Emissions Trading, Electricity Industry Restructuring, and
Investment in Pollution Abatement
Meredith Fowlie1
June 2005
The NOx State Implementation Plan Call was designed to facilitate
cost effective reductions of nitrogen oxides emissions from large station-
ary sources (primarily electricity generators) through the introduction of
an emissions trading program. I investigate the relationship between eco-
nomic regulation and firms ’ long-run response to the incentives created by
this emissions trading program. I estimate a discrete choice model of the
firm’s compliance decision, controlling for unit-level variation in compli-
ance costs and using exogenous variation in state-level electricity industry
restructuring activity to identify an effect of electricity market regulation
on generators’ environmental compliance strategy choices. I present evi-
dence that differences in economic regulation across states have resulted in
a disproportionate amount of the mandated emissions reductions occurring
in more regulated electricity markets. Unfortunately, these are the areas
least in need of pollution control.
Emissions trading programs have become the preferred alternative to more tradi-
tional, prescriptive approaches to regulating point source emissions in the United
States. Currently, all of the major emissions markets are "emissions based": a permit
can be used to offset a unit of pollution, regardless of where the unit is emitted. This
presumes that the health and environmental damages resulting from the permitted
emissions are independent of where in the regulated region the emissions occur. A
growing body of scientific evidence indicates that this assumption is inappropriate in
the case of nitrogen oxides and mercury, two pollutants that have recently been regu-
lated under "cap and trade" (CAT) programs (Hubbard Brook Research Foundation,
Mauzerall et al..).
The vast majority of the emissions currently regulated under CAT programs
come from electricity generators.2 Asymmetries in state electricity industry regula-