Chapter 11 Environmental Regulation of the Energy Industry

1. Chapter 11 Environmental Regulation of the Energy Industry

2. 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.

3. 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

4. 11.2 Regulatory Responses

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

6. Command-and-Control Policies • Most common form, but the least likely to reduce pollution at the least cost. • 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

7. 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.

8. Market-Based Policies

9. ---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.

10. 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*

12. 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

13. 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.

14. 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

15. 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.

16. 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

17. 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.

18. Control cost has nothing to do with damage cost • Improve well-being only if MC and MB differ • 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.

19. 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

20. 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.

21. 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.

22. 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.

23. 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.

24. Everyone outside the local area free rides on the backs of local customers. • This approach is not an economically efficient one.