Air Pollution:

Allowance Trading Offers an Opportunity to Reduce Emissions at Less Cost

RCED-95-30: Published: Dec 16, 1994. Publicly Released: Dec 20, 1994.

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Pursuant to a congressional request, GAO reviewed the Environmental Protection Agency's (EPA) emissions trading program, focusing on: (1) the extent to which allowance trading is expected to reduce sulfur dioxide emissions and compliance costs; (2) the status of the allowance trading market; (3) barriers to increased allowance trading; and (4) the implications for designing a similar approach to curb carbon dioxide emissions.

GAO found that: (1) sulfur dioxide emissions and compliance costs are decreasing despite the low level of allowance trading between utilities; (2) although they could save more by purchasing emission allowances, most utilities are choosing relatively cheap in-plant reduction methods to reduce their emissions below Phase 1 requirements and saving their excess allowances to meet the stricter Phase 2 requirements; (3) the utilities' flexibility in choosing their emission reduction methods has reduced the prices of competing options; (4) utilities have purchased most of their trading allowances through two EPA-sponsored auctions; (5) allowance trading has been limited mainly by the slow phase-in of mandated emission reductions, economic regulation of the electric power industry, uncertain tax treatment of allowances, and confusion over the EPA allowance auction; (6) sulfur dioxide program features that would be helpful in designing a carbon dioxide emissions program include an overall requirement for emissions reductions and a monitoring system to ensure compliance; and (7) modifications that may increase allowance trading in a carbon dioxide program include requiring utilities to achieve the same emissions reductions simultaneously and designing an auction that results in a single price for allowances.

Recommendations for Executive Action

  1. Status: Closed - Not Implemented

    Comments: On June 6, 1996, the Environmental Protection Agency published an Advance Notice of Proposed Rulemaking seeking comment on whether the allowance auction should be changed from the current discriminating price format to a single price format. Comments were due on August 5, 1996. Most of the commenters believed that the auction should remain as it is. Only two comments in support of a change were sent in. Generally, commenters believed that the allowance market has matured in the 2 years since GAO's recommendation, and a change is unnecessary. Although EPA has not yet made a public announcement, the agency does not plan to change the allowance auction due to the lack of support by market participants.

    Recommendation: To improve price information from EPA auctions and help clarify the regulatory treatment of allowances, the Administrator, EPA, should change the design of the auction so that it is a single-price auction.

    Agency Affected: Environmental Protection Agency

  2. Status: Closed - Implemented

    Comments: EPA states that it agrees with this recommendation and that an EPA employee spends 2 days a week at DOE working with the Utility Commission Proceedings Participation Program and the Integrated Resource Planning teams. EPA anticipates that these groups will address allowance ratemaking issues and discuss appropriate ways to encourage action on these important matters. However, EPA did not mention how it will ensure, as opposed to anticipate, such actions.

    Recommendation: To improve price information from EPA auctions and help clarify the regulatory treatment of allowances, the Administrator, EPA, should work with the Department of Energy's Utility Commission Proceedings Participation Program and Integrated Resource Planning teams to help state utility commissions and the Federal Energy Regulatory Commission (FERC) decide how to treat allowances in ratemaking.

    Agency Affected: Environmental Protection Agency

  3. Status: Closed - Implemented

    Comments: FERC considered this issue when it issued its Emission Allowance Policy Statement in Docket No. PL95-1-000. In that case, FERC determined that extensive reporting requirements would be a costly and time-consuming burden for utilities and that there was no basis to conclude that this would enhance the development of the emission allowance trading market. Instead, the Commission adopted the proposal by Edison Electric Institute (EEI) to price emission allowances used in providing coordination service at the utility's replacement cost, based on a national index or average of indices. FERC determined that there were sufficient national indices to set a reasonable price. For example, Cantor Fitzgerald Brokerage, LP keeps a monthly summary regarding the availability and prices of allowance and disseminates it directly to over 350 parties following the market).

    Recommendation: The Chairman, FERC, should require more frequent reporting of the number and prices of allowances traded.

    Agency Affected: Federal Energy Regulatory Commission

  4. Status: Closed - Implemented

    Comments: On December 15, 1994, FERC issued a "Policy Statement and Interim Rule Regarding Ratemaking Treatment of the Cost of Emissions Allowance in Coordination Rates," in Docket No. PL95-1-000, in response to a filing by EEI. On December 30, 1994, FERC issued a ruling on multistate utility cases on allowances that were filed with FERC by Southern Company Services, Inc. and American Electric Power Service Corporation.

    Recommendation: The Chairman, FERC, should issue guidance on how FERC will treat allowances in ratemaking through a policy statement, notice of proposed rulemaking, or a ruling in one of the multistate utility cases on allowances currently before FERC.

    Agency Affected: Federal Energy Regulatory Commission


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