Utility investment behavior and the emission trading market

Abstract

The Clean Air Act Amendments of 1990 require electric utilities to reduce sulfur dioxide emissions and establishes a system of tradeable emission allowances to achieve this objective. This paper develops a model of utility investment decisionmaking that shows how regulatory rules will affect the utility's incentive to choose among different compliance strategies. The results of the model are extended to the overall market for emission allowances to show how the benefits from trading can be affected by regulatory rules. The analysis provides guidance for public utility regulation that will help achieve the social objective of minimizing the cost of pollution control.