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
Market-substituting mechanisms
Imposition of prescribed technologies
Limits on the quantity of pollutants
Payments to reduce pollutants
Subsidies for pollution control measures
2.
Command-and-Control Policies
•
Most common form, but the least likely to reduce
pollution at the least cost.
•
1.
Three categories:
prescribed-technology policies (regulate the types of
pollution control measures that must be used)
Regulates emissions quantities themselves by
restricting either allowed emissions per unit of output,
or allowed emissions per unit of time.
Emergency restrictions
2.
3.
• 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 wellbeing 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.