Markets, Externalities, and the Federal Power Act : The Federal Energy Regulatory Commission’s Authority to Price Carbon Dioxide Emissions

Carbon dioxide (CO2) emissions impose a significant cost on society by contributing to climate change. The electricity sector is a major source of these emissions, yet their external cost is not fully reflected in electricity rates, and the market outcomes thus do not adjust to reflect those true costs—a classic market failure. This leads to emissions that are higher than optimal. Under the Federal Power Act (FPA), the Federal Energy Regulatory Commission (FERC) is tasked with ensuring that interstate wholesale electricity rates are “just and reasonable.” Given the severity of the damages caused by the failure to internalize the CO2 externality, it is crucial to understand whether the external cost of that negative externality can be included in wholesale rates.This Article examines how FERC has embraced market efficiency as the key tool for ensuring just and reasonable rates and has addressed all of the standard market failures that would otherwise distort the efficiency of prices: market power, asymmetric information, public goods, and externalities. The Article then shows that any economically rational effort to achieve an efficient market must attempt to address the external cost of CO2 emissions as well. This Article argues that, from an economic perspective, FERC’s authority to pursue market efficiency should extend to either approving utility plans to internalize those external costs or to set a carbon price, just as it extends to other market failures.FERC’s authority in this area has its limits. Under the FPA’s just and reasonable mandate, FERC has authority to address only the market failures that are directly related to wholesale electricity rates. In addition, FERC cannot act without evidentiary support or act directly to interfere in state-level generation mix choices. But seen from an economic perspective, there should be no impediment to FERC taking action to internalize the direct costs of greenhouse gas emissions—whether through approval of a utility’s plan to take those costs into account or through a market correction issued by FERC itself