Keeping up with Environmental Externality Developments

During the past two years, the term environmental externalities has become increasingly important in energy industries. The economic concept of externalities has been around for a long time, but state requirements that electric utilities factor environmental externalities into plans and decisions are a relatively new development.

State environmental externality requirements applicable to electric utilities are important to organizations in the gas industry because they will affect the market for gas for electric generation, the relative competitiveness of gas and electricity and, potentially, future state requirements applicable to gas utilities.

The INGAA Foundation decided to commission this objective, introductory paper on environmental externality developments to provide a basis for further discussions among organizations in and supportive of the gas industry.

In brief, the paper reviews the underlying economic concepts and the relationship of recent state externality developments to other government efforts to force internalization of externalities, summarizes state Integrated Resource Plan (IRP) requirements for electric utilities which have become the vehicle for considering environmental externalities, explains how externality developments can affect utility decisions and fuel choices, and identifies complex issues raised by state environmental externality requirements.

The paper points out that the fact that some states adopted externality values that were much higher for coal-fired generating units than for gas-fired units may have led some in the gas industry to conclude that commission actions requiring consideration of environmental externalities should be encouraged. However, it may be too early to predict the outcome of state environmental externality efforts or how they will affect the market share of competing energy sources.

The paper also describes important externality developments now underway, identifies key players and interests in externality debates and proceedings, and lists steps the gas industry may want to address in preparing for participation in debates and proceedings.

The analysis underlying this paper leads to the following observations:

1. The underlying objective in recent environmental externality developments is not new and it will not "go away." The underlying economic concept is correct and society can benefit from valid actions to achieve greater internalization of the costs to society of environmental degradation. Furthermore, public opinion-whether or not based on accurate perceptions-is decidedly in favor of reducing environmental degradation.

2. State public utility commission actions to require or encourage regulated electric utilities to take environmental externalities into account have provided a new "lever" to focus attention on a long-standing objective (i.e., increase internalization of external social costs), but the state efforts are one of several levers.

3. State efforts have revealed complex problems, including methodological issues, inadequate scientific data and serious public policy issues, that will have to be confronted.

4. The complex problems will slow public utility commission efforts to take environmental externalities into account, but are unlikely to stop them. Even if the state PUC efforts were slowed or stopped, other federal, state, and local efforts via environmental, health and safety regulations and taxation will continue. Ignoring the matter isn’t an option.

5. There are dangers in the state PUC efforts, as in the case of all efforts with similar objectives, that overall societal benefits will not be increased as much as possible or as efficiently as possible because:

  • a. Requirements may create situations where marginal costs of reducing adverse environmental impact will exceed marginal benefits. For example, damage values could be overstated or the cost of co~~ectimvee asures understated-with the result that electric or gas utilities and their customers would have to spend more than the environmental benefits achieved are really worth; and/or
  • b. Requirements may force attention and spending by utilities and their customers on environmental protection actions that are not, in fact, the highest priority. The Federal government does not now do a good job in prioritizing risk-reduction efforts (i.e., work to reduce the most important risks first). State governments are unlikely to do substantially better.

These dangers are present in most efforts to protect health, safety and the environment.

6. The state PUC efforts are an important experiment in "Federalism" and in the allocation of authority and responsibility among state government agencies. That is, the state PUC actions are tending to put more energy and environmental policy issues on state PUC agendas and to shift responsibility from state environmental and energy agencies to PUCs. The state PUC actions, apart from their direct effects, provide a basis for experimentation with different approaches-compared to Federal requirements imposed nationwide. These effects, themselves, have benefits and costs, depending upon one’s interests. For example:

  • Environmental requirements could differ widely from one state to another.
  • Costs will generally be borne by citizens within the state establishing the requirements but the benefits of reduced adverse environmental effects may not. Depending upon the target (e.g., the particular emissions, discharges or other effects), the benefits may occur within or outside the state boundary.
  • Costs of utilities’ actions are passed through to customers and thus affect the cost of doing business and living within the state establishing the requirements.
  • Control at the state level permits states to take into account interests (e.g., protecting coal mining or oil and gas exploration and production jobs) that may not get equal weight if requirements are established by the Federal government.

7. Environmental externality actions by up to 50 state governments will be more difficult for all interest groups to monitor, compared to actions taken only at the Federal level.

8. Environmental externality actions will increase demands for more and better scientific evidence on relationships between energy activities and environmental damage, and for economic data and analysis to support positions taken by the various parties participating in debates and proceedings.

9. As environmental externality actions become more sophisticated, increased attention is likely to be focused on all aspects of a fuel cycle (i-e., from resource exploration and extraction through end use and waste disposal) rather than being limited to emissions and discharges at the point where energy is used.

10. Actions to take environmental externalities into account will result in "winners" and "losers," compared to the status quo, among producers, transporters, those who convert energy to other products, including electricity, and the ultimate users of energy.

For those without time to review the entire paper, this executive summary is followed by a detailed 3-page table of contents identifying pages where various topics are discussed.

For those who wish to delve directly into the 47-page paper, its basic organization is explained on page 2, immediately following the explanation of the INGAA Foundation’s rationale for commissioning the paper.