Chapter 14 Taking an Interest in Carbon: Secured Financing
V. Market Approach to Emission Regulation
Regulatory activity in the environmental arena accelerated in the United States in the late 1980s and early 1990s. After the period of relative inactivity that characterized the EPA during the Reagan Administration, Congress moved aggressively to reinvigorate U.S.
environmental policy, from the Water Quality Act of 1987 20 to the far-reaching Clean Air Act Amendments of 1990 (CAAA). 21 These laws became the prime examples of the
“command-and-control” form of regulation — regulations that imposed strict pollution limits and specific obligations in connection with industrial operations. These site-by- site, pollutant-by-pollutant regulations were promptly attacked for promoting inefficient behavior and failing to achieve the promised pollution reductions. 22 Interestingly, the CAAA, while containing significant command-and-control-type requirements, 23 also contained the framework for one of the more successful market-driven approaches to environmental regulation championed by the critics of command and control systems, 24 and model for subsequent climate change legislation, including the Kyoto Protocol.
Title IV of CAAA established an annual aggregate cap of sulfur dioxide (SO 2 ) emis- sions for entities covered under CAAA. 25 Beginning in 1995, each Phase 1 utility was required to have a federally issued permit for each ton of SO 2 emitted. A utility that could not reduce its emissions below its allotted cap could purchase permits from utilities that were permitted to sell or bank unused emission permits when they were able to reduce their emissions below their caps. During the ten-year period from the commencement of Phase I, SO 2 emissions were substantially reduced, with significant emission reductions from both Phase I and Phase II utilities. 26 Success of the Acid Rain
20 Water Quality Act of 1987, Pub. L. No. 100-4, 100 Stat. 7 (1987).
21 Clean Air Act Amendments of 1990, Pub L. No. 101-549, 104 Stat. 2399 (1990).
22 See, e.g. , Richard J. Lazarus, The Tragedy of Distrust in the Implementation of Federal Environmental Law , 54 LAW & CONTEMP. PROBS . 311, 329 (1992). For a discussion of the weak- nesses of command and control policies, see Rena I. Steinzor, Reinventing Environmental Regulation: The Dangerous Journey from Command to Self Control . 22 HARV. ENV. L. REV. 202, 113–118 (1998).
23 See, e.g. , CAA Amendments of 1990, supra note 20, § 112 (emission standards for Hazardous Air Pollutants); id. § 111 (technology requirements for New Source Performance Standards).
24 See David Popp, Pollution Control Innovations and the Clean Air Act Amendments of 1990 (Nat’l Bureau of Econ. Research, Working Paper No. 8593, 2001), http:///www.nber.org/
papers/w8593 .
25 The annual cap was set at 8.94 million tons per year, a level 10 million tons below 1980 emission levels.
26 Thirty-fi ve percent below 1980 levels in the fi rst year of Phase I (1995) and a 40 percent reduc- tion below 1980 levels in the fi rst year of Phase II. D. Burtraw et al., Economics of Pollution Trading for SO 2 and NO X (Resources for the Future, Discussion Paper 05-05, 2005).
MARKET APPROACH TO EMISSION REGULATION
Program has made it the model for environmental trading programs. A review of the Acid Rain Program under the CAAA found that its conclusions and recommendations regarding SO 2 emissions trading generally apply to CO 2 emissions trading as well. 27
The CAAA created a set of tradable allowances, establishing a SO 2 emissions credit market among the regulated entities SO 2 emission credits. Though these allowances could be held and traded, the legislation expressly disclaims that they create a property right for allowance holders. 28 Several rationales were given to the disclaimer of prop- erty rights. One reason was the moral issues raised by creating a “right to pollute” that had the inviolable status of a property right. More substantively, Congress wanted to avoid “takings clause” liability if it reduced or eliminated the rights to SO 2 emission allowances. 29 If Acid Rain allowances were private property and subsequent govern- ment legislation devalues, reduces, or eliminates those allowances, such actions might constitute a governmental taking under the Fifth Amendment to the U.S. Constitution. 30 In such circumstances, the allowance owner would be entitled to fair compensation for the allowances so taken. But, “for the system to reduce pollution and in order to retain regulatory flexibility, regulators needed to reserve the power to amend the trading system by increasing the number of allowances needed for compliance (effectively taking some of the value from private persons) or retiring allowances, without being liable for costly compensation.” 31 Property interests in SO 2 allowances were seen as an obstacle to necessary flexibility to manage an emissions cap-and-trade program.
Case law interpreting the nature of Acid Rain allowances is sparse and does not address the property interest issue head on. The federal court’s handling of a claim of entitlement to SO 2 emission allowances is instructive, however. In Ormet Corp v. Ohio Power Co. , 32 the plaintiff claimed entitlement to a proportionate share of the utility’s emission allowances, arguing it had a contract under which it paid for a portion of the operation and maintenance of the defendant’s power plant. In reversing the lower court’s dismissal for lack of subject matter jurisdiction, the appellate court noted that Ormet was not challenging the issuance of allowances by the EPA; rather, it was claim- ing a proprietary interest in a portion of those issued allowances. The Court cited CAAA’s legislative history, stating that emission allowances were intended to be bought and sold like any other commodity and that disputes with respect to issued allowances were to be resolved like other commercial disputes — privately, in the
27 Id. at 45.
28 “An allowance under this title is a limited authorization to emit sulfur dioxide in accordance with the provisions of this title. Such allowance does not constitute a property right.” 42 U.S.C.
7651b(f).
29 See Jeanne M. Dennis, Smoke for Sale: Paradoxes and Problems of the Emissions Trading Program of the Clean Air Act Amendments of 1990 , 40 UCLA L. REV. 1101, 1119–22 (1993).
30 The Takings Clause of the Fifth Amendment to the U.S. Constitution provides, in pertinent part, “nor shall private property be taken for public use, without just compensation.” U.S.
Const. amend. V.
31 Markus Gehring and Charlotte Streck, Emissions Trading: Lessons From SO X and NO X Emission Allowance and Credit Systems Legal Nature, Title Transfer and Taxation of Emission Allowances and Credits , 35 ELR 10220 (2005).
32 Ormet Corp v. Ohio Power Co. , 98 F.2d 799 (4th Cir. 1996).
courts, and not by administrative action before the EPA. 33 Further, the Court reasoned that questions regarding the nature of the initial ownership interest in emission allowances under the Acid Rain Program was a matter of federal law, so state-by-state variations would not upset the uniformity of the national pollution control program.
The necessity of uniform national interpretation of the Acid Rain Program was rein- forced in Clean Air Markets Group v. Pataki , 34 where the court rejected New York’s attempt to legislate aspects of the emission allowance scheme under the CAAA. 35 In that case, the Court found regional restrictions on the Acid Rain program were an obstacle to implementation of a nationwide trading market in emission allowances. 36
The cases interpreting the legal nature of allowances under the Acid Rain program merely touch upon their status as property — they invest certain parties with proprietary interests that can be adjudicated in the courts. Under the plain language of the CAAA, emission allowances are not property. At the same time, however, allowances possess indicia of property — that is, they can be owned (others, except for the federal govern- ment, can be excluded); possessed (the holder can use the allowances to meet obliga- tions); and alienated (allowances can be transferred to others). 37 This ambiguity surrounding the legal character of allowances was repeated in the treaty accords estab- lishing the Kyoto Protocol. 38 Some have characterized emission allowances as de facto property. 39 The concept of de facto property, as applied to emission allowances, recog- nizes that an allowance might have certain hallmarks of property — the right to use, the right to exclude others from use and the right to transfer, (as noted above) — but might not encompass the totality of potential property rights. Viewing emission allowances as de facto property is not completely (or even adequately) defined by the courts inter- preting cap-and-trade programs or the United Nations interpreting the Kyoto Protocol. 40 With that said, however, de facto property is not unknown in the law, and reviewing its judicial treatment in other regulatory contexts provides a way of understanding carbon credits as de facto property to which a security interest might attach.
33 Id. at 806.
34 Clean Air Markets Group v. Pataki , 194 F. Supp 2d 147 (N.D.N.Y. 2002).
35 Specifi cally, the state legislature attempted to disallow (or impose a 100 percent penalty) on emission allowances issued from emitters upwind of the Adirondack Mountains to avoid acid rain hot spots.
36 Id. at 158.
37 42 U.S.C. § 7651(b) (“Allowances, once allocated to a person by the Administrator, may be received, held and temporarily or permanently transferred in accordance with this subchapter. . . .”).
38 “[T]he Kyoto Protocol has not created or bestowed any right, title or entitlement to emissions of any kind on Parties included in Annex I.” Marrakesh Accords, supra note 7, Decision 15/
CP-7. See also UNIDO, supra note 2, at 68 (specifi cally noting that allowances under the Acid Rain cap-and-trade program do not constitute property rights).
39 M. Gehring and C. Streck, Emissions Trading: Lessons form SO X and NO X Emission Allowance and Credit Systems Legal Nature, Title Transfer and Taxation of Emission Allowances and Credits , 35 ELR 10220 (2005).
40 “Allowances might even be characterized as de facto property rights between private parties, though not vis-à-vis governments.” UNIDO, supra note 2, at 68.
SECURITY INTERESTS IN DE FACTO PROPERTY