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Article Excerpt
Many environmental regulations encourage the use of "clean" inputs. When the suppliers of such an input have market power, environmental regulation will affect not only the quantity of the input used but also its price. We investigate the effect of the Title IV emissions trading program for sulfur dioxide on the market for low-sulfur coal. We find that the two railroads transporting coal were able to price discriminate on the basis of environmental regulation and geographic location. Delivered prices rose for plants in the trading program relative to other plants, and by more at plants near a low-sulfur coal source.
1. Introduction
* Burning coal to generate electricity releases sulfur dioxide, a pollutant that harms human health and contributes to acid rain. Electric power plants can reduce sulfur dioxide emissions by burning low-sulfur coal rather than high-sulfur coal or by "scrubbing" their flue gases before they are released into the atmosphere. Since 1971, various forms of environmental regulation have encouraged (or mandated) power plants in the United States to use one of these abatement methods. Title IV of the 1990 Clean Air Act Amendments used a novel program of emissions "allowance" trading to extend sulfur dioxide regulation to a set of power plants that had been exempted from previous federal regulation.
This article investigates how this regulatory change affected the price of low-sulfur coal from the Powder River Basin in Wyoming, the major source of low-sulfur coal in the United States. Because coal is a commodity, one might suppose that the form of regulation should have no effect: the price of coal, before and after a change in regulation, should equal its marginal costs of extraction and transportation. This characterization turns out to be too simple. In particular, two aspects of the market for low-sulfur coal draw it away from this perfectly competitive benchmark.
First, coal is transported from the Powder River Basin by only two railroads, the Burlington Northern Santa Fe (BNSF) and the Union Pacific (UP). Moreover, many power plants are served only by one of the two carriers. These facts suggest considerable potential for market power in transportation, which accounts for a large fraction of the delivered price of coal. Second, power plants vary in their willingness to pay for low-sulfur coal, both because different plants are regulated in different ways and because the geographic location of a plant determines how attractive low-sulfur coal is relative to other abatement options. This variation creates an opportunity for the railroads to price discriminate among plants on the basis of regulatory status and location.
We use detailed data on shipments of Powder River Basin (PRB) coal to examine how delivered prices responded to the advent of the sulfur dioxide allowance market created by Title IV. What we find is compelling evidence of price discrimination by the railroads on the basis of environmental regulation. Controlling for a wide range of other factors, delivered prices of PRB coal rose at power plants that were affected by the new regime, relative to prices at other plants. Moreover, the relative increase in coal prices was greater at plants near Wyoming (where few substitutes were available) than at more distant ones (where the plants had better outside options).
Our identification strategy relies on the fact that only a subset of power plants--known as "Table A" plants--was required to participate in the first phase of the allowance market. We measure the effect of the allowance trading regime by analyzing delivered prices before and after the allowance market took effect, comparing the difference at Table A plants with the change at plants that remained governed by conventional emissions standards. Our results imply that prices at Table A plants, relative to non-Table A plants, increased by over two dollars per ton at the power plants nearest the PRB, but by only nine cents per ton at the most distant plant. The comparison with non-Table A plants is important, since delivered prices at those other plants fell over the same time period (even controlling for transportation cost and other factors). When this general decline in prices is incorporated in the estimated price changes at Table A plants, we find that delivered prices rose at Table A plants within roughly 940 miles, and fell further away. Our estimates control for transportation costs, minemouth prices, and coal characteristics while including fixed effects for power plants, coal mines, and delivery years. Our results are also robust to a variety of alternative specifications.
Although we lack the necessary data to estimate the effect on railroads' profits directly, we perform a few "back-of-the-envelope" calculations to gauge the magnitude of their gains. Those estimates suggest that the annual producer surplus enjoyed by the railroads on deliveries to Table A plants roughly tripled under the new regulation. These gains were on the order of 15% of the total value of the "regulatory rents" created by the new market, where those "rents" are defined as the difference between the market value of the pollution allowances (given away freely to electric utilities by the government) and the variable costs of emissions reductions.
Other studies have noted that the delivered price of PRB coal fell during the mid-1990s, as the allowance trading regime was getting under way (Ellerman and Montero, 1998; Kunce, Hamilton, and Gerking, 2005; Winston, Dennis, and Maheshri, 2004). Indeed, this fall in prices has been cited as a reason that the market prices of sulfur dioxide allowances were much lower than expected (Burtraw, 1996). We shall have more to say in Section 6 about how our findings relate to these other analyses. For now, we note that our conclusions are not inconsistent with a general decline in prices. Rather, we are interested in the effects of the allowance trading program at those plants that were directly affected by the new regime, controlling for contemporaneous changes in transport costs and a range of other factors.
Our findings highlight an often overlooked consequence of market-based environmental policies: namely, that the form of emissions regulation may affect the prices of "clean" inputs such as low-sulfur coal. The familiar argument in favor of emissions trading emphasizes cost-effectiveness: such a program can achieve a given amount of abatement at a lower total cost than emissions standards, because an allowance market equalizes marginal abatement costs across polluting sources. We focus here on the interaction between environmental regulation and input markets. The form of emissions regulation determines not only how much of a clean input (e.g., low-sulfur coal) polluters want to consume but also how much they are willing to pay for it on the margin. When the suppliers of clean inputs have market power, therefore, regulation will not simply increase the quantity consumed but rather will affect price and quantity jointly. In turn, by influencing input prices, the form of regulation can affect the cost of abating emissions. In the case of Title IV, our results suggest that railroads effectively practiced price discrimination on the basis of regulatory status and distance from the PRB. Higher prices for low-sulfur coal at Table A plants were one consequence.
The next section gives an overview of the relevant environmental regulation, along with some background on railroads and low-sulfur coal mines. Section 3 uses a simple bilateral bargaining framework to consider how geography, environmental regulation, and market power in transportation interact to determine delivered coal prices. We describe the data in Section 4, and conduct preliminary analyses in Section 5 to validate our theoretical framework and empirical approach. We present our main empirical results in Section 6. Section 7 concludes.
2. Context
* Regulation of sulfur dioxide emissions. Title IV of the 1990 Clean Air Act Amendments introduced a novel market-based policy to control sulfur dioxide (S[O.sub.2]) emissions from fossil-fueled generating units at electric power plants. (1) Each generating unit in the program is allocated a number of "allowances," each corresponding to one ton of S[O.sub.2] emissions. If the total cap on emissions is binding (as it was in the case of Title IV, which required participating plants to cut their sulfur dioxide emissions by roughly 40% in the first five years), allowances have a positive price. A unit that emits more sulfur dioxide than its allowance allocation can buy permits from other generating units. A generator that emits less than its allocation, either by using low-sulfur coal or by installing and operating a flue-gas desulfurization device (better known as a "scrubber"), may sell its surplus allowances or bank them for future use or sale.
Prior to Title IV, power plants were governed by "command-and-control"-style regulations that imposed maximum allowable S[O.sub.2] emission rates on individual generating units. These regulations varied in stringency depending on the age of a plant and its location. Units built after 1971 were subject to stringent uniform emissions standards imposed by the federal government under the 1970 Clean Air Act. Older units had to meet standards prescribed by the states in order to maintain local ambient air quality; these varied widely among and even within states.
Our analysis focuses on the years 1990-1999, encompassing the first phase of the allowance market created by Title IV and the five years leading up to it. (2) During that decade, environmental regulations divided power plants sharply into two groups. Of particular interest is the set of "Table A plants"--plants housing generating units (3) that were required to participate in Phase I of the new allowance market. (4) These were the largest, dirtiest generating units, built in the 1950s and 1960s, before federal standards took effect. (They are called "Table A" units after the table that listed them in the 1990 legislation.) These plants experienced a shift in regulation over the study period. In the first part of the decade, they were governed by state-level emissions standards. Starting in 1995, they came under the newly created emissions trading program.
The second set of plants was subject to command-and-control regulation over the entire decade. Some of these were built before 1971, but faced fairly stringent state-level emissions standards. (Pre-1971 plants that faced lax state standards were typically the plants targeted by Table A.) Others were built after 1971 and subject to federal emissions standards. (5) Importantly, both federal and state-level emissions standards were essentially constant over the period at any given plant.
[] Railroad market power. Rail rates during the time period covered by this study were generally individually negotiated between shippers and railroads; the details of particular contracts were not publicly known. Several features of the railroad industry appear to allow ample latitude for railroads to exercise some degree of market power. Although rail rates are regulated by a price cap, it was seldom binding for PRB coal transport. (6) Although utilities may file complaints with the Surface Transportation Board, they have had little success in doing so, in part because of the time and expense involved (Grimm and Winston, 2000). Nor does the threat of entry appear to be an effective deterrent to BNSF and UP exercising market power in the PRB. A competing rail line proposed in 1998 remained held up as of early 2007 as a result of opposition from those living along the proposed route. Finally, a secondary coal market among power plants (which might otherwise constrain the railroads' ability to set prices) is effectively ruled out: coal is delivered on specialized coal hopper cars and unloaded into vast piles adjacent to the plant. Arbitrage around the railroads would require a power plant to load the coal onto trucks, a costly means of transporting coal over long distances. Industry sources confirm that resale is rare.
[] Coal extraction in the Powder River Basin. Figure 1 shows the locations of the power plants in our sample, along with the three...
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