Pollution permits make a market: Sulphur dioxide allowances auctioned by sealed bids in Chicago

AN AUCTION of pollution permits in Chicago yesterday ushered in the most sophisticated, ambitious attempt so far to harness the power of the free market for environmental protection.

The permits are to produce one ton of sulphur dioxide gas - the main cause of acid rain - from a fossil-fuel power station. From 1995, if any of the 110 most polluting power stations in the US produces more pollution in a year than it has permits for, it will face large fines.

The central idea is that the market, rather than a government regulator, is best at working out the most cost-effective way of bringing down pollution. The owners of power stations will trade permits, with those facing the highest costs in curbing sulphur emissions buying and utilities that can clean up their act relatively cheaply selling.

Fresh permits will be issued each year but the numbers will decline to a level that halves sulphur dioxide emissions early in the next century. The new system of pollution control does not come into effect until 1995, but the permits have begun to be issued and trading is under way.

The bulk of the permits are being issued annually to utilities by the US Environmental Protection Agency on a pro rata basis - they will get enough to cover their current emissions.

But 2.8 per cent of them are being kept aside for annual auctions at the Chicago Board of Trade, the world's largest futures and options market.

These auctions are intended to encourage intermediaries to come in and establish an open market price rather than allowing the utilities to sew things up between themselves. The auctions are also intended to allow new entrants - companies that want to run new fossil-fuel-burning power stations - to buy the permits they will require.

While 150,000 permits will be auctioned each year, a further 25,000 will be reserved for sale at dollars 1,500 each. The guessing was that the auction prices will be well below this level. The permits are believed to have been fetching between dollars 150 and dollars 300 each in advanced, undisclosed trading between utilities.

The auction yesterday was by way of sealed bids submitted at least three days in advance. Yesterday the CBOT said 150 individuals and companies had bid and all the permits would be sold - there is no reserve price. But the actual prices bid will not be revealed until later today.

The scheme was set up under the US's 1990 Clean Air Act. The CBOT has been contracted to handle the auctions and direct sales, but will not be paid for its services. It hopes to make its money through trading in futures and options of the clean-air permits that will start later this year.

Already broking firms specialising in permits have sprung up.