Practical definition: Successful

Posted by Marc Hodak on July 12, 2010 under Practical definitions | 4 Comments to Read

Let’s look at how the term is used by John Walke, clean-air director at the Natural Resources Defense Council:

“The acid-rain market continues to be relevant to the debate over CO2 because it is a successful model.”

This quote finished off an article about the collapse of the acid-rain market:

The acid-rain market has been considered a success, helping to reduce sulfur-dioxide emissions by half. Permits to emit sulfur had once traded for $1,600 a ton.

But in 2008, in response to lawsuits filed by a handful of utilities and North Carolina, the U.S. Court of Appeals for the District of Columbia Circuit ruled that the EPA had overstepped its authority… Prices of allowances fell in response, and trading dwindled.

In response to the ruling, prices for the pollution allowances plunged to $130 a ton. Utilities held off on projects to clean up their plants…

Last week, the EPA issued new rules to comply with the court’s decision. The new program will limit the use of the market and instead require most of the emission reductions to come from changes at the plants themselves. And millions of allowances that utilities now hold can’t be used under the new program, which will issue its own allowances.

“It really feels like prices are going to zero quickly,” says Peter Zaborowsky, a managing director of Evolution Markets Inc., a White Plains, N.Y.-based provider of environmental brokerage services for utilities and investors. Allowances traded at times at less than $3 last week…

The market’s collapse shows how vulnerable market-based approaches to reducing air pollution are to government actions. That could scare off investors, who won’t commit to a market where the rules can change at any minute.

So, that’s one definition of “successful.” Another player in the acid rain market has another take:

“It is tragic,” says Gary Hart, an analyst at ICAP Energy LLC based in Birmingham, Ala., who has worked on environmental markets for two decades. “It is something that worked so well.”

Until it didn’t.

John Walke said,

Any environmental program, including market-based ones, should be judged by how much pollution they reduce: from 1990 (when the acid rain program was adopted) until 2008, SO2 emissions from coal-burning power plants dropped from 15.7 million tons to 7.6 million tons. This successful result was overwhelmingly due to the acid rain trading program and a 2nd generation trading program. Success should not measured by the trading value of emissions allowances, since that is irrelevant to air quality and our lungs and acidified lakes; allowance values are the concern of profit-seeking traders, not the environment. The acid rain program exceeded its expectations, achieving deeper emissions reductions at lower-than-projected costs, but as with many things in life, we know more and understand now that more needs to be done to clean up the air.
Marc Hodak said,

John – Thanks for your comment.

Clearly the market “worked” in the sense of reducing pollution. But it’s short-sighted to divorce that success from the mechanism that produced it, which you do when saying that the value of emissions allowances is irrelevant to air quality and that the allowance values are of no concern to the environment. As a financial economist, I can assure you that the more those emission allowances were worth, the more likely you were to see reductions in this pollution.

Not only did this program dramatically reduce emissions, but it did so without the costs of a command and control bureaucracy that couldn’t have possibly achieved those emissions as effectively or efficiently, i.e., in a manner that preserved other resources used in the economy to make people’s lives better. This economic fact is largely invisible to non-economists, but it was driven by the market.

If more needs to be done to clean up the air, then we have lost a powerful mechanism for driving that clean up because political forces that are largely ignorant or unappreciative of markets have won the day.

The real point, of course, is that businessmen who were fooled into thinking the government would protect their interests in doing the right thing for the environment won’t make that same mistake when the government dangles another similar program in front of them. And we all lose.
John Walke said,

Marc,

Your economic analysis is sound, but your awareness of Clean Air Act history is either incomplete or not evident in your remarks thus far.

The acid rain program never existed as an isolated environmental market; that is, a host of emissions performance standards, permitting requirements, and ambient air quality standards have existed in tandem with the acid rain program ever since its inception in 1990. Accordingly, these other standards would have and did prevent power plants from increasing emissions at will even if allowance values were low.

The acid rain program primarily was intended to address national and regional air quality (with acid rain the reason for the program’s creation), but complementary air pollution programs long have adressed regional and local air quality (with public health the primary focus of these programs).

Second, as successful as the acid rain program was, one should not make the mistake of attributing all (or even most?) of that success to the rational magic of the marketplace, Adam Smith’s dismembered hand. One little known secret of the program’s success stemmed from the elimination of railroad tariffs on rail lines that then were used to ship massive amounts of low-sulfur coal from the Powder River Basin in Wyoming to power plants in the southeastern U.S., leading those plants to rely on low-sulfur coal (rather than scrubbers) as their compliance strategy for nearly 15 years. The elimination of these tariffs certainly cannot be attributed to market forces.

Third, even after the Clean Air Interstate Rule was vacated in court and SO2 allowance prices dropped precipitously, power plants did not turn off their scrubbers or abandon plans to install new scrubbers; indeed SO2 emissions have dropped as much or more since CAIR was overturnd in court as during a comparable period after its immediate adoption. Why? Because of three factors: (1) the settlement of prior enforcement cases against power plants that broke “command-and-control” laws; (2) state “command-and-control” laws; and (3) the belief that a successor to CAIR was forthcoming and it was not sensible to abandon those controls.

EPA has not abandoned the mechanism of a market-based program, but it is more tightly constrained than CAIR and thus will protect the public more, not less, with a benefit-to-cost ratio that is still in excess of 10-to-1. And an even more rigorous power plant cleanup rule next year will produce vastly greater reductions in power plant emissions of soot and toxic emissions (like mercury, aresenic and lead), with a benefit-to-cost ratio that should be even more impressive.

And that means we all win.
Marc Hodak said,

John,

I am not an expert on the history of the Clean Air Act. I appreciate your informed recap. One nit, though: I did happen to work in the railroad industry when tariffs were eliminated, and I can assure you that deregulation was not only attributable to market forces, it was necessitated by them. I am also, for the record, quite sympathetic to the goals of pollution reduction, which is why I’m happy that rail deregulation made it so easy for so many power companies to reduce their dangerous emissions.

In the end, though, your instructive discussion is off the point I was making. My post began with this quote:

“The acid-rain market continues to be relevant to the debate over CO2 because it is a successful model.”

I believe you acknowledge that, in the end, the market did fail. In fact, you seem to argue that the market that failed was not really all that important in the whole scheme of things, and you may be right. But your quote said the market is relevant the CO2 debate because it was successful. It still looks to me like it’s relevant because it failed as a market, and that failure is relevant to discussion of the “trade” portion of any “cap and trade” legislation.