Banking Pollution Rights, Reducing Innovation

1. Banking Pollution Rights, Reducing Innovation • David Dana • Northwestern University School of Law • (312) 503-0240 • d-dana@law.northwestern.edu

2. Typology of Pollution Regimes • “Command and Control” Regulation • Technology Standards • Technology-Based Performance Standards • Health-Based Performance Standards • Standard Critique of Command and Control: Costly because doesn’t account for different marginal costs of abatement, and no incentive for firms to go beyond-compliance, by developing new technologies or otherwise

3. Typology co. • Market-Mechanism Regulation • Effluent or Emission Taxes • Tradable Allowance/Credits • Trading regimes are politically viable, other market approaches much less so. Not just US – Kyoto Protocol follows a cap-and-trade model. • Examples in US – SO2 acid rain trading regime under 1990 CAA, localized pollutant trading mechanism under State Implementation Plans and as part of Northeast’s OTC Regime

4. The Question of Innovation • Prediction/claims for trading regimes is higher levels of innovation than command and control • But cannot say much empirically given (1) few trading regimes, (2) not much study, (3) difficulty characterizing innovation levels • But there is some perception that trading regimes have not delivered on innovation promise • One reason is that in a trading regimes “clean” firms do not need to innovate/push the limits of technology because they can buy credits from “dirty” firms that can easily generate excess credits simply by adopting the practices/technologies already in place in the clean firms – shifting from high to low sulfur coal, for example. • Are there other reasons a trading regime might not deliver on its innovation promise?

5. How Trading Regimes Work • Each firm must have allowances or credits to cover its level of emissions of regulated pollutants each year • In most cases each firm begins with an allocation of allowances based on its past (lawful) annual emissions of regulated pollutants • Each firm then can is free to buy additional allowances from other firms (and sometimes from the government) to cover its annual emissions • A firm may have more allowances than it needs to meet its annual emissions for any number of reasons – e.g., lower production due to a weak economy, less-polluting production methods due to technological improvements.

6. Banking • When a firm has excess allowances – more than it needs to cover its annual emissions – what can it do with them? • If the regime allows “banking” by polluting firms, then the firm can bank the extra allowances. Allowances can be applied in any given year after their issue date (in the CAA model and Kyoto/EU model) so that banked credits could be used by the firm in any future year to cover its emissions. The firm can also simply withdraw banked credits at some time in the future and sell, rather than use, them.

7. No Banking • In a no-banking regime, polluting firms cannot bank excess credits but they can sell them, typically to any willing buyer. Who would buy? • One major source of buyers: other firms that can use purchased allowances to cover their emissions. • Another source: environmentalists who want to retire allowances permanently. • Another source: broker/investors – not polluting firms – that can buy and then sell to a polluting firm, or that can themselves “bank” the allowances for future sale of the allowances. • So even in what is typically termed a no banking regime – no banking by polluting firms regime –banking is permitted by broker/investors that are not polluting firms.

8. The Limited Debate About Banking (to date) • Policymakers and commentators generally supportive of banking, envision as a means to earlier pollution reductions, greater flexibility for regulated firms • Major concern in policy and academic debates: if a large number of allowances are banked (whether by polluting firms or by broker/investors), and allowances have an indefinite lifespan, its hard to predict how much legal pollution will be produced in any given year in the future. Spikes in pollution may result in acute health effects and other adverse effects.

9. Banking and Innovation in Pollution Reduction/Control • This paper is an effort to consider another possible problem with unrestricted banking, and in particular unrestricted banking by polluting firms • Basic question: does banking of allowances by polluting firms reduce such firms’ incentives to develop new pollution reduction/control technology, and if so, are the benefits (in encouraging innovation) of restricting banking worth the costs? • It’s a theoretical, essentially speculative paper, so it may be entirely wrong as an empirical matter. But it may be useful as a way to frame questions that have not been subject to empirical exploration, at least in part because they have not been deemed pertinent questions.

10. Why Would Polluting Firms Want to Bank Credits • Not to garner value of anticipated price appreciation, that anticipation price appreciation should be reflected in current market prices of allowances, at least if broker/investors are allowed to buy and hold (bank) allowances • That is, broker/investors will pay more for allowances sold by polluting firms if the broker/investors anticipate price appreciation. Polluting firms selling excess allowances thus cash in on anticipated price appreciation. • Polluting firms selling excess allowances don’t get full upside of appreciation but they also do not bear the risk that the anticipated appreciation won’t materialize