Every time "cap and trade" has been introduced in the US (44 times since 1977 in air, water and wastewater markets):
- either covered sources or distributors of products that generate pollution or pollution precursors in product manufacturing or consumption process are compelled to cap and reduce discharges by biding regulations (which regulation may be in the form of at-source discharge limits and reduction schedules or point-of-sale product standards);
- 100% of the emission reductions achieved in historical cap and trade regimes have derived from compliance with these binding regulations;
- the binding regulations almost always provide for credit banking and trading among regulated sources or product distributors;
- then, an emission quota allocation, auction and trading rule are laid on top of the regulated markets.
I am not aware of a single historical example of the US implementing cap and trade without first putting the binding regulations in place. There is not a single historical example in which the emission quota allocation and trading rule has added incremental pressure on the market to reduce emissions beyond the target which will derive form compliance with the binding regulations.
Take the Acid Rain Program. It compels certain power generation units to apply for SO2 permits, which permits included binding SO2 discharge caps. It also obliges states to demonstrate that they are reducing the incidence of acid rain and are complying with increasingly stringent, binding, EPA-administered ambient SO2 and NOx (acid rain precursor) standards.
So, for example, if the SO2 sources within a state are in compliance with the federally-permitted SO2 emission limits—which are defined in both SO2/MM BTU heat input terms and annual absolute emission terms— but not in compliance with federal ambient SO2 and NOx standards, the state has a legal obligation to impose tougher-than-federal SO2 and NOx discharge limits in state source permits to ensure compliance with the federal ambient air quality standards.
No SO2 or NOx source can exceed its permitted emission limits, no matter how many SO2 or NOx allowances the source owner might have in the bank.
So it is the federal ambient air quality standards in combination with the state-administered operating permits that drive any aggregate SO2 or NOx reduction. In theory, the SO2 and NOx allowance supply could decline faster than the sum of the emission limits in permits, but in real life that has never happened. EVER. In ANY US cap and trade-covered market.
How SO2 Quota Allocation Works in the US Acid Rain Program
In the SO2 market, the EPA freely allocates 98% of the SO2 allowance supply. From 1995 through 1999, the EPA freely allocated 11.85 million TSO2 more allowances to the 110 oldest and highest emitting US coal-fired power plants than those plants had the physical capacity to discharge, assuming they were operating at 85% capacity all of the time.
Starting in 2000, the free allocation of SO2 allowances to the oldest, dirtiest plants declined to 95% of their maximum physical capacity to discharge SO2. If the old plant owners elected to hoard their surplus free vintage 1995 through 1999 allowances, this allocation method meant the old plants could continue to operate, in aggregate, at 1995 levels through 2014.
The Acid Rain regulation stipulates that starting in 2000, any utility that develops any new coal-fired power plant has to buy 100% of the US SO2 allowances needed to cover 100% of the plant’s emissions from either the US SO2 allowance auction (2% of annual supply) or the market.
The 110 oldest plants discharge, on average, 3.75 lbs SO2/MM BTU heat input, while no one can build a new plant without physically complying with a maximum 0.5 lbs SO2/MMBTU heat input federal, permit-based emission limit. The 110 oldest plants qualify for their scheduled free SO2 allowance allocations for at least 35 years, even if the plant is shut down.
The Acid Rain regulation also stipulates that every merchant power plant in the US is exempt from the US SO2 cap and allowance allocation, where a "merchant plant" is any plant that sells 15% or more of its output to a non-utility US customer and/or without a regulated rate guarantee or to an export market. Note that the US merchant plants—i.e. any plant whose owners bear any rate risk for 15% or more of their output—are also 100% exempt from the US GHG cap and trade rule under both the Waxman-Markey and Kerry-Boxer GHG bills.
New US merchant plants have to comply with the federal New Source Performance Standard (same for all new plants; has not changed since 1977), and any more stringent limits that the state may have to impose for new sources to ensure compliance with federal ambient air quality standards, but new merchant plant owners have no obligation to acquire or surrender SO2 or GHG allowances.
If/when a utility-owned coal-fired power plant is sold and becomes a "merchant plant", it becomes exempt from the obligation to surrender SO2 allowances and its original owner no longer receives free SO2 allowances.
In other words, under the US Acid Rain program/SO2 cap and trade regulation:
- given a combination of federal ambient air quality standards and state permitting regimes that legally oblige power plant owners to cut SO2 emissions, which legal obligations are permit-based; and
- given that operating permits are not tradable; all the
- SO2 allowance and trading rule does is force the developers of newer cleaner plants to compensate the owners of the oldest dirtiest plants when they shut the old plants down.
Every US cap and trade system that has been initiated in the past—with one notable exception—has been a quota regime designed to compel new market entrants to compensate market incumbents when the market incumbents finally give up their highly profitable, old. operating permits with high emission limits. These permits with high emission limits are extremely valuable and in 47 of 50 US states if environmental regulation is introduced that directly or indirectly expropriates these previously established rights to discharge pollutants or pollution precursors, the regulator (federal or state) that causes that expropriation to happen must compensate the operators whose generous permits have been partially or wholly expropriated.
All the US SO2 market rule does is relieve governments from the obligation to compensate old plant operators and transfers that compensation obligation to the general electricity rate base.
The assumption is that the new source developers’ cost of buying allowances from the old source owners will be spread over all rate-payers. Of course, the quota allocation and trading rule also delivers unprecedented market power to incumbent owners of the old plants.
The Cap and Trade Rule Gives Incumbent High Emitters Unprecedented Market Power
While the original old plant owners will often "swap" SO2 allowances with third parties for short periods, they will rarely, if ever, free up their perpetually bankable allowances to allow new market entrants to build new, more efficient power plants. They hoard their SO2 allowances, ensuring that only entities that receive original SO2 allowance allocations will be able to build any new power plants in the US.
I remain utterly astounded that a majority of US and Canadian academics continue to define this cap and trade system as efficient, fair or a successful form of emission control.
First, the SO2 quota allocation does not establish the emission reduction schedule—the basic federal ambient air quality regulations and state operating permits do. Second there is nothing efficient or "fair" (in a market sense) about the market power the free quota allocation confers on the original owners of the oldest dirtiest power plants.
Don’t Freely Allocate the Auction Quote: A Truly Misinformed Instruction
Please note that the mantra that "all permits should be auctioned" could not be more misinformed.
"Cap and trade" is a simple quota-based supply management and works, in emission markets, the same way it works in dairy, chicken or taxi markets. That is, 100% of any real, sustainable market value that attaches to the quota instrument is value that has to be expropriated from the physical production assets that are newly covered by the quota regime. If there is no devaluation of physical production assets, the real market value of the newly introduced quota certificates is, by definition, zero
Until President Obama came into power, most of Congress and the US administrative brand always understood that the quota allocation process has one, sole purpose: to deliver compensation to the property owners whose assets are devalued by the commitment to cut emissions, and to ensure that the required compensation does not have to originate in the federal Treasury.
Whenever possible (the leaded gasoline, CFC and HCFC22 phase out) Congress has used the free allocation of quota under "cap and trade" to shift compensation burden to US entities that import regulated products, shifting this cost burden not only away from the federal Treasury, but also off the backs of US consumers.
If a US government actually complied with the dominant recommendations of the NGO and academic movements today and elected to auction 100% of the emission allowances/quota (as RGGI has done), then the regulating governments would/will have to directly compensate asset owners for any loss in market value of their assets that can be directly attributed to the new regulatory requirement that they acquire and surrender allowances. RGGI states thought they had avoided this compensation risk by creating such a large RGGI GHG allowance surplus (relative to the maximum physical capacity of the covered existing plants to discharge GHGs) that it could be argued in court that the Net Present Value of the perpetually bankable allowances that RGGI source owners hold is greater than the price they are paying for those allowances today.
But, in fact, in 2008, a coalition of New York power producers filed suit against New York State, arguing that the state’s decision to auction 85% of their RGGI allowances disadvantaged them, relative to their competitors, and resulted in a devaluation of the market value of their assets. Having received multiple legal opinions suggesting that the state would lose the lawsuit, the sate settled in 2009 by freely allocating sufficient RGGI GHG allowances to the complainants to compensate them for their asset devaluation claim.
The Large Majority of US "Cap and Trade" Systems Have Not Survived and the US Acid Rain Program is Now Legless
Just under 50% of the US cap and trade regimes that have been launched in the US were disbanded within 5 years of completion of the pilot phase—where the pilot phase typically ran 2 to 3 years. Of the 35+ water and waste-water cap and trade systems that the US EPA has piloted since 1995, there have only been 3 arm’s length water quota trades in 3 separate markets over the first 7 years after the systems moved from pilot to full market regime. Most of the water cap and trade market systems have been shut down when it was apparent that the cap and trade system delivered destructive market power to incumbents, or when market manipulation was discovered.
Unfortunately a number are now tied up in court. They are not simple to unwind. That is because allowances/quota becomes real property even if/when regulators build language into legislation to try to prevent that from happening.
Once a currency or quota certificate is traded like property, both US and Canadian courts find it is real property and legislators cannot pre-emptively successfully declare it is not real property.
This was tested in Canadian courts when the BC government claimed that tree farm licenses were not real property and TFL holders were not due compensation if/when implementation of the BC Forest Practices Act effectively reduced the annual allowable cut (AAC) in their TFLs. The Supreme Court found against BC and ordered the BC government to compensate two major corporations for their AAC losses.
The US Acid Rain Program
The US Acid Rain Program established compensation for the owners of the US’s oldest, highest-emitting power plants by:
- freely allocating excessive SO2 quota to the old plant owners and
- guaranteeing those owners would receive their free SO2 allocations for at least 35 years (sometimes much more), even if/after they shut down the plants that originally attracted the free SO2 quota; and
- obliging every developer of any new US coal-fired plant to buy SO2 allowances/quota to cover 100% of their SO2 emissions, for the operating lives of the new plants, from the market.
If you want to see the long-term SO2 quota allocations for the US Acid Rain Program, go here. Click on "allowances" and then "Acid Rain Program", then "Owner/Operators". (Alternatively, you can search by "facility".) Select some owner/operators and then hit "Add Owner/Operators". Now go to "Select Output" and then select "Allowance Detail Report". Under "Update Column Selections", put ticks in the box for owner/operator.
Then hit "update column selections". Now go to "View Results" to download the report.
Scrolling through the report, you will see the scheduled volume and even serial numbers for the free SO2 allowance allocations, by original owner/operator, through 2039. Remember, this is a firm, long-term SO2 quota allocation, because each owner operator continues to get their original-scheduled SO2 quota supply through 2039 whether or not they elect to shut down the actual plants that originally qualified them for the allocation in 1995. The SO2 quota allocations in these accounts only shift from one owner/operator to another if/when the original scheduled recipient sells this property right to someone else—which rarely happens.
US "Cap and Trade" Has Never Delivered Incremental Emission Reductions
Given an at-Source or product Standard regulation-based mandate to cut emissions, US "cap and trade" has always been a mechanism through which Congress shifts its legal obligation to compensate facility owners whose assets lose market value to target market participants. In the US Acid Rain Program, the obligation to compensate the old plant owners is shifted to the US electricity rate base.
In the US leaded gasoline, CFC and HCFC22 phase-outs, 70% of the compensation liability was shifted to foreign suppliers of the regulated products to US markets (read: Canada), while 30% of the compensation costs were born by US consumers of the regulated products.
Energy Probe 