For: Edison E lectric Institute 701 Pennsylvania Avenue, Washington, 20004

By: Energy Research Group, Inc. 400 Fifth Avenue Waltham, 02154


### JULY 1 For: Edison Electric Institute 701 Pennsylvania Avenue, NW Washington, DC 20004



### By: Energy Research Group, Inc. 400 Fifth Avenue Waltham, MA 02154



### JULY 1992LIST OF TESTIMONY SUMMARIES

A. James Barnes Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131 ........................................ 1 Stephen S. Bernow Wisconsin Public Service Commission, Docket No. 05-EP-6 ................ 5 Shepard C. Buchanan Wisconsin Public Service Commission, Docket No. 05-EP-6 ............... 11 Emily J. Caverhill Illinois Commerce Commission, ICC Docket No. 91-0050 ................ 15 Marc W. Goldsmith Illinois Commerce Commission, ICC Docket No. 91-0050 ........
........ 18 Alfred E. Kahn Florida Public Service Commission, Docket No. 910883-EI ............... 22 Robert H. Koppe Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131 ....................................... 25 Lester B. Lave Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131 ....................................... 28 Richard K. Lester Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131 ....................................... 32 Karl J. Nalepa Public Utility Commission of Texas, Docket No. 10400 .................. 38 William D. Nordhaus Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131 ........................................ 41 LIST OF TESTIMONY SUMMARIES

A. James Barnes Massachusetts Department ofPublic Utilities Docket No. D.P.U. 91-131
........................................ 1 Stephen S. Bernow Wisconsin Public Service Commission, Docket No. 05-EP-6
................ 5 Shepard C. Buchanan Wisconsin Public Service Commission, Docket No. 05-EP-6
............... 11 Emily J. Caverhill Illinois Commerce Commission, ICC Docket No. 91-0050
................ 15 Marc W. Goldsmith Illinois Commerce Commission, ICC Docket No. 91-00,50
................ 18 Alfred E. Kahn Florida Public Service Commission, Docket No. 910883-EI
............... 22 Robert H. Koppe Massachusetts Department ofPublic Utilities Docket No. D.P.U. 91-131
..........'
............................. 25 Lester B. Lave Massachusetts Department ofPublic Utilities Docket No. D.P.U. 91-131
....................................... 28 Richard K. Lester Massachusetts Department ofPublic Utilities Docket No. D.P.U. 91-131
....................................... 32 Karl J. Nalepa Public Utility Commission ofTexas, Docket No. 10400 ., ................ 38 William D. Nordhaus Massachusetts Department ofPublic Utilities Docket No. D.P.U. 91-131 . '
...................................... 41LIST OF TESTIMONY SUMMARIES (Continued)

Robert D. Rowe Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131 ....................................... 44 Larry E. Ruff Delaware Public Service Commission, Docket No. 29 ................... 52 Gayatri M. Schilberg & William B. Marcus California Energy Commission, Docket No. 88-ER-8 .................... 55 Richard L. Schmalensee Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131 ....................................... 59 Southern California Edison Company California Energy Commission, Docket No. 90-ER-92 ................... 64 William L. Stillinger Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131 ....................................... 70 U.S. Department of Energy Texas Public Service Commission, Project No. 10780 ... ................ 73 Robert D. Rowe LIST OF TESTIMONY SUMMARIES (Continued)

Massachusetts Department ofPublic Utilities Docket No. D.P.U. 91-131
....................................... 44 Larry E. Ruff Delaware Public Service Commission, Docket No. 29
................... 52 Gayatri M. Schilberg & William B. Marcus California Energy Commission, Docket No. 88-ER-8
.................... 55 Richard L. Schmalensee Massachusetts Department ofPublic Utilities Docket No. D.P.U. 91-131
....................................... 59 Southern California Edison Company California Energy Commission, Docket No. 90-ER-92
................... 64 William L. Stillinger Massachusetts Department ofPublic Utilities Docket No. D.P.U. 91-131
....................................... 70 U.S. Department ofEnergy Texas Public Service Commission, Project No. 10780
................... 73A. JAMES BARNES School of Public and Environmental Affairs

SPEA Room 300 Indiana University Bloomington, Indiana 47405

PROFILE Mr. Barnes is Dean of the School of Public and Environmental Affairs and Professor of Public Environmental Affairs at Indiana University. He also serves as Special Counsel to the Washington, D.C. law firm of Beveridge & Diamond. A graduate of Harvard Law School, Mr. Barnes held senior positions in the U.S. Environmental Protection Agency (EPA) including Deputy Administrator, General Counsel and Chief of Staff. From 1970 to 1973, he participated in the establishment of the EPA as an assistant to the first Administrator.
TESTIMONY REFERENCED "Testimony of A. James Barnes on Behalf of Massachusetts Electric Company, Western Massachusetts Electric Company and Boston Edison Company in the Investigation by the Department on its Own Motion as to the Environmental Externality Values to be Used in Resource Cost-Effectiveness Tests by Electric Companies Subject to the Department's Jurisdiction," Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131, October 4, 1991.
STATE REGULATORY ISSUE ADDRESSED The Massachusetts Department of Public Utilities (D.P.U.) is re-examining the monetized environmental externality values for eight air pollutants (CO2, CH4, CO, N2O, NON, SO2, TSPs and VOCs) that are to be incorporated into the electric utility IRM process under its Order on Integrated Resource Management (D.P.U. Order 89-239).
SUMMARY OF CONCLUSIONS Mr. Barnes states that the specific assumption concerning the development of environmental regulations used by the Tellus Institute in deriving the environmental externality costs adopted by the Massachusetts D.P.U. is wrong. He concludes that the, highest cost of control methodology used by Tellus does not reveal the value that environmental regulators place on reducing residual emissions. This theory "is patently inconsistent with the history and practice of environmental regulation in the United States" [p. 34]. Furthermore, D.P.U.

1 PROFILE A. JAMES BARNES School ofPublic and Environmental Affairs SPEA Room 300 Indiana University Bloomington, Indiana 47405

Mr. Barnes is Dean of the School of Public and Environmental Affairs and Professor of Public Environmental Affairs at Indiana University. He also serves as Special Counsel to the Washington, D.C. law firm of Beveridge & Diamond. A graduate of Harvard Law School, Mr. Barnes held senior positions in the U.S. Environmental Protection Agency (EPA) including DeputyAdministrator, General Counsel and ChiefofStaff. From 1970 to 1973, he participated in the establishment of the EPA as an assistant to the first Administrator.
TESTIMONY REFERENCED IITestimony of A. James Barnes on Behalf of Massa'chusetts Electric Company, Western Massachusetts Electric Company and Boston Edison Company in the Investigation by the Department on its Own Motion as to the Environmental Externality Values to be Used in Resource Cost-Effectiveness Tests by Electric Companies Subject to the Department's Jurisdiction,1I Massachusetts Department of Public Utilities Docket No; D.P.U. 91-131, October 4, 1991. '
STATE REGULATORY ISSUE ADDRESSED The Massachusetts Department of Public Utilities (D.P.U.) is re-examining the monetized environmental externality values for eight air pollutants (C02 , CH4, CO, N20, NOx , S02' TSPs and VOCs) that are to be incorporated into the electric utility IRMprocess under its Order on Integrated Resource Management (D.P.U. Order 89-239).
SUMMARY OF CONCLUSIONS Mr.Barnes states thatthe specific assumption concerningthe development ofenvironmental regulations used by the Tellus Institute in deriving the environmental externality costs adopted by the Massachusetts D.P.U. is wrong. He concludes that the highest cost of control methodology usedby Tellus does not reveal the value that environmental regulators place on reducing residual emissions. This theory lIis patently inconsistent with the history andpractice ofenvironmentalregulationin the UnitedStates" [po 34]. Furthermore, D.P.U.

1regulations governing externalities must be compatible with federal environmental

regulations.
ISSUES The following issues concerning environmental externalities were raised in the direct testimony of Professor Barnes. Page citations directly follow all direct quotations from this testimony. Environmental Externality Policy Options "The predominate approach to environmental regulation in this country is command and control" [p.4]. However, the regulations reflect a number of requirements (e.g., desired ambient conditions, technology-based or technology-forcing requirements), a number of distinctions (e.g., existing versus new sources, categories of sources and geographic differences) and a series of political decisions. Consequently, there is "great variability in the extent to which individual sources are controlled and in the costs entailed in meeting the limitation to which they are subject" [p.5]. There are two major federal laws that impose significant environmental requirements on electric generating facilities. Clean Air Act, enacted in 1970 and amended in 1977 and 1990, provides a comprehensive approach to ambient air quality. The key elements of the federal legislation are summarized. National ambient air quality standards (NAAQS) are designed to protect the public health and welfare at levels that provide a margin of safety for the most sensitive members of society. "Cost and other economic factors are excluded; only the impacts on public health can be considered" [pp. 8-9]. State implementation plans (SIPs) must be developed by each state to assure that NAAQS are met. "The SIP process virtually ensures that the marginal costs of meeting the ambient air quality standards will vary for the same type of facilities in different areas of the country or state, as well as for the same kinds of emissions from different types of facilities in the same area" [p. 11]. ® New source performance standards (NSPS), the technology-based requirements that industry must meet for major new or modified stationary sources are set by the EPA and imposed by states through permits. Although "different facilities within a given source category have to meet the same emission standards" [p.14], the cost per ton of pollutant emission reduced varies according to facility-specific differences, such as size or processes.

2 regulations governing externalities must be compatible with federal environmental regulations.
KEY ISSUES The following issues concerning environmental externalities were raised in the direct testimony ofProfessor Barnes. Page citations directly follow all direct quotations from this testimony.
Environmental Externality Policy Options "The predominate approach to environmental regulation in this country is command and control" 

### [pA]. However, the regulations reflect a number of requirements (e.g., desired ambient conditions, technology-based or technology-forcing requirements), a number of distinctions (e.g., existing versus new sources, categories of sources and geographic differences) and a series ofpolitical decisions. Consequently, thereis "greatvariabilityin the extent to which individuai sources are controlled and in the costs entailed in meeting the limitation to which they are subject" [p.5]. There are two major federal laws that impose significant environmental requirements on electric generating facilities. Clean AirAct, enacted in 1970 and amended in 1977 and 1990, provides a comprehensive approach to ambient air quality. The key elements of the federal legislation are summarized.

• National ambient airquality standards (NAAQS) are designed to protect the public health and welfare at levels that provide a margin of safety for the most sensitive members ofsociety. "Cost and othereconomic factors are excluded; only theimpacts on public health can be considered" [pp. 8-9].
• State implementation plans (SIPs) must be developed by each state to assure that NAAQS are met. "The SIP process virtually ensures that the marginal costs of meeting the ambient air quality standards will vary for the same type offacilities in different areas ofthe country orstate, as well as for the samekinds ofemissions from different types offacilities in the same area" [po 11].
• New source performance standards (NSPS), the technology-based requirements that industrymust meetfor majornew or modified stationary sources are setby theEPA and imposed by states through permits. Although "different facilities within a given source category have to meet the same emission standards" [p.14], the cost per ton ofpollutant emission reducedvaries according to facility-specific differences, such as size or processes.

2National eission standards for hazardous air pollutants (NESHAPs) emitted by

stationary sources of certain toxins are based on maximum available control technology requirements (MACT). Compliance costs, on a per unit of pollutant reduced, may well vary between facilities in the same or in a different industry. In non-attainment areas, a major new or modified source of air pollutant emissions must "cover the projected increase in emissions by either (1) reducing its own allowable emissions of the pollutant in question from some other point(s) in facilities it owns in the area or (2) purchasing allowable emission rights from some other source in the area" [p. 19]. The required offset can be acquired at the lowest available cost, the overall allowable emissions to the atmosphere do not increase and the cost of obtaining the offset is internalized" [p. 20]. In addition, the major new or modified source must limit its emissions to the Lowest Achievable Emission Rate (LAER). These limits "and concomitant costs for each unit of emission reduction are likely to be quite different between different source categories" [p. 21]. Existing sources in non-attainment areas generally must install reasonable available control technology (RACT). Although similar emission limits are imposed by state regulators on similar sources, "differences between individual sources in a given category may produce different costs of control at the margin" [p. 21]. Acid rain control, as addressed in the amendments of 1990, sets a national emissions cap for sulfur dioxide (SO2) emissions to be achieved and creates a system of marketable allowances. In so doing, "Congress has assured that the environmental costs associated with the emission of SO2 from new electric generating facilities will be fully internalized" [p. 23]. Clean Water Act contains two sets of provisions that apply to electricity generation. State water quality standards, which are state developed/federally approved, specify ambient quality levels that must be maintained in various water bodies to protect public health and environmental values. Effluent limitation guidelines and new source performance standards for water discharges from steam electric power plants are technology-based standards. Existing facilities must use best available technology (BAT) economically achievable to comply with effluent limitations, while modified or new facilities must meet "a standard for control of the discharge of pollutants which reflects the greatest degree of effluent reduction" [p. 27]. The emission limits and resulting cost of control under these two standards "are different for existing and new plants in the same subcategory" [pp. 27-28]. As illustrated, "Congress has enacted regulatory schemes that ultimately require some sources to control more than others, or to incur different costs of control, without regard to the damage caused by emissions or whether other sources could control more cheaply" [p.
3 National emission standards for hazardous air pollutants (NESHAPs) emitted by stationary sources of certain toxins are based on maximum available control technology requirements (MACf). Compliance costs, on a per unit of pollutant reduced, may well vary between facilities in the same or in a different industry. In non-attainment areas, a major new or modified source ofair pollutant emissions must "cover the projected increase in emissions by either (1) reducing its own allowable emissions ofthe pollutantin question from some otherpoint(s) in facilities it owns in the area or (2) purchasing allowable emission rights from some other source in the area" [po 19]. The required offset can be acquired at the lowest available cost, lithe overall allowable emissions to the atmosphere do notincrease and the cost of obtaining the offset is internalized" [po 20]. In addition, the major new ormodified source must limit its emissions to the Lowest Achievable Emission Rate (LAER). These limits "and concomitant costs for each unit of emission reduction are likely to be quite different between different source categoriesII [po 21]. Existing sources in non-attainment areas generally must install reasonable available control technology (RACf). Although similar emission limits are imposed by state regulators on similar sources, "differences between individual sources in a given category may produce different costs ofcontrol at the margin" [po 21].

e Acid rain control, as addressedinthe amendments of 1990, sets a national emissions cap for sulfur dioxide (S02) emissions to be achieved and creates a system of marketable allowances. In so doing, "Congress has assured that the environmental costs associated with the emission ofS02 from new electric generating facilities will be fully internalized" [po 23]. Clean Water Act contains two sets ofprovisions that apply to electricity generation.

e Statewater quality standards, which are state developed/federally approved, specify ambient quality levels that must be maintained in various water bodies to protect public health and environmental values.

e Emuent limitation guidelines and new source performance standards for water discharges from stearnelectricpowerplants aretechnology-based standards. Existing facilities mustusebestavailable technology (BAT) economically achievableto comply with effluent limitations, while modified or new facilities must meet "a standard for control of the discharge ofpollutants which reflects the greatest degree of effluent reduction" [po 27]. The emission limits and resulting cost of control under these two standards "are different for existing and new plants in the same subcategory" [pp. 27-28]. As illustrated, "Congress has enacted regulatory schemes that ultimately require some sources to control more than others, or to incur different costs ofcontrol, without regard to the damage caused by emissions or whether other sources could control more cheaply" [po
334]. Clearly "it is not reasonable to conclude that in establishing emission limitations, regulators

have forgotten to price the residual emissions" [p. 31]. Environmental Externality Valuation Approaches "The real regulatory world does not resemble the one hypothesized by Tellus as the basis for its `revealed preference' approach to valuing residual emissions" [p. 30]. "If any `preference' regarding residual emissions is `revealed' by the current scheme of environmental regulation it is that relatively little -- if any -- value should be placed on residual emissions because regulators generally believe they have limited emissions to the extent necessary to protect health and the environment" [pp. 5-6]. "Regulators simply do not as a general matter equate the cost of controlling emissions from any particular source with the marginal benefit to society of reducing those emissions... With a few exceptions economic efficiency is not central to the design of the environmental regulatory requirements. As a consequence, the total cost of meeting environmental requirements is higher than it needs to be" [p.5]. "It is not reasonable to conclude that in establishing emission limitations, regulators have forgotten to price the residual emissions" [p. 31]. "Congress and the Executive Branch are now enthusiastically seeking to utilize market mechanisms to achieve environmental objectives in the most cost

-effective way possible" [pp. 30-31]
. An example of this approach is the SO2 allowance trading system established under the 1990 amendments to the Clean Air Act. Zero Externality Values "Where the national ambient air quality standards are met, there is an implicit judgment that any residual emissions are not of significant value or concern because the societal value of concern are protected by the standard" [p. 9]. Within this context, residual damages would have a zero externality value. When the EPA conducts the required study of residual risks some eight to nine years after the MACT standards are met, the "expectation is that the cost of meeting any further reductions that are desirable will be internalized if and when more stringent standards are set" [p. 17].

SUPPORTING DOCUMENTATION None cited.

4 34]. Clearly "itis notreasonable to concludethatinestablishing emission limitations, regulators have forgotten to price the residual emissions" [po 31].
EnvironmentalExternality ValuationApproaches "The real regulatory world does not resemble the one hypothesized by Tellus as the basis for its 'revealed preference' approach to valuing residual emissions" [po 30]. "If any 'preference' regarding residual emissions is 'revealed' by the current scheme of environmental regulation itis that relatively little

-- ifany -- value should beplaced on residual emissions because regulators generally believe they have limited emissions to the extent necessary to protect health and the environment" [pp. 5-6]. "Regulators simply do not as a general matter equate the cost ofcontrolling emissions from any particular source with the marginal benefit to society ofreducing those emissions
...With a few exceptions economic efficiency is not central to the design of the environmental regulatory requirements. As a consequence, the total cost ofmeeting environmentalrequirements is higher than it needs to be" [p.5]. "It is not reasonable to conclude that in establishing emission limitations, regulators have forgotten to price the residual emissions" [po 31]. "Congress and the Executive Branch are now enthusiastically seeking to utilize market mechanisms to achieve environmental objectives in the most cost-effective way possible" [pp. 30-31]. An example ofthis approach is the S02 allowance trading system established under the 1990 amendments to the Clean Air Act.
Zero Externality Values "Where the national ambient air quality standards are met, there is an implicitjudgmentthat any residual emissions are not of significant value or concern because the societal value ofconcern are protected by the standard" [po 9]. Within this context, residual damages would have a zero externality value. When the EPA conducts the required study ofresidual risks some eight to nine years after the MACT standards are met, the "expectationis that the cost ofmeeting any further reductions that are desirable will be internalized ifand when more stringent standards are set" [po 17].
SUPPORTING DOCUMENTATION None cited.

4STEPHEN S. BE OW Tellus Institute 89 Broad Street Boston, Massachusetts 02110

PROFILE Dr. Bernow is Vice President and co-founder of the Tellus Institute. A specialist in environmental and economic externality issues, he directs the environmental costing projects at the non-profit organization. These efforts have addressed the environmental costs and benefits of DSM, gas planning and externalities, externalities in integrated resource planning and externality valuation methods.

TESTIMONY REFERENCED "Prepared Testimony of Stephen S. Bernow on Behalf of Citizens for a Better Environment Concerning Advance Plan 6," Wisconsin Public Service Commission, Docket No. 05-EP-6, November 25, 1991.
STATE REGULATORY ISSUE ADDRESSED The Wisconsin Public Service Commission investigated recommendations that it require the utilities it regulates to include environmental externalities in their resource planning and operating decisions and examined ways to assign values to externalities.
SUMMARY OF CONCLUSIONS Dr. Bernow recommends that the Commission require the utilities it regulates to include environmental externalities in their resource decisions in a consistent manner. By adopting the monetized values developed by Tellus for EPA criteria air pollutants and air gases, greenhouse gases and air toxics, he contends that clear comparisons of the economic and environmental characteristics of resources can be provided. He recommends the use of monetized adders.
KEY ISSUES The following issues concerning environmental externalities were raised in Dr. Bernow's direct testimony and a Tellus Institute report included as an exhibit. Page citations directly follow all direct quotations from this testimony.
5 PROFILE STEPHEN S. BERNOW Tenus Institute 89 Broad Street Boston, Massachusetts 02110

Dr. Bernow is Vice President and co-founder of the Tellus Institute. A specialist in environmental andeconomic externalityissues, he directs theenvironmental costingprojects at the non-profit organization. These efforts have addressed the environmental costs and benefits ofDSM, gas planning and externalities, externalitiesin integratedresource planning and externality valuation methods.
TESTIMONY REFERENCED "Prepared Testimony ofStephen S. Bernow on BehalfofCitizens for a BetterEnvironment Concerning Advance Plan 6," Wisconsin Public Service Commission, Docket No. 05-EP-6, November 25, 1991.
STATE REGULATORY ISSUE ADDRESSED TheWisconsin Public Service Commissioninvestigated recommendations thatit require the utilities it regulates to include environmental externalities in their resource planning and operating decisions and examined ways to assign values to externalities.
SUMMARY OF CONCLUSIONS Dr. Bernow recommends that the Commission require the utilities it regulates to include environmental externalities in their resource decisions in a consistent manner. By adopting the monetized values developed by Tellus for EPA criteria air pollutants and air gases, greenhouse gases and air toxics, he contends that clear comparisons of the economic and environmental characteristics of resources can be provided. He recommends the use of monetized adders.
KEY ISSUES The following issues concerning environmental externalities were raised in Dr. Bernow's direct testimony and a Tellus Institute report included as an exhibit. Page citations directly follow all direct quotations from this testimony.


### 5Environmental Externality Policy Options

Three policy options are discussed in the Tellus report prepared for Citizens for a Better Environment and submitted as an exhibit to Mr. Bernow's testimony. Caps and offsets establish a maximum allowable level of emissions from sources over a geographic area
. Permits issued for the amount of emissions to each source can be traded. High emission sources can offset emissions in excess of the amount allowable from the permits they hold by purchasing permits unused by low emission sources. This creates a market for emission permits
. The 1990 Clean Air Act Amendments establish a national cap on, and an allowance trading system for, SO2 emissions. Pollution taxes and fees tax emission sources directly based on the amount of emissions. The revenue is used for general spending purposes or to set up a fund to purchase emission control equipment. An example is the 1991 New York State Energy Plan. Planning adders and credits are used to incorporate into the utility planning process the human health and environmental impacts as adders to explicit accounting costs associated with each planned alternative. The adders represent the environmental impacts. The means for evaluating the planning alternatives include ranking, quantification of the physical amounts of emissions and valuation of environmental externalities in monetary terms. Valuation of externalities in monetary terms can be accomplished explicitly, based on damage costs, or implicitly, based on abatement costs. Environmental Externality Valuation Approaches Environmental impacts should be monetized to the extent feasible so as to: (a) establish a common denominator from which to make clear and understandable comparisons between explicit economic costs and environmental costs; and (b) allow for the "consistent treatment and evaluation of externalities across utilities and across the different contexts of energy provision" [p. 5]. Although contending that there is sufficient scientific and economic knowledge to develop monetized values for "certain environmental impacts ... in some instances monetary valuation may not be possible or desirable" [p. 5]. Explicit damage estimates of damage caused by environmental externalities is complicated by atmospheric, biological, chemical, geophysical, ecological and physiological relationships over time and space as well as socio-economic and cultural conditions. Consequently, estimating techniques are difficult to perform. Implied monetary valuations of externalities are based on surveys (contingent valuation) to estimate society's willingness to pay or be compensated or on ,market proxies (differences in property values, cost of control, regulators' revealed preferences) of the externality value.

6 Environmental Externality Policy Options Three policy options are discussed in the Tellus report prepared for Citizens for a Better Environment and submitted as an exhibit to Mr. Bernow's testimony. Caps and offsets establish a maximum allowable level of emissions from sources over a geographic area. Permits issued for the amount ofemissions to each source can be traded. High emission sources can offset emissions in excess of the amount allowable from the permits they hold by purchasing permits unused by low emission sources. This creates a marketfor emissionpermits. The 1990 CleanAir ActAmendments establish a national cap on, and an allowance trading system for, S02 emissions. Pollution taxes and fees tax emission sources directly based on the amount of emissions. Therevenue is used for general spending purposes orto set up a fund to purchase emission control equipment. An example is the 1991 New York State Energy Plan. Planning adders and credits are used to incorporate into the utility planning process the human health and environmental impacts as adders to explicit accounting costs associated with eachplanned alternative. The addersrepresentthe environmentalimpacts. Themeans for evaluating the planning alternatives include ranking, quantification of the physical amounts of emissions and valuation of environmental externalities in monetary terms. Valuation of externalities in monetary terms can be accomplished explicitly, based on damage costs, or implicitly, based on abatement costs.
Environmental Externality Valuation Approaches Environmental impacts should be monetized to the extent feasible so as to: (a) establish a common denominator from which to make clear and understandable comparisons between explicit economic costs and environmental costs; and (b) allow for the "consistent treatment and evaluation of externalities across utilities and across the different contexts of energy provision" [po 5]. Although contending that there is sufficient scientific and economic knowledge to develop monetizedvaluesfor "certainenvironmentalimpacts
... in someinstancesmonetaryvaluation may not be possible or desirable" [po 

### 5]; Explicit damage estimates ofdamage caused by environmental externalities is complicated by atmospheric, biological, chemical, geophysical, ecological and physiological relationships over time and space as well as socio-economic and cultural conditions. Consequently, estimating techniques are difficult to perform. Impliedmonetary valuations ofexternalities are based on surveys (contingent valuation) to estimate society's willingness to payor be compensated or on.market proxies (differences in propertyvalues, cost ofcontrol, regulators' revealed preferences) ofthe externality value.

6Cost of control monetization, based on regulators' revealed preferences, is used by Tellus

to estimate the following values.

STEPHEN S. BERNOW MONETIZED EXTERNALITY VALUES*

* These values differ from those given in Dr. Bernow's testimony in Massachusetts and Nevada. The estimated maximum impact on costs for the Wisconsin system "grows to about 13.5 percent by the year 2010" [p. 9]. The average annual increase is one-half percent above the rate of increase that would otherwise occur.

7 Cost ofcontrol monetization, based on regulators' revealed preferences, is used by Tellus to estimate the following values.

Pollutant S02 NO" 

### eo TSPJPM 10 

### voe

Pollutant STEPHEN S. BERNOW MONETIZED EXTERNALITY V ALUES*

$/ton (high) $/ton (low) $JIb (high) $1,560 $0.78 $4,000 $6,770 $2.00 $1,000 $2,500 $0.50 $4,000 $6,000 $2.00 $1,560 $5,500 $0.78
$/ton $23 $230 $4,140 $JIb (low)
$3.38 $1.25 $3.00 $2.75

$/lb $0.01 $0.12 $2.07 * These values differ from those given in Dr. Bernow's testimony in Massachusetts and Nevada.
The estimated maximum impact on costs for the Wisconsin system "grows to about 13.5 percentby the year 2010" [po 9]. The average annual increase is one-halfpercent above the rate ofincrease that would otherwise occur.

7Dr. Bernow also presents a set of values for air toxics, which are primarily heavy metals.

STEPHEN S. BE OW MONETIZED AIR TONICS VALUES
Pollutant w ($/lb) High ($/lb) Arsenic $292.00 $6,470.00 Beryllium $58.00 $1,294.00 Cadmium $389.00 $8,627.00 Trivalent Chromium $0.29 $6.00 Hexavalent Chromium $58.00 $1,294.00 Lead $209.00 $4,621.00 Mercury $973.00 $21,567.00 "In the case of the air emissions of toxic metals I recommend that the high-end values be used initially, given the nascent stage of development of the use of such values in utility planning, the desirability of a risk averse, policy that leans towards environmental and human health protection, and taking account of the fact that our estimates show that this would not impose unacceptably high economic penalties on resource selection (for our example it adds less than 20 percent to overall externalities costs of a new AFBC plant)" [p. 8]. Scope of Monetized Environmental Externalities Integrated resource planning -- Environmental cost should be incorporated into the resource selection process on a system-wide, least-cost planning basis. "Thus, if a utility is considering resource additions (or retirements) and DSM in its long range planning, regulation canrequire that it include environmental costs within its planning evaluation and decisionmaking" [p. 93]. "A fully integrated system planning approach could also include the direct and emissions costs impacts on non-electric sources (e.g., in fossil-fired end-uses that replace electric generation or in steam boilers that are displaced by cogeneration facilities), that can be affected by system resource planning decisions" [p. 94]. Full-cost/Environmental dispatching -- This approach would involve adding to variable operating costs the variable environmental costs associated with continuing operation. "The result would be full-cost dispatching, that would minimize overall costs -- direct and externalities -- of operation and reduce overall pollution (along with the aggregate costs of such pollution) at some increase in direct costs" [p. 94]. Non-utility Resource Impacts -- Externalities should be incorporated into integrated resource planning. The plan should include environmental impacts from all sources the utility uses 8 Dr. Bernow also presents a set ofvalues for air toxics, which are primarily heavy metals. 

# I STEPHEN S. BERNOW MONETIZED AIR TOXIeS VALUES
Pollutant 

# I Low ($/lb) 

# I
Arsenic $292.00 Beryllium $58.00 cadmium $389.00 Trivalent Chromium $0.29 Hexavalent Chromium $58.00 Lead $209.00 Mercury $973.00 High ($/lb) 

# I $6,470.00 $1,294.00 $8,627.00 $6.00 $1,294.00 $4,621.00 $21,567.00
"In the case of the air emissions oftoxic metals I recommend that the high-end values be used initially, given the nascent stage of development of the use of such values in utility planning, the desirability ofa risk aversepolicy thatleans towards environmental andhuman healthprotection, and taking account ofthe fact that our estimates show that this would not impose unacceptably high economicpenalties onresource selection (for ourexampleit adds less than 20 percent to overall externalities costs of a new AFBC plant)" [po 8]. Scope ofMonetized Environmental Externalities Integratedresourceplanning

-- Environmentalcostshouldbeincorporatedintotheresource selectionprocess on a system-wide, least-costplanningbasis. 'Thus, ifa utility is considering resource additions (or retirements) and DSM in its long range planning, regulation can require that it include environmental costs within its planning evaluation and decisionmaking" [po 93]. "A fully integrated system planning approach could also include the direct and emissions costs impacts onnon-electric sources (e.g., infossil-fired end-uses thatreplace electric generation orin steamboilers that are displacedby cogenerationfacilities), that can be affected by system resource planning decisions" [po 94]. Full-cost/Environmental dispatching

-- This approach would involve adding to variable operating costs thevariable environmental costs associatedwith continuing operation. liThe result would be full-cost dispatching, that would minimize overall costs
-- direct and externalities

-- of operation and reduce overall pollution (along with the aggregate costs of such pollution) at some increase in direct costs" [po 94]. Non-utilityResourceImpacts

-- Externalitiesshouldbeincorporatedintointegratedresource planning. The plan should include environmental impacts from all sources the utility uses 

### 8to satisfy energy needs including purchased energy from outside sources, DSM programs and

cogeneration. Bidding Systems -- When seeking new generating capacity or DSM resources environmental externality valuations should be incorporated into the competitive bidding process. "Bid projects should be required to specify their environmental characteristics (e.g., lbs. of NO,, per mWh), upon which they would then be imputed environmental costs. These costs can then be used in a protocol for comparing and ranking the projects (again subject to concerns about viability, etc.)" [p. 97]. Interim CO2 Externality Values Significant global warming could occur as a result of greenhouse gas emissions of C021 methane, CFCs and nitrous oxide. However, many of the cost analyses of options for reducing carbon dioxide emissions give a wide range of results because of differences in methodological approaches and assumptions and country specific situations. "Perhaps the most important observation is that results can differ by a factor of three or four for a given level of emissions reductions" [p. 51]. Many countries have established targets for reducing CO2 concentrations but these are not sufficient and should only be regarded as starting values. Targets on the order of 30 to 60 percent reductions of current CO2 emissions should be anticipated within the next 40 years; for example, "30 percent by 2010 to 2015 and 50 percent by 2030" [p. 49]. Dr. Bernow proposes a value of $23 per ton of CO.. This cost was developed "from estimates of the costs of planting trees as a carbon sink; in particular, the costs that would be incurred in pursuing a significant (but by no means enormous) tree planting program" [p. 54]. Impacts on DSM Resource Selection Options Demand-side management programs are understood to have environmental benefits associated with the avoided cost of new resources. Avoided costs include avoided emissions and their externality values. "The potential of DSM for both reducing costs and improving local, regional and global environmental quality has been well documented and is compelling. The reckoning of environmental externalities of power supply in resource planning and operation will help to realize those benefits" [p. 95]. In addition to the costs and benefits of avoided emissions, DSM technologies have environmental costs and benefits of their own such as the potential for increased indoor air pollution from increased building insulation. "At the same time, programmatic DSM may offer opportunities to avoid these impacts and, indeed, to realize other related benefits (for example, attending to radon leaks when implementing space heating related programs, or capturing CFCs with a refrigerator replacement program that might otherwise be released when the original refrigerator is discarded)" [p. 95]. 9 to satisfyenergyneedsincludingpurchased energyfrom outside sources, DSMprograms and cogeneration. Bidding Systems -- Whenseekingnewgenerating capacity orDSMresources environmental externality valuations should be incorporated into the competitive bidding process. IIBid projects should be required to specify their environmental characteristics (e.g., lbs. of NOx permWh), upon which they would then be imputed environmental costs. These costs can thenbeusedin a protocolfor comparing andranking theprojects (again subject to concerns about viability, etc.)" [po 97].
Interim CO2 Externality Values Significant global warming could occur as a result of greenhouse gas emissions of CO2, methane, CFCs and nitrous oxide. However,**m~ny** of the cost analyses of options for reducing carbon dioxide emissions give a wide range of results because of differences in methodological approaches and assumptions and country specific situations. "Perhaps the most important observation is that results can differ by a factor ofthree or four for a given level of emissions reductions" [po 51]. Many countries have established targets for reducing CO2 concentrations but these are not sufficient and should only be regarded as starting values. Targets on the order of 30 to 60 percentreductions ofcurrent CO2 emissions shouldbe anticipated within the next 40 years; for example, 1130 percent by 2010 to 2015 and 50 percent by 2030" [po 49]. Dr. Bernow proposes a value of $23 per ton of CO2. This cost was developed "from estimates ofthe costs ofplanting trees as a carbon sink; in particular, the costs that would beincurredin pursuing a significant (butby no means enormous) tree planting programll [po 

### 54]. Impacts on DSM Resource Selection Options Demand-side management programs are understood to have environmental benefits associated with the avoided cost ofnew resources. Avoided costs include avoided emissions and their externality values. liThe potential of DSMfor both reducing costs and improving local, regional andglobal environmentalqualityhasbeenwell documented andis compelling. The reckoning of environmental externalities of power supply in resource planning and operation will help to realize those benefits" [po 95]. In addition to the costs and benefits of avoided emISSIOns, DSM technologies have environmental costs andbenefits oftheir own such as the potentialfor increased indoor air pollution from increased building insulation. "At the same time, programmatic DSM may offer opportunities to avoid these impacts and, indeed, to realize other relatedbenefits (for example, attending to radon leaks when implementing space heating related programs, or capturing CFCs with a refrigerator replacement program that might otherwise be released when the original refrigerator is discarded)" [po 95]. 9Fuel Switching

Environmental impacts should be taken into account in end-use fuel switching such as from electricity to natural gas. "As with power supply options end-use fuel switching may also involve upstream impacts associated with extraction, processing and delivery of the fuels (e.g., natural gas leaks, oil spills, transport energy costs, etc.) that could be taken into account" [p. 95]. Mr. Bernow suggests that for simplicity the analysis should be limited to the generation and end-use stages. Cogeneration It is important to account for the environmental impacts of cogeneration since it is becoming more important in meeting energy and environmental goals. "If both electricity and process thermal energy are produced by such a system, where these would otherwise be produced separately, an emissions credit or offset should be computed to adjust the gross emissions for electricity generation to a net impact that takes account of both the marginal energy needed to effect cogeneration and the emissions reduction associated with the reduction in fuel use for the thermal only operation" [p. 96]. The following equation could be used to calculate the net emissions of cogenerators. Let: Enet = Net cogenerator emissions coefficient (pounds/MMBtu) Egross = Gross cogenerator emissions coefficient (pounds/MMBtu) Eboiler = Avoided boiler emissions coefficient (pounds/MMBtu) Scogen = Steam efficiency of the cogenerator (percent) Sboiler = Steam efficiency of the avoided boiler (percent) Then : Enet = Egross - Eboiler x (Scogen/boiler) Multiplying Enet by the facility's heat rate (in MMBtu per kWh) gives the net cogenerator emissions in pounds per kWh.
SUPPORTING DOCUMENTATION Although references were not cited in the direct testimony, the Tellus report ("Valuation of Environmental Externalities for Electric Utility Resource Planning in Wisconsin") upon which the testimony in based and included as an exhibit, contains numerous references.

10 Fuel Switching Environmental impacts should be taken into account in end-use fuel switching such as from electricity to natural gas. liAs with power supply options end-use fuel switching may also involve upstream impacts associated with extraction, processing and delivery of the fuels (e.g., natural gas leaks, oil spills, transport energy costs, etc.) that could be taken into account" [po 95]. Mr. Bernow suggests that for simplicity the analysis should be limited to the generation and end-use stages. Cogeneration Itis importantto accountfor the environmentalimpacts ofcogeneration since itis becoming more importantin meeting energy and environmental goals. "Ifboth electricity andprocess thermal energy are produced by such a system, where these would otherwise be produced separately, an emissions credit or offset should be computed to adjust the gross emissions for electricity generation to a net impact that takes account of both the marginal energy needed to effect cogeneration and the emissions reduction associated with the reduction in fuel use for the thermal only operation" [po 96]. The following equation could be used to calculate the net emissions of cogenerators. Let: Enet 

## = Net cogenerator emissions coefficient (pounds/MMBtu) Egross 

## = Gross cogenerator emissions coefficient (pounds/MMBtu) Eboiler 

## = Avoided boiler emissions coefficient (pounds/MMBtu) Scogen 

## = Steam efficiency ofthe cogenerator (percent) Sboiler 

## = Steam efficiency of the avoided boiler (percent) Then: Enet 

### - Multiplying Enet by the facility's heat rate (in MMBtu per kWh) gives the net cogenerator emissions in pounds per kWh.
SUPPORTING DOCUMENTATION Although references were not cited in the direct testimony, the Tellus report ("Valuation of Environmental Externalities for Electric Utility Resource Planning in Wisconsin") upon which the testimony in based and included as an exhibit, contains numerous references.



### 10SHEPARD C. BUCHANAN Bonneville Power Administration 5904 NE Everett Street Portland, Oregon 97213

PROFILE Mr. Buchanan is employed by the Bonneville Power Administration (BPA) as a consulting economist on energy and environmental matters. Since joining the agency in 1982, he has headed the BPA's Environmental Costs and Benefits Program. In addition to serving as an expert witness on environmental costs and energy planning, he worked with Pace University on a project to advise the State of New York on incorporating environmental externalities into utility resource planning.
TESTIMONY REFERENCED "Direct Testimony of Shepard C. Buchanan on Behalf of the Staff of the Public Service Commission of Wisconsin Concerning Advance Plan 6," Wisconsin Public Service Commission, Docket No. 05-EP-6, November 25, 1991.
STATE REGULATORY ISSUE ADDRESSED The Wisconsin Public Service Commission examined whether it should require the utilities it regulates to account for environmental externalities in their resource planning and operating decisions and also investigated examined methods of incorporating externalities.
SUMMARY OF CONCLUSIONS Mr. Buchannan provides an overview of environmental externalities, methods for monetization and approaches for incorporating these values in utility regulatory actions. He concludes with observations on the environmental costs he expects to be associated with the Wisconsin system.
ISSUES The following issues concerning environmental externalities were raised in the direct testimony or Shepard C. Buchanan. Page citations directly follow all direct quotations from this testimony.

11 PROFILE SHEPARD C. BUCHANAN Bonneville Power Administration 5904 NE Everett Street Portland, Oregon 97213

Mr. Buchanan is employed by the Bonneville Power Administration (BPA) as a consulting economist on energy and environmental matters. Sincejoining the agency in 1982, he has headed the BP A's Environmental Costs andBenefits Program. In addition to serving as an expertwitness on environmental costs and energy planning, he workedwith Pace University on a project to advise the State of New York on incorporating environmental externalities into utility resource planning.
TESTIMONY REFERENCED "Direct Testimony of Shepard C. Buchanan on Behalf of the Staff of the Public Service Commission of Wisconsin Concerning Advance Plan 6," Wisconsin Public Service Commission, Docket No. 05-EP-6, November 25, 1991.
STATE REGULATORY ISSUE ADDRESSED The Wisconsin Public Service Commission examined whether it should require the utilities it regulates to account for environmental externalities in their resource planning and operating decisions and also investigated examined methods ofincorporating externalities.
SUMMARY OF CONCLUSIONS Mr. Buchannan provides an overview of environmental externalities, methods for monetization and approachesfor incorporating these values in utilityregulatory actions. He concludes with observations on the environmental costs he expects tobe associated with the Wisconsin system.
KEY ISSUES The following issues concerning environmental externalities were raised in the direct testimony orShepard C. Buchanan. Page citations directly follow all direct quotations from this testimony.

11Environmental Externality Policy Options

There are several ways that regulatory authorities can implement environmental externality considerations. Resource planning is the most widely discussed avenue. By considering all costs when planning resource activities, utilities are: (a) responding to customers' environmental concerns; (b) anticipating environmental impacts of resources and avoiding future costly retrofits; (c) identifying resource alternatives that may otherwise not have been identified; and (d) fulfilling the governmental function of considering all "costs citizens will bear as a result of planning decisions undertaken by regulated utilities" [p. 18]. Demand-side management can be assessed in terms of cost-effectiveness when monetized externalities are included. A utility and its regulator then "can determine the true avoided cost faced by the utility" [p. 19]. Even if the externalities "are not monetized, identifying them and evaluating them through other means can help utilities and their regulators develop ISM program targets" [p.19]. Rates, which reflect the full cost of externalities, "would result in reduced purchase [of electricity] and, as a result, reduced environmental externalities" [p. 20]. Scope of Monetized Environmental Externalities "Externality costs are costs imposed by residual environmental effects which occur after all regulatory standards and emissions levels have been met. Thus, even when a resource complies with all existing laws and regulations, it still can produce environmental costs" [p. 15]. Accounting for environmental externalities in resource planning "is prudent from a ratepayer point of view because it is the ratepayer who eventually will be required to bear the cost of today's externalities" [p. 15]. Environmental Externality Valuation Approaches Mr. Buchannan defines both monetary valuations that ascribe dollar costs to specified externalities and qualitative methods that rank the severity of importance of the externalities.He focuses on the former evaluation methods as they "much more clearly reveal a decisionmaker's priorities and method of accounting for the real economic damage associated with environmental externalities" [p. 6]. Specifically, he addresses three methods. Contingent valuation "involves surveying affected parties and asking them, directly, how much they would be willing to pay to avoid certain environmental externalities or how much they would require as compensation to voluntarily incur those externalities" [p. 18]. He believes this is the most direct way to evaluate the cost of externalities to society.

12 Environmental Externality Policy Options There are severalways that regulatory authorities can implement environmental externality considerations. Resource planning is the most widely discussed avenue. By considering all costs when planning resource activities, utilities are: (a) responding to customers' environmental concerns; (b) anticipating environmental impacts of resources and avoiding future costly retrofits; (c) identifying resource alternatives that may otherwise not have been identified; and (d) fulfilling the governmental function of considering all "costs citizens will bear as a result ofplanning decisions undertaken by regulated utilities" [po 18]. Demand-side management can be assessed in terms of cost-effectiveness when monetized externalities are included. A utility and its regulator then "can determine the true avoided cost faced by the utility" [po 19]. Even if the externalities "are not monetized, identifying them and evaluating them through other means can help utilities and their regulators develop DSM program targets" [p.19]. Rates, which reflect the full cost of externalities, "would result in reduced purchase [of electricity] and, as a result, reduced environmental externalities" [po 20]. Scope ofMonetized Environmental Externalities "Externality costs are costs imposed by residual environmental effects which occur after all regulatory standards and emissions levels have been met. Thus, even when a resource complies with all existing laws and regulations, it still can produce environmental costs" [po 15]. Accountingfor environmental externalitiesinresource planning 

### "is prudentfrom a ratepayer point ofview because it is the ratepayer who eventually will be required to bearthe cost of today's externalities" [po 15].
Environmental Externality Valuation Approaches Mr. Buchannan defines both monetary valuations that ascribe dollar costs to specified externalities and qualitativemethods thatrankthe severityofimportance oftheexternalities. Hefocuses on theformer evaluation methods as they "much more clearly reveal a decisionmaker's priorities and method ofaccounting for the real economic damage associated with environmental externalities" [po 6]. Specifically, he addresses three methods. Contingent valuation "involves surveying affected parties and asking them, directly, how muchtheywould bewilling to payto avoid certain environmental externalities orhow much they would require as compensation to voluntarily incur those externalities" [po 18]. He believes this is the most direct way to evaluate the cost of externalities to society.
12Control costs incorporate various techniques which involve determining the "marginal cost

of reducing, abating or mitigating an externality" [p. 9]. Also referred to as implied valuation or revealed preference, control costs "show the amount of direct costs of pollution control devices or other costly activities that could be saved by reducing the extent of externalities" [p. 9]. Damage costs are based on physical estimates of the actual changes in the environment as well as the ensuing changes in the goods and services provided by the environment. After identifying the changes, a variety of techniques can be used to monetize them. "Some can be priced directly... other effects can be costed using agreed-upon published values...and some affects may require original studies to estimate values" [p. 10]. These methods share the following common features: ® each can identify how much society should be willing to pay to avoid the environmental externality" [p. 7] that imposes or threatens to impose a damage or cost on society; ® the methods are "well understood and their use is theoretically justified" [p. 7]; and the methods have "particular strengths and weaknesses which make them more or less appropriate for certain applications " [p. 7]. In using the three monetization methods, "it is the lower control or damage cost which should be applied" [p. 7]. Quantitative and qualitative methods can be applied individually or combined. Their development "is limited only by the creativity of their practitioners" [pp. 12-13]. Mr. Buchannan briefly characterizes such monetary evaluation techniques. Percentage of total cost provides an economic advantage for a resource type "by reducing its overall cost by some percentage or by increasing other resource costs by some percentage " [p. 11]. The 15 percent adder assigned to noncombustion alternatives by the Wisconsin Commission is an example. Other quantitative techniques assign scores and weights to environmental characteristics. The resource with the lowest total score (where the lower the number, the lower the environmental effect) would be preferred. ® Qualitative techniques rely on judgment in relative rankings of resource types.
Impacts on DSM Resource Options Mr. Buchannan, while noting the disparity found between the monetized externality costs advanced by the Bonneville Power Administration and in the Pace study, states that

13 Control costs incorporate various techniques which involve determining the "marginal cost ofreducing, abating ormitigating anexternality" [po 9]. Also referredto as impliedvaluation or revealed preference, control costs "show the amount of direct costs ofpollution control devices or other costly activities that could be saved by reducing the extent ofexternalities" 

### [p.9]. Damage costs are based on physical estimates ofthe actual changes in the environment as well as the ensuing changes in the goods and services provided by the environment. After identifying the changes, a variety oftechniques can be used to monetize them. "Some can bepriceddirectly
...othereffects canbecostedusing agreed-uponpublishedvalues
...andsome affects may require original studies to estimate values" [po 10]. These methods share the following common features:

• each can identify how much society should be willing to pay to avoid the environmental externality" [po 7] that imposes or threatens to impose a damage or cost on society;

• the methods are "well understood and their use is theoreticallyjustified" [po 7]; and
• the methods have "particular strengths and weaknesses which make them more or less appropriate for certain applications" [po 7]. In using the three monetization methods, "it is the lower control or damage cost which should be applied" [po 7]. Quantitative and qualitative methods can be applied individually or combined. Their development "is limited only by the creativity of their practitioners" [pp. 12-13]. Mr. Buchannan briefly characterizes such monetary evaluation techniques.

• Percentage of total cost provides an economic advantage for a resource type "by reducing its overall cost by some percentage orby increasing other resource costs by
. some percentage" [po 11]. The 15 percent adder assigned to noncombustion alternatives by the Wisconsin Commission is an example. Other quantitative techniques assign scores and weights to environmental characteristics. The resource with the lowest total score (where the lower the number, the lower the environmental effect) would be preferred. Qualitative techniques rely onjudgment in relative rankings ofresource types. Impacts on DSM Resource Options Mr. Buchannan, while noting the disparity found between the monetized externality costs advanced by the Bonneville Power Administration and in the Pace study, states that
13"inclusion of these costs in resource decisions could make significant amounts of

environmentally benign renewables and DSM programs more attractive " [p. 14]. In Wisconsin, 67 percent of the installed capacity in 1990 was coal-fired . "The available short

-term and long-term environmental costs are at least 1.7 v./kWh and may be as high as 4.0 0/kWh" [p.26]. As these externality costs are fully one-third as much as the internal costs of a new coal plant (according to BPA estimates) or almost equal to the internal costs (according to the Nevada PUC values), Mr. Buchannan concludes that "these costs suggests that it would be difficult to over-invest in energy efficiency through, the implementation of DSM programs" [p. 28]. Fuel Switching "Any analysis of environmental externalities will support fuel switching for certain end-uses" [p. 24]. In its 1990 Resource Program, the BPA found by reducing the forecasted installation of new and replacement electric water heaters from 80 percent to 50 percent, "significant environmental benefits... could be had at a negative cost" [p. 25]. This is attributable to a nearly half-billion dollar savings in total energy bills derived from "reduced investment in new electric generation, saved operating costs of existing resources, increased export sales and lower consumer utility bills" [p. 25].
SUPPORTING DOCUMENTATION Mitchell, Robert and Richard Carson. Using Surveys to Value Public Goods: The Contingent Valuation Method. Washington, DC: Resources for the Future, 1989. National Academy of Sciences. Policy Implications of Greenhouse Warming. Washington, DC: National Academy Press, 1991. Moskovitz, David H. "Why We Need an Environmental Trust Fund." Katz, Myron B. "Proper Price Signals: The Case for Reflecting Externalities in Utility Rates."

14 "inclusion of these costs in resource decisions could make significant amounts of environmentally benign renewables and DSM programs more attractive" [po 14]. In Wisconsin, 67 percent of the installed capacity in 1990 was coal-fired. liThe available short-term andlong-term environmental costs are at least 1.7 ¢/kWh and may be as high as 4.0 ¢/kWh" [p.26]. As these externality costs are fully one-third as much as the internal costs of a new coal plant (according to BP A estimates) or almost equal to the internal costs (according to the Nevada PUCvalues), Mr. Buchannan concludes that "these costs suggests that it would be difficult to over-invest in energy efficiency throughthe implementation ofDSM programs" [po 28].
Fuel Switching "Any analysis ofenvironmental externalitieswill supportfuel switching for certain end-uses" [po 24]. In its 1990 Resource Program, the BPA found by reducing the forecasted installation of new and replacement electric water heaters from 80 percent to 50 percent, "significant environmental benefits
...could be had at a negative cost" [po 25]. This is attributable to a nearly half-billion dollar savings in total energy bills derived from "reduced investment in new electric generation, saved operating costs ofexisting resources, increased export sales and lower consumer utility bills" [po 25].
SUPPORTING DOCUMENTATION Mitchell, Robert and Richard Carson. Using Swveys to Value Public Goods: The Contingent
. Valuation Method. Washington, DC: Resources for the Future, 1989. NationalAcademyofSciences.PolicyImplications ofGreenhouse Warming. Washington, DC: National Academy Press, 1991. Moskovitz, David H. I1Why We Need an Environmental Trust Fund." Katz, MyronB. I1ProperPrice Signals: The Casefor ReflectingExternalitiesinUtilityRates."

14EMILY J. CA ILL Resource Insight, Inc. 18 Tremont Street

-- Suite 1000 Boston, Massachusetts 02108

PROFILE Ms. Caverhill is a research associate at Resource Insight, Inc., a consulting firm whose clients include state utility commission staff, environmental advocates, independent energy producers, consumer advocates and gas utility companies. A former intern with the Conservation Law Foundation of New England, she now concentrates on preparing reports and testimony on the valuation of environmental externalities of power generation.

TESTIMONY REFERENCED "Direct Testimony of Emily J. Caverhill on Behalf of the City of Chicago in Proceedings to Adopt a Comprehensive Electric Energy Plan for the State of Illinois," Illinois Commerce Commission, ICC Docket No. 91-0050," May 15, 1991.
STATE REGULATORY ISSUE ADDRESSED The Illinois Commerce Commission (ICC) undertook an examination of recommended approaches to addressing environmental externalities in the least-cost planning process. The investigation focused on two proposals: (1) adopt a schedule for the development of a valuation method that would be adopted in Illinois by 1992; and (2)' adopt a marginal cost of control methodology, and preliminary externality values based on that method, in the 1994 statewide plan.
SUMMARY OF CONCLUSIONS Ms. Caverhill concludes that, as marginal cost of control is "clearly superior to other valuation methods" [p. 5], this approach should serve as the basis for incorporating monetized costs of fossil generation into electric utility cost-effectiveness analyses. Specifically, non-zero preliminary externality values for five air pollutants should be used by electric utilities in evaluating DSM measures and in utility integration analyses. The values advanced by Ms. Caverhill (in 1990 $/ton of pollutant emitted) are $22 for C021 $1000 for SO2, $3000 for NO,,, $5500 for VOCs and $1700 for particulates (TSPs). In addition, an externality benefit of 4.3v/kWh should be assigned to DSM options.

15 PROFILE EMILY

### J. CA VERRILL Resource Insight, Inc. 18 Tremont Street •• Suite 1000 Boston, Massachusetts 02108

Ms. Caverhillis a research associate atResource Insight, Inc., a consultingfirm whose clients include state utility commission staff, environmental advocates, independent energy producers, consumer advocates and gas utility companies. A former intern with the Conservation Law Foundation ofNew England, she now concentrates on preparing reports and testimony on the valuation of environmental externalities of power generation.
TESTIMONY REFERENCED "Direct Testimony ofEmily J. Caverhill on Behalfofthe City of Chicago in Proceedings to Adopt a Comprehensive Electric Energy Plan for the State of Illinois," Illinois Commerce Commission, ICC Docket No. 91-0050," May 15, 1991.
STATE REGULATORY ISSUE ADDRESSED The Illinois Commerce Commission (ICC) undertook an examination of recommended approaches to addressing environmentalexternalities in theleast-costplanningprocess. The investigation focused on two proposals: (1) adopt a schedule for the development of a valuation method that would be adopted in Illinois by 1992; and (2)adopt a marginal cost ofcontrolmethodology, and preliminaryexternalityvaluesbasedonthatmethod, inthe 1994 statewide plan.
SUMMARY OF CONCLUSIONS Ms. Caverhill concludes that, as marginal cost of control is "clearly superior to other valuation methods" [po 5], this approach should serve as the basis for incorporating monetized costs of fossil generation into electric utility cost-effectiveness analyses. Specifically, non-zero preliminary externalityvalues for five air pollutants should beused by electric utilities in evaluating DSM measures andin utility integration analyses. Thevalues advanced by Ms. Caverhill (in 1990 $/ton ofpollutant emitted) are $22 for CO2 , $1000 for S02' $3000 for NOx, $5500 for VOCs and $1700 for particulates (TSPs). In addition, an externality benefit of 4.3¢/kWh should be assigned to DSM options.

15ISSUES

The following issues concerning environmental externalities were raised in the direct testimony of Ms. Caverhill. Page citations directly follow all direct quotations from their testimony. Environmental Externality Policy Options Ms. Caverhill recommends three ways in which environmental effects and regulations should be reflected in electric utility resource planning and acquisition. Mitigation estimates, for effects that will be mitigated, would "cover current costs of existing rules, future costs of existing rules and future costs of expected rules" [p. 17]. Forecasts of residual effects costs that "will be internalized through taxes, fees, emissions caps or any other method" [p. 17]. Monetize residual effects that "remain after mitigation efforts and that will not be internalized" [p. 18] using a highest marginal cost of control methodology. Environmental Externality Valuation Approaches Ms. Caverhill discusses four approaches currently used to value and apply pollutant impacts: marginal cost of control, percent adder, direct costing and weighting and ranking. Marginal cost of control "uses existing data on the costs and efficiencies of control measures to determine the externalities of utility resource options. For regulated pollutants... this entails identifying the marginal control measures and their costs. For unregulated externalities, such as...C02, the externality value is determined by examining the costs of various mitigation measures, such as tree planting for C02, and determining the cost to meet a predetermined emissions target" [p. 21]. In accordance with the basic rationales underlying this method, implied preference (i.e., societal willingness to pay) and avoided control cost (i.e., costs of required controls directly establish the monetary benefits of emissions reductions), "only the cost of the marginal control measure, usually the most stringent measure with the highest cost (emphasis added), is important" [p. 25]. Percent adder, the addition of a specific percentage to certain less desirable resource options, provides "no direct relationship between a utility's direct avoided cost and its externalities [and, therefore,] the choice of an adder is arbitrary" [p. 28]. Direct costing is an attempt "to establish the cost of externalities by estimating their effects on humans and their environment" [p. 28]. As the "direct estimation of environmental costs

16 KEY ISSUES The following issues concerning environmental externalities were raised in the direct testimony of Ms. Caverhill. Page citations directly follow all direct quotations from their testimony.
Environmental Externality Policy Options Ms. Caverhillrecommends threeways inwhich environmental effects andregulations should be reflected in electric utility resource planning and acquisition. Mitigationestimates, for effects thatwillbemitigated, would "cover current costs ofexisting rules, future costs of existing rules and future costs of expected rules" [po 17]. Forecasts ofresidual effects costs that "will be internalized through taxes, fees, emissions caps or any other method" [po 17]. Monetize residual effects that "remain after mitigation efforts and that will not be internalized" [po 18] using a highest marginal cost of control methodology.
Environmental Externality Valuation Approaches Ms. Caverhill discusses four approaches currentlyused tovalue and apply pollutantimpacts: marginal cost of control, percent adder, direct costing and weighting and ranking. Marginal costofcontrol "uses existing data onthe costs and efficiencies ofcontrol measures to determine the externalities of utility resource options. For regulated pollutants
...this entails identifying the marginal control measures and their costs. For unregulated externalities, such as...C02, the externality value is determined by examining the costs of various mitigationmeasures, such as treeplanting for CO2, and determiningthe cost to meet a predetermined emissions target" [po 21]. In accordance with the basic rationales underlying this method, implied preference (i.e., societal willingness to pay) and avoided control cost (i.e., costs ofrequired controls directly establish the monetary benefits of emissions reductions), "only the cost of the marginal controlmeasure, usually themost stringentmeasurewith thehighest cost (emphasis added), is important" [po 25]. Percent adder, the addition of a specific percentage to certain less desirable resource options, provides "no direct relationship between a utility's direct avoided cost and its externalities [and, therefore,] the choice of an adder is arbitrary" [po 28]. Directcosting is an attempt "to establish the cost ofexternalities by estimating their effects onhumans and their environment" [po 28]. As the "direct estimation ofenvironmental costs
16is a daunting and time consuming task...[it] is not appropriate for use in Illinois utility

planning at this time" [pp. 28-29]. Weighting and ranking "is a complicated and often completely subjective determination of the relative value of reducing specific externalities " [p. 30]. "If there were no other method of estimating the value of reducing externalities, this method might be better than assigning them a zero value. However, the explicit monetization methods (cost of control and direct costing) are better costing tools " [p. 31]. Comparative Advantages of Marginal Cost of Control This method is preferable to qualitative or subjective approaches for considering environmental externalities in utility planning because: ® it "relies on the legislators and environmental regulators, rather than the utilities and their rate-regulating agencies, to assign dollar values to the external effects of utility operations" [p. 31]; ® the externality values developed "are consistent within geographic regions" [p. 32]; ® it "provides consistency across utility resource options" [p. 32]; and ® it sends "a consistent signal about the worth of specific innovations or improvements" [p. 33] to utilities.

Impacts on DSM Resource Options Established externality values should be used in the screening of DSM measures with the externality benefits of DSM being the avoided externalities of the marginal (or displaced) generating units. Given the values advanced by Ms. Caverhill, the avoided externality cost for DSM displacing low sulfur coal-fired energy would be 4.3¢/kWh for Illinois electric utilities. "Integration of DSM with supply-side resources will require the use of the individual preliminary externality values. All externality values should rise over time with inflation" [p. 60].
SUPPORTING DOCUMENTATION None cited in the direct testimony although references are cited in the attachment labeled Exhibit No. 2.0.

17 is a daunting and time consuming task
...[it] is not appropriate for use in lllinois utility planning at this time" [pp. 28-29]. Weighting andranking "is a complicated and often completely subjective determination of the relative value ofreducing specific externalitiesII [po 30]. "Ifthere were no other method ofestimating the value ofreducing externalities, this methodmight be betterthan assigning them a zero value. However, the explicit monetization methods (cost ofcontrol and direct costing) are better costing tools" [po 31]. Comparative Advantages ofMarginal Cost ofControl This method is preferable to qualitative or subjective approaches for considering environmental externalities in utility planning because:

e it "relies onthelegislators and environmentalregulators, rather than the utilities and their rate-regulating agencies, to assign dollar values to the external effects ofutility operationsII [po 31];

e the externality values developed "are consistent within geographic regions" [po 32];

e it "provides consistency across utility resource optionsII [po 32]; and

e it sends "a consistent signal about the worth ofspecific innovations orimprovements" [po 33] to utilities. Impacts on DSM Resource Options Established externality values should be used in the screening of DSM measures with the externality benefits ofDSM being the avoided externalities of the marginal (or displaced) generating units. Given the values advanced by Ms. Caverhill, the avoided externality cost for DSM displacing low sulfur coal-fired energy would be 4.3¢/kWh for lllinois electric utilities. "Integration of DSM with supply-side resources will require the use of the individual preliminary externalityvalues. All externality values should rise over time with inflation" [po 60].
SUPPORTING DOCUMENTATION None cited in the direct testimony although references are cited in the attachment labeled Exhibit No. 2.0.



### 17MARC W. GOLDSMITH Energy Research Group, Inc. 400 Fifth Avenue Waltham, Massachusetts 02154

PROFILE Mr. Goldsmith is president of Energy Research Group, Inc., an energy consulting firm specializing in energy management, strategic planning, technology assessment, regulatory and environmental affairs, policy analysis and communications. Among the consulting services provided to utility and private clients throughout the United States and abroad since 1973 is the preparation and presentation of expert witness testimony on energy issues.
TESTIMONY REFERENCED "Direct Testimony of Marc W. Goldsmith on Behalf of Central Illinois Light Company, Central Illinois Public Service Company, Commonwealth Edison Company, Illinois Power Company, Iowa-Illinois Gas and Electric Company and Union Electric Company in Proceedings to Adopt a Comprehensive Electric Energy Plan for the State of Illinois," Illinois Commerce Commission, ICC Docket No. 91-0050," August, 1991.
STATE REGULATORY ISSUE ADDRESSED The Illinois Commerce Commission (ICC) undertook an examination of recommended approaches to addressing environmental externalities in the least-cost planning process. The investigation focused on two proposals: (1) adopt a schedule for the development of a valuation method that would be adopted in Illinois by 1992 ; and (2) adopt a marginal cost of control methodology, and preliminary externality values based on that method, in the 1994 statewide plan.
SUMMARY OF CONCLUSIONS Mr. Goldsmith concludes that the quality and quantity of available data on environmental impacts are insufficient to justify the assignment of monetized values to environmental externalities. Therefore, he agrees that the informal process recommended by the Department of Energy and Natural Resources (DENR) and supported by the Joint Illinois Utilities be adopted by the ICC. He does, however, caution that the objectives of this process should include: the establishment of analytic boundaries (i.e., measuring environmental impacts at the point of generation, throughout the fuel cycle or at the end-use); the avoidance of bias toward any fuel source; the evaluation of the externality universe and the position of environmental externalities within that universe; the recognition 18 PROFILE MARC W. GOLDSMITH Energy Research Group, Inc. 400 Fifth Avenue Waltham, Massachusetts 02154

Mr. Goldsmith is president of Energy Research Group, Inc., an energy consulting firm specializinginenergymanagement, strategicplanning, technologyassessment,regulatoryand environmental affairs, policy analysis and communications. Among the consulting services provided to utility and private clients throughout the United States and abroad since 1973 is the preparation and presentation of expert witness testimony on energy issues.
TESTIMONY REFERENCED "Direct Testimony of Marc W. Goldsmith on Behalf of Central lllinois Light Company, Central lllinois Public Service Company, Commonwealth Edison Company, lllinois Power Company, Iowa-lllinois Gas and Electric Company and Union Electric Company in Proceedings to Adopt a Comprehensive ElectricEnergyPlanfor theStateofIllinois," Illinois Commerce Commission, ICC Docket 'No. 91-0050," August, 1991.
STATE REGULATORY ISSUE ADDRESSED The Illinois Commerce Commission (ICC) undertook an examination of recommended approaches to addressing environmentalexternalitiesin theleast-costplanning process. The investigation focused on two proposals: (1) adopt a schedule for the development of a valuation method thatwould be adoptedin Illinois by 1992 ; and (2) adopt a marginal cost ofcontrolmethodology, andpreliminaryexternalityvaluesbased onthatmethod, in the 1994 statewide plan.
SUMMARY OF CONCLUSIONS Mr. Goldsmith concludes that the quality and quantity of available data on environmental impacts are insufficient to justify the assignment of monetized values to environmental externalities. Therefore, he agrees that the informal process recommended by the Department ofEnergy andNatural Resources (DENR) and supportedby the Joint Illinois Utilities be adopted by the ICC. He does, however, caution that the objectives of this process should include: the establishment of analytic boundaries (i.e., measuring environmental impacts at the point of generation, throughout the fuel cycle or at the end-use); the avoidance of bias toward any fuel source; the evaluation of the externality universe and the position ofenvironmental externalitieswithin thatuniverse; therecognition 18of constraints imposed by the absence of adequate data; and the inclusion of both costs and

benefits in any determination of monetized environmental externality values.
Y ISSUES The following issues concerning environmental externalities were raised in the direct testimony of Mr. Goldsmith. Page citations directly follow all direct quotations from this testimony.
Environmental Externality Valuation Approaches Mr. Goldsmith discusses three primary approaches currently used to value the impacts of pollutants: direct impact assessment, shadow pricing (also termed "cost of control") and environmental weighting and ranking. Direct impact assessment, which provides a dollar-per-pound cost based on actual impacts, is recognized as the optimal approach to valuating pollutants costs. However, because it is a data intensive and costly process, alternate approaches have been sought. Shadow pricing, which measures the costs of incremental increase in pollution control at and beyond the cost of either Best Available Control Technology or the most stringent regulation, is based on the assumption that incremental control costs can be equated to the incremental cost of that pollutant's impact on society and that the higher the control cost, the greater the amount of external impact. Although shadow pricing allows a number to be easily derived, this methodology does not answer the question of what society should be willing to pay to mitigate air pollution. Environmental weighting and ranking uses estimates derived through a number of methodologies to ascertain the relative impact of a given pollutant on the environment. Although a somewhat more subjective approach, it directs the focus to the relative importance of certain pollutants within an overall context that permits comparisons with other intrinsic costs and benefits of an alternative supply- or demand-side resource. Scope of Monetized Environmental Externalities Environmental externalities, a subset of the wider externalities universe, "are defined as all the costs and benefits not borne by producers or consumers in the course of production or consumption. The determination of externalities requires a valuation of both external costs and external benefits" [p. 4]. In practice, the definition of environmental externalities has been narrowed by the few state regulatory commissions that have assigned monetized values chiefly to air pollutants emitted by electricity generation facilities operated by investor-owned utilities.

19 of constraints imposed by the absence of adequate data; and the inclusion of both costs and benefits in any determination ofmonetized environmental externality values.
KEY ISSUES The following issues concerning environmental externalities were raised in the direct testimony ofMr. Goldsmith. Page citations directly follow all direct quotations from this testimony.
Environmental Externality Valuation Approaches Mr. Goldsmith discusses three primary approaches currently used to value the impacts of pollutants: direct impact assessment, shadow pricing (also termed "cost of control") and environmental weighting and ranking. Direct impact assessment, which provides a dollar-per-pound cost based on actual impacts, is recognized as the optimal approach to valuating pollutants costs. However, because it is a data intensive and costly process, alternate approaches have been sought. Shadow pricing, which measures the costs ofincremental increase in pollution control at and beyond the cost of either Best Available Control Technology or the most stringent regulation, is based on the assumption that incremental control costs can be equated to the incremental cost ofthat pollutant's impact on society and that thehigher the control cost, the greater the amount of external impact. Although shadow pricing allows a number to be easily derived, this methodology does not answer the question ofwhat society should be willing to pay to mitigate air pollution. Environmental weighting and ranking uses estimates derived through a number of methodologies to ascertain therelativeimpactofagivenpollutantonthe environment. Although a somewhat more subjective approach, it directs the focus to the relative importance of certain pollutants within an overall context that permits comparisons with other intrinsic costs and
. benefits of an alternative supp1y- or demand-side resource. Scope ofMonetized Environmental Externalities Environmental externalities, a subset ofthe wider externalities universe, "are defined as all the costs and benefits not borne by producers or consumers in the course of production or consumption. The determination ofexternalities requires a valuation ofboth external costs and external benefits" [po 4]. In practice, the definition of environmental externalities has been narrowed by the few state regulatory commissions that have assigned monetized values chiefly to airpollutants emitted by electricity generation facilities operated by investor-owned utilities.

19Monetized environmental externalities are mainly assigned on a dollar-per-unit of pollutant

value. "Within this context, the values apply only to externality costs; not to benefits. Not only is this contrary to the definition of environmental externalities, it precludes a comprehensive and fair analysis of any environmental externality" [p. 5].
Impacts on DSM Resource Options "[I]n some jurisdictions, one force in the development of monetized environmental externalities has been to make demand

-side management (DSM) more attractive. By incorporating externalities on the generation side, DSM alternatives gain an improved position in the planning process
. If externality values are included when a utility calculates avoided unit cost, the higher the externality value, the higher the avoided costs become. Higher avoided costs allow DSM to appear more cost-effective and to create a ceiling price that appears to justify undertaking greater utility incentives, rebates and 'free' measures" [p. 14].
Constraints on Quantification onetization In the few jurisdictions that have attempted to monetize environmental externalities, the approaches used are incomplete. In turn, the use of these approaches "could impede rather than promote environmental improvements and unnecessarily increase the cost of energy resources to both the customer and to society as a whole" [p. 3]. The electric utility industry has internalized many of the costs associated with air pollutants and, by definition, these costs are no longer externalities. If such costs are assigned an externality value, the potential arises for double counting and, in turn, "the degree of uncertainty surrounding the quantified externality values for air pollutants is increased" [p. 5]. "The current amount and quality of available data [on environmental impacts] do not at this point in time support the values used in monetization of environmental externalities" [p. 10]. "Areas requiring further review and evaluation before a methodology is adopted for quantifying or monetizing environmental externalities in the least-cost planning process include the complexity of the externality universe, the availability and quality of the requisite data, the potential for fuel bias and the need to account for uncertainty" [p. 4]. Impacts of Quantification onetization "Overall, the incorporation of monetized environmental externality values into only the price of electricity for [least-cost] planning purposes: ® can increase the cost of electricity and, by not imposing similar standards on other energy forms, may distort energy markets; 20 Monetized environmental externalities are mainly assigned on a dollar-per-unit ofpollutant value. "Within this context, the values apply only to externality costs; not to benefits. Not only is this contrary to the definition of environmental externalities, it precludes a comprehensive and fair analysis of any environmental externality" [po 5]. Impacts on DSM Resource Options "[I]n some jurisdictions, one force in the development of monetized environmental externalities has been to make demand-side management (DSM) more attractive. By incorporating externalities on the generation side, DSM alternatives gain an improved position in the planning process. Ifexternality values are included when a utility calculates avoided unit cost, the higher the externality value, the higher the avoided costs become. Higher avoided costs allow DSMto appear more cost-effective and to create a ceiling price that appears tojustify undertaking greaterutility incentives, rebates and 'free'measures" [po 14].
Constraints on Quantitication/Monetization In the few jurisdictions that have attempted to monetize environmental externalities, the approaches used areincomplete. In turn, the use ofthese approaches "could impede rather than promote environmentalimprovements and unnecessarily increase the cost of energy resources to both the customer and to society as a whole" [po 3]. The electric utility industry has internalized many ofthe costs associated with air pollutants and, by definition, these costs are no longer externalities. If such costs are assigned an externality value, the potential arises for double counting and, in turn, "the degree of uncertainty surrounding the quantified externality values for air pollutants is increased" [po 

### 5]. "The current amount and quality ofavailable data [on environmentalimpacts] do not at this pointin time support thevalues used inmonetization ofenvironmental externalities" [po 10]. "Areas requiring further review and evaluation before a methodology is adopted for quantifying or monetizing environmental externaJities in the least-cost planning process include the complexity ofthe externalityuniverse, the availability and quality oftherequisite data, the potential for fuel bias and the need to account for uncertainty" [po 4]. Impacts of Quantification/Monetization "Overall, theincorporation ofmonetized environmentalexternalityvalues into only theprice of electricity for [least-cost] planning purposes:

• can increase the cost of electricity and, by not imposing similar standards on other energy forms, may distort energy markets; 

### 20® shifts the focus away from electric end-use technologies, which historically have provided the greatest energy efficiency gains, and fails to recognize the environmental impacts of other end-uses; ® impairs the local, domestic and international competitiveness of the U.S. economy by distorting fuel competition for no environmental benefit; ® heightens the, potential for increased ratepayer costs by biasing the supply planning process toward higher cost generation; and ® increases overall pollution levels by preventing the balancing of environmental costs and benefits" [p. 13].
SUPPORTING DOCUMENTATION None cited.

21 shifts the focus away from electric end-use technologies, which historically have providedthe greatestenergyefficiency gains, andfails torecognize the environmental impacts of other end-uses; impairs the local, domestic andinternational competitiveness oftheU.S. economyby distorting fuel competition for no environmental benefit; heightens the_potential for increased ratepayer costs by biasing the supply planning process toward higher cost generation; and increases overall pollution levels by preventing the balancing ofenvironmental costs and benefits" [po 13].
SUPPORTING DOCUMENTATION None cited.



### 21ALFRED E. KAHN National Economic Research Associates, Inc.

308 North Cayuga Street Ithaca, New York 14850

PROFILE Dr. Kahn is Special Consultant with National Economic Research Associates, Inc. and Professor of Political Economy Emeritus at Cornell University. The former Chairman of the New York State Public Service Commission and the Civil Aeronautics Board is the author of The Economics of Regulation, one of the most respected works on this topic. A member of the Environmental Advisory Committee of the Federal Energy Administration during the Ford administration, the distinguished economist had testified in more than 45 state and federal regulatory commission proceedings.
TESTIMONY REFERENCED "Rebuttal Testimony of Alfred E. Kahn on Behalf of the Tampa Electric Company that the Commission Deny Approval to Construct the Proposed Polk Unit One Project," Docket No. 910883-El, November 20, 1991.
STATE REGULATORY ISSUE ADDRESSED Floridians for Responsible Utility Growth filed a petition requesting the Florida Public Service Commission to deny approval to the Tampa Electric Company for the construction of the proposed Polk Unit One Project until the commission directs the utility to aggressively pursue and acquire more comprehensive demand-side management savings. The proposal under discussion was presented by Paul Chernick of Resource Insight, Inc.

SUMMARY OF CONCLUSIONS Although Dr. Kahn espouses energy conservation policies and believes utilities can and should contribute to the realization of conservation goals, he does not agree that Polk Project approval should hinge on adoption of a prescribed DSM program. He further contends that the DSM undertaking as presented by Mr. Chernick is "bad advice, the course of action he recommends is imprudent and potentially highly injurious to the welfare of TECO's customers and the Florida Company" [p. 3]. Although environmental externalities were not directly at issue, Dr. Kahn outlined his general policy recommendations for factoring environmental costs into resource selection decisions.

22 PROFILE ALFRED E. KAHN National Economic Research Associates, Inc. 308 North Cayuga Street Ithaca, New York 14850

Dr. Kahn is Special Consultant with National Economic Research Associates, Inc. and Professor ofPoliticalEconomyEmeritus at CornellUniversity. Theformer Chairman ofthe New York State Public Service Commission and the Civil Aeronautics Board is the author of The Economics of Regulation, one ofthe most respected works on this topic. A member oftheEnvironmentalAdvisory Committeeofthe FederalEnergyAdministration during the Ford administration, the distinguished economist had testified in more than 45 state and federal regulatory commission proceedings.
TESTIMONY REFERENCED "RebuttalTestimony ofAlfred E. Kahn on Behalfofthe Tampa Electric Company that the CommissionDenyApproval to Construct the ProposedPolkUnit OneProject," DocketNo. 910883-EI, November 20, 1991.
STATE REGULATORY ISSUE ADDRESSED Floridians for Responsible Utility Growth filed a petition requesting the Florida Public Service Commission to deny approval to the TampaElectric Company for the construction oftheproposedPolkUnit OneProjectuntil the commission directs theutility to aggressively pursue and acquire more comprehensive demand-side management savings. The proposal under discussion was presented by Paul Chernick ofResource Insight, Inc.
SUMMARY OF CONCLUSIONS Although Dr. Kahn espouses energy conservation policies and believes utilities can and should contribute to the realization of conservation goals, he does not agree that Polk Project approval should hinge on adoption of a prescribed DSM program. He further contends that theDSMundertaking as presentedbyMr. Chernickis "bad advice, the course of action he recommends is imprudent and potentially highly injurious to the welfare of TECO's customers and the Florida Company" [po 3]. Although environmental externalities were not directly at issue, Dr. Kahn outlined his general policy recommendations for factoring environmental costs into resource selection decisions.

22ISSUES

The following issues concerning environmental externalities were raised in the rebuttal testimony of Dr. Kahn. Page citations directly follow all direct quotations from this testimony.
Environmental Externalities Policy Options In addressing the influence of environmental costs in regulatory requirements for ISM implementation, Dr. Kahn focuses on several general policy directions. "Environmental costs should in principle be factored into choices among alternative supply and demand-side options" [p. 20]. Institutional devices should be identified for: "(a) determining those external costs, not already internalized by existing environmental regulation, (b) deciding to what extent it is in the interest of the people of Florida to recognize them in fuel choice and conservation decisions, and (c) seeing to it that they do indeed get reckoned into those decisions" [p. 20]. Resource use for the prevention or, mitigation of environmental damage must be taken into account. This requires a balancing of the "costs of additional protections, over and above those already mandated, against the benefits" [p. 20].' Appropriateness of State PUC-Imposed Values "Environmental costs are of course real costs; and some agency, at some level of government, must take them into account. But state public utility regulatory commissions must bear in mind the inherent, high probability of distortions and inefficiencies if they impose on only the companies subject to their jurisdiction environmental costs greater than they are already forced to bear under statewide and nationwide environmental controls, merely because they happen to be regulating them already -- for entirely different reasons - - while imposing no controls on their unregulated competitors or customers of their competitors" [p. 19].

Potential PUC Conflicts In deciding how much of uninternalized regional, national or global environmental costs to impose on the state economy and its residents, the PUC "must pay heed to the dangers of piecemeal environmentalism" [p. 21]. Imposing environmental costs on electric utilities and not on non-utility entities whose activities give rise to environmental costs "will inevitably tend to inefficiently distort the choice between them. It could even, by raising the price of electricity while leaving unaffected the direct consumption of fossil fuels at the point of use, impede the process of 23 KEY ISSUES The fonowing issues concerning environmental externalities were raised in the rebuttal testimony of Dr. Kahn. Page citations directly follow an direct quotations from this testimony.
Environmental Externalities Policy Options In addressing the influence of environmental costs in regulatory requirements for DSM implementation, Dr. Kahn focuses on several general policy directions. "Environmental costs should in principle be factored into choices among alternative supply and demand-side options" [po 20]. Institutional devices should be identified for: "(a) determining those external costs, not alreadyinternalizedby existing environmental regulation, (b) deciding to what extent it is in the interest of the people of Florida to recognize them in fuel choice·and conservation decisions, and (c) seeing to it that they do indeed get reckoned into those decisions" [po 20]. Resource use for the prevention or,mitigation ofenvironmental damage mustbe taken into account. This requires a balancing ofthe "costs of additional protections, over and above those already mandated, against the benefits" [po 20]. Appropriateness of State PUC-Imposed Values "Environmental costs are of course real costs; and some agency, at some level of government, must take them into account. But state public utility regulatory commissions must bear in mind the inherent, high probability of distortions and inefficiencies if they impose on only the companies subject to theirjurisdiction environmental costs greater than they are already forced to bear under statewide and nationwide environmental controls, merelybecause they happen to beregulating them already

-- for entirely different reasons -

- while imposing no controls on their unregulated competitors or customers of their competitors" [po 19].
Potential PUC Conflicts In deciding how much ofuninternalized regional, national or global environmental costs to impose on the state economy and its residents, the PUC "must pay heed to the dangers of piecemeal environmentalism" [po 21]. Imposing environmental costs on electric utilities and not on non-utility entities whose activities give rise to environmental costs "will inevitably tend to inefficiently distort the choice between them. It could even, by raising the price of electricity while leaving unaffected the direct consumption offossil fuels at the point ofuse, impede the process of 23electrification" [p. 21], which has been instrumental in conserving energy and mitigating

environmental damage.
SUPPORTING DOCUMENTATION The following were cited in the author's discussion of externalities. Schurr, Sam H., Calvin C. Burwell, Warren D. Devine, Jr. and Sidney Sonenblum. Electricity in the American Economy Agent of Technological Progress. New York: Greenwood Press, 1990. Mills, Mark P., Ecowatts: The Clean Switch, Using Electricity to Save Energy and Cut Greenhouse Gases. Chevy Chase, MD: Science Concepts, Inc., April 1991.

24 electrificationll [po 21], which has been instrumental in conserving energy and mitigating environmental damage.
SUPPORTING DOCUMENTATION The following were cited in the author's discussion of externalities. Schurr, SamH., Calvin C. Burwell, WarrenD. Devine, Jr. and Sidney Sonenblum. 

### Electricity in the American Economy Agent ofTechnological Progress. New York: Greenwood Press, 1990. Mills, Mark P., 

### Ecowatts: The Clean Switch, Using Electricity to Save Energy and Cut Greenhouse Gases. Chevy Chase, MD: Science Concepts, Inc., April 1991.

24ROBERT H

. KOPPE RCG/Hagler Bailly, Inc. P.O. Drawer 0 Boulder, Colorado 80306

PROFILE Mr. Koppe is a Vice President of RCG/Hagler Bailly, Inc. and Manager of the Stoller Power Division. Prior to joining the consulting firm, he managed the Nuclear Engineering Division for Consolidated Edison Company of New York. An engineer, Mr. Koppe has testified as an expert witness in a number of state regulatory proceedings.

TESTIMONY REFERENCED "Testimony of Robert H. Koppe on Behalf of the Massachusetts Electric Company in the Investigation by the Department on its Own Motion as to the Environmental Externality Values to be Used in Resource Cost-Effectiveness Tests by Electric Companies Subject to the Department's Jurisdiction," Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131, May 16, 1991.
STATE REGULATORY ISSUE ADDRESSED As directed in D.P.U. Order No. 89-239, specific values for eight air pollutants are to be used in all electric utility resource plans unless it can be demonstrated that other values are more reasonable. This subsequent docket is intended to investigate such other values.
SUMMARY OF CONCLUSIONS Mr. Koppe presents a market-based set of environmental externality values for NOX, SOX, VOCs, TSPs, CO, C021 CH4 and N20 developed under a contract he managed. The methodology is detailed in the "Final Report on Environmental Externality Valuation" prepared for New England Power Service Company and submitted as an exhibit to Mr. Koppe's testimony.
ISSUES The following issues concerning environmental externalities were raised in the direct testimony of Robert H. Koppe. Page citations directly follow all direct quotations from this testimony.

25 PROFILE ROBERT H. KOPPE RCG/Hagler Bailly, Inc. P.O. Drawer 0 Boulder, Colorado 80306

Mr. Koppeis a Vice President ofRCG/HaglerBailly, Inc. andManagerofthe StollerPower Division. Priortojoiningthe consultingfirm, hemanaged the NuclearEngineeringDivision for Consolidated Edison Company ofNew York. An engineer, Mr. Koppe has testified as an expert witness in a number of state regulatory proceedings.
TESTIMONY REFERENCED "Testimony of Robert H. Koppe on Behalf of the Massachusetts Electric Company in the Investigation by the Department on its Own Motion as to the Environmental Externality Values to be Used in Resource Cost-Effectiveness Tests by Electric Companies Subject to the Department's Jurisdiction," Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131, May 16, 1991.
STATE REGULATORY ISSUE ADDRESSED As directed in D.P.U. Order No. 89-239, specific values for eight air pollutants are to be used in all electric utility resource plans unless it can be demonstrated that othervalues are more reasonable. This subsequent docket is intended to investigate such other values.
SUMMARY OF CONCLUSIONS Mr. Koppe presents a market-based set of environmental externality values for NOx ' SOx, VOCs, TSPs, CO, CO2, CH4 and N20 developed under a contract he managed. The methodology is detailed in the ItPinal Report on Environmental Externality Valuation" prepared for New England Power Service Company and submitted as an exhibit to Mr. Koppe's testimony.
KEY ISSUES The following issues concerning environmental externalities were raised in the direct testimony ofRobert H. Koppe. Page citations directly follow all direct quotations from this testimony.

25Environmental Externality Valuation Approaches

The following describes the methodology used to develop monetized costs for the environmental externalities of air pollutants listed in I.P.U. Order 89-239. For SOX, the market price "estimated to result from the emissions trading provisions of the 1990 Clean Air Act Amendments" [p. 1] is used. For CO2, the monetized value for greenhouse gases developed by Dr. Nordhaus and adopted in I.P.U. Order 89-239 is used. For the remaining six pollutants, "the value for obtaining offsets based on the cost of controlling a broad array of stationary sources of emissions" [p. 2] is estimated. The table on the following page contains the values recommended by RCG/Hagler Bailly and those adopted in the earlier D.P.U. Order.
SUPPORTING DOCUMENTATION Although no full citations are listed in the testimony, the final report submitted as an exhibit contains a number of references.

26 Environmental Externality Valuation Approaches The following describes the methodology used to develop monetized costs for the environmental externalities of air pollutants listed in D.P.V. Order 89-239.

• For SOx, the market price "estimated to result from the emissions trading provisions ofthe 1990 Clean Air Act Amendments" [po 1] is used.

• For CO2, the monetizedvalue for greenhouse gases developed by Dr. Nordhaus and adopted in D.P.V. Order 89-239 is used. Forthe remaining six pollutants, lithe value for obtaining offsets based on the cost of controlling a broad array of stationary sources of emissions" [po 2] is estimated. The table on the following page contains the values recommended by RCG/Hagler Bailly and those adopted in the earlier D.P.V. Order.
SUPPORTING DOCUMENTATION Althoughno full citations arelisted inthe testimony, the final report submitted as an exhibit contains a number of references.

26ROBERT H. KOPPE SUMMARY OF ENVIRONMENT AL EXTERNALITY V

ALUES' FOR ENERGY RESOURCE OPTIONS

Nitrogen Oxides (NOX) - ambient air quality - greenhouse $6,5002 0 $200 0 - total $6,500 $200 Sulfur Oxides (SOX) $1,500 $600 Volatile Organic Compounds (VOCs) $5,300 $200 - $300 Total Suspended Particles (TSPs) $4,000 $300 Carbon Monoxide (CO) - ambient air quality - greenhouse $820 50 $10 - total $870 $10 Carbon Dioxide (C02) $22 Methane (CH4) $220 Nitrous Oxide (N20) $3,960

1

2 DOER estimates (DOER Comments Update, 4/18) based on estimates prepared by Bernow and Marron, Valuation of Environmental Externalities for Energy Planning and Operations, May 1990 Update, Tellus Institute, May 18, 1990. For NOX externality estimates, the summary table on page 33 of the above mentioned study contained a typographical error. The corrected value that appears in this Order was taken from pages 11 and 12 of the above-mentioned study.

27 1

2 ROBERT H. KOPPE SUMMARY OF ENVIRONMENTAL EXTERNALITY VALUES l FOR ENERGY RESOURCE OPTIONS

Nitrogen Oxides (NOx )

- ambient air quality $6,5002

- greenhouse 0

- total $6,500 Sulfur Oxides (SOx) $1,500 $200 0 $200 $600 Volatile OrganiC Compounds (VOCs) $5,300 $200

- $300 Total Suspended Particles (TSPs) $4,000 $300 Carbon Monoxide (CO)

- ambient air quality $820 $10

- greenhouse 50 --


### --

- total $870 $10 Carbon Dioxide (CO2) $22 Methane (CH4) $220 Nitrous Oxide (N2O) $3,960
DOER estimates (DOER Comments Update, 4/18) based on estimates preparedby BernowandMarron, Valuation of EnvironmentalExternalities forEnergyPlanningand Operations, May 1990 Update, Tellus Institute, May 18, 1990. ForNOxexternality estimates, the summarytable onpage 33 ofthe above mentioned study contained a typographical error. The corrected value that appears in this Order was taken from pages 11 and 12 ofthe above-mentioned study.

27LESTER B. LAVE Carnegie-Mellon University Graduate School of Industrial Administration

Schehley Park Pittsburgh, Pennsylvania 15213

PROFILE Dr. Lave is James Higgins Professor of Economics and Professor of Engineering and Public Policy at Carnegie-Mellon University. At the Brookings Institute, he headed the Economics Department and served as a Senior Fellow. He has conducted research on the economics of energy, the environment and health and safety, and has previously testified on environmental issues

. The former President of the Society for Risk Analysis also has consulted with many federal agencies and corporations , taught at several major universities, and served on a number of national science and engineering committee.
TESTIMONY REFERENCED "Testimony of Lester B. Lave on Behalf of Western Massachusetts Electric Company, Massachusetts Electric Company and Boston Edison Company in the Investigation by the Department on its own Motion as to the Environmental Externality Values to be Used in Resource Cost-Effectiveness Tests by Electric Companies Subject to the Department's Jurisdiction," Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131, October 4, 1991.
STATE REGULATORY ISSUE ADDRESSED The Department of Public Utilities is considering estimates of external environmental costs to be utilized by electric utilities in the integrated resource management process.
SUMMARY OF CONCLUSIONS Dr. Lave concludes that externality costs should be based on the marginal benefit of abatement and the current costs adopted by the D.P.U. will increase abatement expenditures needlessly and could lower environmental quality. He presents his "best" and "high" estimates of the marginal benefits of abating criteria air pollutants and carbon dioxide. Even though uncertainties exist, Dr. Lave contends these estimates reflect the best available scientific data and should be adopted by the D.P.U.

28 PROFILE LESTER B. LAVE Carnegie.Mellon University Graduate School ofIndustrial Administration Schenley Park Pittsburgh, Pennsylvania 15213

Dr. Lave is James Higgins Professor ofEconomics and Professor ofEngineering andPublic Policy at Carnegie-MellonUniversity. Atthe Brookings Institute, he headed theEconomics Department and served as a Senior Fellow. He has conducted research on the economics of energy, the environment and health and safety, and has previously testified on environmental issues. The former President of the Society for Risk Analysis also has consultedwith many federal agencies and corporations, taught at several major universities, and served on a number ofnational science and engineering committee.
TESTIMONY REFERENCED "Testimony of Lester B. Lave on Behalf of Western Massachusetts Electric Company, Massachusetts Electric Company and Boston Edison Company in the Investigation by the Department on its own Motion as to the Environmental Externality Values to be Used in Resource Cost-Effectiveness Tests by Electric Companies Subject to the Department's Jurisdiction," Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131, October 4, 1991.
STATE REGULATORY ISSUE ADDRESSED TheDepartment ofPublic Utilities is considering estimates ofexternal environmental costs to be utilized by electric utilities in the integrated resource management process.
SUMMARY OF CONCLUSIONS Dr. Lave concludes that externality costs should be based on the marginal benefit of abatementandthecurrentcosts adoptedbytheD.P.U.willincrease abatementexpenditures needlessly and could lower environmental quality. He presents his "best" and "high" estimates ofthemarginalbenefits ofabating criteria airpollutants andcarbon dioxide. Even though uncertainties exist, Dr. Lave contends these estimates reflect the best available scientific data and should be adopted by the D.P.U.



### 28ISSUES

The following issues concerning environmental externalities were raised in the direct testimony of Dr. Lave. Page citations directly follow all direct quotations from this testimony.
Environmental Externality Policy Options "Precise estimates are not available for many of the health and environmental effects of specific discharges or particular electricity generation techniques [and] uncertainties pervade the estimates that are available" [p. 11]. Consequently, "federal regulators face the choice of waiting for years, possibly decades, until definitive data are available, or making decisions on the basis of currently available data, which sometimes is misleading" [p.12].
Environmental Externality Valuation Approaches "Externality prices must be based on the marginal benefit of abatement... the current D.P.U. [cost of control] prices will increase abatement expenditures needlessly and possibly lower environmental quality" [p.4]. Marginal benefit of abatement provides better estimates of externality valuations than marginal cost approaches such as contingent valuation, cost of repair and lost wages, land values, lost output or cost of repair or replacement. Marginal benefit of abatement is focused on the health impacts of improving air quality such as fewer premature deaths, disability days, asthma attacks, cancers and coughs, as well as the non-health effects such as better visibility, less damage to materials and vegetation and improvements in other social welfare effects. "I find it ludicrous that someone can argue that the current marginal cost of control can be used as a good surrogate for the marginal benefit of control" [p. 10]. Marginal cost of control methods, such as those used by the Tellus Institute for assigning monetized environmental externalities, are inappropriate for a number of reasons. The assertion "that the marginal benefit of abatement can be inferred from the marginal cost of abatement fails to recognize the structure of the Clean Air Act or EPA's procedures for setting emissions standards

. The marginal costs of abatement should be expected to span a wide range, with most being above the marginal benefit of abatement" [p. 10]. The estimates differ across sources for the same pollutant and therefore cannot reveal anything about society's preferences. Legislated emission levels upon which cost of control estimates are based do not consider optimizing social welfare. "The current process for setting emissions standards is so fraught with internal inconsistencies and ad hoc decisions and so 29 KEY ISSUES The following issues concerning environmental externalities were raised in the direct testimony of Dr. Lave. Page citations directly follow all direct quotations from this testimony.
Environmental Externality Policy Options "Precise estimates are not available for many of the health and environmental effects of specific discharges orparticularelectricitygenerationtechniques [and] uncertaintiespervade the estimates that are available" [po 11]. Consequently, "federal regulators face the choice ofwaiting for years, possibly decades, until definitive data are available, ormaking decisions on the basis of currently available data, which sometimes is misleading" [p.12].
Environmental Externality Valuation Approaches "Externalityprices mustbebased onthe marginal benefit ofabatement
...the current D.P.U. [cost of control] prices will increase abatement expenditures needlessly and possibly lower environmental quality" [pAl. Marginal benefit of abatement provides better estimates of externality valuations than marginal cost approaches such as contingent valuation, cost ofrepair and lost wages, land values, lost output or cost of repair or replacement. Marginal benefit of abatement is focused on the health impacts of improving air quality such as fewer premature deaths, disability days, asthma attacks, cancers and coughs, as well as the non-health effects such as better visibility, less damage to materials and vegetation and improvements in other social welfare effects. "I find it ludicrous that someone can argue that the current marginal cost ofcontrol can be ' used as a good surrogate for the marginal benefit of control" [po 10]. Marginal cost of , control methods, such as those used by the Tellus Institute for assigning monetized environmental externalities, are inappropriate for a number ofreasons.

e The assertion "that the marginal benefit of abatement can be inferred from the marginal cost of abatement fails to recognize the structure of the Clean Air Act or EPA's procedures for setting emissions standards. The marginal costs of abatement shouldbe expected to span a wide range, with mostbeing above the marginal benefit of abatement" [po 10]. The estimates differ across sources for the same pollutant and therefore cannot reveal anything about society's preferences. Legislated emission levels upon which cost of control estimates are based do not consider optimizing social welfare. "The current process for setting emissions standards is so fraught with internal inconsistencies and ad hoc decisions and so 

### 29bereft of analysis or considerations of social marginal cost and marginal benefit that it is hard to credit any argument about this selection optimizing anything, save possibly temporary political gain"[p.9]. Accepting marginal cost of control as a good proxy for marginal benefit involves the logical inconsistency that things are already optimal and that further changes to emission standards will only make things worse. Environmental Externality Valuations Since "we found that the relationship between air pollution and health was not statistically significant for areas attaining the primary air quality standards"[p.27], zero values are assigned as the best estimate of the direct health related impacts of all emissions except those incurred indirectly through ozone. Best estimates and high estimates of externality values associated with particular emissions are given. High estimates "reflect the large amount of uncertainty" [p. 3 8]. High values for SO2 are derived by assuming the marginal benefit of abatement in an attainment area is equal to 10 percent of the marginal benefit of attainment in a highly polluted area. "High values for other emissions are derived from the Southern California estimates using high values for the social cost of each of the health effects" [p. 38]. Dr. Lave's estimates for the marginal benefit of abating each emission are summarized in the following table. Interim CO2 Externality Values There is a great deal of uncertainty with respect to the extent of global warming and its effects on human health and wildlife. "Abatement action, if warranted, should await at least a partial resolution of uncertainty" [p.40]. Dr. Lave recommends the use of the externality values developed by Professor William Nordhaus of $2 to $10 per ton.

30 bereft of analysis or considerations of social marginal cost and marginal benefit that it is hard to credit any argument about this selection optimizing anything, save possibly temporary political gain"[p.9]. Accepting marginal cost ofcontrol as a good proxy for marginal benefit involves the logical inconsistency that things are already optimal and that further changes to emission standards will only make things worse.
Environmental Externality Valuations Since "we found that the relationship between air pollution and health was not statistically significant for areas attaining the primary air quality standards"[p.27], zero values are assigned as the best estimate of the direct health related impacts of all emissions except those incurred indirectly through ozone. Best estimates and high estimates of externality values associated with particular emissions are given. High estimates "reflect the large amount ofuncertainty"[p.38]. High values for S02 are derived by assuming the marginal benefit of abatement in an attainment area is equal to 10 percent ofthe marginal benefit of attainment in a highly polluted area. "High values for other emissions are derived from the Southern California estimates using high values for the social cost of each ofthe health effects" [po 38]. Dr. Lave's estimates for the marginal benefit of abating each emission are summarized in the following table.
Interim CO2 Externality Values There is a great deal of uncertainty with respect to the extent of global warming and its effects onhumanhealth andwildlife. "Abatement action, ifwarranted, should await atleast a partial resolution ofuncertainty" [p.40]. Dr. Lave recommends the use ofthe externality values developed by Professor William Nordhaus of $2 to $10 per ton.

30DR. LESTER LAVE ESTIMATES OF EXTERNALITY VALUES PER TON FOR MASSACHUSETTS

SO2 Health $ N $ 800

Visibility 10 40 Other 50 150 Total $ 60 $ 990 PM10 Health $ N $1,100

Visibility 100 400 Total $ 100 $1,500 NO2 Direct Health $ N $ N

Via Ozone 50 400 Other 20 50 Total $ 70 $ 450 VOC Direct Health $ N $ N

Via Ozone 580 1,700 Other 20 100 Total $ 600 $1,800 CO Health N N CO2 2 10 N = Negligible Appropriateness of State PUC-unposed Values Although dollar values are the appropriate measure of marginal benefits, state regulators "will have to be highly selective and careful in determining how to monetize environmental externalities and how it uses these dollar estimates" [p. 8]. Given the current federal and state command and control system of environmental regulation, PUCs "will find it difficult to improve environmental quality while lowering cost, rather than adding another inefficiency and another layer of red tape" [p. 8]. PUCs must be aware that applying artificially high estimates, such as those derived under a cost of control methodology, "will be costly to society. It will lead to unwarranted emissions control expenditures or to choosing an inappropriate technology. If the prices lead to choosing the wrong technology, they could increase health and environmental damages" [pp. 43-44].
SUPPORTING DOCUMENTATTON None fully cited.

31 DR. LESTER LAVE ESTIMATES OF EXTERNALITY VALUES PER TON FOR MASSACHUSETTS

Health $ N $ 800 Visibility 10 40 Other --.2Q**~** Total $ 60 $ 990 PMlO Health $ N $1,100 Visibility --1QQ -.1QQ Total $ 100 $1,500 Direct Health $ N $ N Via Ozone 50 400 Other --.1Q**~** Total $ 70 $ 450 VOC Direct Health $ N $ N Via Ozone 580 1,700 Other --.1Q --1QQ Total $ 600 $1,800 CO Health N N 2 10 N 

### = Negligible Appropriateness of State PUC-imposed Values Although dollar values are the appropriate measure of marginal benefits, state regulators "will have to be highly selective and careful in determining how to monetize environmental externalities and how it uses these dollar estimates" [po 8]. Given the current federal and state command and control system of environmental regulation, PUCs "will find it difficult to improve environmental quality while lowering cost, rather than adding another inefficiency and another layer of red tape" [po 8]. PUCs must be aware that applying artificially high estimates, such as those derived under a cost of controlmethodology, "willbe costly to society. Itwill lead to unwarranted emissions control expenditures or to choosing aninappropriate technology. Ifthe prices lead to choosing the wrong technology, they could increase health and environmental damages" [pp. 43-44].
SUPPORTING DOCUMENTATION None fully cited.



### 31market price of the allowances also makes the economic impact on society difficult to

predict. It is this approach that Dr. Lester recommends as an alternative to the monetized approach adopted by the Massachusetts D.P.U. In essence, the approach developed for SO2 under the federal Clean Air Act Amendments would be emulated for the air pollutants covered under the current state agency policy. Emission taxes are levied on specific pollutant emissions so as to reduce the economic viability of the polluting energy source. Alternately, tax credits may be granted for non-polluting energy sources or rebates issued for qualifying new equipment or facilities purchases. Although pollution taxes provide control over economic impacts and, in principle, are cost-effective, the tax level should be set in accordance with the associated environmental costs. And, knowledge of these costs is frequently lacking. Furthermore, the resultant emissions reductions are difficult to predict.
Scope of Monetized Environmental Externalities Environmental externality costs are applied only in the selection process for new electric power sources. The exclusion of existing power plants greatly curtails the environmental benefits realized in all but the very long term; "in effect, it only makes environmental adjustments to the long-run marginal cost of supply" [p. 15] and may actually precipitate negative environmental impacts. Short-term decisions on the use of existing generating capacity are unaffected. By effectively increasing the cost only of new capacity additions, this approach "creates a bias against the replacement of existing capital stock, where the principal environmental gains are to be had" [p. 18]. Environmental Dispatch A system-wide approach to utilizing existing capacity, not the modification of new resource decisions, is the key to cost-effective emissions reductions. "Environmental quality will actually decline if, for example, the selection of a DSM resource ahead of a new, low-emissions generating unit as a result of considering externalities leads to continued or even increased dispatch of a much dirtier existing unit on the system" [p. 17]. However, even if existing plants were also included in a monetized environmental externality approach, the policy would still fail to address other in-state sources of the same pollutants. In so doing, "the piecemeal nature of the (state) regulatory regime would seriously distort the outcome" [p.18]. Zero Externality Values The application of an externality value to residual SO2 emissions from new resources is made redundant by the 1990 Amendments to the Clean Air Act and should be completely

34 market price of the allowances also makes the economic impact on society difficult to predict. Itis this approach thatDr. Lesterrecommends as an alternative to the monetized approach adopted by the Massachusetts D.P.U. In essence, the approach developed for S02 under the federal Clean Air Act Amendments would be emulated for the air pollutants covered under the current state agency policy. Emission taxes are levied on specific pollutant emissions so as to reduce the economic viability of the polluting energy source. Alternately, tax credits may be granted for non-polluting energy sources or rebates issued for qualifying new equipment or facilities purchases. Although pollution taxes provide control over economic impacts and, in principle, are cost-effective, the tax level should be set in accordance with the associated environmental costs. And, knowledge ofthese costs is frequently lacking. Furthermore, the resultant emissions reductions are difficult to predict. Scope ofMonetized Environmental Externalities Environmental externality costs are applied only in the selection process for new electric power sources. The exclusion of existing power plants greatly curtails the environmental benefits realized in all but the very long term; lIin effect, it only makes environmental adjustments to the long-run marginal cost of supplyll [po 15] and may actually precipitate negative environmental impacts. Short-term decisions on the use of existing generating capacity areunaffected. By effectivelyincreasing thecost only ofnewcapacityadditions, this approach IIcreates a bias against the replacement of existing capital stock, where the principal environmental gains are to be hadII [po 18].
Environmental Dispatch A system-wide approach to utilizing existing capacity, not the modification ofnew resource decisions, is the key to cost-effective emissions reductions. "Environmental quality will actually decline if, for example, the selection of a DSM resource ahead of a new, low-emissions generating unit as a result of considering externalities leads to continued or even increased dispatch of a much dirtier existing unit on the systemll [po 17]. However, evenifexistingplants were also includedin amonetized environmental externality approach, the policy would still fail to address other in-state sources of the same pollutants. In so doing, lithe piecemeal nature of the (state) regulatory regime would seriously distort the outcomell [p.18].
Zero Externality Values The application of an externality value to residual S02 emissions from new resources is made redundant by the 1990 Amendments to the Clean Air Act and should be completely
34eliminated. The social cost of residual SO2 emissions is internalized under the federal

legislation and any additional externality cost would amount to double counting. The use of marginal cost of control to estimate an externality value for carbon dioxide raises a fundamental problem: no regulations curbing CO2 emissions have yet been enacted. "The inferred externality value under present conditions must therefore be zero. Until [regulatory action is taken], there can be no grounds for applying the cost of control method because there is no basis for choosing one control technology over any another for the purposes of pricing the externality" [p. 37].
Interim CO2 Externality Values Given the major uncertainties surrounding the climatological consequences of different greenhouse gas emissions rates and the economic impacts of climate change, only a very crude balancing of costs and benefits can now be made. The United States could set a goal of maintaining aggregate emissions at their current levels by the year 2000. A carbon tax could be imposed on all primary fuels to maintain CO2 emissions at 1990 levels. Due to the inaction of the federal government and most states, the effectiveness of unilateral action on CO2 by any single state is limited
. Therefore, a discount factor of 50 percent could be applied to the tax schedule developed by Harvard economists Dale Jorgenson and Peter Wilcoxen. This would set at a rate of 10 cents per ton of CO2 in the first year (1991) and increased initially by about the same amount until the rate stabilized at $2.30 per ton after the year 2020
. Regardless of the actual value selected, the state D.P.U. should permit plant owners to reduce their effective CO2 emissions through the purchase of greenhouse gas offsets (e.g., recycling CFCs from obsolete automobile air conditioners , collecting methane now vented from coal mines or landfills and the using demand-side management measures to reduce fossil fuel consumption).
Fuel Switching If consideration of environmental externality costs significantly adds to the price of electricity, consumers will be motivated to substitute for non-electric sources upon which externality costs have not been imposed. In turn, these may be more polluting sources that would defeat the very intent of the policy. Appropriateness of State PUC-imposed Values In principle, state regulatory action is appropriate only when the environmental impacts are primary local. This is not the case for the many pollutants emitted from electric power plants that extend beyond state boundaries. Unless environmental cost adders are widely adopted across state jurisdictions, individual state PUC action will place an additional economic burden on residents of that state, create a competitive disadvantage for industry housed in that state and stimulate the relocation of business and power producer operations. 35 eliminated. The social cost of residual S02 emissions is internalized under the federal legislation and any additional externality cost would amount to double counting. The use ofmarginal cost ofcontrolto estimate an externalityvalue for carbon dioxide raises a fundamental problem: no regulations curbing CO2emissions have yet been enacted. liThe inferred externalityvalue underpresentconditionsmust thereforebezero. Until [regulatory action is taken], there can be no grounds for applying the cost of control method because there is no basis for choosing one control technology over any another for the purposes of pricing the externality" [po 37].
Interim CO2 Externality Values Given the major uncertainties surrounding the climatological consequences of different greenhouse gas emissions rates and the economic impacts of climate change, only a very crude balancing of costs and benefits can now bemade. The United States could set a goal of maintaining aggregate emissions at their current levels by the year 2000. A carbon tax could be imposed on all primary fuels to maintain CO2emissions at 1990 levels. Dueto theinaction ofthefederal government andmost states, the effectiveness ofunilateral action onCO2by any single state is limited. Therefore, a discount factor of50 percent could be applied to the tax schedule developed by Harvard economists Dale Jorgenson and Peter Wilcoxen. This would set at a rate of 10 cents per ton of CO2in the first year (1991) and increased initially by about the same amount until the rate stabilized at $2.30 per ton after the year 2020. Regardless ofthe actualvalue selected, the state D.P.U. should permit plant owners to reduce their effective CO2 emissions through the purchase of greenhouse gas offsets (e.g., recycling CFCs from obsolete automobile air conditioners, collecting methane now vented from coal mines or landfills and the using demand-side management measures to reduce fossil fuel consumption).
Fuel Switching Ifconsiderationofenvironmental externalitycosts significantly adds totheprice ofelectricity, consumers will be motivated to substitute for non-electric sources upon which externality costs have not been imposed. In turn, these may be more polluting sources that would defeat the very intent of the policy. Appropriateness of State PUC-imposed Values Inprinciple, stateregulatory actionis appropriate only when the environmental impacts are primary local. This is not the case for the many pollutants emitted from electric power plants that extend beyond state boundaries. Unless environmental cost adders are widely adopted across state jurisdictions, individual state PUC action will place an additional economicburden on residents ofthat state, create a competitive disadvantage for industry housedinthat state and stimulatetherelocation ofbusiness andpowerproduceroperations. 35Ultimately, these ratepayers will not reap the full environmental benefits of their increased

expenditures. This situation is exacerbated by the inability to differentiate among sources anywhere in the world of certain pollutants. In the case of carbon dioxide, this dictates the imposition of environmental cost adders at the global level. For pollutants like sulfur dioxide, implementation should be at the regional or national level.
Potential PUC Conflicts/Disadvantages Factoring environmental costs of electricity generation into production costs is a "clear departure from the historical mission of utility commissions, and is potentially in conflict with that mission" [p. 23] -- protecting consumers against monopolistic exploitation by ensuring utilities provide reliable service at the lowest possible cost. Conversely, externalities is an environmental protection policy that increases ratepayer costs. "In implementing this policy, the (PUC) is implicitly making a trade-off between the economic well-being of the (state's) ratepayers and the perceived environmental well-being of out-of-state residents" [p. 25]. Furthermore, the state regulatory agency is assuming responsibilities that continue to rest with environmental agencies. In turn, this creates a need for administrative capabilities within PUCs that are essentially duplicative of those held by other state agencies. A third potential consequence of this co-mingling of institutional functions could be increased electricity prices to achieve environmental goals. Given that the power to regulate is the power to tax, lifting the obligation to hold rates to a minimum would remove "a principle barrier to its irresponsible exercise" [p. 26]. Furthermore, the introduction of environmental externalities into the IRM process creates "additional opportunities for advocates of specific environmental goals to achieve their objectives, irrespective of whether a broad political or scientific consensus... has been reached" [p.29].
SUPPORTING DOCUMENTATION Andrews, Clinton J. and Stephen R. Connors. "Existing Capacity -- The Key to Reducing Emissions." MIT Energy Laboratory, 17 May 1991 (draft). Andrews, Clinton J. "The Marginality of Regulating Marginal Investments," 11 June 1991 (forthcoming in Energy Policy). Jorgenson, Dale and Peter Wilcoxen. "Reducing U.S. Carbon Dioxide Emissions: The Cost of Different Goals." Department of Economics, Harvard University, December 1990 (mimeo). Kahn, Alfred. Wall Street Journal, 7 August 1991.

36 Ultimately, these ratepayers will not reap the full environmental benefits oftheir increased expenditures. This situationis exacerbatedby the inability to differentiate among sources anywhere in the world of certain pollutants. In the case of carbon dioxide, this dictates the imposition of environmental cost adders at the global level. For pollutants like sulfur dioxide, implementation should be at the regional or national level.
Potential PUC Conflicts/Disadvantages Factoring environmental costs of electricity generation into production costs is a "clear departurefrom thehistoricalmission ofutility commissions, andis potentiallyinconflict with that mission" [po 23] -- protecting consumers against monopolistic exploitation by ensuring utilities provide reliable service at the lowest possible cost. Conversely, externalities is an environmental protection policy that increases ratepayer costs. "In implementing this policy, the (PUC) is implicitly making a trade-off between the economic well-being ofthe (state's) ratepayers and the perceived environmentalwell-being of out-of-state residents" [po 25]. Furthermore, the state regulatory agency is assuming responsibilities that continueto restwith environmental agencies. Inturn, this creates a need for administrative capabilities within PUCs that are essentially duplicative ofthose held by other state agencies. A third potential consequence of this co-mingling of institutional functions could be increasedelectricityprices to achieve environmentalgoals. Given that thepowerto regulate is the power to tax, lifting the obligation to hold rates to a minimum would remove "a principle barrier to its irresponsible exercise" [po 26]. Furthermore, the introduction of environmental externalities into the IRM process creates "additional opportunities for advocates ofspecific environmentalgoals to achieve their objectives, irrespective ofwhether a broad political or scientific consensus...has been reached" [p.29].
SUPPORTING DOCUMENTATION Andrews, Clinton J. and Stephen R. Connors. "Existing Capacity -- The Key to Reducing Emissions." MIT Energy Laboratory, 17 May 1991 (draft). Andrews, Clinton J. "The Marginality of Regulating Marginal Investments," 11 June 1991 (forthcoming in Energy Policy). Jorgenson, Dale and Peter Wilcoxen. "Reducing U.S. Carbon Dioxide Emissions: The Cost of Different Goals." Department of Economics, Harvard University, December 1990 (mimeo). Kahn, Alfred. Wall Street**Journa~** 7 August 1991.
36National Academy of Sciences

. Policy Implications of Greenhouse Warming.- Report of the

Mitigation Panel. Washington, D.C.: National Academy Press, 1991. New York Times, 23 September 1991. Shimshak, R. et al. "Comments of the Division of Energy Resources for D.P.U. 89-239," 23 February 1990.

37 National Academy of Sciences. Policy Implications ofGreenhouse Warming: Report ofthe Mitigation Panel. Washington, D.C.: National Academy Press, 1991. New York Times} 23 September 1991. Shimshak, R. et al. "Comments ofthe Division ofEnergy Resources for D.P.U. 89-239," 23 February 1990.

37J. N EPA Public Utility Commission of Texas 7800 Shoal Creek Boulevard Austin, Texas 78757

PROFILE Mr. Nalepa is a Fuel Analyst in the Electric Division of the Public Utility Commission (PUC) of Texas. Prior to joining the Commission in 1988, he served as a Reservoir Engineer and Technician with an oil and natural gas exploration company for eight years.
TESTIMONY REFERENCED "Direct Testimony of Karl J. Nalepa, Electric Division, Public Utility Commission of Texas on the Application of Texas Utilities Electric Company for Approval of its Notice of Intent," Public Utility Commission of Texas Docket No. 10400, August 28, 1991.
STATE REGULATORY ISSUE ADDRESSED The PUC is required to review the notification filed by TU Electric of its intent to construct new generating facilities. As directed under Substantive Rule 23.31, environmental costs and benefits must be considered for each proposed facility in a utility's Notice of Intent. This requires the monetization of externalities as part of the resource application.
SUMMARY OF CONCLUSIONS Contending that the total cost of a power supply option can only be evaluated when all environmental costs are considered, Mr. Nalepa recommends that the Commission should further investigate environmental externalities and establish either specific values or more specific guidelines for addressing environmental costs in resource plans. He further recommends that TU Electric expand the boundaries of the environmental costs it now considers and incorporate those costs into its subsequent Commission filings.
KEYISSUES The following issues concerning environmental externalities were raised in the direct testimony of Mr. Nalepa. Page citations directly follow all direct quotations from this testimony.

38 PROFILE KARL 

### J. NALEPA Public Utility Commission ofTexas 7800 Shoal Creek Boulevard Austin, Texas 78757

Mr. Nalepa is a Fuel Analyst in the Electric Division of the Public Utility Commission (PUC) of Texas. Prior to joining the Commission in 1988, he served as a Reservoir Engineer and Technician with an oil and natural gas exploration company for eight years.
TESTIMONY REFERENCED IIDirect Testimony ofKarl 

### J. Nalepa, Eleytric Division, Public Utility Commission ofTexas on theApplication ofTexas UtilitiesElectric Companyfor Approval ofits Notice ofIntent,1I Public Utility Commission ofTexas Docket No. 10400, August 28, 1991.
STATE REGULATORY ISSUE ADDRESSED ThePUCis required to review the notification filed by TUElectric ofits intent to construct newgeneratingfacilities. As directedunderSubstantiveRule23.31, environmental costs and benefits must be considered for each proposed facility in a utility's Notice ofIntent. This requires the monetization of externalities as part ofthe resource application.
SUMMARY OF CONCLUSIONS Contending that the total cost of a power supply option can only be evaluated when all environmental costs are considered, Mr. Nalepa recommends that the Commission should further investigate environmental externalities and establish either specific values or more specific guidelines for addressing environmental costs in resource plans. He further recommends that TU Electric expand the boundaries of the environmental costs it now considers and incorporate those costs into its subsequent Commission filings.
KEY ISSUES The following issues concerning environmental externalities were raised in the direct testimony of Mr. Nalepa. Page citations directly follow all direct quotations from this testimony.

38Environmental Externality Policy Options

Environmental externalities are "costs to society resulting from provision of electric services, which costs are not already incorporated in the price of electric services
. They are costs which occur after all government

-imposed environmental standards and regulations are met" [p. 10]. The incorporation of real environmental costs into the utility planning process allows for a true determination of least

-cost sources of future electricity. The most significant environmental effects "which may result directly from fossil fuel-fired power plants" [p. 6] are health care, acid rain, global warming and visibility impairment.

Environmental Externality Valuation Approaches "It is generally believed that unaccounted for costs to society occur as a result of power plant operations and, as difficult as it may be, a serious attempt should be made to quantify those costs" [p. 11]. The two methods for estimating externality values are: damage costs can be established directly and this method "is useful when appropriate analogous examples are available" [p. 12]; and cost of control estimates are the physical costs "of attaining a legislated level of emissions, not the societal costs attributable to the particular pollutant. There may be little relationship between control costs and the actual effects on human health or the landscape " [p. 12]. In proposing monetized externality values , Mr. Nalepa uses the values adopted by the Nevada PUC. He contends that these are applicable to resource planning in Texas. Using the TU Electric 's costs of compliance for sulfur dioxide emissions, as required under the Clean Air Act Amendments of 1990, and "assuming external environmental costs of 5.1 cents per kWh, [Mr. Nalepa] estimated the additional environmental cost of these remaining emissions as $203 million per year" [p. 17]. "By adding environmental costs as estimated by the Public Service Commission of Nevada" [p. 17], the total cost of a pulverized coal plant and an integrated gasification combined cycle plant are nearly identical.
Zero Externality Values Mr. Nalepa concurs with the position of F. Paul Bland, as quoted in the Pace study. "A decision not to consider external costs in itself quantifies them by setting their value at zero. This is unreasonable, given both the strong evidence that the costs are massive, and the significant difference between the externalized costs of traditional central station plants and 39 Environmental Externality Policy Options Environmental externalities are "costs to societyresultingfrom provision ofelectric services, which costs are not already incorporated in the price of electric services. They are costs which occur after all government-imposedenvironmental standards and regulations aremet" [po 10]. The incorporation ofreal environmental costs into the utility planning process allows for a true determination ofleast-cost sources offuture electricity. The most significant environmental effects "which may result directly from fossil fuel-fired power plants" [po 6] are health care, acid rain, global warming and visibility impairment.
Environmental Externality Valuation Approacbes "Itis generallybelievedthatunaccountedfor costs to society occur as a result ofpowerplant operations and, as difficult as it maybe, a serious attempt shouldbemade to quantify those costs" [po 11]. The two methods for estimating externality values are:

• damage costs canbe established directly and this method "is useful when appropriate analogous examples are available" [po 12]; and
• cost of control estimates are the physical costs "of attaining a legislated level of emissions, not the societal costs attributable to the particular pollutant. There may belittle relationship between control costs and the actual effects on humanhealth or the landscape" [po 12]. In proposing monetized externality values, Mr. Nalepa uses the values adopted by the Nevada PUc. He contends that these are applicable to resource planning in Texas. Using the TUElectric's costs of compliance for sulfur dioxide emissions, as required under the CleanAir Act Amendments of 1990, and "assuming external environmental costs of5.1 cents perkWh, [Mr. Nalepa] estimatedthe additional environmental cost ofthese remaining emissions as $203 million per year" [po 17]. "By adding environmental costs as estimated by the Public Service Commission ofNevada" [po 17], thetotal cost ofa pulverized coalplant and anintegratedgasification combined cycle plant are nearly identical.
Zero Externality Values Mr. Nalepa concurs with the position of F. Paul Bland, as quoted in the Pace study. itA decision not to consider external costs in itselfquantifies them by setting theirvalue at zero. This is unreasonable, given both the strong evidence that the costs are massive, and the significant differencebetween the externalized costs oftraditional central station plants and 39alternative energy facilities. A crude approximation, made as exact as possible and changed

over time to reflect new information, would be preferable to the manifestly unjust approximation caused by ignoring those costs" [p. 11].
SUPPORTING DOCUMENTATION Clean Air Act Amendments. Senate Report No. 101-228. Norris, James E. "The Navajo Generating Plant and Grand Canyon Haze," Public Utilities Fortnightly, 15 January 1991. Pace University Center for Environmental Legal Studies. Environmental Costs of Electricity. (New York: Oceana Publications, 1990). Putta, Sury N. "Weighing Externalities in New York State," The Electricity Journal, July 1990. Texas Air Control Board. "Air Quality in Texas." December 1988. Utility Environment Report. 19 April, 17 May, 31 May, 26 July 1991. Wiel, Stephen. "Nevada Adopts Clean Power Rule." Presented at Conference on Demand-Side Management and the Global Environment, April 1991.

40 alternative energyfacilities. A crude approximation, made as exact as possible and changed over time to reflect new information, would be preferable to the manifestly unjust approximation caused by ignoring those costs" [po 11].
SUPPORTING DOCUMENTATION Clean Air Act Amendments. Senate Report No. 101-228. Norris, James E. "The Navajo Generating Plant and Grand Canyon Haze," Public Utilities Fortnightly, 15 January 1991. Pace University Centerfor Environmental Legal Studies.Environmental Costs of Electricity. (New York: Oceana Publications, 1990). Putta, Sury N. "WeighingExternalities inNew YorkState," TheElectricityJournal, July 1990. Texas Air Control Board. "Air Quality in Texas." December 1988. Utility Environment Report. 19 April, 17 May, 31 May, 26 July 1991. Wiel, Stephen. "Nevada Adopts Clean Power Rule." Presented at Conference on Demand-Side Management and the Global Environment, April 1991.

40WILLIAM D. NORDHAUS Yale University 445 Humphrey Street New Haven, Connecticut 06511

PROFILE Dr. Nordhaus is the John Musser Professor of Economics at Yale and a research staff member of the Cowles Foundation for Research in Economics. He previously served as a member of President Carter's Council of Economic Advisors and as Provost of Yale. His economic research has been focused on energy, natural resources and the environment, with a recent emphasis on greenhouse warming. A co-author of the classic textbook, Economics, Dr. Nordhaus has served on several National Academy of Sciences committees.
TESTIMONY REFERENCED "Testimony of Dr. William D. Nordhaus on Behalf of Massachusetts Electric Company in the Investigation by the Department on its Own Motion as to the Environmental Externality Values to be Used in Resource Cost-Effectiveness Tests by Electric Companies Subject to the Department's Jurisdiction," Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131, May 16, 1991.

STATE GU TORY ISSUE ADDRESSED The Massachusetts Department of Public Utilities (D.P.U.) is investing monetized environmental externality values and their inclusion in the electric utility integrated resource management process.
SUMMARY OF CONCLUSIONS Dr. Nordhaus concludes that $2 per metric ton (in 1989 dollars) is a reasonable estimate of the optimal value of reducing carbon dioxide (C02) emissions. In lieu of using this monetized value in resource planning, he recommends utilities be allowed to acquire or produce offsets if they were more economical than the $2 per metric ton cost.
KEY ISSUES The following issues concerning environmental externalities were raised in the direct testimony of Dr. Nordhaus. Page citations directly follow all direct quotations from this testimony. 41 WILLIAM D. NORDHAUS Yale University 445 Humphrey Street New Haven, Connecticut 06511

PROFILE Dr. Nordhaus is the John Musser Professor of Economics at Yale and a research staff member ofthe Cowles Foundation for Research in Economics. He previously served as a member ofPresident Carter's Council ofEconomic Advisors and as Provost of Yale. His economicresearchhasbeenfocused onenergy, naturalresources andthe environment, with a recent emphasis ongreenhousewarming. A co-author ofthe classic textbook, Economics, Dr. Nordhaus has served on several National Academy of Sciences committees.
TESTIMONY REFERENCED "Testimony of Dr. William D. Nordhaus on Behalf of Massachusetts Electric Company in the InvestigationbytheDepartment onits OwnMotion as to theEnvironmentalExternality Values to be Used in Resource Cost-Effectiveness Tests by Electric Companies Subject to the Department's Jurisdiction," Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131, May 16, 1991.
STATE REGULATORY ISSUE ADDRESSED The Massachusetts Department of Public Utilities (D.P.U.) is investing monetized environmental externalityvalues andtheirinclusionin the electricutilityintegratedresource management process.
SUMMARY OF CONCLUSIONS Dr.Nordhaus concludes that $2 permetric ton (in 1989 dollars) is a reasonable estimate of the optimal value of reducing carbon dioxide (C02) emissions. In lieu of using this monetized value in resource planning, he recommends utilities be allowed to acquire or produce offsets if they were more economical than the $2 per metric ton cost.
KEY ISSUES The following issues concerning environmental externalities were raised in the direct testimony of Dr. Nordhaus. Page citations directly follow all direct quotations from this testimony. 

### 41Environmental Externality Poligy Options

"At present, there are great uncertainties about virtually every stage of the relationship between emissions of greenhouse gases (GHGs) and the ultimate impact upon human and natural societies. Although there is a scientific consensus about the existence of the greenhouse effect, the range of possible outcomes is extremely large" [p. 5]. Of the following three policy options relative to GHGs, Dr. Nordhaus concludes that the first strategy "is most relevant for policy because preventative steps can be taken today" [p. 6], while the remaining two can be initiated as climate changes occur. 1. Prevention -- Take steps such as phasing out CFCs, reducing energy consumption or switching to non-fossil fuel to prevent or slow GHG emissions. 2. Climatic Engineering -- Offset climatic warming through CO2 removal or climatic engineering. Among the options considered are reforestation. 3. Adaptation -- Responses to warmer climates made by people, institutions and markets. Environmental Externality Valuation Approaches The impact of climatic change is assessed in terms of both damage costs and reduction benefits. Cost estimates of GHG reductions are based on a survey conducted by Dr. Nordhaus which looked at those achieved through: "(1) reducing CFC emissions, (2) reducing CO2 emissions, and (3) increasing the carbon locked up in trees" [p. 6]. Although there are more than 12 different cost estimates for reducing CO2 that frequently differ by a factor of two or three, "the general shape of the cost curves are similar. The costs of CFC reduction are not terribly controversial. By contrast, the estimates of reforestation options are highly controversial and not well documented" [pp. 6-7]. Benefit values of GHG reduction were derived through the use of a static cost-benefit model. These estimates reflect the"optimal degree of control of greenhouse gases along with an associated value for the reduction of CO2 and other greenhouse gases" [p. 9].

Interim CO2 Externality Values Although estimating the damages from greenhouse warming is extremely difficult, a "doubling of CO2 will lead to economic damages of around $13 billion per year (for the United States, in 1989 prices and at 1989 levels of economic activity). This amounts to approximately one-fourth of one percent of U.S. gross national product" [p. 8].

42 Environmental Externality Policy Options "At present, there are great uncertainties about virtually every stage of the relationship between emissions ofgreenhouse gases (GHGs) and the ultimate impact upon human arid natural societies. Although there is a scientific consensus about the existence of the greenhouse effect, the range ofpossible outcomes is extremely large" [po 5]. Ofthefollowing threepolicy optionsrelative to GHGs,Dr.Nordhaus concludesthatthefirst strategy "is most relevant for policy because preventative steps can be taken today" [po 6], while the remaining two can be initiated as climate changes occur. 1. Prevention -- Take steps such as phasing out CFCs, reducing energy consumption or switching to non-fossil fuel to prevent or slow GHG emissions. 2. Climatic Engineering -- Offset climatic warming through CO2 removal or climatic engineering. Among the options considered are reforestation. 3. Adaptation -- Responses to warmer climates made by people, institutions and markets.
Environmental Externality Valuation Approaches The impact of climatic change is assessed in terms of both damage costs and reduction benefits. Cost estimates ofGHGreductions arebased on a survey conductedbyDr. Nordhaus which looked atthose achieved through: "(1) reducing CFCemissions, (2) reducing CO2 emissions, and (3) increasing the carbon locked up in trees" [po 6]. Although there are more than 12 different cost estimates for reducing CO2 that frequently differ by a factor oftwo or three, "the general shape of the cost curves are similar. The costs of CFC reduction are not terribly controversial. By contrast, the estimates of reforestation options are highly controversial and not well documented" [pp. 6-7]. Benefit values of GHG reduction were derived through the use of a static cost-benefit model. These estimates reflectthe"optimaldegree ofcontrolofgreenhousegases alongwith an associated value for the reduction of CO2 and other greenhouse gases" [po 9].
Interim CO2 Externality Values Although estimating the damages from greenhouse warming is extremely difficult, a "doubling of CO2 will lead to economic damages of around $13 billion per year (for the United States, in 1989 prices and at 1989 levels of economic activity). This amounts to approximately one-fourth of one percent of U.S. gross national product" [po 8].

42The three estimates of the benefits of reducing greenhouse gases are: a "best guess" of $2

per ton of C02; a "low" estimate of $0.50 per ton of C02; and a "high" estimate of $18 per ton of CO2. As shown in studies conducted by Dr. Nordhaus and by the National Academy of Sciences, "there is an ample supply of C02-equivalent emissions that can be curbed at costs of no more than $2 per ton of C02" [p. 13].
Appropriateness of State PUC4i posed Values "There are serious questions about the efficiency of approaches that mitigate a global externality in a region or industry that constitutes only a tiny fraction of the sources of that externality. If a small region takes steps to reduce its greenhouse gas emissions while others do not, this will lead to major economic inefficiencies and to an unfair sharing of the costs" [p. 10].
SUPPORTING DOCUMENTATION Lashof, Daniel A. and Dilip R. Ahuja.'Relative Contributions of Greenhouse Gas Emissions to Global Warming," Nature, vol. 344, April 5, 1990, pp. 529-531. National Academy of Sciences. Policy Implications of Greenhouse Warming. Washington, DC: National Academy Press, 1991. Nordhaus, William D. "The Cost of Slowing Climate Change: A Survey," The Energy Journal, vol. 12, no. 1, pp. 37-65. Nordhaus, William D. "To Slow or Not To Slow: The Economics of the Greenhouse Effect," Economic Journal , vol. 101, May 1991.

43 The three estimates ofthe benefits ofreducing greenhouse gases are: a "best guess" of$2 per ton of CO2; a "low" estimate of$0.50 per ton of CO2; and a "high" estimate of$18 per ton of CO2• As shown in studies conducted by Dr. Nordhaus and by the National Academy ofSciences, "there is an ample supply of CO2-equivalent emissions that can be curbed at costs of no more than $2 per ton of CO2'' [po 13]. Appropriateness of State PUC-imposed Values "There are serious questions about the efficiency of approaches that mitigate a global externality in a region orindustry that constitutes only a tiny fraction ofthe sources ofthat externality. Ifa small region takes steps to reduceits greenhouse gas emissions while others do not, this will lead to major economic inefficiencies and to an unfair sharing ofthe costs" [po 10].
SUPPORTING DOCUMENTATION Lashof, DanielA. andDilipR. Ahuja. "Relative Contributions ofGreenhouse GasEmissions to Global Warming," Nature, vol. 344, April 5, 1990, pp. 529-531. NationalAcademyofSciences.PolicyImplications of Greenhouse Warming. Washington, DC: National Academy Press, 1991. Nordhaus, William D. "The Cost of Slowing Climate Change: A Survey," The Energy**Journa~** vol. 12, no. 'I, pp. 37-65. Nordhaus, William D. "To Slow or Not To Slow: The Economics of the Greenhouse Effect," Economic Journal, vol. 101, May 1991.

43ROBERT D. ROWE RCG/llagler Bailly, Inc. P.O. Drawer 0 Boulder, Colorado 80306

PROFILE Dr. Rowe is a Senior Vice President of RCG/Hagler Bailly and Director of the consulting firm's Environmental Economics, Science and Policy Division. For more than 15 years, he has researched the development and application of damage-based externality valuation methods. At present, he is Project Manager for a multi-year study to assess and model environmental externality damages of electricity resources in the State of New York. His additional experience includes serving as an officer of the Association of Environmental and Resource Economists and a consultant member of the U.S. EPA Science Advisory Board, Clean Air Science Advisory Committee.

TESTIMONY REFERENCED "Direct Testimony of Robert D. Rowe on Behalf of Massachusetts Electric Company on Valuation of Other Environmental Externalities," Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131, October 4, 1991.
STATE REGULATORY ISSUE ADDRESSED On its own motion, the Massachusetts Department of Public Utilities (D.P.U.) undertook an investigation of the monetized environmental externality values to be used in utility resource planning. As set forth in D.P .U. Order 89-239, monetized values were assigned to eight air pollutants and utilities were directed to develop values for other externalities.
SUMMARY OF CONCLUSIONS Dr. Rowe presents damage values on a per unit of pollutant and per kilowatt-hour (kWh) basis for toxic air pollutants, consumptive water use, cooling water and wastewater/thermal discharge, and land use associated with new generating units (coal steam, oil and gas steam, gas turbine, combined cycle, integrated gasified coal and waste to energy). The externality values are damage-based, the approach preferred by the Massachusetts D.P.U.

44 PROFILE ROBERT D. ROWE RCG/Hagler Bailly, Inc. P.O. Drawer 0 Boulder, Colorado 80306

Dr. Rowe is a Senior Vice President ofRCG/Hagler Bailly and Director ofthe consulting firm's Environmental Economics, Science and Policy Division. For more than 15 years, he has researched the development and application of damage-based externality valuation methods. At present, he is Project Manager for a multi-year study to assess and model environmental externality damages of electricity resources in the State of New York. His additional experience includes serving as an officer ofthe Association ofEnvironmental and Resource Economists and a consultant member of the U.S. EPA Science Advisory Board, Clean Air Science Advisory Committee.
TESTIMONY REFERENCED "Direct Testimony of Robert D. Rowe on Behalf of Massachusetts Electric Company on Valuation of Other Environmental Externalities," Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131, October 4, 1991.
STATE REGULATORY ISSUE ADDRESSED On its own motion, the Massachusetts Department of Public Utilities (D.P.U.) undertook an investigation of the monetized environmental externality values to be used in utility resource planning. As set forth in D.P.U. Order 89-239, monetizedvalues were assigned to eight air pollutants and utilities were directed to develop values for other externalities.
SUMMARY OF CONCLUSIONS Dr. Rowe presents damage values on a per unit of pollutant and per kilowatt-hour (kWh)

.basis for toxic air pollutants, consumptive water use, cooling water and wastewater/thermal discharge, andlanduse associated with new generating units (coal steam, oil and gas steam, gas turbine, combined cycle, integrated gasified coal and waste to energy). The externality values are damage-based, the approach preferred by the Massachusetts D.P.U.

44ISSUES

The following issues concerning environmental externalities were raised in the direct testimony of Dr. Rowe. Page citations directly follow all direct quotations from this testimony.
Environmental Externality Valuation Approaches Dr. Rowe applies a "damage function approach linking facility operation to potential resource impacts, and then to social values (damages) for those impacts" [p. 3]. Typical levels of unmitigated residuals are identified, with damage estimates differing according to location and facility type. The estimates developed contain assumptions, rely on professional judgment to address the significance of uncertainties and omissions, and reflect "best information reasonably available." No new primary research was conducted to develop these estimates. There are several caveats pertaining to the application of these estimates. Due to the use of conservative assumptions, available literature and professional judgment, the damages may be overstated for many of the externalities examined. As the estimates apply to individual facilities supplying new capacity, damages from multiple facilities located in the same area "may exceed the sum of the individual facility estimates" [p. 13]. ® It is likely that "site-specific factors for any proposed facility may warrant inclusion or omission of specific externalities" [p. 13]. Overall, where residual emissions and resource impacts from new capacity do exist, they are small, on a per kWh basis, due to environmental regulations. "In total, the sum of the externality damages estimated amount to about 1/10th of a cent/kWh or less regardless of the location and facility type" [p. 12]. The summary of how the values were estimated for four types of environmental impacts follows. The results derived are shown in the following table (included as Tables S-1 and S-3, respectively, in Dr. Rowe's testimony). Air toxic values-were developed from "dispersion models used to link emission levels and plant stack parameters to ambient concentrations. For carcinogens, human population densities and the U.S. EPA's Integrated Risk Information System were used to estimate the maximum expected additional incidence of fatal and non-fatal cancers.. .For lead and mercury, emission rates, dispersion models and uptake biokinetic models were applied to estimate the percent of sensitive populations" [p. 4] with blood levels above "No Adverse Effects Levels". Standard economic values were then applied to both sets of increased risk. "The major result is that the value of air toxic externalities, in total, is very small. The

45 KEY ISSUES The following issues concerning environmental externalities were raised in the direct testimony of Dr. Rowe. Page citations directly follow all direct quotations from this testimony.
Environmental Externality Valuation Approaches Dr. Rowe applies a "damage function approach linking facility operation to potential resource impacts, and then to social values (damages) for those impacts" [po 3]. Typical levels ofunmitigated residuals are identified, with damage estimates differing according to location andfacility type. Theestimates developed contain assumptions, rely onprofessional judgment to address the significance of uncertainties and omissions, and reflect "best informationreasonably available." Nonewprimaryresearchwas conducted to develop these estimates. There are several caveats pertaining to the application of these estimates.

e Due to the use of conservative assumptions, available literature and professional judgment, the damages may be overstated for many ofthe externalities examined.
• As the estimates apply to individual facilities supplying new capacity, damages from multiple facilities located in the same area "may exceed the sum of the individual facility estimates" [po 13]. It is likely that "site-specific factors for any proposed facility may warrant inclusion or omission of specific externalities" [po 13]. Overall, where residual emissions andresource impacts from new capacity do exist, they are small, on a per kWh basis, due to environmental regulations. "In total, the sum of the externality damages estimated amount to about l/lOth of a cent/kWh or less regardless of the location and facility type" [po 12]. The summary of how the values were estimated for four types of environmental impacts follows. The results derived are shown in the following table (included as Tables S-l and S-3, respectively, in Dr. Rowe's testimony). Air toxic values·were developed from "dispersion models used to link emission levels and plant stack parameters to ambient concentrations. For carcinogens, human population densities andthe U.S. EPA's IntegratedRisk Information System were used to estimate the maximum expected additional incidence of fatal and non-fatal cancers...For lead and mercury, emission rates, dispersion models and uptake biokinetic models were applied to estimate the percent of sensitive populations" [po 4] with blood levels above 'No Adverse Effects Levels". ,Standard economicvalues were then applied to both sets ofincreased risk. "The major result is that the value of air toxic externalities, in total, is very small. The 

### 45change in health risks due to lead and mercury emissions from new facilities are virtually

undetectable" [p. 5]. Water consumption values were derived for water withdrawn for power plant operating processes (e.g., condensate cooling, air pollution controls, boiler blowdown) in quantities sufficient to "impair other competing uses for drinking water supplies, aquatic habitat or recreational uses" [p. 6]. In the analysis, a worst case is assumed whereby power plant consumption "precludes or alters other desirable uses" [p. 6] and is substituted or replenished from groundwater sources at a market price cost. "The results indicate that the maximum value is less than 3/100th of a cent/kWh for a coal

-fired facility, and less than 1/1,000th of a cent/ kWh for gas

- and oil-fired and MSW facilities" [p. 6]. Cooling water and wastewater/thermal discharge values reflect damage impacts due to impingement and entrainment at the plant water intake point, and heated cooling water and other wastewaters at the discharge point. In the analysis, the impact defined is that a 500 MW plant would render unusable a one mile equivalent of river or coastal shoreline for recreational fishing and a one square mile inshore area for commercial fishing. "Massachusetts average recreational participation levels, typical recreational fishing values, and commercial fishing returns were applied to estimate the value of the impaired resource" [pp. 7-8]. The resultant externality estimates are "on the order of 3/1,000th of a cent/kWh for coastal plants, and on the order of 3/10,000th of a cent/kWh for inland plants" [p. 8]. Land use impacts, including loss of open space, ash disposal and aesthetics, were assessed individually and damage estimates developed for both total land values and individual impacts. The externality values for the former are up to 1/10th of a cent/kWh for a coal-fired plant in a suburban location and 5/100th of a cent/kWh in a rural location. "Oil-fired and gas-fired plants would have damages on the order of 1/100th of a cent/kWh or less" [p. 11]. Data from Resource Preservation easements were used as an indicator of willingness to pay to avoid development of open space and similar data from Maine were used for open spaces in non-urban locations. The resultant estimates for a 500 MW oil-fired plant are "on the order of 3/1,000th of a cent/kWh for a suburban location and less than 1/1,000th of a cent/kWh for a rural location" [p. 9]. Per household values to avoid proximity (i.e., within one mile) to a hazardous waste facility in eastern Massachusetts, which are consistent with other published values, were used to indicate potential damage of ash disposal from the combustion of coal, oil, municipal solid waste (MSW) and other fuels. The estimated externality costs by plant type are: 6/100th of a cent/kWh (coal-fired plant, suburban site); less than 2/100th of a cent/kWh (coal-fired plant, rural site); and 2/10,000th of a cent/kWh (oil-fired plant). As MSW plants reduce the total quantity of landfill waste, they produce environmental benefits valued "on the order of 2/10th of a cent/kWh in urban areas, 3/100th of a cent/kWh in suburban areas and less than 1/100th of a cent/kWh in rural areas" [p. 10]. The estimated damages for potential aesthetic impacts from power plants and transmission lines were derived from Resource Protection easement values as it was assumed that such 46 change in health risks due to lead and mercury emissions from new facilities are virtually undetectableII [po 5]. Water consumption values were derived for water withdrawn for power plant operating processes (e.g., condensate cooling, air pollution controls, boiler blowdown) in quantities sufficient to "impair other competing uses for drinking water supplies, aquatic habitat or recreational uses" [po 6]. In the analysis, a worst case is assumed whereby power plant consumption "precludes oralters otherdesirableuses" [po 6] andis substitutedorreplenished from groundwater sources at a market price cost. liThe results indicate that the maximum value is less than 3/l00th of a cent/kWh for a coal-fired facility, and less than 1I1,000th of a cent/kWh for gas- and oil-fired and MSW facilities" [po 6]. Cooling water and wastewater/thermal discharge values reflect damage impacts due to impingement and entrainment at the plantwaterintakepoint, andheatedcoolingwater and otherwastewaters at the discharge point. In the analysis, the impact defined is that a 500 MW plant would render unusable a one mile equivalent of river or coastal shoreline for recreational fishing and a one square mile inshore area for commercial fishing. "Massachusetts average recreational participation levels, typical recreational fishing values, and commercialfishing returns were applied to estimate thevalue ofthe impaired resource" [pp. 7-8]. The resultant externality estimates are lion the order of 3/1,000th of a cent/kWh for coastal plants, and on the order of 3/10,000th of a cent/kWh for inland plants" [po 8]. Land use impacts, including loss of open space, ash disposal and aesthetics, were assessed individually and damage estimates developed for both total land values and individual impacts. The externality values for the former are up to 1I10th of a cent/kWh for a coal-fired plant in a suburban location and 5/100th of a cent/kWh in a rural location. "Oil-fired and gas-fired plants would have damages on the order of l/lOOth ofa cent/kWh or less" [po 11]. Datafrom Resource Preservation easements were used as an indicator ofwillingness to pay to avoid development ofopen space and similar datafrom Mainewere used for open spaces in non-urban locations. The resultant estimates for a 500 MW oil-fired plant are lion the order of 3/1,000th of a cent/kWh for a suburban location and less than l/l,OOOth of a cent/kWh for a rurallocation" [po 9]. Perhousehold values to avoid proximity (i.e., within one mile) to a hazardous waste facility in eastern Massachusetts, which are consistent with other published values, were used to indicate potential damage of ash disposal from the combustion ofcoal, oil, municipal solid waste (MSW) and other fuels. The estimated externality costs by plant type are: 6/100th of a cent/kWh (coal-fired plant, suburban site); less than 2/100th of a cent/kWh (coal-fired plant, rural site); and 2/10,000th ofa cent/kWh (oil-fired plant). As MSWplants reduce the total quantity oflandfill waste, they produce environmentalbenefits valued lion the order of 2/10th ofa cent/kWh in urban areas, 3/100th ofa cent/kWh in suburban areas and less than 1/100th of a cent/kWh in rural areas" [po 10]. The estimated damages for potential aesthetic impacts from powerplants and transmission lines were derived from Resource Protection easement values as it was assumed that such 46impacts would be reflected in property values. The estimated damages are 6/100th of a

cent/kWh in suburban areas and 1/100th of a cent/kWh in rural areas.
SUPPORTING DOCUMENTATION None cited.

47 impacts would be reflected in property values. The estimated damages are 6/100th of a cent/kWh in suburban areas and 1/100th oCa cent/kWh in rural areas.
SUPPORTING DOCUMENTATION None cited.



### 47Toxic Emission Damage

Units Annual Emissions

500 MW Coal (tons/yr) 500 MW Oil

(tons/yr) 12 MW MSW

(tons/yr) Coal/Oil-Fired Plant: 150 ft Stack

Damages (1990 $/ton) Coal Damages

(1990 $/kWh) Oil Damages

(1990 $/kWh) MSW Plant: 100 ft Stack

Damages (1990 $/ton) Damages

(1990 $/kWh)
oge Arsenic Beryllium Cadmium Chromium Nickel Dioxins Formaldehyde Furans POMs PCBs

Lead - Rural Lead - Urban Mercury 1 ton/yr

1 ton/yr 1 ton/yr 1 ton/yr 1 ton/yr 1 ton/yr 1 ton/yr 1 ton/yr 1 ton/yr 1 ton/yr
1 ton/yr 1 ton/yr 1 ton/yr 0.226 0.0014 0.013 1.52 0.552
ND 2.24 ND 0.051
ND

0.37 0.37 0.16 0.25

0.055 0.206 0.276 16.56
ND 5.32
ND 0.11
ND

0.20 0.20 0.07 0.00279

0.0000698 0.0185 0.114 0.0958 0.000000482 ND 0.000197 0.0106 0.0000383

0.44 0.44 10,304

5,751 4,313 28,756 575 NA 47 NA 6,145
NA

0 <167 0 0.00000089 0.00000000 0.00000002 0.00001663 0.00000012
NA 0.00000004
NA 0.00000012
NA

0.00 <0.00000002 0.00
t 0006171 0.00000098

0.00000012 0.00000034 0.00000302 0.00000362
NA 0.00000009
NA 0.00000026
NA

0.00 <0.00000001 0.20 0.00
0084 29,535

16,485 12,364

212 NA

0 167 0.00000092

0.00000001 0.00000256 82,423 0.00010516 1,648 0.00000177 226,660,000 0.00000122

46,980,000 0.00010358 28,050 0.00000333 3,140,000 0.00000135 cait^cluo

.................. .................. 0.00 0.00000082 0 0.00

Th0002207;, NA = Not Available ND = Not Detectable (except at trace levels) Table Notes: ROBERT D. ROWE SUMMARY OF MIDPOINT ESTIMATES OF DGES FROM AIR TOXIC EMISSIONS

1. Annual emissions are based on a 500 MW bituminous coal plant, a 500 MW residual oil plant, and a 12 MW (500 ton/day) MSW plant.

48 ROBERT D. ROWE SUMMARY OF MIDPOINT ESTIMATES OF DAMAGES FROM AIR TOXIC EMISSIONS

Toxic Emission

Arsenic Beryllium Cadmium Chromium Nickel Dioxins Formaldehyde Furans POMs PCBs Damage Units

1 ton/yr 1 ton/yr 1 ton/yr 1 ton/yr 1 ton/yr 1 ton/yr 1 ton/yr 1 ton/yr 1 ton/yr

NA

### = Not Available Annual Emissions 500MW Olal

0.226 0.25 0.0014 0.055

0.013 0.206

1.52 0.276 0.552 16.56

ND ND 2.24 5.32 ND ND 0.051 0.11

ND ND

ND = Not Detectable (except at trace levels) Table Notes: OlallOil-Fired Plant: 150 ft Stack

0.00279 10,304 0.00000089 0.00000098 0.0000698 5,751 0.00000000 0.00000012 0.0185 4,313 0.00000002 0.00000034

0.114 28,756 0.00001663 0.00000302 0.0958 575 0.00000012 0.00000362 0.000000482 NA NA NA ND 47 0.00000004 0.00000009 0.000197 NA NA NA

0.0106 6,145 0.00000012 0.00000026 0.0000383 NA NA NA MSW Plant: 100 ft Stack

29,535 0.00000092 16,485 0.00000001 12,364 0.00000256 82,423 0.00010516

1,648 0.00000177 226,660,000 0.00000122 212 NA 46,980,000 0.00010358 28,050 0.00000333 3,140,000 0.00000135

1. Annual emissions are based on a 500 MW bituminous coal plant, a 500 MW residual oil plant, and a 12 MW (500 ton/day) MSW plant.

48Table Notes (Continued)

2. Conversion to kWh is based on a 60 percent load factor for base load coal and oil plants and 100 percent load for MSW plant. 3. Unit damages for carcinogens depend on model concentrations, population exposed, carcinogenic risk factors, and medical damages, including loss of life. 4. Unit damages for mercury are $0 per ton below an emissions rate of 30 tons per year (60,000 pounds). 5. Unit damages for lead in rural areas are $0 per ton for emissions less than 30 tons per year (60,000 pounds ). In urban areas the possibility that a few children exceed the 10 ug/dI threshold leads to small, but positive, damages. 6. Estimates for 300 foot stacks are less than for 100 foot stacks (see Table 3-25).
Source: RCG/Hagler, Bailly, Inc., based on analysis described in Section 3.

49 Table Notes (Continued) 2. Conversion to kWh is based on a 60 percent load factor for base load coal and oil plants and 100 percent load for MSW plant. 3. Unit damages for carcinogens depend on model concentrations, population exposed, carcinogenic risk factors, and medical damages, including loss oflife. 4. Unit damages for mercury are $0 per ton below an emissions rate of30 tons per year (60,000 pounds). 5. Unitdamages for lead inrural areas are $0 per ton for emissions less than 30 tons peryear (60,000 pounds). In urban areas thepossibility that a few children exceed the 10 ug/dl threshold leads to small, but positive, damages. 6. Estimates for 300 foot stacks are less than for 100 foot stacks (see Table 3-25).
Source: RCG/Hagler, Bailly, Inc., based on analysis described in Section 3.

49ROBERT D. ROWE SUMMAR

Y OF DAMAGES IN DOLLARS PER KILOWATT-HOUR FOR 500 MW COAL, OIL, NATURAL GAS, AND 500 TON PER DAY (12 MW) MUNICIPAL SOLID WASTE-FIRED PLANTS

Damage Unit Damages Residual Units Damages (1900 $/ unit) Coal: 300 ft Coal: 150 ft Oil: 300 ft Oil: 150 ft Natural Gas MSW: 100 ft

(1990 $/ kWh) (1990 $/kWh) (1990 $/kWh) (1990 $/ kWh) (1990 $/

kWh) (1990 $/kWh) Air Toxics ton/yr (see Table S

-1) 0.000006 0.000018 0.000003 0.000008 0 0.000221 Water Consumption gal/yr 0.00027 0.000272 0.000272 0.000075 0.000075 0.000069 0
.000075 Wastewater Inland Site gal/ yr 0.00000005 0.000003 0.000003 0.000003 0.000003 0.000003 0
.000003 Coastal Site gal/yr 0
.00000053 0.000030 0
.000030 0
.000030 0
.000030 0
.000030 0
.000030 Land Use (open space) Urban acres NA NA NA NA NA NA 0 Suburban acres 26500 0.000025 0.000025 0.000025 0.000025 0.000020 0 Rural acres 7950 0
.000008 0.000008 0

.000008 0.000008 0.000006 0 Aesthetics

-- NA NA NA NA NA NA NA Ash Disposal Urban tons/yr 33.32 NA NA 0.000016 0
.000016 0 -0.002299 Suburban tons/ yr 5.00 0
.000603 0.000603 0.000002 0.000002 0 -0.000345 Rural tons/yr 1.17 0.000141 0.000141 0.000001 0.000001 0 -0.000081 Total Damages (Inland) Urban 0.000885 0.000896 0

.000098 0.000103 0.000072 -0.002000 Suburban 0.000910 0

.000922 0.000109 0

.000115 0.000092 -0.000046 Rural 0
.000430 0
.000442 0
.000089 0
.000095 0.000078 0.000218 Total Damages (Coastal) Urban 0.000912 0.000923 0
.000125 0.000130 0
.000099 -0.001973 Suburban 0.000937 0.000949 0.000136 0

.000141 0.000119 -0.000019 Rural 0.000457 0.000469 0
.000116 0
.000122 0.000105 0.000245
NA = Not Available MSW = Municipal Solid Waste

50 ROBERT D. ROWE SUMMARY OF DAMAGES IN DOLLARS PER KILOWATT·HOUR FOR 500 MW COAL, OIL, NATURAL GAS, AND 500 TON PER DAY (12 MW) MUNICIPAL SOliD WASTE·FIRED PLANTS
Damage Unit Damages Residual Units Damages (1900 $/unit) Coal: 300 ft Coal: 150 ft Oil: 300 ft Oil: 150 ft Natural Gas MSW: 100 ft (1990 $IkWh) (1990 $IkWh) (1990 $IkWh) (1990 $IkWh) (1990 $IkWh) (1990 $IkWh) Air Toxics ton/yr (see Table S-1) 0.000006 0.000018 0.000003 0.000008 0 0.000221 Water Consumption gal/yr 0.00027 0.000272 0.000272 0.000075 0.000075 0.000069 0.000075 Wastewater

Inland Site gal/yr 0.00000005 0.000003 0.000003 0.000003 0.000003 0.000003 0.000003 Coastal Site gal/yr 0.00000053 0.000030 0.000030 0.000030 0.000030 0.000030 0.000030 Land Use (open space)

Urban acres NA NA NA NA NA NA 0 Suburban acres 26500 0.000025 0.000025 0.000025 0.000025 0.000020 0 Rural acres 7950 0.000008 0.000008 0.000008 0.000008 0.000006 0 Aesthetics -- NA NA NA NA NA NA NA Ash Disposal

Urban tons/yr 33.32 NA NA 0.000016 0.000016 0 -0.002299 Suburban tons/yr 5.00 0.000603 0.000603 0.000002 0.000002 0 -0.000345 Rural tons/yr 1.17 0.000141 0.000141 0.000001 0.000001 0 -0.000081 Total Damages (Inland)

Urban 0.000885 0.000896 0.000098 0.000103 0.000072 -0.002000 Suburban 0.000910 0.000922 0.000109 0.000115 0.000092 -0.000046 Rural 0.000430 0.000442 0.000089 0.000095 0.000078 0.000218 Total Damages (Coastal)

Urban 0.000912 0.000923 0.000125 0.000130 0.000099 -0.001973 Suburban 0.000937 0.000949 0.000136 0.000141 0.000119 -0.000019 Rural 0.000457 0.000469 0.000116 0.000122 0.000105 0.000245

NA 

### = Not Available MSW 

### = Municipal Solid Waste

50Table Notes:

1. Annual kWh are based on a 500 MW coal/oil/ natural gas plant operating at 60 percent load over 30 years and a 500 ton per day MSW plant operating at 85 percent over 30 years. 2. Air toxic emission damages are based on coal/oil plant with 300 and 150 foot stacks and MSW plant with a 100 foot stack

. Unit damages for various toxics are displayed in Table S-1. 3. Coal plant is assumed to have an on-site landfill except for urban site where ash is assumed sent to suburban site. Total area is 325 acres, 75 for plant and 250 for landfill. Only 75 acres are applied to open space damages to avoid double counting ash disposal damages. 4. Municipal solid waste is assumed to be sited at landfill so that no open space damages apply. Plant received a credit (negative damages) for reduction in solid waste. 5. Damages for suburban and rural sites are overstated due to inclusion of air toxic damages based on an urban site.

Source: RCG/Hagler, Bailly, Inc., based on Tables S-1 and S-2.

51 Table Notes: 1. Annual kWh are based on a 500 MW coal/oil/natural gas plant operating at 60 percent load over 30 years and a 500 ton per day MSW plant operating at 85 percent over 30 years. 2. Air toxic emission damages are based on coal/oil plant with 300 and 150 foot stacks and MSW plant with a 100 foot stack. Unit damages for various toxics are displayed in Table S-l. 3. Coal plant is assumed to have an on-site landfill except for urban site where ash is assumed sent to suburban site. Total area is 325 acres, 75 for plant and 250 for landfill. Only 75 acres are applied to open space damages to avoid double counting ash disposal damages. 4. Municipal solid waste is assumed to be sited at landfill so that no open space damages apply. Plant received a credit (negative damages) for reduction in solid waste. 5. Damages for suburban and rural sites are overstated due to inclusion ofair toxic damages based on an urban site.

Source: RCG/Hagler, Bailly, Inc., based on Tables S-l and S-2.



### 511ARRY E. RUFF Putnam, Hayes & Bartlett, Inc. 1776 I Street, Washington, D.C. 20006

PROFILE Dr. Ruff, a Director with the economic and management consulting firm, works principally in the area of electric utility economics. A former economics professor, he has long been an advocate of the principle of environmental externalities as evidenced by his work over the past 20 years in the public and private sectors. He has served in the U.S. Treasury and Environmental Protection Agency researching environmental economics and was involved with energy and environmental issues while working at the Ford Foundation and Brookhaven National Laboratory.
TESTIMONY REFERENCED "Direct Testimony of Larry E. Ruff on Behalf of the Delaware' Power & Light Company on Internalizing Environmental Externalities," Delaware Public Service Commission, Docket No. 29, July 10, 1991.
STATE REGULATORY ISSUE ADDRESSED The Delaware Public Service Commission (PSC) undertook an examination of a proposal to monetize environmental externalities in the resource selection process, using the Massachusetts D.P.U. values (in cents/kWh) for the costs of sulfur dioxide, nitrogen oxide and carbon dioxide.
SUMMARY OF CONCLUSIONS Dr. Ruff recommends that the Commission not adopt the proposal to monetize environmental externalities using a cost of control methodology. He suggests that the Commission work with state and regional authorities to establish a policy for internalizing environmental externalities from all in-state sources at levels commensurate with society's willingness to pay. He also recommends that the Commission reassess the estimates in light of the environmental and regulatory situation in the state of Delaware before adopting a monetization policy.

52 PROFILE LARRY E. RUFF Putnam, Hayes & Bartlett, Inc. 1776 I Street, NW Washington, D.C. 20006

Dr. Ruff, a Director with the economic and management consulting firm, works principally in the area of electric utility economics. A former economics professor, he has long been an advocate of the principle of environmental externalities as evidenced by his work over the past 20 years in the public and private sectors. He has servedin the U.S. Treasury and Environmental Protection Agency researching environmental economics and was involved withenergyandenvironmentalissueswhileworkingattheFordFoundation andBrookhaven National Laboratory.
TESTIMONY REFERENCED "Direct Testimony ofLarry E. RuffonBehalfofthe Delaware'Power & Light Company on InternalizingEnvironmentalExternalities,"DelawarePublicServiceCommission,DocketNo. 29, July 10, 1991.
STATE REGULATORY ISSUE ADDRESSED The Delaware Public Service Commission (PSC) undertook an examination of a proposal to monetize environmental externalities in the resource selection process, using the Massachusetts D.P.U. values (in cents/kWh) for the costs of sulfur dioxide, nitrogen oxide and carbon dioxide.
SUMMARY OF CONCLUSIONS Dr. Ruff recommends that the Commission not adopt the proposal to monetize environmental externalities using a cost of control methodology. He suggests that the Commission work with state and regional authorities to establish a policy for internalizing environmental externalities from all in-state sources at levels commensurate with society's willingness to pay. He also recommends that the Commission reassess the estimates in light of the environmental and regulatory situation in the state of Delaware before adopting a monetization policy.

52ISSUES

The following issues concerning environmental externalities were raised in the direct testimony of Dr. Ruff . Page citations directly follow all direct quotations from this testimony. Environmental Externality Policy Options The fact that the regulatory authorities have set emission targets does not mean that they are appropriate simply because they exist. "The history of environmental policy is replete with demanding, `legally enforceable' standards that were seen to be infeasible soon after (or sometimes before) they were issued, but that nonetheless remained in existence for some time after they had lost any real operational significance" [p. 23]. The Clean Air Act of 1969 is an example of environmental targets that were compromised after being passed. Dr. Ruff suggests two criteria be used to judge the viability of externality valuations. Acceptability - Would society be willing to pay the costs if the emission prices were applied universally to all emission sources? "For example, imagine requiring all the industrial plants in the Delaware estuary to implement all control measures (including shutting down) that would be cheaper than the suggested values of the reduced emissions. It is likely that the costs would be unacceptable to society..." [p. 22]. Necessity - Is there a much better way to meet environmental objectives? Could society's objectives be met using much lower estimates of the value of emissions reductions. "If so, then these lower estimates are the right ones to use for monetizing emissions in utility planning..." [p. 22].

Environmental Externality Valuation Approach Dr. Ruff examines the cost of control method for monetizing the environmental externalities associated with utility resource options

. Estimating the damages associated with pollutant emissions using observed costs of specific control , such as Best Available Control Technology (BACT), raises several problems. "Sub-optimal Pattern of Control - Unless emissions are being reduced in an economically optimal way, marginal costs will differ widely across sources and hence none of them, and particularly not the highest of them, have any necessary relationship to society's true willingness to pay for emission reductions generally" [p. 13]. "Inappropriate Environmental Goals or Targets - If society is not really prepared to pay the costs necessary to meet some goals, then current estimates of the costs of meeting that goal do not represent society's willingness to pay, particularly when history and logic demonstrate clearly that goals are often compromised when the costs get too high" [p. 14]. 53 KEY ISSUES The following issues concerning environmental externalities were raised in the direct testimonyofDr.Ruff. Page citations directlyfollow all direct quotationsfrom thistestimony.
Environmental Externality Policy Options The fact that the regulatory authorities have set emission targets does not mean that they are appropriate simply because they exist. "The history of environmental policy is replete with demanding, 'legally enforceable' standards that were seen to be infeasible soon after (or sometimesbefore) theywereissued, butthatnonetheless remainedin existencefor some time after theyhadlost anyreal operational significance" [po 23]. The CleanAirAct of 1969 is an example of environmental targets that were compromised after being passed. Dr. Ruff suggests two criteria be used tojudge the viability of externality valuations.

e Acceptability

- Would society be willing to pay the costs if the emission prices were applied universally to all emission sources? "Por example, imagine requiring all the industrialplantsintheDelaware estuarytoimplement all controlmeasures (including shutting down) that would be cheaper than the suggested values of the reduced emissions. It is likely that the costs would be unacceptable to society
..." [po 22]. Necessity

- Is there a much better way to meet environmental objectives? Could society's objectives be met using much lower estimates of the value of emissions reductions. "Ifso, then these lower estimates are the right ones to use for monetizing emissions in utility planning
..." [po 22].
Environmental Externality Valuation Approach Dr.Ruffexamines the cost ofcontrol methodfor monetizing the environmental externalities associated with utility resource options. Estimating the damages associated with pollutant emissions using observed costs ofspecific control, such as BestAvailable ControlTechnology (BACT), raises several problems.

e "Sub-optimal Pattern of Control

- Unless emISSIons are being reduced in an economically optimalway, marginal costs will differ widely across sources and hence none of them, and particularly not the highest of them, have any necessary relationship to society's true willingness to pay for emission reductions generally" [po 

### 13].

e "Inappropriate Environmental Goals orTargets

- If society is not really prepared to pay the costs necessary to meet some goals, then current estimates of the costs of meeting that goal do not represent society's willingness to pay, particularly when history and logic demonstrate clearly that goals are often compromised when the costs get too high" [po 14]. 53Environmental Dispatch

A cost/benefit analysis of conservation versus new source options can only be made accurately by considering the overall system impact. "For example, if the new, cleaner source would have operated to displace older, dirtier sources in the merit order, the conservation option might actually increase emissions, forcing tighter control on some existing sources in order to maintain the same total emission level" [p. 19]. A system-wide approach to utilizing existing capacity, not the modification of new resource decisions, is the key to cost-effective emissions reductions.
Zero Externality Values "An inaccurate estimate improperly applied can easily be worse than an estimate of zero" [p. 12]. Whether the estimate is better than zero depends on the specific situation. An estimate may be improperly applied if it is not uniformly used over all sources of emissions thereby placing some sources at a competitive disadvantage. "There is no logic in assuming that an imprecise positive number must be better than zero for the practical job of improving utility decisions in a complex and far-from-optimal situation" [p. 13].

Potential PUC Conflicts/Disadvantages The valuation of externalities is not a policy that can be applied on a piecemeal basis (i.e., on new source selection and not existing power plants, on electric utilities only and not competitive energy sources). "Efforts to internalize costs piecemeal, particularly by authorities who have control over only a limited range of potentially environmentally damaging activities, may well make things worse rather than better, both economically and environmentally" [p. 6].
SUPPORTING DOCUMENTATION None cited.

54 Environmental Dispatch A cost/benefit analysis of conservation versus new source options can only be made accurately by considering the overall system impact. "For example, if the new, cleaner source would have operated to displace older, dirtier sources in the merit order, the conservation option might actually increase emissions, forcing tighter control on some existing sources in order to maintain the same total emission level" [po 19]. A system-wide approach to utilizing existing capacity, not the modification ofnew resource**decision~,** is the key to cost-effective emissions reductions.
Zero Externality Values "An inaccurate estimate improperly applied can easily be worse than an estimate of zero" [po 12]. Whether the estimate is better than zero depends on the specific situation. An estimate may be improperly applied ifit is not uniformly used over all sources ofemissions thereby placing some sources at a competitive disadvantage. "There is no logic in assuming that an imprecise**posit~ve** number must be better than zero for the practical job of improving utility decisions in a complex and far-from-optimal situation" [po 13].
Potential PUC Conflicts/Disadvantages The valuation of externalities is not a policy that can be applied on a piecemeal basis (i.e., on new source selection and not existing power plants, on electric utilities only and not competitive energy sources). "Efforts to internalize costs piecemeal, particularly by authorities who have control over only a limited range of potentially environmentally damaging activities, may well make things worse rather than better, both economically and environmentally" [po 6].
SUPPORTING DOCUMENTATION None cited.

54GAYATRI M. SCHILBERG LL B. MARCUS JBS Energy Inc. 311 D Street, Suite A West Sacramento, California 95605

PROFILE William Marcus and Gayatri Schilberg are Consulting Economists at JBS Energy Inc.
TESTIMONY REFERENCED "Prepared Testimony of Gayatri Schilberg and William B. Marcus on Behalf of the Independent Energy Producers Association on the Measurement and Valuing of Air Emissions in Preliminary ER-90 Resource Cases," California Energy Commission, Docket No. 88-ER-8, February 21, 1990.
STATE REGULATORY ISSUE ADDRESSED The Commission is investigating the method proposed by the Independent Energy Producers (IEP) to analyze air quality impacts on resource choice scenarios.
SUMMARY OF CONCLUSIONS The authors recommend that the Commission adopt the quantified values proposed by the IEP for reducing emissions of all major criteria and non-criteria pollutants including NOX, ROG, SOX, C02, CH4 and N20. They contend that these values are preferred for planning purposes because the "numbers are derived from a coherent theoretical foundation, base differences among basins on an understanding of local and global pollutant effects, contain appropriate relative valuation of pollutants, incorporate fixed charge rates inclusive of utility income taxes... and are conservative" [p. 18].

KEY ISSUES The following issues concerning environmental externalities were raised in the testimony of William B. Marcus and Gayarti Schilberg. Page citations directly follow all direct quotations from this testimony.

55 PROFILE GAYATRI M. SCHILBERG & WILLIAM B. MARCUS JBS Energy Inc. 311 D Street, Suite A West Sacramento, California 95605

William Marcus and Gayatri Schilberg are Consulting Economists at JBS Energy Inc.
TESTIMONY REFERENCED "Prepared Testimony of Gayatri Schilberg and William B. Marcus on Behalf of the Independent Energy Producers Association on the Measurement and Valuing of Air Emissions in Preliminary ER-90 Resource Cases," California Energy Commission, Docket No. 88-ER-8, February 21, 1990.
STATE REGULATORY ISSUE ADDRESSED TheCommissionis investigatingthemethodproposedbythe IndependentEnergyProducers (IEP) to analyze air quality impacts on resource choice scenarios.
SUMMARY OF CONCLUSIONS The authors recommend that the Commission adopt the quantified values proposedby the IEP for reducing emissions of all major criteria and non-criteria pollutants including NOx , ROG, SOx, CO2, CH4 and N2

### 0. They contend that these values are preferred for planning purposes because the "numbers are derived from a coherent theoretical foundation, base differences among basins on an understanding oflocal and global pollutant effects, contain appropriaterelative valuation ofpollutants, incorporate fixed charge rates inclusive ofutility income taxes
... and are conservative" [po 18].
KEY ISSUES The following issues concerning environmental externalities were raised in the testimony of WilliamB. Marcus and Gayarti Schilberg. Page citations directly follow all direct quotations from this testimony.

55Environmental Externalities Valuation Approaches

To estimate the marginal benefit of reductions in NON, ROG, SON, C®2, CH4 and N201 values per ton of emissions are calculated from sources within Southern California, other parts of the state and from purchased out-of-state supply sources. The methodology follows a four step process: ® analyze major pollutants from electricity generation; ® identify local versus global emissions; ® obtain value per ton of each emission based on the theory of revealed preference; and ® obtain societal value of emission reductions by applying per ton emission valuation factors. The marginal benefit of criteria pollutant reductions to society is implied from the cost of controlling emissions in order to comply with environmental regulations. This is justified because "rational regulators reveal the preference of society for emissions reduction" [p. 2]. The benefit of reducing non-criteria pollutants, those for which there is no regulation, such as greenhouse gases, are based on the cost of reforestation. "This cost represents the cost of reducing the greenhouse risk" [p. 3]. The recommended environmental externality values are shown in the following table. Scope of Monetized Environmental Externalities In addition to incorporating monetized environmental externalities into the electric utility least-cost planning process, monetized values should also be used in the new resource screening and dispatch decision processes. "Technologies such as geothermal may thus never receive credit in the planning process for displacing higher emissions from coal, if they are never considered as the deferred resource due to cost screening curves based only on private costs which do not include the value to society of reducing environmental externalities" [p. 16]. "To make proper planning decisions concerning the required quantity of cleaner alternatives to existing generation, the cost effectiveness of retirement and refurbishment in face of other alternatives, and the optimal quantity of demand-side management, the environmental effects need to be considered as well as the private costs" [p. 18].

56 Environmental Externalities Valuation Approaches To estimate the marginal benefit of reductions in NOx , ROG, SOx, CO2, CH4 and N20, values per ton of emissions are calculated from sources within Southern California, other parts ofthe state andfrom purchased out-of-state supply sources. The methodologyfollows a four step process:

@ analyze major pollutants from electricity generation; identify local versus global emissions; obtain value per ton of each emission based on the theory ofrevealed preference; and

• obtain societal value of emission reductions by applying per ton emission valuation factors. The marginal benefit of criteria pollutant reductions to society is implied from the cost of controlling emissions in order to comply with environmental regulations. This is justified because "rational regulators reveal the preference ofsociety for emissions reduction" [po 2]. Thebenefit ofreducing non-criteria pollutants, those for which there is no regulation, such as greenhouse gases, are based on the cost ofreforestation. "This cost represents the cost ofreducing the greenhouse risk" [po 3]. The recommended environmental externality values are shown in the following table. Scope ofMonetized Environmental Externalities In addition to incorporating monetized environmental externalities into the electric utility least-cost planning process, monetized values should also be used in the new resource screening anddispatch decisionprocesses. "Technologies such as geothermalmaythus never receive credit in the planning process for displacing higher emissions from coal, ifthey are never considered as the deferredresource due to cost screening curvesbasedonly onprivate costs which do not include the value to society ofreducing environmental externalities" [po 16]. "To makeproperplanning decisions concerningtherequired quantity ofcleaner alternatives to existing generation, thecost effectiveness ofretirement and refurbishment inface ofother alternatives, and the optimal quantity of demand-side management, the environmental effects need to be considered as well as the private costs" [po 18].



### 56SCIIILBERG & MARCUS RECOMMENDED VALUES FOR EMISSIONS REDUCTION ($/ton of emissions)
South Coast Remainder of Pollutant Air Basin California Out-of-State (basis for value) (basis for value) (basis for value) Nitrogen Oxide (NOr) $24,500 $18,800' $2,700 (SCAQMD) (revealed preference) (New York State Energy Office) Reactive Organic Gases $17,600 $1,130 $665 (ROG)2 (SCAQMD) (vapor recovery (vapor recovery device costs) device costs) Sulfur Oxides (SO..) $18,300 $1,800 $1,000 (SCAQMD) (revealed preference) (revealed preference) Carbon Dioxide (CO2) $14.70 $14.70 $14.70 (reforestation costs) (reforestation costs) (reforestation costs) Methane (CH4) $375 $375 $375 (CO2 multiplier) (CO2 multiplier) (CO2 multiplier) Nitrous Oxide (N20) $3,700 $3,700 $3,700 (CO2 multiplier) (CO2 multiplier) (CO2 multiplier) 1. Except some attainment areas near the Oregon border. 2. ROG is similar to VOC (Volatile Organic Compounds) discussed in other prepared testimony on this issue.
Interim Co., Externality Values Since the emission of CO2 is not currently regulated, revealed preference, society's value as implied by regulatory action, cannot be applied. "In face of the risk of global climate change, however, insurance to minimize that possibility has some value, and thus we recognize that reduction of greenhouse gases does have a positive value to society" [p. 3]. Environmental Dispatch Environmental externality valuations could be incorporated into electricity dispatch decision in order to determine whether they should become an operating criterion. "A sensitivity case should be run incorporating dispatch based on private plus environmental costs. When the base case is compared with this sensitivity the change in utility cost (excluding emissions valuation) will be revealed" [p. 18].

57 SCHILBERG & MARCUS RECOMMENDED VALUES FOREMISSIONS REDUCTION ($/ton ofemissions)
South Coast Remainder of Pollutant Air Basin California Out-of-State (basis for value) (basis for value) (basis for value) Nitrogen Oxide (NOx ) $24,500 $18,80OZ $2,700 (SCAQMD) (revealed preference) (New York State Energy Office) Reactive Organic Gases $17,600 $1,130 $665 (ROGi (SCAQMD) (vapor recovery (vapor recovery device costs)

. device costs) Sulfur Oxides (SOx) $18,300 $1,800 $1,000 (SCAQMD) (revealed preference) (revealed preference) carbon Dioxide (CO2) $14.70 $14.70 $14.70 (reforestation costs) (reforestation costs) (reforestation costs) Methane (CH4) $375 $375 $375 (C02 multiplier) (C02 multiplier) (C02 multiplier) Nitrous Oxide (N 2O) $3,700 $3,700 $3,700 (C02 multiplier) (C02 multiplier) (C02 multiplier) 1. Except some attainment areas near the Oregon border. 2. ROGis similarto VOC (Volatile OrganiC Compounds) discussed in otherpreparedtestimony on this issue.
Interim CO2 Externality Values Since the emission ofCO2 is not currently regulated, revealed preference, society's value as implied by regulatory action, cannot be applied. "In face of the risk of global climate change, however, insurance to minimize that possibility has some value, and thus we recognize that reduction of greenhouse gases does have a positive value to society" [po 3].
Environmental Dispatch Environmental externalityvaluations couldbeincorporatedinto electricity dispatch decision in orderto determinewhetherthey shouldbecome anoperatingcriterion. "A sensitivity case shouldbe run incorporating dispatch based on private plus environmental costs. When the base case is compared with this sensitivity the change in utility cost (excluding emissions valuation) will be revealed" [po 18].

57Appropriateness of State PUC-imposed Values

When valuing emission costs, the distinction must be made between in-state and out-of-state sources as well as between local and global emissions. "The value of local pollutants, which affect only the area of origin, may differ among basins, depending on the level of attainment for that pollutant... The value for reducing global pollutants, however, will be the same no matter where the emissions are generated, as they affect all areas equally" [p. 2].
SUPPORTING DOCUMENTATION None cited.

58 Appropriateness of State PUC-imposed Values Whenvaluing emission costs, the distinctionmustbemadebetweenin-state and out-of-state sources as well as between local and global emissions. "The value oflocal pollutants, which affect only the area oforigin, may differ amongbasins, depending on thelevel ofattainment for that pollutant...The value for reducing global pollutants, however, will be the same no matter where the emissions are generated, as they affect all areas equally" 

### [po 2].
SUPPORTING DOCUMENTATION None cited.

58RICHARD L. SCE LENSES Massachusetts Institute of Technology 50 Memorial Drive -- Room E52-456 Cambridge, Massachusetts 02139

PROFILE Dr. Schmalensee is the Gordon Y. Billard Professor of Economics and Management at the Massachusetts Institute of Technology and serves as the Director of the MIT Center for Energy Policy Research. A widely published author, Professor Schmalensee also is a special consultant to National Economic Research Associates, Inc. As a member of the President's Council of Economic Advisers from 1989 to 1991, he served on the White House Clean Air Strategy Group, the Environmental Policy Review Group, the Global Change Strategy Working Group and the White House Conference on Science and Economic Research.
TESTIMONY REFERENCED "Direct Testimony of Richard L. Schmalensee on Behalf of Massachusetts Electric Company, Western Massachusetts Electric Company and Boston Edison Company in the Investigation by the Department on its Own Motion as to the Environmental Externality Values to be Used in Resource Cost-Effectiveness Tests by Electric Companies Subject to the Department's Jurisdiction," Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131, October 4, 1991.
STATE REGULATORY ISSUE ADDRESSED Under its Order on Integrated Resource Management (IRM), the Massachusetts Department of Public Utilities (D.P.U.) directs electric utilities to consider all air, water, solid waste and spent fuel disposal impacts resulting from plant operation in the resource evaluation process. In addition, D.P.U. Order 89-239 prescribes monetized environmental externality values for eight air pollutants (CO2, CH41 CO, N2O, NOR, SO2, TSPs and VOCs) that are to be incorporated into the electric utility IRM process.
SUMMARY OF CONCLUSIONS Dr. Schmalensee draws three conclusions concerning the development, application and role of externality values in the integrated resource management process. First, the marginal cost of control methodology used in D.P.U. 89-239 "to calculate `externality values' is incorrect in principle and thus likely to lead to undesirable results in practice" [p. 3]. Second, if values are to be calculated, they should be based on non-internalized residual damages and applied only to net incremental emissions after offsets. Third, in lieu of a 59 PROFILE RICHARD L. SCHMALENSEE Massachusetts Institute ofTechnology

50 Memorial Drive .- Room E52-456

Cambridge, Massachusetts 02139

Dr. Schmalensee is the Gordon Y. Billard Professor ofEconomics and Management at the Massachusetts Institute of Technology and serves as the Director of the MIT Center for EnergyPolicyResearch. A widely published author, Professor Schmalensee also is a special consultant to NationalEconomicResearchAssociates, Inc. As a member ofthePresident's Council ofEconomicAdvisers from 1989 to 1991, he served on the White House Clean Air Strategy Group, the Environmental Policy Review Group, the Global Change Strategy Working Group and the White House Conference on Science and Economic Research.
TESTIMONY REFERENCED "DirectTestimonyofRichard L. SchmalenseeonBehalfofMassachusettsElectricCompany, WesternMassachusetts Electric Company and Boston Edison Companyin the Investigation by the Department on its Own Motion as to the Environmental Externality Values to be Used in Resource Cost-Effectiveness Tests by Electric Companies Subject to the· Department'sJurisdiction,"MassachusettsDepartmentofPublicUtilitiesDocketNo. D.P.U. 91-131, October 4, 1991.
STATE REGULATORY ISSUE ADDRESSED Under its Order on Integrated Resource Management (IRM), the Massachusetts Department of Public Utilities (D.P.U.) directs electric utilities to consider all air, water, solid waste and spent fuel disposal impacts resulting from plant operation in the resource evaluation process. In addition, D.P.U. Order 89-239 prescribes monetized environmental externalityvalues for eight air pollutants (C02 , CH4, CO, N2 0, NOx' S02' TSPs and VOCs) that are to be incorporated into the electric utility IRM process.
SUMMARY OF CONCLUSIONS Dr. Schmalensee draws three conclusions concerning the development, application and role of externality values in the integrated resource management process. First, the marginal cost of control methodology used in D.P.U. 89-239 "to calculate 'externality values' is incorrect in principle and thus likely to lead to undesirable results in practice" [po 3]. Second, if values are to be calculated, they should be based on non-internalized residual damages and applied only to net incremental emissions after offsets. Third, in lieu of a 59piecemeal approach to environmental protection, the D.P.U. should address broader

environmental concerns by promoting least-cost control strategies.
ISSUES The following issues concerning environmental externalities were raised in the direct testimony of Dr. Schmalensee. Page citations directly follow all direct quotations from this testimony.
Environmental Externality Policy Options In a market economy, when some costs or benefits are not reflected in the prices of goods and services, "production decisions are not socially optimal. Environmental effects are in many respects the most important example of such 'externalities "' [p. 7]. Two logically distinct conditions most hold if an externality is to exist: (1) "the firm's activities must create damages to activities outside the firm; and (2) these damages must not be treated as costs in the firm's decision-making (that is, they must not be internalized)" [p. 8]. In applying the textbook treatment of externalities, it must be realized that textbooks "typically ignore the critical real world problem of inadequate information and the likelihood that regulatory requirements are set on the basis of criteria other than economic efficiency. The textbook formulation is not intended to provide prescriptions for specific policies but rather to provide a conceptual outline of the basic economic issues involved" [p. 11]. "If the government sets standards using other criteria or without complete information, marginal benefits will not be equated to marginal cost, marginal costs may differ substantially among sources, and the total cost of pollution reduction will not be minimized" [p. 11]. Environmental Externality Valuation Approaches Dr. Schmalensee addresses three valuation approaches in his testimony. Highest cost of control, the approach used by the Tellus Institute (and adopted by the Massachusetts D.P.U.), bears no "relationship to the marginal cost of control [as presented in textbooks], let alone to the environmental damage caused by a pollutant. There is no support for the view that Congress or state legislators have `revealed' through their actions that residual damages have the values that Tellus has calculated. There is not a single marginal cost for all relevant sources for a given pollutant, rather a wide range of marginal costs for different sources.

60 piecemeal approach to environmental protection, the D.P.U. should address broader environmental concerns by promoting least-cost control strategies.
KEY ISSUES The following issues concerning environmental externalities were raised in the direct testimony ofDr. Schmalensee. Page citations directly follow all direct quotations from this testimony.
Environmental Externality Policy Options In a market economy, when some costs orbenefits are not reflected in the prices ofgoods and services, IIproduction decisions are not socially optimal. Environmental effects are in many respects the most important example of such 'externalities'" 

### [po 7]. Two logically distinct conditions m\lst hold if an externality is to exist: (1) lithe firm's activities must create damages to activities outside the firm; and (2) these damages must not be treated as costs in the firm's decision-making (that is, they must not be internalized)II [po 

### 8]. In applying the textbook treatment of externalities, it must be realized that textbooks IItypicallyignorethe criticalrealworldproblem ofinadequateinformation andthe likelihood thatregulatory requirements are set on the basis ofcriteria other than economic efficiency. The textbook formulation is not intended to provide prescriptions for specific policies but rather to provide a conceptual outline ofthe basic economic issues involvedll [po 11]. IIIf the government sets standards using other criteria or without complete information, marginalbenefitswill notbeequatedto marginal cost, marginal costs maydiffer substantially among sources, and the total cost ofpollution reduction will not be minimizedII [po 11].
Environmental Externality Valuation Approaches Dr. Schmalensee addresses three valuation approaches in his testimony. Highest cost of control, the approach used by the Tellus Institute (and adopted by the Massachusetts D.P.U.), bears no "relationship to the marginal cost ofcontrol [as presented in textbooks], let alone to the environmental damage caused by a pollutant. There is no support for the view that Congress or state legislators have 'revealed' through their actions that residual damages have the values that Tellus has calculated.

• There is not a single marginal cost for all relevant sources for a given pollutant, rather a wide range ofmarginal costs for different sources.

60Because marginal costs differ across sources, the observed marginal costs of control do not correspond to the `least cost' marginal curves used in textbooks. Thus the current regulatory approach does not generate the efficient result in which marginal cost and marginal benefit are equated (and thus where marginal cost is a proxy for marginal benefit)" [pp. 18-19]. Given the assumptions that highest cost of control is based on the revealed preference of legislators and regulators in establishing environmental standards and that environmental authorities have optimized environmental standards, there is "no justification for another agency (such as the DPU) imposing additional regulations, since the `right' sources would have been built and the 'right' controls would have been imposed" [p. 20]. Residual damage-based approach begins with an "estimation of the willingness of those affected to pay, per unit of pollution reduction on the margin, to avoid the residual damages that remain after anticipated controls are in place" [p. 21]. The values, derived'from this residual damage-based approach should be applied to all sources, not just to electric utilities, so as to avoid a piecemeal approach to environmental protection. Because "many of the residual damages will differ a great deal depending upon where emissions occur," the calculated externality values "should not simply be imported from other states or regions," should differ for some pollutants "depending upon where the power plant is located" and "should take into account the regulations that are already in place to reduce emissions" [pp. 22-23]. These externality values should only be used when residual emissions cause damages and when these effects are not already internalized in...utility decision-making" [p. 24]. Offset costs is "based upon a least-cost approach that is consistent with efficient environmental controls" [p. 26]. Although relying on control costs rather than damage calculations, this approach allows for a market price to be set for the production or acquisition of offsets -- based upon a societal determination of the appropriate number of emissions -- that "would represent both the opportunity cost and the value of emissions at the margin. The result of allowing offsets and using such a price in resource planning would be to reduce the overall cost of meeting environmental objectives" [pp. 25-26]. Zero Externality Values Some number for an externality value is not always better than no number. "Even the theoretically ideal value -- the value of the marginal residual damage -- may be undesirable on balance because of the `piecemeal problem' and the resulting reactions of sources not covered by the DPU. Moreover, if the value is too high...the distortions become

61 Because marginal costs differ across sources, the observed marginal costs of control do not correspond to the 'least cost' marginal curves used in textbooks.

e Thus the current regulatory approach does not generate the efficient result in which marginal cost and marginal benefit are equated (and thus where marginal cost is a proxy for marginal benefit)" [pp. 18-19].

e Given the assumptions that highest cost of control is based on the revealed preference oflegislators and regulators in establishing environmental standards and that environmental authorities have optimized environmental standards, there is "no justification for another agency (such as the DPU) imposing additional regulations, since the 'right' sources would have been built and the 'right' controls would have been imposed" [po 20]. Residual damage-based approach begins with an "estimation of the willingness of those affected to pay, perunit ofpollution reduction onthe margin, to avoid the residual damages that remain after anticipated controls are in place" [po 21].

e The values. derivedJrom this residual damage-based approach should be applied to all sources, not just to electric utilities, so as to avoid a piecemeal approach to environmental protection.

e Because "many oftheresidual damageswill differ a greatdeal dependinguponwhere emissions occur,' I the calculated externality values "should not simply be imported from other states or regions,'1 should differ for some pollutants "depending upon where the power plant is located" and "should take into account the regulations that are already in place to reduce emissions ll [pp. 22-23].

e These externalityvalues should only beusedwhenresidual emissions cause damages andwhenthese effects arenotalreadyinternalizedin
...utility decision-making" [po 24]. Offset costs is "based upon a least-cost approach that is consistent with efficient environmental controls ll [po 26]. Although relying on control costs rather than damage calculations, this approach allows for a market price to be set for the production or acquisition of offsets

-- based upon a societal determination of the appropriate number of emissions

-- that "would represent both the opportunity cost and the value of emissions at the margin. Theresult ofallowing offsets and using such a price in resource planningwould be to reduce the overall cost of meeting environmental objectives" [pp. 25-26].
Zero Externality Values Some number for an externality value is not always better than no number. "Even the theoretically ideal value

-- the value ofthe marginal residual damage

-- may be undesirable on balance because of the 'piecemeal problem' and the resulting reactions of sources not covered by the DPU. Moreover, if the value is too high
...the distortions become


### 61disproportionately greater, [potentially leading] to even greater rate increases for existing

customers [and] more pollution" [p. 34]. In light of the provisions of the 1990 Clean Air Act, adding an externality value to sulfur dioxide that will be produced by new sources in operation over the next 30 years: ® has no basis in economic theory; constitutes double counting that would, in turn, "distort a utility's choice among alternate resource plans and lead to costs clearly in excess of those intended by Congress;" [p. 30] and, if used on a state only basis, would have "no effect whatsoever on the overall level of SO2 emissions in the U.S. [but would] raise electricity rates for [state] ratepayers and drive down the price of allowances, thereby reducing the cost of electricity and increasing SO2 emissions in other parts of the country" [p. 30].

Interim CO2 Externality Values It does not make environmental or economic sense to apply a large "externality value" for CO2 emissions in Massachusetts. Doing so would be inconsistent with the international nature of potential global warming damages. Any reductions in CO2 emissions in Massachusetts due to the `externality value' would have virtually no benefits to Massachusetts residents. The logic of using existing legislation and regulations to indicate the "revealed preference' for `externality values' would mean that the value should be zero, both in Massachusetts and the United States. No controls have yet been imposed. "Instituting a large CO2 adder in Massachusetts would send the wrong signals to Washington officials searching for a coherent national (and international) strategy for responding to the possibility of global warming" [p. 31]. In anticipation of future regulatory action on CO2 emissions, a modest externality value might encourage utilities to cost-effectively address CO2 levels in the selection of the type of plant needed to meet new capacity requirements.
Potential PUC Conflicts/Disadvantages The Massachusetts DPU faces "four major difficulties in instituting `externality values' in the IRM process:

62 disproportionately greater, [potentially leading] to even greater rate increases for existing customers [and] more pollution" [po 34]. In light of the provisions of the 1990 Clean Air Act, adding an externality value to sulfur dioxide that will be produced by new sources in operation over the next 30 years:

@ has no basis in economic theory; constitutes double counting that would, in turn, "distort a utility's choice among alternate resource plans and lead to costs clearly in excess pf those intended by Congress;" [po 30] and,

@ ifused on a state only basis, would have "no effect whatsoever on the overall level of S02 emissions in the U.S. [but would] raise electricity rates for [state] ratepayers and drive down the price of allowances, thereby reducing the cost of electricity and increasing S02 emissions in other parts of the country" [po 30].
Interim CO2 Externality Values It does not make environmental or economic sense to apply a large "externality value" for CO2emissions in Massachusetts.

EO Doing so would be inconsistent with the international nature of potential global warming damages. Any reductions in CO2 emissions in Massachusetts due to the 'externality value' would have virtually no benefits to Massachusetts residents.

EO The logic of using existing legislation and regulations to indicate the''revealed preference' for 'externality values' would mean that the value should be zero, both in Massachusetts and the United States. No controls have yet been imposed. "Instituting a large CO2 adder in Massachusetts would send the wrong signals to Washington officials searchingfor a coherentnational (andinternational) strategyfor responding to the possibility of global warming" [po 31].

EO In anticipation of future regulatory action on CO2 emissions, a modest externality value might encourage utilities to cost-effectively address CO2levels in the selection of the type ofplant needed to meet new capacity requirements.
Potential PUC Conflicts/Disadvantages TheMassachusetts DPUfaces "four major difficulties in instituting 'externalityvalues' in the IRM process:



### 62Limited source coverage ('piecemeal' problem). The scope of the DPU's authority is limited to utility sources; but there are many other sources for the major environmental contaminants. Duplication. The DPU may establish `externality values' for damages that are already internalized as a result of other regulations or other institutions , thus imposing costs out of proportion to any benefits that might be obtained. Counterproductive conflicts in policies. The 'externality values' established by the DPU may conflict with the environmental policies set by other agencies and may also conflict with other DPU policy objectives. Limited expertise. Environmental agencies have spent decades building up their expertise in environmental areas -- including the relevant science, engineering, economics and law -- and the DPU cannot duplicate this expertise without sacrificing other important missions" [p. 33].
SUPPORTING DOCUMENTATION None cited.

63 Limited source coverage ('piecemeal' problem). The scope ofthe DPU's authority is limited to utility sources; but there are many other sources for the major environmental contaminants.

• Duplication. TheDPUmay establish 'externalityvalues'for damages that are already internalized as a result of other regulations or other institutions, thus imposing costs out ofproportion to any benefits that might be obtained. Counterproductive conflicts in policies. The 'externality values' established by the DPUmay conflictwith the environmentalpolicies setby otheragencies andmay also conflict with other DPU policy objectives. Limited expertise. Environmental agencies have spent decades building up their expertise in environmental areas -- including the relevant science, engineering, economics andlaw -- and theDPUcannot duplicate this expertise without sacrificing other important missions" 

### [po 33].
SUPPORTING DOCUMENTATION None cited.

63SOUTHERN CALIFORNIA EDISON COMP P.O. Box 800 2244 Walnut Grove Avenue Rosemead, California 91770

PROFILE Southern California Edison Company is in investor-owned electricity utility.
TESTIMONY REFERENCED "Testimony of the Southern California Edison Company on Group 1 Hearing Issues: Air Quality, 1992 Electricity Report," California Energy Commission, Docket No. 90-ER-92, November 19, 1991.

STATE REGULATORY ISSUE ADDRESSED The California Energy Commission (CEC) is examining appropriate goals for valuing residual air emissions and mechanisms for applying these values in its 1992 Electricity Report (ER 92).
SUMMARY OF CONCLUSIONS The Southern California Edison Company recommends that the California Energy Commission abandon its use of the control cost approach and adopt a damage-based method for valuing residual emissions in the 1992 Electricity Report. The company proposes that damage-based values be used for nitrous oxides (NOX), reactive organic gases (ROG) and particulate matter (PM10) and a zero value be used for carbon dioxide (CO2). Values for SO2 are awaiting the completion of a commissioned study by the National Economic Research Associates, and no value is recommended for methane (CH4). Pollution offsets should be valued within a range of $2,700 to $22,000 with an average of $12,000.
KEY ISSUES The following issues concerning environmental externalities were raised in the resource assumptions testimony of the Southern California Edison Company ("Edison"). Page citations directly follow all direct quotations from this testimony.

64 PROFILE SOUTHERN CALIFORNIA EDISON COMPANY P.O. Box 800 2244 Walnut Grove Avenue Rosemead, California 91770

Southern California Edison Company is in investor-owned electricity utility.
TESTIMONY REFERENCED "Testimony of the Southern California Edison Company on Group 1 Hearing Issues: Air Quality, 1992 Electricity Report," California Energy Commission, Docket No. 90-ER-92, November 19, 1991.
STATE REGULATORY ISSUE ADDRESSED The California Energy Commission (CEC) is exammmg appropriate goals for valuing residual air emissions and mechanisms for applying these values in its 1992 Electricity Report (ER 92).
SUMMARY OF CONCLUSIONS The Southern California Edison Company recommends that the California Energy Commission abandon its use of the control cost approach and adopt a damage-based methodfor valuing residual emissions inthe 1992ElectricityReport. Thecompanyproposes that damage-based values be used for nitrous oxides (NOx ), reactive organic gases (ROG) and particulate matter (PMlO) and a zero value be used for carbon dioxide (C02 ), Values for S02 are awaiting the completion of a commissioned study by the National Economic Research Associates, and no value is recommended for methane (CH4). Pollution offsets should be valued within a range of $2,700 to $22,000 with an average of $12,000.

KEY ISSUES The following issues concerning environmental externalities were raised in the resource assumptions testimony of the Southern California Edison Company ("Edison"). Page citations directly follow all direct quotations from this testimony.

64Environmental Externality Policy Options

Edison recommends that the use of monetized values for residual emissions be confined to the planning process "in selecting which resources to add once the need for new resources has been determined based on direct costs to utility ratepayers" [p. 8]. The following guidelines are suggested for the proper application of residual emission values. Determine those emissions that remain after controls are in place (i.e., residual emissions). ® Assess internalization so as to avoid double counting. Apply appropriate values using a range of damage-based values so as to reflect the associated uncertainty. Determine the effects of applying monetized values on emissions reductions and resource costs as well as such unintended effects as the "piecemeal" problem. Environmental Externality Valuation Approaches Edison addresses valuation methods within the context of two policy tools used to meet environmental objectives. Valuing residual emissions. It is important to use a correct method to value residual emissions. Edison discusses four monetization methods. Damage-based valuation of residual emissions is the method supported by Edison. "Under the damage function approach, values are set by determining the dollar value per ton of damages for each of the relevant pollutants" [p. 10]. In contrast, the "use of cost-based values can lead both to higher costs than necessary to meet environmental targets and to potential adverse effects on environmental quality" [p. 7]. Revealed preference is an approach that uses the cost of controlling emissions to infer the value that society, as revealed through the actions of legislators and regulators, places on the damages from residual emissions. This approach is problematic because "relevant statutes do not require (or even allow) such balancing of marginal costs and marginal benefits; control costs are not based upon the least-cost means of achieving emissions reductions; and marginal costs differ dramatically across different air quality regulations" [p. 21]. Therefore, "Edison recommends that the CEC recognize the inherent flaw of the control cost approach and abandon it in favor of the damage-based approach" [p. 22]. Resource cost savings is a method that uses control costs to value residual emissions. The cost of control could be used to value the cost savings should the application of monetized values for emissions result in reduced emissions and the ability to relax rules. This is "the

65 Environmental Externality Policy Options Edison recommends that the use ofmonetized values for residual emissions be confined to the planning process "in selecting which resources to add once the need for new resources has been determined based on direct costs to utility ratepayers" [po 8]. Thefollowing guidelines are suggestedfor the properapplication ofresidual emissionvalues.

<II Determine those emissions that remain after controls are in place (i.e., residual emissions).

<II Assess internalization so as to avoid double counting. Apply appropriate values using a range of damage-based values so as to reflect the associated uncertainty. Determine the effects of applying monetized values on emissions reductions and resource costs as well as such unintended effects as the "piecemeal" problem.
Environmental Externality Valuation Approaches Edison addresses valuation methods within the context of two policy tools used to meet environmental objectives. Valuing residual emissions. It is important to use a correct method to value residual emissions. Edison discusses four monetization methods. Damage-based valuation ofresidual emissions is the method supported by Edison. "Under the damage function approach, values are set by determining the dollar value per ton of damages for each of the relevant pollutants" [po 

### 10]. In contrast, the "use of cost-based values can lead both to higher costs than necessary to meet environmental targets and to potential adverse effects on environmental quality" [po 7]. Revealed preference is an approach that uses the cost of controlling emissions to infer the value that society, as revealed throughthe actions oflegislators andregulators, places onthe damages from residual emissions. This approach is problematic because "relevant statutes do not require (or even allow) such balancing of marginal costs and marginal benefits; control costs are 110tbased upon theleast-cost means ofachieving emissions reductions; and marginal costs differ dramatically across different air quality regulations" [po 21]. Therefore, "Edisonrecommends that the CECrecognize the inherentflaw ofthe control cost approach and abandon it in favor ofthe damage-based approach" [po 22]. Resource cost savings is a method that uses control costs to value residual emissions. The cost ofcontrol could be used to value the cost savings should the application ofmonetized values for emissions result in reduced emissions and the ability to relax rules. This is "the


### 65only credible argument for using control costs as a measure of the value of residual

emissions" [p. 23]. Permits market is the approach Edison believes is the best way to meet environmental objectives at least possible costs. "The damages from residual emissions would then be reflected, at the margin, in the prices of emissions permits or the fee charged. These costs in turn become like ordinary production costs that firms take into account when they choose what to produce, how to produce it, and what to charge" [p. 3]. Residual valuations based on marketable permits cannot yet be made since there has not been a market established for emissions other than SOX. Edison recommends the use of damage-based externality values developed in a study it commissioned. The preliminary results of the National Economic Research Associates study, along with a comparison of valuations based on other valuation methods, are summarized in the following table.

COMPARISON OF ALTERNATIVE METHODS FOR RESIDUAL EMISSIONS VALUATION SOUTH COAST AIR QUALITY MANAGEMENT DISTRICT (1989 dollars/ton)

Valuation Method NOX ROG PM10 a gge;= lase :...:.:.::...::.. Edison Preliminary (ER-92) - Low - Mid-range - High 1,500 3,100 9,000 100

800 3,200 3,900

6.900 17,100 SCAQMD 1991 14,400 4,800 28,300 SCAQMD 1988 4,200 1,600 7,900
CEC Staff (ER-92) Marginal Cost 24,500 16,200 26,600 CPUC BRPU Marginal Cost 26,400 18,900 5,700 CEC Staff (ER-92) Average Cost 13,100 8,800 11,900 rket'-:iâasee
....................... ......... ............. ... ............. ........................ Offset Requirements. This requires the reduction of emissions equal to or greater than the addition of emissions resulting from additional generating capacity. Offsets can be obtained from within the utility, provided by public policy or purchased on the market. If additional capacity must be offset by more than one ton for every ton from new capacity, then emissions should decrease as the result of added capacity. "Thus, where offsets are used,

66 only credible argument for using control costs as a measure of the value of residual emissions" [po 23]. Permits market is the approach Edison believes is the best way to meet environmental objectives at least possible costs. "The damages from residual emissions would then be reflected, at the margin, in the prices ofemissions permits or the fee charged. These costs in turnbecomelike ordinaryproduction costs thatfirms take into accountwhen they choose what to produce, how to produce it, and what to charge" [po 3]. Residual valuations based on marketable permits cannot yet be made since there has not been a market established for emissions other than SOx' Edison recommends the use of damage-based externality values developed in a study it commissioned. Thepreliminaryresults oftheNationalEconomicResearchAssociates study, along with a comparison ofvaluations based on other valuation methods, are summarized in the following table.

COMPARISON OF ALTERNATIVE METHODS FOR RESIDUAL EMISSIONS VALUATION SOUTH COAST AIR QUALITY MANAGEMENT DISTRICT (1989 dollars/ton)

Edison Preliminary (ER-92)

- Low 1,500 100 3,900

- Mid-range 3,100 800 6.900

- High 9,000 3,200 17,100 SCAQMD 1991 14,400 4,800 28,300 SCAQMD 1988 4,200 1,600 7,900

CEC Staff (ER-92) Marginal Cost 24,500 16,200 26,600 CPUC BRPU Marginal Cost 26,400 18,900 5,700 CEC Staff (ER-92) Average Cost ==.+== 13,100 8,800 11,900 

# - ..**~** OffsetRequirements. This requires the reduction ofemissions equal to or greater than the addition ofemissions resulting from additional generating capacity. Offsets canbe obtained from within the utility, provided by public policy or purchased on the market. Ifadditional capacity must be offset by more than one ton for every ton from new capacity, then emissions should decrease as the result of added capacity. "Thus, where offsets are used,



### 66there are no residual emissions due to added capacity and therefore no residual emissions

values need to be calculated" [p. 6]. The future of offset prices is uncertain. "The price of electricity should not be impacted [in the forecast period] enough by the price of offsets to reduce the economic feasibility of using electrification as an emissions reduction strategy" [p. 26]. "A major uncertainty affecting prices is the continuous change in regulations, and regulatory interpretations, concerning the need for offsets"[p.25]. Currently, costs of offsets are lower than costs of control since most offsets come from plant shutdowns. The cost difference is expected to diminish with the passage of time as "major emission sources have closed down, and remaining sources are retrofit with controls, fewer offsets will be available from shutdowns" [p. 25].
Scope of Environmental Externality Valuations The company proposes that costs of reducing emissions through new resource additions be compared to the costs of other measures, in addition to generation. The comparative data on residual valuations would be incorporated into four distinct resource plans. 1. Resource plan based on direct costs, which uses "the prescribed methodology with generation resources added to maintain system reliability and to reduce electricity production costs" [p. 8]. 2. Resource plan based on limited set of environmental measures encompasses the same factors as the first plan, but adds the costs associated with residual air emissions (i.e., those not offset or internalized). 3. Resource plan based on broad set of environmental measures is designed to reduce the costs of achieving residual air emissions reduction by substituting more cost-effective measures than those included in the second resource plan. 4. Preferred resource plan takes into account other environmental effects (e.g., land use and endangered species) and other resource planning objectives (e.g., energy efficiency, reliability, electricity cost, flexibility and renewable resource development). There are five stated advantages of this proposed resource planning process. 1. The extent to which generation resources are an appropriate means for achieving improved air quality is identified as are the comparative costs and benefits of potential new resources versus other measures. 2. Environmental quality is recognized as one of many resource planning objectives. 3. A means for explicitly including judgment in resource planning is provided.

67 there are no residual emissions due to added capacity and therefore no residual emissions values need to be calculated" [po 6]. Thefuture ofoffset prices is uncertain. "The price ofelectricity should not be impacted [in theforecast period] enoughbytheprice ofoffsets to reducethe economicfeasibility ofusing electrification as an emissions reduction strategy" [po 26]. "A major uncertainty affecting prices is the continuous change 

### in regulations, andregulatoryinterpretations, concerningthe need for offsets"[p.25]. Currently, costs ofoffsets are lower than costs ofcontrol since most offsets come from plant shutdowns. The cost difference is expected to diminish with the passage oftime as "major emission sources have closed down, andremaining sources are retrofit with controls, fewer offsets will be available from shutdowns" [po 25]. Scope ofEnvironmental Externality Valuations The company proposes that costs ofreducing emissions through new resource additions be compared to the costs ofother measures, in addition to generation. The comparative data on residual valuations would be incorporated into four distinct resource plans. 1. Resource plan based on direct costs, which uses "the prescribed methodology with generation resources added to maintain system reliability and to reduce electricity production costs" [po 8]. 2. Resourceplanbasedonlimited setofenvironmentalmeasures encompassesthe same factors as the first plan, but adds the costs associated with residual air emissions (i.e., those not offset or internalized). 3. Resource plan based onbroad set of environmental measures is designed to reduce the costs of achieving residual air emissions reduction by substituting more cost-effective measures than those included in the second resource plan. 4. Preferredresource plantakes into account otherenvironmental effects (e.g., landuse and endangered species) and other resource planning objectives (e.g., energy efficiency, reliability, electricitycost, flexibility andrenewableresource development). There are five stated advantages ofthis proposed resource planning process. 1. The extent to which generation**resourc~s** are an appropriate means for achieving improved air quality is identified as are the comparative costs and benefits of potential new resources versus other measures. 2. Environmental quality is recognized as one of many resource planning objectives. 3. A means for explicitly includingjudgment in resource planning is provided.

674. Results of analytical resource planning methods are incorporated into the

development of the Preferred Resource Plan. 5. Discussion and debate is focused on policy issues, with the analytical results used as supporting information.

Potential PITC Conflicts/Disadvantages Agencies should apply regulations consistently across all sources of emissions within a relevant region. If implemented on a piecemeal basis, such environmental regulation can result in higher costs than necessary, lead to higher levels of pollution, produce regulatory conflict and adversely impact competitiveness. "If emissions from only part of an industry or economy are regulated, the unregulated parts will tend to expand more rapidly, and those expansions could lead to greater pollution levels" [p. 4]. "Stringent regulations on utilities' emissions could cause large increases in utility rates, which would encourage customers with the ability to bypass the system to do so. Not only would this lead to even greater rates for existing customers; it might also lead to more pollution if less stringently-controlled boilers were used to generate electricity" [p. 5]. Conflicts between regulatory districts can arise if the regulatory requirements are not coordinated among agencies. These conflicts would occur for utilities with only limited jurisdiction over generation sources. Competitiveness in national and international markets could be lost by raising the cost of doing business in the regulated area. In some cases, such as when offsets are required or where marketable permits have been purchased, utilities already internalize the cost of environmental emissions in their resource planning processes. It would be double counting to add PUC-imposed monetized externality values to emissions from these sources. Zero Externality Values "The fact that the United States does not (yet) have regulations governing GHG [greenhouse gas] emissions means that the `revealed preference' approach would assign a zero value to GHG emissions. Edison recommends that GHG emissions be valued at zero at the present time because -- absent equivalent commitments on the part of other jurisdictions -- reducing GHG emissions in California will lead to no perceptible gains to California residents" [p. 28].

68 4. Results of analytical resource planning methods are incorporated into the development ofthe Preferred Resource Plan. 5. Discussion and debate is focused on policy issues, with the analytical results used as supporting information.
Potential PUC Conflicts/Disadvantages Agencies should apply regulations consistently across all sources of emissions within a relevant region. Ifimplemented on a piecemeal basis, such environmental regulation can result in higher costs than necessary, lead to higher levels ofpollution, produce regulatory conflict and adversely impact competitiveness. "Ifemissions from only part ofanindustry or economy areregulated, the unregulated parts will tend to expand more rapidly, and those expansions could lead to greater pollution levels II [po 4]. "Stringentregulations onutilities' emissions could causelargeincreasesin utilityrates, whichwould encourage customers with the ability to bypass the system to do so. Not only would this lead to even greater rates for existing customers; it might also lead to more pollution if less stringently-controlled boilers were used to generate electricityII [po 5]. Conflicts betweenregulatory districts can arise ifthe regulatoryrequirements are not coordinated among agencies. These conflicts would occur for utilities with only limitedjurisdiction over generation sources. Competitiveness in national and international markets could be lost by raising the cost of doing business in the regulated area. In some cases, such as when offsets are required or where marketable permits have been purchased, utilities already internalize the cost ofenvironmental emissions in their resource planningprocesses. Itwouldbe double counting to addPUC-imposedmonetized externality values to emissions from these sources.
Zero Externality Values liThe fact that theUnitedStates does not (yet) haveregulations governing GHG [greenhouse gas] emissions means that the 'revealed preference' approach would assign a zero value to GHG emissions. Edison recommends that GHG emissions be valued at zero at the present time because

-- absent equivalent commitments onthe part ofotherjurisdictions

-- reducing GHGemissions in Californiawill leadto no perceptible gains to California residents" [po 28].



### 68Edison also recommends the use of zero externality values for in-state attainment areas

given that the National Ambient Air Quality Standards for emissions are set well below those shown to impact human health.

Interim CO2 Externality Values An efficient policy directed toward the reduction of greenhouse gas emissions should be comprehensive in that the values should be extended to non-utility emissions and that emissions other that CO2 should be available as offsets. Edison suggests that, in order to "consider possible damages and to anticipate future regulation" [p. 28], the $2.00 per ton of CO2 estimate of Dr. Nordhaus may be appropriate. "The use of a damage-based figure for CO2 should be accompanied by a policy that allows utilities to offset their emissions by finding reductions in CO2 or other GHG emissions in other regions or other sectors of the economy" [p. 28].

SUPPORTING DOCUMENTATION Appendix A of the testimony contains source information used for the calculation of preliminary damage-based estimates . Appendix B is an article reprint, cited as follows. Nordhaus, William D. "To Slow or Not to Slow: The Economics of the Greenhouse Effect," The Economic Journal, July 1991.

69 Edison also recommends the use of zero externality values for in-state attainment areas given that the National Ambient Air Quality Standards for emissions are set well below those shown to impact human health.
Interim CO2 Externality Values An efficient policy directed toward the reduction of greenhouse gas emissions should be comprehensive in that the values should be extended to non-utility emissions and that emissions other that CO2 should be available as offsets. Edison suggests that, in order to "consider possible damages and to anticipate future regulation" [po 28], the $2.00 per ton ofCO2 estimate ofDr. Nordhaus may be appropriate. "The use ofa damage-based figure for CO2 should be accompanied by a policy that allows utilities to offset their emissions by finding reductions in CO2 or other GHG emissions in other regions or other sectors ofthe economy" [po 28].
SUPPORTING DOCUMENTATION Appendix A of the testimony contains source information used for the calculation of preliminary damage-based estimates. Appendix B is an article reprint, cited as follows. Nordhaus, William D. "To Slow orNot to Slow: TheEconomics ofthe Greenhouse Effect," The Economic Journal, July 1991.

69WILLIAM L. STILLINGER Northeast Utilities Service Company

107 Selden Street Berlin, Connecticut 06037

PROFILE Mr. Stillinger is Director of System Planning for Northeast Utilities Service Company (NUSCO), a position he had held since 1987. Prior to joining the subsidiary of Northeast Utilities, he served as a generation planning engineer with the New England Power Pool and with the American Electric Power Service Corporation in the area of transmission planning.
TESTIMONY REFERENCED "Direct Testimony of William L. Stillinger on Behalf of Western Massachusetts Electric Company in the Investigation by the Department on its Own Motion as to the Environmental Externality Values to be Used in Resource Cost-Effectiveness Tests by Electric Companies Subject to the Department's Jurisdiction," Massachusetts Department of Public Utilities Docket No. D.P.U. 91-131, October 1991.
STATE REGULATORY ISSUE ADDRESSED Under its Order on Integrated Resource Management (IRM), the Massachusetts Department of Public Utilities (D.P.U.) directs electric utilities to consider all air, water, solid waste and spent fuel disposal impacts resulting from plant operation in the resource evaluation process. In addition, D.P.U. Order 89-239 prescribes monetized environmental externality values for eight air pollutants (CO2, CH41 CO, N20, NOR, SO2, TSPs and VOCs) that are to be incorporated into the electric utility IRM process.
SUMMARY OF CONCLUSIONS Mr. Stillinger presents two key conclusions. First, defensible environmental externality adders, based on residual damage costs, can be used in evaluating the costs of resource options. However, if used beyond that application, adders can lead to serious economic distortions. Second,' implementation plans for NOR, and potentially for CO2, may require that electric utilities make use of offsetting techniques as an adjunct to installing control equipment.

70 PROFILE WILLIAM L. STILLINGER Northeast Utilities Service Company 107 Selden Street Berlin, Connecticut 06037

Mr. Stillinger is Director of System Planning for Northeast Utilities Service Company (NUSCO), a position he had held since 1987. Prior tojoining the subsidiary of Northeast Utilities, he served as a generation planning engineer with the New England Power Pool and with the American Electric Power Service Corporation in the area of transmission planning.
TESTIMONY REFERENCED "Direct Testimony of William L. Stillinger on Behalf of Western Massachusetts Electric Company in the Investigation by the Department on its Own Motion as to the Environmental Externality Values to be Used in Resource Cost-Effectiveness Tests by Electric Companies Subject to the Department's Jurisdiction," Massachusetts Department ofPublic Utilities Docket No. D.P.U. 91-131, October 1991.
STATE REGULATORY ISSUE ADDRESSED Under its Order on Integrated Resource Management (IRM), the Massachusetts Department of Public Utilities (D.P.U.) directs electric utilities to consider all air, water, solid waste and spent fuel disposal impacts resulting from plant operation in the resource evaluation process. In addition, D.P.U. Order 89-239 prescribes monetized environmental externalityvalues for eight air pollutants (C02 , CH4, CO, N2 0, NOx , S02' TSPs and VOCs) that are to be incorporated into the electric utility IRM process.
SUMMARY OF CONCLUSIONS

.Mr. Stillinger presents two key conclusions. First, defensible environmental externality adders, based on residual damage costs, can be used in evaluating the costs of resource options
.. However, if used beyond that application, adders can lead to serious economic distortions. Second,'implementation plans for NOx, and potentially for CO2 , may require that electric utilities make use of offsetting techniques as an adjunct to installing control equipment.

70ISSUES

The following issues concerning environmental externalities were raised in the direct testimony of Mr. Stillinger. Page citations directly follow all direct quotations from this testimony. Scope of Monetized Environmental Externalities Monetized environmental externalities should only be used for evaluating the costs of new resources because "externality costs are (by definition) not part of the `hard dollar' or market costs of resources. These adders are not capable of accurately measuring the comparative environmental benefits of resources" [pp. 17-18]. "Using the externality adders in most analyses related to electric utility planning and operations, such as generation dispatch, setting rate levels and rate design, near term purchase/sales decisions, or the evaluation of existing resources can lead to undesirable, if not absurd, results" [p. 18]. Environmental Dispatch Regional power pool dispatch, using environmental adders to the generating units' fuel prices, "would be virtually impossible to implement, even if we assume that the utilities and regulators in the six New England states could agree on the same set of externality adders to use" [p. 31]. Environmental dispatch may disrupt the coordinated operation of the integrated electric power system, while imposing operating constraints that may be incompatible with the transmission system design.
Impacts on DSM Resource Options A paper prepared on the work conducted by the MIT Energy Laboratory as part of the Analysis Group for Regional Electricity Alternatives project concluded that "[s]ince the New England system has a great deal of old, inefficient, oil-fired capacity, least-cost planning approaches that substitute investments in demand-side management for new, efficient power plant investments lead to higher aggregate emissions for some major pollutants. This suggests that technology-based pollution externality `adders' favoring demand-side management might be a poor way of structuring `least social cost' planning. Instead, such social costs should be calculated at the system or portfolio level" [p. 29].

71 KEY ISSUES The following issues concerning environmental externalities were raised in the direct testimony of Mr. Stillinger. Page citations directly follow all direct quotations from this testimony. Scope ofMonetized Environmental Externalities Monetized environmental externalities should only be used for evaluating the costs ofnew resourcesbecause "externalitycosts are (by definition) notpart ofthe 'harddollar' ormarket costs ofresources. These adders are not capable ofaccurately measuring the comparative environmental benefits ofresources" [pp. 17-18]. "Using the externality adders in most analyses related to electric utility planning and operations, such as generation dispatch, setting rate levels and rate design, near term purchase/sales decisions, or the evaluation of existing resources can lead to undesirable, if not absurd, results" [po 

### 18].
Environmental Dispatch Regional power pool dispatch, using environmental adders to the generating units' fuel prices, "would be virtually impossible to implement, even ifwe assume that the utilities and regulators in the six'New England states could agree on the same set of externality adders to use" [po 31]. Environmental dispatch may disrupt the coordinated operation of the integrated electric power system, while imposing operating constraints that may be incompatible with the transmission system design. Impacts on DSM Resource Options A paper prepared on the work conducted by the MIT Energy Laboratory as part of the Analysis Groupfor RegionalElectricityAlternatives project concluded that "[s]ince the New England system has a great deal of old, inefficient, oil-fired capacity, least-cost planning approachesthat substituteinvestmentsindemand-sidemanagementfornew, efficient power plant investments lead to higher aggregate emissions for some major pollutants. This suggests that technology-based pollution externality 'adders' favoring demand-side management might be a poor way of structuring 'least social cost' planning. Instead, such social costs should be calculated at the system or portfolio level" [po 29].

71Constraints on Quantification/Monetization

The monetized values set by the Massachusetts D.P.U. present a number of difficulties. ® "Environmental adders silently and incorrectly assume that additional reductions in pollution always provide a net benefit to society. ® Applying environmental adders (in ways beyond tallying a resource option' s costs) violates principles of economic theory. ® Control costs are not a reasonable proxy for damage costs. ® Environmental considerations have long been considered in least cost planning. Applying environmental adders (in ways beyond tallying a resource option's costs) can run counter to a utility's need to remain competitive with alternate forms of power supply" [pp. 19-20].
SUPPORTING DOCUMENTATION Andrews, Clinton J.. et al. "Assessing the Tradeoffs Between Environment, Cost and Reliability: Developing a Coordinated Strategy to Ensure New England's Electricity Supply." MIT Energy Laboratory, May 1990.

72 Constraints on Quantification/Monetization The monetized values set by the Massachusetts D.P.U. present a number of difficulties.

e "Environmental adders silently and incorrectly assume that additional reductions in pollution always provide a net benefit to society.

e Applying environmental adders (in ways beyond tallying a resource option's costs) violates principles of economic theory.

e Control costs are not a reasonable proxy for damage costs. Environmental considerations have long been considered in least cost planning. Applying environmentaladders (inways beyondtallying aresource option's costs) can run counter to a utility's need to remain competitive with alternate forms ofpower supply" [pp. 19-20].
SUPPORTING DOCUMENTATION Andrews, Clinton 

### J.
. et al. "Assessing the Tradeoffs )3etween Environment, Cost and Reliability: Developinga CoordinatedStrategytoEnsureNewEngland'sElectricitySupply." MIT Energy Laboratory, May 1990. '

72U.S. DEPARTMENT OF ENERGY 1000 Independence Avenue, SW Washington, D.C. 20585

PROFILE The U.S. Department of Energy (DOE) is an agency of the federal government. As part of the National Energy Strategy, DOE is expanding its program to provide financial assistance, technical data and evaluation criteria to assist States and utilities in developing effective for integrated resource planning and demand-side management programs.
TESTIMONY REFERENCED "Comments of the United States Department of Energy" to the Texas Public Service Commission, Project No
. 10780, March 23,1992 and "Reply Comments of the United States Department of Energy" to the Texas Public Service Commission, Project No. 10780, April 13, 1992.
STATE REGULATORY ISSUE ADDRESSED The Texas Public Utility Commission is amending its rules regulating electric utilities. Among the issues addressed is the consideration of environmental externalities.
SUMMARY OF CONCLUSIONS The U.S. Department of Energy prefers the use of damage-based cost estimates over other methods for valuing environmental externalities. Environmental externality valuations are appropriately applied to the resource selection process only after all alternatives are considered (i.e., net system impact). Externality valuations should be applied equally over all sources of emissions so as not to distort resource prices and competitive situations between energy supply sources.
KEY ISSUES The following issues concerning environmental externalities were raised in the two DOE submissions. Page citations directly follow all direct quotations. The notation "C" following the page number indicates quotations taken from the Comments submitted; "RC" indicates those from the Reply Comments.

73 PROFILE U.S. DEPARTMENT OF ENERGY 1000 Independence Avenue, SW Washington, D.C. 20585

The U.S. Department ofEnergy (DOE) is an agency ofthe federal government. As part of the National Energy Strategy, DOE is expanding its program to provide financial assistance, technical data and evaluation criteria to assist States and utilities in developing effective for integrated resource planning and demand-side**manageme~t** programs.
TESTIMONY REFERENCED "Comments of the United States Department of Energy" to the Texas Public Service Commission, Project No. 10780, March 23, 1992 and "Reply Comments ofthe United States Department ofEnergy" to the Texas Public Service Commission, Project No. 10780, April 13, 1992.
STATE REGULATORY ISSUE ADDRESSED The Texas Public Utility Commission is amending its rules regulating electric utilities. Among the issues addressed is the consideration of environmental externalities.
SUMMARY OF CONCLUSIONS The U.S. Department ofEnergy prefers the use ofdamage-based cost estimates over other methods for valuing environmental externalities. Environmental externality valuations are appropriately applied to the resource selection process only after all alternatives are considered (i.e., net system impact). Externality valuations should be applied equally over all sources of emissions so as not to distort resource prices and competitive situations between energy supply sources.
KEY ISSUES The following issues concerning environmental externalities were raised in the two DOE submissions. Page citations directly follow all direct quotations. The notation 

## "c" following the page number indicates quotations taken from the Comments submitted; "RC" indicates those from the Reply Comments.

73Environmental Externality Policy Options

As a policy option for meeting environmental goals, "it is appropriate for rate regulators, with responsibility for approving methods of meeting demand growth, to utilize environmental externality measures to help inform them in making these determinations" [p.30C]. Environmental Externality Valuation Methods "Damage measurements should be utilized for establishing externality values

. Other, `proxy' measures -- such as the highest marginal cost of control method -- are unlikely to have any relationship to damages
. Since damages are the principal aspect of environmental externalities, the focus should be on such impacts, even though there likely will be some unanswered questions " [p. 23C]. Most values in a table presented by the Environmental Defense Fund in the Texas proceedings are based on the Tellus Institute and Pace studies and show differences among values for specific externalities to "differ by as much as 16 to 1 " [p.10RC]. "DOE, in its testimony presented before the Massachusetts Department of Public Utilities, pointed out the serious flaws in these two studies " [p. 11RC]. Highest cost of control "is not accepted by many experts, because it produces externality values that have no relationship to damage costs" [p. 11RC]. Scope of Monetized Environmental Externalities "If externality values are applied across the board to all options ; and if offsets are allowed and are taken into account in evaluating options -- then DOE believes that externality values have the potential to be useful" [p. 28C]. "Before applying any externality values it might adopt, DOE recommends that the Commission consider the `net system impact' of the various alternatives under consideration as methods of meeting a demand growth increment. Often, these alternatives -- both conservation/load management as well as supply options -- will have different capacity factors. Those with higher capacity factors will displace more existing generation, when they come into service, than those with lower capacity factors. Since existing generation emits pollutants, there will be, for each pollutant, a net system impact (NSI) for each alternative under consideration. The NSI will consist of (1) the increase in pollution from the new alternative, minus (2) the decrease in pollution from existing generators which operate less often because of the new addition to the electricity system" [p. 21C]. DOE contends that if insufficient data exist to develop a quantitative value for residual pollutant emissions impacts, "a qualitative value should not be used as an alternative. Use of a qualitative value could unjustifiably distort any integrated resource planning process" [p. 22C]. 74 Environmental Externality Policy Options As a policy option for meeting environmental goals, "it is appropriate for rate regulators, with responsibility for approving methods of meeting demand growth, to utilize environmental externality measures to help inform**~hem** in making these determinations" [p.30C].
Environmental Externality Valuation Methods "Damagemeasurements shouldbeutilized for establishing externalityvalues. Other, 'proxy' measures -- such as the highest marginal cost of control method -- are unlikely to have any relationship to damages. Since damages are the principal aspect of environmental externalities, the focus should be on such impacts, even though there likely will be some unanswered questions" [po 23C]. Most values in a table presented by the Environmental Defense Fund in the Texas proceedings are based on the Tellus Institute and Pace studies and show differences among values for specific externalities to "differ by as much as 16 to 1" [p.10RC]. "DOE, in its testimony presented before the Massachusetts Department ofPublic Utilities, pointed out the serious flaws in these two studies" [po 

### llRC]. Highest cost of control "is not accepted by many experts, because it produces externality values that have no relationship to damage costs" [po 11RC]. Scope ofMonetized Environmental Externalities "If externality values are applied across the board to all options; and if offsets are allowed and aretakeninto account in evaluating options -- thenDOEbelieves that externalityvalues have the potential to be useful" [po 28C]. "Before applying any externality values it might adopt, DOE recommends that the Commission consider the 'net system impact' ofthevarious alternatives underconsideration as methods of meeting a demand growth increment. Often, these alternatives -- both conservation/load management as well as supply options -- will have different capacity factors. Thosewith higher capacityfactors will displace more existing generation,when they come into service, than those with lower capacity factors. Since existing generation emits pollutants, there will be, for each pollutant, a net system impact (NSI) for each alternative under consideration. The NSI will consist of (1) the increase in pollution from the new alternative, minus (2) the decrease in pollution from existing generators which operate less often because of the new addition to the electricity system" [po 21C]. DOE contends that if insufficient data exist to develop a quantitative value for residual pollutant emissions impacts, "a qualitative value should not be used as an alternative. Use ofa qualitative value couldunjustifiably distort anyintegratedresource planningprocess" [po 22C]. 

### 74Impacts on DSM Resource Options

DOE "strongly supports level-playing-field competition among various methods of meeting demand growth, with consideration given to both `demand side' (conservation and load management) and `supply side' (various types of new generating units) options" [p. 16C]. However, the reinforcement and maintenance of this policy in regard to environmental externalities "must be addressed carefully so as not to create unjustified, implicit subsidies or roadblocks to affected technologies" [p. 16C]. Zero Externality Values DOE "is opposed to the argument that any economic value assigned to an environmental externality is better than zero " [p. 14RC]. After the year 2000, there will be a constant amount of allowances for SO2 emissions. "Because each ton of SO2 emitted will have a cost associated with it, a cost that can be reduced by reducing emissions, SO2 externalities will be fully internalized" [p. 24C]. Costs that have been fully internalized should therefore have a zero externality value. Interim CO2 Externality Valuations DOE "believes that carbon dioxide (CO2) does not, at this time, meet the criteria for a quantitative examination of externality values. Greenhouse warming is potentially serious, but very little is known with much certainty with regard to levels and impacts of possible temperature increases, and proposals for dealing with emissions of greenhouse gases could be very expensive, with large negative impacts for the U.S. economy" [p. 20C]. Appropriateness of State PUC-i posed Values The Clean Air Act Amendments are designed to internalize the cost of SO2 through the marketable permit trading mechanism. "With respect to SO2 and other criteria pollutants, DOE advises against the application of cost penalties absent a clear indication that environmental impacts of new facilities are not already adequately internalized through existing environmental regulatory programs" [p. 1ORC]. "Additional control through State imposed `adders' (or taxes on particular fuels and technologies) would cause a reduction in societal benefits because the added economic cost would exceed the benefit" [p. 1ORC]. Fuel Switching The application of externality valuations to only one sector, such as electric utilities, "could cause distortions in market price signals and lead to inefficient use of resources. Some 75 Impacts on DSM Resource Options DOE "strongly supports level-playing-field competition among various methods ofmeeting demand growth, with consideration given to both 'demand side' (conservation and load management) and 'supply side' (various types of new generating units) options" [po 16C]. However, the reinforcement and maintenance of this policy in regard to environmental externalities "must be addressed carefully so as not to create unjustified, implicit subsidies or roadblocks to affected technologies" [po 

### l6C].
Zero Externality Values DOE "is opposed to the argument that any economic value assigned to an e.rIvironmental externality is better than zero" [po l4RC]. After the year 2000, there will be a constant amount of allowances for S02 emissions. "Because each ton of S02 emitted will have a cost associated with it, a cost that can be reduced by reducing emissions, S02 externalities will be fully internalized" [po 24C]. Costs that have been fully internalized should therefore have a zero externality value.
Interim CO2 Externality Valuations DOE "believes that carbon dioxide (C02 ) does not, at this time, meet the criteria for a quantitative examination of externality values. Greenhouse warming is potentially serious, but very little is known with much certainty with regard to levels and impacts of possible temperature increases, and proposals for dealing with emissions ofgreenhouse gases could be very expensive, with large negative impacts for the U.S. economy" [po 20C]. Appropriateness of State PUC-imposed Values The Clean Air Act Amendments are designed to internalize the cost of S02 through the marketable permit trading mechanism. "With respect to S02 and other criteria pollutants, DOE advises against the application of cost penalties absent a clear indication that environmental impacts of new facilities are not already adequately internalized through existing environmental regulatory programs" [po 10RC]. "Additional control through State imposed 'adders' (or taxes on particular fuels and technologies) would cause a reduction in societalbenefits because the added economic cost would exceed the benefit" [po lORC].
Fuel Switching The application ofexternality valuations to only one sector, such as electric utilities, "could cause distortions in market price signals and lead to inefficient use of resources. Some 75energy users might shift to energy services not subject to regulation" [p. 28C]. Electric

vehicles would become less attractive while the use of 'fuels other than electricity would become marginally more attractive.
SUPPORTING DOCUMENTATION The following are the references, as cited, in the comments and reply comments concerning environmental externalities. ECO Northwest. Generic Coal Study. 1987. Mendelsohn and Orcutt. An Empirical Analysis of Air Pollution Dose-Response Curves. 1979. National Acid Precipitation Assessment Program. Integrated Assessment. January 1992. Schmalensee, Richard L. "Testimony of Richard L. Schmalensee," Massachusetts Department of Public Utilities, December 13, 1991.

76 energy users might shift to energy services not subject to regulation" [po 28C]. Electric vehicles would become less attractive while the use of-fuels other than electricity would become marginally more attractive.
SUPPORTING DOCUMENTATION Thefollowing are the references, as cited, in the comments and reply comments concerning environmental externalities. ECO Northwest. Generic Coal Study. 1987. Mendelsohn and Orcutt. AnEmpiricalAnalysis of AirPollutionDose-Response Curves. 1979; National Acid Precipitation Assessment Program. IntegratedAssessment. January 1992. Schmalensee,RichardL. "TestimonyofRichardL. Schmalensee,"MassachusettsDepartment ofPublic Utilities, December 13, 1991.

76