Interactions between energy efficiency and emission trading under the 1990 Clean Air Act Amendments

The 1990 Clean Air Act Amendments affect electric utilities in numerous ways. The feature that probably has received the greatest attention is the provision to let utilities trade emissions of sulfur dioxide (SO2), while at the same time requiring them to reduce S02 emissions in 2000 by an aggregate 43%. The emission trading system was welcomed by many as a way of reducing the cost of reducing emissions, by providing greater flexibility than past approaches. This report examines some of the potential interactions between trading emissions and increasing end-use energy efficiency. The analysis focuses on emission trading in the second phase of the trading program, which begins in 2000. The aggregate effects, calculated by an emission compliance and trading model, turn out to be rather small. Aggressive improvement of end-use efficiency by all utilities might reduce allowance prices by $22/ton (1990 dollars), which is small compared to the reduction that has occurred in the estimates of future allowance prices and when compared to the roughly $400/ton price we estimate as a base case. However, the changes in the allowance market that result are large enough to affect some compliance decisions. If utilities in only a few states improve end-use efficiency aggressively, their actions may not have a large effect on the price of an allowance, but they could alter the demand for allowances and thereby the compliance decisions of utilities in other states. The analysis shows how improving electricity end-use efficiency in some states can cause smaller emission reductions in other states, relative to what would have happened without the improvements. Such a result, while not surprising given the theory behind the emission trading system, is upsetting to people who view emissions, environmental protection, and energy efficiency in moral rather than strictly economic terms