Policy Uncertainty in the Market for Coal Electricity

Policy uncertainty affects many important irreversible decisions such as investment, technology adoption, and exit. This is particularly true for environmental policy in the U.S., where Environmental Protection Agency (EPA) rule-making is subject to uncertainty due to judicial challenge and executive turnover. The paper presented in this Research Seminar estimates a dynamic oligopoly model where merchant coal generators face uncertainty over whether the Mercury and Air Toxics Standard (MATS) will be enforced in the future. In order to estimate annual profits, a key input into the model, the authors develop new approaches to estimating ramping and operation and maintenance costs. They estimate generators' beliefs regarding the probability of future enforcement and simulate how policy uncertainty affects generator exit, equilibrium costs, and pollution. The authors find that generators subject to MATS had substantial uncertainty over whether the policy would be enforced, with the implied probabilities of enforcement of 70% in 2013 and 36% in 2014. This uncertainty led to significant delays in both exit and the adoption of abatement technologies and increased generator compliance costs by $1.6 billion.