Optimal "Adders" for Environmental Damage by Public Utilities

Social costing" refers to the consideration of environmental damages and other external costs and benefits in resource planning or dispatch decisions by electric utilities. Typically, utility regulators must take existing regulations promulgated by other levels of government as parametric, so social costing represents a second layer of regulatory review with regard to many issues. The consideration of external costs at the level of utility regulation will have efficiency implications that are not obvious. For example, the practice is particularly contentious when it is believed that industry emissions of a pollutant are "overcontrolled," in that they are subject to an emission limitation more stringent than what would be considered economically efficient. Within a simple but fairly general normative model, this paper presents some simple analytics for the consideration of social costs in utility decision making, assuming the objective of the regulator is to maximize social welfare. The efficient policy depends on the institutional characteristics of preexisting regulation. The role of deviations from marginal cost pricing in electricity pricing and the possibility of customer bypass of the utility grid are explicitly modeled.