Wisconsin Electric1 strongly supports market-based emissions reduction strategies. Market-based systems which include the opportunity to trade emissions provide the flexibility for affected parties to utilize technology and innovation to manage the costs of reducing emissions -- benefiting consumers, shareholders and the environment. Only by incorporating good business practice and sound scientific analysis into environmental control can we continue to improve the environment while maintaining a sound, healthy economy.
Title IV of the Clean Air Act Amendments of 1990 (CAAA) calls for a 10-million-ton reduction in utility sulfur dioxide (SO2) emissions when fully implemented. Under old regulatory schemes, this reduction would have been achieved through command-and-control regulation. In other words, regulators would have determined a specific, inflexible emission limit for a plant or unit, or specified what technology to install to reduce emissions. Then, regardless of cost, the emission limit would have to be met or the technology installed.
The trading provisions of Title IV of the CAAA introduced the concept and use of a market-based system. Utilities are allocated SO2 emissions "allowances." One emission allowance is equal to one ton of SO2. For each ton of SO2 emitted by a utility, the utility must surrender one allowance. Under the market-based approach, utilities with allocations above its projected emissions could trade, sell or bank the excess allowances. A utility with emissions above its annual allocation of allowances has several choices available. It can install emission reduction technologies, switch to a lower sulfur fuel to meet the allocation target, improve efficiency, employ conservation or purchase allowances in the market to cover its needs.
If a utility chooses to buy allowances for compliance, two factors ensure that the environmental goals are being achieved. First, excess allowances available on the market means that another party has already made the needed emissions reduction, otherwise the allowances would not be available. Therefore, the benefit to the environment has already been achieved. Secondly, all other local, state and federal regulations, such as the National Ambient Air Quality Standards (NAAQS), still apply. No utility or plant can buy so many SO2 allowances as to endanger the local air quality by violating any other applicable standard.
The success of the Acid Rain Program is easy to quantify. SO2 emissions in 1995 were 39 percent below allowable emission levels; this was a total of 3.4 million tons of additional reduction.2 In 1996, SO2 emissions were 35 percent, or 2.89 million tons, below 1996 allocation levels.3 Utilities achieved excellent results in complying with the continuous emission monitoring requirements, with both exceptional accuracy results and high monitor availability.4
Trading activity continued to grow in 1996. A total of 4.4. million allowances changed hands in 1996 in what the EPA defines as economically significant transfers (transfers between economically distinct utility, broker or fuel company.)5
Many more trades occurred intra-utility as allowances were traded between unit accounts for compliance. It should be noted that allowances are allocated by EPA to a specific unit. For many owners of multiple units, the most common type of trade is the simple transfer (trade) of allowances between commonly owned units for compliance. Many statistics overlook the quantity of these intra-company trades. Intra-company trading may be the highest volume compliance activity undertaken by a company, and its significance cannot be ignored.
Wisconsin Electric's own experience with the trading provisions of the Acid Rain Program has been very positive. Compliance planning done immediately following passage of the CAAA showed that Wisconsin Electric expected to have a Phase I allocation that exceeded expected emissions by 200,000 to 250,000 allowances over the five years of Phase I (from 1995 through 1999). During Phase II (year 2000 and beyond), the company expects a shortage of approximately 30,000 allowances per year if no action is taken to reduce emissions.
After careful study of emission reduction strategies it was determined that the least-cost compliance methodology for Phase II would be to switch to lower sulfur fuels at several facilities, achieving 10,000- 20,000 tons of total reductions. The balance of the required reduction would be purchased from the market
In order to achieve the total 30,000 ton SO2 reduction on the Wisconsin Electric system alone, absent the market, would have meant the installation of scrubbers on at least two units. Comparing the capital and O&M cost to scrub the two units, to the cost of purchasing the same emissions reduction on the market, there was over a $100 million (in 1995 $'s) savings by pursuing the purchase allowances option.
With such dramatic cost savings available through the market, Wisconsin Electric gradually entered the market as early as 1992 to begin contracting for the sale of the excess Phase I allowances and the purchase of the needed Phase II allowances. Analysis of the market based on projected future allowance costs and internal economic factors (such as the cost of capital and inflation factors), showed that the simultaneous sale and purchase of allowances was the most beneficial to Wisconsin Electric. Other companies with excess Phase I allowances have concluded, using different economic data, that simply banking Phase I allowances for use in later years was the most economically advantageous route to follow. If Wisconsin Electric had chosen to only bank allowances, and not make any other changes, scrubbers would have been required within 5-7 years of the start of Phase I. This made fuel switching and allowance purchase the most viable option when compared to simply banking allowances.
In summary, by choosing the compliance path of fuel switching and allowance purchases for Phase II, Wisconsin Electric has saved its customers over $100 million and deferred the installation of scrubbers for the foreseeable future.
For traders in the emissions market to be able to transact business, they need to know that the commodity that they are trading will be here not only today, but tomorrow as well. For example, one concern that has risen is that the highly controversial proposed standard for PM 2.5 could effectively kill the SO2 trading program. The stringency of the proposed PM 2.5 standard could require that all fossil fuel fired utility boilers would need to be scrubbed. If this were to happen, nearly every utility in the US would have an extensive oversupply of SO2 emission allowances. This huge over supply would drive prices to zero, making the SO2 market and the Title IV trading program meaningless. Care must be taken as programs are added to the regulatory scheme to be certain that negative impacts are minimized, especially on programs as successful as Title IV's trading provisions.
The idea of emissions trading as a means of achieving environmental goals at the lowest possible cost is taking hold in markets other than SO2. Title I of the CAAA encourages trading of nitrogen oxides (NOx) and volatile organic compounds (VOCs) as a means of achieving compliance with ambient air quality standards, while Title III opens the door to trading to meet pending requirements for toxic substances.
The Ozone Transport Assessment Group (OTAG) included the use of market-based systems as a means of compliance in the final recommendations from this group to EPA. World leaders are evaluating and negotiating a world-wide market for CO2 emission stabilization/reduction under the Framework Convention for Climate Change. Other smaller regional and state level markets are being developed for other pollutants.
Simplicity. The Title IV SO2 market is an example in market simplicity. EPA regulations are clear and simple when it comes to recording and processing trades. EPA does not interfere with the market by "approving" trades, they simply record the trade. As long as the party has the allowances on account that they desire to trade, the EPA processes the transaction. This simplicity has kept transaction costs low and helped to create efficiencies that might otherwise not exist. The simplicity of the market has also attracted third parties, such as brokers and independent trading firms. These parties have helped to increase market liquidity. Burdensome regulation that would discourage their participation in new markets and drive costs higher have not been a barrier to entry.
Flexibility. The Acid Rain program allows sources the needed flexibility to choose the desired compliance methodology. Sources can install equipment, reduce usage, or buy allowances, for example, in any combination. The same flexibility should be built into any trading programs for NOx or greenhouse gas emissions. For greenhouse gas emissions this would include the recognition of Joint Implementation projects entered into with non-Annex I nations. Developing nations are the source of some of the most cost-effective greenhouse gas reduction and sequestration projects worldwide. To leave these potential projects out of the picture would be detrimental to the process of achieving greenhouse gas emission reductions at the lowest cost.
For NOx, this may mean allowing inter-sector trading. One example of this would be the ability to scrap older, less-efficient automobiles to achieve the same NOx reduction as otherwise would have had to have been achieved by a utility or industrial boiler on its own.
Certifiable Reductions. The SO2 reductions under the Acid Rain Program are being accomplished with no dispute. Utility emissions are being accurately monitored under the Acid Rain Program through the use of certified continuous emission monitors.
As the debate on greenhouse gas reductions continues at the global level, care must be exercised to ensure that all parties play by a common set of rules. Emission reductions claimed by a party must be real, measurable and certifiable. It would be extremely unfair to the U.S. if we were to closely control and monitor, at great expense, our greenhouse gas reductions under any potential treaty, only to have another country apply a less stringent standard of measurement or conduct. In a global economy, the playing field must be level to minimize any impacts to the U.S.
Recognition of Early Reductions. Parties that commit to making early, voluntary reductions should not be penalized and should be given full recognition for their efforts. What often occurs is that companies that are ahead of the curve and employ environmental foresight by making voluntary reductions prior to the enactment of regulations, are often penalized by having their early reductions ignored or discounted.
The rationale expressed by some to justify this discounting is that the reductions, should have or would have occurred even without the regulation. Admittedly, some parties only make reductions when faced with pending regulations. However, this ignores that many companies do, in fact, make voluntary reductions to better the environment, and further ignores the issue of capital stock turnover. For example, a company may choose to install a technology at a site early if it thought that pending regulations were likely to require a reduction at a later date. Such a choice would be driven by the fact that most pollution control equipment has a 20-30 year life expectancy. No company wants to install equipment one day, just to replace it a few years later with a new piece of equipment. With rules seemingly always in a state of flux, and new proposals surfacing weekly, this is a real concern to utilities.
Regulation should encourage and recognize emission reductions that are voluntary. After all, the sooner a reduction is made, the sooner we will see the benefit to the environment.
Education and Outreach. Public understanding of emissions trading is increasing, but it is still widely misunderstood. Emissions trading is easily sensationalized by the press through the use of provocative headlines over "trading the right to pollute," or claiming that sources that buy emissions have found a "loophole" in the regulations. While these claims help to sell news papers, they do little to build the trust that is needed to expand emissions trading into other sectors. Popular media nearly always overlook the simple fact that SO2 emissions are down dramatically in the first two years of the Acid Rain Program, and costs are far lower through the use of trading than anyone ever predicted they would be. More public outreach is needed as new emission reduction programs, such as the NOx reductions under OTAG, move forward if these programs are to include trading provisions that the public will accept.
To help in this effort, a new industry group, the Emissions Marketing Association (EMA), was formed to promote market-based trading solutions to environmental problems. This group, started by Wisconsin Electric and other key market players, is chartered as an independent, non-profit trade association. EMA currently represents over 60 companies, including several international firms. EMA's mission is to promote the advancement and application of policy and regulation relevant to market-based emissions trading systems; encourage and facilitate information exchange; and provide programs in education and training. Information on the EMA is attached to this testimony.
Trust the Science. The science behind the need for emissions reduction is complex and is evolving as tools are perfected and applied. The OTAG process is a stellar example of this. Never before have the states come together, as they did in the OTAG process, to study the ozone transport phenomenon in such depth. The body of knowledge on ozone transport has been greatly increased, and through rigorous review, there is relative agreement on the inputs and outputs of the process. This sound science provides for the next phase of work in which EPA now must recommend the reductions needed to solve the problem. Subregional efforts are now under way to further refine the science and identify the emission reduction strategies that will result in an improved environment.
Market-based emissions reduction systems that include emissions trading are an effective tool in our national environmental strategy. While environmental protection is, and should continue to be, a top priority on our national agenda, care must be exercised to ensure that required emission reductions are allowed to take place in the most efficient and economical manner possible.
Emissions trading has already proven its success as a tool for reducing the cost of meeting the strict SO2 emission reduction targets of the CAAA, proving that economic and environmental goals can be achieved efficiently and successfully. Market-based approaches to emission reductions will ensure that, as we proceed into the future, Americans will enjoy both the benefits of lower cost power and a cleaner, healthier environment.
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