Clearing the Air

The Facts About

Capping and Trading Emissions

Clearing the Air

The Facts About

Capping and Trading Emissions
I

n 1980, rising public concern about the

extensive health and environmental impacts of

acid rain prompted Congress to commission a

ten-year study on its causes and effects. After

years of debate and extensive research under the

study, Congress established the Acid Rain Program

under Title IV of the 1990 Clean Air Act

Amendments. The program called for major

reductions in electric-generating facilities’

emissions of sulfur dioxide (SO2) and nitrogen

oxides (NOx)—the key components of acid rain—

while establishing a new approach to

environmental protection through the use of

market incentives.

The Acid Rain Program’s centerpiece is a marketbased system for capping and trading SO2

emissions. (The program’s NOx control component

is more traditional and not the focus of this

brochure.) The SO2 requirements are structured in

two phases. Phase I, which began in 1995, limited

emissions from the largest, highest-emitting

electric-generating facilities. Phase II, which began

in 2000, tightened the annual limits on the large

plants, and set restrictions on smaller, cleaner

plants and all new plants. As of 2001, the program

encompassed nearly 2,300 units at 1,000 plants. 

The significant environmental progress and cost

savings resulting from this nationwide experiment

in capping and trading SO2 emissions have

attracted worldwide attention. This brochure

explains how and why this system works, clears

up some common misunderstandings, and

presents the outlook for future programs based 

on this model.
Capping and Trading Emissions: 

The Concept

BEFORE THE PROGRAM

With no reductions required, Unit 1 and Unit 2 each emits 

20,000 tons a year.

THE “CAP”

The cap requires a 50 percent cut in emissions—e.g., from

20,000 to 10,000 tons.

EMISSIONS TRADING UNDER THE CAP

If Unit 1 can efficiently reduce 15,000 tons of emissions

and Unit 2 can only efficiently reduce 5,000 tons, trading

allows each unit to act optimally while ensuring achievement of the overall environmental goal. Unit 1 can hold on

to (and “bank”) its excess allowances or can sell them to

Unit 2, whereas Unit 2 must acquire allowances from Unit 1

or from another source in the program.

Unit 1

20,000

Unit 2

20,000

Unit 1

10,000

Unit 2

10,000

10,000

Unit 1 Unit 2

5,000 Surplus

10,000

15,000
Cap & 

The “Cap” Puts a Ceiling on Emissions

The Acid Rain Program sets a nationwide cap on SO2 emissions from electric-generating facilities. Already, emissions have

been reduced by more than 6.5 million tons from 1980 levels, measuring approximately 10.6 million tons in 2001. By 2010,

the program will lower the cap to 8.95 million tons—a 50 percent reduction from 1980 SO2 emissions.

Emission Allowances Reinforce the Cap 

Each allowance authorizes one ton of SO2 emissions. Limiting the number of available allowances ensures the cap’s integrity.

Allowances are allocated among sources based on emission performance standards and representative fuel use. At the end of

each year, every source must have enough allowances to cover its emissions for that year. Unused allowances may be sold,

traded, or saved (banked) for future use.

Sources Have Many Options for Reducing Emissions

Sources may choose from many alternatives that best meet their needs,

including installing pollution control equipment; switching from high-sulfur

coal to medium- or low-sulfur coal, fuel blends, or natural gas; employing

energy-efficiency measures and/or renewable generation; buying excess

allowances from other sources that have reduced their emissions; or using a

combination of these and other options.

Monitoring and Penalties Ensure Compliance

An EPA-certified monitoring system at each source continuously 

measures and records mass emissions of SO2 to account for every ton of SO2

emitted. Sources must then retire one allowance for each ton emitted. Those

that don’t have enough allowances to cover their annual emissions are automatically fined and must surrender future year allowances to cover any shortfall.

How It Works
Trade

Why It Works

The Cap Provides Environmental Certainty

Even in the case of high growth in the electricity industry, the cap restricts total emissions. This provides a distinct

advantage over traditional command-and-control regulatory methods that establish source-specific emission rates and

can’t ensure that aggregate emissions don’t rise as new sources come on line or as existing sources are used more.

Limiting Allowances Creates Economic Value

A limit on allowances creates scarcity; scarcity ensures economic value for allowances; and value provides

incentive to reduce emissions.

Lower Compliance Costs Raise the Environmental Bar 

Because a cap-and-trade system allows companies to choose the lowest-cost compliance option, regulators can pursue

more ambitious environmental goals for a given expenditure. For example, before Congress agreed to a 10-millionton reduction goal under the Acid Rain Program, most alternative proposals sought only an 8-million-ton reduction

using conventional approaches.

Banking Encourages Early Reductions

By allowing companies to save unused allowances for future use, banking creates a tangible, quantifiable, economic

incentive to decrease emissions beyond allowable levels. Early emission reductions result in earlier human health and

environmental benefits.

Accurate Monitoring Improves Accountability

Accurate monitoring of all emissions and timely reporting ensure that a ton from one source is equal to a ton from

any other source and that the integrity of the cap is maintained. Participating sources must fully account for each

ton of emissions according to stringent protocols. The resulting compliance information is unprecedented in its accuracy and comprehensiveness. All data are publicly available on the Internet, providing complete transparency. 

State and Local Authorities Retain Flexibility

States and localities may impose stricter limits on sources to address specific local air quality concerns. These limits

must be met regardless of a source’s accumulated allowances.
Cap & 

Aren’t sources just

shifting their emissions around instead

of reducing them?

Does the Acid Rain

Program really

address human

health risks?

Doesn’t trading

result in hot spots

(areas of heavy,

localized emissions)

and higher health

risks?

Question Answer

In fact, under a cap-and-trade system, all trading occurs

under a nationwide “cap” that represents a reduction in

total emissions. The Acid Rain Program requires a 50

percent reduction in total U.S. SO2 emissions compared

to 1980 SO2 levels—larger than any reduction previously required by the federal government. Already, SO2

emissions have decreased by more than 30 percent from

1990 levels. And under the NOx cap-and-trade program

that began in 1999, NOx emissions in the Northeast

have decreased by 60 percent from 1990 levels.

The flexibility under a cap-and-trade system isn’t about

whether to reduce emissions. Rather, it’s about how to reduce them at the lowest possible

cost. Sources may buy and sell allowances, but trading is generally only one small component of an overall strategy for meeting emission limits. In fact, the largest polluters have chosen to significantly reduce their emissions before buying allowances from other sources.

Emission reductions under the Acid Rain Program are significant: EPA projects they will 

prevent thousands of premature deaths, and the annual human health benefits in 2010 will

exceed $50 billion. In addition, because trading assigns a monetary value to reducing emissions below the allowable limit, sources are choosing to cut their emissions sooner than

required, resulting in earlier achievement of human health and environmental benefits.

Actually, in addition to the reductions required by the cap, all areas of the country must meet

national, health-based, air quality standards that are separate from the Acid Rain Program’s

requirements. No source may use allocated or purchased allowances to emit more SO2 than

the level specified for protecting human health. Recent analyses show that emissions trading

has not adversely affected attainment of air quality standards. In fact, under the Acid Rain

Program, the greatest reductions were achieved in the highest-emitting states. 

SO2 emissions from utilities have declined

by more than 6.5 million tons since 1980.

0

5

10

15

20

1980 1990 1995 2000 2010

Million Tons of SO2

17.3

15.73

11.87 11.2

8.95

10.6

Actual

Cap

2001

Because the Acid Rain Program’s cap-and-trade system has achieved greater SO2 reductions muc

trolling other environmental problems. For example, northeastern states began implementing a

Midwest and Southeast will also use this model to address a broader area of ozone transport be

using a trading system. Despite the successes and growing use of cap-and-trade programs, the public 

tions and answers should help clarify these common misunderstandings.
Trade

ch earlier than expected and at lower cost to society, it is increasingly seen as a superior option for cona cap-and-trade program to address regional ozone problems in 1999; numerous additional states in the

eginning in 2004; and dozens of countries around the world have agreed to reduce greenhouse gases by

debate reveals that some aspects of emissions trading are not fully understood. The following quesIsn’t the real purpose of emissions

trading to save

sources money?

Isn’t trading

increasing acidity in

acid-sensitive lakes?

Aren’t older, dirtier

sources exempt—or

“grandfathered”—

from the Clean 

Air Act?

Won’t the future use

of banked allowances undo much 

of the progress

achieved by early

reductions?

While a cap-and-trade system reduces compliance costs, it also creates incentives to

reduce emissions below allowable levels, spurring technological innovation and energy efficiency. In the 1990s, scrubber costs dropped by 40 percent, and the sulfur

removal efficiencies of scrubbers improved from 90 to 95 percent. Additionally, the

cap provides environmental certainty, which is absent in other regulatory programs.

In fact, the early SO2 reductions that sources chose to

make are resulting in faster removal of sulfur from sensitive ecosystems. The delay in recovery of acid-sensitive

lakes is more likely due to decades of very high levels of

nitrogen deposition. 

There are no “grandfathered” sources in the Acid Rain

Program. The source of this misconception is the 1977

Clean Air Act, which imposed new-source performance

standards on sources built after the Act’s passage.

Although sources built before 1977 are grandfathered

from these standards, these sources are subject to the

Acid Rain Program’s emission reduction requirements.

Large, older sources are among those that have reduced

their emissions by the greatest amounts.

On average, the Acid Rain Program’s Phase I sources emitted about 28 percent less

than the allowances allocated to them. During Phase II, which has more stringent

emission limits, many utilities seeking low-cost compliance options may turn to their

bank of unused allowances. While this may delay the achievement of an annual

emission reduction target, the cumulative reductions over the first fifteen years of the

program will be identical. 

Question Answer

SO4 deposition

(kg/ha)

1989-1991 1998-2000

Since the Acid Rain Program began, the acidity of

rain has decreased by an unprecedented 25 percent.
Cap & 

Actually, from 1995 to 1998 under the Acid Rain

Program, more than 80 percent of allowances used

for compliance originated from other in-state sources.

Additionally, because the wind carries emissions

across state borders, preventing sources from trading

outside of their states doesn’t appear to have any

measurable environmental benefit. In fact, it could

harm the competitiveness and profitability of in-state

sources, which could result in higher compliance

costs and higher consumer utility bills. Preventing

sources from trading at all would remove any incentive for earlier or deeper in-state reductions. The

most effective way to protect sensitive ecosystems is

to further reduce cap levels.

Not all emission trading programs have the same features. Critical features are the cap, accurate and complete measurement of emissions, and substantial and

automatic penalties for noncompliance. Although a 

trading program cannot work in every circumstance, 

one with these features can be a very effective tool.

1980

1990

1995-99 Avg.

Most of the SO2 trading has occurred

within the Ohio Valley, where the highestemitting sources have made the largest

reductions.

Is restricting 

emissions trading to

within a state’s 

border the only way

to protect vulnerable ecosystems?

Are all emission

trading programs

the same?

Question Answer

See www.epa.gov/airmarkets 

for more information on the 

Acid Rain Program and other 

capped trading programs.
Trade

Moving Forward

During the first phase of the Acid Rain Program, SO2 emissions were reduced further, faster, and cheaper than expectations, resulting in significant human health and environmental benefits over large areas of the country. However,

while the program is achieving the goals of the 1990 Clean Air Act Amendments, air pollution continues to

degrade human health and the environment, compelling additional reductions.

Additional Emission Reductions Are Necessary

The Acid Rain Program has enjoyed an unusually high level of emission reductions and near-perfect compliance.

However, it is becoming increasingly clear that the program’s emission targets may not be sufficient to achieve its

environmental goal of ecosystem recovery. For example, some Adirondack and other sensitive ecosystems remain

acidic, and visibility in the East, including the Great Smokies, remains impaired. Scientists believe that emissions

from electric generating facilities that cause acid rain must be reduced by two-thirds or more beyond current

requirements to allow ecosystems to recover. Also, the relative contribution of sources outside the power sector is

increasing as emissions from power generation are decreasing.

Cap and Trade Will Be Important to Future Cost-Effective Reductions 

The success of the Acid Rain Program has spurred the development of numerous cap-and-trade programs based on

this model, from the regional to the international level. In addition to the domestic programs already planned or in

progress, Congress is considering broader application of cap-and-trade programs. The flexibility and cost savings

associated with cap-and-trade programs enable policymakers to consider approaches that will more expeditiously

and cost-effectively address the human health and environmental problems caused by air pollution.
“We should build on the successes of the past ten years, particularly the Acid Rain Program’s

cap-and-trade approach, which—through cost-effective, market-based approaches—has

shown that environmental and economic interests can be aligned, rather than at odds.”

—Ken Colburn, New Hampshire Department of Environmental Services

“Cap-and-trade programs...will tend to create incentives for the dirtiest plants to clean up

the most, as the per-ton cost of emission reductions may be expected to be the least....[The]

data show that, if anything, trading may be expected to cool hot spots and not create them.”

—Environmental Law Institute

“The superior environmental and economic results of...the SO2 program are precisely what

should have been expected of a program that matched an explicit emissions limit with a market that turned pollution reductions into marketable assets.” —Environmental Defense

“The flexibility of the trading program has encouraged utilities to capitalize on advantageous

trends, such as changing fuel prices and technological innovation, that might have been

delayed or discouraged by traditional regulatory approaches.” —Resources for the Future

“Market-based incentives also clarify the environmental debate for the general public because

they focus on environmental goals....” —Robert Stavins et al., Harvard University

“EPA deserves significant credit for resisting opportunities to review and approve compliance

and trading decisions by private parties and for focusing instead on the integrity of emissions

monitoring and on a strict, no-excuse, banker-type accountability for emissions and

allowances.” —Denny Ellerman et al., Massachusetts Institute of Technology

Office of Air and Radiation

Clean Air Markets Division (6204N)

EPA-430F-02-009

www.epa.gov/airmarkets

May 2002