Regulatory Tailoring, Reliability, and Price Volatility with Stochastic Breakdowns

Although real-world energy supply systems are subject to stochastic failures, the impacts of proposed regulations affecting these systems have typically been evaluated using non-stochastic models. This paper develops an energy market model that explicitly allows for stochastic failures and demonstrates they play an important, or even dominant, role in determining the market impacts of environmental regulations that tailor product specifications to address local or regional conditions, such as fuel-formulation requirements specific to certain regional markets within the United States. While traditional non-stochastic analyses view the tailoring of regulatory requirements by location as an efficiency-enhancing alternative to a -one size fits all- regulatory approach, they fail to consider the adverse impact on reliability in all market segments resulting from the loss of product fungibility due to tailoring. We show that regulatory impact estimates developed without explicit consideration of reliability considerations may be highly inaccurate.