Policy Uncertainty in the Market for Coal Electricity: The Case of Air Toxics Standards

Uncertainty over government policy affects important and irreversible decisions, including firm technology adoption, entry, and exit. The real options literature has found that higher outcome variance may delay irreversible decisions. This paper considers the effect of changes in the timing of uncertainty resolution surrounding the Mercury and Air Toxics Standard (MATS). We estimate a dynamic oligopoly model of technology adoption and exit for coal-fired electricity generators that recovers generators' beliefs regarding future MATS enforcement. We develop a computationally tractable equilibrium concept called Approximate Belief Oligopoly Equilibrium in which all players make decisions incorporating their impact on a reduced set of market states. Generators subject to MATS experienced substantial policy uncertainty: the perceived enforcement probability was as low as 43%. Resolving policy uncertainty early increases expected discounted generator profits by $0.930 billion, but increases pollution by $0.809 to $2.206 billion. Resolving uncertainty early attenuates extreme outcomes in expectation, in this case reducing expected exit.