The Massachusetts Department of Public Utilities (MDPU), is the body charged with the responsibility for regulating rates and quality of service of public utilities in the state. This includes its Electric Power Division, which regulates electric utilities comprising of eight investor owned electric companies.
The MDPU is currently faced with the challenge of prescribing the best approach to valuing the environmental impact
(externality) to be considered during the selection of new power generation sources by electric companies.
Two approaches have been proposed:
1. The implied valuation approach- This uses the marginal cost of pollution control, imposed by regulators as a proxy for estimating the externality. 2. The damage valuation approach- This approach calculates the actual damages caused by residual emissions of pollutants.
The MDPU had prescribed the implied valuation approach, but is revisiting the decision due to criticisms by some of the utility companies. This paper analyses the two approaches against key criteria necessary to achieve the MDPU’s objectives, and recommends the most suitable approach.
Recommendation
The MDPU is advised to consider the implied valuation methodology
Evaluation of Alternatives
Option 1: Damage Valuation
This involves a direct assessment and quantification of damages caused by residual emissions. This methodology assesses the marginal benefit of the abatement of pollution.
Pros
• Most preferred method by the industry participants. • It is the MDPU’s methodology of choice
• It is tougher to abuse the damage valuation approach than the implied valuation approach.
• It assigns a much lower cost to environmental externalities thus meeting the MDPU’s objective of providing affordable electricity to ratepayers.
Cons
• The estimation process can be a large and complex task, fraught with uncertainty and omissions.
• It is complicated and subjective as it is not always easy to quantify long term effects of pollution.
• There are some unquantifiable damages: premature human death, respiratory problem, loss of species etc..
• The estimation of the impact is almost a guess work as the proponents came up with differing wide range of values
• There was no basis for some of the assumptions made i.e. discount rate.