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In the late 1970s, emission reduction credit (ERC) programs emerged from federal Clean Air Act efforts to address significant air pollution problems. The programs were based on the notion that some form of incentive, or quasi-market based mechanism, could leverage additional emissions reductions for less cost, beyond the reductions achieved through direct regulatory efforts. California’s program came into being as part of this effort.

By obtaining emission reduction credits under California’s program, operators whose facilities pollute can offset excessive emissions by trading or purchasing credits representing pollution elsewhere. Agencies that regulate air pollution oversee ERC “banks” and determine whether operators can “deposit” and “withdraw” credits. Credits can be transferred to other companies wanting to pollute more.

Credits are particularly coveted where air quality is so poor that the region is classified as being out of attainment with (i.e., doesn’t meet) federal standards, and therefore unable to absorb the additional pollution burden posed by new industrial projects.

The banking of emission credits is a regulatory approach that seems too good to be true. A company seeking to expand—and pollute more—is incentivized to take voluntary steps to control pollution in some part of its operations. These voluntary reductions in emissions create an emission reduction credit that the company can then use to offset pollution occurring somewhere else— either in its own operations or in some other company’s operations. Over time, companies can split out a portion of the credits to use and continue to bank the rest, sell credits to other companies, or transfer credits to an operation’s new owners.