Policy Uncertainty in the Market for Coal Electricity: The Case of Air Toxics Standards

Uncertainty over government policy affects irreversible decisions including technology adoption, entry, and exit. This paper provides a new approach to measuring the level of policy uncertainty surrounding the Mercury and Air Toxics Standard (MATS). We estimate a dynamic oligopoly model of technology adoption and exit for coal-fired electricity generators that recovers generators' beliefs regarding future MATS enforcement. To implement this approach, we develop a computationally tractable equilibrium concept called Approximate Belief Oligopoly Equilibrium in which all players make decisions recognizing their impact on a reduced set of market states. Generators subject to MATS experienced substantial policy uncertainty: the perceived enforcement probability dropped to 43% in 2014. Resolving policy uncertainty early increases expected discounted generator profits by $1.39 billion but also increases pollution costs by $0.652 to $1.776 billion. In our setting, where policy seeks to mitigate negative externalities and many generators are close to the exit margin, delay in uncertainty resolution helps policy goals. This result would be reversed in settings where the irreversible outcome is unlikely or where a positive externality exists.