NOX BUDGET PROGRAM

1999-2002 Progress 
G

organic compound (VOC) gases react with sunlight, particularly in the warm summer months. Once formed, ozone targets the respiratory system, aggravating

asthma, increasing susceptibility to respiratory illnesses like pneumonia and bronchitis,

and contributing to permanent lung damage. It can also damage forests, reduce the productivity of agricultural crops, and lead to the decay of monuments and buildings.

The Ozone Transport Commission (OTC) was established under the Clean Air Act

Amendments of 1990 to help states in the Northeast and Mid-Atlantic region meet the

National Ambient Air Quality Standard (NAAQS) for ground-level ozone. Historically,

ozone control strategies have focused on VOC emissions. In recognition of the important role of NOx in ozone formation and transport, the OTC has focused much of its

efforts on regional NOx reduction strategies.

The OTC developed an unprecedented, multi-state cap and trade program to control

NOx emissions and address regional transport of ozone. This market-based program,

called the NOx Budget Program, sets a regional “budget” (or cap) on NOx emissions

from power plants and other large combustion sources during the “ozone season”

(from May 1st through September 30th). To meet the budget, sources are required to

reduce emissions significantly below 1990 baseline levels and may use emissions trading to achieve the most cost-effective reductions possible.

The OTC NOx Budget Program has significantly reduced NOx emissions in the Northeast

and Mid-Atlantic region. Through the trading program and earlier Reasonably Available

Control Technology (RACT) requirements, NOx Budget sources have reduced their ozone

season emissions approximately 60 percent below 1990 baseline levels, well under target levels. Deep reductions have occurred in all states across the region. Daily peak

emissions have also declined. In addition, the market-based approach has proven to be

cost-effective, and a viable trading market has emerged. These measures indicate that

the OTC NOx Budget Program is functioning well and achieving its goal of significantly and

cost-effectively decreasing NOx emissions from large combustion facilities.

1
2

Problem

The Clean Air Act requires EPA to set a NAAQS for

ozone. This standard is intended to limit ozone exposure to levels that will protect public health and the

environment. Initially, Clean Air Act implementation

emphasized state planning and local solutions to

attain the ozone NAAQS first set in 1971. However,

despite the implementation of significant, local control strategies in the decades that followed, states

still have had difficulty meeting the ozone standard.

Based on numerous studies and analyses, EPA and

others determined that ozone and its precursors

are capable of being transported over large distances. In particular, atmospheric modeling during

the past decade has demonstrated that long-range

transport of emissions from upwind areas contributes significantly to persistent ozone nonattainment in the Northeast and Mid-Atlantic United

States (see Figure 1). 

As the scientific and policy communities came to

realize the importance of ozone transport, Congress

saw a need for coordinated regional efforts to address this problem and established the OTC through the 1990 Clean Air Act Amendments. The OTC consists

of representatives from the Northeast and Mid-Atlantic states, including

Connecticut, Delaware, District of Columbia, Maine, Maryland, Massachusetts,

New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, Vermont,

and Virginia.

Transport Winds and Ozone Patte

on High Ozone Days

Figure 1

High ozone levels in the Northeast are typically 

ated with persistent transport from west to e

(Data represent high 90th percentile ozone co

Source: Ozone Transport Assessment Group.
3

Understanding (MOU) to create a marketbased emissions trading

program to reduce and cap regional NOx emissions substantially

below levels required by RACT. The NOx Budget Program applies to

more than 1,000 large combustion facilities (budget sources) in signatory states, including over 900 electric generating units (EGUs) and

over 100 industrial units, such as steam boilers and process heaters.

The NOx Budget Program requires that these budget sources collectively meet

a regionwide emissions budget each ozone season (total NOx mass emissions

from May through September) based on reductions from 1990 baseline emissions. Under the program’s cap and trade provisions, each state allocates

emission allowances to their budget sources in accordance with the state’s portion of the regional budget. Each allowance permits a source to emit one ton of

NOx during the ozone season and is associated with a “vintage” year (the year in

which a source can first use the allowance for compliance). Budget sources

must demonstrate that their actual ozone season emissions do not exceed the

amount of allowances held for that period to remain in compliance. Unused

allowances may be sold or saved for use in a subsequent ozone season

(“banked”). Regardless of the number of allowances a source holds, it cannot

emit at levels that would violate RACT or other emission limit requirements.

Budget sources can devise their own strategies

to comply with NOx emission restrictions. The

ability to trade allowances places a value on

emission reductions and encourages sources

to develop the most cost-effective emission

reduction strategies to achieve the overall

emission reduction target. For example, owners

can control emissions at a unit with low control costs to levels below the unit’s

allowance allocation and then use the extra allowances at other units with higher

control costs or sell the allowances to other entities. This approach allows the

OTC states to achieve greater reductions than they could under a traditional regulatory approach for the same overall cost.

The NOx Budget Program, while based in large part on the successful implementation of EPA's national cap and trade Acid Rain Program for controlling

sulfur dioxide (SO2), represents the first example of a group of states coming

For further information on the

OTC program, see:

www.epa.gov/airmarkets/otc 

and 

www.sso.org/otc
4

Under this collaborative state/federal partnership, the states established the

program requirements and emission budgets in accordance with the MOU

requirements and then allocated allowances to each affected unit. EPA administers the data systems used to manage the program and provides technical

assistance to the OTC states and to affected sources, such as tracking

allowance transfers, maintaining unit and account information, assisting with

monitoring issues, and preparing end-of-season compliance reports.

Accurate monitoring of all emissions and timely reporting ensure that a ton of NOx

emitted from one budget source is equal to a ton from any other source, that the

integrity of the budget is maintained, and that the states have accurate and comprehensive compliance information. All emissions and allowance data from budget

sources are publicly available

on the EPA Web site, providing complete transparency. To

date, budget sources have

achieved a very high rate of

compliance.

Reductions

Achieved in

Phases

The OTC states established

three separate phases for

reducing NOx emissions from

large combustion sources

(see Figure 2). Phase I

involved year-round RACT controls. Phases II and III

comprised the OTC NOx

Budget Program: Phase II had

an initial ozone season budget

beginning in 1999, with the

OTC NOx Reduction Strategy Overview 

Phase Geographic Emissions Reduction Target Ozone Seas

Distinctions Emission Le

1990 Baseline Not applicable Not applicable 473,000 to

(approx. ba

Phase I: RACT All areas Approximate 40% reduction 290,000 to

requirements (approx., no 

beginning May 1, 1995 applies)

Phase II: Trading Inner Zone 65% or 0.20 lb/mmBtu 219,000 to

program beginning (based on 1990 heat input) (budget leve

May 1, 1999

Outer Zone 55% or 0.20 lb/mmBtu 

(based on 1990 heat input)

Phase III: Trading Inner & Outer 75% or 0.15 lb/mmBtu 143,000 to

program beginning Zones (based on 1990 heat input) (budget leve

May 1, 2003, but...

Northern Zone 55% or 0.20 lb/mmBtu 

(based on 1990 heat input)

Phase III replaced by No zones, but 0.15 lb/mmBtu (based on 141,000 to

NOx SIP Call Trading excludes ME, 1995 or 1996 baseline heat (budget leve

Program on May 1, NH, and VT input with growth factor)

2003

Figure 2

Source: OTC and EPA.
5

reduction targets— about 70 percent from 1990 baseline levels. This approach, utilizing a firm budget that

decreases in stages, is known as a declining cap.

In developing their NOx Budget Program, the OTC

states establish three zones—“Inner,” “Outer,” and

“Northern”—and required different emission rates for

Phases II and III in the different zones (see Figure 3). In

contrast, the NOx SIP Call uses the same emissions

rate throughout the affected region to establish the

emissions budgets.

The OTC’s Inner Zone generally comprised the contiguous ozone nonattainment areas along the heavily populated corridor from the

Washington, D.C., metropolitan area to southern New Hampshire. The OTC set

the most stringent reduction targets for this zone. The Northern Zone contained all of Maine and Vermont, northeastern New York, and all but southern

New Hampshire, and had the least stringent reduction target. The Outer Zone

contained the rest of the OTC region.

The use of a separate Northern Zone has had little effect on the OTC NOx

Budget Program. Maine and Vermont have not participated in Phase II of the

program and are not affected under the NOx SIP Call. Maine will meet the OTC

MOU requirements for 2003 through unit-specific emission limits, with provisions for intra-source emissions averaging. Vermont has only a single affected

source that has already met the 2003 emission reduction target, with 2001

emissions of 4 tons, well below the 1990 baseline of 27 tons. While portions of

New Hampshire and New York also were in the Northern Zone, they included

those portions beginning in 1999 as part of the OTC NOx Budget Program.

Figure 3

The OTC states that signed the MOU split t

into Inner, Outer, and Northern Zones, and p

for different reduction targets in each zone

Northe

Outer Z

Inner Z

Source: OTC and EPA.
6

reductions well below required levels. Moreover, these

significant reductions have occurred throughout the

region, and the seasonal reduction strategy appears to

have successfully reduced daily peak emission levels.

Emissions Reduced by 60

Percent from 1990 Levels

OTC NOx Budget Program sources successfully reduced

their regional ozone season NOx emissions in 2002 by

nearly 280,000 tons, or about 60 percent, from 1990

baseline levels. Emissions have been lower than the regional budget in each of the four ozone seasons (1999-2002),

in which participants have been able to “bank” unused

allowances for use in the future. The use of banking (in

combination with progressive flow control—see page 15)

did not result in any single season peaks above budget levels.

The decrease in the budget from 1999 to 2000 reflects the allocation of credits for reducing emissions prior to the start of the trading program in 1999

only. The slight increases in the 2001 and 2002 budgets and emissions resulted from the delayed entry of the District of Columbia and Maryland into the

program. For 1999, Figure 4 includes no data for Maryland or the District. The

year 2000 data also do not include the District, but include about 1,800

allowances and 2,300 NOx tons for the small number of sources in Maryland

that participated in 2000. The regional budget increased by about 12,500 tons

in 2001 and 9,000 tons in 2002 as the District and additional Maryland

sources joined the program. At the same time, emissions increased by about

15,500 and 12,000 tons, respectively.

Reductions Achieved through RACT and

Subsequent Budget Requirements 

The first large, regional NOx reductions in the OTC were achieved in the summer of

1995 when Phase I RACT rules went into effect for existing sources. These rules

are comparable to, and in some states more stringent than, the NOx rules that EPA

has enacted nationwide for existing coal-fired boilers under the Acid Rain Program.

Ozone Season NOx Tons

0

100,000

200,000

300,000

400,000

500,000

1990

Baseline

1995 Est.

(Post-RACT)

1999 2000 2001 2

Emissions from NOx Budget Prog

Figure 4

NOx Budget Program units reduced ozone se

sions by 60 percent from 1990 levels, achiev

reductions than required each year of the pr

Source: OTC and EPA.
7

tions achieved under the OTC NOx Budget Program

reflect about a 35 percent reduction from estimated

RACT levels during the ozone season.

Inner and Outer OTC Zones

Achieved Similar Reductions

The OTC states developed different zones in the NOx

Budget Program in order to achieve deeper emissions

reductions in areas with the most significant ozone

nonattainment problems. The states debated whether

or not to impose ratio restrictions on trading between

the zones but eventually decided to permit interzonal

trading on a one-for-one basis. The effect of this decision was that both zones reduced ozone season NOx

emissions by a similar amount from baseline levels (see

Figure 5). Because trading was allowed freely between

the zones, all areas achieved comparable reductions. 

States Across the Region

Achieved Reductions

A state-by-state comparison shows that, in 2002, all NOx

Budget Program states (except the District of Columbia)

achieved significant reductions from 1990 ozone season

NOx baseline levels (see Figure 6). Moreover, all of the

states, except Maryland and the District of Columbia, had

2002 emissions below state budget levels. The anomalous results in Maryland stem from litigation and a

subsequent consent order that delayed the participation of several sources in the

trading program. The District of Columbia began participation in 2001 and had emissions below baseline and budget levels. In 2002, NOx emissions in the District were

above baseline and budget levels. All of the units in the District are relatively low-emitting oil and gas fired units, and the total expected reduction from 1990 baseline

levels was less than 100 tons per season (only about a 17 percent reduction). The

District is likely to have some year-to-year variability given this mix of units, the small

degree of reduction required, and the overall small emissions budget. Ozone S

Outer Zone Inner Zone 0

50,000

100,000

58% 

Figure 5

Inner and Outer Zones of the OTC region ha

achieved comparable percent reductions.

State NOx Reductions from 199

Baseline

Figure 6

Reductions from 1990 levels have occurred 

the NOx Budget Program states. 

1990 Bas

2002 Bud

2002 Em

Note: Results for the District of Columbia and Rhode Is

not appear on the map because of their small scale. Th

seasonal emissions are below 700 tons in each jurisdi

Source: EPA.

Source: EPA.

Scale: NJ 1990 baseline = 4
8

counties after 1990. In other cases, there may have been very low operating levels for existing units in the counties during the 1990 baseline year. Such minimal

increases are not expected to produce localized peaks of ozone, given the nature

of ozone and the major NOx emissions reductions regionally.

Daily Peak Emissions Appear to Have Declined

Epidemiological studies indicate that many of the health effects associated with

ozone are attributable to short, peak exposures, and the ozone NAAQS was developed to protect against such short-term exposures. The NOx Budget Program,

however, is a seasonal program that ensures significant average NOx reductions in

the ozone season but does not necessarily ensure that emission reductions are

achieved on a short-term basis. There have been concerns that a seasonal cap

would not ensure the reduction of short-term, peak NOx emissions that may occur

on hot, high electricity demand days, when ozone formation often is a concern.

An analysis of daily emissions from NOx Budget units

that are affected under the Acid Rain Program, however,

shows that average and peak daily emissions from these

units have declined during the ozone season (see Figure

7). These Acid Rain units account for the vast majority of

budget source emissions in the region. Ozone season

average daily NOx emissions from these units declined

nearly 30 percent between 1997 and 2002. Also, the

ozone season days with the highest total emissions from

Acid Rain units for each year of the trading program had

emissions significantly lower than the corresponding values prior to implementing the program. It appears that

the seasonal program design of the NOx Budget

Program does, in fact, provide NOx reductions from

affected sources on high electricity demand days.

Reducing peak daily NOx emissions during the ozone season remains an important concern, and EPA and the

OTC states will continue to examine trends in peak emissions and their relationship to high ozone days.

 Daily NOx Tons

1997 1998 1999 2000 2001 2

0

500

1000

1500

2000

2500

Highest Daily Emissions Average Daily Emis

First Year of NOx Budget Program

Daily Ozone Season Emissions Tren

(OTC Acid Rain Units Only)

Figure 7

Data for Acid Rain Program units from befo

after the NOx Budget Program show that t

sonal budget is reducing daily emissions, ev

days with the highest emissions.

Source: EPA.
9

decided to include these additional industrial units in the NOx Budget Program.

The industrial units in the NOx Budget Program have consistently emitted below

budget levels during the program, and thus have achieved significant reductions

from baseline levels. The ozone season emissions from the affected industrial

units on average have been more than 10 percent below their allowance allocations. These results are comparable to the results for the electric generating

sector and indicate that industrial combustion units can be effectively integrated

into a cap and trade program. 

Compliance Strategies Do Not Appear to

Have Shifted Emissions to Upwind States

Under the NOx Budget Program, sources can use means other than add-on controls to meet the emissions budget. One method is to reduce utilization of

high-emitting units and shift production to lower-emitting units within the program

or to sources that are outside the budget. If production shifts to upwind, unaffected units with higher emission rates, the effectiveness of the NOx Budget Program

would be reduced because pollution could be transported back into the region.

Shifting of emissions

to unaffected, upwind

units has been an

ongoing concern for

the OTC states and

EPA, and there are

some reports that

sources are purchasing off-peak power

from outside the OTC

region to reduce total

seasonal emissions as

part of their compliance strategy. Figure 8

Increases in OTC nuclear generation appear to offset increases in regional deman

account for much of the decrease in fossil generation.

1 1999 excluded from analysis because Energy Information Administration (EIA) reports that 1999 da

sales have likely errors (Pennsylvania data are low).

2 Plant demand (e.g., for pollution control systems) can require part of a unit’s gross load, so the use o

gross generation for Acid Rain Program units may overstate the decline in generation available to th

Changes in Ozone Season Regional Generation and Sales

Category 1997 and 1998 2000 and 2001 Change 

2-Year Average MWh 2-Year Average MWh1 Average 

Nuclear Net Generation 59,132,000 77,787,000 18,655

Acid Rain Unit Gross Generation2 119,525,000 119,019,000 -506,00

Utility Sales 213,085,000 224,355,000 11,270,

Source: EPA and EIA.
10

The decline in OTC fossil plant utilization as a percent of utility retail electricity

sales, however, was more than offset by an increase in the OTC region’s nuclear

generation over the same period. The ratio of nuclear generation to utility retail

electricity sales averaged 28 percent in 1997 and 1998, and increased to an

average of 35 percent in 2000 and 2001. (See Figure 8.)

These data do not identify where power generated in the region is distributed but

do show that the increase in nuclear generation in the OTC region is large enough

to offset the combined effect of the decrease in fossil generation from Acid Rain

Program units and the increase in utility retail electricity sales. So, although some

companies participating in the program may have purchased electricity from

upwind fossil plants in non-OTC states to comply with NOx requirements and shifted

emissions out of the region, this preliminary analysis indicates that the three percent decline in fossil fuel generation as a percent of regional utility electric sales in

the OTC region cannot necessarily be attributed to shifting of electricity production

out of the region. Rather, the significant increases in nuclear generation indicate

that fossil fuel generation is more likely to have shifted to the nuclear sector. 

In addition, the difference in emission rates between

OTC units and units in neighboring states has

declined since 1997, in large part because of reductions from EPA NOx requirements under the Acid

Rain Program (see Figure 9). The reduced gap

between emission rates in the two areas lessens the

air quality impacts from shifting generation to upwind

sources, although the average emission rates in

upwind states remain nearly twice the level of rates

in the OTC. EPA expects that NOx SIP Call reduction

requirements in these non-OTC states will decrease

the gap in emission rates even further beginning in

2004. While these future actions should reduce concerns of emissions shifting to sources upwind of the

OTC region, EPA and the OTC states continue to

examine this important issue, especially with the

ongoing electric power industry restructuring in the

region and possible changes in federal energy policy.

Average NOx Emission Rate

(lb/mmBtu) 0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

1997 1998 1999 2000 2001 2

OH, VA, WV Acid Rain Units

OTC Acid Rain Units

NOx Budget Program Ozone Season

Emission Rates Compared to Neighb

States (Acid Rain Units)

Figure 9

Potential for shifting generation remains a conce

ozone season NOx emission rates for Acid Rain P

units in neighboring upwind states remain higher 

OTC emission rates, although the gap is declining

Source: EPA.
11

Problems

Despite the work that the OTC states have done to

achieve NOx emission reductions from large combustion facilities, much of the Northeast urban corridor

still has not attained the 1-hour ozone NAAQS,

though state plans are now in place to achieve this

1-hour goal (Figure 10 shows all nonattainment counties in this region as of January 2003). In 1997, a

new, more stringent 8-hour ozone standard was

finalized based on scientific evidence that longer-term

exposures, at levels lower than under the previous

standard, can cause significant health effects.

Additional areas in the Northeast and Mid-Atlantic

region are expected to be designated as nonattainment under this new standard.

Ozone conditions generally are evaluated on a 1-hour

basis or 8-hour basis to match the averaging time of

the ozone NAAQS. To measure ozone trends, EPA

uses the second highest maximum 1-hour value (for

the 1-hour NAAQS) and the fourth highest maximum

8-hour value (for the 8-hour NAAQS).

From 1990 through 2001, average ambient ozone conditions in the OTC states remained relatively constant (see

Figure 11). Figure 11 does show a spike in ambient ozone

levels in 2002 associated with poor weather conditions

during that summer. The figure provides data from two

EPA data sources: the Aerometric Information Retrieval

Information System (AIRS), which has data from ambient

ozone monitoring stations (generally located in urban and

suburban areas) that are used to evaluate attainment,

and the Clean Air Status and Trends Network (CASTNet),

a predominantly rural monitoring network designed primarily to collect dry deposition data that also provides

ozone data (Figure 11 includes CASTNet data through

Ozone Attainment Classification 

OTC States (1-Hour Standard)

Figure 10

Many of the areas in the OTC region still do n

the 1-hour ozone standard (as of January 20

Classification

Severe

Serious

Moderate

Marginal

Attainment or Uncl

1-Hour Standard (initially set in1971): Daily maximum 

concentration shall not exceed 0.120 parts per millio

more than once per year on 3-year average basis.

8-Hour Standard (promulgated in 1997): Daily maxim

hour concentration shall not exceed 0.08 ppm based 

average of the annual 4th highest daily maximum 8-h

Ozone Classifications: Areas are classified based on 

degree to which the daily maximum ozone levels exce

ozone standard on a ppm basis. For example, if the 4

est value over a 3-year period was 0.170 ppm, an are

be a “serious area” under the 1-hour standard becau

value is greater than 0.160 ppm but less than 0.180 

Source: EPA.
12

neous increases in NOx emissions from some types of

mobile sources in the region and by long-range transport of

ozone into the region from states upwind of the OTC. In addition, the strong influence of weather differences from year

to year make it difficult to detect trends in ozone. EPA and

states intend to continue examining ozone trends as more

years of data become available.

While the efforts of the OTC states have not necessarily

resulted in a decline in ozone levels yet, the NOx Budget

Program has been critically important in keeping total

NOx emissions from increasing in the region and in holding ambient ozone levels in check, despite increases in

emissions of some types of mobile sources and long

range transport into the region.

Future Mobile Source Emission

Reductions Are Part of the

Solution

While NOx Budget Program sources have reduced annual

emissions significantly, they are not the only NOx sources

in the region. Even though NOx Budget sources reduced

their annual emissions over 40 percent since 1990, annual emissions data from the National Emissions Inventory

(NEI) show that total annual NOx emissions in the region

between 1990 and 1999 declined by only 10 percent. This

is because, since 1990, emissions from other sources in the region, particularly

mobile sources, have increased or stayed the same (see Figure 12).

Mobile source NOx emissions in the OTC region are starting to decline. EPA projects

that, by 2020, EPA and states will reduce mobile source NOx emissions to only about

one-third of year 2000 emissions through measures such as the National Low

Emission Vehicle (NLEV) Program. The goal of improving ambient ozone conditions

through NOx reduction strategies will take the combined effort of stationary source

measures, like the OTC NOx Budget Program, and these mobile source programs. Annual NOx Tons

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

3,500,000

4,000,000

1990 1996 

Comparison of Annual NOx Emiss

from Mobile Sources and Industr

Fossil Fuel Combustion in OTC St

Figure 12

During the 1990s, NOx emissions from the 

source category reduced the gains from sta

source NOx emission reductions. 

60

70

80

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 200

AIRS 2nd Highest Daily Maximum 1 Hr Avg (142 - 1

CASTNet 2nd Highest Daily Maximum 1 Hr Avg (10 

CASTNet 4th Highest Daily Maximum 8 Hr Avg (10 

Figure 11

Average data from monitoring sites across th

region do not show any significant regional do

trend in ambient levels between 1990 and 20

Source: EPA and CASTNet.

Source: EPA.
13

standard and that these reductions would have to

come from a much larger region than the OTC. EPA

modeling also has shown that emission reductions in

the OTC alone would not be sufficient to attain the

ozone NAAQS. Many of the OTC states petitioned EPA

under section 126 of the Clean Air Act to require

reductions in upwind states.

At the same time, EPA’s NOx SIP Call requires upwind

states to develop control strategies to reduce their significant contribution to nonattainment in downwind

states. Based on the success of the NOx Budget

Program and the Acid Rain Program, EPA has developed under the NOx SIP Call a regional NOx cap and

trade program. EPA designed the SIP Call trading program structure and procedures to resemble closely the

OTC NOx Budget Program and gave the SIP Call states

the option to be part of the trading program to take

advantage of the cost savings of achieving emissions reductions through trading. 

The OTC states are poised to begin implementing the SIP Call (in place of Phase

III of the OTC program) on May 1, 2003. Other states in the expanded region

that are contributing to regional transport of ozone also have chosen to join the

program. These states will initiate monitoring in 2003 and require compliance

with their respective budgets beginning in May 2004 (see Figure 13). In addition,

OTC states plan to achieve additional NOx reductions by requiring controls on

stationary sources other than budget sources, by promoting energy efficiency,

and through state programs for multi-pollutant reductions. EPA anticipates that

implementation of the NOx SIP Call, along with additional ozone attainment

efforts by the OTC and other SIP Call states, will lead to improved ambient

ozone levels across the entire region.

Figure 13

Beginning in May 2004, the NOx SIP Call tr

program will extend the NOx Budget Progra

and trade program concept to additional st

the eastern United States.

OTC Trading S

Additional SIP 

(or Partial St

Source: EPA.
14

Allowance transfer activity can involve three main components: transfers from or to the state as part of allocating

or surrendering allowances; transfers within a company or

between related entities (holding company transfers to a

small operating subsidiary, for example); and transfers

between separate economic entities. The latter category of

transfers are categorized broadly as “economically significant trades.”

Economically significant trades represent about half of the total

trades so far. These transactions provide the strongest indicator of true market activity because they represent an actual

exchange of assets between unaffiliated participants. The volume of economically significant trades generally has been

increasing from year to year, which indicates a maturing market (see Figure 14). These trades include only Phase II

allowances (vintage years 1999-2002), and the trading volume

remained high even in 2002, the final year of Phase II.

Industrial sources, although representing a smaller portion of the affected sources

than electric generating units, have been active in allowance trading, with transfers to

and from electric generating units, brokers, and other market participants.

OTC Allowance Prices Stabilized Well Below

Initial Expectations

Another indicator of a maturing market is pricing activity. An analysis of market prices

from the program’s inception indicates that the early trading prices for NOx allowance

credits for vintage 1999 allowances ranged from $1,500 to $3,000. Then, just prior

to the beginning of the 1999 ozone season, prices for vintage 1999 allowances spiked

at over $7,000 per ton because of initial fears that there would be a shortage of

allowances. By the end of 1999, prices for both vintage 1999 and 2000 allowances

had fallen to less than $1,000 per ton as fears of a shortage were allayed. From April

1999 through December 2002, the price for vintage 1999, 2000, 2001, and 2002

allowances generally converged to a level of less than $750 per ton (see Figure 15).

Volume of Allowances Traded

Year

1998 (13 weeks) 1999 2000 2001 2

0

20,000

40,000

60,000

80,000

100,000

120,000

Volume of Economically Signific

Trades (1998-2002)

Figure 14

Trading volume of Phase II allowances (vi

years 1999-2002) between separate ec

entities generally increased during Phase 

OTC NOx Program.

Source: EPA.
15

allowance bank has increased steadily over the first

four years of the NOx Budget Program.

The ability to bank allowances also encourages early

reductions below budget levels, which provides an environmental benefit as well. In fact, as the OTC states

make the transition

to a broader trading program under

EPA’s NOx SIP Call

in 2003, only a portion of the banked

allowances are being carried forward to

future years, so the benefit of the early

reductions will be permanent. As part of the

NOx SIP Call, EPA made available a pool of

allowances that states could use to reward

early reductions (or to allow for delayed

implementation if sources faced hardship in meeting the initial compliance deadline). Most of the OTC states have established a process to provide SIP Call

allowances from this “compliance supplement pool” in exchange for banked OTC

allowances held by units in the applicable states. The total compliance supplement pool for all of the OTC states is less than 25,000 allowances, while there

are over 90,000 NOx Budget Program banked allowances (based on preliminary

2002 data). Because the total allowances in the OTC states’ share of the compliance supplement pool is far less than the total banked allowances, many of

the early reductions that those banked OTC allowances represent will be permanent upon transition to the NOx SIP Call.

The use of banked allowances, however, could allow emissions to exceed the

emissions budget in a particular year. To address this potential concern, the OTC

NOx Budget Program has allowance deduction provisions (referred to as “flow

control”) that provide sources a financial incentive to avoid using a high volume of

banked allowances for compliance in a single ozone season. Flow control applies if

the bank holds allowances equal to more than 10 percent of the total budget. If

an owner uses banked allowances for compliance when flow control applies, only

a portion of the source’s banked allowances can be surrendered on the customary 1:1 basis (one allowance for each ton of emissions). If additional banked

$0

$1,000

$2,000

Dec-97 Dec-98 Dec-99 Dec-00 Dec

Figure 15

After an initial price spike, allowance prices 

dropped well below expectations.

Source: Natsource LLC and Cantor Environmental Broke

Growth in Banked

Allowances

1999: 43,585

2000: 60,589

2001: 78,746

2002: 91,000

(Note: 2002 figure is approximation based on preliminary data.)
16

four compliance seasons have not exceeded budget levels. These

results indicate that flow control may help to avoid exceedances of

the NOx budgets. Because the NOx SIP Call trading program has

similar flow control provisions, EPA and the OTC states will be able

to continue monitoring the effects of this incentive mechanism. 

The Program Has Been Highly Cost-Effective

Cost-effectiveness is a common measure for comparing the costs of reducing a

ton of emissions under different regulatory programs. For NOx, since 1990, EPA

has used $2,000 per ton of reduction ($2,600 in 2000 dollars) as an upper

limit for evaluating highly cost-effective NOx control strategies. While it is difficult

to determine the actual cost of Phase II of the OTC NOx Program, there are indications that costs are significantly below EPA’s highly cost-effective cut-off of

$2,600 per ton. 

Before the OTC NOx Budget Program, a study conducted for EPA (Estimated

Effects of Alternative NOx Cap and Trading Schemes in the Northeast Ozone

Transport Region, September 1995) projected that the compliance costs for

Phase II of the OTC NOx Program (i.e., from 1999-2002) would result in an

approximately $60 million total annualized cost, approximately $38 million for

add-on control equipment and $22 million for operating costs (all figures have

been updated to year 2000 dollars based on the Producer Price Index). This

study projected that the average cost per ton of NOx reduction would be approximately $1,200 per ton. 

The 1995 EPA study acknowledged that it probably underestimated projected

costs for several reasons. The study excluded industrial units and did not model

electric generating units in parts of western Pennsylvania and certain other

areas within the OTC. The study also did not address the impact of keeping

emissions from new units within the budget — the study indicated these costs

would add approximately $10 million to the annual cost projections. Notably, the

study showed that the compliance costs under the trading program would be

far lower than a “no trading ”scenario, where total annual costs of installing addon control equipment were projected to be over $130 million (2000 dollars).
17

costs were, at least partly, incurred in response to more stringent future

requirements.

Another indicator of the cost of the program is the price of allowances. Since a

source can choose to buy allowances instead of reducing NOx emissions, the

price of an allowance should indicate the highest cost (the marginal cost) that a

source would have to pay to reduce an additional ton of NOx. Once the OTC NOx

Budget Program established itself by the end of 1999, allowance prices have

ranged between $600 and $1,700 per ton and have generally been less than

$1,000 per ton. Assuming these allowance prices represent the marginal cost

of the program, the average cost of a ton of NOx reduction under the program

would appear to be lower. Given that allowance prices for the program after

1999 have been well under $2,600 per ton, it appears that, once the OTC NOx

Budget Program was established, it was highly cost-effective and was certainly

less costly than a “no trading” program would have been.

There are several additional factors that may have helped keep the cost of NOx

reductions under the NOx Budget Program lower than projected. There was an

unforeseen increased use of nuclear power in the region, which decreased the

need for reliance on fossil generation. In addition, the combustion modifications

that had been installed under the RACT requirements appear to have been optimized for greater effectiveness, resulting in additional NOx reductions.
Northeast and Mid-Atlantic states, and the NOx Budget Program is one of the states’

key initiatives in this regional effort. The state/federal partnership has ensured a high

quality interstate emissions trading program with consistent monitoring and reporting

requirements. A viable trading market has emerged, and sources have achieved a high

rate of compliance. In addition, the program has successfully reduced NOx emissions

from budget sources throughout the region, while ozone conditions have not deteriorated since 1990, despite increases in NOx emissions from mobile sources and continued

transport of pollutants into the region from states downwind of the OTC states. 

However, ambient ozone conditions remain a serious problem in the region, and further

emission reduction efforts both within and upwind of the OTC region will be necessary to

achieve the ozone standard. The OTC states will achieve further reductions through a

reduced emissions budget for the affected sources beginning in 2003, and they have

been developing regional NOx emission reduction programs for additional sources. In addition, the success of the OTC NOx Budget Program in achieving NOx reductions has laid the

groundwork for a significant reduction in emissions throughout the eastern United States

through a broader trading program. State and local programs as well as EPA mobile

source programs also will be essential to the overall ozone attainment strategy.

EPA projections indicate that these combined efforts to reduce NOx emissions will contribute to improved ambient ozone conditions. In particular, EPA’s benefits assessment for

the NOx SIP Call predicts significant public health benefits as a result of full implementation

of regional NOx reductions. Broad NOx emission reductions also will aid efforts to reduce

exposure to particulate matter, reduce nitrogen deposition, and improve visibility.

While EPA and the states will have to monitor the long-term air quality trends to ensure

that these environmental goals are met, the NOx Budget Program has been an important

step in efforts to reduce ambient ozone levels and achieve these other environmental

goals. Moreover, the ability of the OTC states to achieve NOx reductions in the context of a

firm, declining emissions cap across multiple industrial sectors, on schedule, cost-effective

ly, and without significant geographic disparities, provides further support for the use of

cap and trade emission reduction programs to address regional air pollution problems.

18
General Background Information on the OTC

NOx Budget Program. See www.epa.gov/

airmarkets/otc for access to OTC compliance

reports, an overview of the program, and access

to emissions and allowance data. See www.sso.

org/otc for the OTC's main Web site, including

access to program documents, formal actions

such as OTC Memoranda of Understanding, and

links to the Web sites of the individual states.

1990 OTC NOx Baseline Emission Inventory,

July 1995 (EPA-454/R-95-013). This report

provides a detailed explanation and listing of the

data used to identify the baseline emissions for

the OTC NOx Budget Program. 

Emissions Data. EPA receives quarterly reports

with NOx mass emissions data for sources subject to the NOx Budget Program. These data

are used in a variety of the findings in this

report. At this time, EPA is still finalizing 2002

data as part of completing allowance true-up

activities for 2002 compliance, and thus the

2002 data in this report are considered preliminary. To access the emissions data, see

www.epa.gov/airmarkets/emissions/

prelimotc/index.html. You can also conduct

queries on emissions data for these units at

cfpub.epa.gov/gdm.

Allowance Data. EPA also maintains the OTC

allowance data in the NOx Allowance Tracking

System (NATS). To access NOx allowance data,

see www.epa.gov/airmarkets/tracking.

Ambient Ozone Data. Various data sources are

available to identify ambient ozone results and

trends. This report relies on Air Quality System

(AQS) data (see AQS Summary Data Tables at

www.epa.gov/aqspubl1/select.html) and data

from U.S. EPA's Clean Air Status and Trends

Network (CASTNet) at www.epa.gov/castnet.

Control Cost Information. For information on

what assumptions EPA uses to assess the

costs of various control technologies in modeling control strategies for electric generating

units, see Documentation of EPA Modeling

Applications (V.2.1) Using the Integrated

Planning Model, March 2002 (EPA 430/R-02-

004). The 1995 study of potential compliance

cost impacts for the OTC NOx Budget Program

used an earlier version of the same modeling

application (see Estimated Effects of Alternative

Cap and Trading Schemes in the Northeast

Ozone Transport Region, ICF Resources,

September 1995).

Electric Generation Data. An analysis of shifts in

electric generation requires access to generation

data. EPA's Emissions and Generation Resource

Integrated Database (E-GRID) is one source of

data (see www.epa.gov/airmarkets/egrid). 

E-GRID combines data from EPA and Energy

Information Administration (EIA) databases. You

may also want to review EIA reports and databases (see www.eia.doe.gov). This report used

data from the EIA 759, 826, and 906

Electricity Databases, as well as EIA Electric

Power Monthly Reports.

issues discussed in this report, including the following:

19
Office of Air and Radiation

Clean Air Market Programs

EPA-430-R-03-900

1200 Pennsylvania Ave, NW

(6204N)

Washington, DC 20460

www.epa.gov/airmarkets 

March 2003

Ozone Transport C

444 North Cap

Washington

Phone: (202

Fax: (202

E-mail: ozo

Web site: www