The Welfare Impacts of Restructuring and Environmental Regulatory Reform in the Electric Power Sector

The American electric power industry is undergoing dramatic changes in the way it is structured and regulated. As of September of 1998, state utility regulators, state legislatures or both in 18 states had made the decision to implement retail competition within 5 years or less. Competition in electricity markets and associated new opportunities for expanded inter-regional electricity trading could result in substantial changes in the mix of generation technologies employed to produce electricity, in the efficiency of power plant operations, and in the price and quantity of electricity traded in the marketplace. This study evaluates potential retail competition and proposed new regulations to reduce NOX emissions. We present estimates of changes in economic welfare resulting from projected changes for the year 2003 in electricity consumption and generation and associated environmental effects. We find that retail restructuring would produce customer and producer surplus benefits that substantially outweigh health damages from the slight increases in NOX emissions. On the other hand, NOX emission reductions enforced under an average cost pricing scenario (traditional cost of service regulation absent retail competition) would lead to customer and producer surplus losses that are only slightly less than their environmental benefits. The NOX emission reductions are less costly in terms of foregone customer and producer surplus when initiated in a restructured electricity industry. In this institutional setting, the additional effect of policies enforcing NOX reductions is positive and substantial. Hence, we find retail restructuring has potentially important positive environmental benefits because it improves the affordability of NOX emission reductions. Finally, we find that allowing NOX trading, as opposed to uniform performance standards, can lead to a $200 million increase in consumer and producer surplus in electricity markets with virtually no change in aggregate health related benefits. Ψ The authors are grateful to the U.S. Department of Energy, the U.S. Environmental Protection Agency, and the State of Maryland Department of Natural Resources for support of this project. Also, the authors are indebted to Cary Bloyd, Martin Heintzelman and Evelyn Wright for technical assistance, and to Lumina Decision Systems for modeling assistance. Burtraw, Palmer and Paul October, 1998 2