Introduction to Market-Based Regulation of Air Emissions
A recent trend in environmental regulation is to attempt to harness market forces to achieve environmental regulatory goals at less expense than traditional command and control regulations. Such market-based approaches generally involve allowing a regulated entity to purchase or finance environmental projects that are performed by others in lieu of making more expensive operational or equipment changes that would otherwise be required to comply with environmental regulations.
The best known of these initiatives is the sulfur dioxide emission trading program of Title IV of the Clean Air Act Amendments of 1990. Under this federal program, the United States Environmental Protection Agency (EPA) established a cap on total sulfur dioxide (SO2) emissions (which are believed to be related to acid rain) and allocated emission allowances to electric utilities and other sources subject to Title IV. The affected facilities may trade these emission allowances among themselves. Thus, a facility that reduces SO2 emissions may sell its excess emission allowances to other facilities that are either unable to achieve emission reductions at the same cost or which are new facilities that need to obtain a quantity of allowances to be able to operate. Today, these emission allowances are traded on the Chicago Board of Trade, just like other commodities. Environmental groups and private citizens are also buying emission allowances and retiring them, thereby reducing air pollution in a measurable way. Notably, the current market price of SO2 emission allowances is much lower than had been originally predicted, indicating that sources are reducing emissions more quickly than had been anticipated.
This article examines Michigan's new emission reduction credit trading and emission averaging rules, which are similar to, but in many significant ways different from, the Federal Clean Air Act SO2 emission trading program.
Michigan's Emission Reduction Credit Trading and Emission Averaging Rules
On February 29, 1996, the Michigan Department of Environmental Quality (DEQ) Air Quality Division (AQD) issued regulations to provide for a voluntary emission reduction credit trading and emission averaging system (the Emission Trading Rules).1 Under these rules, sources that reduce emissions below allowable levels can generate emission reduction credits that: (1) may be transferred to another firm; or (2) may be used to offset emission increases from another process owned by the same firm. The rules allow trading of emissions of all "criteria" pollutants2 except ozone. Thus, Michigan's emission trading program is potentially much broader than the federal SO2 emission trading program.
The Emission Trading Rules do not impose new restrictions on emission sources-- participation is wholly voluntary. The rules are intended to encourage participation by small sources, many of which have no emission controls in place. These small emission sources may be able to achieve emission reductions less expensively than larger sources of emissions, most of which already have costly emission controls in place, and can then sell the resulting emission reduction credits to larger sources that need to offset or reduce their emissions, but could do so only at substantially greater expense. In this way, small emission sources are given an incentive to reduce emissions even though emission reductions are not required, and large sources may be spared the expense of installing additional air pollution control systems. The result should be that the people of Michigan receive more emission reductions per dollar spent on air pollution control. Moreover, because ten percent of the emission reduction credits generated are retired to provide an environmental benefit, the air should become even cleaner than it would be without emission trading if the program is used frequently.
"Emission reduction credits" are transferable between air pollution sources that are in separate categories and/or that are owned by different parties. Such credits are distinct from emission reductions for "emission averaging," which can occur between emission sources in the same source category and which are under common ownership or control.
To qualify under the Emission Trading Rules, emission reductions must meet the following criteria:3
- The emissions must be included in an emission inventory compiled by AQD. Large sources of emissions (over 100 tons per year of certain pollutants) must report their emissions to AQD annually. Emissions from smaller sources, however, are not required to be reported and may not be represented on the appropriate emission inventory. This prerequisite could reduce the ability of small emission sources to participate in the emission trading program.
- The emission reductions must have occurred on or after January 1, 1991. Each ton of emission reductions occurring before March 16, 1996 (the effective date of the Emission Trading Rules) generates only 0.5 ton of emission credits, however, while each ton of emission reductions after March 16, 1996 generates 0.9 ton of credits.4
- The emission reductions must not have already been used for a different regulatory purpose.5
- The emission reductions must be real, meaning that a change in the operation or method of air pollution control of a source has occurred that has resulted in a reduction in actual emissions. A reduction in actual emissions is measured by comparing the emissions after the change to the emissions during the two years (or two ozone seasons) before the change unless the source demonstrates that a different time period is representative of historical operations and consistent with the state implementation plan.6
- The emission reductions must be surplus, meaning that reductions were made below an established baseline that were not required by any applicable air pollution control requirement.
- The emission reductions must be enforceable, meaning that they are embodied in a restriction under a regulation or in a permit that can be enforced by the AQD and the EPA. This means that sources wishing to register creditable emission reductions will need to accept voluntary restrictions on their emissions through a permit or rule that creates voluntary limitations.
- The emission reductions must be permanent, meaning that the reductions shall be continuous for the period during which the emission reduction credits are generated.
- The emission reductions must be quantifiable, meaning that the amount, rate, and characteristics of the reduction can be measured through a reliable method that has been endorsed by the DEQ or the EPA.
There are a number of ways a facility can reduce emissions to generate emission reduction credits for trading or averaging, including:7
- Installing or modifying air pollution control equipment that is not required.
- Permanently modifying a process or process equipment, i.e., making a change that cannot be reversed by something as simple as throwing a switch or opening a valve.
- Reformulating raw materials or products.
- Implementing an energy conservation program.
- Implementing operational changes that result in emission reductions.
- Implementing a pollution prevention program.
- Curtailing or shutting down an operation. This method of emission reduction is not usable for emission averaging.
- Implementing emission reductions required by a rule, but before the relevant compliance date.
- Implementing area and mobile source controls, under certain conditions.8 This method of emission reduction is not usable for emission averaging.
- Any other method that results in emission reductions and is approved by the AQD.
The first step in the process of trading credits or emission averaging is to register the emission reductions or an emission averaging plan with the AQD.9 Registration forms and instructions are available from the AQD and from the AQD's Internet home page found at http://www.deq.state.mi.us/aqd. Within 30 days after the registration is submitted, the AQD will determine whether the registration notice is complete, and the changes the source made to create the emission reductions shall become legally enforceable operating requirements on the effective date of the notice of completeness or another date approved by the AQD.10 With certain exceptions, the amount of emission reductions that are registered will be reduced by 10% to provide an air quality benefit.11 A similar registration notification is required when emission reduction credits are traded or used.12 Although the AQD will determine whether registration notifications are complete, the AQD has contracted with an outside contractor, Clean Air Registry, Inc., to maintain a registry that contains the information submitted in the various registration notifications. The emission trading registry can be accessed via modem at (410) 576-7976.
A number of other restrictions apply to the use of emission averaging and emission trading credits. Emission reduction credits are generally valid for five calendar years13 with certain exceptions.14 Emission reductions resulting from measures taken to correct violations of applicable requirements are not eligible for use in emission averaging or generating emission reduction credits.15 In addition, the AQD may restrict emission averaging or the use of emission reduction credits that would result in increases of certain specified toxic pollutants.16 Various other miscellaneous restrictions on emission averaging and emission trading can be found in these rules.17
The AQD will not certify that emission reduction credits or an emission averaging plan is in compliance with the regulations. Each person who participates in emission averaging, or the generation, trading, or use of emission reduction credits is solely responsible to assure that all processes under his or her control are in compliance with all applicable requirements.18 If one who has submitted an emission averaging plan or registered emission reduction credits discovers a shortfall in the amount of emission reductions that meet the requirements of these rules, that person must notify the AQD of the deficiency within 30 days of discovering the shortfall and reconcile the shortfall within 30 days after notifying the AQD.19 If the emission averaging plan or emission reduction credits have not been used, then the person can amend or withdraw the emission averaging plan or the emission reduction credit registration after notifying the AQD.20 If the AQD discovers that there is a shortfall in the amount of emission reductions that meet the requirements of these rules, and those emission reductions have been used or traded, the person who registered the emission reduction credits or emission averaging plan is required to generate or obtain an amount of emission reductions equal to three times the amount of the shortfall, which will then be retired.
The AQD may take additional enforcement action against a person that registers or uses invalid emission reduction credits or an invalid emission averaging plan.22 This means that persons who purchase emission reduction credits will need to take precautions to verify that the seller has generated valid emission reduction credits. If a source purchases and relies on emission reduction credits that later turn out to be invalid, the purchaser may be faced with the need to purchase new emission reduction credits to replace the invalid ones and/or an enforcement action. This may discourage buyers from purchasing emission reduction credits from small companies that are less readily able to guarantee that the emission reduction credits are valid, or less able to provide reliable indemnification if the credits turn out be invalid. If this proves to be a significant barrier to the ability of small companies to market the emission reduction credits they generate, it may drastically undermine one of the benefits of an emission trading program: encouraging small sources that can reduce emissions at relatively little cost to sell the resulting credits to a large source that could reduce emissions only at greater expense.
Records pertaining to an emission averaging plan or emission reduction credits must be retained for at least five years after the emission trading plan has expired or each emission reduction credit is used, expired, or retired,23 and the AQD may audit individual transactions that occur under these rules.24
Potential Uses for Emission Reduction Credits and Emission Averaging and Their Limitations
Air emission sources may not use emission averaging or emission trading to comply with a very large portion of the air pollution requirements that apply in Michigan.25 Essentially, emission trading cannot be used to avoid the expense of installing air pollution control equipment. The question remains: what can emission trading be used for? Some of the uses for emission trading that have been identified by the AQD include the following:
- Offsets for major new or modified sources. Major new or modified sources in areas that are not in compliance with national ambient air quality standards ("nonattainment areas") are required to obtain "offsets," which are compensating emission reductions from other sources to counterbalance the increased emissions from the major new or modified source. Emission trading can be a convenient, and hopefully not too costly, way for sources to obtain offsets required in nonattainment areas. This may become more important in the future if EPA revises its air quality standards to be more stringent so that more areas in Michigan are in nonattainment. EPA is currently considering the possibility of making the ozone smog and particulate matter standards more stringent.
- Compliance with Reasonably Available Control Technology ("RACT") Requirements. Sources can use emission trading to temporarily or permanently comply with RACT requirements for volatile organic compound (VOC) emissions found in the Michigan air rules. Because RACT standards applied to existing sources before the Emission Trading Rules went into effect, virtually all sources subject to RACT requirements are already in compliance with them. Facilities that include several sources subject to RACT requirements may find, however, that emission averaging can provide greater flexibility than the current system of imposing emission limitations on each individual source.
- BACT/LAER compliance. Emission trading can not be used in place of installing Best Available Control Technology (BACT) or Lowest Achievable Emission Rate (LAER) control equipment when such equipment is required, but may be used to comply with the BACT or LAER emission rate limits when the properly installed and operated equipment fails to meet the emission limit. This circumstance generally means that the capabilities of the required control equipment were overestimated when the source's air permit was issued. In the past, this would be grounds for revising the terms of the permit to reflect the actual capabilities of the control equipment. Emission trading would allow such sources to buy emission credits to avoid the need to reopen their permit. One warning: reopening the permit is a permanent solution to this problem, while emission credits would have to be bought throughout the life of the affected equipment.
- Retaining "synthetic minor" status. Several air pollution control requirements apply only to "major" sources, which are generally defined by reference to the source's potential to emit air pollutants. In some circumstances, it is possible for a "major" source to voluntarily accept restrictions on its emissions to bring the emissions below the levels that define a "major" source. Such sources are known as "synthetic minor" sources. Often these sources reduce their potential to emit air pollutants by limiting their production rate to levels below the maximum output of the facility. Emission reduction credits may be used to compensate for a change in the method of operation of a synthetic minor source (such as an increase in production rate) that results in a temporary increase in emissions that would exceed the level that would make the source a "major" source.26 Such an increase in emission must last for less than 12 months, and must not occur more often than once in a 24-month period.27
- As a compliance "bridge" or "buffer." Emission trading can be used as a "bridge" to temporarily keep a source in compliance with the requirements described in 1-4, above, until a more permanent solution is implemented. AQD also notes that sources that use emission trading in the circumstances described in 1-4, above, may want to purchase a "buffer" of extra credits in case some of the emission reduction credits relied upon later turn out to be invalid.
- Encouraging economic development. State and local groups interested in fostering economic development could purchase emission reduction credits and donate or sell them at a discounted rate to new or expanding businesses to use to comply with the requirements described in 1-4, above.
- Air quality improvement. Individuals or environmental groups could purchase emission reduction credits and retire them to improve air quality. If necessary, Michigan could purchase emission reduction credits and retire them to ensure that the state meets air quality targets set by EPA.
This article appeared in the January 1997 Michigan Bar Journal. Please contact S. Lee Johnson, an associate in our Environmental Department, for further information.
- 1996 MR2, 336.2201 et seq.
- The "criteria" pollutants include ozone, volatile organic compounds (VOC), nitrogen oxides (NOx), SO2, particulate matter, carbon monoxide, and lead.
- 1995 MR 2, R 336.2201, .2208(1).
- 1996 MR2, R 336.2212.
- Specifically, the emission reductions must not have previously been used as offsets for a new source that underwent nonattainment new source review, for "netting" to avoid new source review, or for demonstrating attainment or maintenance of any national ambient air quality standard. 1996 MR 2, R 336.2208(1)(b).
- 1996 MR 2, R 336.2206(2), .2207(2)(a).
- 1996 MR 2, R 336.2208(2).
- "Area sources" are small emission sources that are not generally regulated as stringently as larger, "major" sources. "Mobile sources" are moveable emission sources such as cars, trucks, and certain portable equipment.
- 1996 MR 2, R 336.2213.
- 1996 MR 2, R 336.2213(5) and (6).
- Emission reductions occurring between January 1, 1991 and March 15, 1996 (the effective date of the Emission Trading Rules) shall be discounted by 50%. 1996 MR 2, R 336.2212. VOC or NOx emission reductions that are used to comply with restrictions during subsequent ozone seasons are discounted 10% per ozone season. 1996 MR 2, R 336.2212(5).
- 1996 MR 2, R 336.2214.
- Some emission reduction credits may expire sooner, 1996 MR 2, R 336.2212(2), while emission reduction credits generated by the permanent shutdown of a source can be used to provide offsets for nonattainment new source review indefinitely. A single change that reduces emissions can be used to generate new emission reduction credits each year the change is in place, unless circumstances change to make the change no longer eligible to produce emission reduction credits. Shutting down a process can produce emission reduction credits for only the first five years, however, unless they are used to offset emission from a new source. 1996 MR 2, R 336.2208(6). Emission reduction credits of VOCs as a class of compounds may not be used to allow increased emissions of a specific VOC, unless the AQD determines that the use would result in an environmental benefit. 1996 MR 2, R 336.2204(5).
- 1996 MR 2, R 336.2212(1).
- 1996 MR 2, R 336.2204(9).
- 1996 MR 2, 336.2204(11).
- These additional restrictions include the following, among others: Emission reduction credits may not be used to comply with federally mandated mobile source requirements. 1996 MR 2, R 336.2204(12). Emission reduction credits for VOCs or NOx that are used using an ozone season must have been generated during an ozone season. 1996 MR 2, R 336.2205. Certain restrictions also apply to emission averaging and the transfer of emission reduction credits between attainment and nonattainment areas. 1996 MR 2, R 336.2211.
- 1996 MR 2, R 336.2216(1).
- 1996 MR 2, R 336.2216(2).
- 1996 MR 2, R 336.2216(3).
- 1996 MR 2, R 336.2210.
- 1996 MR 2, R 336.2217(4).
- The emission trading rules prohibit any use of emission averaging or emission reduction credits in a way that would violate federal air quality maintenance or improvement requirements. 1996 MR 2, R 336.2204(1). The rules also restrict the kinds of requirements for which emission trading can be used to achieve compliance. Emission averaging and emission reduction credits may not be used in place of complying with federal New Source Performance Standards ("NSPS"), National Emission Standards for Hazardous Air Pollutants ("NESHAP"), or Maximum Available Control Technology ("MACT") limitations, or in place of installing state-required Best Available Control Technology for Toxic Air Contaminants ("T-BACT") control technology. Emission averaging and emission reduction credits may not be used in place of installing federally-required Best Available Contol, Technology ("BACT") or Lowest Achievable Emission Rate ("LAER") controls, but may be used to comply with BACT or LAER emission limits when the properly installed and operated BACT or LAER equipment fails to achieve the required level of control. Emission averaging and emission reduction credits may not be used if the result would be an increase in the maximum hourly emission rate of a toxic air contaminant, unless the AQD determines that the increased hourly emission rate will not cause or exacerbate an exceedance of a toxic air contaminant health-based screening level. 1996 MR 2, R 336.2204(3).
- 1996 MR 2, 336.2204(6).
- 1996 MR 2, R 336.2201(ee).