The market's collapse shows how vulnerable market-based approaches to reducing air pollution are to government actions. That could scare off investors, who won't commit to a market where the rules can change at any minute.
The current problems in the acid-rain market stem from 2005, when the EPA, with the backing of many utilities and environmental groups, announced major new reductions in smog-forming and soot-producing emissions, and expanded the reach of the cap-and-trade system in more than two dozen, mostly Eastern, states.
But in 2008, in response to lawsuits filed by a handful of utilities and North Carolina, the U.S. Court of Appeals for the District of Columbia Circuit ruled that the EPA had overstepped its authority in expanding the markets and that parts of the new rules conflicted with existing Clean Air Act regulations. The court allowed the expansion of the market to take place, but it ordered the EPA to rewrite its rules to comply with existing law. Prices of allowances fell in response, and trading dwindled.
In response to the ruling, prices for the pollution allowances plunged to $130 a ton. Utilities held off on projects to clean up their plants.
Last week, the EPA issued new rules to comply with the court's decision. The new program will limit the use of the market and instead require most of the emission reductions to come from changes at the plants themselves. And millions of allowances that utilities now hold can't be used under the new program, which will issue its own allowances.
Who is the villain of this story? The North Carolina attorney general? He might get my vote. Obama's EPA? Another strong challenger. Who am I missing? (hint: his name starts with Greg Mankiw)