I. Title of the Best Practice

II. Overview of the Best Practice

A. General Description
The United States has successfully used a "cap-and-trade" emissions trading program as a tool to reduce sulfur dioxide (SO2) emissions which cause acid rain. This program has met the stated environmental goal at substantially lower compliance costs than other approaches. Ten northeastern States are now using a similar emissions trading approach to reduce emissions of nitrogen oxides (NOx) which contribute to the formation of ground-level ozone or smog. As described in the following sections, the sulfur emissions trading program provides emitters maximum flexibility over both time and space, it yields both health and ecological benefits, it is highly cost-effective, it encourages technological innovation, and has strong accountability and enforcement elements. Although less mature, similar claims can be made for the NOx trading program.

B. Special Characteristics of the Best Practice

1. Highlights of the SO2 Emissions Trading Program:
The SO2 trading program, established under the 1990 Clean Air Act Amendments, calls for major reductions of sulfur dioxide through the use of market incentives. The ultimate goal of the program is to reduce the emissions that cause acid rain which, in turn, leads to acidification of lakes and streams, damages building materials, contributes to visibility degradation, and impacts public health. The program caps the total amount of SO2 that may be emitted by electric utilities nationwide at about one half of the amount emitted in 1980, and allows flexibility for individual utility units to select their own methods of compliance.

The SO2 trading program represents a dramatic departure from traditional policy and measure regulatory methods that establish source-specific emissions limitations. Instead, the program introduces a trading system for SO2 that facilitates lowest-cost emissions reductions and an overall emissions cap that ensures the maintenance of the environmental goal. This allows the United States to put its market-based culture to work for the environment. The program features tradable SO2 emissions allowances, where one allowance is a limited authorization to emit one ton of SO2. Allowances may be bought, sold, or banked by utilities, brokers, or anyone else interested in holding them. Existing utility units were allocated allowances for each future compliance year and all participants of the program are obliged to surrender to EPA the number of allowances that correspond to their annual emissions starting either in Phase I or Phase II of the program. Sources determine their own compliance strategy, measure and report emissions, and conduct trades.

Some utilities installed "scrubbers" between the combustion unit and the stack to remove sulfur from emissions prior to its release into the atmosphere. Under the SO2 trading program, scrubbers have become more efficient at removing sulfur and also more cost-effective. Other utilities have switched to lower sulfur fuels, for example by switching to lower sulfur coal or from coal to natural gas, or by blending coals to produce a lower average sulfur fuel. Low sulfur coal has turned out to be less expensive than predicted at the beginning of the program, largely because transportation costs dropped under deregulation of the railroads. Overall, the innovation in compliance strategies and lower costs can be attributed to the flexibility sources are accorded in choosing their own emission reduction strategies.

Sources are also required to install and maintain continuous emission monitors (CAMS), or alternative emission measurement equipment at each source. Sources are responsible for conducting quality assurance testing on the monitors, according to daily, quarterly, and annual testing procedures, and to report both the quality assurance data and the emissions data to EPA quarterly. One of the most important features of the monitoring system for this program is the automated data collection and reporting -- computer systems were installed along with the measurement equipment to capture the emissions data and to provide electronic reports in a standard format. The standard electronic format allows EPA to conduct computerized quality assurance testing on every report, in addition to more detailed audits for some reports, to ensure environmental accountability.

At the end of each year, utilities must demonstrate compliance with the provisions of the SO2 trading program. Utilities are granted a 60-day grace period during which additional SO2 allowances may be purchased, if necessary, to cover each unit's emissions for the year. At the end of the grace period (the Allowance Transfer Deadline), the allowances a unit holds in its Allowance Tracking System (ATS) account must equal or exceed the unit's annual SO2 emissions. In addition, in 1995-1999 (Phase I of the program), units must have sufficient allowances to cover certain other deductions as well. Any remaining SO2 allowances may be sold or banked for use in future years. Computer technology also provides another mechanism for accountability: the daily status of allowance holdings and all of the emissions data are published by EPA on the World Wide Web, allowing the public to assess directly the effectiveness of the program. During the first four years of the program, there has been 100% compliance by the utilities required to hold enough allowances to cover their emissions.

When the Clean Air Act legislation was developed in 1990, a typical "command and control" program, which would have required each electric utility boiler to install standard pollution control technology, was estimated to cost about US$5 billion annually. To achieve the same level of emissions reductions using a "cap-and-trade" emissions trading program (which would allow electric utilities to choose the most cost-effective approach for each boiler) was estimated in 1990 to cost about US$4 billion annually. Once the program actually became effective, pollution control costs dropped dramatically, and with trading, the U.S. Government Accounting Office has since estimated that the SO2 program will cost about US$2 billion annually.

This dramatic drop in the nationwide cost of compliance is reflected in the allowance price. In 1990, the industry estimated that allowances would cost US$600-$1,000, while the government estimated that the allowance price would fall in the range of US$400-$600. Prices fell to a low of approximately US$70 in March of 1996, as the dramatic emission reductions of the first year of control became widely known. Since then, prices have climbed back to the current level of approximately US$200. Activity in the allowance market continued to increase in 1998. The volume of allowances transferred between companies in economically significant trades increased from 7.9 million in 1997 to 9.5 million in 1998. It is believed that the current trend in price and volume reflects the approach of Phase 2, which requires a full 50% reduction from all 2,000 utility sources beginning in the year 2000.

The U.S. has already experienced significant emission reductions under the first phase of the control program: by 1995, the U.S. experienced a 30 percent drop in national SO2 emissions from 1980. In fact, emissions from Phase I units have remained significantly below the required reductions for each of the first 4 years of the program.

In addition to the significant reduction in emissions, the U.S. has experienced dramatic drops in acidic deposition in some of the most sensitive regions of the country, which should eventually lead to fewer acidic lakes and streams. EPA has quantified the significant health benefits of the program at US$12-40 billion by the year 2010. The visibility benefits are estimated to be US$3.5 billion by 2010, and although not quantified, less damage to buildings and monuments is also expected. EPA will continue to study the environmental impacts of the program

2. Highlights of the Nox Emissions Trading Program:
Ten northeastern States are now using this approach to reduce emissions of nitrogen oxides (NOx) which contribute to the formation of ground-level ozone or smog. This program essentially shares most of the major features described above for the SO2 trading program: affected sources must record and report their emissions to EPA, and hold enough NOx allowances at the end of the ozone-season to cover their emissions. This NOx program also affects approximately 300 sources that participate in the SO2 trading program. There are approximately 600 additional sources participating in the NOx program which are not affected by the SO2 trading program (the additional units are primarily the electric utility units too small to have been required to participate in the SO2 program). NOx sources have begun reporting their emissions, and NOx allowance trading activity has also started. However, the first affected ozone-season ended in September 1999, and it will be assessed after the 3-month grace period.

C. Reasons for Inclusion as a Best Practice
The measurable success of these two programs lends strong support for both international and domestic emissions trading programs as practical and cost-effective mechanisms to achieve reductions in the emissions of greenhouse gases.

D. Problems and Solutions
The two-phased approach of the participation of sources can complicate administration and undermine achievement of emission reduction goals and has been perhaps the most serious flaw of the SO2 allowance program. Two types of problems can occur: a) with interconnected electric utility grids, participating sources can shift electrical load to nonparticipating sources whose emissions could increase and undermine the emission reduction goal, and b) if sources in a particular region are allowed to voluntarily participate while others in the same region can chose not to participate, there is a risk of allowances being earned by the voluntary participants and used by other participants in lieu of reducing emissions, while the nonvolunteering sources increase their emissions and cause a net increase in emissions.

Administrative mechanisms to compensate for these problems can be complex and are of limited effectiveness in ensuring the environmental integrity of the program. For example, complex allocation formulas had to be developed for substitution units (those Phase II units that volunteered to participate in Phase I) to prevent creation of large numbers of excess allowances. Further, in determining compliance of the Phase I units, it is necessary to review significant amounts of information on most of the 2000 Phase II units (to ensure that load shifting does not undermine intended emissions reductions). Approximately 75 percent of the cost of developing and implementing the permitting provisions of the SO2 program and at least one third of the cost of developing and operating the allowance tracking system, or about US$6.6 million, can be attributed to the complexity of Phase I. In retrospect, all affected sources should have been included from the outset in Phase I with emissions limitations tightened in Phase II to accomplish the goals of the program.

III. Categorizing the Best Practice

1. Classification(s) (Indicate main classification(s) only.)
( X ) Regulatory Approach (Policy approaches-- regulations, incentives, etc.)
( ) Practical Action (Action undertaken independently by a social actor)
( ) Social Network Mechanism (Cooperative structure)

2. Social Actor(s) Involved (Indicate main social actor(s) only.)
( ) Citizens
( X ) Central government
( X ) Local government
( X ) Business

3. Sector(s) (Indicate main sector(s) only.)
( X ) Energy
( ) Household
( ) Transportation
( ) Industrial Enterprises
( ) Other (Non-Industrial) Business
( ) Agriculture/ Land Use/ Forestry
( ) Other (Please specify.)

4. Target Greenhouse Gas(es)
( ) CO2
( ) CH4
( ) N2O
( ) HFC
( ) PFC
( ) SF6
( X ) Other (Please specify.) SO2 and NOx

IV. List of References

http://www.epa.gov/acidrain/

V. Please indicate a person to contact for more information about this Best Practice.

Contact Person:	Mary Shellabarger
Title:	Emissions Trading Policy Analyst
Organization:	U.S. Environmental Protection Agency, Clean Air Markets Division
Email:	shellabarger.mary@epa.gov
Tel:	202-564-9188
Fax:	202-565-6672
Address:	401 M St., SW (6202N) Washington, DC 20460 USA