"Second-Best" Adjustments to Externality Estimates in Electricity Planning with Competition
Some public utility commissions use monetary place-holders to reflect externality values in the financial evaluation of utility investments. This approach can be justified as a "second-best" policy tool if existing environmental regulation can be taken as given. This paper addresses two possible unintended consequences of this policy: the effect on the price-marginal cost gap and the potential substitution towards unregulated generation. We compute a "second-best adder" to correct for externalities in electricity planning in three regional case studies using a normative model of economic efficiency. Such adders are found to differ from externality estimates by 10-20 percent or more.
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