24 ELR 10695 | Environmental Law Reporter | copyright © 1994 | All rights reserved

Transforming Economic Incentives From Theory to Reality: The Marketable Permit Program of the South Coast Air Quality Management District

Daniel P. Selmi

Editors' Summary: Modern environmental law has relied almost exclusively on either mandating or forbidding certain conduct in order to reduce pollution. In addressing pollution that causes acid rain, the 1990 Amendments to the Clean Air Act adopted a new approach: Encouraging pollution reduction through market-based incentives. The South Coast Air Quality Management District (SCAQMD or the District), which is responsible for regulating air pollution in the Los Angeles metropolitan area, adopted this approach in its Regional Clean Air Incentives Program (RECLAIM). The program creates a system of marketable permits for emitting nitrogen oxide and sulfur oxide.

This Article begins with a review of the theory behind marketable permit programs. It then examines the history of pollution control in the District. Next, the Article analyzes the development, structure, and operation of RECLAIM. The author notes that any conclusions about RECLAIM are preliminary at this point, because the emission reductions that RECLAIM calls for extend until at least 2003. Nevertheless, the Article suggests aspects of the program that observers should watch, especially the interaction between economic incentives and "command-and-control" regulations, the use of District resources, and the regulated community's confidence in the program.

Daniel P. Selmi is a professor of law at Loyola Law School, Los Angeles, California, where he teaches environmental law, land use, and torts. During 1993-1994, he was on sabbatical as a visiting scholar at the Environmental Law Institute. Professor Selmi acted as a consultant to the South Coast Air Quality Management District during the preparation of the RECLAIM program and with respect to current litigation over it. The author wishes to thank Peter Greenwald, Esq., and Robert Kwong, Esq., of the District Counsel's Office of the South Coast Air Quality Management District, for their comments on an earlier draft of this Article, and David Ackerly for his research assistance. All opinions expressed in this Article are solely those of the author.

[24 ELR 10695]

At the time that modern environmental law emerged in the early 1970s, economists and other commentators frequently suggested the use of emission fees and marketable permits as means of controlling pollution.¹ That advice, however, was almost entirely ignored, as environmental law over the past quarter century has relied almost totally on "command-and-control" mechanisms to reduce pollution.² The reasons for this choice are well-documented and intuitively obvious: Command-and-control regulation is politically appealing, has a traditional and known enforcement structure, and provides a level of comfort to both regulators and the regulated community that untested economic incentives could not match.³

[24 ELR 10696]

But the limits of command and control as a vehicle for attaining environmental protection goals have become more apparent in recent years, and efforts to implement economic incentives are on the rise.⁴ One significant development was the inclusion of the acid rain trading provisions in the 1990 Amendments to the Clean Air Act.⁵ Most recently, the South Coast Air Quality Management District (SCAQMD or the District), the agency charged with regulating air pollution in the Los Angeles metropolitan region, concluded a three-year development process by adopting regulations that implement a marketable permit system for emissions of nitrogen oxide (NO_x) and sulfur oxide (SO[x]).⁶ The system, known as the Regional Clean Air Incentives Program or RECLAIM, is the most ambitious attempt by state regulators to substitute an economic incentive program for the control of emissions in place of traditional command-and-control rules.

This Article explores the features of the RECLAIM marketable permit program, emphasizing the most important implementation decisions that the District faced in crafting the program and explaining the choices that it made. This Article also draws some preliminary conclusions about the practical difficulties that agencies face in shifting from systems based on governmental commands to systems in which the principal control mechanism is a marketable permit containing an emission cap.

Marketable Permits: The Theory

The economic theory of marketable permits is well-explained in the literature.⁷ Accordingly, this Article will summarize the theory only briefly so as to establish the context for discussion of the RECLAIM program.

Marketable permit systems are conceptually simple and contain several features that distinguish them from command-and-control regulation. Under such a system, the regulatory agency allocates parts of an overall emissions "pie" to various facilities that contain sources of air pollution. The allocation system can be an auction, a "first come, first served" regime, a distribution based on historical emission patterns, or some other process. The allocation establishes a "cap" on emissions from the sources at that facility. A command-and-control system, in contrast, establishes specific emissions limitations from individual sources on a "pounds per unit" basis, but does not set an overall limit on the amount of pollution from those sources.⁸

Once the emissions are allocated, facilities may choose how they will stay within the emissions cap. For example, they might over control some sources and let others emit freely, change production processes, or alter the type of fuel used to reduce emissions. Most importantly, they may choose to control pollution to levels less than allowed by the emissions cap, either througha process change, a retrofit of equipment, or a curtailment of operations, and then sell the excess reductions to other companies. Those companies might choose to buy the excess reductions because they can acquire rights to them at a cost that is lower than controlling the emissions from their own plant.

Thus, marketable permits implement a "least cost" system of pollution control. In contrast, under command-and-control systems the level of cleanup is mandated by the regulatory agency enforcing the pollution controls, and sources have no incentive to control pollution beyond what is required of them.

Previous Regulatory Initiatives in the South Coast Air Basin

Like almost every pollution control agency in the United States, the South Coast Air Quality Management District in the past had used command-and-control mechanisms almost exclusively in its regulatory efforts. The centerpiece of these efforts was the adoption of the 1989 Air Quality Maintenance Plan (AQMP), which divided proposed control measures into three separate "tiers" based on the economic and technological availability. Tier I measures were those that the District could adopt within a five-year period using currently available technological applications and management practices, while measures in Tier II were expected to be available for implementation within the next 10 to 15 years.⁹ Tier III strategies, in contrast, were conceptually sketched but not developed to the point where they could be described with particularity.¹⁰

To implement the AQMP, a document that received widespread press coverage,¹¹ the District embarked on an extensive series of rulemakings designed to regulate a large number of air pollution sources. Over a period of time, however, resistance gradually built to those efforts, with objections centering on the cost of air pollution controls in the air basin and on the allegation that the District's regulations [24 ELR 10697] were deterring businesses from locating or expanding in southern California.¹² Responding to the difficulties it faced in further implementing the command-and-control rules called for by the plan, the District began a lengthy consideration of whether an economic incentive system might accomplish the same air quality goals while reducing both the costs and the level of government interference necessary to achieve those goals.¹³ The outcome of this process was the approval of RECLAIM in October 1993.¹⁴

The RECLAIM Program

The Regulatory Universe

* The Regulated Pollutants. A threshold question in any pollution control program is what pollutants are to be regulated. The District began by evaluating the initial inclusion of two pollutants in the marketable permit system: NO_x and reactive organic gases (ROG).¹⁵ This choice related directly to the District's obligation under the federal Clean Air Act¹⁶ to attain the national ambient air quality standards in the country's most polluted air basin.¹⁷ It is well-established that both ROG and NO_x are precursors to ozone, and the South Coast Air Basin is in a state of extreme nonattainment for that pollutant.

The District ultimately chose to delay adoption of any marketable permit system for ROG and severed it from its NO_x and SO[x] rulemaking.¹⁸ The District's investigation revealed that including ROG emissions in the new system posed significant administrative and regulatory problems unlike those of NO_x and SO[x]. For example, the administrative burdens of including ROG would be greater because adding ROG to the market could mean regulating an additional 2,000 sources. More importantly, however, the means by which reactive organic compounds are released into the atmosphere differ substantially from releases of the other two pollutants, since ROG releases often occur when products such as paints are used in a manufacturing process. As a result, monitoring amounts of ROG emissions is a much more difficult undertaking than monitoring emissions of other pollutants. Moreover, toxic air contaminants can be released at the same time as ROG, further complicating use of a regulatory approach based on market principles.¹⁹

In place of ROG, the District chose to include SO[x] based on evidence that it is a precursor to fine particulate matter. Although the District has attained the national ambient air quality standard for sulfur dioxide, it has not yet met the national standard for particulates.²⁰

Facilities Included in the Program. The District regulates over 31,300 facilities emitting air pollutants, and of that total, 6,600 facilities emit NO_x and 950 emit SO[x]. The District evaluated a variety of conflicting variables in deciding which of these NO_x and SO[x] sources would be part of the RECLAIM market. These variables included impacts on small businesses, cost-effectiveness of control measures, effect on overall economic competitiveness in the region, and consideration of whether a viable trading market was possible.²¹ The District's expressed goal was to create a robust market by capturing in it "a greater fraction of the emissions inventory with the smallest possible Universe of Sources," thus minimizing administrative burdens during the initial phase of RECLAIM implementation.²²

To examine possible market structures, the District analyzed actual emissions data from all facilities that emitted two or more tons per year of any criteria pollutant. The District obtained this data from the emission fee billing system that it had previously put in place.²³ The District used a second database extracted from its permit records to evaluate emissions from facilities with less than two tons of annual emissions.

The District examined the distributional pattern of emissions from facilities in each category of the Standard Industrial Classification (SIC) Code. For most industrial categories, the District found that a natural "break" in the emission pattern seemed to occur around the grouping of facilities with annual emissions of four tons, although a few industrial categories "broke" at a lower level. Ultimately, this information led the District generally to include in the RECLAIM market all [24 ELR 10698] facilities with permitted emissions of greater than four tons per year during any year after 1989.²⁴

Some facilities,²⁵ however, were exempted even though they otherwise would fall within this category. The District's advisory work group recommended an exemption for essential public services due to their inability to control the conditions that lead to emissions and their lack of financial capacity to function under the marketable permit program. This group of permanently exempt sources includes police and fire fighting facilities, water delivery operations, and public transit. Other public facilities were exempted initially but may opt to enter the program. This group includes prisons, schools, hospitals, colleges and universities, and publicly owned wastewater treatment facilities.²⁶ Equipment rental facilities also were excluded because of their inability to control renters' use of the equipment.²⁷

Additionally, the District excluded from the market all SO[x] emissions that are combustion byproducts of the burning of natural gas. This exemption effectively removed all utilities in southern California from the SO[x] market, because they currently burn only natural gas.²⁸ Finally, the District was concerned about awarding emission rights to facilities that were not actually in operation, because those rights could be traded to other facilities that were emitting pollutants, thus substituting real emissions for the "phantom" ones of the closed facility. Accordingly, it required that all facilities in the market at its inception must actually be operating; no facility that has gone out of business can receive an emissions allocation.²⁹

As noted above,³⁰ some facilities that are not in the RECLAIM universe may opt in, but a decision to enter is irrevocable. Once a source becomes part of RECLAIM, it cannot return to its previous mode of regulation by command-and-command rules. Moreover, a facility cannot opt to join RECLAIM if it is subject to a compliance date established by an existing command-and-control rule that falls within six months of the facility's application for entry into the market.³¹

In the end, the NO_x market encompasses approximately 390 facilities, a figure that accounts for slightly less than two-thirds of the total NO_x emissions reported from all permitted stationary sources in the South Coast Air Basin. Interestingly, these 390 facilities amount to only about 6 percent of the total number of facilities that emit NO_x;³² thus, a relatively small number of facilities accounts for a very large proportion of the NO_x emissions in the Basin.

The structural features of the SO[x] market are similar. A total of 41 facilities are included in the market, representing about 85 percent of the SO[x] emissions reported from all stationary sources emitting that pollutant. These 41 facilities, however, amount to only about 4 percent of the total number of facilities that emit SO[x].³³

Allocation of Emission Rights and Rates of Reduction

* The Initial "Baseline" Allocation. Admission into the RECLAIM market means that a facility will be given an initial allocation of emissions for its use each year, but that allocation will decline annually over time. In theory, the District possessed considerable discretion in awarding the initial allocations; in practice, however, the District faced significant equitable constraints.

Most importantly, almost all the NO_x and SO[x] sources included in the market were previously subject to command-and-control rules requiring various levels of emission control. These sources demanded that the District take these prior efforts into consideration in setting the baseline allocation. After examining numerous potential allocation models³⁴ and initially suggesting a model that would not take past control efforts into account, the District adopted the allocation principle that each RECLAIM facility would receive a starting allocation that was no less than its "current operating level."³⁵ Thus, a facility would determine its initial allocation of either SO[x] or NO_x by calculating the emissions that it was emitting previously.

The formula used for this calculation is the same for both the NO_x and SO[x] markets. In general, the source determines its annual "throughput" for each equipment category in the facility -- generally, fuel use³⁶ -- and multiplies it by an emission "factor" that represents the level of emission control currently required. Annual throughput data for each facility is first segregated into equipment and process categories, and then further separated by fuel type.

Standardized emission factors that are fuel- and process-specific are then applied to this throughput data to obtain the allowed level of initial emissions.³⁷ For example, the emission factor for one category of steam generating boilers has an emission factor of 47.750 pounds per million cubic [24 ELR 10699] feet (mmcf) of natural gas,³⁸ and this number would be multiplied by the equipment's throughput -- the amount of natural gas used -- to arrive at the initial allocation for that piece of equipment. These emission factors are set to correspond to the implementation of District rules with compliance dates from 1990 to the end of 1993.³⁹ Finally, the emissions from each specific piece of equipment or process in a facility are summed to arrive at the initial emissions allocation for that facility.⁴⁰

One difficulty with using this method is that the annual throughput on which the calculation is based often varied widely between 1989 and 1992. Industry strongly argued that basing the calculation on the year 1992 would be unfair, as the level of throughput for that year reflected the severe economic recession that southern California was experiencing. Industry feared that as the economy recovered from the recession, facilities would be constrained by a RECLAIM emissions allocation based on "recession throughput."⁴¹ That constraint, of course, would not exist under command-and-control rules, because they impose no overall limit on pollution from a facility. Instead, they simply place a concentration limit, such as parts per million by volume or grams per liter in cases of volatile organic compounds (as opposed to a mass limit) on each unit of emissions, allowing the overall "pie" of emissions to fluctuate without any overall emissions ceiling. Thus, overall emissions will rise as economic activity increases even though the specific pollution control levels on each unit of equipment or each process remains unchanged.

This conceptual problem occupied a great deal of the District's attention. To resolve it, the District evaluated over two dozen alternative allocation formulas, which varied from using the highest adjusted reported emissions to using average adjusted emissions. At the same time, however, the District's discretion was constrained by a California state law that had been amended specifically to address marketable permit systems.⁴² This law mandated that any new marketable permit system must secure emission reductions that are "equivalent" to those under the existing command-and-control system at less cost.⁴³ Thus, the District could not stray too far from the pattern of emissions reductions called for under the command-and-control measures included in its AQMP.

The District ultimately adopted a flexible approach to determining a facility's baseline that reflected the equities raised by industry. A facility may choose the peak year activity for the years between 1989 through 1992, and throughput for that peak year will be used to calculate the facility's starting allocation.⁴⁴ A facility thus selects an annual throughput level from the 1989 through 1992 levels that the facility reported in its annual emissions fee report submitted to the District.⁴⁵

Two other significant equity concerns arose in the allocation process. One concerned whether special treatment should be given for so-called emission reduction credits (ERCs) that the District previously had issued to companies that had reduced their emissions more than was required. These companies objected that an allocation system based solely on throughput would effectively confiscate the ERCs, and they would lose their investment in the technology that controlled the excess emissions. Similarly, companies that had gone through the new source review process recently and obtained offsets argued that they should receive some sort of credit for these offsets in their baseline allocation.

The District's solution was to give facilities the option of adding their ERCs to their initial, baseline allocation or converting the ERCs to units that could be traded to other facilities under the RECLAIM trading program. Those ERCs would not be subject to any reduction in emissions between 1993 and the year 2000. After that date, however, they would be treated like any other type of allocation.⁴⁶

A second equity issue concerned the so-called clean fuels mandate imposed on gasoline refiners by the California Air Resources Board and the federal Clean Air Act. Under that mandate, refiners must retrofit their equipment over the next few years in order to produce reformulated fuels. Those alterations will result in increased emissions from the refineries.⁴⁷ The affected oil companies argued that it was [24 ELR 10700] unfair to require them to spend the considerable sums needed to retrofit their refineries and then to exclude the increased emissions caused by the retrofitting from the facility's baseline.⁴⁸ Responding to this argument, the RECLAIM rules allow those refineries an increase in their baseline allocation equal to the increase in emissions resulting from the "clean fuels" modifications.⁴⁹

* Intermediate and Ending Allocations. The goal of the RECLAIM program is, of course, to attain the federal and California ambient air quality standards for ozone and particulates, and the initial NO_x and SO[x] allocations must be reduced substantially to meet those standards. At the same time, the reductions under RECLAIM must meet the deadlines for attainment established by federal and state law. Even given these constraints, however, a wide variety in the rates of reduction required from facilities is theoretically possible between the starting date of the program and the attainment deadline. For example, the District could simply require a single, steady rate of reduction for all facilities that it has provided with a starting allocation and set that rate so that the desired overall level of emission reductions takes place. Alternatively, it could devise different reduction rates for separate categories of sources, or it could vary the percentage by which the allocation is reduced each year.

In practice, however, two significant factors affected that decision. Most importantly, the District was in the process of implementing the series of pollution control measures called for in its AQMP at the time it adopted RECLAIM. Under that prior regime, the actual levels of control on stationary sources in the RECLAIM program varied, depending on such factors as when the regulation mandating that control was enacted and the compliance deadlines in it. Requiring an equal rate of reduction for all sources in the RECLAIM market could be viewed as unfair to sources that previously had installed stringent control technology, as opposed to other sources whose existing controls were less stringent.⁵⁰

The second important factor was the state-law requirement that the RECLAIM program produce emission reductions that are "equivalent" to those required by the prior command-and-control program.⁵¹ Opponents of RECLAIM might raise legal challenges to the emission reductions under the new program on the grounds that those reductions were not equivalent to those under the prior program.

Consideration of these two factors suggests that the emission reductions required by RECLAIM should closely track and implement the specific reductions called for by the District's Air Quality Management Plan. If that strategy were followed, RECLAIM would reflect the level of controls in which individual sources had invested before its adoption, and the RECLAIM rates of reduction would closely match those planned for under the command-and-control regime, thus avoiding any "equivalency" problem. Thus, it is not surprising that the District followed this approach. The chief underlying premise of the program is that RECLAIM emissions, in the aggregate, must be equivalent to the AQMP emission projections for the years 2000 and 2003, and that facility reductions must reflect the emission reductions called for in that plan.⁵²

Each facility is required to reduce its baseline emissions in two successive steps. From 1993 to the year 2000, emissions must be reduced to a level known as the "year 2000 allocation," while by 2003 emissions must be further reduced to a level known as the "year 2003 allocation" or the "ending year allocation." These two allocation points are calculated to reflect the level of emission control that the District's Air Quality Maintenance Plan previously required from specific sources by those dates using command-and-control methods.

The starting point is the throughput levels found in the facility's initial allocation which, as discussed above,⁵³ are derived from the peak activity year between 1989 and 1992. To calculate the intermediate "year 2000 allocation," those levels are multiplied by equipment- or process-specific emission factors that reflect implementation of existing rules and "Tier I" control measures that the AQMP had scheduled for implementation between 1993 and the year 2000.⁵⁴ These calculations are made for all sources within a facility and then are added together to arrive at the year 2000 allocation for the facility as a whole.⁵⁵

It is likely, however, that when these allocations for all facilities are added together, the sum of these emissions -- known as the "unadjusted intermediate allocation" for all facilities -- will be greater than the emissions inventory called for in the AQMP. This situation could occur because facilities may base their initial allocation on their peak throughput between 1987 and 1992, a choice that may mean that the reductions by the year 2000 are somewhat less than [24 ELR 10701] envisioned in the AQMP.⁵⁶ To remedy this shortfall, the District will reduce every facility's year 2000 allocation by an equal percentage so that the AQMP emission inventories for year 2000 will be achieved.⁵⁷ Thus, after the Tier control I measures are applied to the initial baseline allocation, if a further reduction in the aggregate emissions from RECLAIM facilities is needed to meet the AQMP emission projection for the year 2000, all facilities will have to reduce their emissions by an additional equal amount.⁵⁸

The District's projections indicate that the year 2000 "unadjusted intermediate allocation" for the NO_x market will have to be reduced, or "shaved," by 12 to 15 percent in order to match the AQMP emission projections for that year.⁵⁹ In contrast, the unadjusted intermediate allocation for SO[x] is projected to be lower than the AQMP emission projection for that year; accordingly, the excess SO[x] emissions will be distributed back to facilities in the market.⁶⁰

The actual reductions under the program through the year 2002 are thus facility-specific; they vary depending on each facility's starting, intermediate, and ending allocations.⁶¹ In turn, those facility allocations are determined by the types of equipment at each facility, because the emission factors vary for different types of equipment.⁶²

The allocation for the year 2003 is determined somewhat differently. Rather than use emission factors to obtain the reductions for an individual facility, as is the case for the year 2000 allocation, the District applies a percentage inventory adjustment to each facility's unadjusted year 2000 allocation. The reduction is calculated so that the sum of all year 2003 allocations for all RECLAIM facilities will equal the AQMP's projected inventory for RECLAIM sources in the year 2003.⁶³

* Rates of Reduction to Meet the Intermediate and Ending Allocations. The method described thus far determines the overall allocation for each facility for the years 1994, 2000, and 2003. Once these allocations for each facility are set, the next step is to determine the rate of reduction between those yearly allocations. For every year between 1994 and 2000, each facility in the SO[x] and NO_x markets must reduce emissions on a "straight-line" basis.⁶⁴ In other words, during the period between 1994 and 2000, each facility will reduce its emissions by the same percentage each year. The rate of reduction, as a percentage of the overall starting allocation, will not change from year to year. A similar "straight-line" reduction will be used between 2000 and 2003, if that second reduction is needed.⁶⁵ For the years after 2003, all facilities will have the same allocation as in the year 2003, unless during the AQMP revision process the District determines that additional reductions are necessary to attain the air quality standards by the year 2010.⁶⁶

This straight-line reduction method will produce a specific, yearly emissions cap for each facility that will be lower than the previous year's cap except in the rare instance where a facility's initial allocation equals or is less than the year 2000 or year 2003 allocations. That cap cannot be exceeded and will be made binding on the facility by its permit to operate.⁶⁷

Use of the Tier I control measures in the AQMP as the primary component in calculating the intermediate year 2000 allocation, and thus the individual yearly reductions between 1993 and 2000, obviously has important implications for specific facilities. The aggregate rate of NO_x reduction for all sources between 1994 and 2000 will be about 11 percent per year.⁶⁸ One result of this methodology, however, is that new or "clean" facilities in the RECLAIM program will tend to have lower rates of yearly reduction than other facilities in the program.⁶⁹ The reason for this difference is that the total emission reductions required for a given facility between 1993 and 2000 will depend on whether the emission controls required by the AQMP are reflected in the initial "peak year" baseline allocation. If they are, the difference between that initial allocation and the 2000 allocation will be less than in the situation where the AQMP requires implementation of controls between 1993 and 2000. In that instance, the rate of reduction required yearly to attain the year 2000 allocation will be lower.

Thus, the actual emission reductions at a facility will depend largely on the controls required on it before the implementation of RECLAIM. For example, for equipment categories now controlling at "best available control technology" levels, very few actual reductions through the year 2000 will be needed.⁷⁰

The Trading Mechanism

* The Currency: RECLAIM Trading Credits. A basic feature of a marketable permit system is that if a facility reduces [24 ELR 10702] emissions to a level below its allocation cap, it may sell the unused emission allocations to other facilities that would otherwise emit at levels exceeding their cap. In RECLAIM, the currency used for such trading is known as the RECLAIM Trading Credit or RTC. An RTC is defined as having a "denomination of one pound of [a] RECLAIM pollutant" and a term of one year.⁷¹ This is a small denomination, designed to accommodate small transactions.

To emit a pound of SO[x] or NO_x, a facility subject to RECLAIM must hold an RTC for that emission. The facility can obtain the RTCs it needs in one of two ways: (1) as part of the RTC allocation given to a facility by the District, or (2) by the purchase of an RTC through a market transaction.⁷² Persons who do not own or operate a RECLAIM facility also may purchase RTCs if they wish; thus, "middlemen" can repackage RTCs to meet a facility's needs or simply hold RTCs as a means of reducing total emissions.⁷³

The District originally proposed to issue RTCs with a single yearly expiration date. Its consultants on market-based trading, however, pointed out that this system would cause an administrative "logjam" as trading accelerated near the expiration date, and that it might result in a shortage of available credits at year-end. Conversely, a glut of RTCs on the market could occur if facilities held on to RTCs in numbers substantially above those needed to match their emission levels and then sold them at the end of the yearly period.⁷⁴ In response, the original RECLAIM proposal was modified to divide facilities randomly into two equal categories: (1) facilities in Cycle One, in which credits expire on December 31 of each year, and (2) facilities in Cycle Two, in which credits expire on June 30.⁷⁵ Fifty percent of the total RTC allocations will be placed in each cycle for the NO_x and SO[x] markets.

Once issued, RTCs are not restricted to use in a single cycle. For example, facilities in Cycle One can sell credits to facilities in Cycle Two. But if an RTC is sold from a facility in one cycle to a facility in another, the expiration date of the RTC sold does not change. Thus, a Cycle One facility will have a compliance year that ends on December 31, and its District-issued allocation of RTCs will expire then as well. If, however, it purchases an RTC from a Cycle Two company in February of that year, the purchased RTC will continue to expire on June 30.⁷⁶ Its expiration date will not change simply because it is now owned by a facility whose own allocations are on a different cycle than the purchased RTC.

One result of this system is that emissions may "migrate" from one calendar year to another. For example, a facility in Cycle Two will receive its allocation in July, an allocation that is intended to authorize emissions until the end of June the following year. In theory, then, one-half of that allocation was intended for use in the following year. Under the trading system, however, those "second year" emissions could be traded to another facility, which is free to use them before the following year. If it does so, the emissions from the following year will have "migrated" back a year.

The District recognized this possibility and conducted an analysis to determine if such migration could occur and possibly create an air quality problem by accumulating emissions in a single year. The analysis of possible trading patterns concluded that no long-term air quality problem was likely.⁷⁷

* Recording Trades. The RECLAIM market will operate without direct regulatory intervention by the District, which will merely record transactions and disseminate information, relying on others to facilitate transactions.⁷⁸ The principal vehicle for recordation is an RTC listing that the District maintains. The listing will contain all RTCs held by a facility, whether as part of the allocation received from the District or in an RTC certificate. These two accounts in the RTC listing thus will reveal the current RTC holdings of all facilities.⁷⁹

Market participants will negotiate the terms of their own RTC trades, including price, quantity, and method of payment, without the District's participation. When parties agree to a trade, they or their brokers must jointly complete a Registration of RTC Transfer, a document that identifies the trading parties, the amount and type of emissions traded, the transaction date, the effective date of the transfer (which can be different from the transaction date), and the price per pound of emissions.⁸⁰ When the District receives this document, it will debit the transferor party's balance in the RTC listing, reducing either the allocation account or the [24 ELR 10703] certificate account. A credit for the same amount of RTCs will then be entered into the transferee's account.⁸¹

This process for registering trades serves two functions. First, it enables the District to monitor transactions and accurately record the current rights to emit held by each facility, a prerequisite for enforcing the yearly emissions cap. The parties can shape the timing of any RTC transfer by agreeing on an effective date that either precedes or supersedes the date on which the transaction is reported to the District, and this date will ultimately be used to determine whether the source's actual emissions exceed the rights to emit that it holds.⁸² Second, the collection of price information through the registration process will allow dissemination of that vital information to market participants.

The unknown but critical question is whether the market will function smoothly at an acceptable price level. The District's assumption, which seems reasonable, is that facilities will be inclined to sell unneeded RTCs because they are only valid for one year; holding on to them too long risks losing their entire value when they expire.⁸³ As to price, at some point price increases could reach a juncture where political opposition would call into question the program's continued existence. California law anticipates this possibility, requiring the District's Governing Board to reassess the RECLAIM program if the market price of trading units exceeds a predetermined level set by the Board.⁸⁴ Under RECLAIM, the District's Governing Board has decided to reevaluate the program if the average annual price of RTCs ever exceeds $ 25,000 per ton for NO_x and $ 18,000 per ton for SO[x]. These price levels are calculated to correspond to twice current average cost of best available control technology for the two pollutants.⁸⁵

The Enforcement Mechanism

* Permits. Regulation and enforcement under both command-and-control and marketable permit systems center on issuance of a permit that meets the requirements of Title V of the 1990 Clean Air Act Amendments.⁸⁶ The features of a permit under the RECLAIM program, however, are different from permits under the former system. Under command-and-control regulation, the regulatory agency establishes emission controls for specific pieces of equipment, and those controls are then formalized and implemented through permits for each piece of equipment. Permit terms include equipment-specific operational limitations as well as inspection and maintenance requirements. Similar pieces of equipment may have different requirements imposed on them depending on when they were installed.⁸⁷

The RECLAIM marketable permit program replaces the existing, equipment-specific regulatory system with an emission cap for an entire facility.⁸⁸ All existing permits for individual units at a facility are combined into one facility permit. That permit will itemize all sources at the facility, including sources not within the RECLAIM program, and will set forth the facility's RTC allocation for each year.⁸⁹ It will also include any conditions that the District placed on a specific source before the enactment of the RECLAIM program, such as a "lowest achievable emission rate" requirement imposed pursuant to new source review, or a unit-specific requirement imposed to control a toxic air contaminant.⁹⁰

Under RECLAIM, the District retains the right to establish unit-specific concentration limits for some NO_x and SO[x] sources subject to RECLAIM and to include those limits in the facility permit.⁹¹ The purpose is to ensure that technology requirements for new source review are met. Similarly, while most sources will choose to calculate their emissions through the use of emission rates that will not be part of the permit, facilities may opt to use concentration limits that would become part of the permit.⁹²

Under command and control, the permit at all times sets the emission limits with which the individual source must comply, and enforcement undertakes to determine whether equipment is in place and operating correctly. Under RECLAIM, the permit will set an emissions cap for an entire facility; it will contain the facility's allocation for each year through the year 2010.⁹³ The ebb and flow of trading under RECLAIM, however, will be monitored through changes in the RTC listing. If a facility sells RTCs from that allocation in compliance with the RECLAIM trading requirements, the facility's allocation as reflected in the RTC listing will decrease.⁹⁴ Conversely, if the facility purchases RTCs, [24 ELR 10704] it may either increase its emission allocation in the RTC listing⁹⁵ or hold them in an RTC certificate.⁹⁶

Thus, in contrast to command and control, the permit alone does not dictate whether a facility's emissions are within the program's requirements or are in violation. Instead, that determination can only be made by examining the total number of RTCs that the facility holds, and that figure is revealed in the RTC listing, not the permit.

* Compliance Cycles. As discussed above,⁹⁷ RECLAIM allocations are made on a yearly basis, with facilities split into two separate, 12-month permit cycles that end at different times. A significant question in the design of RECLAIM is how to structure enforcement of the permit system. One possibility is simply to use the complete 12-month permit cycle as the enforcement period; as long as a source's emissions for the year did not exceed the RTCs held by that source for that period, it would be in compliance.

The District, however, chose a different model that allows it to more closely track emissions and permit activity during the yearly cycle. Enforcement is carried out through quarterly compliance periods. At the end of each quarter, a facility must submit a Certification of Quarterly Emissions to the District that indicates its actual emissions for the quarter.⁹⁸ When it receives the facility's certification, the District debits the facility's annual allocation balance in the RTC listing, and those debited emissions cannot be traded or used during the remainder of the compliance year.⁹⁹

Facilities are given a 30-day period at the end of the quarter in which to buy RTCs that can be applied to emissions for that prior quarter.¹⁰⁰ After this period expires, a facility may correct errors in quarterly reporting up until the end of its compliance year, but to avoid a penalty for misreporting, any error must be due to conditions beyond the reasonable control of the facility holder. In addition, the correction must be made within 30 days of the error's discovery or the date on which the error could reasonably have been discovered, whichever is earlier.¹⁰¹

At the end of a facility's yearly compliance cycle, permit holders have a 60-day reconciliation period in which to certify emissions that occurred during the last quarter.¹⁰² During that period, the facility can purchase any RTCs it needs to cover its actual emissions for the final quarter, or it can trade surplus RTCs that it does not need. After that 60-day period elapses, any unused RTCs for that compliance cycle expire and cannot be transferred or used to comply with the emissions cap.

Thus, the RECLAIM enforcement system requires both quarterly and annual compliance. The District intended the quarterly compliance system to operate as a sort of "reality check." The quarterly audit would inform a facility about whether it was using up its yearly allocation at a rate that would require it to purchase RTCs, or whether it was emitting less than the allocation amount and thus could consider selling RTCs. The District would learn whether it was likely that a facility's allocation would be insufficient to cover upcoming quarters, and thus that -- without an infusion of purchased RTCs -- an exceedance of the emission cap by the facility was probable. In that instance, the District might decide to closely watch the source's actions in the market during the next period.¹⁰³

* Monitoring and Reporting. Monitoring is essential to the success of any marketable permit trading system, and the RECLAIM program includes elaborate monitoring and reporting requirements. To ensure that sources will have sufficient certainty about the monitoring required of them, the monitoring requirements generally correlate with the equipment size rather than amount of emissions.¹⁰⁴ Otherwise, facilities would be forced to base their use of monitoring on estimates of possible emissions during the future and might be subject to a penalty if those emissions exceeded the estimate. Furthermore, because larger facilities tend to use larger equipment, this correlation between monitoring requirements and equipment size means, generally speaking, that those larger facilities will be required to undertake more expensive and more accurate monitoring. Those facilities also must submit emissions reports more frequently than smaller facilities.

The RECLAIM program divided sources emitting NO_x into three groups for monitoring purposes: Major sources, large sources, and process units. A major source¹⁰⁵ must install a "continuous emissions monitoring system" (CEMS),¹⁰⁶ which is defined as equipment that "continually measures all parameters necessary to directly determine mass emissions of a RECLAIM pollutant."¹⁰⁷ The District's rules applicable before RECLAIM required most major sources to use CEMS, but the rules mandated monitoring [24 ELR 10705] of NO_x concentrations rather than mass emissions, as RECLAIM now requires. The CEMS system now must measure certain variables, such as "stack NO_x concentration" and "exhaust flow rate," from which total daily mass emissions can be calculated.¹⁰⁸ Major sources can request the District's Executive Officer to certify an alternative system if it is demonstrated to be as accurate as CEMS.¹⁰⁹

The CEMS system will report emissions continuously to the District. If a CEMS unit breaks down, the facility may use an alternative "missing data" procedure to establish its emissions. That procedure, however, is extremely complex and not necessarily beneficial to the user; it was formulated with the intention of deterring CEMS breakdowns by discouraging use of this alternate procedure.¹¹⁰

The intermediate group of NO_x sources, denominated "large sources,"¹¹¹ must use "continuous process monitoring systems" (CPMS), which are continuous measuring devices to determine fuel usage and other applicable data.¹¹² Alternatively, large sources may accept an emission factor, an equipment-specific emission rate, or a concentration limit as the sole method for determining compliance with the emissions limitation.¹¹³ If they do, however, the rate or limit will be placed in the facility's permit and will be binding, a restriction that will curtail some of the discretion to change emission patterns that the facility otherwise would possess under RECLAIM. Large sources must report data to the District on a monthly basis.

Finally, the smallest group of NO_x sources, known as "process units,"¹¹⁴ may use CEMS or CPMS. Most likely, however, they will opt for one of two less expensive alternative monitoring methods that the RECLAIM rules authorize: (1) a dedicated fuel meter, and/or (2) a timer combined with an emission factor or an emission rate.¹¹⁵ These sources will submit emission reports on a quarterly basis.

In contrast to NO_x emitters, sources of SO[x] are divided into two rather than three compliance categories. A "major source" of SO[x] emissions, which includes much of the equipment associated with oil refining as well as sources with reported emissions of 10 tons per year or more between 1987 and 1991,¹¹⁶ must install CEMS or an equivalent monitoring system. They must also electronically report emissions on a daily basis to the District.¹¹⁷ Once again, District rules predating RECLAIM required most sources falling into this category to use CEMS, and like the CEMS requirement for NO_x sources,¹¹⁸ CEMS for SO[x] sources must measure specific variables from which the facility can calculate total daily emissions.¹¹⁹

The other category of SO[x] emitters is "process units."¹²⁰ Facilities operating this equipment may elect to install CEMS but also may choose a fuel meter and/or a timer.¹²¹ Use of fuel is then multiplied by an emission factor to calculate the total SO[x] emissions, and a facility reports its emissions for each separate process unit on a quarterly basis.¹²²

All sources of SO[x] and NO_x using CEMS must electronically transmit total daily mass emissions from each source to the District daily, and they must report in written form once a month.¹²³ In addition, these sources must maintain all data measured or reported to the District for a three-year period.¹²⁴

* The Penalty Structure. Command-and-control regulation establishes emission limitations for specific equipment sources, and enforcement under that type of system is therefore designed to ensure compliance by individual sources. In contrast, because RECLAIM limits total emissions from facilities, not from individual sources, a facility violation of a RECLAIM emission cap is calculated on a "per day, per violation" basis regardless of the number of individual sources operated within that facility.¹²⁵ If a facility exceeds its yearly emissions allocation during any quarter and has not remedied the exceedance by the end of the reconciliation period following that quarter, the facility is in violation.¹²⁶

The RECLAIM rules include three separate types of penalties that the District may impose for such violations. The first is a "make whole" remedy, designed to ensure that the facility is put in the same situation that it would occupy if it had complied with the emissions cap.¹²⁷ On determining that a violation of the cap has occurred,the Executive Officer is to reduce the facility's annual emissions allocation for the subsequent compliance year by the total amount of the [24 ELR 10706] exceedance.¹²⁸ The reduction apparently is mandatory.¹²⁹ The Executive Officer also may revise the facility's permit and impose conditions on it to prevent future violations of the emissions cap.¹³⁰

Second, the facility is also subject to a civil penalty that can be imposed administratively or judicially.¹³¹ The rules define any exceedance of the emissions cap as "a single, separate violation of this rule for each day of the compliance year (365 days)."¹³² The violator is then given the opportunity to establish that the number of violations is less than 365 by proving the exact number of days during which the facility in question operated after it exceeded the emissions cap.¹³³ In other words, the rule defines any violation of the emissions cap as a "365-day" violation and thus shifts the burden of proof to the violator to establish that the actual number of days was less than 365.¹³⁴ Additionally, once the number of days has been decided, the rule establishes a separate formula for calculating the penalty: One violation for each day of the exceedance plus one violation for each 1,000 pounds, or portion thereof, of the pollutant emitted in excess of the emissions cap.¹³⁵ Thus, the penalty formula takes into account the amount of excess emissions from the facility as well as the length of the violation.

The third remedy for a violation of the emissions cap is the most serious: the Executive Officer can petition the District Hearing Board to revoke the facility's permit to operate. If the Hearing Board grants that petition, the rules call for invalidation of all RTCs held by the facility, and should the facility thereafter apply for another permit, it will be treated as a new source and must meet all new source review requirements.¹³⁶ Presumably, use of this penalty form will be rare and reserved for egregious violators.

* Treatment of Breakdowns and Variances. As with command-and-control rules, a marketable permit system must address the circumstances under which variances will be available and how the inevitable breakdowns in pollution control equipment will be treated. A particular danger is that an excessive number of variances from the requirements of an economic incentive system may undermine the pricing signals from the market, with variances that authorize excess emissions not accounted for by RTCs causing an effective devaluation of RTC values. Furthermore, variances were traditionally sought because a source was exceeding an emission limitation and, without the variance, would be subject to a penalty. In a marketable permit system, however, the source has the ability to cover the excess emissions by purchasing RTCs and avoid any penalty. Thus, the workings of a marketable permit system undermine the rationale for granting variances.

The RECLAIM variance provisions implicitly reflect these concerns by prohibiting variances by a RECLAIM facility either from the required quarterly certification of emissions or from compliance with the facility's emissions cap.¹³⁷ Under the rules, the primary reason for seeking a variance would be to secure relief from the monitoring requirements imposed on facilities. If a facility receives such a variance, however, the facility will be subject to the alternative "missing data" method of calculating emissions,¹³⁸ a consequence that should deter most facilities from seeking variances of this type. Thus, as a practical matter, it appears that variances will be rare under RECLAIM.

In applying breakdown provisions to a marketable permit system, the fundamental policy choice is whether emissions during the breakdown period should be counted toward compliance with the annual emissions cap or exempted from it. The RECLAIM rules provide that if the facility operator complies with the requirements for reporting a breakdown, excess emissions resulting from the breakdown will not be deducted from the facility's annual emissions allocation.¹³⁹ Qualifying for this breakdown exception, however, is not an easy task. The facility must submit a written "breakdown plan" within seven days of the outage containing, among other requirements, evidence that the breakdown did not result from operator error or neglect, that steps were taken immediately to correct the condition, and that it was beyond the facility's "reasonable control" to correct the breakdown within 24 hours.¹⁴⁰ Furthermore, the breakdown exemption is effective only for a maximum of 30 days; after that, the facility's emissions will count toward its annual allocation.¹⁴¹

* Recordkeeping Errors. Finally, recordkeeping errors are subject to enforcement through the imposition of penalties. Most importantly, if the Executive Officer determines that a facility's quarterly certification of emissions is inaccurate, the rules define that infraction as a separate violation for each day in the quarter. And here, unlike exceedances of the emissions cap that are presumed to result in violations for the entire year,¹⁴² the rules do not give the source the opportunity to prove that the violation should cover a lesser period of time.¹⁴³

[24 ELR 10707]

Implementing Marketable Permits: Some Preliminary Conclusions

The RECLAIM program should provide a useful initial test of the implementation of economic incentive principles in regulatory areas that formerly were the exclusive domain of command-and-control regulation. Not only does the District have the institutional capacity needed to adopt and enforce such a program in a competent manner, the amount of emissions subject to trading and the numbers of facilities that can trade are large enough to avoid the market imperfections that would exist in a smaller program.

The results of this test will take time to evaluate, as the emission reductions called for by the RECLAIM regulatory program extend until at least the year 2003. The District's process of adopting RECLAIM, however, created an extensive record detailing the issues and obstacles that arose in formulating the program. Some preliminary observations can be drawn from this experience about the feasibility of implementing marketable permits and the importance of certain issues in that undertaking.

Equity and Prior Environmental Control Efforts

Given the steady drumbeat criticism of command-and-control mechanisms, much of it coming from industry, one might assume that industrial sources of air pollution would unanimously support a change to marketable permits. After all, a marketable permit system holds the promise of giving sources increased flexibility in deciding how to allocate their resources and should save them considerable amounts of money. However, the record of RECLAIM's adoption demonstrates that such an assumption cannot be made.

Regulatory history plays the critical role in determining the level of support from specific segments of industry affected by the proposed change. Some industries to be included in RECLAIM were recently subject to regulatory compliance deadlines and invested heavily in new pollution control equipment to comply with those deadlines. In contrast, other industries were controlled much less stringently and had not gone through an administrative proceeding in which the regulatory agency evaluated the technology of pollution control for that specific industry.¹⁴⁴ Because of these differences, those two classes of industries have very different interests at stake in the transition to a new system.

If the RECLAIM proceedings are any indication, each industry -- and, indeed, individual companies in a particular industry -- will carefully weigh the immediate economic impact on them in deciding whether to support or oppose a change to marketable permits. Equity issues dominated the negotiations leading to the adoption of RECLAIM, with the primary issue being how prior pollution control efforts would be reflected in the establishment of the emissions cap.¹⁴⁵

Regulatory history also played a large role in another issue that took significant time to resolve in the adoption of RECLAIM. As noted above,¹⁴⁶ while a command-and-control regime regulates the rates at which sources emit pollutants but places no overall cap on those emissions, a marketable permit system imposes just such a cap on facilities. The difficulty arises in deciding what emission levels the cap should reflect, given that the previous system imposed no such cap.

One possibility is to set the cap to reflect a facility's current level of emissions. At the time of RECLAIM's adoption, however, the southern California economy was in the midst of a severe recession, and actual emissions were less than they had been in previous years when economic activity was higher. Industry argued that fairness dictated that the cap should reflect the higher emission rates of previous years, which were more typical of overall emission rates over time. The District ultimately opted for a flexible approach, allowing sources to choose the maximum throughput over a range of years and to base the initial cap on that chosen rate, thus ensuring that the recession emission levels would not be reflected in the RTC allocations.¹⁴⁷

This choice, however, brought on more controversy. Environmentalists argued that this option effectively awarded industry "free" emissions: Facilities were being given rights to emit pollutants at levels they would not currently need.¹⁴⁸ They also argued that this method violated the state-law requirement that RECLAIM produce reductions equivalent to those under the preexisting command-and-control system.¹⁴⁹ The environmentalists claimed that the new system could not be equivalent if it authorized emissions at rates that were higher than the actual rates of emissions under the prior command-and-control system.

The lesson here is that although a marketable permit system differs fundamentally from command-and-control regulation, adoption of that system does not occur in a regulatory vacuum. Instead, it is preceded by years of agency regulation, different levels of investment by sources in pollution control equipment, and expectations built on both that history and investment. Based on how these factors affect their individual situations, sources that are proposed for inclusion in a marketable permit system will make various and conflicting arguments about how this history [24 ELR 10708] should affect features of the new system, particularly the baseline allocation.

Regulatory agencies will be under great pressure to expand the initial allocation to ensure fairness, effectively trading off more stringent controls now for emission reductions in later years under the marketable permit system. From the agency's perspective, an important advantage of the system is that once it is in place, the agency no longer faces an industry-by-industry push to tighten emission standards, a process that necessarily depletes its political capital. Thus, it may be willing to compromise at the outset in return for the long-term gains that the program should accomplish.

Monitoring Requirements

Monitoring promises to be a source of continual tension in the initial implementation of a marketable permit program. The RECLAIM record reveals numerous comments by industry that monitoring requirements imposed by the District were excessively expensive and inconsistent with the regulatory flexibility that a marketable permit system was supposed to provide.¹⁵⁰ For example, one commenting party opposed the District's proposal to require inspection of a particular refinery part every 12 months, arguing that an inspection costs a small facility about $ 100,000 per shutdown, and for that reason, the current industry standard was a single shutdown every three years. The District nonetheless required yearly inspections.¹⁵¹

The District attempted to ensure that monitoring was not too burdensome by generally correlating the intensity of monitoring requirements with increases in the size of equipment, thus effectively imposing the most expensive monitoring on larger sources that presumably are more able to afford it. At least initially, however, the overriding concern of environmental regulatory agencies implementing marketable permit programs must be to ensure sufficient control over emissions under the new program. The certainty afforded by the imposition of specific emission limitations for equipment sources under the prior command-and-control system no longer exists. Accordingly, at the outset agencies are likely to hedge against the unknown by insisting on stringent monitoring measures.

The cost of monitoring, in turn, operates as a constraint on the size of the trading program. At some level, the expense of even minimal monitoring becomes high in comparison to the emission reductions that can be achieved by placing emission caps on small sources. Thus, a de minimis level will exist and will serve as a practical cutoff point for the use of marketable permit programs.¹⁵²

In time, the friction over the appropriate level of monitoring should lessen. The emphasis on monitoring in marketable permit programs should result in technological innovation in monitoring systems, innovation which, in turn, may lead to cost reductions in monitoring equipment. In the formative periods of marketable permit systems, however, monitoring requirements will be a contentious issue.

Marketable Permits in a Command-and-Control Statutory Structure

Just as a marketable permit program must take into account facilities' prior pollution control efforts, the existing framework of pollution control law also will constrain its development. That framework gives some minimal encouragement to economic incentive systems.¹⁵³ For the most part, however, the substantive and procedural requirements of air pollution law are solidly premised on the use of command-and-control regulation.¹⁵⁴

For example, California law does contain explicit provisions authorizing the District to adopt a marketable permit program.¹⁵⁵ Those provisions, however, do not establish any procedures and requirements tailored to the specific regulatory features of marketable permits. Instead, the principal focus of the state law is negative; the legislature sought to ensure that any marketable permit program put into effect produces emission reductions that are at least equivalent to those compelled by the preexisting command-and-control system.¹⁵⁶ If the state was serious about requiring implementation of economic incentives, it would require agencies to adopt such a program or, at least, it would establish an alternative statutory framework that reflects the institutional needs of such systems.

Existing statutory requirements premised on command and control can pose significant obstacles to the effective implementation of marketable permit systems. Perhaps most importantly, specific requirements can provide grounds for those opposing any change to mount a judicial challenge to the new program. For example, the federal Clean Air Act [24 ELR 10709] mandates existing sources in nonattainment areas to use "reasonably available control technology" (RACT),¹⁵⁷ while California law compels existing sources to put in place technology known as "best available retrofit control technology" (BARCT).¹⁵⁸ One purpose of a marketable permit system, however, is to avoid regulatory "straight-jackets" that mandate use of particular control technologies. Instead, marketable permits allow sources that fall into a single category to use a variety of different control measures and thus to minimize pollution control costs while maintaining the overall emissions cap. Opponents of RECLAIM argued that the failure to require specific technology on existing sources violated the Clean Air Act's RACT requirement and the California BARCT requirement.¹⁵⁹

Both the U.S. Environmental Protection Agency and the California Air Resources Board issued opinions concluding that the RACT and BARCT control requirements did not prevent the adoption of RECLAIM. According to those agencies, neither federal nor state law requires agencies to impose specific technologies on individual sources; rather, the RACT and BARCT mandates could be met across the board on a programmatic basis instead of on an individual basis.¹⁶⁰ These conclusions are defensible and are unquestionably consistent with the legislative intent in both federal and state law recognizing marketable permits as a legitimate pollution control system. In adopting legislation envisioning -- and, indeed, encouraging -- the adoption of alternative programs such as RECLAIM, neither Congress nor the California legislature could have intended to frustrate such programs through an overly stringent interpretation of existing statutes. Nonetheless, the existence of these requirements raises obstacles to implementation of economic incentive programs.

A similar difficulty in applying statutes premised on command and control arises in enforcing the new marketable permit system. Air pollution enforcement statutes usually authorize the imposition of civil penalties on a "per violation" basis on sources that exceed emission limitations.¹⁶¹ They assume that a source will be violating an emissions limitation that applies to a piece of equipment on a continuous basis, and that any emission over that amount is a violation. A marketable permit system, in contrast, allows the aggregation of numerous individual sources in facilities; it is the facility, not the individual source, that must stay within the emission cap.

The violation of a marketable permit thus is qualitatively different than a violation of an emissions limitation. The key to the violation here is the amount that the cap is exceeded, not the number of days of the violation. A regulatory agency implementing a marketable permit program somehow must define a violation in a way that deters facilities from violating emissions caps while simultaneously honoring statutory language written in terms of "per day" violations. For example, if it defines a violation of the emission cap as a single violation, the amount of civil penalties recoverable under the usual statutory structure would likely be far too small.

The existence of these command-and-control requirements in statutes can add considerable legal uncertainty to the implementation of economic incentive programs. The long-term solution to these problems is the enactment of separate legislation for marketable permit systems that avoids these definitional obstacles and omits command-and-control requirements that are unnecessary under marketable permit systems. For example, new source review requirements under existing law mandate that new or modified sources implement "lowest available emission rate" (LAER) technology and "offset" the remaining emissions to ensure that a net air quality benefit occurs. The RECLAIM program honors these requirements by requiring new sources to meet LAER even if they will be in the marketable permit program.¹⁶² But it is hard to see why a specific control technology is needed for such sources; they could simply be allowed to enter the market as long as they obtained sufficient trading units for the new pollution they will generate.

Institutional Resources

A rulemaking proceeding leading to the adoption of a system like RECLAIM differs markedly from most rulemakings carried out by environmental regulatory agencies. Those efforts typically single out one set of sources for regulation; in contrast, a marketable permit scheme will encompass a broad array of sources from a variety of industries. Thus, the rulemaking in many ways more closely resembles the type of rulemakings encountered in economic regulation, [24 ELR 10710] in which a broad universe of sources has interests at stake,¹⁶³ than it does the typical pollution control proceeding, which is more narrowly focused.¹⁶⁴

This new type of proceeding puts a considerable strain on agency resources. The RECLAIM rulemaking was carried out by a public agency that is large, sophisticated, and knowledgeable, but even with these types of resources, the program took almost three years to complete. Much of the delay was inevitable given the approach adopted by the District; it chose to undertake a multifaceted program of public involvement through various task forces and steering groups, with the hope of building a consensus for the program. This type of process necessarily takes time and involves extensive negotiations, particularly as the program nears fruition.

Future proceedings like RECLAIM can be expected to be even more complex. As individual sources realize the import of the new system -- a system that will establish the emission limits for facilities over a lengthy period of time -- they are likely to devote extensive resources to participation. The process will probably become more politicized, with intensive legislative oversight a likely possibility. Moreover, the expertise required of an agency adopting such an economic incentive program must now extend to areas not previously pertinent to the agency's functions, such as the likely outcome of various market scenarios that the agency is considering.

Agencies must adapt to these new circumstances. They must be able to marshall the considerable resources necessary to undertake this new type of rulemaking, and they must obtain the expertise that is required.

The Question of "Consumer Confidence"

Perhaps the most important determinant of whether a marketable permit system will succeed is the psychological reaction of the regulated community. The question is whether facilities will act on the economic incentives that the system offers in the same manner that they react to other market incentives, or will instead resist the operation of those incentives.

This question stems from the inescapable fact that any marketable permit program will nonetheless be a government regulatory program, and thus have features not found in a true free market. For example, given the public health risks if the system should fail, regulatory agencies will take the position that should the need arise, they must be able to interfere with any regulatory authorization allowing the emission of pollutants under the permit system. They will, as the District did, reject arguments that such interference amounts to a "taking" of private property that requires compensation under the Fifth Amendment.¹⁶⁵ Ironically, the regulators also will face requests from industry that they promise to interfere in the market under certain circumstances. Thus, parties commenting on the RECLAIM proposal argued that the District should provide some sort of "safe harbor" for facilities that make good-faith efforts to purchase trading credits in the market but cannot do so because of high prices.¹⁶⁶

These tensions between the unfettered operation of the market and the necessary level of regulatory interference should smooth out over time as experience with the system grows. Some fears may turn out unwarranted. For example, while a regulatory agency may refuse to recognize that a confiscation of emission rights could be challenged as a Fifth Amendment taking, political realities will act as a firm restraint on such a confiscation. Unless the need is overwhelming, the regulatory agency is not likely to interfere, a move that would bring a political backlash with it.

The real danger that could doom such programs is a pervasive feeling by market participants that the market will be short-lived or that changes in its operation will occur frequently.¹⁶⁷ If that feeling persists, market participants are likely to ignore market signals and shape their actions according to different norms. Agencies must take pains to assure the market participants, both by word and deed, that they are committed to long-term implementation of the market. They must also seek to minimize uncertainties in the program, with the aim of ensuring that the level of uncertainty corresponds as closely as possible to that normally associated with market operations. Only then will a true test of economic incentive principles take place.

Replacing "Command and Control"

Finally, there is the question of the extent to which marketable permits can truly "replace" command-and-control systems. If RECLAIM is successful, it will provide strong evidence that marketable permits in other areas of the country could replace the existing or proposed control mechanism under similar circumstances, i.e., for large-scale emissions of pollutants that are easily monitored, such as NO_x [24 ELR 10711] and SO[x]. Smaller sources of these pollutants, however, probably will not be included in the market as regulatory agencies, with legislative bodies watching closely over their shoulders, determine that the implementation costs for including them (such as monitoring and control costs) exceed the benefits of their participation. Furthermore, as noted above,¹⁶⁸ considerable creativity is necessary to apply a marketable permit program to sources of pollution, such as reactive organic compounds that are more diverse than NO_x or SO[x], and somerestrictions on trading also may be necessary in some markets to ensure that an undue concentration of air pollutants does not occur in a localized area.¹⁶⁹ Also, there is considerable resistance to allowing the trading of toxic air contaminants, particularly given the dangers of localized accumulations of those pollutants as a result of trades.

Thus, even if marketable permits are successful, they will not completely replace command-and-control systems. The challenge is to ensure that, where a marketable permit system applies to some emissions from a facility but others are subject to command and control, the command-and-control requirements do not impair the economic incentives built into the marketable permit program. Here again, however, RECLAIM should provide some practical experience, as its program does not totally replace command-and-control requirements at all facilities subject to the marketable permit system.

Conclusion

The experiment has begun with the first recorded transaction occurring earlier this spring,¹⁷⁰ and it bears close scrutiny. Developments should get particularly interesting a few years into the program, when trading activity is expected to quicken. If successful, the RECLAIM program could be a new, useful addition to the models of environmental regulation followed in this country.

1. See, e.g., ZYGMUNT J. B. PLATER ET AL., ENVIRONMENTAL LAW AND POLICY: NATURE, LAW, AND SOCIETY 868 (1992) ("In the 1970s -- the formative period in modern environmental regulation -- effluent taxes were a prominent part of the literature on pollution control."). The authors then note, however, that "[t]here is little in the American experience that even vaguely resembles the use of effluent taxes." Id. For early articles on the use of economic incentives to control pollution, see, e.g., J. H. DALES, POLLUTION, PROPERTY, AND PRICES (1968); THE ECONOMICS OF AIR POLLUTION (Harold Wolozin ed., 1966); and Larry E. Ruff, The Economic Common Sense of Pollution, PUB. INTEREST, Spring 1970, at 69; see also JAMES E. KRIER, ENVIRONMENTAL LAW AND POLICY: READINGS, MATERIALS, AND NOTES ON AIR POLLUTION AND RELATED PROBLEMS 418-68 (1971) (materials on subsidies and pricing mechanisms, including auction or market systems, to control pollution).

2. Command-and-control systems have been defined as "measures that require or proscribe specific conduct by regulated firms." Richard B. Stewart, Regulation, Innovation, and Administrative Law: A Conceptual Framework, 69 CAL. L. REV. 1259, 1264 (1981).

3. For the most complete discussion of the benefits of such systems, see Howard Latin, Ideal Versus Real Regulatory Efficiency: Implementation of Uniform Standards and "Fine Tuning" Regulatory Reforms, 37 STAN. L. REV. 1267 (1985).

4. See Richard D. Morgenstern, The Market-Based Approach at EPA, EPA J., May/June 1992, at 27.

5. Pub. L. No. 101-549, 104 Stat. 2399.

6. SCAQMD Rules 2000-2015 (Oct. 1993). The agency based the rules in large part on a five-volume set of administrative materials: SCAQMD, RECLAIM (final, Oct. 1993) [hereinafter RECLAIM RULEMAKING PACKAGE].

7. See Franz Thomas Litz, Harnessing Market Forces in Natural Resources Management: Lessons From the Surf Clam Fishery, 21 B.C. ENVTL. AFF. L. REV. 335 (1994); Esther Bartfeld, Point-Nonpoint Source Trading: Looking Beyond Potential Cost Savings, 23 ENVTL. L. 43 (1993); Arnold W. Reitze Jr., A Century of Air Pollution Control Law: What's Worked; What's Failed; What Might Work, 21 ENVTL. L. 1549 (1991); Robert W. Hahn & Gordon L. Hester, Marketable Permits: Lessons for Theory and Practice, 16 ECOLOGY L.Q. 361 (1989); Bruce A. Ackerman & Richard B. Stewart, Reforming Environmental Law, 37 STAN. L. REV. 1333 (1985).

8. The California Air Resources Board nicely summarized the difference:

[C]ommand-and-control does not restrict facility operations to actual emissions, but to an emissions rate. Therefore, provided a source operates by a prescribed emissions rate or concentration limit, its emissions are not constrained by hours of operation or throughput; additionally, unlike RECLAIM, facility-wide emissions under a command-and-control structure are not capped in any one year by a mass limit, not to be exceeded in subsequent years.

CALIFORNIA AIR RESOURCES BOARD, STAFF REPORT ON PUBLIC MEETING TO CONSIDER APPROVAL OF THE SOUTH COAST AIR QUALITY MANAGEMENT DISTRICT'S REGIONAL CLEAN AIR INCENTIVES MARKET 9 (Feb. 8, 1994) (copy on file with author).

9. SOUTH COAST AIR QUALITY MANAGEMENT DISTRICT & SOUTHERN CALIFORNIA ASSOCIATION OF GOVERNMENTS, AIR QUALITY MANAGEMENT PLAN: SOUTH COAST AIR BASIN 4-1 (Mar. 1989).

10. Id. at 4-25.

11. See, e.g., Testing the Limits, NAT'L L.J., May 29, 1989, at 1916 (observing that the plan had launched a debate with national implications that raised new questions "about how much people are willing to sacrifice to clean up their environment.").

12. See, e.g., SOUTH COAST AIR QUALITY MANAGEMENT DISTRICT SPECIAL COMMISSION ON AIR QUALITY AND THE ECONOMY, AIR QUALITY REGULATIONS AND THE ECONOMY 2 (July 10, 1992) (on file with author) ("What the Commission has found, in general, is that significant numbers of the regulated community -- Federal and State agencies, schools, businesses, and individuals -- continue to perceive the District's programs as having an unnecessarily harsh economic impact upon their operations."); see also Economy Redefining Clean Air Battle, RIVERSIDE PRESS ENTERPRISE, Aug. 29, 1993, at A-1 (describing the Agency as "reeling under a withering barrage of criticism").

13. See generally John P. Dwyer, THE USE OF MARKET INCENTIVES IN CONTROLLING AIR POLLUTION: CALIFORNIA'S MARKETABLE PERMITS PROGRAM, 20 ECOLOGY L.Q. 103 (1993); Evan Goldenberg, The Design of an Emissions Permit Market for RECLAIM: A Holistic Approach, 11 UCLA J. ENVTL. L. & POL'Y 297 (1993).

14. See generally Coralie Kupfer, RECLAIM: Elements of the New SCAQMD Program -- Will It Be a Hit or a Miss?, 1994 CAL. ENVTL. L. REP. 37 (1994).

15. ROG is closely related to pollutants known as volatile organic compounds (VOC). See SOUTH COAST AIR QUALITY MANAGEMENT DISTRICT, MARKETABLE PERMITS PROGRAM, WORKING PAPER #3, ENFORCEMENT -- "THE CRITICAL ELEMENT," 1-1 n.1 (Aug. 20, 1991) (copy on file with author) ("The terms ROG and VOC are interchangeable. However, products such as solvents, coatings, and inks are generally referred to as 'VOC (Volatile Organic Compound)' products, or materials but emissions from these products are referred to as 'Reactive Organic Gas (ROG)' emissions.").

16. 42 U.S.C. §§ 7401-7671q, ELR STAT. CAA §§ 101-618.

17. See id. § 7410, ELR STAT. CAA § 110.

18. The District is currently continuing its efforts to ultimately include ROG in the market. See SCAQMD Faces Stiff Resistance in Bid to Design RECLAIM VOC Program,INSIDE EPA'S CAL. REP., Feb. 11, 1994, at 1, 10 (noting that SCAQMD officials held an informal "brainstorming" meeting in January with representatives of the business and environmental communities to discuss issues).

19. See, e.g., B. J. Kirwan & Richard S. Zbur, Special Report: A Clean Air Incentive Market for Southern California, CAL. ENVTL. INSIDER, Apr. 30, 1992, at 6:

Since compliance with the emissions cap will become the major enforcement mechanism [of marketable permits], environmental groups have expressed concern that current emission measurement and monitoring techniques for reactive organic gas (ROG) emissions may make it difficult for regulatory agencies to effectively monitor compliance. In addition, environmentalists are concerned that the program does not impose new restrictions on emissions of air toxics.

20. The District defines "SO[x] emission" as "sulfur dioxides" emitted. SCAQMD Rule 2000(c)(62) (Oct. 1993).

21. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at 2-2.

22. SOUTH COAST AIR QUALITY MANAGEMENT DISTRICT, RECLAIM: REGIONAL CLEAN AIR INCENTIVES MARKET, vol. II, at II-A-1 (Supporting Documentation) (rev. draft, July 1993).

23. Id. at II-A-2.

24. SCAQMD Rule 2001(b) (Oct. 1993). The District considered whether its decisional criteria for inclusion in the program should consider both permitted and unpermitted emissions. Ultimately, it chose to include only the former category of emissions. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at 2-3.

25. It should be emphasized again at this point that unlike the preexisting command-and-control system, RECLAIM establishes an emission cap for "facilities" as a whole, rather than individual sources within those facilities. See SCAQMD Rule 2000(c)(32) (Oct. 1993) (defining "facility" to mean "any source or grouping of sources or other air contaminant-emitting activities which are located on one or more contiguous properties within the Basin in actual physical contact, or separated solely by a public roadway or other public right-of-way, and are owned or operated by the same person …").

26. Id. Rule 2001(i)(2).

27. Id. Rule 2001(b)(1)(B), (2)(C).

28. Id. Rule 2001(i)(2)(A).

29. Id. Rule 2001(i)(1)(J). If the District allocated trading credits to a business that is no longer operating, the business could, of course, immediately trade the credits to a company that is in operation.

30. See supra note 26 and accompanying text.

31. SCAQMD Rule 2001(f)(1)(D) (Oct. 1993).

32. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at 2-4.

33. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at 2-5.

34. The rulemaking package noted:

The District evaluated over two dozen iterations of Allocation formulas that have varied from allocating the highest adjusted reported emissions to averaging adjusted reported emissions. As shown in Table II-B-1, other variations in Allocation proposals included normalizing start or end points to the projected AQMP inventories and applying ceilings and floors to Allocations to minimize windfalls and shortfalls in starting points to facilities.

RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-B-3.

35. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-B-3.

36. SCAQMD Rule 2000(c)(64) (Oct. 1993) (defining "throughput" to mean a "measure of activity, including, but not limited to … fuel us[e] …").

37. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-C-1.

38. See SCAQMD Rule 2002, tbl. 1 (Oct. 1993) (listing emission factors for, among other types of equipment, steam generating boilers and heaters).

39. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-B-3 ("The NO_x and SO[x] starting Allocation emission factors represent implementation of rules with compliance dates from 1990 to December 31, 1993."). Four District rules are expected to result in NO_x emission reductions between 1990 and 1993. Those rules regulate emissions from (1) electric power generating systems; (2) industrial, institutional, and commercial boilers, steam generators, and process heaters; (3) small industrial, institutional, and commercial boilers, steam generators, and process heaters; and (4) boilers and process heaters in petroleum refineries.

40. Since there were no District rules regulating SO[x] emissions with compliance dates between 1990 and December 31, 1992, the starting year SO[x] emission allocation is based solely on the peak emission year between those dates. No emission factor is applied to reduce that amount. See RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-E-7.

41. See, e.g., RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at 22, cmt. 93 (suggesting that the District use 1987-1988 emissions for the initial allocation because that figure is "recession neutral").

42. CAL. HEALTH & SAFETY CODE § 39616 (Deering 1994).

43. Id. § 39616(c)(1) ("The program will result in an equivalent or greater reduction in emissions at equivalent or less cost compared with current command and control regulations and future air quality measures that would otherwise have been adopted as part of the district's plan for attainment."). This equivalency standard was previously located in former Health and Safety Code § 39620 (renumbered and amended by 1993 California Statutes ch. 144 § 1).

44. SCAQMD Rule 2002(c)(1) (Oct. 1993) (allocation formula using "the throughput for each NO_x and SO[x] source or process unit in the facility for the maximum throughput year from 1989 to 1992, inclusive").

45. The District established a process by which facilities were allowed to correct errors submitted in the emissions fee billing reports, which served as the source of information for facility emissions. It also should be noted that companies may choose different peak years for different facilities. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at II-Z-33.

46. SCAQMD Rule 2002(c)(3), (4) (Oct. 1993). Additionally, another important limitation was placed on this option. Before RECLAIM, a facility that shut down could receive ERCs for those foregone emissions and sell them to new sources proposing to locate in the basin. The District's socioeconomic study analyzing RECLAIM's impacts concluded that the program could provide an incentive for non-RECLAIM facilities to shut down in order to generate and sell trading units under the program. To avoid that outcome, which could worsen the current recession in southern California, non-RECLAIM facilities that shut down were prohibited from converting their credits into RECLAIM trading units. Id. Rule 2002(c)(4) (non-RECLAIM facilities may elect to have their ERCs converted to RECLAIM Trading Credits "so long as the written request is filed before July 1, 1994").

47. The increase in emissions, however, will be considerably less than the decrease in emissions from automobiles that will use the reformulated gasoline.

48. See, e.g., RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at 26, cmt. 107 (objecting that the District's proposal to increase the emissions cap to account for reformulated gasoline requirements should not be limited to a 20 percent increase).

49. SCAQMD Rule 2002(c)(12) (Oct. 1993). There is a limit on the overall amount of the emission increase in its allocation that a refinery can claim, and that increase may not be claimed until the actual modification to the refinery occurs. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at 2-18 to -19.

50. The rulemaking package noted:

The primary equity issue raised throughout the development of Allocation proposals is acknowledgement of recent control efforts. RECLAIM facilities that are operating at BACT [Best Available Control Technology] levels, for example should not receive higher rates of reductions than facilities operating with less controls.

RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-B-3.

51. CAL. HEALTH & SAFETY CODE § 39616(c)(1) (Deering 1994).

52. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-C-4.

53. See supra notes 44-45 and accompanying text.

54. SCAQMD Rule 2002(d)(1)(A) (Oct. 1993) (formula includes use of "the applicable Tier I Allocation emission factor for the subject source"). The District had already put some of the Tier I measures into effect through rulemaking before the enactment of RECLAIM; others awaited District action at the time of RECLAIM's adoption.

55. The emission factors used thus represent two separate categories of control measures: (1) those existing control measures already found in SCAQMD rules and scheduled for implementation between 1994 and 2000, and (2) those control measures included in the AQMP but not yet formalized through specific rules applicable to sources. The difference between the two categories is that the emission factors found in the existing rules had been adopted after a rulemaking that focused solely on emission control technologies available in that industry. The control measures in the AQMP, in contrast, have not yet been a part of such a rulemaking. Instead, they were examined along with all the other control measures for various sources that are included in the plan.

56. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-C-4.

57. SCAQMDRule 2002(d)(4) (Oct. 1993) ("If the sum of all RECLAIM facilities' ending [year 2000] Allocations differs from the year 2000 projected inventory for these sources under the 1991 AQMP, the Executive Officer will establish a percentage inventory adjustment factor that will be applied to adjust each facility's year 2000 Allocation.…").

58. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-C-5.

59. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-C-5.

60. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-C-5.

61. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-C-5.

62. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-Z-17 ("Initially the District looked at SIC codes in connection with industry-specific emission reductions. The current proposal bases reductions on equipment categories.").

63. SCAQMD Rule 2002(e)(1) (Oct. 1993).

64. Id. Rule 2002(f)(1) ("Allocations for the years between 1994 and 2000 for RECLAIM NO_x and SO[x] facilities shall be determined by a straight line rate of reduction between the starting Allocation and the year 2000 Allocation.").

65. Id. (Allocations for the years 2001 and 2002 "shall be determined by a straight line rate of reduction between the year 2000 and year 2003 Allocations.")

66. Id.

67. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-C-5 ("The straight line between the starting, intermediate, and ending year Allocations identifies their annual emission caps between 1994 and 2003.").

68. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at II-Z-7.

69. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-B-3 ("Lower rates of reduction, in general, are given to facilities that are permitted to BACT [Best Available Control Technology] levels or are using cleaner air pollution technologies.").

70. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at II-Z-28. Indeed, in some instances the emission factors used in reporting the "peak year" activity for the initial 1993 allocation may actually be lower than those that will be used in calculating the year 2000 allocations. This situation could occur if sources are currently controlling emissions at rates that are more stringent than those required by the AQMP. To calculate the year 2000 allocation, facilities will use the same factors that facilities use for reporting emissions in the peak activity year.

71. SCAQMD Rule 2000(c)(53) (Oct. 1993).

72. Id.

73. Responding to a comment that allowing non-RECLAIM participants to buy RTCs may result in artificial price increases in the market, the District stated that this feature will allow facility needs to be met at lower cost than if the facility had to put the package together on its own. The District also noted that its consultants advised that participation by nonfacilities "will ensure market liquidity." RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at 45 (response to comment 194).

74. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-R-3.

75. SCAQMD Rule 2007(c)(1) (Oct. 1993).

76. As the District explained in a response to a comment:

Upon their issuance, RTCs will be assigned an expiration date. This date identifies the last day during which a pollutant could have been emitted and be accounted for by the RTC. An RTC expiration date cannot be altered, even if it [is] sold to a facility with a compliance cycle that does not coincide with the RTC issue and expiration dates.

RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at II-Z-45 (response to comment 3).

77. The District concluded:

Evaluations to date indicate that the risk of emissions migrating from one year into the next is minimized by the scheduled reductions in a facilities' annual RTC Allocation.… Even though a migration from one year into the next is possible, the desired overall reductions in any three-year period would be achieved. This is because an increased usage of RTCs in any year would be offset by an RTC inventory decrease in the periods immediately preceding and/or following the increase, and the available future-year RTCs decrease every cycle year.

RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at 3-20.

78. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at II-Z-46:

The District is aware of several market sponsors that are interested in helping to ensure that a viable market for RTCs will develop. If, after RECLAIM is implemented, it appears that persons needing to complete RTC transaction[s] cannot efficiently do so, the District may take steps to make the market more accessible.

79. SCAQMD Rule 2007(d) (Oct. 1993) ("The Executive Officer will maintain an RTC Listing specifying all RTCs held by each facility or person. The Listing is the official and controlling record of RTC holdings.").

80. Id. Rule 2007(e)(2)(B).

81. Id. Rule 2007(e)(2)(F) ("When the buyer is a RECLAIM facility, the Executive Officer shall amend the buyer's Allocation or issue an RTC certificate in the name of the buyer.…").

82. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at II-Z-31. This reconciliation is done on a quarterly basis. See infra notes 98-101 and accompanying text.

83. One sponsor of auctions of RECLAIM credits agrees, stating that "[m]anagers cannot afford … not to trade RTCs that will expire at years' end." CANTOR FITZGERALD EBS & DAMES & MOORE AIR TRADE SERVICES, RECLAIM RTC/ERC CLEAN AIR AUCTION SEMINAR (Nov. 1 1993) (unpaginated).

84. CAL. HEALTH & SAFETY CODE § 39616(f) (Deering 1994).

85. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at 5-28.

86. Pub. L. No. 101-549, tit. V, 104 Stat. 2399, 2635-48.

87. For example, the Clean Air Act requires existing sources to reduce emissions to a level reflecting use of "reasonably available control technology," while new sources must comply with the "lowest achievable emissions rate." 42 U.S.C. §§ 7502(c)(1), 7503(a)(2), ELR STAT. CAA §§ 172(c)(1), 173(a)(2).

88. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at 3-14.

89. SCAQMD Rules 2000(c)(32), 2006(b)(4)(A), (B), (C) (Oct. 1993).

90. Id. Rule 2006(b)(4)(G).

91. Id. Rules 2011, 2012. Unlike an emission factor, which is simply applied to throughput, a concentration limit is a limit on the pollution itself. It is defined as "a value expressed in ppmv [parts per million volume], [and] is measured over any continuous 60 minutes." Id. Rule 2000(c)(13).

92. Id. Rules 2004(g)(1), (2), 2006(b)(4)(D). One commenting party objected to this procedure on the basis that enforcement of source-specific permit conditions through a concentration limit "would contradict one of the stated goals of RECLAIM to allow facilities to decide the best and most cost effective means of controlling emissions." RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-Z-34. The District responded by noting that concentration limits were optional at the wish of the permit holder that does not wish to use emission rates, and that these limits must be enforceable to ensure that emissions are accurately quantified. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-Z-34.

93. SCAQMD Rule 2006(b)(4)(B), (C) (Oct. 1993).

94. Id. Rule 2007(g)(3):

[A] Facility Permit holder may elect to reduce the Allocation and, upon such amendment to the Facility Permit by the Executive Officer, shall be issued an RTC Certificate. The value of the certificate shall be equivalent to the reduction in the Allocation in the year for which the certificate is issued.

95. Id. Rule 2007(g)(4) ("RTC certificates may be surrendered for application to create or increase an Allocation.").

96. Id. Rule 2007(e)(2)(F) ("When the buyer is a RECLAIM facility, the Executive Officer shall amend the buyer's Allocation or issue an RTC certificate in the name of the buyer.…").

97. See supra notes 74-75 and accompanying text.

98. SCAQMD Rule 2004(b)(1), (2) (Oct. 1993).

99. Id. Rule 2004(b)(3); see also RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at 32 (response to comment 132) ("The District will reduce RTC balances each quarter as emissions are certified. Only RTCs that have not been used to account for emissions will be allowed to be traded in the market.").

100. SCAQMD Rule 2004(b)(1) (Oct. 1993).

101. Id. Rule 2004(c)(1).

102. Id. Rule 2004(b)(4).

103. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at II-Z-29 (response to comment 1) ("Quarterly reporting and reconciliation helps ensure that the District and market participants can track the availability and use of RTCs"); RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at 35 (response to comment 145) (the quarterly reconciliation "is needed to ensure the enforceability of RECLAIM, and to ensure that facilities operating in RECLAIM have adequate knowledge of the use and availability of RTCs.").

104. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at II-Z-52 (response to comment 5) (Responding to the comment that monitoring, reporting, and recordkeeping requirements should be based primarily on equipment and not on emissions size, the District stated: "Equipment size relates to several important criterion [sic], including emissions. In addition, by using equipment size as the categorization criteria there leaves little doubt [sic] which type of monitoring would be required.").

105. SCAQMD Rule 2012 defines 10 separate types of equipment as "major NO_x sources." They include: (1) equipment with a rated capacity of 500 million Btu or more per hour; (2) petroleum refinery fluid catalytic cracking units and tail gas units; (3) any equipment burning or incinerating solid fuels or materials; and (4) any NO_x source or process unit that reported emissions equal to or greater than 10 tons per year between 1987 and 1991. SCAQMD Rule 2012(c)(1) (Oct. 1993).

106. Id. Rule 2012(c)(2)(A) (Major sources must "install, maintain and operate a direct monitoring device for each major NO_x source to continuously measure the concentration of NO_x emission.…").

107. Id. Rule 2000(c)(14).

108. Id. Rule 2012, tbl. 2012-1.

109. Id. Rule 2012(c)(2)(B).

110. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at II-Z-59 (response to comment 44) ("It is the object of the Missing Data Procedure to maximize CEMS uptime by deterring its non-use.").

111. Similar to the definition of "major NO_x source," the definition of "large NO_x source" includes five separate subcategories. SCAQMD Rule 2012(d)(1) (Oct. 1993).

112. Id. Rule 2012(d)(2)(A).

113. Id. Rule 2012(d)(2)(C).

114. "Process units" generally have combustion equipment between 10 and 40 million Btu per hour with an annual heat input of 23 billion Btu or less. Id. Rule 2012(e)(1).

115. Id. Rule 2012(e)(2).

116. Id. Rule 2011(c)(1).

117. Id. Rule 2011(c)(2), (3).

118. See supra note 108 and accompanying text.

119. SCAQMD Rule 2000(c)(14) (Oct. 1993) (CEMS "means any system of equipment thatcontinuously measures all parameters necessary to directly determine mass emissions of a RECLAIM pollutant.").

120. Id. Rule 2011(d) (defined as a SO[x] process unit that is not a major SO[x] source or equipment designated in the District's Rule 219 as not requiring a written permit).

121. Id. Rule 2011(d)(2)(A).

122. Id. Rule 2011(d)(2)(B).

123. Id. Rules 2011(c)(3)(A), (B), 2012(c)(3)(A), (B).

124. Id. Rules 2011(g), 2012(i).

125. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at 34 (response to comment 144) ("The penalty assessed for emissions in excess of an Allocation or Quarterly Certification shall be based on a single violation per day for the facility, regardless of the number of sources operated."). The penalty structure does, however, take the total amount of emissions in violation into account in deciding on the appropriate penalty amount. See infra note 135 and accompanying text.

126. SCAQMD Rule 2004(d)(1) (Oct. 1993) ("Emissions from a RECLAIM facility from the beginning of a compliance year through the end of any quarter shall not exceed the annual emissions Allocation in effect at the end of the applicable reconciliation period for such quarter."). As discussed above, after each quarter the District reduces the annual allocation by the amount of the facility's emissions for that quarter. See supra notes 98 and 99 and accompanying text.

127. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at 6 (Proposed Rule 2010 response to comment 18) ("In developing the proposed penalty rules, the District considered the economic gain which a RECLAIM facility could potentially realize by violating the rules and every attempt was made to impose a penalty system which would recapture any profit gained by a violator.").

128. SCAQMD Rule 2010(b)(1)(A) (Oct. 1993).

129. The language of the rule ("will") is mandatory. The rulemaking package first seems to confirm this conclusion ("an automatic reduction") but then declares that the rule "allows" the Executive Officer to reduce the subsequent year's allocation. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at 4-2.

130. SCAQMD Rule 2010(b)(1)(B) (Oct. 1993).

131. Id. Rule 2010(c). Criminal penalties are, of course, also available. See CAL. HEALTH & SAFETY CODE §§ 42400-42400.3 (Deering 1994).

132. SCAQMD Rule 2004(e)(2) (Oct. 1993).

133. Id. Rule 2004(d)(2).

134. The rule reads in pertinent part:

The Facility Permit holder shall have the burden of establishing the number of days, or such lesser period as can be established, that the cumulative facility emissions were less than the annual emission Allocation. If the Facility Permit holder is not able to establish the number of days or period during which the cumulative facility emissions were less than the annual emission Allocation, the facility shall be in violation [for each day of the compliance year.]

Id. Presumably, a facility using a continuous emissions monitoring system would be able to establish the precise number of days of violation easily. Those using a continuous process monitoring system would have somewhat more difficulty, while sources using fuel meters may well have the most difficult time.

135. Id.

136. Id. Rule 2010(b)(2).

137. Id. Rule 2004(i)(1).

138. Id. Rule 2004(i)(3). For discussion of the "missing data" provision, see supra note 110 and accompanying text.

139. SCAQMD Rule 2004(i)(2) (Oct. 1993).

140. Id.

141. Id. Rule 2004(i)(5).

142. See supra notes 132-34 and accompanying text.

143. Of course the penalty amount that may be administratively imposed, $ 500 per violation per day, is a maximum penalty. For the penalty amount that may be administratively imposed, see SCAQMD Rule 2010(c)(1) (Oct. 1993). The Executive Officer may well determine that a lesser penalty is appropriate under the circumstances.

144. Interestingly, the single lawsuit filed challenging the District's adoption of RECLAIM was filed by a series of sources that were scheduled for control under the District's air quality maintenance plan, but whose controls had not yet been adopted. Alliance of Small Emitters v. South Coast Air Quality Management Dist., No. BC094283 (Los Angeles Super. Ct. petition or writ of mandate and complaint for declaratory and other relief filed Dec. 2, 1993). The author is one of the counsel representing the District in that litigation.

145. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-B-3 ("The primary equity issue raised throughout the development of Allocation proposals is acknowledgment of recent [emission] control efforts.").

146. See supra note 8 and accompanying text.

147. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. I, at 5-20:

It would also be unfair to cap facilities at recession levels of production based on their most recent emission reports. This would increase demand for credits by these companies if they expand to levels allowed under existing command and control rules. A recession-based cap for facilities could also potentially drive the cost of credits high in the initial years of the program when facilities will need to transition from a command and control approach to a fundamentally different mass emission based market system.

148. See Marla Cone, Smog Market Set To Open in Southland, L.A. TIMES, Dec. 28, 1993, at A19 ("While most environmental groups endorse the concept of a market approach to pollution, they believe the AQMD gave away so many concessions to industries that clean-air benefits will be minimal for the first few years.").

149. See CAL. HEALTH & SAFETY CODE § 39616(c)(1) (Deering 1994).

150. See, e.g., SOUTHERN CAL. GAS CO., POSITION PAPER: REGIONAL CLEAN AIR INCENTIVES MARKET (RECLAIM) 2 (June 1993):

As rulemaking on the RECLAIM program progressed, however, it became increasingly clear that RECLAIM was shaping up to become an even greater economic burden than command and control regulation. Gas Company staff consistently argued against excessive monitoring, reporting and enforcement requirements. While changeswere made, each version of the proposed rules burdened the program with increased compliance costs. It is estimated that under RECLAIM, the Company's monitoring and recordkeeping costs would increase more than two-times over the next ten years, exclusive of costs to actually reduce emissions which would cost even more.

151. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, Comments on Proposed Rules 2011 and 2012, cmt. 6:

Removal of the orifice plate requires unit shutdown. The shutdown of a fluid cracking plant for one day typically costs a small facility $ 100,000. Orifice plates are currently removed about every 36 months or during plant turnarounds. The 12 month requirement stated in Section E.2 should be changed to match the industry standard of 36 months.

152. Presumably an emission fee program would face a similar problem. Like a marketable permit program, a fee program depends on accurate monitoring of emissions.

153. See, e.g., 42 U.S.C. §§ 7410(a), 7511a(g), ELR STAT. CAA §§ 110(a), 182 (referring to marketable permit programs that can be included in state implementation plans); CAL. HEALTH & SAFETY CODE § 39616(a)(2) (Deering 1994) ("While traditional command and control air quality regulatory programs are effective in cleaning up the air, other options for improvement in air quality, such as market-based permitting programs, should be explored.…").

154. See, e.g., 42 U.S.C. § 7410(e)(2)(A), ELR STAT. CAA § 110(e)(2)(A) (referring to enforceable emissions limitations and other control measures, means, or techniques, including economic incentives such as fees, marketable permits, and auctions of emission rights); cf. 42 U.S.C. § 7503, ELR STAT. CAA § 173 (requiring "lowest achievable emission rate" technology for new sources).

155. CAL. HEALTH & SAFETY CODE § 39616(b) (Deering 1994).

156. See id. § 39616(c)(1).

157. 42 U.S.C. § 7502(c)(1), ELR STAT. CAA § 172(c)(1).

158. CAL. HEALTH & SAFETY CODE §§ 40440(b)(1), 40919(c) (Deering 1994).

159. See RECLAIM SOCIOECONOMIC AND ENVIRONMENTAL ASSESSMENTS, FINAL, app. III-H, cmt. 17-31 (Oct. 1993) ("Nothing in the 1990 Amendments [to the Clean Air Act] specifically authorizes substituting a trading regime for RACT requirements.").

160. The U.S. Environmental Protection Agency (EPA) issued an opinion concluding that "[e]mission may be aggregated, for purposes of meeting the RACT requirement, by sources covered by a RACT requirement." RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-M-7 (Letter from William G. Rosenberg, Assistant Administrator for Air and Radiation, EPA, to James M. Lents, Executive Officer, SCAQMD (Feb. 28, 1992)). The Agency further stated that "EPA has the authority to redefine RACT in terms of mass emissions limits instead of emission rate limits or accept demonstrations of equivalency." RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-M-8. The California Air Resources Board reached a similar conclusion with respect to application of BARCT: "BARCT determinations … must reflect the characteristic aspects of the source's particular 'class or category' in the setting of emissions limitations, but need not be defined solely as particularly appropriate technology. As such, 'BARCT' would allow an emission limitation, one determined, to be met through emission credit trading." RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-M-18. The Board further concluded that emission trading would be allowed "across classes or categories of sources" and are not limited to sources within a particular class or category of sources. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-M-18 (Memorandum from Michael P. Kenny, General Counsel, California Air Resources Board, to Mike Scheible, Assistant Executive Officer, California Air Resources Board (Jan. 27, 1992)).

161. See 42 U.S.C. § 7413(b)(2), ELR STAT. CAA § 113(b)(2) (authorizing a civil action "to assess and recover a civil penalty of not more than $ 25,000 per day for each violation").

162. SCAQMD Rule 2005(b)(1)(A) (Oct. 1993) declares that the Executive Officer shall not approve the application for a permit for a new or relocated facility unless the applicant demonstrates that every emission source located at the facility will use best available control technology. The California definition of BACT complies with the federal LAER requirement. See also RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, at II-L-2 ("Federal law thus would not allow a source to acquire emission credits under a marketable permits program in lieu of complying with LAER.").

163. For example, natural gas ratemaking proceedings involve a broad array of interests concerned with the rate set by the Federal Energy Regulatory Commission. See 42 U.S.C. § 7172(a)(1)(C) (1988); 59 Fed. Reg. 40256 (Aug. 8, 1994).

164. It could be argued that the adoption of a marketable permit system is similar to the adoption of a state implementation plan under the Clean Air Act, because that plan must encompass all pollution sources subject to regulation. Those plans, however, are often vague and must be implemented in the future. The marketable permit system, in contrast, sets specific emission caps.

165. SCAQMD Rule 2007(b)(4) (Oct. 1993) ("Nothing in District rules shall be construed to limit the District's authority to condition, limit, suspend or terminate any RTCs or the authorization to emit which is represented by a Facility Permit."); see also id. Rule 2007(b)(1) ("An RTC is a limited authorization to emit RECLAIM pollutants in accordance with the restrictions and requirements of District rules and state and federal law.").

166. RECLAIM RULEMAKING PACKAGE, supra note 6, vol. II, Comments to Proposed Rule 2004, at 8, cmt. 33 and response thereto (rejecting comment that "[a] safe harbor provision should be added to proposed Rule 2004 for facilities that make a good faith effort to purchase RTCs at a predetermined maximum price.").

167. ROGER G. NOLL, DISCUSSION PAPER ON MARKETABLE PERMITS PREPARED FOR THE ADVISORY COMMITTEE FOR A MARKETABLE PERMITS PROGRAM FOR STATIONARY SOURCES, SOUTH COAST AIR QUALITY MANAGEMENT DISTRICT 3 (Dec. 13, 1990):

The emissions allowed under a permit must be clearly defined for a reasonably long period. Firms will be unwilling to risk buying permits if the amount of emissions associated with them is uncertain and the durability of the permit is short compared to the planning horizon of the firm. Standards promulgated under the existing system are normally reexamined only after several years. In the intervening period, a firm is reasonably sure that it will be free of further requirements as long as it complies with its permit. Emissions trading will be seriously disadvantaged if traded permits are substantially less durable and well-defined than nontraded permits.

168. See supra notes 18-19 and accompanying text.

169. See SCAQMD Rule 2005(e) (Oct. 1993) (restricting offsets for new sources to one of two geographical "Trading Zones").

170. See First RECLAIM Sale Recorded; 500 Lb. NO_x Credits Go for $ 1 Apiece, INSIDE EPA's CAL. REP., Apr. 1, 1994, at 5. The transaction was considered a largely symbolic gesture, as the purchaser intends to retire the credits by distributing them to its em [Missing Text]

24 ELR 10695 | Environmental Law Reporter | copyright © 1994 | All rights reserved