Banking Pollution Rights, Reducing Innovation

1
Banking Pollution Rights, Reducing Innovation

• David Dana
• Northwestern University School of Law
• [phone]
• d-dana_at_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 doesnt 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 Northeasts 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/technolog
  ies 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?
• Its 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 dont
  get full upside of appreciation but they also do
  not bear the risk that the anticipated
  appreciation wont materialize