Center for the Study of Energy Markets

This paper analyzes the extent to which the conditions in the emissions permit market for oxides of nitrogen (NOx) operated by the South Coast Air Quality Management District (SCAQMD) in the Los Angeles metropolitan area interacted with competitive conditions in the California electricity market to enhance the ability of electricity suppliers with some or all of their generation units located in SCAQMD to exercise unilateral market power. We present evidence consistent with the view that NOx emissions permits were a convenient vehicle for enhancing the ability of suppliers to exercise unilateral market power in the California electricity market. We find that generation unit owners with some of their plants located in the SCAQMD paid statistically significantly higher prices for 2000 and 2001 NOx emissions permits than other participants in the SCAQMD emissions market, despite the fact the prices they paid for 1998 and 1999 vintage permits were no different from other SCAQMD participants. We then present evidence consistent with the view that wholesale electricity suppliers did not operate and bid their generation units requiring NOx emissions permits in a manner consistent with higher emission permit prices being a cause of increased production costs. Taken together, this evidence suggests that NOx emission permit prices during 2000 and 2001 were primarily used by these generation unit owners to cost-justify higher bids into the California electricity market that would set higher prices for all electricity they produced.