Hotspots in Emission Trading Programs: Evidence From The Ozone Transport
Commission’s NOX Budge"
The use of Market Mechanisms and Incentives (MM&I) for
environmental protection has increased over the last several years, and
proposals for new MM&I policies are increasing. Notable (perhaps even
principal) among these proposals are cap-and-trade (C/T) systems, which as the
name implies, create a permanent limit on total emissions yet provide firms
with flexibility in compliance. Several concerns have been raised about the
environmental and economic outcomes of C/T systems, in particular about the
potential for “hot spots” and about the viability of markets in emission
allowances. Environmentalists are concerned that C/T systems may allow for
localized pollution problems while industry is concerned that there be a
large, stable enough market in allowances so that they can count on being able
to buy or sell allowances at reasonable and predictable prices (Dudek and
Goffman 1992; Solomon and Rose 1992; Campbell and Holmes 1993; Chinn 1999).
The results so far have been mixed on both counts, some emission trading
programs have had problems with hot spots and environmental justice issues and
others have not (Drury 1999; Swift 2001). Similarly, some emission allowance
markets have been successful and others have not (Foster and Hahn 1995;
Carlson et al. 2000; Israels et al. 2002).
This paper examines several key aspects of an early multi-state
C/T system designed to control oxides of nitrogen (NOX) in nine
Northeastern States, the Ozone Transport Commission’s (OTC) NOX
Budget. Several earlier papers have examined the political economy of the OTC
NOX Budget (Farrell 2001; Farrell and Morgan 2003). Electricity
generating plants, including co-generators, dominate regulated facilities in
the OTC NOX Budget (representing more than 90% of seasonal NOX
emissions) and will have a key role in the upcoming NOX SIP Call,
so this paper focuses on the electric power sector (U.S. Environmental
Protection Agency 1998).
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