Good morning. My name is Mary Gade. I am the director of the Illinois Environmental Protection Agency. Thank you for inviting me to testify before the Joint Economic Committee today on the issue of emissions trading, a keystone in Illinois' efforts to use market forces to achieve enhanced environmental benefits by the most cost-effective methods.
While some of my colleagues on the panel will discuss the advantages of trading systems, I will focus today on a unique program we expect to launch in 1999 in Illinois. Now in the final stage of rulemaking, the Illinois volatile organic compounds (VOC) trading system for the Chicago metropolitan area will be the first of its kind in the nation. We were pleased when President Clinton chose to honor our efforts in designing this program as an outstanding example of government re-invention in March 1995.
We believe this program will give Illinois businesses the tool they need to meet targeted reductions required by the Clean Air Act. Make no mistake, this is no small obligation. Chicago was classified in 1990 as one of the nine worst ozone non-attainment areas in the country under the 120 parts per billion standard. Ground-level ozone or smog significantly impacts the health and well-being of 7 million Illinoisans each year. Despite increasingly stringent and costly controls on most of our industries, the Chicago metro area continues to have ozone exceedences. In fact, just last week we had our first exceedence of the year, at 128 parts per billion. Confronted with this difficult environmental challenge and concerned about negative impacts on Illinois' economy, Illinois EPA weighed our options.
We recognized that relying solely on the traditional "command and control" regulatory approach would impose tremendous costs on our industry and could be a deterrent to innovation. Consequently we turned to market-based approaches.
The Emissions Reduction Market System (ERMS) in Illinois is the result of four years of review and study that has drawn in top experts from the public and private sectors. The Illinois EPA held workshops, hearings and assembled a multi-faceted design team that did thorough research and investigation of market-based approaches before proceeding with our program.
The system that resulted from this collaboration is built upon three fundamental policy considerations. The first, and most critical, is to assure that air quality goals are met. We did this by establishing an explicit cap on total VOC emissions implemented through a fixed number of VOC emission allotments -- that is authorizations to emit 200 pounds of VOCs -- which are tradeable, and to a limited extent, bankable. This approach is modeled in part after the Title IV Acid Rain Program. The cap on mass emissions distinguishes this program from traditional command and control requirements as well as some other emissions trading frameworks. Second, Illinois EPA recognized a minimum amount of governmental interference was desirable in a free market system, so we worked hard to limit the regulatory involvement that would be necessary once the program was up and running. As a result, transaction costs will be reduced, creating an incentive for increased participation by sources and maximizing the cost savings that are realized. Finally, to safeguard environmental progress, we incorporated sound performance accountability standards.
We believe Illinois' market-based strategy will result in significant reductions in one of the two major pollutants contributing to unhealthy levels of ozone while providing increased flexibility and significant cost-savings for business and industry.
Illinois' program has several novel features but is not a pioneer. Without the foresight of the Congress in laying the foundation for market mechanisms to reduce pollution as part of the 1990 amendments to the Clean Air Act, Illinois' program might still be in the starting blocks. The success of sulfur dioxide trading under the Acid Rain program is an important forerunner of our efforts. We carefully reviewed the structure and the data generated by the Acid Rain program in crafting Illinois' system.
Illinois EPA did not set out to create the country's first VOC trading program. In fact, after the Clean Air Act Amendments of 1990, the Agency initially targeted NOx emissions for reduction. We were convinced they were the key to reducing unhealthy ozone levels. We turned to the approach we knew best and started to develop Reasonably Available Control Technology (RACT) regulations for NOx . Because of the legitimate fears over cost by the business community, we simultaneously began working on something new -- a NOx trading system.
In June 1993, I was joined by Sam Skinner, president of Commonwealth Edison, our state's largest electric utility, in jointly announcing the development of a NOx trading program. A design team was formed with staff from Illinois EPA, Commonwealth Edison, and the Environmental Defense Fund, and developed a draft proposal distributed in September 1993.
However, the plot took a major twist in December 1993. Results from the Lake Michigan Air Directors' Consortium regional air quality modeling project showed for the first time that NOx reductions in the Chicago nonattainment area would not improve and might even exacerbate ozone conditions in the Lake Michigan airshed. In reaction to these findings, and without much humor, we joked about graduating from the School of Hard NOx . This unexpected finding shifted the onus for controls in the Chicago metropolitan area on VOC emission reductions.
The findings were subsequently reaffirmed by the extensive modeling and research done by the Ozone Transport Assessment Group, which I was privileged to chair. OTAG was a unique two-year collaboration between the states, U.S. EPA and hundreds of private stakeholders. OTAG confirmed the importance of localized VOC reductions in addressing urban ozone attainment and the existence of substantial NOx reduction disbenefits on high ozone days in Chicago and New York City and to a lesser extent in other major northern cities.
Unfortunately, when Illinois EPA began to review options for obtaining increased VOC reductions, we were stymied.
A thorough review of the potential for using additonal RACT for reducing VOC emissions could identify only one, cold cleaning degreasing, that was a viable option. That left only the option of ratcheting down further and requiring even more dramatic VOC emissions cuts from industries that were already heavily regulated.
The inevitable conclusion was that VOC trading should be pursued. Our work with the NOx proposal had strengthened our conviction that real benefits would result from an emissions trading program. We asked four of the largest VOC emitters in the Chicago area -- Caterpillar, Abbott Labs, Corn Products and Amoco -- to join our design team. The team also met with other interested parties and encouraged submission of written comments. Finally, the new proposal was submitted to the scrutiny of a formal peer review process by three experts before the final report was issued in March 1995. Incidentally, one of the team members is my fellow panelist today, Dan Dudek of the Environmental Defense Fund. We are grateful for EDF's significant contribution to this project.
Our design was formally endorsed by Governor Jim Edgar and the Illinois General Assembly in legislation approved in the summer of 1995. Senate Bill 460 expressed support for using market-based approaches and authorized Illinois EPA to propose rules for an emissions reduction market system. Illinois EPA submitted proposed regulations to the Illinois Pollution Control Board in hearings that were recently concluded. The Board heard enthusiastic testimony in support of the program from the Chemical Industry Council of Illinois, on behalf of about 80 manufacturers statewide.
The plan was also endorsed by the Illinois Environmental Regulatory Group, which represents 45 firms in the Chicago area that are major sources of VOCs. We anticipate final rulemaking by early fall.
The Illinois EPA design team concluded our program must have six key elements to be successful and incorporated them in our proposal. They are a cap on emissions, including all significant sources, providing flexibility, confidence in the market mechanism, enforcement for meeting reduction targets, and the potential for cost savings.
First and foremost is establishing a cap on emissions. A carefully-crafted cap ensures both the environmental performance of the system and drives the cost-savings. The team also determined it was environmentally appropriate and would provide additional flexibility to the trading participants if the cap was based on reductions in VOCs during the five-month "ozone season" from May through September. A review of the monitoring data indicated that no hourly concentrations of ozone have been measured above 100 parts per billion outside of those months.
The Illinois program sets a cap requiring a 12 percent reduction of VOCs from a baseline level of VOC emissions for each source. The baseline is determined by using an average of the seasonal emissions from prior representative years.
The allotments will be written into the Title V permits of each source and will be valid for the season in which it has been issued and the next season. The total number of allotments for the entire metro area will be limited to achieve the overall 12 percent reduction in VOC emissions -- about 1500 tons per season. In addition, it is important to emphasize that the reductions go beyond those already achieved under RACT requirements. To further ensure the market will not create any toxic "hot spots," sources will also still be subject to federal Maximum Available Control Technology (MACT) standards that apply to toxic VOC emissions. This will prevent increases in toxic VOCs being offset by decreases in non-toxic VOC emissions in the Chicago metro area under the trading system.
The second key element of the program is including all sources whose emissions significantly impact the target reductions. The system will capture about 90 percent of the total point source emissions of VOCs in the Chicago metro area by requiring any business with a Title V permit to participate if their emissions exceed 10 tons per season. An estimated 244 individual sources emitting 12,500 tons of VOC emissions per season and representing 28 different industrial categories, including printers, food processors, can coaters, oil refineries and chemical companies will be required to participate.
Third, the system must have as much flexibility as possible.
Stakeholders told us repeatedly that governmental review and/or approval of specific trading transactions would severely hamper performance of the system.
Consequently, this "cap and trade" program does not require regulatory review or approval of specific transactions because of the nature of the trading units in the market. All have been created upfront and do not require validation during the transaction process.
The system also includes a secondary source of allotments called the Alternative Compliance Market Account in response to industry concerns that adequate allotments would be available for purchase. This account in effect provides a "safety net." One percent of each source's baseline will go into this account and would come out of the 12 percent reduction. In addition, 20 percent of allotments held by sources that have shut down will go into the account, as well as any voluntary contributions. Anyone may purchase the allotments from this account at a price of $10,000 per ton or a level tied to a multiple of the average market price.
We also allow for banking of unused emission trading units as an incentive for sources to make early reductions. This approach also enables sources to plan ahead and cope with year to year fluctuations in operations. However, unlike in the Acid Rain program where allowances have an unlimited lifetime, in the Illinois VOC program, the lifetime of the trading units is limited to two years. We have done this to reduce the potential for "emission spikes" or exceedences of the total budget.
We have also built in exemptions for sources who wish to make deeper reductions without participating in the trading program or for sources who have already installed the maximum level of feasible controls.
In another unique measure of flexibility, the Emissions Reduction Market System also includes the potential for inter-sector trading. Companies could reduce their costs of meeting VOC reduction targets by purchasing and scrapping vehicles resulting in an equivalent tonnage reduction. Based on Illinois EPA's experience from a prototype "Cash for Clunkers" program in partnership with General Motors and the Environmental Defense Fund, a full-scale program that scraps approximately 5,000 vehicles would cost less than $2,500 per ton for VOC reductions.
Fourth, the Illinois EPA design team wanted to make sure our VOC trading system had the confidence of investors and participants. Many sources subject to the VOC Emission Reduction Market System were concerned about the availability of trading units and relevant price information. The Acid Rain program uses an annual auction as one mechanism to ensure a supply of allowances on the market and as an indicator of the market price for allowances. The VOC sources in the Chicago area felt that our Alternative Market Compliance Account could serve as sufficient insurance that there will be trading units available for purchase. Therefore, an official auction was unnecessary. To provide additional information on the price of trading units, the Illinois EPA agreed to post and update average price information on our trading system electronic bulletin board.
Fifth, in order for the system to ensure the underlying goal of reducing pollutants, there must be consequences for not complying or delaying implementation of the VOC reduction targets. Therefore, we have included a series of checks and balances to make sure the fundamental interests of all stakeholders, including the public welfare, are protected.
Participating sources will be required to provide actual VOC emissions data for the allotment period as well as data on its emissions transactions. If it is determined a source does not have sufficient allotments to cover its emissions, they must be made up from the set-aside account or from the following year's allotment. Sources that exceed their allotments will have to pay a penalty through purchasing an additional 20 to 50 percent more trading units or making the equivalent emission reductions.. This feature provides both an economic disincentive for noncompliance and maintains the integrity of the environmental goal. Finally, the Agency will conduct an Annual Performance Review of all aspects of the market system to evaluate its impact in producing emission reduction benefits.
Last, but certainly not least, the program must have the potential for significant savings. Using accepted U.S. EPA methodology for estimated control costs by industrial category, Illinois EPA projected industries in the Chicago faced additional costs of $700 per ton to more than $18,000 per ton to further reduce VOC emissions. Although we will not know the price of the allotments until the market actually starts operating, an educated guess based on accepted forecasting methods is they will sell for less than $3,000 per ton.
Our analysis also indicated that imposing California-level strict controls on the Chicago metro area would require industries to spend up to $20.9 million to get only about 50 percent of the reductions we will achieve under our system at a projected cost of only $3.2 million. The analysis also estimated the trading program will result in an areawide gross regional product savings of $34 million and personal income savings of $22 million over an eight year period.
The savings or benefit to individual sources, will of course, vary significantly. We looked at the potential for trading among several specific VOC sources in the Chicago metro area. The trading program will provide an economic benefit to both industries with relatively high costs for increased VOC reductions and those that can meet the target at relatively low cost but can then generate excess credits to sell. For example, a rubber and plastic facility has ozone season emissions of 30.2 tons of VOCs. To meet the 12 percent reduction requirement on its own, the facility determined it would need to install a thermal oxidizer at an annual cost of $279,300. But with the new trading system, it can instead purchase 3.6 tons (the 12 percent reduction) of allotments at a price ranging up to $10,000 per ton. That would result in at least $243,300 in potential cost savings
Among witnesses appearing before the Illinois Pollution Control Board in support of the VOC trading program was Steve Ziesmann of Abbott Laboratories, who also served on our design team. Mr. Ziesmann noted that because Abbott has multiple VOC discharge sources in the Chicago metro area, having to reduce emissions at each site by 12 percent would cost between $15 and $20 million. Using the market-based trading system, Abbott will be able to achieve the overall 12 percent target by higher reductions at some of the sites, with a total cost of between $2 and $4 million.
"The cost to Abbott, and to society, of achieving the same level of emission reductions under ERMS will be much less than what it may have been under a traditional 'command and control' regime," Mr. Ziesmann testified.
It is our expectation that a VOC trading program in Illinois will work dramatically better than if we continued to rely only on a traditional command and control approach. While do not yet have the system in place, from the lessons from other market systems and from our partnership with business and the environmental community over the past four years, we are confident this is the right direction.
Our past efforts at command and control regulation led to years of litigation, mistrust between the business community and our Agency and the imposition by court order of a federal implementation plan, but not attainment of the federal ozone standard. Continuing down that road would only severely hamper the Illinois economy and not necessarily obtain cleaner air.
The Illinois Emissions Reduction Market System does not pit jobs against clean air but instead gives companies a powerful market incentive for innovation. By opening up a range of cost-effective choices, it is our hope industry will be spurred to go beyond complying with regulations geared to the "least common denominator." Free from one-size-fits-all bureaucratically prescribed technologies and control strategies, business will be able to make business decisions that are also good for the environment and the public health. Illinois is bullish about market-based solutions to achieving pollution reductions. We have high hopes for this system. It can not afford to fail and it will not fail. #
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