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Electricity Generation and Environmental Externalities:
Case Studies

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Executive Summary

Electricity constitutes a critical input in sustaining the Nation’s economic growth and development and the well-being of its inhabitants. However, there are by-products of electricity production that have an undesirable effect on the environment. Most of these are emissions introduced by the combustion of fossil fuels, which accounts for nearly 70 percent of the total electricity generated in the United States.

The environmental impacts (or damages) caused by these emissions are labeled environmental "externalities." Included in the generic term "externality" are benefits or costs resulting as an unintended byproduct of an economic activity that accrue to someone other than the parties involved in the activity.

This report provides an overview of the economic foundation of externalities, the Federal and State regulatory approaches, and case studies of the impacts of the externality policies adopted by three States.


The Federal Role

Since the 1960s, the United States has witnessed a growing concern over the degradation of the environment. This concern resulted in passage of The National Environmental Policy Act (NEPA) of 1969, the first major Federal initiative to protect the environment and to reduce pollution to non-threatening levels. That effort was followed by major laws that address air and water pollution, solid waste recovery, pesticide and toxic substance regulation, resource conservation, noise abatement, endangered species protection, and other areas of concern.

Federal regulations do not, by themselves, provide a prescription for handling externalities in any systematic manner. Rather, the Federal legislative initiatives seek to restrict (or raise the cost of) using the environment as a repository for emissions. Compliance with most Federal environmental requirements results in added costs to the electric utilities. These costs are reflected in the costs of generating power and in the rates that customers pay for buying electricity. Federal actions may, therefore, be seen as a way of incorporating and internalizing externalities.

Recent Federal regulations strive to shift the focus of environmental regulations to market-based approaches with the intent of containing pollution within specified limits. Voluntary cooperation (without any legislative mandate) is also being encouraged. Within the framework of these approaches, energy efficiency, conservation and demand-side management programs all have a role to play.

The State Role

Treatment of externalities at the State level is far from uniform. Recent reports indicate that slightly over half of State utility commissions currently take environmental externalities into consideration in their resource planning process. Of these, only seven States have specified monetary externality values for designated air emissions from power plants.

Among the States that monetize externality values, the general trend is to incorporate them within the framework of the integrated resource planning (IRP) process, which requires the utilities to evaluate supply- and demand-side options on a consistent basis to meet future demand reliably at the lowest system costs.

The three States (Massachusetts, Wisconsin, and California) that were chosen for the case studies presented in this report incorporate monetized externality values within the IRP process. These States were selected for a detailed study due to their proactive involvement in handling externalities. They had regulations in place for at least a few years so as to allow them to have some effect. The selection of these States also provided a diverse regional mix. The objective was to evaluate the impact externality incorporation had on resources selected to meet future needs.

The analysis presented in this report is based on a review of documents available in the public domain from State public utility commissions and electric utilities. In addition, meetings were held with officials at public utility commissions and with officials of the largest investor-owned utility in each of the three States.

Contact:
Suraj Kanhouwa
suraj.kanhouwa@eia.doe.gov
Phone: 202/287-1919