NOx emission allowances were originally created through the implementation of the Ozone Transport Commission to control inter-state ozone pollution in the Northeastern states including the District of Columbia. This was accomplished by creating a summertime cap for emissions (between May 1st and September 30th). All major sources, including utilities, electrical generators larger than 15 MW and industrial boilers with a heat input exceeding 250 MMBtus/hr.

Although a state program, NOx trading differs little from the Federal So2 market’s cap-and-trade system. While the program is implemented on a state-by-state basis, there are no inter-state limitations on NOx emission allowances and as a result of state SIP NOx programs being quite similar, an allowance may be purchased in one state and used in another.

The OTC’s program was replaced by the SIP Call Budget program in 2003, in response to the EPA’s call for State Implementation Plans (SIPs) in an effort to reduce regional pollution in larger tracts of land. Trading has expanded considerably, with the number of allowances growing from 135,000 to approximately 500,000 annually. The program regulates emissions on electrical generators with a rating of 25MW or higher, industrial processes that have heat inputs of or exceeding 250 MMBtu/hour and in some regions, cement kilns. As of May 31st, 2003, electrical generators are required to make 80-85% reductions in NOx emissions, other sources are required to make 65% reductions and cement kilns are required to make 35% reductions in NOx emissions.

The SIP NOx program entered its second phase on May 31st of 2004. On May 1st 2004, an additional 11 states were added into the program and were required to control the NOx levels within their state to levels equal to those in the original eight states.

The NOx program operates similarly to the SO2 program. Sources that are affected by regulation are issued allowances by their state governments. An allowance allows for an affected source to produce one ton of NOx emissions during the control period for a given vintage year. All allowances are tracked by the EPA’s NOx Allowance Tracking System (NATS). Emissions are reviewed annually by the EPA and a number of allowances equivalent to the emissions are deducted from the NATS account of the affected source. Accounts for the current vintage year are frozen during this process and remain locked until the process is complete.

Prior to review by the EPA, affected sources short on allowances may purchase allowances to cover their emissions and sources that have reduced their emissions may sell them for a profit. Unused NOx allowance may be banked forward, but unlike SO2 allowances they do not maintain their value over time. If the total number of banked NOx allowances exceeds 10% of the current vintage years allocation, a value reduction will be carried out. The value reduction is dependant upon the number of banked shares and the current year’s allocation, it is not cumulative or linear.

0.1*Current Budget Total number of banked allowances

= Percentage of allowances that may be used at a 1:1 value

Banked allowances falling outside of the percentage useable at a 1:1 ratio may be used at a 2:1 ratio for one ton of NOx emissions.

NOx Regulations under CAIR

CAIR is the EPA’s newest program for the regulation of SO2 and NOx emissions and was finalized on March 10, 2005. This new program will create the largest reductions in SO2 and NOx emissions in a decade. CAIR states that:

• • States must achieve the required emission reductions using one of two compliance options: 1.) Meet the state’s emission budged by requiring power plants to participate in the EPA administered interstate cap-and-trade program, that caps emissions in two stages, or 2.) meet an individual state emission budget through measures of the state’s choosing.

The CAIR program will be implemented in several stages. Stages already implemented include the drafting and approval of State Implementation Plans (SIPs) for the regulation of SO2 and NOx. CAIR FIP rules states that all stationary fossil-fuel filed boilers or combustion turbines operating at any time on or after November 15th, 1990, or the start up of the unit’s combustion chamber if they are a generator with a capacity of greater than 25 MWe producing electricity for sale. Some cogeneration units or waste-to-energy units are exempt from the CAIR program.

In 2009, CAIR will reduce NOx emissions by 1.7 million tons, a 53% reduction from 2003 levels. In 2015, CAIR will reduce NOx by 2 million tons, achieving a regional emissions level of 1.3 million tons, 61% reduction from 2003 levels.

Promogulate CAIR Rule	2005
State Implementation Plans due	2006
Phase I NOx Cap in place	2009
PhaseII NOx and SO2 Cap in place	2015

Listed below are various transactions that can be arranged in NOx trading and what each consists of.

Immediate Settlement Transaction:This type of NOx transaction is the most liquid. Immediate Settlement Transactions can occur for allowances of any vintage; however, generally the most active allowances are those of the current vintage. After a successful trade, a cash settlement typically is to be paid to the seller within 3 days of confirmation from the EPA’s Allowance Tracking System verifying that the allowances were successfully delivered from the seller’s account to the purchaser’s account.

Forward Transactions: A forward transaction consists of an agreement between buyer and seller to exchange allowances for money at a future date as specified. The allowance is sold at a price based on the forward market curve, which is a speculation of the price of the allowance based on the current price and escalated based on the money of market participants for the specific term of the trade.

Stream Transactions: Streams of allowances may be sold in consecutive years, (i.e., from 2008 through 2010`) allowing the seller to deliver a set number of allowances each consecutive year.

Option Transactions: Many different varieties of options are available, allowing the buyer a great deal of flexibility. Options range from straight put and call options that place a ceiling or floor for prices, to more complex options including collars, straddles, strangles, put and call spread options and time spreads. Most option transactions are “European,” only exercisable on the expiration date. The Expiration date for options is typically the 15th of each month, or the nearest business day.
Vintage Swaps or Loans: Allowances may be exchanged directly for other allowances in a swap or loan. A utility short on credits may trade allowances of a future vintage in exchange for current vintage allowances that may be used if the utility is short. Both sides of this transaction benefit, as the utility that is short on allowances has covered its emissions and the seller has insured future stability by securing more allowances of a future vintage, as they generally trade at a lower rate. Generally in allowance swaps, a ratio based on price is used to determine the number of allowances that will be exchanged.

Cross-Commodity or Interpollutant Swap:In a non-monetary exchange, allowances may be exchanged for allowances of another emission or commodity at an appropriate price ratio, ensuring that both sides of the transaction are equal in value.