AQMD May Trade Strict Rules for ‘Smog Exchange’ : Environment: Radical concept would give companies an allotment of pollution shares to buy and sell.

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In New York City, you can deal in orange juice futures; in Chicago, you can trade in pork bellies. In Los Angeles, the next hot commodity may well be bought and sold on the local “smog exchange.”

For months, a committee appointed by the board of the South Coast Air Quality Management District has been designing a market in dirty air. In the process, AQMD may scrap nearly all its regulations controlling emissions from factories, refineries, dry cleaners, charbroilers and other industries--a prospect that frightens some and delights others.

Rather than holdings in a business, every share traded on the smog exchange would represent the right to spew a certain amount of pollutant into the air.


More than 16,000 polluters no longer would be subject to 23 AQMD measures that specify equipment, material and processes that must be used to reduce nitrogen oxides and hydrocarbons, two key components of smog. Another 43 proposed rules would not be enacted. Instead, each company would be assigned a definite number of shares. A business would be free to choose how to stay within its limits, perhaps using new technology, shutting down a facility or buying shares from another company.

Each share would be worth 5% less pollution each year, in theory forcing an overall cleanup of the region’s smoggy skies.

The concept of the pollution marketplace is a radical about-face from AQMD’s tradition of tight regulation. If it moves from concept to reality, it would be by far the largest experiment in the country with emissions trading, a principle endorsed by the new federal Clean Air Act. As such, the market’s evolution is being closely watched.

To business, the pollution market represents a measure of independence from the yoke of AQMD’s measures, many of which have met with fierce resistance. Enthusiastic industrialists say they would have a powerful incentive to find new ways to decrease smog. There would be profit in doing so; they could sell their unused pollution shares.

They say they could keep jobs in the area and consumer prices down because they could come up with cheaper controls than those imposed by AQMD. “We think we know the most about how our plants operate and how to improve them,” said Doug Henderson, executive director of the Western States Petroleum Assn.

To environmentalists, the market represents a potential opportunity--but also a huge gamble with the public’s health. There are flaws in the current system, they say, but the air is getting demonstrably cleaner.


“If (a market) doesn’t work,” said Tom Soto, president of the Coalition for Clean Air, “this will be the S & L failure of air quality.”

Tim Little, coalition executive director, said: “They say, ‘It’s going to be very simple. Trust us.’ But what if you don’t trust them?”

Despite such wariness, Soto, who is a member of the AQMD committee, said he and other environmentalists may be willing to support a market-based system of air pollution control. “It would really legitimize the environmental movement. It’s no longer the fringe,” he said. “There would be a dollar value placed on being environmentally sound.”

He added that environmental groups could buy shares and keep them out of circulation, contributing tangibly to the cleanup campaign.

For now, AQMD is running on parallel tracks, pursuing two methods at once for solving the tenacious smog problem in Los Angeles, Orange, Riverside and San Bernardino counties. The board is working to revise its set of proposed regulations for the next 20 years, with the bulk of those measures aimed at industry. Public hearings have been held in all four counties and a vote is expected this summer.

Meanwhile, the market committee meets monthly in a conference room at AQMD’s El Monte complex, hoping to present its recommendations in the fall. The business representatives, environmentalists and bureaucrats on the panel have lots to talk about. There are major differences over who should be eligible to participate in a market and how the shares should be allocated. There are concerns about practicalities and worries about the effects on small businesses.


Still, Patricia Nemeth, the AQMD official in charge of the project, said there is a better than even chance the disagreements will be smoothed over and a market established. “On a one to 10 scale, I give it a seven.”

Trading could begin in two years, she said.

The signal to proceed came with passage of the Clean Air Act last year, Nemeth said. The law includes a trading program among several hundred utilities nationwide that produce sulfur dioxide, which causes acid rain. The program’s presence in the law, Nemeth said, meant that the U.S. Environmental Protection Agency was more likely than not to approve a mass pollution market for local agencies such as AQMD.

The EPA’s air policy director, Rob Brenner, said: “We’re real interested in trying to develop an innovative program. We’re committed to try and use these market-based approaches whenever feasible.”

Academics have been discussing free-market approaches to regulation for years. The California Council for Environmental and Economic Balance, a business-labor group founded by former Gov. Edmund G. (Pat) Brown Sr., has been pushing the idea of a large local market since 1988.

A limited market exists here. Since the 1970s, companies that set up new plants or expand facilities have been required to guarantee that the new pollution would be offset by a reduction in some other operation’s pollution.

The idea of these offsets is not so much to clean up the air as to make sure that economic growth does not foul the skies even more. The companies involved still have to comply with the district’s mandates on equipment and processes.


As a “smog broker” selling offset rights, Josh Margolis has had a preview of how a full-scale market could work. Margolis is vice president of AER*X, Inc., a Washington-based trading and consulting firm.

A typical client in the offset market is a cogeneration company that wants to locate a plant in Southern California to make electricity and steam, an operation that involves burning coal or natural gas and, inevitably, producing pollution.

Margolis could offer offset rights from businesses such as these listed with AER*X: a boat builder that closed; a helmet firm that shut down one facility; a maker of spas, showers and bathtubs that changed to a cleaner manufacturing process; a company that replaced high-emission diesel engines with electric engines.

The transaction is like buying a house. The purchaser has to bid for the rights, make a down payment and go through escrow. The money is transferred when AQMD certifies the exchange. “It can be as short as three months or as long as a year,” Margolis said.

Rights can cost $2,700 to $22,000 for each ton per year of pollutants emitted.

Trading so far has been restrained. There were eight sales of rights for nitrogen oxides in 1985; five in 1989 and two in 1990. From 1985 to 1990, about 200 hydrocarbon transactions were completed.

Other smog-plagued cities have offset programs--that is how AER*X survives.

Expanding the market to every business in the Los Angeles Basin that emits nitrogen oxides and hydrocarbons would mean an explosion in trades and in brokers, Margolis said.


“There is nothing this big anywhere else in the world. If they go ahead and do it, it’s going to mean that industry has all sorts of options they didn’t have before,” Margolis said. The AQMD, he said, is “on the cutting edge, the bloody edge, if you will.”

Industry is pushing very hard for the chance to let free enterprise replace AQMD’s strictures. Robert A. Wyman, an attorney representing what he calls the “Regulatory Flexibility Group,” has met with top EPA officials in Washington to pave the way for federal approval. Wyman’s clients in the Regulatory Flexibility Group include the Atlantic Richfield Co., Hughes Aircraft Co. and Southern California Edison Co. He also represents the Los Angeles Times on air quality issues.

Henderson, who represents the petroleum industry, used the occasion of a luncheon for a prominent U.S. senator to lobby another guest, AQMD Executive Officer James M. Lents.

Victor Weisser, president of the San Francisco-based group started by former Gov. Pat Brown, discussed with AQMD board Chairman A. Norton Younglove the best way to construct the market.

On the other hand, environmentalists have been doing most of their talking among themselves. “We’re looking at the issues. We don’t have a formulated position,” said Mary Nichols, senior attorney with the Natural Resources Defense Council.

Nichols has some strong doubts. She questions the basic assumption that first led to the market proposal. “I don’t think the costs of the current program have been unreasonable, given the high level of economic activity here and the harm being done by air pollution,” she said.


She said she also worries that “we may end up with some consequences that will be socially quite unacceptable.” The market is geared toward large companies with lots of cash and large staffs that can handle complicated transactions, she said. She worries that big business will purchase shares from small businesses that would be tempted to sell out and close down.

“What if the refineries end up buying out all the dry cleaners?” she asked.

At least one economist says that such merchants are financially pressed by the air regulations anyway. “If the rules put them out of business, they just go bankrupt,” said Stanford University Prof. Roger Noll, a consultant for Weisser’s group. “If they sell their emission rights, they go out of business with a smile on their face.”

Nichols would prefer to see a much smaller pilot market than the one being considered. Such talk is anathema to the most fervent market advocates. Wyman said: “We actually would like to see the district cast the net wider.” Many options and variations in control costs are needed to stimulate trading, he said.

The biggest hurdle, in the eyes of AQMD, is enforcement. The district needs to be able to verify that the market is reducing pollution in the air, not just on paper.

If a new system did not clear up smog, Younglove said, “We’d have to go back to the regulations.”

“It’s like raising a child,” he said. “We’ll be saying, ‘If you want, be good and you’ll have ice cream. If you misbehave and embarrass me, we’ll beat your bottom.’ ”