So much for one cap-and-trade scheme. The acid rain cap-and-trade program is frequently praised as an effective market-oriented regulatory mechanism to reduce sulfur dioxide (SOx) from power plant emissions and as a model for carbon cap-and-trade. On July 6, EPA finalized new rules that tighten limits on SOx and virtually eliminate trading. The market for allowances to emit one ton of SOx collapsed from a high of $1,600 per ton in 1995 to $3 per ton in early July. Millions of allowances held by utilities and investors are now worthless.

In the early years, EPA’s SOx cap-and-trade program worked well. Since 1995, the program led to a 50 percent reduction in these emissions. EPA initially allocated a set number of baseline allowances to electric power companies. These utilities then had to “pay” for each ton of SOx emitted with one allowance. By switching to low-sulfur coal, increasing plant efficiencies, and investing in pollution control technology, electric generators reduced emissions. With reduced SOx emissions, the utility then sold allowances or reduced the number of purchased allowances needed each year. The emission reductions and market for trading SOx credits grew until late 2005 when litigation undermined the certainty of EPA’s rules. In 2008, the DC Circuit Court finally vacated portions of the rule and ordered a revision.

The EPA’s new Clean Air Transport Rule devalues SOx emission credits accumulated or purchased under the previous rules, and substantially limits, if not precludes, trading of emission allowances. The final cap in the previous rule was 8.65 million tons of SOx per year. The new rule shrinks the annual SOx limit to 4.1 million tons.

Beware of EPA-created markets. Genuine markets are dynamic. Supply, demand, and price respond to the ever changing dynamics of free exchange. In contrast, markets created and controlled by government are volatile, fragile, and subject to fraud. When the government creates an artificial market for trading emission allowances, i.e. government permission slips, one new EPA edict can nullify the market and vaporize the value of emission credits.

– Kathleen Hartnett White