AN ANALYSIS OF A GLOBAL CO2 EMISSIONS TRADING PROGRAM

HOONG N. YOUNG[*]

Copyright © 1996 Journal of Land Use & Environmental Law

I. INTRODUCTION

With the recent conclusion of the global warming conference in Kyoto, Japan, the greenhouse effect and its impact on global warming has again emerged as a major issue.[1] The resulting treaty, the Kyoto Protocol, hails as a historic first step in the battle against global warming.[2] The Kyoto Protocol commits the European Union to reducing its greenhouse gas emissions below 1990 levels by 8%, the United States by 7%, and Japan by 6%.[3] As part of the plan which President Clinton said "plays to our strengths" of innovation, creativity, and entrepreneurship, emissions trading will have a role in reducing greenhouse gases.[4]

This comment analyzes two of the emissions trading programs that are currently used in the United States and the lessons we can learn from them for implementing a global carbon dioxide (CO2) emissions trading program. Part II details the effect of increased levels of greenhouse gas emissions on the greenhouse effect, leading to warnings of global warming. Part III compares and contrasts the three approaches currently used to reduce pollution emissions—traditional command and control, emission taxes, and emissions trading. Part IV describes two major existing emissions trading programs in the United States: the Sulfur Dioxide (SO2) Program and RECLAIM. Part V critiques the strengths and weaknesses of these two programs. This comment also highlights some of the problems a global CO2 emissions trading program will face and suggests some possible solutions to these problems.

II. GREENHOUSE EFFECT AND GLOBAL WARMING

Much talk now focuses on the "greenhouse effect" and its impact on the world's climate. Put simply, the atmospheric greenhouse works by allowing shortwave radiation from the sun to enter the earth's atmosphere, thereby warming the earth's land and water surfaces.[5] As the earth releases some of this heat in longwave radiation, the energy is blocked from escaping the earth's atmosphere by greenhouse gases.[6] This greenhouse effect has kept the earth con siderably warmer than otherwise possible. The increase in the amount of carbon dioxide, one of the primary gases causing the greenhouse effect, has sparked both alarm and debate.

Burning fossil fuels like coal and oil is the main cause for the increase in CO2 levels.[7] In 1996, the United States accounted for approximately 23% of the world's total of six billion tons.[8] Europe accounted for 14% while China accounted for about 12% of global carbon emissions.[9] Though currently at about half of the United States' current emissions, China is projected to surpass the United States within twenty years.[10]

Since the 1970's, scientists have been warning the world about the possibility of a rise in average global temperature due to the increased greenhouse gases concentration in the atmosphere.[11] Scientists now believe the concentration of CO2 in the atmosphere has increased 30% since the start of the Industrial Revolution, from 280 to 360 parts per million.[12] If left unchecked, scientists expect CO2 concentrations to increase to 550 parts per million by the middle of the next century.[13] In 1995, a United Nations-sponsored panel of 2000 scientists found a "discernible human influence" on the global climate and declared that the doubling of greenhouse gases could warm the average global temperature "by 2 to 6 degrees Fahrenheit over the next 100 years."[14] The panel believes the average sea level will rise between six and thirty-seven inches by the year 2100 due to the melting of polar ice caps.[15]

Critics of global warming argue that predictions are made based on crude computer simulations.[16] However, evidence exists of the current impact from global warming. A study from the World Wide Fund for Nature pointed out that 1997 was predicted to be the second hottest year in history.[17] The study also predicted that the world is experiencing its biggest thaw since the ice age, and that since 1850 Europe's glaciers have lost about half of their volume.[18] Though the debate on global warming continues, President Clinton joins many world leaders in expressing the need to reduce CO2 emissions.[19]

In 1992, the United States joined the Framework Convention on Climate Change (FCCC) at an international "Earth Summit" in Rio de Janeiro.[20] The FCCC is an international agreement that calls for substantial reductions in the release of man-made greenhouse gases.[21] The initial goal of the FCCC was to reduce greenhouse gas emissions by developed countries to 1990 levels by the year 2000.[22] Unfortunately, that standard was not legally binding upon the signatories.[23] In 1996, the United States shifted positions at an international conference in Geneva.[24] Undersecretary of State Timothy Wirth announced that voluntary compliance with the goals of the FCCC was a failure and that legally binding emission standards should be created.[25] Subsequent international meetings were held in Geneva and in Bonn during February, 1997.[26] These meetings led to negotiations on a binding agreement that was finalized in December, 1997, in Japan.[27]

In addition to the gas emissions reductions to which the United States, Japan, and the European Union have committed, twenty-one other industrialized countries must meet similar reductions under the Kyoto Protocol between 2008 and 2012.[28] All are committed to further reductions in the future.[29] The inclusion of an emissions trading program was a major victory for the United States.[30] Though details have yet to be worked out, the trading program would allow a country that cannot meet its emissions target to purchase quotas from a country that has reduced emissions below its target.[31]

III. TRADITIONAL COMMAND AND CONTROL, EMISSION TAXES, & EMISSIONS TRADING

The Kyoto Protocol introduces a fairly new approach for reducing CO2 emissions. Traditionally, the United States has applied a "command and control" method to deal with pollution.[32] For ex ample, with air pollution, the Clean Air Act (CAA)[33] authorizes the Environmental Protection Agency (EPA) to set national ambient air quality standards (NAAQS).[34] The EPA and states then establish a source specific technology-based emissions limit to assist individual polluters in meeting the NAAQS.[35] Many economists and scholars argue that the command and control method unnecessarily increases cleanup costs.[36] For example, the 1977 Amendments to the CAA[37] required all utilities to install expensive scrubbers to remove sulfur dioxide (SO2) from emissions even though many utilities could have reduced SO2 emissions by switching to low sulfur coal.[38] Many also believe that command and control discourages innovative pollution control technology.[39] Since the EPA sets cleanup goals based on currently available technology, little incentive exists for firms to spend money on research and development of new pollution control methods.[40]

An alternative to the command and control system is taxing producers for each unit of pollution they emit.[41] The tax would force producers to take into account the cost of pollution. Without the tax and without command and control, the emitted pollution and its effects on the environment are only externalities that are not included when producers analyze costs.[42] In theory, the efficient firm would try to reduce pollution until the incremental cost of reducing pollution equals the incremental benefits of further pollution reduction.[43] This would result in a socially optimal level of pollution at the lowest cost.[44] However, there are extreme difficulties with implementing an emissions tax. It is often difficult to assess the social costs of pollution.[45] Many costs are measured in terms of aesthetic damage or damage to a person's health.[46] In many cases, it is not possible to foresee all the damages polluting can cause. Even if costs could be estimated, regulators would have to constantly update the taxes to include changes in economic activity, inflation, or other changes in the level or impact of that particular source's pollution.[47] Finally, it will be politically difficult to implement a tax-based pollution control since the tax would mean higher costs to producers which would probably be passed on to the consumers.[48]

A transferable pollution permitting system, or emissions trading system, is an alternative to the emissions tax.[49] Under an emission trading system, regulators establish the allowable pollution level for a given area and grant permits to existing producers so that emissions do not exceed prescribed pollution levels.[50] Each producer is allocated permits based on the "producer's past pollution levels or through a competitive bidding auction."[51] Firms that reduce their pollution emissions below their allocated level can sell their surplus permits to other firms or individuals.[52] Firms that cannot reduce their pollution emissions to meet their allocated level can purchase more permits.[53] Under this system, firms can choose the most cost-effective way to stay within their allocated emissions level.[54] The ability to profit from the selling of emission credits encourages firms to develop innovative pollution control devices.[55]

The emissions trading system has several advantages over the emissions tax system. First, an emissions trading system fits well with current regulatory schemes such as the CAA, which establishes allowable pollution levels.[56] Regulators set allowable pollution levels while the market decides the price of the tradable permits.[57] Under the emissions tax system, regulators must somehow calculate the price of the emissions tax and make the tax high enough so that the desired level of pollution reduction can be achieved.[58] Second, under the emissions trading system, regulators will not have to worry about adjusting prices for inflation or changes in economic activity because the market would make these adjustments automatically.[59] Third, while both programs would reduce emissions, a tax imposes additional financial burdens on industry.[60] Not only would firms have to pay for the cost of reducing emissions, firms would also have to pay for the tax liability of remaining emissions.[61]

Proponents for emissions trading markets have determined four requirements for a successful program.[62] First, there must be enough participants in the market; both to sell and to buy emissions credits.[63] Without enough participants, price information would be difficult to establish and prices for credit might not accurately reflect actual supply and demand.[64] Second, transaction costs must be kept low.[65] Otherwise, buyers and sellers will be discouraged from trading in a market that could have been beneficial to both. Robert Hahn and Gordon Hester identified high transaction costs as the single most important obstacle to the success of pollution markets.[66] Third, in order for a market-based program to work, there must be effective enforcement.[67] Both monitoring and sanctions are needed for effective enforcement to exist. Without effective enforcement, the market will become distorted and inefficient.[68] Finally, the regulatory system must engender confidence in market participants of its stabili ty.[69] In a market system, there will be tension between the participants' need for stability and the regulators' need to change the rules as new information becomes available.[70] Though this problem exists for most markets, it is particularly important in the area of pollution control because the commodity, pollution credits, only retain their value if the government maintains the market.[71]

IV. EXISTING U.S. EMISSIONS TRADING PROGRAMS

In recent decades, the United States has gained valuable experience from implemented emissions trading programs. Two programs, the SO2 program and the RECLAIM program, can provide insights to the types of problems that a global CO2 emissions trading program would face.

A. SO2 Trading Program

The SO2 emissions allowance trading program was enacted through Title IV of the 1990 Clean Air Act Amendments (CAAA),[72] ushering in the largest-ever nationwide emissions trading program.[73] Title IV of the CAAA was passed to combat the problem of acid rain.[74] Title IV was "designed to achieve a 10 million-ton annual reduction in SO2 emissions from 1980 levels by the year 2010¼Of this reduction, 8.5 million tons is to come from electric utilities, the nation's major source of SO2 emissions."[75] Sulfur dioxide emissions reduction will consist of two phases.[76] Phase I requires 110 of the nation's largest electric utility plants to reduce their emissions by 3.5 million tons a year, beginning January 1, 1995.[77] Phase II requires almost all utilities to reduce annual emissions by another five million tons beginning January 1, 2000.[78]

Utilities were given freedom in deciding how to meet the required emission reductions. Each utility in the program was assigned an emissions allowance based largely on its emissions between the years of 1985-1987, plus bonus allowances available under a variety of special provisions.[79] Each allowance gives the right to emit one ton of SO2.[80] At the end of each year, each utility must prove to the EPA that it holds at least as many allowances for SO2 emissions as it emitted that year as measured by devices at the end of stacks called continuous emission monitors (CEM).[81] The EPA grants each utility thirty days to obtain the allowances necessary to cover its actual emissions during the previous year.[82] If a utility emits more than its specified emissions allowance, the utility will be fined $2,000 for each ton that exceeds its limit and the utility will be required to offset the excess amount the following year.[83]

In order to meet these allowance limits, the utility could switch to low sulfur coal, install new scrubbers, or shut down some plants.[84] The utilities also had the option of trading emission allowances.[85] Utilities that did not emit as much SO2 as their allowance limits were given emission credits.[86] These credits could then be banked for future use by these utilities or they could be sold for profit.[87] For those utilities that could not meet their emissions allowances, they had the option of purchasing emission credits.[88] Credits could be purchased at the annual EPA auction or they could be purchased through private transactions.[89]

The EPA has effectively monitored the utilities with the CEM equipment by requiring utilities to report on their emissions regularly.[90] The EPA also has an automated allowance tracking system (ATS) that monitors all deductions of allowances, as well as the issuance, transfer, and tracking of allowances.[91] The ATS allows the EPA to ensure that actual emissions do not exceed available allowances.[92]

B. RECLAIM Program

As the only area in the United States classified as "severe nonattainment," the South Coast Air Quality Management District (SCAQMD) in the Los Angeles basin introduced the Regional Clean Air Incentives Market (RECLAIM) in 1994.[93] RECLAIM is a regional market designed to improve air quality through the reduction of two pollutants, nitrogen oxides (NOx) and SO2.[94] The RECLAIM Program would include stationary facilities emitting four or more tons of NOx or SO2 per year.[95] This meant 390 facilities, representing approximately 65% of the permitted stationary NOx emissions in the Los Angeles basin were included,[96] and forty-one facilities, representing 85% of total emissions from permitted stationary SO2 sources.[97] Facilities could voluntarily join the program even if they did not meet the emission standards, however, a facility could not leave RECLAIM after it joined.[98] Sources not participating in RECLAIM are still subject to existing command and control regulations.[99] Like the national SO2 emissions trading program, participants of RECLAIM were each assigned a specific emissions allowance.[100] Each facility was given an allocation of credits to cover all emission sources, such as furnaces and boilers.[101]

The "cap and trade" market is also incorporated into RECLAIM.[102] It sets an area-wide total emissions cap that declines over time.[103] Each facility's emissions allowance is also reduced according to a schedule until the year 2003.[104] SCAQMD hopes RECLAIM will reduce total NOx emissions from the 390 participating facilities by 75% of the starting emission levels.[105] Facilities registered in the RECLAIM program must reconcile their pollution accounts once a year.[106] If a facility pollutes more than its allocated limit, it must purchase pollution credits at one of the Pacific Exchange's emissions credit auctions.[107] If a facility reduces emissions below what it was allocated, it may sell its excess credits.[108]

The monitoring, reporting, and record keeping (MRR) for RECLAIM is quite complex. Sulfur dioxide emitters fall into two categories: major sources and process units.[109] Major sources must install CEM systems to monitor emissions, and they must install a device that reports total daily mass emissions electronically, via modem, to the District.[110] Process units must elect to measure either their fuel usage or their operating time and production/processing/ feed rate.[111] Process units must also use an emission factor to determine mass emissions.[112] Both major sources and process units must report emissions to the District on a quarterly basis.[113]

The MRR requirements are even more complex for NOx emitters. These emitters are classified either as major sources, large sources, or process units.[114] "Major sources face the most stringent requirements, while process units face the least."[115] The requirements for major sources of NOx are similar to those for major sources of SO2.[116] Facilities that are considered large sources can choose to comply with MRR requirements for major sources or the more relaxed requirements for large sources.[117] Large sources are required to "operate a totalizing fuel meter and any other device that the Executive Officer considers necessary for measuring fuel usage."[118] A large source must also calculate mass emissions using either an emissions factor or an equipment-specific emission rate or concentration limit.[119] In addition, a large source must report mass emissions to the District on a monthly basis.[120] Process units can comply with MRR require ments by complying with major source or large source regulations, or process units can choose to comply with less restrictive requirements specifically for process units.[121] Under the less restrictive requirements, process units must install totalizing fuel meters and/or timers, or any other devices that the Executive Officer specifies as being functionally equivalent.[122] Like all the other NOx sources, process units must report mass emissions to the District on a quarterly basis.[123]

V. ANALYSIS OF EXISTING PROGRAMS

The United States' two major existing emissions trading programs should be examined to determine their strengths and weaknesses. The strengths of the SO2 and RECLAIM programs can assist in constructing an efficient CO2 emissions trading program. Additionally, weaknesses in the SO2 and RECLAIM programs can pinpoint potential problem areas in a similar type emissions program.

A. SO2 Program

Since the first phase of the program began in January 1995, there have been some pleasant surprises. To begin with, significant emission reductions have been met early on in the program.[124] After January 1995, utilities have been aggressively reducing emissions and taking advantage of the opportunity to bank the allowances earned.[125] The volume of banked allowances in 1995 and 1996, and the projected amounts through 2000, is much larger than predicted.[126] Many utilities are banking these credits for use during Phase II of the program.[127] This has resulted in a win-win situation for both the environment and the industry.[128] The environment is benefiting from the earlier reduction in SO2 emissions because it can now start to recover from the effects of lower SO2 emissions and improve public health earlier than would otherwise be possible.[129] The utility industry will benefit from banking allowances because the overall cost of compliance with the more stringent Phase II requirements will be lowered.[130] The lowering of overall costs will help facilitate a smoother transition to Phase II standards.[131]

Allowance prices have also been much lower than originally predicted.[132] While the CAAA were being debated in Congress in 1990, experts predicted the cost of each allowance could be as high as $1,500, with a common guess of $750.[133] Since trading began, the price has fallen from $250-$300 in 1992, $110-$140 in 1995, to $70 in 1996. However, the price rebounded to around $100 in 1997.[134]

Not all would consider the fact that prices have been lower than expected as proof of the market system working efficiently. Critics are blaming the set-up of the EPA auction for the low prices.[135] Currently, every buyer pays what he bids, but the seller with the lowest asking price gets the highest bid.[136] This mismatch occurs because the "lower asking prices increase the probability that a seller trades with high-bidding buyers."[137] Because more than one seller exists in the market, sellers have under-stated the value of their allowances to start the bidding.[138]

Another surprise is that the marginal cost of emissions reductions has been dramatically less than projected.[139] Experts had pre dicted the cost of compliance using traditional methods at $1,500 per ton.[140] They had expected marginal costs to be close to $525 per ton under the market system.[141] So far, recent studies suggest marginal costs to be less than $350 per ton.[142] However, the $350 per ton cost of compliance is still more than three times higher than what allowances are currently selling for ($100 in 1997).[143] This is probably due to a number of factors. One major factor is that, as mentioned previously, utilities are banking a larger amount of emission allowances than expected.[144] The probability that meeting the stringent Phase II standards will be more costly may account for this. The Phase I bank of allowances will delay the full effect of the 8.95 million-ton-cap on SO2 until 2010.[145] This "delay until 2010 for the most expensive compliance options means that allowance prices today, measured at a discount rate of 8%, should have a value of about one-third that of the cost of these compliance options."[146] In fact, the current market price of allowances ($100) is about one third of the econometric estimates of long-run marginal cost ($350).[147]

The program's administrative costs have also been low compared to traditional pollution controls. The approximate cost of the program on a yearly basis was $12 million.[148] This would come out to be about $1.50 per ton of pollution reduced.[149] For the first five years, the government spent only $60 million to set up the SO2 trading program though the estimated cost of the program had been up to $3.5 billion.[150]

Despite all the benefits of the SO2 trading program since it went into effect, there have been some problems. First, there has been a lower than expected volume of inter-utility trading and trading between economically distinct entities. According to the EPA's Allowance Tracking System (ATS), from 1994 to the end of the first quarter in 1997, more than 38 million private allowances were transferred in 2,400 transactions.[151] The majority of these transactions were intra-firm or reallocations.[152] Together, they represented 50% of all transfers and 75% of all allowances transferred.[153] Trading between economically distinct entities amounted to 8.9 million allow ances in more than 1,100 trades.[154] Utilities acquired approximately 3.5 million of these allowances.[155]

Several explanations have been given as to why the utilities have not done much trading. One reason is that state commissions run most electric companies and regulate what the companies can do.[156] For example, the state commissions regulate "acceptable rates of return, recoverable costs, the distribution of financial risks and re turns between ratepayers and shareholders."[157] Some state com missions have required the utilities to pass on the savings they make on trades to their customers, taking away the incentive to trade in order to make a profit.[158] Many state commissions have not issued any rules on the regulatory treatment of allowance transactions.[159] Because the utility industry is risk-averse by nature, most utilities have not been willing to trade until their state commissions enact new regulations.[160] Finally, in order to protect local, high-sulfur coal production, some state commissions have insisted that their utilities meet the CAAA emissions standards by installing scrubbers.[161]

Another problem the SO2 trading program has run into is though total national emissions have been lowered, regional or local emissions might not have improved. New York State, for example, is unhappy that utilities in New York can profit from selling emission allowances to Midwestern states whose extra emissions might rain back down on the Adirondacks.[162] Critics are also unhappy with the fact that a utility can pollute as much as it can purchase in emission credits.[163] They argue that, from the limited data available, often it is economically efficient to dump pollutants on economically disadvantaged people.[164]

However, defenders of the SO2 emissions trading program would argue that "under Title IV, sources also must comply with source-specific emission reductions set by states to ensure attainment of ambient standards."[165] Therefore, some of the local concerns can be addressed on the state level by having the state set more stringent emissions standards, thereby lowering pollution levels. Even if the problem cannot be alleviated on the state level, proponents of trading programs will point out that in time, even hot spots will eventually be cleaned.[166] As time progresses, the cost of emissions credits will rise as cheaper pollution control methods become avail able.[167] This will cause even utilities located in "hot spots" to reduce emissions.[168]

One final issue challenging the success of the SO2 program is the lack of property rights associated with the tradable allowances. In order to leave room for further regulations and to protect the EPA from future Fifth Amendment "takings" claims, "the CAA explicitly states that allowances are not real property rights."[169] Without the security of knowing that what they own has property rights, a trader in the SO2 market lacks the rights that most traders on regular markets have.[170]

B. RECLAIM Program

Several points about RECLAIM distinguish it from the SO2 trading program.[171] First, instead of setting up a single market, RECLAIM set up two distinct zones, a western and eastern trading zone, within the RECLAIM region for trading.[172] This was done because the predominating winds blew the pollution from west to east.[173] Facilities in the western zone can only purchase credits in the western zone, whereas facilities in the eastern zone can purchase credits from either, or both, trading zones.[174]

Second, RECLAIM allows any person to generate trading credits by scrapping old, high-polluting vehicles.[175] Only passenger cars made in 1981 or earlier that are operable and registered in the Basin can qualify.[176] A limit of 30,000 vehicles can be scrapped each year to create trading credits.[177] The inclusion of mobile source credits in the stationary scheme of RECLAIM is quite innovative.[178]

Finally, on April 11, 1997, SCAQMD approved Rule 2506.[179] This rule allows equipment and products, known as area sources which include producers of NOx and SO2 but do not require a SCAQMD permit, to be eligible for RECLAIM credits as these sources are replaced by cleaner burning equipment.[180] Utilities participating in RECLAIM are excited about this addition to RECLAIM because of the increased economic benefits companies can enjoy when they convert equipment, such as boilers, internal combustion engines, and water heaters, to more energy-efficient models.[181]

Early studies indicate that the trading program is off to a good, but slow start. Market participation was only 50% in 1995.[182] This figure appears low considering that emissions credits cannot be banked.[183] However, the high annual baseline set early on in the program probably explains the market participation rate. Regulators wanted to make sure that the annual emissions limits reflected average production levels for each facility and were not being distorted by special conditions, such as a lower production level brought about by a recession.[184] In the end, SCAQMD allowed each firm to choose their baseline level based on actual emissions for one year between 1989-1992.[185] As a result, the total allocation for 1993 was higher than actual emissions.[186] There is evidence that the surplus allowances built into the annual targets during the early years are disappearing. In the first quarter of 1997, the dollar value of emissions trading exceeded the "annual amounts for the first three years of the RECLAIM program."[187]

The structure of RECLAIM's open market trading has created a buyer-beware market.[188] Unlike the SO2 program where facilities start with allowances that can be used as currency, any facility wanting to sell credits needs to assert to the EPA that it has already reduced its emissions and earned credits.[189] The EPA will then acknowledge the credits, but it will not verify them.[190] The buyer is responsible for verifying that the purchased credits are good.[191]

VI. GLOBAL CO2 EMISSIONS TRADING PROGRAM

Experience with the SO2 emissions program and the RECLAIM program can be useful in developing a global CO2 emissions trading program. Past results from both programs indicate that a CO2 trading program on a global scale is possible. However, it is important that the world community learn from the problems of the past programs.

A global CO2 emissions trading program would allocate allowable CO2 emissions level for each country. Countries that curb emissions below their allowance would be able to sell their credits. Countries that cannot or will not meet their allowance would have to buy credits. One major obstacle facing a global program is that sources of CO2 are more varied than the sources of SO2.[192] In RECLAIM, the restricted geographic size of the program kept the participants within a workable range.[193] In the SO2 program, the main culprits were the utility plants who attributed 70% of SO2 emissions.[194] In the United States alone, utilities account for only 36% of CO2 emissions.[195] Mobile sources, such as automobiles, trucks, and airplanes, account for approximately 32% of CO2 emissions in the United States.[196]

A suggestion for dealing with emissions from mobile sources would be to regulate the carbon content of fuels.[197] Refineries that produce fuel would be given allowances according to the desired reduction in CO2 levels.[198] The market would determine the price of these allowances; consumers (users of mobile sources) would then pay for the increase cost.[199] However, opponents of this plan fear that targeting only producers would create a market that is too small.[200] Also, they fear that distributing all the CO2 rights to this relatively small group would create a windfall for these firms as the value of these rights increase with time.[201] "An EPA consultant esti mated that the CFC permit allocation system would produce $1.8 to $7.2 billion in windfall profits for producers."[202] Though the profits would be spread over a much larger number of firms, a fossil fuel offset program would also result in windfall profits for the producers.[203]

An alternative suggestion for dealing with emissions from mobile sources would be to hold manufacturers of mobile sources (automobile, truck, and airplane manufacturers) responsible for the CO2 producing potential their products emit.[204] Because CO2 emissions can be calculated with relative ease from fossil fuel consumption and emission factors, it would be feasible to require manufacturers to calculate the CO2 producing potential of their products.[205] If a manufacturer's annual CO2 producing potential is higher than its allowance, the manufacturer would need to purchase additional emissions credits.[206]

In anticipation of a global program, Costa Rica is preparing to issue tradable credits to people who invest in a program that protects portions of Costa Rica's rain forest that would otherwise be logged.[207] However, extending the program to include such activities is probably reaching too far. Though biodiversity is important, too many kinds of land use, such as forest clearing for agriculture or urban and industrial projects, can lead to increased levels of CO2.[208] "Data on releases of CO2 by forest degradation through logging, shifting cultivation, erosion, lowering of groundwater tables, and desertification are of poor quality or unavail able."[209] Also, it would be nearly impossible to develop an accurate system to monitor, for example, whether a particular forest area is really being protected from logging.[210] For this reason, some have suggested the inclusion of these sources would be unworkable in a global program.[211]

Another area of concern with the Kyoto Protocol is the fact that, like the SO2 program, there will be at least two phases in the global program. Currently, the Kyoto Protocol requires compliance by the developed countries.[212] Developing countries like China and Mexico are against an emissions limit because they fear it would impede their economic growth.[213] Therefore, the plan proposes a program for developing countries to be drafted at a later time.[214] This two-phase program could lead to some of the same problems as the SO2 program. In the SO2 program, the two-phase approach led to the situation where many potential sellers of allowances had to achieve emissions reductions before potential buyers of any allowances needed them.[215] This has led to lower trading levels than expected. With the global program, it is uncertain what the results of excluding developing countries from the market will be. In order to stimulate an active market, the program must set the targeted reduction levels low enough so that the participating countries will be forced to consider trading as an option for controlling their emissions. A predetermined time schedule for all regulated sources is also likely to stimulate more trading than the SO2 program.[216]

Monitoring emissions by participants will be another challenge to the program. The United States is currently in a better position to deal with the task of monitoring CO2 emissions.[217] The CEM, already installed in most utility plants to monitor SO2 emissions, can be used to measure CO2 emissions as well.[218] In fact, the EPA has already been receiving information about CO2 emissions from most sources of emissions covered under Title IV.[219] The Director of EPA's Acid Rain Division also believes that "this technology can apply to other large combustion sources."[220]

For many countries, however, effective monitoring would be a major problem. Most countries do not have a system of CEM established.[221] The need for monitoring will require countries to spend money setting up a system to monitor emissions.[222] However, the problem with monitoring will exist whether the world adopts a command and control program or an emissions trading program to reduce CO2. Both programs will require the monitoring of emissions. Therefore, the argument against an emissions program based on monitoring costs is not very sound because monitoring costs cannot be avoided. In addition, an argument can be made that a CO2 emission trading program will encourage participants to monitor each other to ensure fairness.

As previously mentioned, it is fairly easy to calculate CO2 emissions based on fossil fuel consumption and emission factors.[223] Therefore, it would not be necessary to force all participating countries to install CEM. Instead, a self-reporting program could be set up based on experience from the lead-trading program.[224] In the lead-trading program, "the total amount of lead put in gasoline by a particular refiner could be easily determined by the amount of lead additives the refiner purchased."[225] Refiners were required to calculate the amount of lead they used and to keep track of all trades.[226] The EPA required refiners to submit quarterly reports detailing the amount of lead rights used or traded.[227] Verification of each refiner's reports is available by examining sales reports of lead manufac turers.[228] Therefore, utilities and other major sources of CO2 can be required to submit reports. These reports could be verified by the sales reports of producers of fossil fuels.[229]

World leaders also need to decide whether or not to allow the banking of credits. Allowing firms to receive credits for emission rights not used in a particular year would result in increased emission in future years. Also, the banking of credits could result in less trading in the market as firms hold on to their credits for future use. On the other hand, by not allowing the banking of credits, a firm that did not use all of its emissions allowance, whether by actual emissions or trading, would lose those particular excess allowances. The environment would benefit from these allowances never being emitted.

However, the advantages of allowing credits outweigh the disadvantages. First, even though future emissions will be higher if banking is allowed, total global emissions will still be reduced because the forgone emissions were included in the global quota in the first place. Second, allowing the banking of credits could help firms lower overall costs of reducing pollution. As the total emissions allowance gets more stringent with time, firms will benefit from the cost savings of having extra emissions credits to use in the future. Finally, there were higher than expected reductions in the SO2 emissions early in the program because firms were allowed to bank their credits.[230] If the same occurs in the CO2 program, the early reductions in CO2 emissions would also be a win-win situation for everyone.

In RECLAIM, two trading zones were set up because of the movement of the pollution by atmospheric winds.[231] In the SO2 program, states like New York are challenging the open trading policy because it continues to allow Midwestern states to pollute and cause the fall of acid rain on New York.[232] These localized problems will be less of an issue with the CO2 program. Unlike the other two pollutants which caused problems on regional basis, CO2 poses a global threat.[233] Carbon dioxide's climate-warming effects are independent of where it is emitted.[234] Allowing some countries to continue their rate of emissions by purchasing credits will not lead to problems for their neighboring countries. As long as global emissions are reduced, the effects of global warming will eventually be lessened. This fact should facilitate trading because it enhances the worth of emissions credits.[235]

The setting of the baseline and the emissions cap have always been highly debated issues in developing an emission trading program. In the SO2 program, utilities pushed hard for the earliest baselines they could while environmentalists fought hard for later baselines.[236] In the end, levels from the year of 1980 were chosen as the baseline.[237] In RECLAIM, a similar debate occurred in setting baselines. In the end, SCAQMD decided to allow each firm to choose their baseline level based on actual emissions for one year between 1989-1992.[238] Participants could choose from a range of 4 years because SCAQMD recognized that many industries were suffering from the effects of a recession and thus were producing at a lower level.[239] Unlike the SO2 program, where Congress chose to set the goal of reducing SO2 emissions by 10 million tons from 1980 levels without much debate,[240] RECLAIM's goal was based more on environmental concerns. What SCAQMD hopes is to have the air quality in its region meet the EPA's national ambient air quality standards.[241]

During the negotiations at the Kyoto Conference, the United States pushed for a reduction in global CO2 emissions to 1990 levels by the years 2008-2012.[242] The European Union, backed by many Third World countries, pushed for a 15% reduction from 1990 levels by the year 2010, while Japan had hoped for a 5% reduction from 1990 levels by the year 2012.[243] In the end, a compromise position was agreed upon by the world leaders.[244] Unfortunately, the emissions reduction targets set by the Kyoto Protocol appear to have followed the path of the SO2 Program—that is, they seem to have been decided based on compromises between nations rather than being environmentally based.

VII. CONCLUSION

The time has come for the world to address the possible global warming effects greenhouse gases are having on this planet. With experiences from the SO2 emissions trading program, RECLAIM, and four other trading programs, the United States should lead the world in developing a global CO2 emissions trading program. By utilizing the strengths and learning from the weaknesses of past emissions trading programs, a CO2 emissions trading program on a global scale is possible.

_______________________________

[*] J.D./MBA, Case Western Reserve University, School of Law and Weatherhead School of Management (1999). The author wishes to thank Professor Wendy Wagner for her guidance on this paper, Julia Kuo for her assistance in editing, and his family for all the support they have given. Return to text.

[1] Diplomats from 160 nations negotiated for 10 days in Kyoto, Japan. See A. Adam Glenn, A Deal Is Struck in Kyoto (Dec. 11, 1997) . Return to text.

[2] See id. Return to text.

[3] See id. Return to text.

[4] See Clinton Takes Middle Road on Global Warming, STAR TRIB. (Minneapolis), Oct. 23, 1997, at A1. Return to text.

[5] See Richard L. Lawson, Global Warming Treaty May Freeze U.S. Growth, COAL AGE, July 1997, available in LEXIS, Nexis Library, News Group File. Return to text.

[6] See Global Warming 'Real'; But Clinton Says New Taxes to Fight It Won't Pass Muster, THE CHATTANOOGA TIMES, Oct. 7, 1997, § National, at A8. Return to text.

[7] See id. Return to text.

[8] See id. Return to text.

[9] See id. The Kyoto Protocol does not affect developing countries, like China, so their emissions are not restricted. See Glenn, supra note 1. "All the initiatives are aimed only at developed countries even though greenhouse gas emissions are growing at much faster rates in many of the developing countries." See Lawson, supra note 5. Return to text.

[10] See Global Warming 'Real'; But Clinton Says New Taxes to Fight It Won't Pass Muster, supra note 6, at A8. Return to text.

[11] See Lawson, supra note 5. Return to text.

[12] See Global Warming 'Real'; But Clinton Says New Taxes to Fight It Won't Pass Muster, supra note 6, at A8. Return to text.

[13] See id. Return to text.

[14] Id. Return to text.

[15] See id. Return to text.

[16] See id. Return to text.

[17] Id. "1995 was the hottest year." NSW: WWF Report Reveals the Dangers of Global Warming, AAP NEWSFEED, Sept. 29, 1997, § Nationwide General News, at Australian General News. Return to text.

[18] See id. Return to text.

[19] See Clinton Takes Middle Road on Global Warming, supra note 4, at A1. Return to text.

[20] See Lawson, supra note 5. Return to text.

[21] The FCCC was signed by 166 countries and ratified by 93. U.S. Program Awards Grants to Developing Nations, Global Warming Network Online Today, Jan. 4, 1996, available in LEXIS, Newsletter Library. Return to text.

[22] See Lawson, supra note 5. Return to text.

[23] See id. Return to text.

[24] See id. Return to text.

[25] See id. Return to text.

[26] See id. Return to text.

[27] See id. Return to text.

[28] See Glenn, supra note 1. Return to text.

[29] See id. Return to text.

[30] See id. Return to text.

[31] See id. Return to text.

[32] See U.S. GAO, Air Pollution: Allowance Trading Offers an Opportunity to Reduce Emissions at Less Cost, GAO/RECD-95-30 (Dec. 1994) at 15 [hereinafter GAO Report]. Return to text.

[33] Air Pollution Control Act, ch. 159, 69 Stat. 322 (1955) (codified as amended at 42 U.S.C. §§ 7401-7671q (1997)). Return to text.

[34] See id. § 7409. Return to text.

[35] See id §§ 7411(a)(1), 7475(a)(4), 7502(c), 7503(a) (1997); Michael C. Naughton, Establishing Interstate Markets for Emissions Trading of Ozone Precursors: The Case of the Northeast Ozone Transport Commission and the Northeast States for Coordinating Air Use Management Emissions Trading Proposals, 3 N.Y.U. ENVTL. L.J. 195, 200 (1994). Return to text.

[36] See GAO Report, supra note 32, at 15. Return to text.

[37] Clean Air Act Amendments of 1977, Pub. L. 95-95, 91 Stat. 712 (codified at 42 U.S.C. §§ 7401-7671q (1997)). Return to text.

[38] Douglas R. Bohi & Dallas Burtraw, SO2 Allowance Trading: How Do Expectations and Experience Measure Up?, ELEC. J, Aug. 1997. Return to text.

[39] See GAO Report, supra note 32, at 15. Return to text.

[40] See Naughton, supra note 35, at 201. Return to text.

[41] See id. Return to text.

[42] See id. Return to text.

[43] See id. Return to text.

[44] See id. Return to text.

[45] See id. Return to text.

[46] See id. Return to text.

[47] See id. at 202. Return to text.

[48] See id. Return to text.

[49] See id. Return to text.

[50] See id. Return to text.

[51] Id. Return to text.

[52] See id. Return to text.

[53] See id. Return to text.

[54] See id. Return to text.

[55] See id. Return to text.

[56] See id. Return to text.

[57] See id. at 203. Return to text.

[58] See Gary E. Marchant, Freezing Carbon Dioxide Emissions: An Offset Policy for Slowing Global Warming, 22 ENVTL. L. J. 623, 632 (1992). Return to text.

[59] See Naughton, supra note 35, at 203. Return to text.

[60] See Marchant, supra note 58, at 633. Return to text.

[61] See id. Return to text.

[62] See Matthew Polesetsky, Will a Market in Air Pollution Clean the Nations Dirtiest Air? A Study of the South Coast Air Quality Management District's Regional Clean Air Incentives Market, 22 ECOLOGY L. Q. 359, 372 (1995). Return to text.

[63] See id. Return to text.

[64] See id. Return to text.

[65] See id. Return to text.

[66] See id. at 372-73. Return to text.

[67] See id. at 372. Return to text.

[68] See id. at 373. Return to text.

[69] See id. at 372. Return to text.

[70] See id. at 374. Return to text.

[71] See id. at 373-74. Return to text.

[72] Clean Air Act Amendments of 1990, Pub. L. No. 101-549, 104 Stat. 2399 (codified at 42 U.S.C. §§ 7401 - 7671q (1997)). Return to text.

[73] See Brian Doherty, Selling Air Pollution, REASON, vol. 28, no.1, at 32 (1996). Return to text.

[74] See GAO Report, supra note 32, at 2. Return to text.

[75] Id. Return to text.

[76] See id. Return to text.

[77] See id. Return to text.

[78] See id. Return to text.

[79] See Doherty, supra note 73, at 34. Return to text.

[80] See id. Return to text.

[81] See id. Return to text.

[82] See id. Return to text.

[83] See id. Return to text.

[84] See GAO Report, supra note 32, at 2. Return to text.

[85] See id. Return to text.

[86] See id. Return to text.

[87] See Doherty, supra note 73, at 35. Return to text.

[88] See id. Return to text.

[89] See id. Return to text.

[90] See GAO Report, supra note 32, at 2. Return to text.

[91] See id. Return to text.

[92] See id. Return to text.

[93] See Scott Lee Johnson, Economic Assessment of the Regional Clean Air Incentives Market: A New Emissions Trading Program for Los Angeles, 72 LAND ECON. 277, 278-79 (1996). Return to text.

[94] See Thomas H. Klier et al., What can the Midwest Learn from California About Emissions Trading?, CHI. FED. LETTER (Fed. Reserve Bank of Chi., Chicago, Ill.), Aug. 1997, at 1. The program seeks to reduce the emissions of sulfur oxides (SOx); however, under the RECLAIM Program rules, the term SOx refers to sulfur dioxide. See Johnson, supra note 93, at 277 n.1. Return to text.

[95] See Klier et al., supra note 94, at 1. Return to text.

[96] See id. Return to text.

[97] See id. Return to text.

[98] See id. Return to text.

[99] See Polesetsky, supra note 62, at 372. Return to text.

[100] See Klier et al., supra note 94, at 1. Return to text.

[101] See id. Return to text.

[102] See id. Return to text.

[103] See id. Return to text.

[104] See id. Return to text.

[105] See id. Return to text.

[106] See Phyllis Orrick, The Sky's the Limit: How Buying and Selling Pollutants Could Help Clean Up the Bay Area's Air, S.F. WKLY, Sept. 3, 1997, § News. Return to text.

[107] See id. Return to text.

[108] See id. Return to text.

[109] See Polesetsky, supra note 62, at 402. Return to text.

[110] See id. Return to text.

[111] See id. at 403. Return to text.

[112] See id. Return to text.

[113] See id. Return to text.

[114] See id. Return to text.

[115] Id. at 403-04. Return to text.

[116] See id. at 404. Return to text.

[117] See id. Return to text.

[118] Id. Return to text.

[119] See id. Return to text.

[120] See id. Return to text.

[121] See id. Return to text.

[122] See id. at 404-05. Return to text.

[123] See id. at 403-05. Return to text.

[124] See Bohi & Burtraw, supra note 38. Return to text.

[125] See id. Return to text.

[126] See id. Return to text.

[127] See id. Return to text.

[128] See id. Return to text.

[129] See id. Return to text.

[130] See id. Return to text.

[131] See id. Return to text.

[132] See id. Return to text.

[133] See id. Return to text.

[134] See id. Return to text.

[135] See Doherty, supra note 73, at 35-36. Return to text.

[136] See id. at 36. Return to text.

[137] Id. (internal quotes omitted). Return to text.

[138] "This curious system was written into the act by Congress, emulating the structure of Treasury auctions. But unlike the Treasury bills market, the emissions market has more than one seller, which leaves room for unnaturally low sale prices." Id., at 36-37. Return to text.

[139] See Bohi & Burtraw, supra note 38. Return to text.

[140] See id. Return to text.

[141] See id. Return to text.

[142] See id. Return to text.

[143] See id. Return to text.

[144] See id. Return to text.

[145] See id. Return to text.

[146] Id. White suggests using an 8% discount rate. See id. at n.10 (citing KEITH D. WHITE, ET AL., The Emission Allowance Market and Electric Utility SO2 Compliance in a Competitive and Uncertain Future, EPRI TR-105490s (Sept. 1995) (prepared for the Electric Power Research Institute); RESEARCH DATA INTERNATIONAL, INC., PHASE I 1995 DATABOOK, (1995)). Return to text.

[147] See id. Return to text.

[148] See Joseph Kruger & Melanie Dean, Looking Back on SO2 Trading: What's Good for the Environment Is Good for the Market, FORTNIGHTLY, Aug. 1997, § Features, at 30. Return to text.

[149] See id. Return to text.

[150] See id. Return to text.

[151] See id. Return to text.

[152] See id. Return to text.

[153] See id. Return to text.

[154] See id. Return to text.

[155] See id. Return to text.

[156] See GAO Report, supra note 32, at 45. Return to text.

[157] Id. Return to text.

[158] See id. at 46. Return to text.

[159] See id. at 45. Return to text.

[160] See id. at 45-46. Return to text.

[161] See id. at 57. Return to text.

[162] "The Adirondack Council, an Albany-based environmental group, and the Natural Resources Defense Council are suing the EPA to set standards dictating how much SO2 can fall on specific regions, not just a cap for the whole nation." Doherty, supra note 73, at 35. Return to text.

[163] See id. Return to text.

[164] See id. Return to text.

[165] Kruger & Dean, supra note 148. Return to text.

[166] See John J. Fialka, Selling Pollution as a Commodity, SACRAMENTO BEE, Oct. 12, 1997, § Forum, at F01. Return to text.

[167] See id. Return to text.

[168] Prices for emissions credits will increase with time as the cap on SO2 emissions decreases. Eventually, utilities will find it cheaper to install new technology, such as Scrubbers, to meet their emissions limits than for them to purchase emissions credits. See id. Return to text.

[169] Doherty, supra note 73, at 36. Return to text.

[170] See id. Return to text.

[171] Initially, RECLAIM forced all participants to sell their emissions credits. However, a SCAQMD rule change now allows companies to hang "on to these credits as insurance to protect against being short when SCAQMD 'trues up' emission levels at the end of the cycle." Ace 'Reclaim' Auction Indicates Rising Prices, More Interest in SO2 Credits, UTIL. ENV'T REP., Mar. 1, 1996, § Emissions Trading, at 8. Return to text.

[172] See Polesetsky, supra note 62, at 392. Return to text.

[173] See id. Return to text.

[174] See id. Return to text.

[175] See id. at 397. Return to text.

[176] See id. Return to text.

[177] See id. Return to text.

[178] See id. Return to text.

[179] See SCAQMD Expands 'RECLAIM' to Include Emission Credits for Small Equipment, UTIL. ENV'T REP., Apr. 25, 1997, § Emissions Trading, at 9. Return to text.

[180] See id. Return to text.

[181] See id. Return to text.

[182] See Klier et al., supra note 94, at 2. Return to text.

[183] See id. Return to text.

[184] See id. at 1. Return to text.

[185] See id. Return to text.

[186] See id. Return to text.

[187] Prepared Testimony of Peter F. Guerrero, FED. NEWS SERVICE, July 9, 1997, available in LEXIS, News Library, Fednew File. Return to text.

[188] See Doherty, supra note 73, at 37. Return to text.

[189] See id. Return to text.

[190] See id. Return to text.

[191] See id. Return to text.

[192] See GAO Report, supra note 32, at 65. Return to text.

[193] See Doherty, supra note 73, at 33. The RECLAIM program covers emissions in Los Angeles, Orange, and San Bernardino counties in Southern California. Id. Return to text.

[194] See GAO Report, supra note 32, at 66. Return to text.

[195] See id. Return to text.

[196] See id. Return to text.

[197] See id. Return to text.

[198] See id. Return to text.

[199] See id. Return to text.

[200] See Marchant, supra note 58, at 653. Return to text.

[201] See id. Return to text.

[202] See id. at 653 n.103. Return to text.

[203] See id. Return to text.

[204] See id. at 655. Return to text.

[205] See id. Return to text.

[206] See id. Return to text.

[207] See Fialka, supra note 166. Return to text.

[208] See GAO Report, supra note 32, at 66. Return to text.

[209] Id. Return to text.

[210] See Fialka, supra note 166. Return to text.

[211] See GAO Report, supra note 32, at 66. Return to text.

[212] See Glenn, supra note 1. Return to text.

[213] See William Drozdiak, U.S. Allies Criticize Anti-Warming Plan; Clinton Proposals Decried as 'Insufficient', WASH. POST, Oct. 24, 1997, § A, at A29. Return to text.

[214] See Glenn, supra note 1. Return to text.

[215] Phase I only covered the most polluting plants—which should have the lowest pollution reduction costs and are the most likely sellers. See Doherty, supra note 73, at 37. Higher-cost reducers do not have to concern themselves with the program until Phase II which begins in the year 2000. See id. This has lead to a separation of likely sellers and buyers. See id. Return to text.

[216] See GAO Report, supra note 32, at 64. Return to text.

[217] See id. at 66. Return to text.

[218] See id. at 62. Return to text.

[219] See id. Return to text.

[220] Id. Return to text.

[221] See id. at 67. Return to text.

[222] See id. Return to text.

[223] See supra note 205 and accompanying text. Return to text.

[224] See Marchant, supra note 58, at 647-48. Return to text.

[225] Id. at 648. Return to text.

[226] See id. Return to text.

[227] See id. Return to text.

[228] See id. Return to text.

[229] See id. at 648-49. Return to text.

[230] See Bohi & Burtraw, supra note 38. Return to text.

[231] See Polesetsky, supra note 62, at 392. Return to text.

[232] See Doherty, supra note 73, at 35. Return to text.

[233] See GAO Report, supra note 32, at 66. Return to text.

[234] See id. at 67. Return to text.

[235] See id. Return to text.

[236] See Doherty, supra note 73, at 34. Return to text.

[237] See id. Return to text.

[238] See Klier et al., supra note 94, at 1. Return to text.

[239] See id. Return to text.

[240] See Lisa Heinzerling, Selling Pollution, Forcing Democracy, 14 STAN. ENVTL. L. J. 300, 324 (1995). Return to text.

[241] Telephone Interview with Brian L. Yeh, Air Quality Analysis & Compliance Supervisor, South Coast Air Quality Management District Stationary Source Compliance (Jan. 12, 1998). Return to text.

[242] See Drozdiak, supra note 213 at A29. Return to text.

[243] See Glenn, supra note 1. Return to text.

[244] See id. Return to text.