Electric Utility Response to Allowances: From Autarkic to Market-Based Compliance

A. Denny Ellerman


Allowances are a central feature of Title IV; and, from the time Title IV was enacted, there has been concern about how rate-regulated electric utilities would make use of this novel instrument for achieving environmental goals. In particular, many questioned whether utilitieswould use allowances in a manner that would achieve the cost savings associated with emissions trading. There is, in fact, no requirement to trade allowances. If they wished to do so, utilities could treat allowances simply as non-tradable permits and reduce emissions to match the allocation to each unit. That utilities have not done so is one of the most important facts about electric utility use of allowances in Phase I.

Still, the way that electric utilities have made use of allowances has changed significantly from the early years of Phase I compliance planning to the present. The central feature of this change is the relation of internal compliance decisions to the external allowance market; and that change can be characterized as a movement from autarkic to market-based compliance. Like all attempts to categorize human activity, there are exceptions and the change is uneven, but the main outlines persist. This evolution in electric utilities’ use of allowances helps to explain what are otherwise puzzling phenomena in Phase I, and it also reveals what may be viewed as one of the most attractive features of allowances, the ability to mitigate the cost of mistakes.