The cost of reducing utility S02 emissions : not as low as you might think

Abstract

A common assertion in public policy discussions is that the cost of achieving the SO2 emissions reductions under the acid rain provisions of the Clean Air Act ("Title IV") has been only one-tenth or less of what Title IV was originally expected to cost. Initial cost estimates are cited in the range of $1000 to $2000 per ton of SO2 reduction and contrasted to SO2 allowance prices of about $100 per ton. Unfortunately, these are "apples-to-oranges" comparisons, leading to erroneous conclusions that greatly overstate the true divergence of actual costs from initial cost estimates. When the facts are viewed in a conceptually appropriate, "apples-to-apples" context, one finds that actual costs for SO2 reductions have been and are likely to remain near the low end of the initial range of estimates.

We all must learn to recognize conceptual pitfalls in these assessments of the SO2 program, to avoid unrealistic expectations of major new regulatory initiatives. For example, many regulatory advocates are now using the erroneous characterization of Title IV costs being one-tenth or less of their originally projected levels to argue that the new market-based regulatory approaches render ex ante cost estimates meaningless or at least much too high. This fundamentally incorrect line of reasoning already has been used to dismiss concern over cost estimates for new regulations, such as the PM2.5 and ozone air quality standards. These and other major policy initiatives deserve to be debated in light of appropriate and realistic assessments of their likely costs. This requires correcting the current misunderstandings about the actual costs of the Title IV SO2 emissions allowance market.

The following paper leads the reader through an interpretation of the facts regarding the estimated and actual costs of the SO2 program. Some of the key points include: (1) Initial cost estimates for the Title IV SO2 program were not over $1000 per ton. (2) Initial cost estimates for a fully-implemented Phase II cap ranged from $225-500 per ton, and costs were projected to be lower than this until the Phase II cap would be fully achieved, about ten years from now. (3) Much confusion has arisen from comparing different cost and price concepts that become important in an allowance trading system, such as average and marginal cost, and the price of an allowance. (4) When a market has a temporary oversupply (which has been true of the SO2 allowance market), spot market allowance prices will fail to reflect the capital cost portion of control costs, which can be a large part of the total costs. (5) The allowance price may reflect future control costs, but regulatory uncertainty may cause future costs to be highly discounted.

The average control cost actually experienced in Phase I has been about $200 per ton. This is within the range that was initially projected. Today's most up-to-date estimates for Phase II (future) average costs are about $185 to $220 per ton. This is at the low end of the initial range of estimates. Allowance prices have been much lower, but we explain how they are consistent with actual average costs of $200 per ton.