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Article Excerpt
This study analyses the un-priced environmental harm caused by generating electricity from fossil fuels in the ECAR control region south of the Great Lakes in 2004 and again in 2015 when the recent Clean Air Interstate Rule will have its full effect. Using existing damage values, we estimate wholesale electricity under-pricing for coal-fired plants at about $40 per MWh in 2004, almost as much again as the $45/MWh actual price. Averaging across all fuels, the price of electricity was more than $30/MWh too low. The under-pricing will still be $18/MWh for coal plants and $15 for all generation sources in 2015, a decade after CAIR was adopted. Recognizing this environmental price now could reduce pollution levels, increase energy conservation and lead to wiser choices of new generation technology.
1. INTRODUCTION
Air pollution regulation in the US and elsewhere generally proceeds from modest initial regulation to increasingly strict emission limits as our knowledge about harm caused and control cost improves. (Davies and Mazurek, 1998, chs. 2, 4, 5; Freeman, 2002.) Legislative and regulatory procedures delay the promulgation of regulations, along with industry lobbying and administrative and court challenges. Industry must be allowed time to purchase and install pollution control equipment, or to replace inherently dirty production equipment. A decade or more may pass between a decision to regulate and the achievement of the intended emission rate. Even then, if harm is underestimated, costs are overestimated or there is insufficient political will to equate marginal costs and benefits, the degree of control is inefficiently low.
Even when the control is optimal, if it is imposed by regulation, the product of the polluting firms will be under-priced because the polluter does not pay for the harm caused by the remaining emissions. Too much of the product will be produced and consumed. If control is sub-optimal the remaining harm will be larger and the under-pricing greater. This pattern of insufficient control and under-pricing is still playing out with respect to air emissions from fossil-fuelled electricity generating units, particularly coal units.
In 2004, after a half century of state and local regulation of air emissions and over three decades of federal regulation, studies showed that reducing air pollution emissions from fossil-fuelled electricity generation units would still give rise to large net benefits, mostly from improved public health. Banzhaf, Burtraw and Palmer (2004, p. 318) estimated optimal US national average effluent charges for sulfur dioxide S[O.sub.2] and nitrogen oxide (N[O.sub.x]) emissions at $3,500/ton and $1,100/ ton respectively, far more than the price of emission allowances in 2004. See Table 1. They estimated that such charges would lead to an 89% reduction of S[O.sub.2], a 70% reduction of N[O.sub.x], and a 5% reduction in carbon dioxide (C[O.sub.2]) nationwide in 2010 compared to a baseline without the charges. These damage values mean that the average US coal plant caused marginal environmental harm worth about $26 per megawatt-hour (MWh). The next year, the US EPA (2005a, p. 2-4) reported that the benefits of its proposed Clean Air Interstate Rule, hereafter CAIR, which will use a cap-and-trade program to reduce utility emissions in 2015 of S[O.sub.2] and N[O.sub.x] by 70% and 60% respectively in 28 eastern states, greatly exceed the total costs. It appears that after decades of regulation emissions will still exceed the optimum.
But if the net benefits of abatement are great, the damage per MWh of electricity generated today must also be great, implying that electricity is significantly under-priced. This will lead to inadequate investment in clean generation and over-consumption of electricity. These are serious concerns when some jurisdictions are struggling to find ways to supply increasing electrical demand and when the new generation plants will last for decades. The under-pricing of electricity will be greatest in regions where population density is high and coal is the dominant power source, such as the states south of the Great Lakes. US studies generally ignore harm caused in Canada by US utility emissions. Neither do they ask how much wholesale electricity is under-priced as a result of the shortfall in regulation.
This paper examines the control of air emissions from fossil-fuelled generating stations in the Great Lakes region of the United States in 2004 and in 2015 after the full effects of the 2005 Clean Air Interstate Rule are felt. We use existing estimates of the marginal harm from air emissions and the emission rates from existing and projected generation facilities to estimate the under-pricing of electricity in five states in both years. We consider the traditional pollutants, sulfur dioxide and nitrogen oxides, plus carbon dioxide. While C[O.sub.2] emissions have yet to be regulated by the United States Congress or the EPA they are increasingly recognized as causing significant future harm and regulation at the state and federal level seems inevitable. We suggest that in our study region wholesale electricity prices fell short of covering full private plus external costs by more than $30/MWh in 2004, two-thirds of the wholesale price in that year. Despite great reductions in forecast N[O.sub.x] and S[O.sub.2] emissions by 2015 the wholesale price of power will still fall short of full costs by over $15/MWh in 2015, or 30%. This enormous under-pricing of electricity must result in over-consumption and inadequate conservation of electricity, a distortion of generation investment incentives and excessive environmental harm.
The reasons are several. First, emission rates for S[O.sub.2] and N[O.sub.x] exceed the rate at which marginal cost equals marginal benefit in this region, even with CAIR. Second, as a direct consequence, electricity prices today include only a fraction of the marginal damage costs from discharging conventional pollutants because pollution allowance prices are far less than marginal damage costs in this region. Third, most studies ignore global warming, yet analyses have suggested benefits from near-term C[O.sub.2] reductions of as much as $10/MWh for coal-fired generation. Fourth, the US analysis ignores any benefits that might accrue in Canada, yet half of the air pollution in southern Ontario blows in from the US. (Yap et al. 2005.) Finally, regulated utility prices do not fully include the opportunity cost of allowances because they are distributed at no cost.
We study states in the ECAR electricity control region, excluding those only fractionally in ECAR. (1) We call these states "ECAR Lite." We answer two questions for coal and gas-fired power plants:
* By how much did the 2004 wholesale price fall short of private plus social cost because of the marginal external harm from criteria pollutants, the Canada adjustment and C[O.sub.2]?
* By how much does the EPA's forecast 2015 wholesale price with the CAIR program fall short of marginal social cost because of the marginal external harm from criteria pollutants, the Canada adjustment and C[O.sub.2], given forecast 2015 emission rates?
We make two comparisons: one for a competitive plant and another for a plant subject to traditional rate regulation. The difference is that the former will fully include allowance prices in its price while the latter will only include them to the extent that their emissions exceed the free distribution of allowances. We use plant-specific generation activity and emissions from actual 2004 data and from the EPA's simulated 2015 CAIR generation and emissions to estimate average emissions by state for coal and gas-fired generation. We then apply damage estimates to calculate the harm caused per MWh of generation by fuel and state. We use a pricing model to calculate the under-pricing of coal and gas-fired electricity by state and the state average under-pricing for both regulated and competitive utilities.
2. EFFICIENT PRICING OF ELECTRICITY
Basic price theory says that when price equals marginal cost (MC), consumer surplus and producer surplus are maximized if there are no externalities. (Varian, 1990, ch. 28; Joskow and Schmalensee, 1983, p. 81.) Where production causes harm to another party, the efficient level of production is achieved if the marginal external cost is added to the marginal private cost to set the price to which the consumer will then equate to her value. (Varian, 1990, ch. 30.) If consumers pay less than this marginal cost, there is a welfare loss arising from excess production. More recently, general equilibrium analyses have shown that existing distorting taxes such as income and sales taxes cause the optimal price of a polluting good to exceed private costs by less than the marginal external harm caused, in some cases much less. (Bovenberg and Goulder, 1996.) General equilibrium analysis is beyond the scope of this paper, so the under-pricing estimated here is overstated to the extent...
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