National SO2

The EPA’s 1990 Clean Air Act set the objective of reducing acid rain-causing emissions in the atmosphere, concentrating specifically on sulfur dioxide (SO2) and Nitrogen Oxide (NOx). The EPA’s final goal for SO2 emissions is to reduce emissions to a level equal to 10 million tons under the emissions levels measured in 1980. In order to meet this new standard, the government initiated a two-phase plan tightening the emissions from all fossil-fuel fired plants.

The EPA’s emission reduction plan functions on the basis of a cap-and-trade system, utilizing a free market with a limited number of emission allowances to create emission reductions. Under this system, utility units are allocated allowances based on historic fuel use (from 1985-1987) and a specific emissions rate (either the actual emissions rate during the baseline years, or 1.2lbs SO2 emission per million BTU fuel input, whichever is lower). Each allowance is equivalent to one ton of SO2 emissions. A total number of 8.95 million allowances were issued by the EPA in 2000 divided into “vintages” to be issued for each vintage from 2000 to 2030. Allowances of a given vintage may be used for their vintage year, or any year after that point. Allowances are tracked through the EPA’s central database, the ATS (Allowance Tracking System). For every ton of SO2 emitted by a given utility, one allowance in their account is retired in the ATS. Emissions are reviewed annually, beginning March 1st, when all allowances of previous vintage years are temporarily frozen to allow the EPA to justify the actual emission output. Once the emission output is determined, the EPA deducts a number of allowances that corresponds to the tons of emissions emitted by the utilities. After this the accounts are unfrozen.

Utilities with an insufficient number of allowances may purchase them from sources that have an excess, or have reduced their emissions below the allocated levels. Allowances of a previous vintage may be banked to be used in the future. Anyone may open a general account with the EPA to acquire allowances.

SO2 regulations under CAIR

CAIR is the EPA’s newest program for the regulation of SO2 and NOx emissions, and was finalized on March 10, 2005. This new program will create the largest reductions in SO2 and NOx emissions in a decade. CAIR states that:

• States must achieve the required emission reductions using one of two compliance options: 1.) Meet the state’s emission budget by requiring power plants to participate in the EPA administered interstate cap-and-trade program, that caps emissions in two stages, or 2.) meet an individual state emission budget through measures of the state’s choosing.

The CAIR program will be implemented in several stages. Stages already implemented include the drafting and approval of State Implementation Plans (SIPs) for the regulation of SO2 and NOx. CAIR FIP rules state that all stationary fossil-fuel filed boilers or combustion turbines operating at any time on or after November 15th, 1990, or the start up of the unit’s combustion chamber if they are a generator with a capacity of greater than 25 MW producing electricity for sale. Some cogeneration units or waste-to-energy units are exempt from the CAIR program.
In 2010, CAIR will reduce SO2 emissions by 4.3 million tons, a 45% reduction from 2003 levels. In 2015, CAIR will reduce SO2 by 5.4 million tons. At full implementation, CAIR will reduce SO2 emissions to a mere 2.5 million tons, 73% below 2003 levels.

Transaction Structures

• Immediate Settlement Transaction- This type of NOx transaction is the most liquid. Immediate Settlement Transactions can occur for allowances of any vintage; however, generally the most active allowances are those of the current vintage. After a successful trade, a cash settlement typically is to be paid to the seller within 3 days of confirmation from the EPA’s Allowance Tracking System verifying that the allowances were successfully delivered from the seller’s account to the purchaser’s account.
   
• Forward Transactions-A forward transaction consists of an agreement between buyer and seller to exchange allowances for money at a future date as specified. The allowance is sold at a price based on the forward market curve, which is a speculation of the price of the allowance based on the current price and escalated based on the money of market participants for the specific term of the trade.
   
• Stream Transactions- Streams of allowances may be sold in consecutive years, (i.e., from 2008 through 2010`) allowing the seller to deliver a set number of allowances each consecutive year.
   
• Option Transactions- Many different varieties of options are available, allowing the buyer a great deal of flexibility. Options range from straight put and call options that place a ceiling or floor for prices, to more complex options including collars, straddles, strangles, put and call spread options and time spreads. Most option transactions are “European,” only exercisable on the expiration date. The Expiration date for options is typically the 15th of each month, or the nearest business day.
   
• Cross-Commodity or Interpollutant Swap- In a non-monetary exchange, allowances may be exchanged for allowances of another emission or commodity at an appropriate price ratio, ensuring that both sides of the transaction are equal in value.