E C O N O M I C R E P O R T O F T H E P R E S I D E N T

Permit Trading: Sulfur Dioxide Trading ProgramIn the atmosphere, emissions of SO 2transform into sulfates and sulfuricacid and are transported over large distances. Because 70 percent of all U.S.SO 2emissions come from electric utilities, and many of these are based in theeastern half of the United States, the sulfates are usually deposited in theNortheast. Acidic deposition, also known as acid rain, can acidify lakes,resulting in fish kills; it can reduce the alkalinity of forest soils, thereby harmingvarious tree species; and it can degrade various ecosystem functions. Inaddition, SO 2has been linked with several respiratory problems.To address the acid rain problem, the 1990 Clean Air Act Amendmentsdirected the EPA to design a tradable permit system for SO 2. The programrequired the 110 highest emitting, primarily coal-fired, power plants (representing263 units) in the Eastern and Midwestern States to hold, starting in1995 (phase I), permits sufficient to cover all their SO 2emissions. Starting in2000 (phase II), all large fossil fuel-fired power plants (approximately 2,000units) in the eastern half of the United States will have to hold enough SO 2permits to cover their emissions. Most allocations are based on the product ofa common emissions performance standard and historical utilization,although a small percentage every year (about 3 percent) are auctioned at theChicago Board of Trade. Utilities can freely buy and sell permits, and entitiesnot required to hold permits to cover emissions may also participate in theSO 2market. Utilities can also bank emissions permits for use in future years.The SO 2market has enjoyed very active participation and yieldedsubstantial cost savings. Innovations in scrubber technology as well as theavailability, due to rail deregulation, of low-cost, low-sulfur coal fromWyoming and Montana have contributed to compliance estimates as low ashalf of what had been predicted for the program. The market hasexperienced high volume, in part thanks to the role of private brokers. Comparedwith a traditional regulatory alternative, the fully implemented SO 2market has generated cost savings of up to $1 billion annually. Theheterogeneity of abatement costs for SO 2in the utility industry has beenrecognized as one reason why the SO 2market has experienced such heavyvolume and substantial cost savings. The absence of individual trade reviewsby the government and a system of seller liability have also contributed tohigh trading volumes. Banking of permits has also occurred to a substantialdegree: total SO 2emissions in 1995 were nearly 40 percent below theenvironmental goal because of banking activity (Chart 7-4). These bankedpermits will likely be used during phase II, which has tighter annualemissions limits.Chapter 7 | 259