Definitions
Types of Emission Trading Markets
Emission Trading Registries
SO2 Markets

DEFINITIONS

Emission allowances are typically given by regulators to large sources of pollution, and allow those sources to release a prescribed amount of a pollutant. Surplus allowances can be sold, traded, or banked for future use.

Emission reductions are decreases in pollutant emissions that result from actions like installing more advanced pollution control technology, switching to cleaner fuels, improving energy efficiency, and increasing renewable energy use.

Emission reduction credits are given to recognize actions taken to reduce pollution. The amount of the credit corresponds to the amount and type of emission reduction. Credits can typically be sold, traded, or banked for future use.

Emission trading involves the transfer of ownership of emission reduction credits or emission allowances.

Offsets  A company can offset its own emissions by causing a reduction or sequestration of emissions outside its operations.

For a detailed explanation of the different types of emissions trading systems, see see the Airbank's web site at There are three main types of emissions trading systems: open market, multi-source cap-and-trade markets, and offset trading.

Open Market Emissions Trading

Open market emissions trading provides incentives for voluntary reductions of air contaminant emissions in return for the ability to sell the reductions achieved to others. These markets also provide alternative means for regulated businesses and industries to achieve compliance with their air pollution control obligations, when conventional control methods were not available or not cost effective. Open markets can include regulated businesses that are not large enough to be included in a typical cap-and-trade markets.

Credits are created under an open market system when sources or facilities voluntarily reduce their emissions over a finite period of time. These credits are generally called Discrete Emission Reductions (DERs); however in some states, the term Emission Reduction Credits (ERCs) is used. The open market emissions trading system involves the transfer of verified DERs to be sold at a specified environmental discount. The portion of DER credits that must be retired for the benefit of the environment in each transaction is usually 10 percent but can range up to 20 percent for new "permit insurance" uses. The reductions can be traded to other facilities that need to comply with certain regulatory limits. Environmental groups and private individuals may also voluntarily retire emission credits in order to ensure that the emission reductions represented by the credits remain permanently removed from the air. This retirement is in addition to the required 10 percent environmental discount.

Credits created under an open market system must meet strict creation and use criteria, set by the state, to ensure the process yields continuous environmental improvement and the credits are, therefore, a valuable commodity. The most common types of DERs being traded today are nitrogen oxides (NOx) and volatile organic compounds (VOCs). Both of these pollutants contribute the formation of ground level ozone. New Jersey has recently added new provisions for the generation and banking of greenhouse gas (GHG) credits in its open market, although no uses for GHG credits are proposed in the new rules.

Multi Source Cap-and-Trade Emissions Trading Markets (Allowance Trading)

Under a multi source cap-and-trade market or allowance trading system, an annual area-wide emissions limit or cap is established for a defined region of air pollution sources, with a reduction schedule set over time. Shares of this cap are usually distributed to sources of emissions in the form of allowances. Allowances can be allocated several different ways but have traditionally been given to each participating source for its own exclusive use according to its historical annual emissions. Under this system, sources which emitted the most pollution in the past (pre-budget enactment) are rewarded with the most allowances.

Each participating source must possess enough allowances at the end of the annual compliance period equal to their emissions during that period. A source can accomplish this through a number of avenues, including various emission control approaches, DSM programs, use of its assigned allowances, or the purchase of allowances in the trading market. Unused allowances can be banked for future use, traded, retired, or sold.

The U.S. EPA’s Acid Rain Program—established to reduce emissions of sulfur dioxide (SO₂) and nitrogen oxides (NOx)—is the most well-known example of an allowance trading program. Anyone can purchase SO₂ allowances through a broker, environmental groups, or the annual auction conducted every March by the Chicago Board of Trade. For more information on EPA's SO₂ and NOx Trading Programs, see the Agency's website at www.epa.gov/airmarkets/trading/index.html.

Offset Trading

Offset programs were developed in the late 1970s under EPA’s New Source Review (NSR) program for permitting the existence of certain new, or significantly modified, air pollution sources in non-attainment areas without further adversely affecting the region’s air quality.

Under offset programs, new or modified sources, such as major new construction projects, must not only install the most stringent level of control technology available, but also must provide additional emission reductions (offsets) generated by neighboring sources to alleviate the projected residual emissions beyond that control level.

An emission offset is a permanent reduction in a source’s emission rate, created by an action taken above and beyond that required of the source. Offsets can be created by installing advanced technology controls beyond regulatory requirements or from the permanent shutdown of an air pollution source (the latter being the most common). Offset trading also incorporates the transfer of current emission rates between sources that extend indefinitely into the future.

Many companies and political jurisdictions currently hold offsets. These offsets are available for sale, or in certain instances, are offered to applicable sources free of charge. In New Jersey, offsets can be used only to meet NSR requirements. However, in Massachusetts, Michigan, and Texas, such offsets can be converted in certain instances to discrete emission credits for compliance use under an open market trading system.

Emission reduction trading requires an emission trading registry. Similar to financial exchanges for stocks and bonds, an emission trading registry would facilitate a market for emission reduction credits. Registries typically assume no responsibility for the validity or legitimacy of the emission credit that is posted for sale. Their primary function is the clearing and trading of the market and is presumed that the "buyer beware".

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