Environmental regulation of utilities such as the electricity industry is complicated by the appearance of two market failures, both of which provide a basis for intervention: environmental pollution; and a significant degree of monopoly power. The interaction of environmental and economic regulation is an increasingly important policy area as energy markets around the world are subjected to privatisation and often liberalisation. This policy relevance was highlighted at a recent meeting of the UK Royal Geographical Society, where calls for further study of this area were made.

Electricity generation is responsible for significant amounts of a range of atmospheric pollutants (including carbon dioxide and sulphur dioxide).

The efficacy of environmental regulation in this area needs to be considered in the light of the simultaneous economic regulation. The standard economic analysis of environmental policy instruments is no longer adequate. This paper, building on previous work, presents a game theoretic

model of the interactions between the two regulators and their regulatees.

The model consists of:

* an environmental regulator charged with reducing levels of atmospheric emissions to an exogenously set target level (as, for example, derived from international obligations);

* an economic regulator charged with preventing the exploitation of monopoly power whilst maintaining positive profits for the generating firms;

* and duopoly firms who act to maximise profits and may choose either to co-operate to form a monopoly or to compete with each other.

This model describes the post-privatisation UK electricity generation industry, the experience of which continue to be studied carefully by countries which are considering privatisation and liberalisation policies.

In this paper we present the results of modelling work showing the welfare effects of differing environmental policies. We compare the effects in terms of price, quantity, consumer surplus and profits of the following environmental policies: an emissions tax; an abatement technology standard; and a maximum allowable level of emissions. We then test the robustness of the conclusions to the following changes in the regulatory regimes: co-operation between the two regulators (i.e. one regulatory body responsible for both environmental and price regulation); two regulatory agencies acting simultaneously, and two regulatory agencies operating under conditions of Stackleberg leadership by the environmental regulator.

In this period of increasing privatisation of public utilities in both developed and developing counties it is an opportune time to reassess the regulatory procedures of both environmental and economic regulators. This paper not only advances theoretical modelling in this area, but is also directly relevant to policy making.

Our analysis shows the relative effectiveness of different environmental policy instruments under conditions where both externalities and a significant degree of monopoly power are apparent. The effectiveness of differing regulatory regimes is also examined and policy recommendations are made.