PowerPoint PresentationSlide 2Slide 3Characteristics of Well-Functioning MarketsWhy Markets?Slide 6Cap and Allowance TradingSlide 8Slide 9Slide 10Slide 11Slide 12Slide 13Slide 14Other Experiences: ERC ProgramsERC Program: ExperiencesLessons: Market Design MattersSlide 18Trade Outside a CapSlide 20Slide 21Slide 22Point-Nonpoint Source OffsetsOffset ExamplesSlide 25Wetland Mitigation CreditsSlide 27Slide 28Slide 29Slide 30Slide 31Slide 32Trading Programs for Trading Programs for Environmental Environmental Protection: Lessons Protection: Lessons and Experiencesand Experiences Kurt Kurt StephensonStephensonVirginia TechVirginia TechMay12, 2005May12, 2005Objective for this afternoonObjective for this afternoon1.1.Rationale & Requirements for Market- Rationale & Requirements for Market- based Environmental/Natural based Environmental/Natural Resource Trading PolicyResource Trading Policy2. Experiences and Lessons2. Experiences and Lessons• Cap and Trade ProgramsCap and Trade Programs• Trade outside a cap – credit offsetsTrade outside a cap – credit offsetsFirst Principles: Anatomy of First Principles: Anatomy of an Market Exchangean Market ExchangeCompensation ($)Rights to the CarBuyers SellersGovernmentFacilitate trade Address third-party effectsPolice (Monitor & Enforce)Characteristics of Well-Functioning Characteristics of Well-Functioning MarketsMarkets• Decentralized (private) decision-Decentralized (private) decision-makingmaking• Low transaction costs Low transaction costs • Stable system of rights that limit uncertainty, Stable system of rights that limit uncertainty, • but dbut define unacceptable behaviorefine unacceptable behavior• Clear and timely penalties for rule violationClear and timely penalties for rule violationWhy Markets? Why Markets? Private incentives that create public benefitsPrivate incentives that create public benefits• Dynamic incentives, discovery/creationDynamic incentives, discovery/creation• Incentives for cost-effectiveness (least Incentives for cost-effectiveness (least cost)cost)Knowledge is disperse, sometimes tacit, and Knowledge is disperse, sometimes tacit, and incompleteincompleteApplication of Market-basedApplication of Market-based Principles to Environmental Principles to Environmental Protection: Protection: Cap and TradeCap and TradeCap and Allowance Trading Cap and Allowance Trading GovernmentProtect Environmental Quality (Define Cap/Commodity)Address Third-Party Effects Monitor and Enforce100 100100 100 AllowancesAllowances100 Allowances100 AllowancesCompensation ($)Allowances/Rights125 Allowances125 Allowances75 Allowances75 Allowances12575Characteristics of Well-Functioning Characteristics of Well-Functioning MarketsMarkets• Decentralized (private) decision-Decentralized (private) decision-making (“internal” and “external” making (“internal” and “external” flexibility)flexibility) • Low transaction costs Low transaction costs • Stable rules that limit uncertainty about Stable rules that limit uncertainty about allowance ownership and use, butallowance ownership and use, but• DDefine unacceptable behaviorefine unacceptable behavior• Clear and timely penalties for rule violationClear and timely penalties for rule violationWhy Markets for Environmental Why Markets for Environmental Protection?Protection?•Caps provide the public assurance that Caps provide the public assurance that EQ goals are achieved over timeEQ goals are achieved over time•Opportunity to trade Opportunity to trade •allows movement of resources to allows movement of resources to higher valued useshigher valued uses•creates continuous private incentives creates continuous private incentives to discover new EQ technologies & to discover new EQ technologies & strategiesstrategies•Compliance more timely and effectiveCompliance more timely and effectiveGovernmentProtect Environmental Quality (Define Cap/Commodity)Address Third-Party Effects Monitor and Enforce100100Compensation ($)Allowances/Rights200 acre 200 acre ftft200 acre 200 acre ftftMarket-based environmental policy and Market-based environmental policy and conventional policyconventional policyConventionalConventionalMarket-basedMarket-based““Push” mentality Push” mentality ““Pull” mentality Pull” mentality Regulator’s job: Regulator’s job: technical engineertechnical engineerRegulator’s job: Regulator’s job: police officerpolice officerNo negative impactNo negative impactBalancingBalancing System-wide “best” System-wide “best” options can be options can be calculatedcalculated““Knowledge problem”Knowledge problem”Experiences from the Clean Air Experiences from the Clean Air Act: Act: Air program has the most extensive Air program has the most extensive experience with EQ trading programs. experience with EQ trading programs. • SOSO22 cap and allowance trading cap and allowance trading• Emission Reduction Credit Programs Emission Reduction Credit Programs (ERC)(ERC)Not all programs are designed the Not all programs are designed the same & not all programs produce same & not all programs produce same outcomessame outcomes..SOSO22 Cap and Allowance Trade Cap and Allowance Trade•Congressionally identified annual Congressionally identified annual national SOnational SO2 2 allowance cap. Allowance allowance cap. Allowance defined in advance as permission to defined in advance as permission to discharge 1 ton of SOdischarge 1 ton of SO22/yr./yr.•Utilities have discretion to determine Utilities have discretion to determine control strategiescontrol strategies•Utilities may bank, buy, or sell Utilities may bank, buy, or sell allowances with minimum cost of allowances with minimum cost of transacting.transacting.•EPA tracks allowances (trades and use) EPA tracks allowances (trades and use) and monitors/enforcesand monitors/enforcesSOSO22 Cap and Allowance Outcomes Cap and Allowance OutcomesSOSO22 prices (control costs) lower than prices (control costs) lower than estimatedestimated• Mining industry responseMining industry response• Rail industry responseRail industry response• Scrubber industry responseScrubber industry responseTrading light during initial stagesTrading light during initial stages100% Compliance100% ComplianceOther Experiences: ERC ProgramsOther Experiences: ERC Programs•Extensions of conventional regulator-Extensions of conventional regulator-directed