Dissatisfied with CAIR replacement, market calls for legislative fix

Proposals to replace the existing US SO2 and NOx emissions reduction schemes may not be enough to remove market uncertainty.

The US Environmental Protection Agency (EPA) has proposed new regulations to reduce power plant emissions of sulphur dioxide (SO₂) and nitrogen oxide (NO_x) after a 2008 court ruling stalled the market for trading in these emissions allowances. If enacted, the rule would be finalised next year and reductions would begin to take effect by 2012, according to the EPA.

The proposal, called the Transport Rule, would replace the 2005 Clean Air Interstate Rule (CAIR), which the US Court of Appeals for the D.C. Circuit ordered the EPA to revise in 2008. The court allowed CAIR to remain in place temporarily while the EPA finalised this replacement rule.

However, the uncertainty surrounding the future of the market has pushed prices down considerably since the EPA was ordered to rework the rule. According to Paul Tesoriero, director of environmental markets at brokerage Evolution Markets, SO₂ allowance prices dropped from around $200 per ton to between $20 and $30 per ton after the 2008 court ruling. Since the EPA proposed the new rule last week, prices have fallen as low as $5 per ton.

Gregory Arnold, managing partner at CE2 Capital Partners, an environmental trading and investment firm, says: "The D.C. Circuit Court’s decision left the EPA with a limited set of market-based options to achieve its policy goals [of reducing these emissions]. The delays, uncertainty and damage caused by the Court’s ruling have had a negative impact on the SO₂ market."

Many market participants believe it will take a a legislative overhaul of the programme to boost the market. "I think all parties would like a legislative fix," says Tesoriero. "Without that, the EPA can only do so much [to create a new, effective programme]."

Arnold adds: "Once the dust settles, expect very low trading activity. It will take a legislative “fix”, hopefully in the next Congress, to restore what had been the role model for a successful environmental market.”

A major issue is the EPA's proposal to use a new allowance allocation system, rather than the one used under CAIR, which could leave many in the market holding worthless allowances.

"The EPA has said it doesn't see a way to convert the current allowances, so it is going to have to start from scratch," says Tesoriero. "This has caused SO₂ prices to drop since the rule was announced because current allowances may not be worth anything under the new programme."

The Environmental Markets Association (EMA), a trade group that represents market participants such as utilities, brokers, traders and exchanges, issued a statement urging the EPA to allow current allowances to be converted into any subsequent programme under the new rule.

It also said: "We would encourage Congress to provide the EPA with sufficient flexibility in the future to avoid the problems that it has encountered in trying to maintain a viable emissions trading market."

According to the EPA, the Transport Rule, in conjunction with other state and EPA actions, would reduce SO₂ emissions by 71% over 2005 levels and NO_x emissions would drop by 52% by 2014.

The annual cost of compliance with the proposed rule is estimated at $2.8 billion in 2014. The EPA expects emission reductions to be made by proven and readily available pollution control technologies already in place at many power plants.

Public comments on the proposal will be accepted for 60 days after the rule is published in the Federal Register. The EPA will also hold public hearings on the rule, with dates and locations to be announced shortly.

See the August issue of Energy Risk (also online at energyrisk.com) for an exclusive interview with Chicago Climate Exchange founder Richard Sandor on the outlook for US emissions trading.