How Do Emissions Trading Programs Work?

Limit on Pollution Emissions

Emissions trading programs work by first setting an environmental goal: a national, or sometimes regional, limit on the overall amount of pollution that sources are allowed to emit into the environment. This environmental goal is a critical part of an emissions trading program.

The pollution limit:

  • Is typically set at a level lower than pollution levels at the beginning of the program, ensuring that overall pollution is reduced.
  • Is intended to protect public health and the environment and sustain that protection into the future, regardless of growth in the number of pollution sources or increased use of affected sources.
  • Provides stability and predictability to the public, to affected sources, and to the allowance trading market.

In some programs, such as the Cross-State Air Pollution Rule (CSAPR), the program is implemented in phases, meaning that the pollution limit is reduced over time.

Allowances and Allowance Trading

Affected sources, such as power plants, that are included in an emissions trading program receive allowances that authorize a certain amount of pollution. For example, in EPA’s Acid Rain Program, each allowance authorizes a source to emit one ton of sulfur dioxide (SO2). Depending on the program, sources receive allowances in different ways, such as free allocations or auctions. Once an affected source has an allowance, the source can decide whether to use it for compliance, trade it in the allowance market, or save that allowance for compliance in the future.

Compliance Flexibility

Emissions trading programs provide affected sources with the flexibility to choose among many options to comply with the environmental goal.

For example, a power plant can:

  • Install pollution control technology, such as a scrubber to remove pollution before it comes out of the smokestack.
  • Replace existing pollution controls with more advanced technologies.
  • Tune-up existing controls so they run better.
  • Switch to alternative fuels that emit less pollution.
  • Shift production to lower emitting or more efficient units.

Sources can also purchase allowances from the market, which provides the incentive for other affected sources to reduce their emissions more than necessary so that they can sell or bank surplus allowances. The ability to bank allowances for later use often means that sources reduce pollution below the limit in early years, sometimes referred to as “overcompliance,” resulting in greater environmental protection sooner than required by the program.

Compliance and Accountability

Successful emissions trading programs require sources to monitor the pollution they emit through very accurate methods, such as continuous emissions monitoring systems, and report those data. One way that emissions trading programs provide transparency and accountability is by making data available to the public.  This adds another level of scrutiny to the data and encourages compliance with the programs.  For example, the data collected from power plants in EPA’s emissions trading programs are available through the Air Markets Program Data (AMPD) system and on the Power Plant Emission Trends page. EPA also releases an annual progress report that presents data on emissions and compliance, allowance market activity, and environmental results under emissions trading programs.

For an affected source to comply with the program, the source must hold enough allowances at the end of a compliance period to account for the amount of pollution they emitted. If a source does not have enough allowances to account for its emissions, they face an automatic penalty. Under the Acid Rain Program, for example, the source must surrender future compliance year allowances to offset the amount of the allowance shortage plus pay an automatic monetary penalty of $2,000 per ton, adjusted for inflation.  Other programs, such as CSAPR, require an automatic allowance surrender penalty of two additional allowances from a future compliance year for each ton for which they did not surrender a valid allowance.

Useful Terms:

  • Emission limit: total amount of tons that affected sources within a state or group of states collectively must meet to achieve the environmental goals of the program.
  • Allowance: a limited authorization to emit a specific quantity (e.g., one ton) of a pollutant from an affected source.
  • Allocation: a method to distribute allowances to affected sources and/or other entities.
  • Banking: saving unused allowances for future compliance periods.

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