Environmental activists also have problems with the program's national scale. National reductions in overall sulfur emissions are all well and good, but regional desires can conflict with the national standards. New York state was unhappy that a state utility could profit from selling emission allowances that might end up in the hands of a Midwestern utility--whose extra emissions might rain back down on the Adirondacks. The New York Assembly has twice passed bills banning such sales, but the bills haven't gotten through the Senate.
The Adirondack Council, an Albany-based environmental group, and the Natural Resources Defense Council are suing the EPA to set standards dictating how much sulfur dioxide can fall on specific regions, not just a cap for the whole nation. "The EPA's rules have a catchall prohibiting states from taking actions that interfere with allowance trading. We're trying to challenge that provision," says David Hawkins, an NRDC lawyer pursuing the case.
California's Citizens for a Better Environment is also suing about emissions trading, over Southern California's RECLAIM program. A provision of California's Clean Air Act requires any new pollution-control program to be at least as good as the program it replaces. Because initial allocations under RECLAIM are higher than the recession-created trough that industrial activity in the Los Angeles area is crawling out of, CBE says RECLAIM fails that test.
CBE is also concerned with localized problems versus widespread trading. "If groups in a certain area buy enough credits, they can pollute as much as they want," says CBE staff attorney Richard Drury. "And from our limited data, they seem to center in poor areas. It's economically efficient to dump things on poor people. Hot-spot problems and environmental justice can't be addressed with trading schemes, only with command-and-control."
If New York state or California's CBE are able to squash participation in allowance markets in ways they don't like, or if every trading decision has to be vetted for its possible effects on specific regions or localities, national trading programs, or even multi-county ones like RECLAIM, would be severely hampered.
Many partisans of the sulfur trading program are disturbed at how sluggish the market is. Despite low, low prices, hardly anyone seems to want to buy the darn things--even, the General Accounting Office reports, when it costs a utility more to reduce emissions than to buy allowances. The GAO calculates that if utilities traded more, by 2002 they could be saving $1.2 billion more a year than by intrautility trading alone. But something is holding utilities back--perhaps many things.
To begin with, the utility industry is uniquely unsuited for a brave new experiment in applying market forces. Utilities are among the most highly regulated businesses in the country, watchdogged closely by multiple levels of government. Local air-quality districts, state public utility commissions, the Federal Energy Regulatory Commission, and the EPA can all have a say on a utility's every move.
Utilities don't charge customers what the market will bear. Every pricing decision, and every cost decision, needs to be justified in "prudence reviews" before regulatory boards, either before or after the fact. The utility industry has never been one where bold, independent action was welcome, and that corporate culture won't change instantly with a wave of the EPA's magic market wand. Utilities crave answers from their public utility commissions before they act.
But most state regulators haven't made the important decisions the emissions market requires. For example, how will the value of the emissions--or the profits made by trading them--be treated in the ratemaking process? Without knowing beforehand what the end results of allowance trading might be, and without knowing if they'll be able to reap the profits of any smart trading decisions, utility executives tend to err on the side of caution. The result: no trading.
"If utilities are going to take the risk inherent in purchasing and selling allowances, you need a commensurate reward," says James Evans, the director of environmental activities with the Edison Electric Institute, which represents investor-owned utilities. "They need to know whether there will be an equitable split between ratepayers and shareholders. It could end up being heads I win, tails you lose. If you make a good deal, the benefits go to the ratepayers. But if in retrospect it appears that had you done something differently it would have been a better deal, then your shareholder bears the burden. In that scenario, which is not unlikely, there's no incentive at all to take that risk."
Public utility regulators are now debating how to handle emissions deals in prudence reviews and ratemaking. But so far only four states involved in Phase I of the sulfur dioxide market have yet made rigorous, detailed regulatory decisions fully covering their treatment of allowances, says Ken Rose of the National Regulatory Research Institute.
Unfortunately, now isn't the best time for utilities to adjust to the vagaries of allowance markets. The industry is facing enormous regulatory changes. On the horizon are the possibilities of selling off federal power administrations, breaking up vertically integrated utilities, and placing all power in the system in power pools where energy flows in and out on a pure bid system. In the midst of great uncertainty, skittish utilities are neglecting the needs of this strange new market system that they weren't really prepared for in the first place.
Besides the inherent problems of national goals vs. local standards and the nature of the utility industry, the 1990 trading program also suffers from design peculiarities that stymie the market.
The pollution-trading market lacks something that most regular markets have: more-or-less dependable property rights. To leave regulatory wiggle room, and to protect the EPA from possible future Fifth Amendment "takings" problems, the Clean Air Act explicitly states that allowances are not real property rights. The government can change the rules of its market game at any time. New regulatory notions are always on the EPA's agenda, so making drastic changes in your operations expecting the regulatory regime to stay the same seems foolish.
James Johnston, a former senior economist with Amoco Corp., says this lack of firm property rights is the key to the market's inactivity. "The government's like Lucy holding out the football to Charlie Brown," says Johnston, who is now with the Heartland Institute, a Chicago-based free market think tank. "You never know when they'll pull it [allowance rights] away." Allowance prices are so low for a simple reason, Johnston maintains: No one values them highly because their security as property can't be trusted.
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