Market based programs have become an important consideration in the development of air quality management plans. This is particularly true for the case where climate change gases are under consideration. However, market based programs have been applied to address lead in fuel, SOx regulation, and NOx control. Basically, a market based approach does not normally specify the rules that a single business must meet, but instead specifies an emissions cap or average emissions level that must be met among a group of sources and allows the companies to trade emission reduction credits to meet the requirements of the rule. In this case, a company that reduces emissions greater than the average reduction that is required, gets a credit, which can be sold to a business that is falling short of meeting its emission reduction goals. In theory, the market finds the most cost effective ways to reduce emissions. Market based programs are extensively discussed in Chapter 8. The purpose here is to provide only an overview.

Market based programs are generally broken into three categories. One type of program is commonly referred to as “cap and trade,” a second type of program is commonly referred to as “allowance trading,” and a third type of program uses emission fees.

In a cap and trade program, each business has an emission cap set for it. This cap might decrease over time or stay constant. A business must always stay under that cap. If it cannot stay under the cap then it must obtain emission credits from another business or emissions credit broker that equals the amount of emissions that the business produces above its cap. If a business reduces emissions below its cap, then it can receive an emissions credit that can be sold or traded to persons who want or need the credits.

In an allowance trading program, an emissions regulation is set for each business or an average emission rate. The business has the option of meeting the regulation by modifying their manufacturing process or by adding control equipment; or they can obtain an emission allowance credit to operate in excess of the regulation. If the business can operate below the regulatory requirement, it is eligible to receive an allowance certificate for the emissions below the requirement that it can trade. This type of program operates very much like a cap and trade program, but the regulatory agency must develop the necessary regulations in advance of the program.

In an emission fee program, and emission fee is set for any emissions above a preset level. For each kilogram or ton of emissions above the limit, the producing business must pay a fee. The fee is set and increased if necessary to produce the needed emission goals.

There are many variations on the programs described above and there are combinations of these programs that have been considered and in a few cases put into practice.

The cap and trade program is the most often implemented market based program. It is the simplest to implement in that the regulatory agency does not have to develop specific business regulations to set up such a program. Emission fees are almost universally opposed by businesses since they see it as a tax with little environmental benefit.

Market based programs offer significant opportunities to reduce environmental compliance costs. However, they offer significant opportunities for abuse. Clear, verifiable information must exist with respect to business emissions or there will be much cheating in the development of emission credits and little clean air will result. Cap and trade programs may not involve specific emission regulations, which means that it can be easier to produce emissions in excess of a cap that regulators have trouble quantifying.

The regulatory program for the Los Angeles metropolitan area developed a cap and trade program called RECLAIM. This program set caps on large sources of SOx and NOx and reduced them by 75% over a ten year period. Some of the utilities in the program simply reduced operations and/or bought credits to meet their emission requirements. They did not consider the addition of control equipment to meet the regulatory requirements. As the emission caps reduced, emission credits became less available and much more expensive. When electricity demand began to rise, these companies could not produce the needed credits for their excess emissions, but due to the need for electricity, the local regulatory agency was reluctant to force the utilities to shut down. The alternative was to take these utilities out of the RECLAIM program to give them time to add control equipment. This delayed the reduction of NOx emissions by several years over what it should have been. This is a case where the market based system failed, not due to a lack of emissions information, but due to a lack of due diligence on the part of the utilities. It is thus imperative that a regulatory agency keeps its eye on the steps being taken by the critical industries in a region to insure that they are taking meaningful steps toward complying with a cap and trade rule.