P

olicymakers around the world are planning international environmental commodities markets intended to forestall climate change, slow biodiversity decline, and tackle other global environmental

problems. The European Union, for example, is

developing a regional market for carbon dioxide

emissions to meet targets set under the Kyoto Protocol. Some

U.S. state governments, ignoring the Bush administration’s

position on climate change agreements, want to integrate

their emissions trading systems into a global market for

greenhouse gases.

The proposed market strategies would create incentives

for producers and consumers to make better use of natural

resources. The approach gives producers flexibility to meet

regulatory standards that protect human health and ecological systems. But since the road from policy prescription to

actual market solution is full of pitfalls, it is useful to analyze

the implementation of existing market-based programs and

extract lessons for the future.

Although it receives relatively little attention, a crucial factor in the success of the U.S. sulfur dioxide trading program—the mother of all market-based environmental

policies—turns out to be information and communication

technologies and electronic monitoring systems. Information

technology can reduce the operational transaction costs of

an emissions trading system. By handling vast amounts of information efficiently, information systems permit accurate

tracking of emissions and allowance accounting to ensure

compliance. Furthermore, Internet access to regulatory information increases the transparency and accountability of

market-based environmental management.

Policy on Paper

Title IV of the 1990 U.S. Clean Air Act Amendments, designed to address the acid rain problem by controlling sulfur

dioxide (SO2) emissions, presented an implementation challenge. The mandate to the U.S. Environmental Protection

Agency (EPA) was to create a market-based approach to air

quality management, now known as the cap-and-trade system.

The resulting Acid Rain Program set a predetermined cap

on overall SO2 emissions while allowing trading of entitlements among pollution sources and other interested parties

to meet this standard in a cost-effective manner. The creation

of allowances—quasi-property rights for emissions—promised gains by allowing the free trade of these permits, thus inFALL/WINTER 2004 9

Information

Technology 

THE UNSUNG HERO OF MARKET-BASED ENVIRONMENTAL POLICIES

Blas Pérez Henríquez

P
10

RESOURCES

troducing flexibility for electric utilities burning fossil fuels

in complying with regulations.

By 1994, a fairly robust environmental commodities market in SO2 allowances had taken shape. The Chicago Board

of Trade runs EPA’s annual auction of a small percentage of

allowances, which generates valuable price information. However, the vast majority of allowances are traded in an over-thecounter secondary air pollution allowance market. The SO2

emissions market is regarded as efficient and has been characterized by reasonably good liquidity.

In short, the Acid Rain Program led to the development

of a functioning market with low transaction costs, price

transparency, and extensive trading activity. When in 1999,

EPA Acid Rain Division became the Clean Air Markets Division (CAMD), the new name reflected the extent to which air

quality management in the United States was now supported

by emissions trading.

Implementation Challenges

Markets depend on information. While designing the Acid

Rain Program in 1990, EPA administrators decided to reduce

regulatory uncertainty by abandoning such past practices as

certification of electric utility compliance plans and requiring detailed facility-specific permits—processes that increased transaction costs and discouraged trading. However,

those mechanisms had been used to ensure compliance with

environmental standards and new mechanisms would have to

be found. The challenge was to maintain the environmental

credibility of the emissions trading program while program

participants expanded in number and increased demand for

market exchanges. The Acid Rain Program forgoes the need

to obtain government approval of compliance technologies

and strategies and focuses on environmental results through

stringent measurement of emissions at each source. It is

therefore simpler than its predecessor, reducing transaction

costs and encouraging market development.

To function, the Acid Rain Program needed information

management systems to track allowance transactions and

monitor actual emissions. Fortunately, technological advances in information technology allowed EPA to design a system that would reduce costs both for government regulators

and for traders by limiting intervention once Congress had

set the environmental goal.

Now, after more than a decade of implementing the Acid

Rain Program, EPA administrators say that their main task

consists of two activities: processing huge amounts of information and disseminating huge amounts of information.

EPA’s CAMD has become an emissions and allowance “accountant,” in charge of managing information and processing it for compliance purposes. Emissions and allowance information also needs to flow back to producers, to make the

allowance market efficient and build credibility in the emissions trading approach. According to Joe Kruger, EPA’s chief

of the Market Policy Branch, “Without recent advances in information technologies, these activities would be considerably more diffcult, if not impossible.”

The Essential Digital Infrastructure

Information technology is what has made the SO2 emissions

trading program work. It reduces paperwork and filing costs,

and provides public information online through its database

registries, making the system transparent and credible as well

as permitting electronic reporting, verification, and processing of emissions data. Furthermore, it stretches administrative resources so that the program can cost-effectively cover

a larger universe of sources.

The key elements based on information technology that

have been particularly crucial are the allowance tracking

system (ATS), the emissions tracking system (ETS), and the

continuous emissions monitoring systems (CEMS). These

components facilitate regulatory compliance, assist in allowance market development, and allow public access to

emissions data.

Allowance Tracking System. ATS was developed as the central

registry of allowances used for compliance with the Acid Rain

Program. 

There are various companies in the private sector that

track and disseminate allowance price information for emissions trading markets. In contrast, EPA’s ATS tracks transfers

of allowances between accounts held by sources and others.

Sources that wish to use allowances for compliance must hold

them in these accounts.

In addition to its role in compliance, ATS provides a framework for categorizing transactions of SO2 within the program

that is useful in understanding the allowance market. It provides details of all private allowance transfers reported, enThe concept of a market 

in emissions allowances was 

attractive in theory, 

but information technology

made it happen.
FALL/WINTER 2004 11

abling researchers, market participants, and others to distinguish between “real trades” and those that are only internal administrative transactions between a firm’s different

emissions sources. There is no regulatory component in this

process of categorization; it is conducted to learn more about

environmental markets development. Companies are not required to report allowance transfers unless they will use them

for compliance.

ATS makes possible more efficient transaction recording

processes during the annual reconciliation period in which

sources must hold a quantity of allowances equal to or

greater than the amount of SO2 emitted during that year.

When the program began in 1995, the rules allowed up to

five days to process records because all communications were

sent by mail. By 1997, EPA was processing 89% of the transactions in just 24 hours. Today, about 80% of transfers are entered online via the Web by the sources themselves.

Emissions Tracking System (ETS). Although timely allowance

transfers are one piece of compliance, the emissions tracking component is probably more important. EPA’s Janice

Wagner, chief of the Market Operations Branch, which runs

the allowance trading mechanism’s data systems, calls ETS

“the backbone of the program.” All quarterly reports are now

submitted electronically to ETS, allowing the agency to perform automated data processing to ensure compliance while

making the results available to the public. Using the ETS

mainframe software, EPA checks utilities’ quarterly reports

of emissions and automatically sends a score in an “instant

feedback” report. If necessary, EPA contacts the utilities to

resolve data problems.

Continuous Emissions Monitoring Systems. CEMS are mechanical devices that sample, analyze, measure, and record

emissions on a continuous basis. Each emissions unit must

install continuous monitoring equipment and report its

emissions regularly.

This technology has provided credibility and facilitated

the emergence of a relatively effcient market for SO2 allowances, despite the expense of deploying the monitoring

system—an average annual cost of about $124,000 per unit

(including operating and capital costs). Capital and operating costs of CEMS amounted to 7% of total observed compliance costs in 1995. The estimated total additional cost is

not insignificant—$48 million to $54 million—but the payoff is high-quality data and documentation of early environmental benefits from emissions reductions. According to the

EPA, these data are the “gold standard” that backs up the currency of emissions allowances.

Measurement tools are essential for accurately quantifying

the pollution commodity being traded and that accuracy in

turn promotes smoothly operating markets and environmental integrity. The CEMS requirement thus instills

confidence in the market-based approach by verifying the existence and value of the traded allowance.

In 1995, American Electric Power Company submitted its

emissions data to EPA via modem. Soon other utilities—

Georgia Power, Allegheny Power, and Grain Island Power—

followed. CEMS sent emissions data to a utility’s computer

system, which then compiled it for submission to EPA on a

quarterly basis. An EPA software program was developed to

assist utilities in preparing, reviewing, and submitting their

quarterly reports. This software allows users to check the format and completeness of quarterly reports before submission, and utilities then submit the reports electronically to

EPA’s computer center. Since virtually all companies inSource: EPA CAMD (2002)

Source Installs Continuous 

Emmissions Monitors

Electronically Submits Emissions

Data Each Quarter

MONITORING AND 

REPORTING PROCESS

EPA Provides Feedback to Source

EPA Processes and Quality Assures Data

ETS
12 RESOURCES

cluded in the SO2 allowance-trading program submit emissions data electronically over the Internet, these processes

have been considerably streamlined in contrast to the older

dial-up modem data transmission system.

Annual Reconciliation. At the end of each calendar year, EPA

compares the number of tons emitted with the allowance

holdings of the utility unit to ensure that it is in compliance.

Units not in compliance pay a stiff penalty for every ton they

emit for which they don’t hold an allowance. They are also required to relinquish allowances in the amount of the excess.

Public Access to Data. EPA’s data system now serves as an

emissions data repository for SO2, nitrogen oxides (NOx),

and carbon dioxide (CO2), by source, from the utility industry. The SO2 and NOx emissions data may also help states design programs to comply with the National Ambient Air

Quality Standards provisions of the Clean Air Act for SO2,

ozone, and particulate matter. While the CO2 data being collected by ETS only cover the electric power sector, these data

will help in the creation of a valuable emissions inventory

database for assessing the nation’s progress in stabilizing

greenhouse gases. Finally, although the ETS and ATS have

historically been different systems, they will increasingly be

integrated as EPA reengineers its data management systems.

International Implications

The U.S. SO2 allowance trading program demonstrates that

when emissions are capped and accurately measured, an

efficient market can develop and the costs of meeting environmental goals can be reduced. Underlying the entire

process are electronic monitoring devices, information systems, and Internet communications.

Information technology has become an important tool

helping regulators overcome the asymmetry of incentives between themselves and industry: firms have no incentive to

provide information to the regulator about the industrial

processes being regulated. EPA administrators believe that

digital processing changed regulators’ role from inspecting

compliance choices to measuring results and tracking emissions and allowances—a less costly duty that depends on credible and precise information flows on both pollution

emissions and allowance transfers.

Although the extent of the gains from trade derived from

the program and its efficiency effects are still debated, to EPA

administrators the steady decline in the cost of reducing a ton

of SO2 is proof of the cost savings attributable to the system.

From their perspective, the Acid Rain Program is a success:

emissions are down by millions of tons, utilities are fully compliant, and trading activity follows an upward trend.

Lessons from implementation of cap-and-trade programs

in the United States as well as continued technological

progress, such as the possibility of combining remote-sensing

technologies in monitoring systems with nanotechnology and

global positioning systems, can support the development of

more ambitious market-based environmental policy applications.

In the case of developing an international emissions trading mechanism, however, such an arrangement would have

to undergo its own process of institutional evolution to become a credible and cost-effective solution to greenhouse gas

emissions. In particular, an international greenhouse gas

market must provide certainty and transparency in its exchange mechanisms and also address the more challenging

economic, technical, social, and political dimensions of the

international environmental policymaking context. Information communication technologies and modern monitoring systems will certainly be a critical part of this effort. ■

Blas Pérez Henríquez is executive director of the Center for Environmental Policy in the Goldman School of Public Policy and assistant

dean, Executive and International Programs, at the University of California, Berkeley. His research focuses on the intersection of policy, markets, and the use of information technologies to improve policymaking.

Further Readings

www.epa.gov/airmarkets

Ellerman, A. Denny, et. al. 2000. Markets for Clean Air: the U.S.

Acid Rain Program. Cambridge,UK., New York, NY.: Cambridge University Press

Organisation for Economic Co-operation and Development

(OECD). 1997. Evaluating Economic Incentives for Environmental Policy. Paris: OECD 

EPA administrators say 

that their main task consists 

of two activities: processing 

huge amounts of information

and disseminating huge 

amounts of information.