The Program (cont.)
The cap was denominated in allowances, which were provided to all affected
sources. Strictly speaking, an allowance authorizes a unit within a utility to emit one ton of
SO2 during a given year. Allowances are standardized and issued by
vintage years, or the first year in which the allowance can be surrendered to the EPA to cover a source's
actual emissions for that year. Allowances are also bankable, meaning unused
allowances can be used in future years. Most importantly, allowances are tradable, and
any individual can open an account to buy or sell them. These attributes make
allowances both an asset and a rationed commodity, empowering the involvement of
financial markets.
Although at its core the SO2 market is a part of a regulatory program, it has many attributes of a financial market as well. For example, market institutions such as brokerage houses and law firms specializing in contracts have emerged with the market. Allowances are transferred and traded among parties, creating an efficient market mechanism.
Utilities can chose among a host of options with which to reduce their emissions, including switching from high-sulfur fuels (primarily coal) to lower sulfur fuels (low-sulfur coal or natural gas) or installing pollution control equipment. Trading allows the market to redistribute the rights to emit SO2, thereby determining a more efficient and economic source of reductions.
Sources are required to execute allowance transactions through the EPA's allowance tracking system (ATS). The ATS allows the public to review all transactions as well as the accounts of all market participants. Improvements in the ATS have also allowed the EPA to reduce the time and cost of completing transactions to minutes.
At the end of each year, each unit must hold a number of allowances at least equal to its actual annual emissions. Utilities not in compliance face severe penalties and find no reprieve from their responsibilities to reduce overall emissions. The penalties include a $2,000 per ton fine adjusted for inflation. And, the offending source must supply offsetting allowances in the next year through reduced allocations or an emission reduction proposal submitted to EPA.