The Regional Clean Air Incentive Market (RECLAIM)

1. The Regional Clean Air Incentive Market (RECLAIM) September 2, 2014 David Porter

2. Outline • What is RECLAIM? • Why tradable permits as policy? • Policy Design Issue 1: The Property Right • What is an Experiment? • Policy Design Issue 2: The Market

3. RECLAIM • SCAQMD was under pressure from EPA to meet clean air standards • LA Basin had the highest number of “high” pollution days of any city in US in the early 1990s • Prior to 1994, AQMD used the standard command and control method: • BACT – each piece of equipment is regulated • R&D firm disincentives and costs ignored (coatings) • Fails to offer any incentives for firms to cut back emissions any further than mandated percentages

4. RECLAIM • Rather than attempting to regulate each source, RECLAIM focuses on regulating the net pollution at the facility • Each facility is allotted pollution permits and is subject to severe fines if their annual emissions level is not within the fixed limit • Businesses which are able to reduce emissions by more that their allotted annual limit are then able to sell their excess reductions to other facilities • This creates a significant economic incentive to reduce net emissions, as those emissions credits are a relatively liquid asset • By allowing businesses to interact amongst themselves RECLAIM minimizes the costs associated with emissions reductions

5. Policy Design Issue 1: The Property Right • Fixed amount of pollution per year in basin • NOX, SOX and VOC • Allocate right to pollute Lbs per year • Zones (hot spots) • Reduce allocation by fixed percent per year • The cap declines annually (8.3% per year on average for NOx and 6.8% per year on average for SOx) from 1994 to 2003.

6. Tradable Credit • The Process considered had • Allocation of credits (pounds designated by year) • Trade credits (swaps, cash, portfolio, etc.) • Monitoring and Reporting (quarterly) • Restrictions – use only current year credits for current year pollution – NO BANKING • Reconciliation Period Created • End of year accounting (delay/uncertainty of use)

7. End of year effect? • At year end • Long or short • Rational Expectations? • Proposal to Stagger Credits Jan. 1 to Dec 31 Credits 1997 1998 1999 2000 2001 2002 Jul. 1 to Jun 30 Credits 1997 1998 1999 2000 2001

8. Microeconomic Systems as an Experimental Science • A Microeconomic system is comprised of: • The Environment • The Institution • The Environment consists of: • The list of participants • The resources to be allocated among participants • Participant characteristics which are private information

9. The Institution: Rules of the Game • The Institution consists of: • Language • Allocation rule which transforms messages into allocations • Pricing rule transforms messages into sums to be paid or received

10. Outcomes: allocations and prices Institutions: language of the market, rules of communication and contract Behavior: rational, bounded, etc. Environment values, costs, information, resources

11. Science of Economics • Control environment parameters • Induce value and costs (experimenter knows incentive structure) • Information can be controlled • The environment can be replicated • The Institution (rules) can be changed and outcomes observed and measured • Real people • Real Incentives • Replicable

12. Outcomes: allocations and prices Treatments: Change rules Model Predictions Institutions: language of the market, rules of communication and contract Behavior: rational, bounded, etc. Environment values, costs, information, resources Controlled by Experimenter

13. Experiments and Public Policy • Typically, policy design is based on simple models of behavior or “gut-feel” • Models are based on conditions that are not faced in the field application • Policy impacts can be great if the design is not tested • Lab testing of the system to determine possible flaws are standard in engineering but ignored in public policy design • Sometimes seeing is believing (details can be important)

14. An Experiment with Annual and Staggered Credits Year 1 Year 2 Year 3 Year 4 Year 5

15. Policy Design Issue 2: The Market • The general market conditions that will be the focus of our design process are: • The RECLAIM market is thin with a small number of participants; • There is a need only to trade at quarterly compliance intervals when facilities can update their emission plans; • There is no history of market trades; and • Buyers and sellers would like to transact by selling whole portfolios of credits (all or nothing trading, economies of scale, complementary pollution emissions requirements, etc.)

16. Order Types • A multi-market order for agent i is a vector <bi, qi1, ...., qin, Fi> where: • bi >0 means agent i is willing to pay at most bi for the order, • bi <0 means agent i is willing to accept at least bi for the order. • qij >0 means agent i wants to purchase up to qij units of j in the order, • qij <0 means agent i wants to sell up to qij units of j in the order, • Fi is a scale factor (0 < Fi< 1) which indicates that agent i is willing to accept any one order of the form <fi bi, fi qi1, ...., fi qin,> where fi [Fi,1].

17. Experiments/Field • When there are complements or minimum fills the mechanism outperforms standard practice • Not much harm is done when demands are linear • During the summer of 2000 there was a drastic increase in the demand for power production. • The power industry purchased 67 percent of the available RTCs. Because power-producing facilities only comprise roughly 14 percent of RECLAIM allocations, the increased demand for RTCs led to a decrease in supply. For NOx RTCs in particular, prices increased from approximately $4,284 per ton traded in 1999 to roughly $39,000 per ton traded during the first ten months of 2000.

18. Current Condition • Energy crisis in California gave the Governor ammunition to let firms (mainly electricity producers) off the hook • RECLAIM “discontinued” • Smog alerts on the rise