Is the Trading in Tradable Permits for Mercury Worthwhile?

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1 Is the Trading in Tradable Permits for Mercury Worthwhile? The success of the tradable permit system in controlling SO 2 emissions from U.S. coal burning power plants has lead to consideration of a similar system for mercury emissions from those same plants. It is unlikely that such a system for mercury will generate the same success that the SO 2 system has due to the probable lower variance of marginal control costs for mercury and a greater probability of local hot spots. A system of nontradable permits in which compliance may be achieved as power plants desire would result in similarly low control costs while avoiding several potential problems of tradable permits. Keywords: mercury, tradable permits, coal Allen Bellas, Ph.D. Assistant Professor College of Management Metropolitan State University 730 Hennepin Avenue Minneapolis MN allen.bellas@metrostate.edu Ian Lange Ph.D. Candidate Department of Economics University of Washington Box Seattle WA ilange1@u.washington.edu

2 I. Background The use of cap-and-trade programs for pollution control at the federal level in the U.S. achieved its first major success with tradable permits for sulfur dioxide (SO 2 ), established by the Clean Air Act Amendments of 1990 (CAAA90). The general results of this program have been greater than expected emissions reductions at lower than expected costs, even though trading volume and permit prices were initially much lower than expected i. Under Section 112 of the CAA90, the EPA is authorized to regulate power plants on hazardous air pollutants if appropriate and necessary ii. In December 2000, the EPA stated that mercury emissions were a sufficiently large threat to public health that they should be regulated. In December 2003, the EPA proposed a cap-and-trade program for mercury emissions from coal burning power plants, with final regulations to be set by December This date has recently been moved back to mid If mercury is regulated under Section 111 of CAA90, state implementation plans could be used to create a national system of tradable permits with each state deciding how to initially allocate permits iii. If, however, mercury is regulated under Section 112 of CAA90 the standard of maximum achievable control technology (MACT) would be imposed and all new and existing coal burning plants would be required to install EPA approved mercury control devices iv. As a result of its success, the SO 2 market has served as a model for other pollution control programs and systems of tradable permits, once just a radical economic proposal, have gained relatively wide acceptance. The results from the SO 2 permit market are being used as an argument for regulating mercury with the same type of program. It has been argued that critics of the mercury program shouldn t confuse the tool (emissions trading) with the goal (lower mercury emissions in a timely manner) v. They observe that SO 2 emissions have fallen almost everywhere and suggest that the same could be expected for mercury. However, tradable permits have their limits. In particular, the degree to which pollutants have acute rather than chronic and local rather than global impacts will make tradable permits less attractive as instruments to reduce pollution damage. For local pollutants, the relationship between emissions and damages differ between sources, thus equating marginal control costs across sources will not minimize pollution damage for a given cost. vi In addition, opportunities for cost savings through trades depend on the variation in marginal control costs across affected generating units. Greater variation in marginal control costs implies greater opportunities for cost savings through trades while less variation suggests reduced opportunities for cost savings. This paper will argue that the successes found with SO 2 are unlikely to be replicated with mercury. The reasons for this are historical differences in their regulation and inherent differences in their nature. Mercury Permits 1

3 II. History of Regulation Federal regulation of SO 2 began with the 1970 Clean Air Act, which established new source performance standards (NSPS), initially specifying that new coal burning boilers not emit more than 1.2 pounds of SO 2 per million Btu (mmbtu) of heat input. Existing boilers went unregulated at the federal level while state regulation varied greatly by region, including some nonbinding regulation. vii The 1977 Clean Air Act amendments reaffirmed the limit for new boilers and added the requirement that 90 % of SO 2 (70% for those burning low sulfur coal) be removed from new boilers emission stream, essentially mandating control devices. This requirement was largely a result of high sulfur eastern coal interests desire to quell demand for low sulfur western coal. viii CAA90, which introduced the system of tradable permits for SO 2 emissions, applied to all boilers above 25 megawatts regardless of their inception date and established maximum total SO 2 emissions for each affected boiler, unless permits were transferred to that boiler from another. The effect of different regulations having been applied to different boilers is to endow boilers with a variety of control cost schedules based on the technology that they have previously been mandated to use. Neither the federal government nor state governments have regulated mercury emissions from coal-fired power plants in the past; as a result dedicated mercury control devices have not been installed. The 2002 Energy Information Agency Form 767 survey data indicate 67 of 1044 coal burning boilers as having devices that remove mercury, but these devices seem to have been primarily for removal of particulates or SO 2. ix If, as expected, control devices are the primary means of compliance and if there are national markets for these devices, there is no reason to believe that any one unit will have an important cost advantage over another. The simultaneous imposition of mercury regulations on all operating boilers will result in there being less diversity of control costs for mercury than there was at the start of SO 2 permit trading, and this will limit the opportunities for trade. Given the differences in the history of regulation for these two pollutants, there is likely to be less variation in marginal control costs for mercury than there is for SO 2. As a result, the cost savings that might potentially be gained from trading mercury emissions will be much smaller than has been the case with SO 2. III. Sulfur versus Mercury Sulfur and mercury both exist in small amounts in coal and are released to the atmosphere following combustion. As the concentration of sulfur and mercury in coal rises or falls, so does the quantity released. Differences in the regional distribution of sulfur and mercury and in the nature of their resulting pollution make mercury less well suited for a tradable permit system. Both sulfur and mercury content in coal vary regionally. Regional differences in sulfur content are important as plants located in regions with abundant sources of low sulfur coal have a significant cost advantage in SO 2 reduction. A large portion of the emissions Mercury Permits 2

4 reductions under tradable SO 2 permits came through the purchase of lower sulfur coal, particularly from Wyoming s Powder River Basin. x The amount of western coal produced increased from 334 million tons in 1990 to 550 million tons in 2002, a 65 percent increase. xi Higher sulfur content coal basins, such as the Interior Basin, have seen their production decrease from 205 million tons to 146 million tons over the same time period, a 30 percent decrease. As would be expected when sulfur is priced due to the type of regulation, firms are switching to low sulfur coal. In fact, the availability of low sulfur coal has been more important to the success of the CAA90 tradable permits than has their tradability. Early analysis of the permit system showed greater than expected reductions in SO 2 emissions at lower than expected costs in spite of relatively few trades, and almost no interfirm trades, taking place. Instead the cost savings and over-compliance resulted from firms being given flexibility in meeting the SO 2 emissions limits imposed by CAA90. The flexibility rather than the tradability drove over-compliance and cost reductions. There is much less interregional variability in the mercury content of coal, meaning that location is less important in determining the cost of mercury reductions. There are no large deposits of exclusively low mercury coal that nearby plants may draw upon to gain a cost advantage in mercury reductions. Separating coal shipments by region of origin (West, Interior, or Appalachian) for the first quarter of 1999; we find that the lowest regional median mercury content was 67 percent of the highest. For sulfur, the lowest regional median content was 34 percent of the highest xii. In addition, mercury content is more variable within coal producing regions and even within individual seams (smaller areas within a supply region). xiii This suggests that in addition to regional differences being smaller, there may not be consistent cost advantages for plants that purchase coal from a particular region or even a particular mine. SO 2 emissions and the resulting acid rain, though not ideal, are good candidates for regulation through tradable permits. The damage done by SO 2 occurs when it rises into the atmosphere, is converted to sulfuric acid and then falls as acid rain. The problems caused by acid rain are regional in nature as sulfur is relatively light in weight and tends to disperse over a large area. The problem is also chronic rather than acute. Damage from acid rain occurs as a result of exposure over long periods of time. Emissions reductions need not be targeted at particular times or localities to have an impact. Instead, reductions in the aggregate level of emissions over a longer period of time, such as a year, can reduce acid deposition in such a way as to generate environmental benefits. Short periods of high SO 2 emissions are unlikely to cause great damage. So, a permit system that reduces total annual emissions may be appropriate for addressing the problem of acid rain. Damages associated with mercury emissions are also chronic rather than acute. Mercury, a heavy metal, accumulates over time. Total emissions over a long period determine environmental levels of mercury. Infrequent, short periods of high emissions aren t necessarily a problem as long as total emissions over a longer period of time are at acceptable levels. This aspect of mercury pollution is consistent with a system of Mercury Permits 3

5 tradable permits allowing emissions at any time over the course of a year, or even longer. Because it is only total long-term emissions that matter, intertemporal trades create no particular problems. The problem with trading mercury emissions is that local concentrations are important. Efficient regulation of a local pollutant requires that the marginal cost of damage reductions be equated between sources, thus minimizing the cost of the damage reductions. xiv A national trading program would minimize the cost of achieving emissions reductions but not the cost of achieving damage reductions. Mercury is dense and likely to be deposited near the point of emission, thus a national system of tradable permits is likely to result in hot spots, small areas with high emissions levels. If these hot spots are highly populated or environmentally sensitive, total damage from mercury emissions could increase in spite of decreasing aggregate national emissions. This fear was echoed by the Children s Health Protection Advisory Committee in their letter to the EPA administrator xv. The current cap-and-trade program does not include safeguards against hot spots. The EPA states that since SO 2 emissions fell almost everywhere, the same will happen with mercury xvi. As we have discussed above, past SO 2 emissions are a result of past regulations inherent bias against low sulfur coal, therefore when sulfur was allowed to be priced, power plant emissions fell everywhere as they abated more efficiently by purchasing low sulfur coal. While mercury content varies by coal region, it does not vary greatly and past regulation has not favored high mercury coal, thus mercury emissions are not likely to fall in a uniform fashion. Switching to or blending with low sulfur coal has been responsible for a large portion of the decrease in SO 2 emissions, but because there will be reduced opportunities to do this with mercury; such a uniform decrease in emissions levels is unlikely. IV. A Policy Prescription Drawing upon the experience of SO 2 permits and an understanding of what makes permits perform well as regulatory instruments, we offer the following proposal for controlling mercury emissions. Each boiler should be allocated a level of mercury emissions xvii, analogous to permits, which cannot be traded but may be moved between boilers within a plant. In light of differing damage functions, emissions should be allocated such that plants near large population centers receive smaller allocations, but this may be politically infeasible. The restriction that permits not be freely mobile will reduce the chance of local hot spots arising. Although it would be beneficial to allow adjacent or neighboring plants to trade, the cost of the supporting infrastructure is likely to outweigh the benefits of trading. In addition, the permit market in these areas would be thin and open to problems resulting from unequal market power. xviii The number of permits or the total allowable emissions should be reduced over time in anticipation of development of lower cost methods of emissions reduction. Finally, the permits should be bankable as it is total emissions over longer periods of time that determine damages rather than short-term fluctuations. Mercury Permits 4

6 Allowing permits to be banked would leave long-term emissions unchanged but would allow cost-saving intertemporal tradeoffs by utilities. While permits should not be tradable, it could be desirable to allow them to be retired. This has been done to a limited extent with SO 2 permits, but the lack of geographic mobility of mercury permits would allow interested local parties to acquire permits and directly reduce emissions in specific areas. Reducing local mercury emissions through retirement would be an effective option for achieving more efficient reductions as larger populations would likely have greater willingness to pay for mercury control. Allowing some level of emissions but not specifying how that level is to be achieved will allow plants flexibility. This flexibility resulted in cost savings in SO 2 control even before trading became commonplace and triggered innovation in power plant input markets. xix While most power plants are expected to achieve compliance primarily through control devices, the increased flexibility allowed by not mandating a method of compliance will allow power plants to choose among available options and will force manufacturers to compete. This competition and freedom of choice resulted in lower cost and more efficient SO 2 control devices. xx The results should transfer easily to the mercury control industry. If firms achieve compliance through control devices, there are unlikely to be great differences in marginal costs of control, so the potential cost savings lost due to a lack of trading should be small. In exchange for this likely loss of cost savings, a system of nontransferable permits will likely reduce damages from mercury emissions by insuring that emissions don t increase in highly populated areas. V. Conclusion Tradable permits carry the promise of achieving emissions reductions at minimum cost. However, the link between reductions in emissions and reductions in pollution damage is not always perfect. Depending on the nature of the pollutant in question, damage may increase even as emissions are reduced as a result of hot spots. Further, the benefits of trading depend on the amount of variation in marginal control costs. When this variation is large there are ample opportunities for mutually beneficial trades, but when the variation is small, trade opportunities are reduced. Tradable permits have been relatively successful in controlling SO 2 emissions because these emissions and their resulting pollution damage have characteristics that are consistent with regulation through tradable permits. Mercury emissions appear to have characteristics less consistent with tradable permits. In particular, the amount of variation in the marginal cost of mercury control will likely be less than in the marginal cost of SO 2 control. As a result, the potential benefits from making mercury allowances tradable are likely to be less than the benefits from making SO 2 allowances tradable and, more importantly are likely to be less than the damage from making them tradable. Mercury Permits 5

7 VI. Endnotes i Schmalensee, Richard, Denny Ellerman, Paul Joskow, Juan-Pablo Montero, and Elizabeth Bailey (1998), An Interim Evaluation of Sulfur Dioxide Emissions Trading Journal of Economic Perspectives. 12 (3), pp ii Mercury Fact Sheet 2000: iii Mercury Fact Sheet 2004: iv Section 112(n)(1)(A), v Burtraw, Dallas and Alan Krupnick (2003), A Mercurial Reaction on Mercury? RFF Feature. December 12 (Washington DC: Resources for the Future). vi For example, more control and a higher marginal cost of control are desirable in highly populated areas. vii Ackerman, Bruce and William Hassler (1981), Clean Coal/Dirty Air (New Haven, CT: Yale University Press). P viii Ackerman and Hassler, 1981, p ix Energy Information Administration (2002), Form EIA-767: Steam Electric Plant Operation and Design Report (Washington DC: Energy Information Administration). x Energy Information Administration (1997), The Effects of Title IV of the Clean Air Act Amendments of 1990 on Electric Utilities: An Update (Washington DC: Energy Information Administration), p 5. xi Energy Information Administration, U.S. Coal Supply and Demand, Various Years (Washington DC: Energy Information Administration). xii Data on mercury and sulfur content of delivered coal available at: Last accessed in February xiii Energy Information Administration (2001), Reducing Emissions of Sulfur Dioxide, Nitrogen Oxides, and Mercury from Electric Power Plants EIA Special Report, (Washington DC: Energy Information Administration). Available at: xiv Baumol, William and Wallace Oates (1988), Theory of Environmental Policy (Cambridge, UK: Cambridge University Press,). Chapter 12. xv xvi xvii One option for determining initial allocations of mercury emissions is historical heat input, the basis used for SO 2. If mercury is regulated under Section 111 then the method of initial allocation could be left to the states with the additional advantage of being able to observe fifty different experiments in permit allocation. xviii van Egteren, Henry, Marian Weber (1996), Marketable Permits, Market Power and Cheating, Journal of Environmental Economics and Management. 30, pp xix Burtraw, Dallas (1996), The SO2 Emissions Trading Program: Cost Savings Without Allowance Trades. Contemporary Economic Policy, 14, pp xx Bellas, Allen and Ian Lange (2004), Secondary Benefits of Market-based Environmental Regulation: The Case of Scrubbers. University of Washington Working Paper. And Burtraw, Dallas and Karen Palmer (2003), The Paparazzi Take a Look at a Living Legend: The SO2 Cap-and-Trade Program for Power Plants in the United States, RFF Discussion Paper 03-15, p Mercury Permits 6