Cap-and-Trade under the Clean Air Act

Last week the International Emissions Trading Association (IETA) held a seminar in Washington on the Clean Air Act and its potential role in the management of greenhouse gases in the US economy. Specifically, the IETA seminar focussed on the potential for a cap-and-trade system under the Clean Air Act. The seminar had an excellent turnout, with about 70 people from US industry, Capitol Hill, various Washington based concerns and a spattering of international visitors such as myself.
For starters, there was little disagreement amongst the speakers that a cap-and-trade type construction is feasible under the Clean Air Act, so the discussion quickly progressed from feasibility to possibility. Three key obstacles came up during the presentations and discussion:
  • The role of a National Ambient Air Quality Standard (NAAQS):  the use of cap-and-trade may require the Environmental Protection Agency (EPA) to promulgate a NAAQS for greenhouse gases. This would mean setting a limit for greenhouse gas concentrations in the air as measured in the United States and most probably at a level below the 388 ppm that is currently recorded on Mauna Loa in Hawaii. As the speakers noted, given that the level of GHGs in the atmosphere is a function of global energy use, industrial production and agricultural practices, an NAAQS is not a practical option.
  • Setting parameters within the cap-and-trade system: the creation of a cap-and-trade system would require the EPA to create rules around a number of issues, such as the overall cap for a given year and the mechanism by which allowances would be distributed and particularly the approach that would be employed for any free distribution of allowances. The point was made that the EPA must always act in a way that is technically defensible, rather than being arbitrary and capricious. One example given: establishing the level of the cap for the USA, with some link to an overall global need to reduce emissions could be deemed arbitrary given the nature and inherent uncertainty of climate science. As such, legal challenge could be expected which in turn would delay implementation.
  • Caution in rulemaking, stemming from the experience with the Clean Air Interstate Rule (CAIR): CAIR is a program that is designed to permanently cap emissions of sulfur dioxide (SO2) and nitrogen oxides (NOx) in the eastern United States. It had wide support yet was remanded to the EPA (without vacating it) following a ruling by the U.S. Court of Appeals for the D.C. Circuit in response to what was described by the speaker at the IETA meeting as a “fringe challenge”. The outcome left many of the CAIR participants financially exposed as allowance prices fell following the decision.
According to the speakers at the conference the above points could result in uncertainty and delayed implementation for a lengthy period (perhaps as much as ten years) as challenges are addressed. It was noted that even if a market resulted it may suffer from liquidity problems given the reluctance of industrial players to hold allowances following their experience with CAIR.
Whilst the speakers did not rule out a cap-and-trade type approach, their view was that EPA would eventually progress down the “Best Available Control Technology” (BACT) route, but that even this could be more broadly implemented as a standard (e.g. xx tonnes of CO2 per unit of production) rather than a prescriptive requirement for a certain piece of technology.
My personal take on this is that in the end, a BACT approach may result in higher costs for the US economy than is actually necessary to reduce emissions. A comprehensive, economy wide cap-and-trade system can deliver the required reductions at lowest overall cost to the economy. It does this by moving progressively through the abatement curve (of reduction opportunities) in an organized way, driven by the allowance trading aspect of the design in combination with the cost of abatement for a given project. But an EPA driven approach will dive into the abatement curve at somewhat arbitrary points linked to certain technologies, potentially leaving lower cost abatement opportunities on the table. This may ultimately cost the economy more than a cap-and-trade system.