Chapter 11 Environmental Regulation of the Energy Industry

11.1 Environmental Costs and Environmental Externalities

• As our overall economic well-being has improved, we have become far more cognizant of our unintentional impacts on the environment.

• Those unintended side effects are called externalities.—a type of social cost, which is defined as a cost that falls outside private, market transaction.

• Environment is a public good. (no body has property rights for it)---nonexclusivity.

• Problems:• Free riders: those who obtain benefits w/o paying for

them.

• Costs to comply with some environmental regulations often appears to exceed the benefits.

• Conflicts bw economists and environmentalists

11.2 Regulatory Responses

• Society would like to reduce the output from Xc to X*.• To do so, there are 7 regulatory policy instruments:

1. Market-enhancing mechanisms:

Output taxes on polluting activities

Direct taxes on pollutants

Tradable emissions permits

2. Market-substituting mechanisms

Imposition of prescribed technologies

Limits on the quantity of pollutants

Payments to reduce pollutants

Subsidies for pollution control measures

Command-and-Control Policies

• Most common form, but the least likely to reduce pollution at the least cost.

• Three categories:

1. prescribed-technology policies (regulate the types of pollution control measures that must be used)

2. Regulates emissions quantities themselves by restricting either allowed emissions per unit of output, or allowed emissions per unit of time.

3. Emergency restrictions

• A command-and-control policy will yield the most efficient outcomes only by accident.

• Quotas are another common command-and-control approach.

---Problem: does not account for environmental damage.

Market-Based Policies

---a transfer of wealth from buyers to the government. And what government does with the money affects the well-being of the economy.

Problem:

An output tax provides no incentive for the plant owner to install efficient pollution control measures, and produce with the most efficient technology.

Emissions Taxes

--imposes specific market prices on the pollutants themselves. provides incentives

• Reduce emissions• Optimal level of generation and set of inputs• Increase the cost of production and raise MPC raise

the P, and reduce the amount of electricity purchased to X*

Tradable Emissions Permits

---A permits that allows polluters to pollute for a price.

• Known as a cap-and-trade system.• For SO2 and NOx most successful• 1990 Clean Air Act Amendments (1990 CAAA)• To achieve reduction in pollution, at the lowest cost;

providing with right incentives

• Allow polluters to buy and sell rights to pollute and exchange.

• Let the market decide the best way to reach the emission goal.

• Regulators first determine the total amount of pollution that will be set at the optimal level.

• Total control costs are minimized.

• Cap-and-trade system work best when the affected pollutants are widely dispersed.

11.3 Measuring Environmental Costs and Benefits

• We cannot directly observe the prices individuals are willing to pay for improved environmental quality.

• Etimation process can be complex:• Ex: the Four Corners region

Problems:• Public goods• Value to whom• Defining the view itself

Preserving Health and Well-Being

• Comparison the costs of regulations with cost of premature death and increased incidence of disease?

Debate over Statistical value of life

• In reality, noneconomic goals, may take priority over costs and benefits.

11.4 Environmental Costs and Energy Prices

• Laws, imposing air pollution emissions caps or using a market-based cap-and-trade system…all raise price of energy.

• New Source Review (NSR), Clean Air Act Dilemma: While maintenance upgrades reduce emissions, they

increases output.

Equipment Replacement Provision Back to NSR, recreating the case-by-case uncertainty

11.6 Externality Adders

• Utility regulators impose externality cost “adders” on a utility’s generation resources, based on the MC of control measures

• Require utilities to incorporate those costs into integrated resource planning (IRP)

---Completely wrong.

1. Control cost has nothing to do with damage cost

2. Improve well-being only if MC and MB differ

3. Choices bw technologies should be based on total social costs, rather than MC.

Recently, some states reimpose command-and-control regulations, which lead to unanticipated side effects.

11.7 Current Regulatory Policies:Renewable Energy and Global Climate Change

Renewable Portfolio Standards (RPS)

• In 2005, RE provided 9% of total electricity generation in US.

• Many state governments, want to increase reliance on renewables rapidly

• RPS: mandates producers and users to derive certain percentage of their electricity from renewable sources

• Established in the District of Columbia and nearly half of the US states.

• RPS combines methods of tax and subsidies.

• Debate over whether RPS will increase electricity prices.

Policies that Address Climate Change

• Climate change policies that increase the cost of fossil fuels will affect overall demand.

• Changes in forecast growth rates also affect other investment decisions.

• Kyota Treaty: sets emissions reduction targets

• Emission reduction may provide large benefits in the future or turn out to have been needed.

Climate Change Policies and Fairness

• Emissions and output taxes on carbon will produce identical results.

• From economic efficiency, emissions quotas on carbon will be less valuable then emissions taxes.

• Even so, it may make sense to enforce emissions limits that are not fully tradable.

Gains and Losses:

• State-level mandates for renewable resources and greenhouse gas emission reductions---a new type of regulatory approach.

• Unlike traditional regulatory approach, this approach force utility ratepayers to bear all the costs, while exporting the vast majority of the benefits elsewhere.

• General reason: renewable resources have greater direct monetary costs than their fossil fuel counterparts.

• Similarly, enforcing specific greenhouse gas limits at the state level increases the cost of electricity.

• Everyone outside the local area free rides on the backs of local customers.

• This approach is not an economically efficient one.