Air Pollution: Overview and Issues on Emissions Allowance Trading
Programs (Testimony, 07/09/97, GAO/T-RCED-97-183).

GAO discussed its work on the allowance trading program to control acid
rain, focusing on: (1) cost savings and pollution reductions from the
Environmental Protection Agency's (EPA) acid rain, or sulfur dioxide
(SO2), allowance trading program; (2) experiences with trading programs
designed to control other air pollutants, and (3) issues that need to be
considered in expanding trading programs.

GAO noted that: (1) in 1994, GAO reported that trading and increased
flexibility provided under the Clean Air Act could reduce compliance
costs by $3.1 billion per year as compared to conventional regulatory
approaches; (2) GAO also estimated that SO2 emissions could be reduced
by approximately 2 million tons below the level specified in the act;
(3) currently, there is more trading of allowances between utilities
than GAO reported in 1994 and prices being paid for allowances have
fallen through 1996, suggesting large cost savings; (4) in addition,
EPA's 1996 compliance report indicates that emissions of SO2 were 2.9
million tons, or 35 percent, below the emissions cap; (5) to date, there
has been limited experience in applying trading programs to other types
of air pollutants; (6) in one example of a trading program, the South
Coast Air Quality Management District has implemented a trading program
in the Los Angeles area to reduce air pollutants that contribute to the
area not meeting national air quality standards; (7) district officials
believe the program will be more cost-effective than traditional
regulatory approaches; (8) EPA plans to issue additional guidance for
states to follow in establishing various types of trading programs that
the agency believes will provide states with more flexibility to decide
the most cost-effective way to reduce emissions; (9) several key issues
need to be considered in expanding emissions trading programs to other
pollutants; and (10) these issues include the need for reliable
emissions data, penalties to discourage noncompliance, the allocation of
emissions allowances, and the development of trading boundaries, to
ensure that actual emissions reductions are achieved.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-RCED-97-183
     TITLE:  Air Pollution: Overview and Issues on Emissions Allowance 
             Trading Programs
      DATE:  07/09/97
   SUBJECT:  Air pollution control
             Cost control
             Environmental law
             Environmental policies
             Electric utilities
             Industrial pollution
             Precipitation (weather)
             Air pollution
IDENTIFIER:  EPA National Ambient Air Quality Standards
             California Regional Clean Air Incentives Market Program
             OTC NOx Budget Program
             
******************************************************************
** This file contains an ASCII representation of the text of a  **
** GAO report.  Delineations within the text indicating chapter **
** titles, headings, and bullets are preserved.  Major          **
** divisions and subdivisions of the text, such as Chapters,    **
** Sections, and Appendixes, are identified by double and       **
** single lines.  The numbers on the right end of these lines   **
** indicate the position of each of the subsections in the      **
** document outline.  These numbers do NOT correspond with the  **
** page numbers of the printed product.                         **
**                                                              **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced.  Tables are included, but    **
** may not resemble those in the printed version.               **
**                                                              **
** Please see the PDF (Portable Document Format) file, when     **
** available, for a complete electronic file of the printed     **
** document's contents.                                         **
**                                                              **
** A printed copy of this report may be obtained from the GAO   **
** Document Distribution Center.  For further details, please   **
** send an e-mail message to:                                   **
**                                                              **
**                                            **
**                                                              **
** with the message 'info' in the body.                         **
******************************************************************


Cover
================================================================ COVER


Before the Joint Economic Committee
Congress of the United States

For Release
on Delivery
Expected at
10 a.m.  EDT
Wednesday
July 9, 1997

AIR POLLUTION - OVERVIEW AND
ISSUES ON EMISSIONS ALLOWANCE
TRADING PROGRAMS

Statement of Peter F.  Guerrero, Director,
Environmental Protection Issues,
Resources, Community, and Economic
Development Division

GAO/T-RCED-97-183

GAO/RCED-97-183T


(160399)


Abbreviations
=============================================================== ABBREV

  EPA -
  NAAQS -
  VOCs -
  RECLAIM -

============================================================ Chapter 0

Mr.  Chairman and Members of the Committee: 

We are pleased to be here today to testify on the work we have done
on the allowance trading program to control acid rain, which was set
forth under the Clean Air Act, and to provide some observations on
the feasibility of applying a similar trading approach to control
other types of air pollution.  Under emissions trading programs,
pollution sources that reduce their emissions below the required
levels can sell their extra allowances to other sources of pollution
to help them meet their requirements.  Trading of emissions
allowances can be a less costly means to achieve pollution reductions
than traditional regulatory approaches. 

Our testimony today specifically focuses on (1) cost savings and
pollution reductions from EPA's acid rain--or sulfur dioxide
(SO2)--allowance trading program, which are based largely on our
December 1994 report\1 as updated to reflect current program data,
(2) experiences with trading programs designed to control other air
pollutants, and (3) issues that need to be considered in expanding
trading programs.  In summary, we found the following: 

  -- In 1994, we reported that trading and increased flexibility
     provided under the act could reduce compliance costs by $3.1
     billion per year as compared to conventional regulatory
     approaches.\2 We also estimated that SO2 emissions could be
     reduced by approximately 2 million tons below the level
     specified in the act.  Currently, there is more trading of
     allowances between utilities than we reported in 1994 and prices
     being paid for allowances have fallen through 1996, suggesting
     large cost savings.  In addition, EPA's 1996 compliance report
     indicates that emissions of SO2 were 2.9 million tons, or 35
     percent, below the emissions cap. 

  -- To date, there has been limited experience in applying trading
     programs to other types of air pollutants.  In one example of a
     trading program, the South Coast Air Quality Management District
     has implemented a trading program in the Los Angeles area to
     reduce air pollutants that contribute to the area not meeting
     national air quality standards.  District officials believe the
     program will be more cost-effective than traditional regulatory
     approaches.  EPA plans to issue additional guidance for states
     to follow in establishing various types of trading programs that
     the agency believes will provide states with more flexibility to
     decide the most cost-effective way to reduce emissions. 

  -- Several key issues need to be considered in expanding emissions
     trading programs to other pollutants.  These issues include the
     need for reliable emissions data, penalties to discourage
     noncompliance, the allocation of emissions allowances, and the
     development of trading boundaries, to ensure that actual
     emissions reductions are achieved. 


--------------------
\1 Air Pollution:  Allowance Trading Offers an Opportunity to Reduce
Emissions at Less Cost (GAO/RCED-95-30, Dec.  16, 1994). 

\2 This estimate is for the year 2002 and assumes that utilities
trade with one another until all cost savings opportunities are
realized. 


   BACKGROUND
---------------------------------------------------------- Chapter 0:1

Emissions allowance trading differs from the traditional approach to
environmental protection, commonly referred to as
"command-and-control." Under a command-and-control approach, sources
of pollution are required to install control technologies or meet
plant-specific reductions of emissions for all sources.  According to
critics of this regulatory approach, command and control is
needlessly costly because it imposes similar reduction requirements
on sources that sometimes incur very different control costs, rather
than concentrating reductions at those sources with the lowest
control costs. 

Recognizing the economic and environmental benefits of emissions
trading, the Congress adopted a new regulatory approach to deal with
the issue of acid rain by reducing SO2 emissions, a major cause of
the problem.  Specifically, title IV of the Clean Air Act allows
electric utilities, the major source of SO2 emissions, to trade
allowances to emit SO2 with other utilities.  After setting the
overall reductions in SO2 emissions to be achieved, the Congress
defined each source's specific emissions limits and directed the
administration to allocate allowances to sources in amounts equal to
the emissions limits.  These emissions limits for all sources
combined to meet a total emissions cap.  Sources that emit SO2 must
install continuous emissions monitors and regularly report their
actual emissions to EPA.  Utilities that reduce their emissions below
the required levels can sell their extra allowances to other
utilities to help them meet their requirements.  Utilities that
exceed their emissions allowances forfeit allowances to cover the
excess emissions and must pay fines that are set at several times the
estimated average cost of complying with SO2 emissions limits. 

The use of market approaches to address environmental problems is not
new.  EPA introduced limited forms of trading emissions into its
regulations in the late 1970s.\3

More recently, the Clean Air Act Amendments of 1990 also addressed
the use of market-based approaches to attain and maintain the
National Ambient Air Quality Standards (NAAQS) for other air
pollutants, particularly ozone.  Section 110(a)(2)(A) of title I of
the act describes general requirements for state implementation plans
to meet the NAAQS and clarifies that states can use "economic
incentives such as fees, marketable permits, and auctions of emission
rights" to meet the act's requirements. 

The 1990 amendments to the act also recognize that the long-range
transport of ground-level ozone is a regional problem that states and
localities cannot be expected to fully address by themselves. 
Therefore, the amendments provided for the creation of interstate
transport regions to deal with the ozone problem on a regional basis. 
The trading of emissions allowances can be a particularly useful
approach to address regional problems with ozone in a cost-effective
manner. 


--------------------
\3 For more details on these earlier approaches to trading, see A
Market Approach to Air Pollution Control Could Reduce Compliance
Costs Without Jeopardizing Clean Air Goals (GAO/PAD-82-15, Mar.  23,
1982). 


   ACID RAIN PROGRAM HAS REDUCED
   COMPLIANCE COSTS AND EMISSIONS
---------------------------------------------------------- Chapter 0:2

In December 1994, we reported that the acid rain program would result
in significant cost savings as compared to a traditional
command-and-control regulatory approach.  Thus far, reports of SO2
emissions have indicated that the acid rain program has also been
successful in achieving greater than planned reductions in emissions. 


      COST SAVINGS
-------------------------------------------------------- Chapter 0:2.1

As we reported previously, utilities have taken advantage of the
regulatory flexibility under title IV to choose less costly ways to
reduce emissions.  As vendors have competed to fulfill utilities'
compliance needs, utilities' ability to choose among various
compliance measures has lowered prices for low-sulfur coal,
scrubbers, and allowances.  For individual utilities, we reported
that the cost savings were large.  For example, the Central Illinois
Public Service expected to save $225 million as a result of allowance
trading and the act's flexibility to choose among control options. 
Illinois Power reported saving $91 million by purchasing allowances
instead of installing scrubbers.  Similarly, Duke Power projected
savings of $300 million, and Wisconsin Electric Power Company
estimated saving almost $90 million by avoiding the installation of
scrubbers.  Carolina Power and Light expected to reduce its future
compliance costs by two-thirds as a result of purchasing allowances. 

Projected cost savings through the acid rain program are substantial
and depend on the level of trading.  In 1992, EPA estimated that the
costs of achieving compliance could be up to 50 percent lower than
the costs under a traditional command-and-control approach, depending
on how much trading occurred between utilities.  We also estimated
large potential savings.  According to our 1994 estimates, emission
reductions would cost as much as $4.5 billion per year by 2002 if
utilities were forced to use the types of controls typically
prescribed under more traditional regulations.  Under the act's more
flexible approach, we estimated that utilities would spend about $2.6
billion per year if they restricted themselves to internal trading,
resulting in annual savings of $1.9 billion.\4

Finally, we estimated that costs could be reduced an additional $1.2
billion per year by 2002 if utilities traded with one another until
all cost-savings opportunities were realized, resulting in annual
cost savings of $3.1 billion.  However, at the time we made these
estimates, there was very little trading of allowances occurring
between different utility companies and, thus, little evidence that
this additional $1.2 billion per year in cost savings would be
realized. 

In 1994, we reported that various factors were causing the low level
of allowance trading at that time.  Among them, phasing in emissions
reductions over several years had reduced the urgency to buy and sell
allowances.  We also reported a major barrier to trading was that
state utility commissions and the Federal Energy Regulatory
Commission had provided limited guidance on whether utilities could
recover allowance trading costs.  Without this guidance, many
utilities may have avoided trading and instead installed scrubbers or
fuel-switching equipment. 

Recent data from EPA indicate that the amount of actual trading
between utilities has been increasing since the time of our report. 
The number of allowances traded between utilities, or between
utilities and other entities (e.g., brokers), has increased about 400
percent, from 881,852 in 1994 to 4,407,302 in 1996 (see fig.  1 for
quarterly trading data).\5 EPA's data suggest that utilities are
making substantial efforts to achieve potential cost savings. 

   Figure 1:  Trends in Acid Rain
   Allowance Trading, 1994-97

   (See figure in printed
   edition.)

Source:  EPA Data

EPA holds an annual auction to ensure the availability of allowances
for utilities needing them.  EPA designed the auction as a "price
discriminating" auction in which bidders pay what they bid, thereby
resulting in a range of winning prices.  Allowances can also be
traded by utilities outside of EPA's auction.  We reported in 1994
that, since the auction did not produce a single winning price,
utilities found the range of winning prices confusing as an indicator
of the actual market price for allowances.  According to several
utilities, market analysts, and some economic research, an auction
resulting in a single, market-clearing price, would provide more
accurate price data. 

The prices paid for allowances have generally fallen since our 1994
report.  Specifically, prices for allowances at EPA's auction have
fallen from an average winning bid of $159 in 1994 to $68.14 in 1996. 
In the most recent 1997 auction, the average winning bid was $110.36. 
EPA also auctions allowances for use 6 and 7 years after the auction,
and prices for these allowances have also fallen from highs of $148
and $149 respectively in 1994 to lows of $65.36 and $64.21 in 1996. 
The average winning bid for 6-year advances in the most recent 1997
auction was $105.51 and for 7-year advances it was $104.16.  Prices
of allowances sold outside EPA's auction in the private market
indicate the same generally decreasing trends, which taken together
with increased trading between utilities and other entities, indicate
that the costs of complying with the Act may be even lower than we
suggested in 1994.  We previously reported that the costs of reducing
pollution were falling as a result of competition between compliance
options spurred by title IV's flexible regulatory approach.  An
official at the Chicago Board of Trade, which is responsible for
holding the annual auction, concurred in this assessment and
attributed the declining prices to (1) the act's inherent flexibility
in allowing utilities to pick less expensive ways to comply with the
law, in particular by using low sulfur western coal, and (2) the
impact this has had on dramatically lowering the price of scrubbers. 


--------------------
\4 Internal trading means that a utility can lower costs by cutting
back emissions in one of its power plants and using the resulting
allowances to cover emissions in another of its plants. 

\5 Allowances equal one ton of SO2.  1994 allowances are for three
quarters of the year. 


      EMISSIONS REDUCTIONS
-------------------------------------------------------- Chapter 0:2.2

Title IV of the act is designed to achieve a nationwide
10-million-ton reduction in SO2 emissions from 1980 levels by the
year 2010.  Of this reduction, 8.5 million tons is expected to come
from electric utilities, the nation's major source of SO2 emissions. 
The reduction is being implemented in two phases.  In Phase 1,
beginning January 1, 1995, the utilities with the highest levels of
emissions--primarily large midwestern coal-fired plants--had to
reduce their annual emissions by a total of 3.5 million tons.  In
Phase 2, beginning January 1, 2000, utilities must reduce their
annual total emissions by another 5 million tons. 

The acid rain program, including the use of emissions trading, has
been successful in reducing emissions of SO2 from utilities.  To
achieve the program's overall goals to reduce emissions, the program
imposes an annual nationwide emissions cap on SO2.  EPA reports that
actual emissions from Phase 1 utilities were 5.4 million tons in 1996
or about 35 percent below the emissions cap of 8.3 million tons for
that year.  EPA's data also indicate that since 1980, the program's
baseline year for emissions reductions, emissions reductions have
occurred in every one of the 21 states containing utilities affected
by Phase 1. 


   TRADING FOR OTHER AIR
   POLLUTANTS
---------------------------------------------------------- Chapter 0:3

As noted previously, title I of the act allowed states to use
economic incentives, including the auctioning of emissions
allowances, to meet national ambient air quality standards for air
pollutants and ozone precursors, such as nitrogen oxides (NOx) and
volatile organic compounds (VOCs).  Despite this legislation and
attempts by EPA to implement new guidance on trading emissions
allowances, there has been little trading for these other air
pollutants. 


      CAP AND TRADE PROGRAMS
-------------------------------------------------------- Chapter 0:3.1

Emissions cap and trade programs under title I are designed in a
similar fashion to the title IV acid rain program.  States or
localities set total caps on emissions and identify those sources
that are responsible for meeting the overall emissions cap. 
Emissions allowances are then allocated to each individual source. 

One prominent example of a title I program has been ongoing in
southern California since October 1993.  Los Angeles is the only area
of the country under the act's classification that is considered in
the extreme class of ozone nonattainment.  As part of its efforts to
comply with the act, the South Coast Air Quality Management District
developed a trading program to reduce emissions of NOx and sulfur
oxides (SOx) from stationary sources.  This program, called the
Regional Clean Air Incentives Market (RECLAIM), was approved by the
California Air Resources Board in October 1993.  Nearly 400
stationary sources, which accounted for about 70 percent of NOx and
SOx stationary-source emissions in the district, were initially
included in this program.\6 Sources were included if they held
permits for equipment or processes that emit generally greater than
four tons of NOx or SOx per year. 

RECLAIM requires that overall emissions of NOx and SOx be reduced
gradually every year and replaces many existing command and control
rules for NOx and SOx.  As with the acid rain program, those sources
in RECLAIM can choose the most cost-effective means to reduce
emissions.  Sources that reduce emissions below their allocation can
sell their excess allowances to other sources for whom the cost of
those allowances is less expensive than installing emissions
controls.  Sources not participating in RECLAIM are still subject to
existing command and control rules for NOx and SOx. 

District officials believe that RECLAIM is affording stationary
sources significant cost savings over complying with a conventional
command-and-control approach.  The district originally estimated that
the cost of this trading program would be $80.8 million annually as
compared to $138.7 million with a conventional command-and-control
compliance system.  Although they have not yet fully analyzed these
costs, they believe that the program has been cost-effective. 
District officials told us that cost comparisons will be included in
the initial RECLAIM 3-year audit to be completed next year. 

Trading in RECLAIM indicates that there is an active market in
emissions allowances.  According to the district, $33 million in
allowances has been traded as of April 1997.  As shown in figure 2,
the dollar value of allowances traded in the first quarter of 1997
already exceeds the annual amounts for the first 3 years of the
RECLAIM program.  Sources included in this program were initially
allocated emissions allowances based on historical emissions data
reported in a selected year that those sources believed was
representative of normal economic conditions.  As a result, the total
program allowances exceeded actual emissions at the program's start. 
District officials believe that the increased trading in the first
quarter of 1997 indicates that surplus allowances built into annual
targets during the program's early years are starting to disappear. 

   Figure 2:  Trends in RECLAIM
   Allowances Traded, 1994-97

   (See figure in printed
   edition.)

Note:  1997 data is for the first quarter only. 

Source:  South Coast Air Quality Management District data

At the start of the RECLAIM program, environmental groups were
concerned that, because of the initially generous allocation of
allowances, actual emissions would initially increase.  Another issue
raised was that RECLAIM could adversely affect air quality in certain
areas of the South Coast District because the program established a
total cap rather than specific controls for each source.  As a result
of these concerns, the California Air Resources Board requires the
district to audit the program each year and submit a report that
assesses emission reductions and analyzes air quality in specific
areas within the district.  The district's most recent audit found
that actual NOx and SOx emissions for 1995 were both somewhat higher
than in 1993 (the program's baseline year).  However, the increase
was partially attributed to procedures for dealing with missing data
which tend to overstate actual emissions.  The audit report noted
that emissions in the third program year (1996) should be lower due
to the expected installation and certification of continuous
emissions monitors for most major sources.  The audit also reported
that emissions do not appear to have geographically shifted because
of the program. 

District officials attempted to extend RECLAIM to emissions of VOCs
but were unsuccessful.  One reason was that the reliability of
emissions data for VOCs is less certain than for NOx and SOx due to
their chemical makeup and because they are difficult to monitor. 
Additionally, there was a lack of agreement among the district and
its stakeholders on the baseline level of emissions for VOCs. 

In addition to the RECLAIM program, a concept for another cap and
trade program has been developed for 12 northeastern and mid-atlantic
states and the District of Columbia.  This program, known as the
Ozone Transport Commission's (OTC) NOx Budget Program, caps the
summertime NOx emissions for participating areas at 219,000 tons in
1999 as compared to the 1990 baseline of 490,000 tons.  In 2003, the
emissions cap will decrease to 143,000 tons.  NOx emissions
allowances will be allocated to emissions sources in each of the
states and the District of Columbia.  The program plans to use an
allowance trading system to help achieve the goals to reduce
emissions in a cost-effective way.  Each participating state may
develop its own regulations to implement the NOx Budget Program
including the allocation of its share of the NOx budget and the use
of allowance trading.  The OTC NOx Budget Program is scheduled to go
into effect in 1999. 

An interstate allowance trading program is also being considered by
the 37 easternmost states (OTC and 24 additional states).  This
group, known as the Ozone Transport Assessment Group, is currently
studying possible strategies to reduce NOx emissions, including an
emissions cap and adopting emissions trading. 


--------------------
\6 As of the end of 1995, sources in RECLAIM had declined to 330. 
According to district officials, the decrease is primarily because
district staff found that some sources had less than four tons of
emissions per year or belong to an exempt category. 


      OPEN MARKET TRADING
-------------------------------------------------------- Chapter 0:3.2

To facilitate the development and implementation of additional
emissions trading programs, EPA proposed an "open market trading"
rulemaking in August 1995.  This proposal was intended to provide
states and industry with another option to comply with the
requirements of title I in the most cost-effective manner possible. 
Open markets were proposed to create incentives for sources to
achieve more emissions reductions than required by permit and thereby
create surplus emissions' credits.  These credits are similar to
allowances under cap and trade programs except that they are based on
the rate of emissions from a source instead of total emissions. 
Rather than installing control equipment, other sources could find it
more cost-effective to purchase these credits on the open market,
thereby meeting their compliance obligations at a lower cost. 

EPA's proposed rulemaking on open market trading was the number one
priority out of 25 regulatory initiatives for EPA announced by
President Clinton and Vice President Gore in March 1995.  However,
despite its priority, EPA has not issued the rule because several
concerns were raised about it.  For example, states were moving
forward with their own trading plans and believed that EPA's proposal
was too prescriptive and would not allow them the needed flexibility
to design their own trading programs.  The Environmental Defense Fund
also expressed concerns that this type of trading rule would not
ensure environmental benefits because it did not include any cap on
emissions. 

EPA officials told us that they now plan to issue guidance on open
market trading rather than a new rule to provide states with more
flexibility to decide the most cost-effective ways to reduce
emissions.  EPA officials told us they expect to finalize this
guidance by December 1997.  Although EPA has not issued formal
guidance, some states appear to be moving forward with their own open
market trading programs.  However, other states are waiting for EPA
to provide additional clarification on trading issues.  For example,
New Jersey wants to see some level of standardization across the
country in calculating emissions credits so that interstate trades
can be made. 


   ISSUES TO CONSIDER FOR
   EXPANDING EMISSIONS TRADING
---------------------------------------------------------- Chapter 0:4

Although trading under title I has been limited thus far, the
experiences under the acid rain and RECLAIM programs point to five
key issues that EPA, states, and other stakeholders will need to
consider when adopting additional trading programs. 


      RELIABLE MONITORING AND
      REPORTING OF EMISSIONS
-------------------------------------------------------- Chapter 0:4.1

Reliable emissions monitoring and reporting systems are important to
help ensure environmental benefits.  As noted in our 1994 report,
each utility must install EPA-certified continuous emissions monitors
and regularly report those emissions to EPA to help ensure that
actual emissions are accurately tracked.  At the end of each year,
EPA grants utilities 30 days to obtain the allowances necessary to
cover their actual emissions during the previous year.  After this
grace period, EPA deducts allowances from a utility's allowance
holdings in an amount equal to its recorded emissions.  The deduction
of allowances, as well as the issuance, transfer, and tracking of
allowances, is conducted through an automated system.  Operating like
a bank, this system tracks the allowances held by utilities and any
other companies, organizations, or individuals possessing allowances. 
The tracking system provides EPA with a way to determine compliance
by ensuring that a source's actual emissions do not exceed its
available allowances.  Similarly, the RECLAIM program requires major
sources to install continuous emissions monitors to track NOx and SOx
emissions.  The reliability of emissions data from other pollutants,
such as VOCs, is less certain.  Thus, determining ways to obtain
reliable data for these other pollutants will be a key issue in
developing additional trading programs. 


      ADEQUATE FINANCIAL PENALTIES
-------------------------------------------------------- Chapter 0:4.2

Financial penalties in emissions trading programs must be large
enough to discourage noncompliance.  For example, if a utility does
not have enough allowances to cover its SO2 emissions, the acid rain
program imposes an automatic penalty of $2,000 per ton, indexed
yearly to inflation.\7 The penalty is currently about twenty-five
times higher than today's allowance prices.  In addition, a utility
that does not comply also has its allowance holdings reduced in the
next year by one allowance for each excess ton of SO2 emitted.  EPA
reported that all units were in full compliance for 1995.  Under
RECLAIM, facilities that fail to achieve their annual emissions
allowance may also be subject to monetary penalties.  The South Coast
Air Quality Management District reports that 92 percent of RECLAIM
facilities complied with their allocations during the 1995/1996
compliance year and attributed most instances of noncompliance to
misunderstandings of proper procedures. 


--------------------
\7 According to EPA, the actual penalty in 1996 was $2,454 per ton. 


      EMISSIONS BASELINES AND
      ALLOCATIONS
-------------------------------------------------------- Chapter 0:4.3

Although determining emissions' baselines and allocations can be
difficult, stipulating a fixed amount of emissions to be reduced
helps ensure environmental benefits.  The acid rain program has
built-in safeguards to ensure that environmental protection is
achieved regardless of how much or how little allowance trading
occurs.  These same protections could serve as environmental
safeguards in applying this approach to controlling other air
pollutants.  As described previously, the RECLAIM program has similar
emissions caps. 

Despite the environmental benefits of an emissions cap, it can be
difficult and resource intensive to agree on the baseline and how to
allocate it to emissions sources.  This can also be an issue under a
command-and-control approach.  In the acid rain program, average
1985-87 emissions\8 were chosen as the baseline against which to
measure the required reductions to reduce utilities' incentives to
maintain higher emissions for the express purpose of receiving larger
initial allowances.  Additionally, choosing an average of emissions
over several years, rather than singling out 1 year, increases the
chance that the emissions baseline represents normal economic
activity.  In the RECLAIM program, it was only after extensive debate
that a baseline level was set for NOx and SOx emissions.  Much of the
debate centered on whether to choose as a baseline year one in which
the region was suffering from a recession, thereby establishing an
emissions baseline that would have been lower than normal. 


--------------------
\8 The calculation was based on energy input data for utilities
multiplied by standard emissions factors. 


      DETERMINING TRADING AREAS
-------------------------------------------------------- Chapter 0:4.4

Determining the area boundaries for any trading prior to implementing
a program is important because, to the extent area boundaries can be
enlarged without jeopardizing air quality, trading is made easier. 
For instance, an SO2 allowance in one state can be traded for an
allowance in another state, thereby expanding the number of potential
trades.  Similarly, scientists know that ground-level ozone is a
regional phenomenon because pollutants that cause it can be
transported long distances by meteorological conditions.  Thus,
trading allowances for air pollutants that cause ozone can sometimes
be done among sources in several states. 


      AUCTION DESIGN
-------------------------------------------------------- Chapter 0:4.5

The design of any auction associated with a trading program is also
an important feature in encouraging trading.  As noted previously,
EPA's annual SO2 auction has resulted in allowances being sold at
multiple prices, causing uncertainty about what constitutes a fair
market price.  In adopting emissions trading programs that include an
auction, a single price design would be preferable as we noted in our
1994 report. 


   CONCLUSION
---------------------------------------------------------- Chapter 0:5

The acid rain program, including the trading of emissions allowances,
has been successful thus far in reducing SO2 emissions at reduced
compliance costs.  However, there has been limited success in
expanding emissions trading to other pollutants covered under the
act.  Several important issues, such as developing and implementing
reliable emissions monitoring and reporting systems, determining
penalties for noncompliance, and allocating emissions reductions
among participants, must be addressed in adopting any emissions
trading program.  As a consequence, it will take time for EPA and the
states to resolve these issues. 

In judging the feasibility and success of these trading programs to
improve environmental quality at less cost, it is important to note
that traditional command and control regulatory approaches have
shared many of the same problems and challenges, such as establishing
agreed upon emissions baselines.  In summary, Mr.  Chairman, whether
regulatory or market-based programs are implemented, mechanisms must
be incorporated into such programs to provide for periodic monitoring
and evaluation which will help ensure that environmental goals are
achieved. 


-------------------------------------------------------- Chapter 0:5.1

This completes my prepared statement.  I will be happy to respond to
any questions you or Members of the Committee may have. 


*** End of document. ***