An analysis of SO sub 2 emission compliance under the 1990 Clean Air Act Amendments

The effectiveness of SO{sub 2} emission allowance trading under Title 4 of the 1990 Amendments to the Clean Air Act (CAA) is of great interest due to the innovative nature of this market incentive approach. However, it may be a mistake to frame the compliance problem for a utility as a decision to trade or not. Trading of allowances should be the consequence, not the decision. The two meaningful decision variables for a utility are the control approaches chosen for its units and the amount of allowances to hold in its portfolio of assets for the future. The number allowances to be bought or sold (i.e. traded) is determined by the emission reduction and banking decisions. Our preferred approach is to think of the problem in terms of ABC's of the 1990 CAA Amendments: abatement strategy, banking, and cost competitiveness. The implications of the general principles presented in this paper on least cost emission reductions and emissions banking to hedge against risk are being simulated with version 2 of the ARGUS model representing the electric utility sector and regional coal supplies and transportation rates. A rational expectations forecast for allowances prices is being computed. The computed allowance price path has the property that demand for allowances by electric utilities for current use or for banking must equal the supply of allowances issued by the federal government or provided as forward market contracts in private market transactions involving non-utility speculators. From this rational expectations equilibrium forecast, uncertainties are being explored using sensitivity tests. Some of the key issues are the amount of scrubbing and when it is economical to install it, the amount of coal switching and how much low sulfur coal premiums will be bid up; and the amount of emission trading within utilities and among different utilities.