Postprint version. Published in Resource and Energy Economics, Volume 32, Issue 3, August 1, 2010, pages 327-340.
Following the U.S. Clean Air Act Amendments of 1990, electric utilities dramatically increased their utilization of low-sulfur coal from the Powder River Basin (PRB). Recent studies indicate that railroads hauling PRB coal exercise a substantial degree of market power and that relative price changes in the mining and transportation sectors were contributing factors to the observed pattern of input substitution. This paper asks the related question: To what extent does more stringent SO2 policy stimulate input substitution from high-sulfur coal to low-sulfur coal when railroads hauling low-sulfur coal exercise spatial monopoly power? The question underpins the effectiveness of incentive-based environmental policies given the essential role of market performance in input, output, and abatement markets in determining the social cost of regulation. Our analysis indicates that environmental regulation leads to negligible input substitution effects when clean and dirty inputs are highly substitutable and the clean input market is mediated by a spatial monopolist.