Some Welfare Effects of Emission Allowance Trading in a Twice-Regulated Industry

The 1990 Clean Air Act Amendments establish a national market in emission allowances to dramatically reduce SO2, emissions from electric utilities, who already face economic regulation. Regulatory treatment of allowances will affect the new market. We present simulation results for a simple industry in which two electric utilities face a common Averch-Johnson regulatory constraint and an emissions constraint. In this model the performance of the allowance market depends importantly upon the rate-making treatment of compliance assets by utility regulators. Compared to a command and control scheme, the allowance market substantially reduces the cost of achieving a given environmental standard.