Glossary

A

Accumulation: the build up of a particular pollutant over time

Acid Rain: term applied to acid precipitation formed when emissions of sulfur dioxide (SO₂) and oxides of nitrogen (NO_x) react in the atmosphere with water and other compounds

Acid Rain Program: created under the Clean Air Act to reduce acid rain; employs a cap and trade framework to achieve SO₂ reductions

Acute Loading: a term that applies to the short-term build up of a pollutant and which suggests that, in the short-term, significant amounts of a pollutant can accumulate

Allowance: the term generally used to refer to the emission reduction unit traded in emissions trading programs; in the Acid Rain Program this term specifically means the limited authorization to emit one ton of SO₂ during a given year.

Allowance Loan: transaction wherein an owner of allowances, the lender, allows another party, the borrower, to use the allowances. The borrower customarily promises to return the allowances after a specified period of time with payment for their use, called interest. The allowances returned are not necessarily the exact ones loaned, but are allowances of similar vintage years

Allowance Loan Rate: payment for the lending of allowances over a specified period of time, calculated including the cost-of-carry charge

Allowance Tracking System (ATS): a computerized system administered by EPA and used to track the allowances and allowance transactions by all market participants

Allowance Transfer Form (ATF): official form used to report allowance transfers to the ATS. The ATF lists the serial numbers of the allowances to be transferred and includes the account information of both the transferor and the transferee

Ask: the price a prospective seller is willing to accept (a.k.a. "offer")

Average Weighted Price: calculation used to determine price taking into account the quantity of allowances sold

B

Bear Market: prolonged period of falling allowance prices.

Bid: price a prospective buyer is willing to pay

Broker: person who acts as an intermediary between a buyer and a seller, usually charging a commission

Bubble: a regulatory term which applies to the situation when a company combines a number of its sources in order to control pollution in aggregate; under a bubble facility operators are allowed to choose which sources to control as long as the total amount of emissions from the combined sources is less than the amount each source would have emitted under the conventional requirement

Bull Market: prolonged rise in the price of allowances. Bull markets usually last at least a few months and are characterized by high trading volume

C

Call Option: a contract that grants the right to buy, at a specified price, a specific number of allowances by a certain date

Clean Air Act Amendments of 1990: reauthorization of the Clean Air Act; passed by the U.S. Congress; strengthened ability of EPA to set and enforce pollution control programs aimed at protecting human health and the environment; included provisions for Acid Rain Program

Clearing Price: price at which a buyer and seller agree to transact a trade

Collar/Zero-cost Collar: set of contracts used to hedge against the risk of prices moving in both directions; involves purchasing a call option and selling a put option. Option premiums in a collar that cancel each other out are "zero-cost" collars

Confirmation Sheet: formal memorandum from a broker to a client giving details of an allowance transaction

Cost-of-carry: out-of-pocket costs incurred while an allowance holder retains allowances for future transfer

Counterparty: the party opposite the buyer or seller in a transaction

Credit Risk: the financial risk that an obligation will not be paid and a loss will result

D

Deferred Swap: a trade of one allowance for another in order to exchange the vintage years of the allowances; settlement occurs after more than 180 days

Demand-side: a term referring to the need (or demand) for power generation among a utility's customers

Designated Representative: for a unit account, the individual who represents the owners and operators of that unit and performs allowance transfer requests and all correspondence with EPA concerning compliance with the Acid Rain Program; for general accounts this refers to the person who is authorized to transact allowances from each account

Dispatch: the ordered use of generation facilities by an electric power utility including which units will operate, when they will operate, and at what capacity

E

Exercise Date (or Expiration Date): last day on which an option can be exercised

F

Forward Settlement: purchase or sale of a specific quantity of allowances at the current or spot price, with delivery and settlement scheduled for a specified future date

G

General Accounts: accounts in the SO₂ or NO_x ATS's which were created after the initial allocation; general accounts can be opened by any individual and they are not automatically adjusted for compliance

Global Climate Change: change in the earth's climate; caused by increasing greenhouse gas (GHG) concentrations in the atmosphere; human activities considered to be major new source of GHGs

Greenhouse Gases: variety of gases including carbon dioxide, methane, and nitrous oxide; the buildup of these gases in the atmosphere prevents energy from the sun to escape back out into space, creating the "greenhouse effect"

Ground-level Ozone: the occurrence in the troposphere (at ground level) of a gas that consists of 3 atoms of oxygen (0₃); formed through a chemical reaction involving oxides of nitrogen (NO_x), volatile organic compounds (VOC), heat and light; At ground level, ozone is an air pollutant that damages human health, vegetation, and many common materials and is a key ingredient of urban smog.

H

Hedge: strategy used to offset investment risk. A perfect hedge is one eliminating the possibility of future gain or loss

I

Immediate Settlement: conclusion of an allowance trade in which a party pays for allowances within days of the confirmation of the transaction

Immediate Vintage Year Swap: an trade of one allowance for another in order to exchange the vintage years of the allowances; settlement occurs within days (or at least less than 180 days)

J

K

Kyoto Protocol: an agreement under the UNFCC signed by 84 nations; establishes greenhouse gas targets ("budgets") and framework for implementation; the Protocol has been agreed to and signed by the U.S. and now awaits ratification by the U.S. Senate

L

Long: a market position in which a party records (or anticipates recording) emissions less than its yearly emissions allocation, thus it has surplus allowances

Long-term Forward purchase or sale of a specific quantity of allowances, with delivery and settlement scheduled for a specified future date, usually more than one year out

M

Market Maker: an individual or company that maintains firm bid and offer prices in allowances by standing ready to buy or sell allowances at market prices

N

National Ambient Air Quality Standards (NAAQS): health-based standards for a variety of pollutants set by EPA that must be met by states across the country

Natural long: a party whose allowance allocation is greater than its actual emissions

Natural short: a party whose allowance allocation is less than its actual emissions

Nitrogen Oxides (NO_x): gases produced during combustion of fossil fuels in motor vehicles, power plants and industrial furnaces and other sources; is a precursor to acid rain and ground-level ozone

NO_x Budget Program: a NO_x  cap and trade program adopted by 13 jurisdictions in the Northeast to address ozone transport in that region

O

Offers: price at which someone who owns an allowance is willing to sell (a.k.a. "Ask")

Option: a contractual right to buy or sell allowances at an agreed price; the option buyer pays a premium for this right. If the option is not exercised after a specified period it expires Option Premium: amount per share paid by an option buyer to an option seller for the option Out-of-the-money Call Option: term used to describe an call option whose strike price for an allowance is higher than the current market value

Out-of-the-money Put Option: term used to describe a put option whose strike price for an allowance is lower than the current market value

Over-the-counter Market: Market in which allowance transactions are conducted through the direction interaction of counterparties rather than on the floor of an exchange

Ozone Transport Assessment Group (OTAG): a multi-stakeholder workgroup convened to address problems associated with the long-range transport of ozone and its precursors; encompassed stakeholders in 37 jurisdictions

P

Put Option: a contract that grants the right to sell, at a specified price, a specific number of allowances by a certain date

Power Pool: a situation where output from different power plants are "pooled" together, scheduled according to increasing marginal cost, technical and contractual characteristics (so-called must-runs), and dispatched according to this "merit order" to meet demand

Q

R

Regional Clean Air Incentives Market (RECLAIM): initiated in 1993; a set of market initiatives designed address air pollution in the Greater Los Angeles area of California; includes cap and trade programs for NO_x and SO_x

Retire (Allowances): to remove a portion of allowances from the market

S

Scrubbers: a pollution control technology utilized in power plants to remove pollutants from plant emissions

Short: a market position in which a party records (or anticipates recording) emissions in excess of its yearly emissions allocation, thus it has a deficit of allowances

Short-term Forward: purchase or sale of a specific quantity of allowances at the current or spot price, with delivery and settlement at a specified future date, usually within one year

Smog: originally meaning a combination of smoke and fog, smog now generally refers to air pollution; ground level ozone is a major constituent of smog

SO₂ Allowance Auction: provided for in the Clean Air Act, the SO₂ auction is held annually by the US EPA; the auctions help to send the market an allowance price signal, as well as furnish utilities with an additional avenue for purchasing needed allowances

South Coast Air Quality Management District (SCAQMD): the air pollution control agency for the four-county region including Los Angeles and Orange counties and parts of Riverside and San Bernardino counties

Special Allowance Reserve: roughly 2.8 percent of the cap set aside each year to supply the annual allowance auction

State Implementation Plan (SIP): the plan that each state must develop and have approved by the US EPA which indicates how the state will comply with the requirements in the Clean Air Act; each State's SIP is amended as they address specific or new requirements such as the NO_x reductions required in the NO_x SIP Call

Strangle: sale or purchase of a put option and a call option on the same underlying instrument, with the same expiration, but at strike prices equally out of the money.

Strike Price (or Exercise Price): price at which the allowance underlying a call or put option can be purchased (call) or sold (put) over the specified period.

Sulfur Dioxide (SO₂): a gaseous pollutant which is primarily released into the atmosphere when as a by-product of fossil fuel combustion; the largest sources of SO₂ tend to be power plants that burn coal and oil to make electricity

Supply-side: a term referring to the generation (or supply) of power by a utility

Swap: an exchange of one allowance for another to exchange the vintage years of the allowances held in accounts

T

Time Weighting: an investment strategy in which allowance purchases and sales are transacted over an extended period of time and in small increments, thereby eliminating risk associated with highs and lows in the market

Trader: anyone who buys or sells allowances with the intention of making a profit

U

Unit Accounts: accounts in the SO₂ or NO_x ATS's which hold allowances initially allocated to those sources required to participate in either the acid rain or OTC NO_x programs; EPA adjusts these accounts for compliance each year

United Nations Framework Convention on Climate Change (UNFCC): a treaty signed in 1992 by 165 countries and ratified by 160 countries (including the U.S.); took effect in March 1994; set a target of stabilizing greenhouse gas concentrations in the atmosphere to a level that would prevent dangerous anthropogenic interference with the climate system; established a framework for agreeing to specific actions

V

Vintage Year: represents the first year in which the allowance can be used for compliance

W

X

Y

Z