Environmental Externalities in Electric Power Markets

Acid Rain, Urban Ozone, and Climate Change
Electric power plants that burn fossil fuels emit several pollutants linked to the environmental problems of acid rain, urban ozone, and the possibility of global climate change. Damages caused by those emissions are viewed by many economists as "externalities" and an inefficiency of the market when electric power rates do not reflect, nor ratepayers directly pay, the associated social costs. Until recently, efforts to control power plant emissions have focused on the command-and-control approach of setting standards. More recent efforts, including the Clean Air Act Amendments of 1990, have involved incentive-based measures, such as emissions fees and systems of marketable emissions allowances. A few State regulatory bodies are experimenting with methodologies to "price" environmental externalities and incorporate that cost information in deliberations about least-cost ways to meet projected demand for electric power. The spread of these methodologies could be affected by increased competition in the electricity industry, which would allow electric power customers direct access to a variety of electric power providers.
The central theme of the 1991 National Energy Strategy, developed by the U.S. Department of Energy (DOE), was to secure "a more efficient, less vulnerable, and environmentally sustainable energy future."(2) Also, the Energy Policy Act of 1992(3) (EPACT) required DOE to develop a least-cost national energy strategy that considers the economic, energy, environmental, and social costs of various energy technologies. Many observers argue that this requires incorporating all environmental costs of energy production, including the generation of electric power, in the costs of energy. When these costs are not captured by the marketplace, government involvement at the Federal, State, or local level may be proposed to "internalize" them in electric power prices.

This article discusses the emissions resulting from the generation of electricity by utilities and their role in contributing to the environmental problems of acid rain, urban ozone, and climate change. It then discusses the general concept of environmental externalities and assesses the means that have been devised to ameliorate them. The article analyzes the emissions-control requirements for electric utilities of the Clean Air Act Amendments of 1990 (CAAA) (4) and concludes with a brief examination of State initiatives directed at addressing environmental externalities associated with electric power generation. The article does not purport to analyze all externality costs and benefits associated with electric power generation or suggest what actual externality costs are or should be.

Air Emissions from Electric Power Plants
Pursuant to the provisions of the Clean Air Act of 1970 (5) and its amendments, the Environmental Protection Agency (EPA) identified six common "criteria air pollutants" that are found all over the United States: volatile organic compounds (VOCs), nitrogen oxides (NOx), carbon monoxide (CO), particulate matter less than 10 microns in diameter (PM10), sulfur dioxide (SO2), and lead. These pollutants are all subject to limits established by EPA in the National Ambient Air Quality Standards (NAAQS). Fossil-fired electric power plants emit all (though only trace amounts of lead) as byproducts of electricity generation. Several of these pollutants contribute to acid rain and urban smog, and some may contribute to global climate change.

In addition to the criteria pollutants, many State public utility commissions (PUCs) have been examining carbon dioxide (CO2), methane (CH4), and nitrous oxide (N2O) as well. Those gases are greenhouse gases, which accumulate in the atmosphere, block infrared radiation to outer space, and reradiate the captured heat to the atmosphere. Many scientists believe that the resultant augmentation of the atmosphere's natural warming effect will ultimately change the Earth's climate.