But before the market gets to work in government-created pollution markets, the overall allowed level of pollution gets decided politically. Markets aren't allowed to answer the question, How much pollution do we want? Perhaps none could. So pollution baselines get set by bureaucratic ukase. And since different parties want different baselines, that means political fights.
Southern California's proposed VOC RECLAIM program was scuttled over those fights. Environmentalists thought the proposed baseline was too high. Because of a local business recession, industry had been emitting less pollution than the initial maximum under VOC RECLAIM. Environmentalists bristled at a pollution-control program that started off allowing more emissions than the year before. Businesses argued that the glide path doesn't matter if the end result is the same; enviros complained that the end result means nothing to the people stuck breathing bad air now. SCAQMD couldn't split the difference and gave up.
For the national sulfur dioxide trading program, the designers had to steer a path between environmentalists' mistrust of trading the right to pollute and the business community's mistrust of tough reduction goals. "What we had to do was throw everyone in a room for however many weeks and not let them out till they had a baseline," remembers Boyden Gray, then a White House official who fought hard for the sulfur trading program. His role was such that one emissions-trading insider swears, admiringly and ironically, that Gray "command-and-controlled emissions trading on the utility industry."
Utilities fought for the earliest baselines they could get, Gray explains, so they could benefit from reductions they'd already done. Environmentalists wanted later baselines to make sure reductions started from the lowest possible level. The eventual compromise cut national sulfur dioxide emissions from their 1980 level by 10 million tons a year, on a glide path ratcheting down year by year until 2010.
Electric utilities were given yearly allowances to pollute, largely based on what emissions were from 1985-87. Each allowance gives the right to emit one ton of sulfur dioxide. At the end of the year, each utility must prove to the feds that it holds at least as many allowances as it emitted tons of sulfur dioxide that year, as measured by devices called continuous emission monitors at the end of stacks. If it doesn't, it's fined $2,000 per extra ton emitted and faces an equal reduction in its allowance baseline for next year. Within those parameters, utilities have room to maneuver--and to buy and sell.
Here's where the theoretic glories of emissions-trading schemes come in. If one utility can reduce emissions below the number of allowances it holds for that year, it can make money selling extra allowances to a utility that couldn't reduce enough. This gives reason to beat the regulation: If you do better than the regs demand, you can profit by selling excess allowances to others.
In theory, this system also allows everyone to reduce pollution as cheaply as anyone can. If another utility can cut emissions more cheaply than your utility can, you can reap the benefits of their know-how by buying their extra allowances. Economists' models hold out sugar-plum promises of huge efficiency gains and cost savings if the market in allowances is robust--possibly billions every year.
Have those economists' dreams come true? It's still early in the game for sulfur dioxide trading. While trading began in 1992, the actual commands for emission reductions began only in 1995--and then only for 110 of the most highly polluting utilities. The second phase begins in the year 2000, when every sulfur-dioxide-emitting utility becomes part of the market--another 700 or so potential buyers or sellers.
Some apparent magic has already appeared. Sulfur dioxide emissions are falling far ahead of the EPA's schedule. A General Accounting Office study of the allowance trading program finds that by 1997 annual sulfur dioxide emissions will be 30 percent lower than expected. Utilities are doing better than the EPA demands.
Also, prices for the two main reduction options--switching to lower-sulfur coals and installing scrubbers to eliminate sulfur at the end of your stacks--are falling. Here's where the real benefits of the program come in, some analysts say. "The purpose of this program isn't to trade allowances," says Dallas Burtraw of Resources for the Future, a Washington-based environmental think tank. "It's to give firms flexibility to comply in the least-cost manner. And the program has thrown input markets into direct competition with each other and set loose forces that have created innovation."
Falling prices are hitting every industry that allows utilities to reduce emissions: rail transport, coal markets, scrubber markets. Rail transport prices from the West, where much lower-sulfur coal is, to Eastern and Midwestern users have fallen 50 percent, Burtraw says. When the Clean Air Act Amendments of 1990 were first passed, low-sulfur coal was projected to cost $40 a ton in 1995. Instead, the price hovers around $25 a ton. Scrubber prices have also fallen by around 20 percent. Other forces undoubtedly contributed to these trends. But competition among different potential compliance mechanisms is clearly helping push costs down.
The price for complying by buying emissions allowances is also lower than expected. The EPA has held an annual allowance auction in March since 1993, selling off 2.8 percent of the total yearly allowance allocation and distributing the proceeds back to the utilities. Allowances at this auction, conducted by the Chicago Board of Trade, are going at fire-sale prices.
At the first auction in 1993, the average price for a spot allowance was $156. By 1995, it had plummeted to $132, about half the EPA's forecasts. Private brokers condemn the EPA auction as no indication of the real market--most utilities are doing private trades outside the auction's auspices--but in the outside market, allowance prices in late 1995 had fallen as low as $120.
Another positive side effect of allowance trading has been the rise of environmental charities that strike at the guts of the stated goal of environmental activism: cleaning the environment. For less than $150, an eager environmentalist can make sure that a whole ton of crud never enters the air. A Cleveland-based environmental charity called INHALE (National Healthy Air License Exchange) has spent about $120,000 buying allowances since the program started, and acts as broker for individuals (and in some cases, schools) that want to put their environmental dollars to direct use. Some utilities have been giving away allowances to charity; Northeast Utilities of Connecticut, for instance, donated 10,000 to the American Lung Association in 1993.
Despite some benefits, all is not rosy with emissions-trading markets. For one, the sulfur program's national structure sticks in many people's craws. Free marketeers like Fred Smith at the Competitive Enterprise Institute, a Washington think tank emphasizing free market environmentalism, condemn the program as "market socialism" because the government set the sulfur reduction goals--goals based on the assumption that sulfur-dioxide-generated acid rain was a severe crisis, killing forests and lakes across the nation. That crisis view isn't supported by the National Acid Precipitation Assessment Program, the government's own study on acid rain. "The sulfur trading market diverts attention from what to do to how to do it. We shouldn't fall back on instruments to avoid discussing goals," Smith says.
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