Experimental testbedding of a pollution trading system: Southern California's RECLAIM emissions market

Abstract

I. IntroductionThe efficient management of air quality through the use of pollution emissions trading systems is not a new idea (see Montgomery (1972)). It is well known, theoretically, that one can achieve an efficient allocation of abatement among many firms by establishing an appropriate structure of pollution rights, if trade occurs so that a competitive equilibrium is achieved. However, the implementation of such systems is new and it appears, in many cases, that the efficiency gains promised by the theorists are foregone because the implemented market design is not up to the challenge. See, for example, Atkinson and Tietenberg (1991), Burtaw (1994), Hahn and Hester (1989), and Joskow, Schmalensee and Bailey(1999). Even under the best of situations, emission trading markets are very thin. Because most trades are bilateral, with few known alternatives, price-taking behavior is not incentive compatible. Because firms need to complete trades only occasionally, 1 price discovery is difficult if not impossible. Traditional markets, broker-dealer systems, or traditional auctions simply do not provide the information and incentives needed to guide traders to a competitive equilibrium. Gains from exchange often go unrealized.In the early 90's a new emission trading program was created by the South Coast Air Quality Management District (SCAQMD), the agency charged with pollution control in the geographical area around Los Angeles. Environmentalists, polluting firms, and others supported it as the only apparent solution to a situation of escalating compliance and abatement costs. It was believed and hoped that a trading program would produce significant cost-savings for firms over the existing command-control approach. The program is called the REgional CLean Air Incentives Market (RECLAIM) and it allocates permits to facilities and allows trade. But, rather than having one market for one universal permit, in order to retain some measure of regulatory control, the 3 SCAQMD created 136 different permits. They created a different permit for each of two pollutants (nitrogen and sulfur oxides --NOx and SOx) to better control each, for each of two land zones (upwind and downwind) to better control the distribution of the pollutants, for each of 17 separate years from 1994 to 2010 with possible continuation beyond) to better control the distribution of pollution over time, and for each of two compliance cycles to better control year end price volatility. 2 In total, there are 136 different permits that firms must consider as they attempt to minimize their costs of compliance. This means that there are 136 markets for pollution permits in the RECLAIM program. The complexity associated with such an interdependent system of commodities makes trading by traditional methods extremely difficult. Emission trading in LA is more like multi-lateral bargaining than competitive markets. The benefits to be harvested from the RECLAIM program in reduced compliance costs could easily remain unrealized. Participants in the program recognize...

Experiments in Environmental Economics and Some Close Relatives

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