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  An Introduction to Climate Change Legislation


The Electricity Sector and Climate Policy

Karen L. Palmer and Dallas Burtraw


The electricity sector is the most prominent target for climate policy because it is the largest single source of carbon dioxide (CO2) emissions and of potential CO2 emissions reductions in the United States. Moreover, because electric power generators are among the largest point sources of important air pollutants such as sulfur dioxide (SO2), nitrogen oxides (NOx), and mercury, the industry has been extensively regulated in the past. An economy-wide climate policy will achieve emissions reductions at least cost, but advocates of an electricity-focused policy believe it could serve as a bridge to -or component of - a broader policy. State governments have moved ahead of the federal government in adopting various climate-related policies that affect the electricity sector, some of which may complement and some of which may conflict with a future federal policy.

IB 11
The Electricity Sector and Climate Policy

  • One of the major challenges of designing a federal cap-and-trade system for greenhouse gas (GHG) emissions is addressing the heterogeneous way such a system would affect electricity producers and consumers across the country. This heterogeneity arises from regional differences in the way electricity is regulated and in the fuels used for electricity generation.

  • In states with market-determined prices, free allowance allocation to emitting companies can deliver net gains to companies and provide little relief to customers.

  • In states under cost-of-service regulation, free allowance allocation is likely to produce essentially the opposite result: providing benefits to customers with little net financial impact on companies.

  • In general, the electricity industry should be able to pass through a large fraction of the cost of emissions reductions by charging consumers higher prices for electricity. At the sector level, only a small share of allowances created by a cap-and-trade policy would need to be distributed for free to incumbent generators to preserve the market value of the industry's portfolio of existing assets - this point being most relevant for market-based generators. At the level of an individual firm, however, the effects of a mandatory climate policy on the market value of existing assets can be more severe.

  • Technology standards, performance standards, and programs to increase energy efficiency are thought to be less cost-effective, from a broad economic perspective, than emissions caps (or taxes) as a means of reducing CO2 emissions. Nonetheless, these other policies may be justified as ways to address a market-failure. If CO2 emissions are capped, a key effect of these other policies would be to reduce the demand for, and therefore the price of, CO2 emissions allowances; but they would not produce additional emissions reductions below the cap.


