Table des matières a voc trading Market for the Basle Region 4

2 Market design

2.1 General conditions

Trading must focus on quantity. Yet as legislation stands, all standards are expressed in terms of concentrations. Thus, it was necessary to translate the authorised emission concentrations into quantities (kilos or tons). When calculating quantities, due consideration was given to average concentration, hourly output and the average annual duration of plant operation.

As the federal standard could not be exceeded, manoeuvring room was limited to the difference between the concentration authorised by the Swiss Clean Air Act (OPair) and the lower one set by the canton. For sources emitting between 5 and 10 tons per year, the margin of flexibility was 50 per cent, as against 66 per cent for the (few) plants emitting more than 10 tons. Plants emitting less than 5 tons per year were not granted any flexibility and were thus necessarily excluded from the market.

Those who set up the new system did not wish the operation to benefit only industry through reduced spending on abatement efforts. They decided to make the system also benefit nature and, hence, the general public. Thus, part of the emission reduction (20 per cent) is final; it cannot be offset by an increase in emissions from another source. In practice, this translates into a trading ratio of 0.8. When the project was in the planning stage, its designers were counting on a trading ratio of 0.7. After facing strong opposition from industry, the legislators finally opted for a ratio that was slightly more favorable for firms.

2.2 Tradable credits

In order to take due consideration of the uncertainties linked to measuring emissions and maintaining administrative costs within reasonable limits, emission reductions below the cantonal limit must exceed 10 per cent. Beyond this threshold, the firm can receive permits equivalent to 80 per cent of the emission reduction. It will be recalled that the 80 per cent rule was introduced with a view to ensuring that industry and environment shared the benefits of the operations. This sharing was no doubt the prerequisite for persuading ecologists to agree to an easing of current regulations. This dual condition constitutes an obstacle to trading and prevents firms from taking full advantage of differences in marginal abatement costs in order to enhance the efficiency of air protection measures. A gap between marginal costs will remain once the market has reached equilibrium. At the beginning of the experiment, it was planned that the canton would set up a credit trading exchange. Finally, it may be noted that permits issued by one of the two cantons are accepted in the other.

Table 2: Allocation of VOC emission credits: an example

	Tons/year
Emission level according Federal standards	40
Emission level according cantonal standards	20
Safety margin (10%)	2
Baseline emission level from which reductions are measured	18
Actual emissions	8
Quantity used for credit allocation	10
20% reduction	2
Emission credits allocated	8

Permits can be "banked" for future use but lose 20 per cent of their value each year. The reason for such a high depreciation rate is not clear. It appears that the legislators feared that firms would accumulate large quantities of emission rights over long periods.

The system is still strongly imbued with a command-and-control type culture. Moreover, laws in the two cantons provide that the regulatory authority do not issue credits for small quantities ("Bagatellenmengen", art. 9, para 3) in order to reduce administrative costs.

The main characteristics of the emission trading system set up in the Basle region are as follows:

• 
  for the majority of sources, there has been no change with regard to the previous regulatory regime, as firms remain subject to emission ceilings (OPair 92 and VVESA BS/BL);
  
• 
  the Basle standards can be exceeded inasmuch as any overshooting is offset by compensation. In this case, compensation is sanctioned by the sale of a credit;
  
• 
  there is no need to use permits to start up a new plant; all the operators have to do is to avoid exceeding the Basle ceilings;
  
• 
  there is no cap on total emissions.
  

2.3 Bubbles

Most frequently, the bubble is limited to sources belonging to a given plant, but it can also encompass sources belonging to several plants. Under cantonal law, total emissions must be at least 15 per cent less than the sum total of emissions authorised for each individual source. The reduction of 15 per cent corresponds to the safety margin and makes it possible to share the benefits of the trade between industry and environment. The 15 per cent limit was calculated on the basis of a model to ensure that facilities are treated identically with the two instruments. As with permits, federal emission standards may not be exceeded. The setting-up of a bubble must be approved by the cantonal regulatory authority (the two cantons share the same environmental agency).

Introducing a bubble considerably simplifies trading and administrative procedures. If the bubble covers sources belonging to a single firm, trading is implicit and does not give rise to any payments (internal trading). Permits are no longer needed for emission trading, and the regulatory authorities are not required to approve each transaction. All that is needed is the authorities' approval when the bubble is set up.

The two instruments may be combined. If the various sources under the bubble emit an overall quantity of VOCs less than that authorised in the light of the 15 per cent deduction, the firm in question is entitled to permits. In the example below, the firm obtained tradable permits allowing it to emit 29 tons.

Table 3: Combination of the two instruments: bubbles and tradable credits
for VOC emissions*

Emission level	tons/year
According Federal standards (Opair 92)*	373
According cantonal standards	172
15% reduction	26
Emissions authorised under bubble	146
1995 emissions
Actual emissions under the bubble	110
Gap	-36
20% reduction	7
Credits allocation	29

2.4 New sources

3 Functioning of the market

To date, the regulatory authority has approved the creation of four bubbles and a fifth request is being examined. Each bubble covers only sources from a given production unit belonging to one of the major chemical groups. Thus, only internal trading takes place. For the Novartis production unit in Basle, quantities of authorised VOC emissions have decreased by 26 tons (see table above). For the four bubbles set up to date, authorised quantities have been lowered by 70 tons per year (Nyfeler 1996). There is no overall estimate of the decrease in abatement costs following internal trading. However, for Novartis, the flexibility made possible by the bubble has led to verifiable cost-savings of several millions. Internal offsets have made it possible to avoid installing equipment worth CHF 7 million (Eigenmann 1996).

For the large Basle chemical plants, VOC abatement costs are soaring. Ever since major abatement efforts began in 1986, the cost of reducing pollution has increased threefold, rising from CHF 10 000 to CHF 30 000 per ton¹. Offsets between sources have made it possible to avoid residual abatement, which features a very poor cost-effectiveness ratio.

The tradable credit market has been virtually non-existent to date. There has not been any demand for credits and thus no external trading. Moreover, only a few tradable credits covering an overall quantity of 61 tons have been allocated.

4 Obstacles to trading

The reason most frequently put forward to explain the absence of a market is the federal authorities' refusal to agree to ease the standards of the Federal Clean Air Decree (OPair). This is undoubtedly one of the causes of the low level of interest aroused by the new instruments, but it is not the only one. The market design, the fact that the two cantons introduced emission ceilings for large emitters only (>5 tons/year), the time chosen for the introduction of tradable permits and the lack of interest in external trading are elements to be kept in mind if we are to understand the reasons for the relative failure of the Basle experiment.

4.1 Insufficient flexibility

The market is thought to lack manoeuvring room to operate normally which in turn explains the limited number of transactions that have taken place to date. This hypothesis is often put forward. The federal government cannot accept a situation where the emission standards laid down in the OPair are exceeded². Consequently, the flexibility margin for offsetting is limited by the gap between the federal standard and the cantonal standard. Yet this explanation is not entirely convincing since there is a considerable difference between the two ceilings (a ratio of 1:2 for sources emitting between 5 and 10 tons per year and even 1:3 for sources emitting more than 10 tons). However, the total lack of flexibility of federal standards does not allow small firms - those with facilities which annually emit less than 5 tons of VOCs - to participate in the market. The other reason for excluding small sources is the decision of the two cantons concerned not to modify emission standards for sources emitting less than 5 tons per year.

Staehelin-Witt and Spillmann (1992) give another explanation for the low intensity of trading. When a firm carries out an abatement effort, it has little incentive, from a technological and economic point of view, to comply solely with the federal standard. Most often, investing in abatement also makes it possible to comply with both federal and cantonal standards. This is thought to be a reason for the lack of demand for permits.

Part of the difficulties encountered are no doubt due to the rigidity of the federal standards. However, the fact that trading has failed to develop as expected is also due to other factors. Otherwise, there is no explaining the presence of internal trading under the bubbles and the total lack of external trading.

Figure 2: Flexibility margin for emission trading

4.2 Characteristics of the emission credit system

Quantity or concentration

Observers of the Basle experiment feel that the system established is not a true market for tradable permits, since firms remain subject to emission concentration standards (Staehelin-Witt and Spillmann 1992, Eigenmann 1996). Indeed, the emission standards for the various types of facilities are maintained, as firms have the possibility of emitting higher concentrations of VOCs on the condition that offsetting takes place. Thus, the system adopted by the two cantons is a credit system and it remains very close to a regime of direct regulation.

The arguments put forward by Staehelin-Witt and Spillmann are not totally convincing. For all firms wishing to participate in the market, emission concentrations are converted into quantities by forming a bubble or by requesting a credit. In this case, trading is denominated in kilos or tons, not in mg/m3. On the other hand, it is true that participation in the market is optional.

Absence of initial distribution

The fact that allowances are not distributed at the start of each period constitutes one of the characteristics of the Basle model. Therefore, there is no cap on total emission. Firms which limit themselves to complying with the initial emission standards do not see any change when compared with direct regulation. They do not need permits if they comply with the emission standards for each of their facilities. However, the situation is different for firms which introduce more stringent abatement measures than those required by the law and which reduce their VOC emissions below the cantonal limits. Such firms may immediately engage in internal trading (if they have received approval to set up a bubble) and sell the credits obtained insofar as they find a buyer or bank the credits for future use. Direct regulation remains the rule, and the purchase or sale of permits and implicit trading under a bubble remain the exception.

Treatment of new sources

One of the advantages of a "cap-and-trade" permit system is the fact that the regulatory authority monitors the total quantity of pollutants emitted in the region with a view to achieving an air quality goal. The Basle system does not offer this advantage. Companies which start up a new source are not obliged to purchase credits from other firms in the area if they comply with emission standards. Moreover, this is one of the reasons why to date, there has not been any demand for credits and thus no transactions.

Exclusion of small emitters

With a limit set at 5 tons per year, only large plants belonging to the chemical or pharmaceutical industries have stationary sources emitting enough VOCs to participate in trading. Yet they have already made major efforts to reduce their emissions and marginal abatement costs are very high today. Smaller sources (<0.1 kilo/h) have not been affected by the clean air measures, which in turn explains why abatement costs are generally lower there than in the chemical sector. If it were possible to group together all stationary sources in a single market, the significant differences between marginal abatement costs would constitute a powerful incentive for trading and the market would be more active. Yet federal and cantonal regulations do not allow trading between sources which emit more than 5 tons and those which emit smaller quantities. This artificial limit represents a barrier to trading and leads to a loss of efficiency (measured on the figure below by the difference between the grey surfaces).

Figure 3: Absence of trading between large and small emission sources

Stringency of restrictions on trading

The regulation which makes the allocation of credits contingent on an emission reduction of at least 10 per cent below the cantonal limit reduces the potential for trading. Given the transaction costs, the difference between marginal costs for buyer and seller must clearly be more than 10 per cent for a transaction to take place. The regulation fixing the trading ratio at 0.8 has the same effect. Due to these two constraints, there must be very significant differences between the abatement costs of the two parties interested in a trade for it to take place. An example with figures reveals to what extent the two regulations mentioned above constitute an obstacle to trading. Let us imagine that marginal abatement costs, which are assumed to be constant, are CHF 30 000 per ton of VOCs in plant A and CHF 60 000 in plant B. Let us further suppose that transaction costs come to CHF 2 500 for each of the parties. Plant A has already made abatement efforts and its VOC emissions - 8 tons per year - meet the authorised limit. On the other hand, plant B must reduce its emissions by 1 ton per year to comply with legislation. It is not difficult to imagine that A, which has significantly lower abatement costs, could reduce its emissions in the place of B and obtain compensation by selling permits. Although abatement costs are very different, no trading is possible between the two plants. Indeed, the minimum amount required by the seller is more than what the buyer is prepared to pay.

Table 4: Restrictions limiting the potential for trading

		Plant A	Plant B
	Actual emissions	8 t	9 t
	Reduction required	-	1 t
	Reduction of emissions to obtain a credit for one ton (0.8t + 1.25t)	2.05 t
	Abatement cost in CHF (2.05 t)	61 500
	Transaction cost in CHF	2 500	2 500
	Minimum amount in CHF which A requires to participate in trade	64 000
	Maximum amount in CHF that B is prepared to pay to avoid abatement expense		57 500

Environmental officers in major firms have not appreciated the decision to erect such substantial barriers to trading. However, they feel that this is not the determining reason for the low intensity of trading.

Cumbersome procedure

Emission credits are subject to dual approval. When the request is submitted, the Cantonal Environmental Agency sees to it that the emission reduction comes from an abatement effort made by the firm and not special circumstances (a temporary standstill of a facility, a decrease in activity for economic reasons). The sale must also be approved by the regulator, the goal being to avoid an increase in emissions in non-attainment areas. This is one of the causes for the increase in transaction costs. However, the firms surveyed adapt quite well to these few administrative constraints and do not consider that they represent a significant obstacle to trading.

Insecurity

Proper transparency and clear operating rules are the prerequisites for developing the market. In the Basle case, the discretionary power of the regulator to decide whether or note a reduction of VOC emissions entitles a firm to a credit constitutes a problem. At the time they decide to make a supplementary abatement effort, firms do not know if they will be able to obtain compensation.

Moreover, the firms surveyed feel that it is unfair that the value of the credits banked diminishes every year. As there may be no demand for the moment, a firm which makes a substantial abatement effort may fear that it will not obtain any compensation. Credits which are not used or exchanged within a five-year period lose all their value.

There is a third insecurity factor: the law does not foresee the impact of tighter emission standards on the value of the rights. Thus, firms do not know if the value of the credits will be adjusted to fit more stringent emission standards or if it will remain the same.

4.3 Acceptability

By firms

The majorities of the facilities concerned belong to the big chemical or pharmaceutical multinationals. These firms are making efforts to portray themselves as firms respectful of nature. Thus, they cannot adopt, in their environmental policy, behaviour which may shock part of the population and damage the firm's image. When these firms are asked if they could consider paying (i.e. purchasing an emission credit from another firm) rather than taking abatement measures, the answer is clearly negative. On the other hand, it is easier to imagine that these firms might participate in the market as sellers of rights. The most likely scenario is that these firms will bank permits for internal use.

Bubbles are merely viewed as an alternative means of controlling emissions (by quantity rather than concentration). This type of instrument is very well accepted by firms, which would even like to see it come into widespread use. On the other hand, firms are much less enthusiastic about the sale of permits and above all their purchase (perceived as buying a "right to pollute"). There are certainly cultural reasons for the poor acceptance of this instrument. Environmental officers in major firms have indicated that, in the 80s, when all firms were making major abatement efforts, they could have considered purchasing rights enabling them to postpone an abatement operation. Today, the conditions have changed and they would no longer enter the market as purchasers.

By the federal regulator

The Office Fédéral de l’environnement, des forêts et du paysage (OFEFP) has never been very enthusiastic about the idea of using emission certificates to reach its policy goals. A study carried out for another federal office highlighting the advantages of permits in a clean air policy met a rather cool reception (Stritt and Jeanrenaud 1992). However, it would be a mistake to conclude that the OFEFP is against this type of instrument in principle. In the context of its policy of reducing emissions of greenhouse gases, tradable certificates are viewed as one of the means of achieving the very ambitious goals deriving from the Kyoto agreement. In the case of VOCs, the OFEFP's opposition to permit-based experiments and the refusal to accept an easing of federal emission standards can be explained by the fact that the federal government had opted for a tax. The recent amendment of the Law on the Environment made it possible to levy taxes on VOCs. The degree came into force in early 1998 and the tax will be levied starting January 2000. The tax on VOCs, along with the tax on extra-light heating oil³, will be the first incentive tool of environmental policy at the federal level. The OFEFP feels that owing to the specific structure of VOC emissions - many small sources and diffuse emissions - the tax is a more appropriate means of action and one which is easier to administer than tradable permits. The federal regulatory authority no doubt considers that simultaneous recourse to the two instruments is not desirable⁴. The Basle firms participating in the permit market would be subjected to the tax.

By society

No work has been done on the way in which permit trading is perceived and accepted by industry and the population in Switzerland. Nevertheless, interesting information may be found in a study by Bürgenmeier et alii (1997) on ecotaxes. In general, the acceptability of incentive taxes by firms seems rather good, as two thirds of them have expressed a favourable view. This result is surprising if one brings to mind the opposition of industry to the federal government project to introduce a tax on CO2⁵. The major firms in the Basle area have supported the project to set up an emission-trading market. Talks with environmental officers reveal that trading carried out within one plant are generally better accepted than external trading. The idea of selling a "right to pollute" has not really been accepted by firms or the public in general.

4.4 Timing

The abatement efforts in the chemical industry were made between 1986 and 1994. During this period, VOC emissions from sources belonging to the major firms in the industry diminished by more than 90 per cent. As far as these firms are concerned, the bulk of their investments in abatement efforts have already been made. Thus, the right time to introduce a system of tradable permits was during the mid-80s, which means that the new instruments came too late. According to the firms surveyed, this was one of the primary causes of the experiment's lack of success.

4.5 Emission structure

Those who designed the project in the early 90s based themselves on the idea that 80 per cent of VOC emissions came from 20 per cent of all sources. Had this hypothesis proved correct, a system of tradable permits reserved for major VOC emitters would have perhaps performed as expected. Yet the emission structure today is quite different, as the lion's share of VOCs comes from small stationary sources and traffic (Staehelin-Witt 1998). Over the past few years, the large chemical and pharmaceutical plants have made major abatement efforts, reducing their VOC emissions by more than 90 per cent. Today, some 1 000 tons/year come from the chemical industry - including emissions from small firms in the sector - out of a total of some 17 000 tons for all of the sources in the Basle region. VOC emissions from each of the production centres of the major chemical and pharmaceutical firms come to around 100 kilos per year. Thus, the new emission structure is less favourable for emission trading than the initial structure.

4.6 Reorientation of corporate priorities

In the second half of the 80s, the general conditions were propitious for the implementation of an ambitious environmental protection policy. The favourable business climate, the support of the local population and the employees of the firms targeted participating for the federal and cantonal clean air policy led the major chemical and pharmaceutical firms to earmark very substantial amounts for the fight against pollution. The effort which the major companies were asked to make was out of proportion compared to the effort which small and medium-sized firms and owners of motor vehicles were asked to make.

In recent years, however, as a result of globalisation, competitive pressures, mergers and employees' fears for their jobs, the environment no longer enjoys as high a priority as it did when the project was designed. Today, firms attach greater importance to their responsibilities with regard to other stakeholders and in particular shareholders. Employees are more concerned with holding on to jobs than air quality. All these elements explain the tepid reception for a new cap-and-trade model, very similar to the program of tradable permits already in use in the US (B,S,S. 1995, Staehelin-Witt 1998). The big firms feel that they have already done quite a bit, that additional reductions would not be effective given the very high marginal abatement costs, and that it is time to shift the burden of abatement efforts to small and medium-sized firms and motor vehicle owners.

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