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Acid Rain Program SO2 Allowances Fact Sheet

Allowance Trading

The innovative, market-based sulfur dioxide (SO2) allowance trading component of the Acid Rain Program allows utilities to adopt the most cost-effective strategy to reduce SO2 emissions at units in their systems. Affected utilities are required to install systems that continuously monitor emissions of SO2, nitrogen oxides (NOx), and other related pollutants in order to track progress, ensure compliance, and provide credibility to the trading component of the program. In any year that compliance is not achieved, excess emissions penalties will apply, and sources either will have allowances deducted immediately from their accounts or may submit a plan to EPA that specifies how the excess SO2 emissions will be offset.

Introduction

Allowance trading is the centerpiece of EPA's Acid Rain Program, and allowances are the currency with which compliance with the SO2 emissions requirements is achieved. Through the market-based allowance trading system, utilities regulated under the program, rather than a governing agency, decide the most cost-effective way to use available resources to comply with the acid rain requirements of the Clean Air Act. Utilities can reduce emissions by employing energy conservation measures, increasing reliance on renewable energy, reducing usage, employing pollution control technologies, switching to lower sulfur fuel, or developing other alternate strategies. Units that reduce their emissions below the number of allowances they hold may trade allowances with other units in their system, sell them to other utilities on the open market or through EPA auctions, or bank them to cover emissions in future years. Allowance trading provides incentives for energy conservation and technology innovation that can both lower the cost of compliance and yield pollution prevention benefits.

The Acid Rain Program established a precedent for solving other environmental problems in a way that minimizes the costs to society and promotes new technologies.

Frequently Asked Questions About the Allowance System

  1. What Are Allowances?
  2. How Are Allowances Allocated?
  3. How Else Can Allowances Be Obtained?
  4. Who May Participate in Allowance Trading?
  5. What Is the System for Keeping Track of Allowances?
  6. What Information is Contained in AMS Accounts?
  7. How Are Allowance Transfers Submitted?
  8. How Is Compliance Determined?

What Are Allowances?

An allowance authorizes a utility or industrial source to emit one ton of SO2 during a given year or any year thereafter. At the end of each year, the source must hold an amount of allowances at least equal to its annual emissions, i.e., a source that emits 5,000 tons of SO2 must hold at least 5,000 allowances that are usable in that year. However, regardless of how many allowances a source holds, it is never entitled to exceed the limits set under Title I of the Act to protect public health.

Allowances are fully marketable commodities. Once allocated, allowances may be bought, sold, traded, or banked for use in future years. Allowances may not be used for compliance prior to the calendar year for which they are allocated.

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How Are Allowances Allocated?

Allowances were allocated for each year beginning in 1995. Phase I included certain electricity generating units. EPA allocated allowances at an emission rate of 2.5 pounds of SO2/mmBtu (million British thermal units) of heat input, multiplied by the unit's baseline mmBtu (the average fossil fuel consumed from 1985 through 1987). These allowance allocations are listed in Table A of the Clean Air Act and codified in the Allowance System Regulations (Part 73, Table 1). Alternative or additional allowance allocations were made for various units, including affected units in Illinois, Indiana, and Ohio, which were allocated a pro rata share of 200,000 additional allowances each year from 1995 to 1999.

In Phase II, which began in the year 2000, EPA expanded the group of affected sources to include virtually all units over 25 MW in generating capacity, and tightened the allowance allocation. Allowance allocation calculations were made for various types of units, such as coal- and gas-fired units with low and high emissions rates or low fuel consumption. EPA allocated allowances to each unit at an emission rate of 1.2 pounds of SO2/mmBtu of heat input, multiplied by the unit's baseline. Beginning in 2010, the Act places a cap at 8.95 million on the number of allowances issued to units each year. This effectively caps emissions at 8.95 million tons annually and ensures that the mandated emissions reductions are maintained over time.

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How Else Can Allowances Be Obtained?

In addition to annual allocations, allowances are also available upon application to three EPA reserves. In Phase I, units could apply for and receive additional allowances by installing qualifying Phase I technology (a technology that can be demonstrated to remove at least 90 percent of the unit's SO2 emissions) or by reassigning their reduction requirements among other units employing such technology. A second reserve provides allowances as incentives for units achieving SO2 emissions reductions through customer-oriented conservation measures or renewable energy generation. The third reserve contains allowances set aside for auction, which are sponsored yearly by EPA. Anyone can participate in the annual allowance auction which is held at the end of March every year.

Units that began operating in 1996 or later are not allocated allowances. Instead, they have to purchase allowances from the market or from the EPA auction to cover their SO2 emissions.

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Who May Participate in Allowance Trading?

Allowances may be bought, sold, and traded by any individual, corporation, or governing body, including brokers, municipalities, environmental groups, and private citizens. The primary participants in allowance trading are officials designated and authorized to represent the owners and operators of electric utility plants that emit SO2.

Any person or group, including brokers and investors, wishing to purchase allowances may open a general AMS account.

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What Is the System for Keeping Track of Allowances?

EPA's role in allowance trading is to record allowance transfers that are used for compliance and to ensure at the end of the year that a source's emissions do not exceed the number of allowances it holds. To accomplish this, EPA maintains an Allowance Management System (AMS). Each affected utility source, corporation, group, or individual holding allowances has an account in the AMS. Parties must notify EPA to have transfers recorded in their AMS account, but it is not necessary to record all transfers with EPA until such time that the allowances are to be used to meet a source's SO2 emissions limitation requirement. AMS accounts are, however, the official records for allowance holdings and transfers used for compliance purposes. To facilitate tracking and recording, EPA assigns every account an identification number and every allowance a serial number.

Any person or group, including brokers and investors, wishing to purchase allowances may open a general AMS account.

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What Information is Contained in AMS Accounts?

AMS accounts track:

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How Are Allowance Transfers Submitted?

Allowance transfer requests and all correspondence with EPA concerning compliance with the Acid Rain Program must be performed by authorized account representatives. For a source account, the Designated Representative, who represents the owners and operators of that unit, performs this function. For a general account, the Authorized Account Representative is the person who represents the parties with an ownership interest in the allowances, and who signs the Account Information Form to open the account.

Forms and more information are available on the Allowance Transfer page.

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How Is Compliance Determined?

At the end of the year, sources must hold in their compliance accounts a quantity of allowances equal to or greater than the amount of SO2 emitted during that year. To cover their emissions for the previous year, sources must finalize allowance transactions and submit them to EPA by March 1 (February 29 - leap year) to be recorded in their compliance accounts. The amount of emissions is determined in accordance with the monitoring and reporting requirements described in the Continuous Emission Monitoring Rule.

After the March 1 deadline and the final submitted transfers are recorded, EPA deducts allowances from each sources compliance account in an amount equal to its SO2 emissions for that year. If the sources's emissions do not exceed its allowances, the remaining allowances are carried forward, or banked for future use. If a source's emissions exceed its allowances, the source must pay a penalty and surrender allowances for the following year to EPA as excess emission offsets.

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