Social Costs of Energy

The international conference on the social costs of energy, which is reflected in this volume, concentrated on the social costs of electricity production, although many aspects apply to other areas just as well. The relatively narrow focus of the conference reflects the mainstream of the empirical research conducted so far; it should not be misinterpreted as a value judgement on the relative importance of this specific instance of social costs in market economies.

This report is meant to provide guidance to PUCs and other parties interested in the social costing debate, although it will also yield useful information to those concerned with improving environmental policy in general.

Incorporating environmental considerations including externalities in utility planning and operation is best accomplished by an overall system approach. The approach should balance criteria such as environmental improvement, economics, and reliability of supply. In addition, utilities must also take into account thresholds for health, safety, and other significant factors.

New England Electric System companies have incorporated this balanced approach in its strategic long-range plan, NEESPLAN 3—Environment, Economy, and Energy for the 1990’s. NEESPLAN 3 sets forth specific, balanced goals for improving the environment, controlling the cost of electricity, and maintaining a reliable energy supply.

Processes now used to estimate the cost of “environmental damage” should continue to be evaluated as a component of cost-benefit analyses. Information from such evaluations may provide useful data to influence new and revised environmental laws and regulations. The appropriate role for utility rate regulators is to insure that utilities anticipate the potential for such changes and factor them into their resource plans.

The increased attention towards the identification and quantification of external costs of energy use is justified for several reasons. Firstly, economic science provides well-founded arguments to internalise externalities in pricing and decision making. Secondly, a number of countries have already started to develop and/or implement certain policy instruments to do so. Thirdly, there are both in the E.C. and in the U.S. legal requirements to take account of externalities in decision and policy making.

Should utility companies incorporate environmental externalities in their planning and operations? Of course they should, so long as our society has failed to fully internalize the impact of power plants and energy distribution facilities.

This paper discusses the general reluctance towards internalizing external costs. It thus focuses on a phenomenon of economic irrationalism. Those who have set out to stabilize on a sustainable basis the very foundations of economic and social life must brace themselves for a good deal of irrationalism.

The purpose of this paper is to share some insights from an ongoing study of fuel cycle externalities. The fuel cycles being studied involve the use of coal, biomass, oil, hydro, natural gas, uranium, wind, and photovoltaic sources to generate electric power. Conservation options are also to be addressed.

(1) The energy sector is a key area of any modern economy. Our material prosperity depends to a decisive extent on the energy-supply situation. The availability of energy is one of the most important prerequisites for nearly all industrial production processes.

In estimating environmental damages of fuel cycles, one would ideally like to start with the basic relationship between the energy outputs and the environmental impacts, as shown in Figure 1. In doing this there may be one or more stages, as for example is the case with air pollutants, where the energy source generates emissions and these emissions in turn impact on the environment depending on how they are deposited spatially. The method of estimating the energy-environment relationship is referred to as the dose-response function, which can be fairly simple (linking the pollutant — eg SO₂ to the measured variable of interest — eg. no of work days lost work day); or very complex, with the dependent variable being the probability of losing a work day, as a function of age, occupation, pollution levels of more than one pollutant, relative humidity etc. The next step is to value the impacts, using price and market data and this stage can also range from the simple direct valuation to a very complex model that allows for all the inter-linkages between markets and changes in prices.

The work described in this paper forms part of the collaborative project between Directorate General XII of the Commission of the European Community and the United States Department of Energy to assess the external costs of fuel cycles. A partial evaluation of the damages to agricultural crops arising from the operation of a new coal fired power station is presented to demonstrate the project methodology. This involves the use of a damage function approach to allow impacts to be expressed on a marginal basis, suitable for use in energy planning analysis. The methodology is thus different to that used in other studies in which externalities have been calculated from estimates of national damages and aggregated measures of polluting activities^{1 2}.

Estimating the risk of a nuclear meltdown is one of the most delicate problems associated with the monetary valuation of external effects. The relationship between the incredible damage potential of such an accident and its exceedingly small probability is extreme. Experts differ greatly in their evaluation of nuclear energy rating it between being the safest or the most dangerous form of energy production depending upon whether the emphasis is put upon the probability of an accident or upon the the damage potential.

The generation of electricity is generally known as a major source of environmental pollution. This applies not only to conventional energy systems but also to some extent to renewable energy technologies, if one considers the complete life-cycle of these technologies. During the various stages of the life-cycle of each given technology, which include fuel extraction, preparation, transport, conversion, operation, distribution, utilisation, waste processing and disposal, emissions are generated and dispersed into the environment, thereby imposing a burden on living systems and items of value to human society. These burdens, in turn, have an impact on the physical and biological environment as well as on human health and life. As these impacts impose significant costs on society, decisions concerning energy planning and the selection of energy systems ought to be based on a comparative analysis of various energy technologies and their “upstream” and “downstream” activities.

The evaluation and enumeration of external costs of energy consumption has gained increasing interest in recent years, since it has become obvious that a variety of environmental and societal damages are caused by the energy system. As long as these external costs are not included into the prices of energy, market mechanisms will never tend to reach the optimal structure of the energy system: offering the energy with minimum overall costs.

Public interest requires electric utilities to have a social obligation beyond the mere provision of electricity. As an example, the New York State Legislature recently passed (August 1992) an energy bill that establishes an integrated resource planning process to provide guidance to State electric utilities for procuring future electricity resources. It calls upon the State’s investor owned utilities to consider all options and “select the source or sources which best serve the public interest, taking into consideration such factors as … preservation or creation of economic opportunities, …”¹ before purchasing power, investing in new plants, or repowering or extending the life of existing plants. To this extent, economic development has become an important consideration in the procurement of electricity resources.²

The neglect of environmental damage and other external effects when deciding about investments in the field of electricity supply may cause wrong allocations of resources. A first step to avoid such misallocations is the quantification and monetizing of the external effects. Once the external costs are known, optimal decisions resp. optimal energy supply systems can be identified.

Internalizing the environmental costs imposed on society by polluters is the wave of the future in addressing environmental degradation. By signalling to industry the true societal costs of their operations, inclusion of environmental costs in the price of goods produced gives an economic incentive to industry to reduce pollution. This can be an important supplement to regulation.

The recent amendments to the Clean Air Act will drastically reduce emissions of criteria pollutants regulated under National Ambient Air Quality Standards (SO_xNO_x, CO, Ozone, PM & Lead). As of yet, emissions of CO₂, considered to be the major cause of global warming problem, are not covered under the Clean Air Act, thus are not required to be controlled. However, given that international pressure is mounting to limit emissions of CO₂, their control has become the focus of attention at both national and state levels.

The business of electric power generation which was once the nearly exclusive domain of investor owned and public utilities is now open to a more diverse group of participants on a competitive basis. The passage of the Public Utility Regulatory Policies Act (PURPA) in 1978 was instrumental in cracking the utility monopoly and opening opportunities for diverse forms of electric generation by independent power producers (IPPs). One of the purposes of PURPA is to reduce dependence on fossil fuels through the use of renewable energy resources and more efficient use of non renewable resources which were not a significant part of the utility resource mix. To achieve its objective, the PURPA required the utilities to purchase power from certain IPPs at a price equal to the utility’s avoided cost--the levelized life-time cost in cents/kwh that the utility would incur if it had to produce the energy itself. The price offered by the utilities for power purchases from the IPPs and its own customers is labeled as the “buy back rate” in utility jargon.

Utility regulators have been expanding the range of costs included in evaluating utility decisions such as the selection of new supply sources or the analysis of conservation programs. In addition to known direct costs to the utilities, regulators are including various allowances for risks and for environmental and economic externalities. Considerable controversy has arisen regarding the inclusion of environmental externalities and the specific methods used in setting externality values.

With growing acceptance of the need for preventative action, the international debate on greenhouse policies has shifted from scientific issues to economic questions. Broadly speaking, proposals for incorporating global warming externalities move along the same lines as the debate over other environmental externalities—valuation-based price signals (monetized surcharges or carbon taxes) versus quantity constraints (emission caps or reduction targets). However, the global warming issue has produced specific forms of these alternative approaches. Most important for the current discussion are the so-called insurance buying approach (Krause et al. 1989) and the “no (economic) regrets” approach.

In the past, consideration of environmental and social impacts of electricity generation were often confined to the Environmental Impact Statement (EIS) and siting processes and focused upon the existence of impacts, mitigation strategies and costs, and whether acceptable levels of externalities could be reached to allow operation of a facility in a selected location. Today, the emphasis has expanded to quantify the social value (damage) of externalities that may remain even after siting regulations are met. Resource selection decisions are then based upon total social costs rather than just financial costs.

As the environmental movement has gradually accepted the use of economic incentives as a means of accomplishing environmental goals, the question of which incentives should be employed is arising more frequently. In recent years, we have witnessed controversies — often counterproductive from an environmental perspective —— concerning which economic instruments constitute correct environmental policy. There is a need for environmentalists to take stock, in a rational and dispassionate manner, of the alternative economic instruments which are available. The intent here is to outline the pluses and minuses of these instruments as regards their ability to deliver environmental protection. The following charts summarize the assets and liabilities of each policy as discussed in the paper.

Regulators in the Los Angeles Air Basin in California are developing an emissions trading program that provides a far better means of internalizing utility externalities in utility resource planning than the approach now being developed by Public Utility Commissions (PUCs) in many states. PUCs in at least 29 states have reportedly either adopted or considered requiring “environmental adders” to reflect the social costs from power plants that remain after environmental controls are in place.

We are witnessing a major transition in public policy regarding economics, the environment and human well-being. Appropriately enough, it has come at the onset of a new century, indeed millennium. Despite the groundwork laid before us, and that being laid today, we expect that our counterparts and the world’s citizens decades from now will recognize some but not all of the methods and approaches developed today, and hope they will look back with some kindness upon our modest beginnings.

Beside the environmental and health damages caused by the use of conventional energy sources, which have been discussed under the heading of external or social costs at length during the conference so far, there seems to be another fundamental problem, which most likely is not dealt with adequately by the energy markets. It is the problem of long term scarcity of non renewable resources of the planet earth being exhausted at an ever increasing rate.