Escape from Third-Best: Rating Emissions for Intensity Standards
University of Arizona Department of Economics Working Paper No. 12-03
43 Pages Posted: 14 Apr 2012 Last revised: 22 Apr 2016
Date Written: December 28, 2013
An increasingly common type of environmental policy instrument regulates the carbon intensity of transportation and electricity markets. In order to extend the policy's scope beyond point-of-use emissions, regulators assign each competing fuel an emission intensity rating for use in calculating compliance. I show that welfare-maximizing ratings do not generally coincide with the best estimates of actual emissions. In fact, the regulator can achieve a higher level of welfare by properly selecting the emission ratings than possible by selecting only the level of the standard. Moreover, a fuel's optimal rating can actually decrease when its estimated emission intensity increases. Numerical simulations of the California Low-Carbon Fuel Standard suggest that when recent scientific information increased the estimated emissions from conventional ethanol, regulators should have lowered ethanol's rating (making it appear less emission-intensive) so that the fuel market would clear with a lower quantity.
A revised version has been published in Environmental and Resource Economics (2016).
Keywords: externality, emission, intensity, rating, second-best, ethanol
JEL Classification: H23, Q42, Q58
Suggested Citation: Suggested Citation