Emissions Trading, Electricity Industry Restructuring and Investment in Pollution Abatement



bilateral contracts, in day ahead markets and through spot markets or "real time"
transactions. Generators submit bids (prices and quantities) that they are willing to
produce; Independent system Operators (ISOs) combine these bids into an aggregate
supply curves and intersect this curve with demand. Energy and reserve markets
clear intermittently throughout the day. Units are dispatched so as to meet load at
least cost, subject to system security, stability and transmission constraints.

Three ISOs operate centralized power markets in the region regulated by the
SIP Call17, all operate as uniform price auctions. For generators operating in these
regions, the extent to which the electricity price they receive will increase to reflect
or track their environmental compliance costs is determined not by a regulator, but
by the wholesale electricity market. The effect of the manager’s choice of rn; on the
average wholesale price she receives per kWh Pn will depend on how the increase in
marginal operating costs affects the position of the nth unit in the order of dispatch.

Whereas firms in more regulated markets can pass a significant portion of variable
and capital compliance costs through to electricity customers, firms in restructured
electricity markets must recover capital and variable compliance costs in the wholesale
spot market or in long term supply contracts that are based on expected spot prices.
This suggests that firms in restructured markets will be more cost sensitive when
making their compliance decision (i.e. the βκ and βv coefficients will be larger in
absolute value), as compared to firms facing similar compliance frontiers who are
subject to rate of return regulation.

In the years leading up to the NOx SIP Call, credit rating changes in the energy
sector were overwhelmingly negative.18 This trend has affected generators operating
in restructured industries disproportionately. While the credit ratings of merchant
energy companies and some companies with a significant degree of non-core activities
have fallen drastically, most regulated utilities have been affected to a far lesser extent

13



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