Jack P. Broadbent
Assistant Deputy Executive Officer
Tracy A. Goss
Air Quality Specialist
South Coast Air Quality Management District
21865 E. Copley Drive
Diamond Bar, CA 19765
The Los Angeles region suffers from the worst air pollution levels in the United States. The South Coast Air Quality Management District (District) has developed the Regional Clean Air Incentives Market (RECLAIM) program for reducing air contaminant emissions, which relies on allocating air pollution credits to major sources in the region. This paper discusses the allocation methodology, trading program, and enforcement objectives of the RECLAIM program. It also reviews the lessons learned from this program for application to other allocation schemes.
The South Coast Air Quality Management District (District) has developed an innovative program to achieve the goal of clean air for the greater Los Angeles region. The Regional Clean Air Incentives Market (RECLAIM) is a market-based regulatory program that represents a departure from the traditional method of reducing air pollution emissions from facilities. The RECLAIM program regulates the largest stationary sources of oxides of nitrogen (NOx) and oxides of sulfur (SOx), which are primarily emitted from combustion equipment. It provides a non-prescriptive regulatory approach based on market incentives that allows facilities more flexibility in meeting environmental goals at lesser cost. The RECLAIM program was adopted in October 1993 and implemented in January of the following year.
The District regulates stationary sources in Los Angeles, Orange, Riverside, and the non-desert portion of San Bernardino County. This region is referred to as the South Coast Air Basin (Basin). The Basin is in non-attainment with both state and federal standards for ozone, of which NOx is a precursor. The Basin is the only area in the United States in extreme non-attainment for ozone. The Basin is also in non-attainment for NOx, but it has met the federal standard for nitrogen dioxide (NO2). Although the Basin is in attainment for sulfur dioxide, it is not in attainment for fine particulate matter (PM10), for which sulfur dioxide is a precursor.
For the past 40 years, environmental regulations have largely been based on command-and-control regulations. The method of control was simple and straightforward: define the problem emissions; set the standards to reduce the emissions; and regulate the activity in question.
Command-and-control regulations for the reduction of air contaminant emissions, particularly over the last ten years, have been broadened to include reduction requirements for smaller businesses and consumer products representing a variety of industries. As a result of these efforts, there has been a notable improvement in air quality. However, population growth in Southern California continues at a steady rate. By the year 2010, the region's population is expected to increase from 15 million to 22 million. Recognizing this growth, all sources will need (on average) to reduce emissions by 70 percent in order to achieve the federal public health standard for ozone and PM10 by 2010. Market incentives can be a viable and cost-effective alternative for reducing air contaminant emissions.
The development of the RECLAIM program began in 1990, when the District began to explore market incentives as a more cost-effective means to promote air pollution control. In February 1991, the District focused its investigation on the feasibility of an emission credit trading program.
The objective was to design a regulatory structure that would be equal to and better than the existing command-and-control rules. The goal was to develop an enforceable program that would lower the cost of attaining clean air.
Through the Feasibility Study, a series of five working papers were developed. The first four papers set forth the framework for an emissions trading program, while the fifth evaluated the potential socioeconomic and air quality impacts of the program. Recommendations from these five working papers were refined to form the proposal for the RECLAIM program. In March 1992, the District initiated rule development.
Throughout the Feasibility Study, program elements were consistently evaluated against five criteria: greater or equal level of enforcement than the existing system; greater or equal emission reductions (Air Quality) than the 1991 AQMP; lower implementation costs than the 1991 AQMP; fewer job impacts than the 1991 AQMP; and fewer public health impacts as a result of program implementation. As rule development began, these criteria were transformed into rule development goals for the formation of the administrative structure of the program.
As rule development began, the District formed ten working groups to assist in the development of the various components of the program. The working groups provided input relative to the development of an allocation methodology, structure of the trading market, monitoring protocols, enforcement and compliance, mobile source credits, energy impacts, and socioeconomic impacts. The most contentious issue was the development of the allocation methodology.
Along the way, the draft rules went through five revisions. A full Environmental and Socioeconomic Report was prepared and, in October 1993, after two hearings and 12 hours of testimony, the NOx and SOx RECLAIM regulations were adopted.
The RECLAIM program is based on the concept of "bubbling" emissions at the facility level, limiting total mass emissions from each facility, and requiring facilities to meet annual emission reduction targets. Each facility will have flexibility in determining how to comply with its facility limit. Choices may include installing pollution control equipment, using reformulated materials or buying emission credits from other facilities.
RECLAIM was developed to give affected facilities the flexibility to reduce emissions in the most cost-effective manner. The program is designed to incentivize technology advancement as facilities reduce their mass emissions.
While the District has developed and is implementing a number of market incentive programs (including annual emission fees, mobile source offsets, bubbling and averaging periods, delayed compliance schedules for aerospace operations, and new source offset trading), the RECLAIM program is a much broader application of a market incentives program because it covers multiple pollutants across multiple industries.
Which facilities to include in RECLAIM was determined based on the objective of developing a strong market for each of the pollutants to be regulated. A strong market should capture the greatest fraction of the emissions inventory with a manageable number of sources, thus minimizing the administrative burden. Careful consideration was given to the economic competitiveness of businesses as well as to the market impacts that could result from excluding certain industries from RECLAIM. Fairness relative to emissions reduction potential was also considered.
The RECLAIM program applies to a wide variety of industries. These include combustion sources such as metal melting facilities, electric utilities, and petroleum refineries. The District regulates approximately 31,300 stationary sources; of these, approximately 6,600 emit NOx, and 950 emit SOx. This represents the maximum number of sources in each market.
All facilities with permitted emissions greater than four tons per year of NOx or SOx, are included in the program. Given certain specified exemptions for facilities, such as landfill gas control, hospitals, universities, and other public-type facilities, RECLAIM regulates more than 350 of the largest sources of NOx and SOx in the Basin.
One of the most critical components of RECLAIM is the annual emissions allotment, or allocations, for the facilities in the program. Each facility's Allocation is determined by selecting the facility's highest annual reported activity from 1989, 1990, 1991, or 1992. This activity is based on throughput that is then multiplied by an emissions factor that represents implementation of existing requirements through December 31, 1993. In addition, emission reduction credits (ERCs) resulting from real, permanent, and quantifiable emission reductions, and external offsets that were provided for New Source Review purposes have been added to each facility's Allocation.
Each RECLAIM facility receives non-tradeable emissions credits equal to the difference between the highest year's emissions between 1987 and 1991, and the Allocation. The non-tradeable credit will be devalued by one-third each year for three years. The non-tradeable credit may be used only for increased hours of operation or throughput. To utilize the non-tradeable credit, the facility must pay an impact mitigation fee of $5,000 per ton. In the event a facility sells any tradeable RTCs, the non-tradeable credits become invalid and are no longer available to the facility.
Along with allocations, emissions trading is an integral part of the market incentives program. RECLAIM allows each facility the option to reduce its own emissions or buy credits from another facility to offset their excess emissions. Facilities that reduce emissions through production, material, or equipment modifications can recapture portions of their compliance costs by selling their excess emission reductions on the open market. The District tracks RTCs and verifies that the seller has made the emission reductions. RTCs are bought and sold in pounds of pollutant (either NOx or SOx) per year.
An RTC may be bought, sold, traded or otherwise transferred or acquired. RTCs may not be used as collateral or security for indebtedness. RTCs are also not a security or property within the meaning of the California state or federal constitutions. It can, however, be treated as a commodity. The District has the authority to limit, suspend, or terminate any RTCs, or the authorization to emit.
A provision is contained within RECLAIM that calls for a program evaluation in the event the price of RTCs reach a certain level. Prices are based on supply-and-demand. If prices get too high, the trading market function could hinder the benefits of the program. In this event, amendments to the program may be necessary to, in effect, lower RTC prices to a more reasonable level.
In the NOx and SOx markets, facilities are divided into two compliance cycles. The first compliance cycle runs from January 1 to December 31 of each year. Cycle two runs from July 1 to June 30 of each year. Since RECLAIM is based on annual allocations, and since the two cycles overlap by six months, facilities are able to trade between cycles. This helps ensure that RTCs will be available and provides a liquid market with better price stability.
As a part of the program, each facility must monitor emissions, maintain records, and report emissions in accordance with guidelines specified in the enforcement protocols. The largest facilities are required to monitor NOx and SOx emissions via continuous emissions monitors. The amount of emissions released into the atmosphere are electronically reported daily to the District in 15-minute intervals. Smaller sources monitor their emissions by establishing emissions concentration levels or by utilizing fuel usage reports. Emissions from these sources are reported in a less frequent time frame. Source testing at the facility also plays a major role in monitoring. In order to verify compliance, emissions are tracked and analyzed through a District central computer. In addition, regular facility inspections and audits of emissions records and reporting activities are conducted.
The key to the development of the RECLAIM program was consensus building involving all parties affected by the program. This included various business and environmental groups, as well as local, state, and federal agencies.
As a part of the Feasibility Study, the District established a Steering Committee and an Advisory Committee to assist and guide the District on key issues concerning the program's design. The Advisory Committee consisted of over 60 representatives from public agencies, large and small businesses, labor, environmental, research, health, ethnic, and financial organizations. From the start, the US Environmental Protection Agency and the California Air Resources Board were involved in the work. Their support was a critical ingredient in the development of RECLAIM.
The rule development process took a year and a half. During the rule development process, over 1,000 individuals and organizations participated in working group meetings. Each aspect of the new program was extensively debated. Ultimately, the endorsement of the final program came as a result of the extensive public participation process utilized for RECLAIM.
Due to the complexity of the program, concerns were raised about smaller businesses being subject to the program, particularly in the early years of implementation. Where larger businesses have the resources and know-how to operate under advanced regulatory programs, many of the smaller businesses do not and lack the sophistication to come up to same level of understanding as the larger sources. Therefore, it was decided that smaller businesses emitting less than 4 tons per year of either NOx or SOx be excluded from the program. This would allow time for the program to be implemented, and then, at a later date, sources emitting between 2 and 4 tons could be added to the universe list.
As indicated earlier, the allocation formula was one of the most critical issues resolved during the rule development process. The Allocation methodology was developed based on three principles: equivalency in meeting emission reduction objectives; equity; and fairness. The first fundamental test for RECLAIM was that the emission reduction requirements for each facility be equivalent to the adopted rule reductions and future control measures that would be applicable to the facility. Second, the distribution of emission allocations must be equitable to all sources and recognize recent emission control and reduction efforts. Lastly, the Allocation methodology must be fair in that each facility under RECLAIM should enter the program with an emission allocation that accommodates its necessary current operating levels.
One of the primary concerns raised by industry was that the allocation methodology should not lock-in recent recessionary impacts resulting from the economic downturn of the early 1990's. Through the rule development process, the District analyzed two dozen different Allocation methodologies and took great pains to resolve this and other concerns. Other concerns included the recognition of previous emission reductions and facilities operating at Best Available Control Technology (BACT) levels. After more than two years of consultations with public, industry, and environmental groups, and the development and review of dozens of different allocation formulas, an equitable and environmentally-sound approach was selected.
The allocation methodology provides sufficient flexibility for facilities to recover from the recent economic downturn in the region by allowing facilities to choose pre-recessionary throughput levels. In addition, the price of RECLAIM Trading Credits (RTCs) is relatively low and affordable and can be used to accommodate business expansion. Thus new companies can have the same capability for growth afforded existing companies.
A non-tradeable allocation was added as a safety net for RECLAIM facilities wishing to increase their allocations if they plan to expand productions during the first three years of the program. The concept of the non-tradeable emissions was developed to provide relief for companies in the event that the market price of credits reached unreasonably high levels. However, as the price of credits continue to be reasonably affordable, the use of the non-tradeable emissions has not been necessary.
During the rule development process, the District investigated to what extent the government should be involved in the trading market. To address this and other trading issues, the District contracted with the Pacific Stock Exchange and Cal-Tech University.
At present, the District does not regulate the RTC market. Buyers and sellers make agreements on their trades without prior authorization from the District. The District's role in the market is simply to register the trades and maintain a current listing of RTCs. RTC transactions become effective when registered with the District. The District updates the RTC listing daily. The RTC listing is managed in two parts: who retains ownership of RTC certificates, and RTCs currently reflected in the facility's allocation. These organizations recommended only a limited involvement by the District in the market.
An important lesson learned thus far is that a viable market can be developed through private market makers. A limited government role in ensuring a viable market has allowed for private parties to step up and establish RTC auction.
A key lesson learned from this program, that for a market-based program to be effective in improving air quality and to provide equitable treatment to all participants, there must be a strong enforcement program. Under RECLAIM, industry receives flexibility in choosing the methods for reducing emissions at their facilities. The flexibility that RECLAIM affords the facilities is balanced by stringent enforcement provisions. In addition, RECLAIM incorporates severe penalty provisions that act as a deterrent for any potential violations. As a result, inspections have shown that the more than 350 facilities demonstrate a high rate of compliance.
One of the five evaluation criteria for the development of RECLAIM is that the program must demonstrate an equal or greater level of enforcement than the existing regulatory system. Basically, there are three enforcement requirements: (1) the holder of a Facility Permit must demonstrate that the facility's actual emissions do not exceed the emission cap, (2) the necessary emission reductions must be achieved each year, and (3) increased emissions monitoring is required to verify compliance.
The RECLAIM program designates a penalty structure for facilities that exceed their emission allocations. The District examined many alternative approaches in the search for a means of determining the number of counts of violations which would provide a strong deterrent without being unnecessarily harsh. The formula for determining the number of violations was designed to provide consideration in determining the number of days of violation and the amount the allocation was exceeded. In short, any facility exceeding its allocation would be subject to a violation for each day the facility was in excess of its allocation, plus an additional violation for each 1,000 pounds over the facility allocation. This structure was considered an adequate deterrent for exceeding allocations.
The key to a successful enforcement program is that it must be consistently applied to all parties and that the program must be fair. The threat of stringent penalties, backed-up by active enforcement actions, acts as a strong deterrent to any potential violations.
In 1995, the greater Los Angeles region enjoyed the cleanest air on record. This is, in part, due to the success of the RECLAIM program. RECLAIM is on track in accomplishing its clean air objectives.
The design of the program has resulted in a phenomenal compliance rate. Inspections have found that 85 percent of the facilities are in compliance with their emission reduction objectives. More than 25 of the regions largest emission sources have been recognized for an "A+" compliance record for meeting the RECLAIM program requirements.
During the first two years of the program, more than 450 transactions have taken place. This has resulted in more than 100,000 tons of NOx and SOx emissions being traded at a value of more than 11 million dollars.
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