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6.1.9. Lead Credit Trading

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Economic Incentives for Pollution Control

As early as the 1920s tetra-ethyl lead was added to gasoline by refiners to increase octane and reduce premature combustion in engines, allowing more powerful engines to be built. Lead additives in gasoline were the least expensive of several ways of raising octane. The additives also prevented premature recession of soft valve seats, a feature of most automobile engines manufactured prior to 1975 (but not after).

By the 1970s virtually all gasoline contained lead at an average of almost 2.4 grams per gallon. EPA acted to curtail lead use in gasoline for two reasons. New production vehicles by 1975 were equipped with catalysts to meet tailpipe emission standards for hydrocarbons, carbon monoxide and nitrogen oxides mandated by the 1970 Clean Air Act. Unleaded fuel was required for vehicles manufactured after model year 1975, since exhaust system catalysts would be fouled and not function properly if run on leaded gasoline. As catalyst-equipped vehicles began to dominate the fleet, sales of unleaded gasoline reached about 80 percent of all gasoline sales by the mid 1980s.

Concerns about the role of airborne lead in adult hypertension and cognitive development in children motivated EPA to also limit the overall use of lead in gasoline. EPA required that the average lead content of all gasoline sold be reduced from 1.7 grams per gallon after January 1, 1975 to 0.5 grams per gallon by January 1, 1979. Initially these limits were applicable as quarterly averages for the production of individual refineries, implicitly allowing trading across batches of gasoline at individual refineries. Later EPA broadened definition of averaging to allow refiners who owned more than one refinery to average or "trade" among refineries to satisfy their lead limits each quarter.

During the late 1970s the demand for unleaded gasoline grew steadily as more catalyst-equipped vehicles were sold. By the early 1980s, the market share of leaded gasoline had shrunk to the point that EPA's limits on the average lead content of all gasoline ceased to have an impact on the lead content in leaded gasoline. Meanwhile, evidence mounted concerning the magnitude and severity of the health effects attributable to lead.

EPA acted to curtail sharply the remaining use of lead in gasoline, initially setting as a limit an average level of 1.1 gm/gal beginning on November 1, 1982. EPA lowered the average to 0.5 gm/gal by July 1, 1985 and 0.1 gm/gal by January 1, 1986. To facilitate the phasedown, EPA allowed two forms of trading, inter-refinery averaging during each quarter and banking for future use or sale.

Inter-refinery averaging, which operated from November 1, 1982 to December 31, 1985, allowed refineries to "constructively allocate" lead. To take an example, suppose refiner A produced 200 million gallons of gasoline in the first quarter of 1983 with an average lead content of 1.4 gm/gal. Refiner A could buy 60 million grams of lead credits from refiner B, who produced an equal quantity of gasoline with lead content of 0.8 gm/gal. In 1985, EPA permitted refiners to bank credits for use until the end of 1987, in effect extending the life of lead credits to that date.

Lead credits were created by refiners, importers and ethanol blenders (who reduced the lead content of gasoline by adding ethanol). For example, when the average lead content was limited at 1.0 gm/gal, a refiner producing 1 million gallons of gasoline with average lead content 0.5 gm/gal would earn 500,000 lead credits. EPA enforcement relied on reporting requirements and random testing of gasoline samples. Reporting rules were simple; each refiner or importer was obligated to provide names of entities with whom it traded, the volumes for each trade, and the physical transfer of lead additives. The data allowed EPA to compare reported lead additive purchases and sales for each transaction to assure compliance. Discrepancies in reported figures could trigger investigations and enforcement actions. Well over 99 percent of all transactions were reported accurately; however several dozen fraudulent transactions occurred. Loeb (1996). In one quarter alone, the now-defunct Good Hope refinery in Louisiana accounted for over one-half of all reported lead credits sold during one quarter. Subsequent investigation uncovered the fraud.

Judged by market activity, the lead credit trading program was quite successful. Lead credit trading as a percentage of lead use rose above 40 percent by 1987. Some 20 percent of refineries participated in trading early in the program, rising to 60 percent by the end of the program. Hahn and Hester (1989). Early in the program 60 percent of refineries participated in banking, rising to 90 percent by the end. Trading allowed the EPA to phase out the use of lead in gasoline much more rapidly than otherwise would have been feasible. Given that refiners faced very different opportunities for reducing the lead content of gasoline, a rapid phase-down without trading would have rewarded refiners collectively, since the market price of gasoline would have been determined by the high cost producers.

During the period when lead credits were traded, the price increased from about 3/4 cents/gm to 4 cents/gm. Anderson, Rusin and Hoffman. Nearly one-half of all lead traded was between refineries owned by the same firm. Kerr (1993). With external transactions, refiners revealed a preference to deal with normal trading partners even though they could obtain a better price elsewhere. This indicates that even though there was an active market in lead credits, trading did not produce least cost outcomes.

EPA estimated that the banking provisions alone would involve 9.1 billion grams of lead credits and save refiners $226 million. Subsequently, the amount of lead banked was placed at just over 10 billion grams. The lead trading program may be viewed in retrospect as a considerable success. The use of lead in leaded gasoline was sharply reduced over a short period of time without spikes in the price of gasoline that otherwise might have occurred. The market in lead credits was quite active, though, as noted above, refiners did not maximize gains from trade. Also, despite seemingly foolproof procedures for catching fraudulent trades, some small refiners and ethanol blenders nonetheless sold many more credits than they had earned.

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