Buying and Selling U.S. Licenses to Pollute Air : Environment: The President’s clean air bill would make smog control a profit opportunity rather than simply a regulatory burden.

Josh Margolis is pushing hard to close the deal. Working the telephone, he talks prices, wheedles a bit, pitching his product like a broker of pork bellies or penny stocks.

Except the product Margolis peddles is more unusual than those--it’s a license to pollute the atmosphere. His firm, AER*X, brings together companies seeking to buy and sell government entitlements that allow them to dirty the air up to a point--a valuable commodity in urban areas with strict limits on new sources of industrial emissions.

So far, Margolis’ matchmaking has been limited to a small class of polluters. But if the Bush Administration gets its way with a series of free-market proposals to clean up the nation’s smog and acid rain, Margolis’ Washington-based firm could be headed for the big time.

The President’s clean air bill proposes to radically restructure the way industrial polluters have been regulated for the past 20 years. Instead of the “thou shalt” system, in which industry is commanded how much to cut its emissions and exactly how to achieve those reductions, a system of incentives and deadlines would be substituted, allowing firms to select whatever methods they consider most cost-effective to meet general pollution goals.

At the heart of the system would be something called the “emission reduction credit.” Every ton of pollution that industry manages to cut beyond its assigned limit would become a marketable asset--a credit--to be banked for expansion at some later time or to be sold to the highest bidder.

Rather than simply a regulatory burden, pollution control would become a profit opportunity. And that’s where Margolis comes in.

“It’s amazing what you can achieve if you speak to a company’s bottom line,” Margolis said. “There’s water in the desert if you give someone the incentive to find it.”

Take the Bush proposal on acid rain. It would set annual limits on emissions of acid-producing pollutants by the nation’s dirtiest power plants, forcing substantial cutbacks. But each utility would be free to choose how to achieve the limits.

Those located close to supplies of low-sulfur coal in Western states, for example, might choose to burn the cleaner fuels. Others might choose to install antipollution technology. A few might decide to buy credits from more efficient utilities. In each case, presumably, the utility would be guided by an overriding principle--to attain the necessary pollution control at the lowest overall cost.

Not everyone likes the notion of pollution as a property right or an asset, rather than a social evil to be vanquished. “It sends the wrong message,” said Casey Padgett of Environmental Action. The patchwork of industry decisions that would result from such a system, he argued, could also complicate regulation.

Moreover, some industry officials fear that companies would hoard their credits or charge exorbitant prices for them, freezing out new competitors and creating monopolies.

A dirty generating plant, for example, might reduce its emissions not only enough to reach its limits but also to surpass them, earning credits that could be traded for cash. Across town, meanwhile, an industrial competitor, such as a power co-generation company that sells steam captured in electricity production, might decide to add another facility.

That new facility--even if it were state-of-the-art clean--would still add small amounts of new pollutants to the atmosphere and so would be required to buy some credits from someone.

But the utility sitting there with extra pollution credits might refuse to sell, on the theory that the better strategy is to keep out a low-cost competitor rather than add a bit of extra cash to one quarter’s bottom line.

“It could translate into a no-growth environmental bill because utilities won’t sell those (credits),” warned John Foster, a lawyer for several power co-generation companies in the Northeast.

Still, it is the marriage of profit and pollution control envisioned in the Bush bill that unites many traditionally warring parties in the clean-air debate and buoys prospects for its passage after 12 years of congressional stalemate and steadily worsening air quality.

The free-market strategy appeals to conservative Republicans in the White House and Congress who want to “let industry do what industry does best--create profits,” said Robert Hahn, until recently senior staff economist for the President’s Council of Economic Advisers and author of the free-market proposals.

And for strong clean-air advocates like Dan Dudek, an economist with the Environmental Defense Fund, the plan offers a promising tool to “get more stuff out of the air sooner.”

Dudek, who advised White House drafters of the bill, said the old regulatory strategy ignores how companies operate in a competitive environment and how they limit their pollution costs by exploiting whatever natural business advantages they have, such as access to particular fuels or natural resources, or the idiosyncrasies of a particular state’s utility rate regulation.

The old system, Dudek argued, does little to encourage initiative or innovation on the part of companies. “Human beings don’t like being told what to do, especially by bureaucrats at some distant location,” he said.

Dudek also makes the point that, by prescribing a specific piece of equipment to achieve a specific rate of plant emission, environmental laws have, up to now, removed the incentive to cut pollution beyond the prescribed level.

By forcing companies to view pollution control purely as a business cost, he said, companies have less incentive to use it as a point of competitive advantage.

“If we make firms take account of the atmosphere through the economic system, but leave them to do it, that will change behavior radically,” said Dudek. “It gives them reason to think of environmental quality as a profit opportunity.”

The free-market ideas permeate the Bush bill. One provision is designed to cut smog-producing hydrocarbons by placing limits on the amount of gasoline vapors that escape into the air during smoggy summer months.

Oil companies could use any mixture of fuels, including non-gasoline alternatives, so long as they achieved equivalent reductions of hydrocarbons.

Another would expand the existing system of credits for extraordinary reductions in the six most common pollutants for which standards have been set by the Environmental Protection Agency.

But perhaps the furthest-reaching provision is the proposed nationwide cap on acid-rain-causing sulfur dioxide at 1980 levels after the year 2000, the section of the Bush bill most dependent on the workings of a trading system.

Under the proposal, 107 utilities--chiefly in the Midwest and Southeast--would be allowed to generate certain levels of sulfur dioxide every year based on the amount of electricity they generate. Utilities would own those “allowances” even if they closed a plant or slashed emissions below required levels, and they could sell them any time after 1995.

After the year 2000, utilities in growing areas seeking to meet increased electricity demand would buy them from a utility located in a slower-growing area.

Such free-market approaches to regulation have been discussed for years in academic circles. But they found little political support because of the innate distrust that environmentalists had of industry and the difficulties of monitoring corporate performance.

But in 1976, the concept quietly slipped through the back door of government.

That year Paul DeFalco, the EPA’s top official in California, faced a crisis. Los Angeles was violating nearly every standard for pollution set by the EPA. But companies kept pressing to move into the area to set up new plants and facilities or expand ones that were already there.

The solution: DeFalco required that every ton of new pollution put into the Los Angeles air would have to be offset by at least a ton of reductions somewhere else in the region. The responsibility to find and guarantee the offset fell to the new polluter.

Other polluted cities picked up the offset concept, and it soon became a national regulation applied to new, large industries emitting at least 100 tons per year of the six most common pollutants. Variations on the same regulatory principle have been dubbed the “bubble” policy and pollution “netting.”

In every case, the right to pollute is a marketable commodity, and while the traffic is confined to large polluters of just six substances, Margolis stays busy serving as chief broker at AER*X, the only company that trades emissions credits nationwide.

AER*X, with revenue now in excess of $1 million a year, reports its volume of brokered trades has been growing at more than 30% a year. It has already put together 50 deals since 1984, usually taking a 15% commission on each trade.

A staff of eight, including engineers, economists and a public policy specialist, works out of offices in downtown Washington. Another two engineers run the company’s branch in Santa Monica.

AER*X attracts firms looking to buy and sell credits largely by word of mouth, supplemented by occasional ads in newspapers and trade journals. Once a potential client is identified, AER*X engineers examine the books and inspect plant technology to find a better way of controlling pollution.

For sellers, it can result in more credits to offer. For buyers, it can mean fewer credits to pay for. “We have a real incentive to be pollution gold miners,” said AER*X President John Palmisano.

One of last year’s clients was a large fiberglass products company in Southern California that cut its emissions of hydrocarbons by nearly 1,000 pounds per day--a reduction of more than 50%--by altering its manufacturing process.

In search of a buyer, Margolis combed an official list of firms seeking to expand or open new facilities in the area and tapped the network of real estate developers, engineers and lawyers known to represent expansion-minded industries.

The credits were finally sold to a sewage treatment plant for $1,250 a pound per day.

Margolis was pursuing another California deal recently, cradling the phone in the crook of his neck as he scanned a large wall map of Los Angeles dotted by pastel flags-yellow for sellers, pink for buyers.

“It’s just a matter of getting these guys off the dime,” he said.