A key issue associated with the operation of a trading scheme is ownership of the pollution rights. A legal challenge has recently undermined performance of the US's cap and trade market in emissions of sulphur dioxide (SO2) and nitrogen oxides (NOx), whilst in Europe the right of governments to assign carbon dioxide permits at no cost has been questioned because it could be construed as state aid if recipient organisations are able to generate windfall profits by passing emission costs on to consumers. Such examples have the potential to significantly disrupt the future operation of greenhouse gase trading systems.
In the US, the Environmental Protection Agency (EPA) implemented Phase II of a cap and trade scheme to regulate the discharge of SO2 from power plants in 2000 and expanded the scheme to include NOx in 2003. The program known as the Clean Air Interstate Rule (CAIR) successfully lowered emissions of these gases from 28 eastern states plus the District of Columbia. North Carolina (a downwind state) and several electricity companies subsequently challenged the EPA's authority to limit the number of allowances in circulation, to set state budgets for SO2 and to require certain exempt units to acquire allowances and in July 2008, the District of Columbia Court of Appeal found in their favour. In its ruling, the court was unable to find any statute that conferred authority on the EPA to terminate or limit allowances. As a consequence, CAIR and an associated trading scheme for regulating the atmospheric emissions of mercury (CAMR) were deemed unlawful and a requirement placed on the EPA to re-design them.
Following an appeal in December 2008, the Court ruled that despite fundamental flaws, CAIR was to be re-instated and to remain in place whilst the EPA sought a replacement. A timetable was not established, but legal experts expect that it will probably involve amendments to the Clean Air Act (CAA) which originally established the EPA's acid rain programme.
The ruling by a Federal Court has highlighted the fact that allowances under a cap and trade program may not really be property rights and this has had a significant impact on the operation of a market such as CAIR. In particular, prices for SO2 and NOx that were already weakening, have fallen further, encouraging utilities to use up existing allowances, emit more pollutants than they would and postpone the construction of new controls. This takes one back to a recurring theme with trading emissions, that accounting effort is focussed on contingent liabilities and not the balance sheet.
The EPA's web page on progress of the Clean Air Interstate Rule (CAIR) presents details of the rulings made. Also consult web pages from the following organisations for further commentary: