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CEIC-03-13

"Temporal Hotspots in Emission Trading Programs: Evidence From The Ozone Transport Commission’s NOX Budge"

Alexander E. Farrell

Abstract:
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 (NO_X) in nine Northeastern States, the Ozone Transport Commission’s (OTC) NO_X Budget. Several earlier papers have examined the political economy of the OTC NO_X Budget (Farrell 2001; Farrell and Morgan 2003). Electricity generating plants, including co-generators, dominate regulated facilities in the OTC NO_X Budget (representing more than 90% of seasonal NO_X emissions) and will have a key role in the upcoming NO_X SIP Call, so this paper focuses on the electric power sector (U.S. Environmental Protection Agency 1998).

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