internal trading means that a utility can lower costs by cutting back emissions in one of its power
plants and using the resulting allowances to cover emissions in another of its plants.
5
 Allowances equal one ton of SO2. 1994 allowances are for three quarters of the year.



Page 4                                                                           GAO/T-RCED-97-183
Figure 1: Trends in Acid Rain
Allowance Trading, 1994-97
                                 Number of allowances, or tons of SO 2 traded quarterly
                                 2,500,000




                                 2,000,000




                                 1,500,000




                                 1,000,000




                                  500,000




                                         0
                                             2Q94 3Q94   4Q94   1Q95 2Q95   3Q95   4Q95 1Q96   2Q96    3Q96 4Q96   1Q97




                                Source: EPA Data




                                EPA holds an annual auction to ensure the availability of allowances for
                                utilities needing them. EPA designed the auction as a “price discriminating”
                                auction in which bidders pay what they bid, thereby resulting in a range of
                                winning prices. Allowances can also be traded by utilities outside of EPA’s
                                auction. We reported in 1994 that, since the auction did not produce a
                                single winning price, utilities found the range of winning prices confusing
                                as an indicator of the actual market price for allowances. According to
                                several utilities, market analysts, and some economic research, an auction
                                resulting in a single, market-clearing price, would provide more accurate
                                price data.

                                The prices paid for allowances have generally fallen since our 1994 report.
                                Specifically, prices for allowances at EPA’s auction have fallen from an
                                average winning bid of $159 in 1994 to $68.14 in 1996. In the most recent
                                1997 auction, the average winning bid was $110.36. EPA also auctions
                                allowances for use 6 and 7 years after the auction, and prices for these



                                Page 5                                                                GAO/T-RCED-97-183
                        allowances have also fallen from highs of $148 and $149 respectively in
                        1994 to lows of $65.36 and $64.21 in 1996. The average winning bid for
                        6-year advances in the most recent 1997 auction was $105.51 and for 7-year
                        advances it was $104.16. Prices of allowances sold outside EPA’s auction in
                        the private market indicate the same generally decreasing trends, which
                        taken together with increased trading between utilities and other entities,
                        indicate that the costs of complying with the Act may be even lower than
                        we suggested in 1994. We previously reported that the costs of reducing
                        pollution were falling as a result of competition between compliance
                        options spurred by title IV’s flexible regulatory approach. An official at the
                        Chicago Board of Trade, which is responsible for holding the annual
                        auction, concurred in this assessment and attributed the declining prices
                        to (1) the act’s inherent flexibility in allowing utilities to pick less
                        expensive ways to comply with the law, in particular by using low sulfur
                        western coal, and (2) the impact this has had on dramatically lowering the
                        price of scrubbers.


Emissions Reductions    Title IV of the act is designed to achieve a nationwide 10-million-ton
                        reduction in SO2 emissions from 1980 levels by the year 2010. Of this
                        reduction, 8.5 million tons is expected to come from electric utilities, the
                        nation’s major source of SO2 emissions. The reduction is being
                        implemented in two phases. In Phase 1, beginning January 1, 1995, the
                        utilities with the highest levels of emissions—primarily large midwestern
                        coal-fired plants—had to reduce their annual emissions by a total of
                        3.5 million tons. In Phase 2, beginning January 1, 2000, utilities must
                        reduce their annual total emissions by another 5 million tons.

                        The acid rain program, including the use of emissions trading, has been
                        successful in reducing emissions of SO2 from utilities. To achieve the
                        program’s overall goals to reduce emissions, the program imposes an
                        annual nationwide emissions cap on SO2. EPA reports that actual emissions
                        from Phase 1 utilities were 5.4 million tons in 1996 or about 35 percent
                        below the emissions cap of 8.3 million tons for that year. EPA’s data also
                        indicate that since 1980, the program’s baseline year for emissions
                        reductions, emissions reductions have occurred in every one of the 21
                        states containing utilities affected by Phase 1.


                        As noted previously, title I of the act allowed states to use economic
Trading for Other Air   incentives, including the auctioning of emissions allowances, to meet
Pollutants              national ambient air quality standards for air pollutants and ozone



                        Page 6                                                      GAO/T-RCED-97-183
                         precursors, such as nitrogen oxides (NOx) and volatile organic compounds
                         (VOCs). Despite this legislation and attempts by EPA to implement new
                         guidance on trading emissions allowances, there has been little trading for
                         these other air pollutants.


Cap and Trade Programs   Emissions cap and trade programs under title I are designed in a similar
                         fashion to the title IV acid rain program. States or localities set total caps
                         on emissions and identify those sources that are responsible for meeting
                         the overall emissions cap. Emissions allowances are then allocated to each
                         individual source.

                         One prominent example of a title I program has been ongoing in southern
                         California since October 1993. Los Angeles is the only area of the country
                         under the act’s classification that is considered in the extreme class of
                         ozone nonattainment. As part of its efforts to comply with the act, the
                         South Coast Air Quality Management District developed a trading program
                         to reduce emissions of NOx and sulfur oxides (SOx) from stationary
                         sources. This program, called the Regional Clean Air Incentives Market
                         (RECLAIM), was approved by the California Air Resources Board in
                         October 1993. Nearly 400 stationary sources, which accounted for about
                         70 percent of NOx and SOx stationary-source emissions in the district, were
                         initially included in this program.6 Sources were included if they held
                         permits for equipment or processes that emit generally greater than four
                         tons of NOx or SOx per year.

                         RECLAIM  requires that overall emissions of NOx and SOx be reduced
                         gradually every year and replaces many existing command and control
                         rules for NOx and SOx. As with the acid rain program, those sources in
                         RECLAIM can choose the most cost-effective means to reduce emissions.
                         Sources that reduce emissions below their allocation can sell their excess
                         allowances to other sources for whom the cost of those allowances is less
                         expensive than installing emissions controls. Sources not participating in
                         RECLAIM are still subject to existing command and control rules for NOx
                         and SOx.

                         District officials believe that RECLAIM is affording stationary sources
                         significant cost savings over complying with a conventional
                         command-and-control approach. The district originally estimated that the
                         cost of this trading program would be $80.8 million annually as compared

                         6
                          As of the end of 1995, sources in RECLAIM had declined to 330. According to district officials, the
                         decrease is primarily because district staff found that some sources had less than four tons of
                         emissions per year or belong to an exempt category.



                         Page 7                                                                           GAO/T-RCED-97-183
to $138.7 million with a conventional command-and-control compliance
system. Although they have not yet fully analyzed these costs, they believe
that the program has been cost-effective. District officials told us that cost
comparisons will be included in the initial RECLAIM 3-year audit to be
completed next year.

Trading in RECLAIM indicates that there is an active market in emissions
allowances. According to the district, $33 million in allowances has been
traded as of April 1997. As shown in figure 2, the dollar value of
allowances traded in the first quarter of 1997 already exceeds the annual
amounts for the first 3 years of the RECLAIM program. Sources included in
this program were initially allocated emissions allowances based on
historical emissions data reported in a selected year that those sources
believed was representative of normal economic conditions. As a result,
the total program allowances exceeded actual emissions at the program’s
start. District officials believe that the increased trading in the first quarter
of 1997 indicates that surplus allowances built into annual targets during
the program’s early years are starting to disappear.




Page 8                                                         GAO/T-RCED-97-183
Figure 2: Trends in RECLAIM
Allowances Traded, 1994-97
                                Dollar value of allowances traded
                                16,000,000


                                                                                                                   12,935,066

                                12,000,000
                                                                               9,974,260

                                                                                                   8,656,276
                                 8,000,000



                                 4,000,000

                                                     1,502,131


                                          0
                                                       1994                     1995                   1996          1997
                                                                                       Calendar year

                                                                                     NOx    SOx



                              Note: 1997 data is for the first quarter only.

                              Source: South Coast Air Quality Management District data




                              At the start of the RECLAIM program, environmental groups were concerned
                              that, because of the initially generous allocation of allowances, actual
                              emissions would initially increase. Another issue raised was that RECLAIM
                              could adversely affect air quality in certain areas of the South Coast
                              District because the program established a total cap rather than specific
                              controls for each source. As a result of these concerns, the California Air
                              Resources Board requires the district to audit the program each year and
                              submit a report that assesses emission reductions and analyzes air quality
                              in specific areas within the district. The district’s most recent audit found
                              that actual NOx and SOx emissions for 1995 were both somewhat higher
                              than in 1993 (the program’s baseline year). However, the increase was
                              partially attributed to procedures for dealing with missing data which tend
                              to overstate actual emissions. The audit report noted that emissions in the
                              third program year (1996) should be lower due to the expected installation
                              and certification of continuous emissions monitors for most major




                              Page 9                                                                           GAO/T-RCED-97-183
                      sources. The audit also reported that emissions do not appear to have
                      geographically shifted because of the program.

                      District officials attempted to extend RECLAIM to emissions of VOCs but were
                      unsuccessful. One reason was that the reliability of emissions data for VOCs
                      is less certain than for NOx and SOx due to their chemical makeup and
                      because they are difficult to monitor. Additionally, there was a lack of
                      agreement among the district and its stakeholders on the baseline level of
                      emissions for VOCs.

                      In addition to the RECLAIM program, a concept for another cap and trade
                      program has been developed for 12 northeastern and mid-atlantic states
                      and the District of Columbia. This program, known as the Ozone Transport
                      Commission’s (OTC) NOx Budget Program, caps the summertime NOx
                      emissions for participating areas at 219,000 tons in 1999 as compared to
                      the 1990 baseline of 490,000 tons. In 2003, the emissions cap will decrease
                      to 143,000 tons. NOx emissions allowances will be allocated to emissions
                      sources in each of the states and the District of Columbia. The program
                      plans to use an allowance trading system to help achieve the goals to
                      reduce emissions in a cost-effective way. Each participating state may
                      develop its own regulations to implement the NOx Budget Program
                      including the allocation of its share of the NOx budget and the use of
                      allowance trading. The OTC NOx Budget Program is scheduled to go into
                      effect in 1999.

                      An interstate allowance trading program is also being considered by the 37
                      easternmost states (OTC and 24 additional states). This group, known as
                      the Ozone Transport Assessment Group, is currently studying possible
                      strategies to reduce NOx emissions, including an emissions cap and
                      adopting emissions trading.


Open Market Trading   To facilitate the development and implementation of additional emissions
                      trading programs, EPA proposed an “open market trading” rulemaking in
                      August 1995. This proposal was intended to provide states and industry
                      with another option to comply with the requirements of title I in the most
                      cost-effective manner possible. Open markets were proposed to create
                      incentives for sources to achieve more emissions reductions than required
                      by permit and thereby create surplus emissions’ credits. These credits are
                      similar to allowances under cap and trade programs except that they are
                      based on the rate of emissions from a source instead of total emissions.
                      Rather than installing control equipment, other sources could find it more



                      Page 10                                                    GAO/T-RCED-97-183
                          cost-effective to purchase these credits on the open market, thereby
                          meeting their compliance obligations at a lower cost.

                          EPA’s proposed rulemaking on open market trading was the number one
                          priority out of 25 regulatory initiatives for EPA announced by President
                          Clinton and Vice President Gore in March 1995. However, despite its
                          priority, EPA has not issued the rule because several concerns were raised
                          about it. For example, states were moving forward with their own trading
                          plans and believed that EPA’s proposal was too prescriptive and would not
                          allow them the needed flexibility to design their own trading programs.
                          The Environmental Defense Fund also expressed concerns that this type
                          of trading rule would not ensure environmental benefits because it did not
                          include any cap on emissions.

                          EPA officials told us that they now plan to issue guidance on open market
                          trading rather than a new rule to provide states with more flexibility to
                          decide the most cost-effective ways to reduce emissions. EPA officials told
                          us they expect to finalize this guidance by December 1997. Although EPA
                          has not issued formal guidance, some states appear to be moving forward
                          with their own open market trading programs. However, other states are
                          waiting for EPA to provide additional clarification on trading issues. For
                          example, New Jersey wants to see some level of standardization across the
                          country in calculating emissions credits so that interstate trades can be
                          made.


                          Although trading under title I has been limited thus far, the experiences
Issues to Consider for    under the acid rain and RECLAIM programs point to five key issues that EPA,
Expanding Emissions       states, and other stakeholders will need to consider when adopting
Trading                   additional trading programs.

Reliable Monitoring and   Reliable emissions monitoring and reporting systems are important to help
Reporting of Emissions    ensure environmental benefits. As noted in our 1994 report, each utility
                          must install EPA-certified continuous emissions monitors and regularly
                          report those emissions to EPA to help ensure that actual emissions are
                          accurately tracked. At the end of each year, EPA grants utilities 30 days to
                          obtain the allowances necessary to cover their actual emissions during the
                          previous year. After this grace period, EPA deducts allowances from a
                          utility’s allowance holdings in an amount equal to its recorded emissions.
                          The deduction of allowances, as well as the issuance, transfer, and
                          tracking of allowances, is conducted through an automated system.
                          Operating like a bank, this system tracks the allowances held by utilities



                          Page 11                                                    GAO/T-RCED-97-183
                          and any other companies, organizations, or individuals possessing
                          allowances. The tracking system provides EPA with a way to determine
                          compliance by ensuring that a source’s actual emissions do not exceed its
                          available allowances. Similarly, the RECLAIM program requires major
                          sources to install continuous emissions monitors to track NOx and SOx
                          emissions. The reliability of emissions data from other pollutants, such as
                          VOCs, is less certain. Thus, determining ways to obtain reliable data for
                          these other pollutants will be a key issue in developing additional trading
                          programs.


Adequate Financial        Financial penalties in emissions trading programs must be large enough to
Penalties                 discourage noncompliance. For example, if a utility does not have enough
                          allowances to cover its SO2 emissions, the acid rain program imposes an
                          automatic penalty of $2,000 per ton, indexed yearly to inflation.7 The
                          penalty is currently about twenty-five times higher than today’s allowance
                          prices. In addition, a utility that does not comply also has its allowance
                          holdings reduced in the next year by one allowance for each excess ton of
                          SO2 emitted. EPA reported that all units were in full compliance for 1995.
                          Under RECLAIM, facilities that fail to achieve their annual emissions
                          allowance may also be subject to monetary penalties. The South Coast Air
                          Quality Management District reports that 92 percent of RECLAIM facilities
                          complied with their allocations during the 1995/1996 compliance year and
                          attributed most instances of noncompliance to misunderstandings of
                          proper procedures.


Emissions Baselines and   Although determining emissions’ baselines and allocations can be difficult,
Allocations               stipulating a fixed amount of emissions to be reduced helps ensure
                          environmental benefits. The acid rain program has built-in safeguards to
                          ensure that environmental protection is achieved regardless of how much
                          or how little allowance trading occurs. These same protections could
                          serve as environmental safeguards in applying this approach to controlling
                          other air pollutants. As described previously, the RECLAIM program has
                          similar emissions caps.

                          Despite the environmental benefits of an emissions cap, it can be difficult
                          and resource intensive to agree on the baseline and how to allocate it to
                          emissions sources. This can also be an issue under a
                          command-and-control approach. In the acid rain program, average 1985-87


                          7
                           According to EPA, the actual penalty in 1996 was $2,454 per ton.



                          Page 12                                                             GAO/T-RCED-97-183
                            emissions8 were chosen as the baseline against which to measure the
                            required reductions to reduce utilities’ incentives to maintain higher
                            emissions for the express purpose of receiving larger initial allowances.
                            Additionally, choosing an average of emissions over several years, rather
                            than singling out 1 year, increases the chance that the emissions baseline
                            represents normal economic activity. In the RECLAIM program, it was only
                            after extensive debate that a baseline level was set for NOx and SOx
                            emissions. Much of the debate centered on whether to choose as a
                            baseline year one in which the region was suffering from a recession,
                            thereby establishing an emissions baseline that would have been lower
                            than normal.


Determining Trading Areas   Determining the area boundaries for any trading prior to implementing a
                            program is important because, to the extent area boundaries can be
                            enlarged without jeopardizing air quality, trading is made easier. For
                            instance, an SO2 allowance in one state can be traded for an allowance in
                            another state, thereby expanding the number of potential trades. Similarly,
                            scientists know that ground-level ozone is a regional phenomenon because
                            pollutants that cause it can be transported long distances by
                            meteorological conditions. Thus, trading allowances for air pollutants that
                            cause ozone can sometimes be done among sources in several states.


Auction Design              The design of any auction associated with a trading program is also an
                            important feature in encouraging trading. As noted previously, EPA’s
                            annual SO2 auction has resulted in allowances being sold at multiple
                            prices, causing uncertainty about what constitutes a fair market price. In
                            adopting emissions trading programs that include an auction, a single
                            price design would be preferable as we noted in our 1994 report.


                            The acid rain program, including the trading of emissions allowances, has
Conclusion                  been successful thus far in reducing SO2 emissions at reduced compliance
                            costs. However, there has been limited success in expanding emissions
                            trading to other pollutants covered under the act. Several important
                            issues, such as developing and implementing reliable emissions
                            monitoring and reporting systems, determining penalties for
                            noncompliance, and allocating emissions reductions among participants,
                            must be addressed in adopting any emissions trading program. As a



                            8
                             The calculation was based on energy input data for utilities multiplied by standard emissions factors.



                            Page 13                                                                          GAO/T-RCED-97-183
           consequence, it will take time for EPA and the states to resolve these
           issues.

           In judging the feasibility and success of these trading programs to improve
           environmental quality at less cost, it is important to note that traditional
           command and control regulatory approaches have shared many of the
           same problems and challenges, such as establishing agreed upon
           emissions baselines. In summary, Mr. Chairman, whether regulatory or
           market-based programs are implemented, mechanisms must be
           incorporated into such programs to provide for periodic monitoring and
           evaluation which will help ensure that environmental goals are achieved.


           This completes my prepared statement. I will be happy to respond to any
           questions you or Members of the Committee may have.




(160399)   Page 14                                                    GAO/T-RCED-97-183
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