Electricity Restructuring and Air Quality: Uncertain Technological, Economic, and Policy Changes Make the Likelihood of Environmental Deterioration Hard to Gauge in the Wake of Deregulation

By Parker, Larry B.; Blodgett, John E. | Forum for Applied Research and Public Policy, Fall 2001 | Go to article overview

Electricity Restructuring and Air Quality: Uncertain Technological, Economic, and Policy Changes Make the Likelihood of Environmental Deterioration Hard to Gauge in the Wake of Deregulation


Parker, Larry B., Blodgett, John E., Forum for Applied Research and Public Policy


After decades of operating in a regulated market, the electric utility industry is undergoing significant change, both from new generating and transmission technology and from shifting policy perspectives with respect to competition and regulation.

The advent of new technologies, particularly natural-gas-fired combined cycle, has lowered entry barriers to competitors of traditional utilities; it has also lowered the marginal costs of those competitors below the costs of some traditional utilities. Technological advances have been combined with policy initiatives, such as the Energy Policy Act of 1992 and state retail competition initiatives, to encourage the introduction of competitive forces into the electric generating sector.

There is a growing belief that the rationale for economic regulation of electric utilities at the federal and state levels-that electric utilities are natural monopolies (1)--is being overtaken by events, and that market forces can and should replace some of the current regulatory structure. Regulation and rate-of-return rate making--in which a regulatory body allows the utility to obtain a guaranteed rate of return on investment in return for meeting the electricity demand of its franchised service area--arguably exist as a partial substitute for the marketplace. (2) With emerging new generating and transmission technologies, market forces are increasingly seen as able to replace government regulation in many instances.

In most cases, electric utility industry functions--generation, transmission, and distribution--have traditionally been integrated, or bundled. Current efforts to increase competition in the industry have involved segmenting these functions in terms of both corporate and rate structures. The overall purpose of restructuring the industry is to promote economic efficiency, which will presumably lead to lower overall rates.

Some argue that this market orientation could sacrifice other values the regulatory system traditionally has balanced against economic efficiency, particularly equity and environmental considerations. The new economic signals being given by a competitive generation market could result in increased emissions of undesirable pollutants for two basic reasons.

* Lower or more volatile prices from restructuring could encourage utilities to contain risk through incrementally investing in existing facilities rather than in construction of new capacity that meets stringent air emissions standards.

* A competitive market would encourage comparing the market value of existing facilities with the marginal cost of constructing new capacity; making older facilities more valuable than they were under a cost-of-service regulatory scheme.

Both signals would result in the rehabilitation and full use of older, more polluting generating facilities.

Front Coal to Gas

Some cost studies indicate that the lion's share of cost savings from restructuring the electric utility industry would come from the increased use of existing coal-fired capacity; which is disproportionately more polluting than alternative sources of power. (3) If that is true, the need to construct new, cleaner generating capacity could be delayed by restructuring, as production from existing capacity is maximized. How much emissions might increase would depend on which facilities generate the additional power and on controls imposed by existing or prospective Clean Air Act requirements.

The general scenario goes as follows. A competitive generating sector would result in a revaluation of generating assets--that is, moving the value of generating capacity toward the marginal cost of constructing new capacity, currently represented generally by a natural-gas-fired, combined-cycle facility. In general, older facilities that have been fully depreciated would tend to have market values greater than their current book value under regulation; in contrast, newer, capital intensive facilities, such as some nuclear plants, would have market values less than their current book value--depending on location, availability of alternatives, and electricity demand.

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