Where We Are in 2008 and Lessons for Future Cap and Trade Programs

1. Where We Are in 2008 and Lessons for Future Cap and Trade Programs for the Spring Environmental Marketing Association Meeting Sam Napolitano U.S. Environmental Protection Agency Office of Air and Radiation April 2009

2. Overview • EPA’s cap and trade program results • CAIR • Title IV (Acid Rain SO2 Program) • NOx SIP Call (NOx Budget Trading Program) • Key lessons learned • Elements of a good climate change cap and trade program

3. Clean Air Interstate Rule • December 23, 2008 District Court decision remanded CAIR rule to EPA without vacatur • January 1, 2009 first annual NOx cap and trade program commenced smoothly • May 1, 2009 CAIR ozone season program begins • January 1, 2010 CAIR SO2 program begins • EPA is undertaking the rule replacement process and has held 9 listening sessions with stakeholders • One thing everyone agrees on: fix the rule so it holds up in Court next time

4. SO2 Emissions Have Fallen from 1990-2008 * 2008 SO2 Emissions are Preliminary

5. Acid Rain Levels Have Dropped Annual Mean Wet Sulfate Deposition 2005-2007 Average 1989-1991 Average

6. Acid Rain SO2 Annual Program Costs: Much Lower than Originally Predicted

7. Summertime NOx Emission Have Fallen Total NBP NOx Emissions in 2008 Were 481,421 Tons NBP sources reduced ozone season (May- September) NOX emissions by approximately • 9% below the 2008 cap, along with a 6% increase in heat input • 62% from 2000 (before implementation of the NBP) • 75% from 1990 (before implementation of the Clean Air Act Amendments)

8. 64% of Areas in the East Designated Nonattainment in 2004 Met Standard in 2007

9. 2008 Coal Controls for SO2 and NOX Virtually all coal-fired units have electrostatic precipitators, baghouses, or other advanced controls for high levels of particulate removal. Source: Updated NEEDS and Data & Maps, EPA, 2009

10. Key Lessons From Existing Programs • Cap and trade costs less than direct control, thus EPA can pursue more substantial emissions reductions than would be otherwise attainable. • Caps, not allocation methodology or trading, protect the environment. • Well-crafted legislation makes program implementation and compliance more straightforward and timely. • CAA’s 1990 Title IV Acid Rain Program vs CAIR • Cap and trade complements other approaches. • CAA Title IV and NOx Budget Trading Program get broad regional reductions • CAA Title I provisions address local concerns • Allowance banking lowers cost, helps reduce volatility, and enables early emissions reductions providing early benefits. • CAA Title IV vs RECLAIM and first phase EUETS • Accountability and information transparency help reduce volatility and are keys to program success and acceptance. • CAA Title IV vs first phase EUETS • Simplify rules and obligations as much as possible. • Complexity increases administrative and compliance costs and opportunities for market manipulation.

11. Cap and Trade Design Elements • Timing and levels • Coverage and point of regulation • Offsets • Other forms of cost containment • Allowance distribution and auction • Market oversight • Other important considerations

12. Timing and Levels • Cumulative reductions are more important than reductions in any one year • The reduction pathway matters: banking is key to stimulating early reductions and lowering costs • Choosing a cap is dependent on several factors: • Quantity of global reductions necessary to lessen impacts • Economic and technical feasibility • International action • Other domestic policy decisions (e.g., cost containment, complementary measures) • Long-term goal will provide investment certainty but should allow for future re-evaluation

13. Cost Containment • A well designed cap and trade program is a cost containment measure • Poorly designed systems drive up costs • Uncertainty can impact technology development • Specific containment measures should be: • Targeted • Transparent • Limited in scope • Simple to administer • Integral to the setting of timing and levels, but should not interfere with the functioning of the cap and trade program

14. Potential Cost Containment Mechanisms • Banking • Borrowing • Offsets • International Trading • Safety Valve – allows purchase of additional allowances at certain price. • Allowance Reserve– limited number of allowances available from within cap. • Allowance Cushion – limited number of allowances available above cap. • Carbon Market Efficiency Board

15. Allowance Distribution and Auction • Appropriate level of detail in legislation • Generally allocate at the point of regulation • Consider unique circumstances that could affect impact of allocation methodology and price signals • Allocation considerations: • Level of allocation over time • Assistance to sectors facing international competition • Lost investment value • Existing sources relative to new ones • Auction design considerations: • Reserve price and disposition of unsold allowances • Frequency • Multiple vintages per auction • Participation, bidding limits, disclosure requirements • Administration • Proportion of allowances auctioned over time • Potential uses of auction revenue (R&D, equity, revenue recycling)

16. Market Oversight • Market oversight functions • Explain market changes/price fluctuations • Identify dysfunctions, weaknesses, areas of improvement • Discover fraud or misconduct • Existing authorities • Commodity Futures and Trading Commission (CFTC) • Federal Energy Regulatory Commission (FERC) • EPA for various aspects of trading • Confidence is important for a well-functioning market. • Market manipulation can take time to detect and cross over to multiple commodities (e.g., allowance prices, fuels markets) . • Allowances now traded through a number of channels, with varying amounts of oversight. • Speculation in energy markets and financial crisis are drawing attention.

17. Other Important Considerations • Emissions measurement, reporting and verification • Cap and trade requires a complete record of total emissions from each affected source and frequent and timely emissions reporting to instill confidence in the market and facilitate compliance. • Measurement methods should create incentives for greater accuracy. • Linking • Linking with other mandatory cap and trade programs increases market size, and can lower overall system costs and increase liquidity. • Some design features make linking difficult – safety valves, rate-based trading, voluntary compliance, weak or ineffective monitoring and compliance, and offset programs that do not guarantee additionality. • Competitiveness • The cap and trade system design will need to address concerns about competition from countries without caps or other GHG policies and be consistent with international trade agreements.

18. Clean Air Markets www.epa.gov/airmarkets Visit the Clean Air Markets web site to view: • Emissions data • Allowance transfers • Program rules and guidelines • Studies and reports See new updated Cap and Trade Section of website: http://www.epa.gov/captrade/index.html