Sulfur Dioxide Control by Electric Utilities : What are the Gains from Trade?

Title IV of the 1990 U.S. Clean Air Act Amendments offers firms facing high marginal costs for pollution abatement the chance to purchase the right to emit sulfur dioxide from firms with lower costs. In the long run such allowance trading may achieve substantial cost savings over an quot;enlightenedquot; command and control program with a uniform emission-rate standard. But in the short run what has lowered costs is technical change and the fall in low-sulfur coal prices.Title IV of the 1990 U.S. Clean Air Act Amendments established a market for transferable sulfur dioxide emission allowances among electric utilities. The market offers firms facing high marginal costs for pollution abatement the opportunity to purchase the right to emit sulfur dioxide from firms with lower costs. It is expected to yield more cost savings than a command and control approach to environmental regulation.To evaluate the performance of the market for sulfur dioxide allowances, Carlson, Burtraw, Cropper, and Palmer use econometrically estimated marginal abatement cost functions for power plants affected by Title IV. They investigate whether the much-heralded fall in the cost of abating sulfur dioxide can be attributed to allowance trading.They find that for plants that use low-sulfur coal to reduce sulfur dioxide emissions, technical change and the fall in low-sulfur coal prices have lowered marginal abatement cost curves by more than half since 1985. And that is the main source of cost reductions rather than trading allowances per se.In the long run, allowance trading may achieve cost savings of $700 million to $800 million a year more than could be expected from an quot;enlightenedquot; command and control program with a uniform emission-rate standard. But comparing potential cost savings in 1995 and 1996 with actual emissions costs suggests that most trading gains were unrealized in the first two years of the program.This paper-a product of Environment and Infrastructure, Development Research Group-is part of a larger effort in the group to examine the successes and failures of environmental regulation as a guide to formulating environmental policy. Maureen Cropper may be contacted at mcropper@worldbank.org