The impact of state-level public utility commission regulation on the market for sulfur dioxide allowances, compliance costs, and the distribution of emissions

The 1990 Clean Air Act Amendments (1990 CAAA) created a system of tradable allowances for the control of sulfur dioxide (SO2) emissions from electric utilities. This market based system is a departure from traditional command and control (CAC) methods of controlling air pollution. However, the participants in this market are subject to regulation by state public utility commissions (PUC). This paper examines the impact of PUC regulation upon the compliance decisions, compliance costs, and the distribution of emissions of electric utilities and the market for SO2 allowances. This research extends previous work by Bohi and Burtraw (1992) and Fullerton, McDermott, and Caulkins (1997) by extending utility compliance to an explicit market setting, and follows previous work done on the sulfur dioxide allowance market by Coggins and Smith (1993) and Winebrake, Farrell, and Bernstein (1995).; Utilities facing PUC regulation minimize the cost of electricity generation and emissions compliance subject to constraints on electricity demand and emissions allowed. In order to comply with the emissions constraint utilities can either buy/sell allowances, switch or blend fuels, or make a discrete choice on installation of a scrubber. Using utility data for the year 1996, the market for SO2 allowances is simulated under various scenarios. The simulations indicate that the increase in utility compliance costs due to state-level PUC regulation ranges anywhere from 4.5% to 139% depending on scenario assumptions with the regulatory treatment of scrubbers leading to majority of cost increases. Moreover, the simulations indicate that despite holding generation constant, the move from a regulated to an unregulated environment has impacts on the distribution of emissions sources and compliance costs. In some scenarios, the change in the distribution of emission sources may have impacts on the Northeast, which is already concerned about sulfur deposition from plants in the Midwest and Mid-South. Despite lower costs in the aggregate in the unregulated regime, there may be some states where utilities see their compliance costs increase.