When to Pollute, When to Abate? Intertemporal Permit Use in the Los Angeles Nox Market

Abstract

Intertemporal tradability allows an emissions market to reduce abatement costs. We study intertemporal trading of nitrogen oxides permits in the RECLAIM program in Southern California. A theoretical model captures the program's key intertemporal features: two overlapping permit cycles, two compliance cycles for facilities, and tradable permits. We characterize the competitive equilibrium; show that it is cost effective; and demonstrate the firms' incentive to delay abatement, i.e., to trade intertemporally. Using model extensions to explore market design issues, an arbitrage condition implies that the equilibrium is invariant to overlapping compliance cycles, but depends crucially on overlapping permit cycles. We empirically investigate intertemporal trading of permits using panel data on RECLAIM facilities for 1994-2006. Facilities undertake trading by using a considerable proportion of permits of the opposite cycle. We econometrically test two theoretical propositions -- delayed abatement and trading across cycles -- with a difference-in-differences estimator. The results neither contradict nor provide conclusive support of the theory.