Document pBO0gGvdq98RvLj3NoY5r16dd

RICHARD M. FAIRBANKS.HZ HENRY L. DIAMOND ALBERT J. BEVERIDGE. HI GARY H.BAI5E A.JAMES BARNES HAROLD HIMMELMAN CHRISTOPHER H. BUCKLEY. JR. JONATHAN Z.CANNON ANDREW E.MISHKIN CHARLES A. PATRI2IA SCOTT W. BOWEN CATHERINE M. DUNLAP KARL 5. BOURDEAU * CYNTHIA A. LEWIS * not MCHtCM or o. c *ah LAW OFFICES Beveridge, Fairbanks & Diamond One Farragut Square South Washington, D. C. 20006 TELEPHONE (202) 63S`7800 September 25, 1978 CARL EAROLEY ELLIOTT GOLDSTEIN OF COUNSEL cable ADDRESS "INDLAW" TELECOPIER (202) 638'4lS4 Mr. Joseph E. Hadley, Jr. Keller & Heckman Suite 1000 1150 17th Street, N.W. Washington, D.C. 20036 Dear Joe: Enclosed is an article entitled "Health and the Environment" from a recent issue of the EPA Journal. This article is written by the Administrator of EPA, Mr. Costle. Please note his assertions with respect to vinyl chloride. Once again, he implies that vinyl chloride at any level can cause cancer. It is this kind of loose talk which continues to hurt the chemical industry. Sincerely yours GHB:jn Enclosure Gary ifc=8STse ucc 105462 ` I, Environmentally Speaking Health and the Environment Ry i '(iiitji'ir, fv1. '.'r;!-; / : ; !- * When the cost of nealth care in America has risen to $ 140 incidence is especially high in communities where there is a billion a year, witn most of this going for after-the-fact heavy concentration of chemical industries. When Dr. David attempts at treatment and cure, it is obvious that we need tBoaltimore of MIT received the Nobel Prize in 1975 for his reo der our national arid individual priorities. How much work linking viruses and cancer, he said: "The role of vi more health-effective and cost-effective it would be if more ruses in cancer is small. The best hope today for cures is emphasis were placed on prevention--on keeping harmful research into environmental causes of cancer." materials out of the air, water, and soil--and out of our Each day, each of us breathes 16,000 quarts of air. They people. often contain a debilitating mixture of sulfur oxides, In the United States, national concern for the environ carbon monoxide, photochemical oxidants, nitrogen mental aspects of public health is of fairly recent origin. dioxide, particulates, and other airborne pollutants. Not until after World War II did we really become aware of We have accumulating evidence that mercury, lead, and the health dangers, both immediate and long term, of many cadmium in the environment can attack the central nervous of the substances we produce, use. and often release into system. We know that fluorocarbons weaken the protective our environment. shield of the ozone layer, greatly increasing the risk of skin The ratio of environmentally-induced disease to all dis cancer. Last year, we acted to ban fluorocarbons in inter eases is large and growing larger. As Dr. Ernst Wynder has state commerce as of April 15, 1979. pointed out. In a society where infectious diseases have There is clear evidence that carbon tetrachloride and bien largely overcome through sanitary measures, immuni chlorinated phenols can damage the liver; ethylene glycol zation, and anti-biotics. the major causes for today's toll are and cadmium sulfate can produce kidney disease; asbestos largely unhealthy lifestyles, unhealthy working environ and beryllium can cause lung disorders; vinyl chloride and ments and disease-producing products." arsenic can cause cancer. The more experience we gain, and the more data we ac Asbestos and chloroform have been found in our drink cumulate on the health effects of pollutants, the deeper our ing water. In fact, we are now aware that chloroform and concerns become. Scientists have developed compelling other trihalomethanes occur in drinkingwater as a result ot evidence that children can contract ghronic and acute dis the way we have been chlorinating that water to make it safe abilities as a result ot air pollution. One study concluded for drinking. So our problems are compounded by the irony that as many as 20 percent of the children in a city such as that, in treating water to protect public health, we can actu New York can develop severe and chronic respiratory dis ally create reactions that c >uld prove harmful. eases. During the 1973-74 oil embargo, the most significant Another chemical trouble spot was the discovery of the factor in a dramatic drop in death rates in the San Francisco widespread contamination of the Nation's waters by poly area--a 13.4 percent decrease compared with the same chlorinated biphenyls (PCB's). Yet another was the revela ptriod over the previous four years--appears to be reduced tion that the pesticide. Kepone, had caused nerve damage exposure to pollutants from auto exhausts. among workers. The World Health Organization estimates that from 60 to 90 percent of all cancer is the result of "environmental factors" in the broadest sense of the term..The rate of cancer deaths is greater than at any time since World War II; the UCC 105463 7 C O A mi IDMA Incidents like these helped to convince Congress to pass the Toxic Substances Control Act. This law marks a recogni tion that we live in a chemical age, and that that age may be a mixed blessing. Those chemicals will be our single great est environmental challenge in the next couple of decades. They seem to be everywhere, if often only in small quantities. The kinds of problems I have just mentioned do not lend themselves to quick-fix solutions. They demand thoughtful, rational, careful analysis and decision-making. And this kind of analysis and decision-making cannot be carried out in a vacuum. Nor can,the problems simply be handed over to government officials, however ethical and competent, with instructions to "solve them--tell us what to do." The problems are deeply rooted in our highly technological industrialized society, and they must be addressed in terms that are not just acceptable to, but in fact arrived at by, that society. For most toxic chemicals, for instance, the decisions are not going to be that clear-cut. We're going to have to make tough judgments about the appropriate degree of control, weighing the risk posed by a given chemical against its economic importance. With the Toxic Substances Control Act, EPA is now required to regulate not just the residues of dangerous chemicals, but their manufacture, use, and distribution.This is a new order and a big one. I believe I am safe in predicting that within a decade this program will dominate all others in EPA. it will shift our emphasis to prevention, to keeping harmful substances out of our air, water and soil, rather than concentrating on cleaning them up after the damage has been done. We have not abandoned our concern with the natural environment. Understanding human impact on the environment pro vides us with critical clues regarding our own present and future well-being (and environmental harm often serves as an "early warning" about potential threats to public health) In addition, there is a close correlation between measures that protect public health and those that protect the environ ment. But we clearly have an increased concern with public health issues. This concern is well illustrated by our strong new focus on toxic chemicals. There is growing concern on the part of the public about what the chemical age has done to its world. Along with thi however, there's also a growing skepticism about how real some of the dangers are. I don't believe that this skepticism means there is a wide spread sentiment for giving up on efforts to deal with new public health threats. In fact, I'm very conscious of a very strong opposite pressure; that is, to get the toxic contami nants out of our air and water so that people won't face being involuntarily exposed to them. However, the response does mean that both public and private officials concerned with health matters have an important responsibility. For governmental agencies like EPA, it means we have ti be candid, laying what we do know about toxic chemicals before the public, but making clear where our knowledge is limited. For industry, it means not attempting to play on the pub lic's doubts. Legitimate concerns about the chemical revolu tion deserve better than a Madison Avenue counter-attack by the private sector. And for the health community, it means making a far greater commitment than has been shown in the past to examining the health effects of toxic chemicals, and to educating the public about such effects. Leaving this duty to government alone is a luxury that this country can no longer afford. JULY/AUGUST 1978 VJQC 105464 THE EMERGING MARKET IN AIR POLLUTION RIGHTS Bruce Yandle If from any revolution in nature the atmosphere became too scanty for the consumption,... air might acquire a very high marketable value. -- John Stuart Mill Principles of Political Economy (1862 edition) F air pollution can be described as a "revo Ilution" in the nature of the "atmosphere," then John Stuart Mill's early observation on air quality may well have come of age. For today we can see the beginnings of the process by which clean air--what is called "air quality" in regulatory language--enters the market. As a result of recent actions by the U.S. Environmental Protection Agency and the Congress, property rights in air pollution emis sions are now being traded, albeit tentatively and in a rudimentary way. A system of marketable air emission rights --that is, rights to emit pollutants into the air --could provide an astonishing array of social benefits. First and of key importance, such a market would make it possible both to hold air emissions to a desired level and to allocate them to those who produced the greatest eco nomic benefits to society. Firms desiring to expand production could do so if the value of their product enabled them to purchase the right to use scarce air quality. The possibility of trading the rights would allow for growth and change. Second, having to pay for air emis sion rights would make the value of air quality obvious to both buyers and sellers, thus leading Bruce Yandle is professor of economics, Clemson University. He wishes to express appreciation to Robert L. Greene for helpful comments and criti cism. UCC 105465 REGULATION, JULY/AUGUST I97S 21 EMERGING MARKET IN AIR POLLUTION RIGHTS A system of marketable air emission rights --that is, rights to emit pollutants into the air--could provide an astonishing array of social benefits. to conservation and an efficient use of pollution control devices. Moreover, the fact that emis sion rights had a cost would cause firms to search for alternative methods of producing their products, thus creating an additional in centive for discovering and implementing new control technologies. After all, by reducing emissions below some established level, a firm could generate a saleable emission right--that is, the right to bring the amount of pollution up to a predetermined level. It is certainly conceivable that an air emis sion rights market could do much of the job being done by environmental regulators. More over, through allocating air emission rights, the market would establish priorities for industrial expansion, while inducing technical efficiency in the control of air emissions. Air quality would be maintained or even improved, effi ciency enhanced, and social conflict reduced. Air Quality: The Costs of Inflexibility Competing uses of air quality (clean air) gen erate conflicts reminiscent of those caused by competing uses of land. But today, instead of pitched battles between farmers who want to cultivate crops and ranchers who want open grazing, we have controversy between those who want cleaner air to breathe and those who demand air-using products such as steel, food, medical care, electricity, and transportation-- with workers who are trying to protect their jobs often joining in. Traditionally, air quality (indeed, the air itself) was treated as a free good--one be longing to everybody. Since there was no ra tioning mechanism, the capacity of the air to assimilate pollutants was used intensely in cer tain locations--which is to say that pollution became a problem. Responding to the clamor of competing air users who were unable to bar gain in a "propertyless" environment (one can not trade pieces of something that belongs generally and in an undifferentiated way to Glossary Regulators and economists, in the course of con ducting their business, invent jargon that is likely to be unfamiliar to most readers. The terms in this article that may need explaining are defined below, in the order of their occur rence. Air quality Generally, the physical and aesthetic character istics of air that relate to a person's level of satisfaction; technically, a measure of a specific amount of a pollutant defined by EPA's "na tional ambient air quality standards." Air emission rights In a strict sense, a legally enforceable property right--a title or deed--to a specified maximum rate of emission for a precise pollutant (for ex ample, 100 tons of S02 a year) in a given place. National ambient air quality standards (NAAQSs) A set of maximum concentration levels for air pollutants that are to be reached and main tained throughout the United States. NAAQSs were provided for by the 1970 Clean Air Act, which established a two-part standard: pri mary standards (to be attained generally by 1975) relate to human health, and secondary standards (to be achieved in "a reasonable time") relate to property, crops, livestock, and public transportation. EPA's regulations cover particulate matter, sulfur oxides, carbon mo noxide, photochemical oxidants, hydrocarbons, and nitrogen oxides. Stationary emission source (major) A structure, building, facility, or operation with "allowable" emissions (after the application of controls) of 100 tons or more a year of particu lates, sulfur oxides, nitrogen oxides, or hydro carbons, or 1,000 tons or more a year of carbon monoxide. Narrowly interpreted, a single sta tionary machine with the emissions noted here. (Mobile sources, by contrast, are automobiles, locomotives, and other wheeled or tracked ve hicles.) State implementation plan An environmental management program de signed by a state to meet the requirements of the Clean Air Act. Includes the identification of stationary emission sources, the development of plans for controlling them, the establishment of procedures for preconstruction review and en forcement, and the assurance of timely attain ment of national air quality standards. 22 AEI JOURNAL ON GOVERNMENT AND SOCIETY UCC 105466 riSHGct EMERGING MARKET IN AIR POLLUTION RIGHTS everyone), Congress passed the Clean Air Act of 1970. That act identified clean air as being in short supply--meaning that, at a price of zero, the amount of clean air demanded for use is greater than the amount available. To deal with this problem, the act set national standards for ambient air quality (the quality of air sur rounding any given place), established dead lines for meeting the standards, and required states to adopt EPA-approved implementation plans to meet them. To this end, specific emis sion standards determined by available tech nology were set for new emitters of pollutants, and construction review procedures were in stituted to make sure the new emitters com plied with the relevant regulations. One effect of the Clean Air Act has been to limit economic growth in areas where ambient air conditions are below the national stand ards (nonattainment areas, in the EPA ver nacular). For example, as a result of the act, a major new emission source (roughly, a build ing or operation emitting 100 tons of certain pollutants annually) may not be allowed in a nonattainment area. The act has also limited growth in "pristine" areas, such as those con taining national parks. Thus, development has been restricted in some places because they are clean, and in others because they are dirty. Predictably, contention over air quality standards developed between forces favoring industrial development and those that were more concerned about the natural environ ment. In some cases, the cost of improved en vironmental quality was so high as to be almost unbearable--so high, in fact, that com promises had to be made. For example, in the winter of 1973-74, EPA granted a total of seven ty-seven emergency variances for sulfur diox ide emissions to ease the conversion from burn ing Arab oil to burning higher sulfur coal. An other compromise, noted by Allen Kneese and Charles L. Schultze, occurred in 1973 when EPA relaxed its more stringent emission control ap proach and permitted the use of tall smoke stacks for dispersing sulfur oxides from smelt ers and power plants. At the time, the smoke stack approach appeared to be the only alterna tive to plant shutdowns. While too many compromises may have been made for desired quality standards to be met, these compromises were thought to be proper at the time--that is, thought to make possible less painful and sufficient progress to ward the attainment of national standards. Certainly EPA's task of managing things so as to achieve its goals and still allow some flexibil ity was not easy. As it became apparent that progress toward meeting national air quality standards was too slow, and as environmental regulators therefore grew less inclined to make exceptions, it was recognized that the air qual ity standards allowed little room for industrial growth in regions that were behind schedule in achieving cleaner air. Ultimately this had to lead to a confronta tion between costs and benefits. Thus, in No vember 1976, EPA explicitly considered--but rejected--a trade-off policy that would balance economic costs and air quality benefits: Some have argued that a new source should be allowed to worsen existing [air quality] violations if a "cost-benefit" analy sis indicates that the economic costs of necessary emission controls . . . are exces- sive in relation to the resulting air quality benefits ... [but] the Clean Air Act simply does not allow such an approach. Applica tion of such a policy could allow further delay in achieving already-overdue stand ards. [41 Federal Register 55527] In other words, EPA was saying, the act treats the damage that additional emissions cause in nonattainment areas as infinite in value. The 1970 Clean Air Act was like a first landuse zoning ordinance in that it had to provide for both conforming and nonconforming users. The act implicitly gave initial air emission rights (not called that in the act) to firms in both categories. However, thj quantity of rights the nonconform ing firms received fell short of the quantity they were already using --the shortfall, of course, measuring the im provement that had to be made. While the right*; were important (because firms could not operate without them), their potential value was reduced by the fact that they could be used only for existing plants--not even by existing firms for their other plants. The rights could not be sold, bartered, or stored for future use-- nor, indeed, were they strictly defined. If direct transfers of rights had been allowed, it is con ceivable that a market would have developed at that time. Potential users would have paid for air emission rights in particular locations; and those who preferred cleaner air might have UCC 105467 REGULATION. JULY/AUGUST 197* 23 EMERGING MARKET IN AIR POLLUTION RIGHTS joined together to buy rights and hold them, thereby expressing their true demand for air quality. But since rights were not transferable, the advocates of cleaner air turned to the po litical process and the courts as their avenues for expressing their preferences; and the firm that wished to expand either met the standard or perhaps acquired an existing plant, merged, or adapted one of its own plants to produce a similar product without changing the level and types of emissions. In nonattainment areas, EPA attempted to assist firms that wished to expand existing emission sources (existing plants), but was not so flexible for new plants that would be major sources of emissions. Under a strict interpretation of the air quality controls, there are two kinds of prob lems for expanding firms: First, since new ma jor sources of emissions are excluded from certain regions, managements may have to set tle for second-best locations. (While the social costs and benefits of settling for second' best are not clear, what is clear is that some regions gain air quality as a result, while others gain in come and goods, and all of society most likely pays more for food, health care, education, clothes, soft drinks, and many other products.) Second, existing firms that wish to expand by building new emission sources are treated much the same whether or not they are al ready operating plants in the area. (While some assistance may be offered to help in meeting standards, it may not be enough to prevent the expanding firm from having to move to another location.) In either case, the adjustment costs of settling for second best or of holding down growth are in addition to the direct costs of treating air discharge. According to estimates by the Council on Environmental Quality, the direct costs alone for controlling air pollution from stationary sources will total $74.3 billion over the ten-year period 1975-84. Both adjust ment and direct costs could be reduced if ex changes of emission rights were encouraged. A Market Begins Logically enough, EPA's shift to a stricter pol icy on new sources of pollution forced it to con front the problem of in-plant expansion (but not so much, to start with, the problem of in firm expansion generally). In the course of the summer and fall of 1976, certain kinds of inter nal trade-offs began to be allowed on a case-bycase basis, the initiative apparently coming from EPA officials in no-growth areas. Thus, EPA might approve an expansion in one pro duction operation if the resulting increases in a particular kind of emission were more than offset by reductions in the same emission from another source in the same plant. For example, a steel producer might expand production by replacing open-hearth furnaces with basic oxy gen furnaces of a larger capacity. Internal trade-offs of this kind brought valuable flexibil ity, giving managements some room to achieve certain of their growth objectives by adjusting both product mix and production technique. Plant-specific emission rights had begun to emerge and property rights in air quality use had reached the barter stage. This result may not have been intended by EPA--indeed, it seems not to have been--but nonetheless a crude and limited market was taking shape. (Opportunities for using this market were, however, restricted somewhat by later court decisions.) More specific possibilities for expanding the air emission market developed about the same time. In a speech on November 17, 1976, John R. Quarles, then deputy administrator of the Environmental Protection Agency, pro posed that industrial expansion be made possi ble in nonattainment areas by allowing firms to trade their emission rights. Quarles went on to suggest that firms seeking to grow either by expanding their operations in one area or by moving into a new area would be allowed to obtain emission rights from existing emission sources in the same area. As with internal trade offs, a greater than oue-for-one emission offset was a given requirement. While recognizing that the offset idea was not perfect, Quarles said it was the only policy that would satisfy th~ Clean Air Act "without imposing intolerable restrictions on growth." Not all reactions to Quarles's suggestion were favorable. Bethlehem Steel, for example, ran half-page advertisements in major news papers calling the policy a "Catch-22." Bethle hem was saying, in effect, that air emission rights could not be found in areas convenient to its markets. Industrialists in Texas expressed a similar concern about petrochemical produc tion: how could firms in the same industry 24 AEI JOURNAL ON GOVERNMENT AND SOCIETY VJCC 105468 .'rifljjSa EMERGING MARKET IN AIR POLLUTION RIGHTS possibly generate a greater than one-for-one off set? (Journal of Commerce, May 25, 1977.) On ... John R. Quarles ... proposed that in dustrial expansion be made possible in non attainment areas by allowing firms to trade their emission rights. the other hand, environmentalists charged that the trade-off proposal would let the camel's nose under the tent--a little dirt today, a lot more dirt tomorrow. Their concern might have been somewhat relieved had Quarles's an nouncement not been so limited--that is, if it had allowed for the purchase of offsets by all of the interested parties. As an example of some of the problems of a trade-off policy, let us consider the Sohio case. For three years, Standard Oil of Ohio (Sohio) had been seeking permission to build a pipeline terminal near Long Beach, Califor nia, in order to bring Alaskan Slope oil to the U.S. market, but its efforts had been blocked by California's regional air plan. Without the ter minal, the oil would have to be shipped around South America or through the Panama Canal (in smaller tankers) to Texas--or, possibly, to Japanese refineries from whence finished products would be reshipped to the U.S. market. ... environmentalists charged that the trade-off proposal would let the camel's nose under the tent--a little dirt today, a lot more dirt tomorrow. Then Sohio offered a solution to the im passe. It would purchase an old (and polluting) facility in the Long Beach area, close it, and build the new (and cleaner) pipeline terminal. The transfer of emission rights from the old to the new facility was explicit in the offer--as was the idea that, after the transfer, these rights would have a new and higher value both to Sohio and society. The fact that a voluntary exchange could result in both cleaner air and more oil for U.S. consumers had appeal. But it was not yet clear just how widely the trade-off policy would be applied. Moreover, Sohio's of fer was somewhat experimental. Many legal and technical questions would have to be answered before an actual trade could be permitted. The Regulators Respond EPA, recognizing that the trade-off policy was a matter of considerable public interest, sought public comment on the idea through an "in terpretative ruling" published on December 21, 1976. The ruling, without ever using these words, outlined the conditions for an extremely limited market in emission rights for nonat tainment areas--but a real market nonetheless. The ruling provides in general that a ma jor new source may locate in an area with air quality worse than a national standard only if stringent conditions can be met. These conditions are designed to insure that the new source's emissions will be controlled to the greatest degree possible; that more than equivalent offsetting emis sions (emissions offsets) will be obtained from existing sources.... [41 Federal Reg ister 55525] Respondents to EPA's announcement asked (1) whether states would be able to tighten emission standards for existing sources, making them more severe than national stand ards, in order to release air emission rights for use by other (new) sources, (2) whether a source would be able to persuade (or pay) a competing source to further control its emis sions in order to permit the new source to be built, and (3) whether states would be required to develop a new regulation for each emission offset situation [41 federal Register 55526]. EPA answered that states could set standards more stringent than those of the federal gov ernment, but would not be required to become air emission brokers. State regulators would enforce standards, review construction permit requests to ensure that they met requirements, and approve emission exchanges if offsets were included in an EPA-approved state plan. The 1977 amendments to the Clean Air Act (enacted August 7, 1977) allow EPA's inter pretative ruling to continue in operation for nonattainment areas until July 1, 1979. At that time, any nonattainment area not covered by a state implementation plan that ensures re- UCC 105469 REGULATION. JULY/AUGUST 197* 25 -rJLatttni EMERGING MARKET IN AIR POLLUTION RIGHTS gional achievement of national air quality standards by December 31,1982, will face a ban on new major sources of emissions--in effect, a limited industrial growth situation. If a state initiates an offset-trading program, that pro gram can continue until July 1, 1979, and be yond under EPA-approved, state-operated ar rangements. The Limited Market It is clear that EPA's interpretative ruling set in motion a crude but limited market mecha nism. Along with the requirement that non attainment areas demonstrate progress toward meeting national air quality standards, the rules of the market appear to be these: (1) In treating its discharge, new major emission sources must use a technology that yields "the lowest achievable rate of emission." This means that a new source cannot gain ad ditional emission rights by shifting from an in ferior to a superior technology. Nor can it sell existing rights if new, cleaner technology is developed. (2) Only the same kinds of emissions are subject to exchange. For example, emissions of SO, may be substituted for emissions of SO,. (3) An emission offset of more than onefor-one is required, or, to put it another way, each transaction carries an in-kind tax. (4) There can be no banking of emission credits or rights, for these must be used or lost. Also, there can be no net sales or pur chases. (5) Only parties desiring to build new emission sources can enter the market as buy ers. Proponents of improved air quality cannot buy emission rights and destroy or hold them. Just how much flexibility does this policy allow? In what circumstances will there be a market? It is unlikely that a firm seeking to expand a plant will find room within the present rules for fruitful negotiations with a direct competi tor. Both firms will tend to have the same costs and the same value for their products, and also to have emission standards based on similar treatment technology. Of course, firms or plants on the verge of going out of business may be po tential offset sellers, but their number would be limited. This leaves plants from different indus tries (and the firms owning them) as the po tential bargainers. A firm desiring to enter a region where no additional emissions are permitted may nego tiate with an existing firm that discharges the same emission but produces a different prod uct. Successful bargains can be struck if the right to discharge pollutants is sufficiently valu able to the entering firm. In fact, it might be possible for an entering firm to offer enough to enable the existing firm to treat its emissions more than required by the standard, thereby releasing additional air emission rights and en abling both firms to operate. Alternatively, an existing firm might be induced to reduce its output and thereby its emissions. Again, both the new and the existing plant could operate (the latter at a reduced level), and air emission rights would tend to be allocated to their most beneficial use. The offset policy offers some flexibility, but the market is certainly limited. Current Transactions in the Market The Sohio case illustrates the possibilities that EPA's new policy offers to firms wishing to ex pand in nonattainment regions. Under the rul ing, California's South Coast Air Quality Man agement District has overseen Sohio's effort to find offsets for hydrocarbons, sulfur dioxide, and other emissions that its proposed pipeline terminal would generate. When its original trade-off proposal did not work out, Sohio be- 26 AEI JOURNAL ON GOVERNMENT AND SOCIETY UCC 105470 -jaksai EMERGING MARKET IN AIR POLLUTION RIGHTS gan to pursue the same scheme in separate ne gotiations with three major Long Beach drycleaning establishments and with California Edison. The three dry-cleaners have agreed to equip their plants with tighter emission con trols (reportedly at the oil company's ex pense), thereby releasing emission rights to Sohio. California Edison has agreed to the same arrangement. As of now, Sohio, its engineering studies reportedly completed and its purchase orders for the two transactions standing by, is awaiting final decisions by the state and federal regulators. The value of these transactions is estimated at approximately $90 million. The Sohio case raised major environmen tal questions that were considered and an swered in public hearings and negotiations. One crucial question was, how much greater than one-for-one should the offset ratio be? At this point, Sohio has been told to plan on the basis of a two-for-one exchange on sulfur dioxide and up to a 7.2-for-one exchange on hydrocarbons. Proponents of clean air see the trade-off ruling as beneficial: with a two-for-one offset, two units of sulfur dioxide would be removed by Sohio for every one unit added, for a net gain from the trade-off of one. On the other hand, those concerned about production costs note that the cost of reducing emissions rises as those easiest to control are eliminated, so that each additional offset in an area becomes more expensive than the one before. Sohio's search has been a difficult one, and indeed it may turn out that many efforts to find offsets will only uncover violators of existing emission standards--will lead, in other words, not to new "emission rights" but only to the elimination of present violations. Even so, the emission rights market can still offer net bene fits when an approved transaction occurs. While the Sohio case illustrates a potential transaction under EPA's policy, the cases of Volkswagen's Pennsylvania plant and General Motors' Oklahoma City plant illustrate actual transactions. In both of these cases, emission offsets had to be obtained to compensate for hydrocarbons from paint lines and other man ufacturing operations. For a time it appeared that VW would not be able to operate its U.S. facility but, after considerable search, the state of Pennsylvania came up with the necessary off set, by agreeing to reduce its own emissions of hydrocarbons from asphalt processing and pav ing. In the GM case a refinery in Oklahoma City installed improved controls (without be ing compensated), reducing its emissions in order to make room for GM's. A trade-off similar to VW's occurred in Vir ginia when the Hampton Roads Refinery sought a construction permit and the state of Virginia made adjustments in its asphalt operations so as to allow construction. While there might be some costs to taxpayers in these states as a re sult of these barter transactions (more costly paving operations for public works, for ex ample), there might also be benefits in the form of increased tax revenues, reduced unemploy ment, and cleaner air. Gains in efficiency are, of course, difficult to assess when a public body--a state, for in stance-changes its operations in order to as sist a private firm. Nevertheless, it is possible that the transferability of emission rights could lead to improvements in a state's own environ mental control. It is also possible, however, that a state might act so as to put the burden of a new plant's emissions solely on the taxpayers and, figuring emission rights therefore to be costless, continue to seek new industiy. In any event, the transactions that have so far oc curred--both private and public--imply that air emission rights (like property rights to land and other resources) are transferable and may be of greater social value when used in ways differing from their current use. Improving the Emission Rights Market To be sure, EPA's emission rights market is only embryonic and contains a number of im perfections that firms might exploit. Since emission rights cannot be banked, some firms might delay adopting the best treatment tech niques in the hope of selling out before the ax fall*. Firms entering the market might like wise behave "strategically"--might, since emis sion rights acquired from other firms must be used or lost (cannot be resold), be less than fully diligent in operating their emissions con trol systems. Allowing the banking of the rights or their (unrestricted) sale would limit behav ior of this sort. Moreover, since the emission rights ob tained by newly constructed plants cannot be held for future use--that is, the only rights that UCC 105471 REGULATION. JULY/AUGUST 1978 27  -.> i '> m * EMERGING MARKET IN AIR POLLUTION RIGHTS can be used are those obtained in accordance with the original EPA-approved plan--a firm needing emission rights will look to the short rather than the long run and will obtain only the amount that fits its immediate needs. If that firm decides to increase its output two or three years later, it will have to wait till con struction plans are approved before purchas ing the necessary new emission rights--at whatever the going price is then. If rights were bankable, a growing firm could plan and invest more rationally for emission control than it can now. Thus, by precluding the development of a "futures" market in air emission rights, EPA may be limiting the time horizon for pollution control planning and thereby limiting progress toward cleaner air. The "use them or lose them" policy may indeed provide certainty, though it is certainty of the wrong kind. Contrariwise, there may be insufficient certainty of other kinds. First, any change in a state's overall air quality plan, in the national ambient air quality standards, or in the clean air statute could change the value of all emission rights. Indeed, a change in the direction of more stringent standards could eliminate some emission rights entirely. Emis sion rights, like any property right, require government protection. If it is uncertain that government will protect them, firms will sharp ly discount the future value of the rights, and only those transactions that give promise of high return will be likely to occur. Air quality regulators could reduce uncertainty and there by push forward the investment horizons of emission rights' purchasers by carefully defin ing all emission rights and by strictly enforcing requirements that emissions be monitored. (Monitoring would protect the nascent prop erty right.) State authorities could add protec tion to the new property rights by keeping other air quality users from "poaching" and by ensuring some minimum life to emission rights at the time of an approved exchange. One other problem deserves mention. As noted, requiring a more than one-for-one offset will lead to reduced emissions when trade-off transactions are made. It will also, however, re duce the number of transactions that occur, since it makes emission rights more expensive when traded than when held (that is, there is a tax on the transaction). This will encourage less efficient users of these rights to hold on to --and use--the rights they have, rather than trading them to more efficient users. The effi ciency of the market in rights is thus substan tially reduced. An Expanded Market Alternative The problem of limiting pollution emissions into the air is fundamentally the same as the problem faced when any resource becomes scarce: somehow society must bring about the The problem of limiting pollution emis sions into the air is fundamentally the same as the problem faced when any re source becomes scarce: somehow society must bring about the birth of a market. birth of a market. The approach taken by EPA and the Congress represents one stage in the birth struggle. While EPA's interpretative rul ing of December 1976 gives explicit recognition to market forces, further moves could be made to maintain or improve air quality and also ameliorate the shortcomings noted in the pres ent policy. Consider, for example, a system in which state authorities, after defining the amounts of specific emissions that could be absorbed (in our case, by the atmosphere) in a given region or market, could simply hold an auction for rights to discharge those emissions, letting any one bid. In calculating their bids, firms would have to consider the costs of alternative treat ment, of moving, and of siiutting down. And those who wished to remove the rights from the market in order to prevent the emissions alto gether would have to consider other ways in which they might attain their goals. (This is to i,ay that all opportunity costs would be consid ered.) Furthermore, those who happened to be earning extra profits because of the "free" air quality with which they were endowed by loca tion would face the costs they had previously not faced. All users of air emission rights would have the opportunity to gain the continued use of the rights at a cost. Their calculations would take into account future revenues, benefits, and costs and should produce a fairly complete identification of demand. Once the auction were 28 AEI JOURNAL ON GOVERNMENT AND SOCIETY UCC105472 'Ajsntw&Qi EMERGING MARKET IN AIR POLLUTION RIGHTS completed, emission rights would be like any other private property: owners would respond to changing market conditions by buying and selling as they saw fit. (The system described here is like the one proposed for water quality by J. H. Dales.) In this system, the first definition of rights would set the maximum amount of discharge --that is, the amount that could not be legally exceeded. As with the offset market, there would be wealth distribution questions to con sider here if existing plants obtained saleable assets through the first definition of emissions. But, in our case, if the government desired to improve the conditions of overall air quality resulting from the auction (remember that some rights might be banked or simply de stroyed), it would have to enter the market and purchase rights like any other buyer. A full market to a limited quantity of rights would be in operation. Conclusion The process by which a previously "free" nat ural resource enters into a market--that is, the process by which scarcity is recognized, rights established, defined and guaranteed, and the market created--is not an easy one. For this reason, any market in air emission rights may be somewhat limited, perhaps for a consider able time, perhaps permanently. But the mar ket for land is also limited. Owners of land may be required to follow performance standards and zoning ordinances. Excavation, mining, sewage, and waste-disposal requirements fur ther reduce the number of potential property rights that are subject to free market forces. Moreover, in some places land is owned by the state and leased for controlled uses. Still, there is a functioning market for land in which sig nificant rights are freely traded. One might expect to see similar develop ments in the market for air emission rights, as it evolves. The property rights approach al lowed by EPA's ruling and subsequently con tained in the 1977 Clean Air Amendments is akin to land's being zoned and then bought and sold. An alternative approach would be for the government to determine, as it sometimes does with land, what amount (of air quality in our case) is to be used, to hold title to that amount, and to lease certain units of it for ap proved purposes. An air emission fee or charge might accomplish this, the fee perhaps rising and falling to allocate the fixed number of units among prospective users, much as rents rise and fall to allocate housing. Either an air emission rights approach or a fee approach would induce cost-effective be havior on the part of polluters--that is, lead them to find the least-cost way of producing goods, given the cost of air use. Despite the im proved procedures, however, an unsettled ques tion remains: what is the optimal amount of air quality to be marketed? Given that we lack answers to this question and given the public's unwillingness to release the question for a market answer, we are not likely to achieve total efficiency. But society might wish at least to encourage cost-effective behavior. The steps taken by EPA may be historic: we may indeed have witnessed the first day of a new market. It is a market created not in the twinkling of an eye by government fiat but in a give-and-take process involving industry, envi ronmental groups, and EPA. None of these set out to create a market or saw the first halting steps for what they were. But if the policy dis cussed here continues to be successfully carried out, air quality will have joined land, bread, water, and even peanut butter as another prod uct too valuable to keep out of the market. And John Stuart Mill will have called the shot cor rectly. Selected References Council on Wage and Price Stability. "Air Quality Standards: Interpretative Ruling." Comments be fore the U.S. Environmental Protection Agency, March 3, 1977. Dales, J. H. Pollution, Property and Prices. Toronto: University of Toronto Press, 1968. Hite, James C.; Macaulay, Hugh H.; Stepp, James M.; and Yandle, Bruce, Jr. The Economics of En vironmental Quality. Washington, D.C.: American Enterprise Institute, 1972. Kneese, Allen V., and Schultze, Charles L. Pollution, Prices and Public Policy. Washington, D.C.: The Brookings Institution, 1975. Macaulay, Hugh H., and Yandle, Bruce. Environ mental Use and the Market. Lexington, Mass.: D. C. Heath and Company, 1977. Quarles, John R., Jr. "To Grow or Not to Grow-- That Is Not the Question." Fifth Annual Interna tional Pollution Engineering Conference, Ana heim, California, November 10, 1976. UCC 105473 REGULATION. JULY/AUGUST 1*7* 29