Acid rain program (1995-)
The Acid Rain Program (ARP) covers SO2 emissions from US power plans burning fossil fuels. The first phase of the program (1995-99) covered 263 electricity generating facilities and saw emissions capped at a declining volume from 8.7 million tons (Mt) to 7.0 Mt/year (Ellerman et al. 2003). The second phase, starting in 2000 and with no end date, imposed a cap converging on 9.5 Mt/year until 2010, when a final, fixed statutory cap of 8.95 Mt/year was introduced. More than 2,000 facilities were brought under the ARP cap in the second phase.
Actual emissions from covered facilities in phase 1 were much lower than the cap, which led to the buildup of a significant cumulative surplus or allowance bank of 21.6 Mt by 2000 (United States Environmental Protection Agency 2009). The surplus was partly due to the anticipation of what was perceived as more stringent caps in the second phase, prompting firms to take early action to save allowances for future use, and partly due to firms with low abatement costs opting into the system to earn allowances (Ellerman et al. 2003). This bank began to be drawn down after the start of Phase 2, as emissions exceeded the annual cap in the years 2000-2005 (see Fig. 2). From 2006, emissions again fell below the cap, causing the bank to increase every year thereafter.
What made the initial surplus possible, and why did the bank soar from 2008 and onwards? Schmalensee and Stavins (2012) point to technological innovation and a quickly maturing market in the years following 1995, as electricity generators sought to build up an allowance cushion ahead of stricter requirements in phase 2. At the same time, rail deregulation in 1976 and 1980 reduced freight rates for low-sulfur coal from Wyoming and Montana to power plants east of the Mississippi. The new coal supplies meant that some operators would have lowered their sulfur emissions even without the ARP.
From 2008, however, demand for SO2 allowances started to decline following unsuccessful attempts to tighten the SO2 cap and court rulings stating that unlimited interstate SO2 emission trading led to unacceptably high local emission levels in some states. As individual states had to reduce pollution within their own boundaries, for example by demanding the use of scrubbers or shutting down plants, the interstate market essentially died (Schmalensee and Stavins 2012). Thus, even as the ARP SO2 cap-and-trade regulation remains in force it no longer influences SO2 emission levels across the US in any meaningful way.
Efforts to reduce ozone pollution emerged in states in the US Northeast in the 1980s. Ozone pollution at the ground level is formed when NO
and volatile organic compounds (VOCs) react with sunlight. Ozone increases the symptoms of respiratory illnesses and asthma, and damages plants and buildings (United States Environmental Protection Agency 2003).
The first cap-and-trade program to control NO
emissions was set up by states from Maryland to Maine, plus parts of the Washington, D. C. metropolitan area. The cap-and-trade program was set up under the Ozone Transport Commission (OTC), a wider effort to limit ozone pollution in the region (Carlson 2009). This initial cap-and-trade program, called the OTC NO
Budget Program (OTC NBP) covered large electricity producers and industrial facilities starting in 1999.
The state-led OTC NBP was in 2003 replaced by a cap-and-trade program nested within the federal NO
State Implementation Plan (SIP) Call from 1998. This program covered 20 states. NO
cap-and-trade expanded further in 2009, with the Clean Air Interstate Rule (CAIR) and its NO
ozone season program, which replaced the NBP in the East. CAIR covers 27 states and the District of Columbia, and caps both SO2 and NO
Both the OTC and the NO
SIP call/CAIR programs experienced tight allowance market conditions and high prices in the beginning followed by later bank accumulation and lower prices (Burtraw and Szambelan 2009). High natural gas prices in 2003 led to more coal burning which caused higher NO
emissions and allowance prices (United States Environmental Protection Agency 2009). Expansion of the program in 2004 to encompass new states introduced a large allowance surplus. A minor proportion of the bank was used in 2005 as emissions exceeded the cap by one percent, but from 2006, the bank grew continually as annual emissions remained comfortably below the cap.
What explains the widening gap between NO
emissions and caps? In the case of the OTC, key factors are unexpected changes in the fuel mix, as nuclear power replaced coal, and better-than-expected performance of abatement technology due to the pre-existing and complementary regulation requiring the use of reasonably available control technology or RACT (United States Environmental Protection Agency 2004).
In the NO
SIP call/CAIR program, small-scale modifications to existing power plants, fuel switching, and retirement of old power plants were important drivers. Switching from coal and oil to gas appears particularly important, as the use of gas increased by 65 percent from 2003 to 2008 (Burtraw and Szambelan 2009). Furthermore, complementary reduction efforts at regional and state levels also contributed “significantly” to emission cuts (United States Environmental Protection Agency 2012).
EU emission trading (2005-)
The EU introduced a cap-and-trade system to help reach the collective European Kyoto target for 2008-12, after efforts to introduce an EU-wide carbon tax had failed. The EU ETS covers CO2 and nitrous oxide (N2O) emissions in sectors such as electricity, metals, cement, refineries, paper, and glass.
The initial three-year phase (2005-07) was designed as a test run, and permits issued for this period were not transferable to future periods. In the first phase, member states were in charge of the initial distribution of permits to industry. As the first batch of verified emission data was published in April 2006, showing much lower emissions than permitted under the aggregate cap, allowance prices crashed. The cap was subsequently lowered for the second (2008-12) phase, in line with the EU’s collective Kyoto commitment. The tighter cap contributed to EU installations emitting more than the annual cap in 2008, forcing them to borrow from their 2009 allowance supply or to use external offset credits to remain in compliance. However, amid the global economic downturn, emissions in 2009 fell below the cap, where they have stayed. The market is likely to remain over-supplied for years to come, some analysts estimate until 2025 (Point Carbon 2014) As a response, the European Parliament in 2013 passed a measure to postpone or “back-load” the auctioning of some allowances, while starting a discussion about measures such as tightening the cap.
The first phase of the EU ETS constitutes a good example of generous cap determination based on insufficient information. Verified emission data were not available for most EU ETS companies before the launch of the program in 2005, and country caps were thus set largely based on projections. There is also reason to suspect an ”upward bias introduced because the parties providing the data received allocations based on the same data” (Ellerman et al. 2010, 161).
While generous allocation was the primary reason for the unexpected ease of abatement in phase 1, this may not be said for phase 2. While a stricter phase 2 cap may have been set given the benefit of hindsight, the permitted emission level was calculated to a level reflecting the EU’s target for the first Kyoto commitment period (2008-12), and was considered strict at the time.
The economic downturn that hit the market in 2008 is the main explanation for the unexpectedly low emissions in subsequent phases, and the accumulation of a large allowance bank (Laing et al. 2013). Industrial production fell, and along with it demand for electricity and thus the need to burn coal and gas. The housing market also contracted, reducing demand for steel and cement, two other carbon-intensive commodities.
Besides the recession, renewable energy subsidies have boosted power production from wind and solar, reducing the demand for allowances. In addition, innovation in emission abatement has played a role in the EU ETS. For example, cement production was not expected to contribute to emission cuts, but the sector nevertheless contributed to the abatement effort by fuel switching, notably from coal to waste and biomass, and by using alternatives to emissions-intensive clinker, such as fly ash (Laing et al. 2013).
Kyoto Protocol (2008 - 12)
The Kyoto Protocol to the UN Framework Convention on Climate Change (UNFCCC) was agreed in 1997 and entered into effect in 2005. At its heart lies an international cap-and-trade system. Countries classified as “developed” under the UNFCCC in 1992 were given emission targets for the five-year period from 2008 to 2012, normally expressed with reference to their 1990 emissions. Kyoto furthermore lets countries with emissions below their targets to sell surplus allowances to countries that struggle to reach theirs.
The initial thought behind the Kyoto market was that the US and other OECD countries would serve as a source of demand for surplus allowances from East European countries and carbon credits derived from projects in developing countries, including China and India. However, as the US withdrew from Kyoto in 2001, the market balance changed. In particular, Russia and Ukraine were left with huge allowance surpluses that did not have any prospects of being purchased in full.
These surpluses originated in skilful and persistent bargaining by Russia and Ukraine, which ensured them Kyoto allowances corresponding to their full 1990 emission levels, even though their industrial output and emissions had plummeted (Grubb 2003; Henry and Sundstrom 2010). Reduced emissions following the economic downturn of recent years only added to this surplus. Finally, Canada’s withdrawal from Kyoto, effective in December 2012, increased the surplus further, as Canada would have been a net buyer of Kyoto allowances.
Regional greenhouse gas initiative (2009-)
The RGGI cap-and-trade system covers electricity generators using fossil fuels in nine US states: Connecticut, Delaware, Maryland, Massachusetts, Maine, New Hampshire, New York, Rhode Island, and Vermont. Even before RGGI went into effect, emissions started to decline in the face of two major developments: Switching from coal to gas and demand reduction. First, the shale gas boom in the US made gas more profitable than coal for generating purposes, prompting many generators to switch fuels (Newell et al. 2014; Murray et al. 2014, 10). As in the ARP, much of this switching would have taken place even absent a price on pollution. Second, the recession affected power demand, again reducing the need to burn fossil fuels and thus also demand for RGGI permits. At the end of 2011, the cumulative surplus stood at 186 million short tons, effectively the size of the ten-state cap. To address this imbalance, the participating states in February 2013 proposed to cut the cap by 45 percent starting in 2014 (Regional Greenhouse Gas Initiative 2013). As a result, allowance prices have increased from US $1.93/ton in 2012 (the floor price) to US $5.02 in the June 2014 auction (Regional Greenhouse Gas Initiative 2014).
Unlike most other cap-and-trade systems, RGGI imposes a price floor that ensures a minimum incentive to reduce emissions even in the presence of a large allowance surplus. If market participants fail to buy all the allowances offered at an auction, the unsold allowances are withheld from the market. Most states earmark proceeds from the auctions for energy efficiency and renewable energy. Thus, the design of RGGI’s auctioning system itself contributes to lowering emissions.
Tokyo ETS (2010-)
In 2006, the Tokyo Metropolitan Government (TMG) introduced a target to reduce its GHG emissions by 50 percent by 2050 and 25 percent by 2020 (Rudolph and Kawakatsu 2012). To reach this target, the city in 2002 introduced a program under which 1,000 large emitters were required to monitor and report their GHG emissions on an annual basis. These data served as a precursor of the cap-and-trade system that was introduced in 2010.
The collective target of the Tokyo ETS is to reduce emissions by 17 percent in 2015-19 under a baseline drawn from three consecutive years freely selected from 2002 to 2007 (Rudolph and Kawakatsu 2012). The program covers factories, buildings, and other facilities using district heating and cooling. Indirect emissions from power consumption are counted using a uniform conversion factor for the amount of CO2 emitted per unit electricity produced.
In the second year of operation, covered entities achieved a 23 percent aggregate reduction on their baselines, a fact partly explained by energy efficiency measures put in place after the Fukushima nuclear disaster. A second explanation for the surplus is the fact that companies have been permitted to select years with high emission levels as the baselines against which their emission performance is compared. Unexpected reduction measures and generous cap determination are thus the key explanations for Tokyo’s ETS surplus.