The Obama administration declared late last week that carbon dioxide and five other industrial emissions threaten the planet. The landmark decision lays the groundwork for federal efforts to cap carbon emissions.  As reported by the Wall Street Journal, the Environmental Protection Agency finding that the emissions endanger "the health and welfare of current and future generations" is "the first formal recognition by the U.S. government of the threats posed by climate change," EPA Administrator Lisa Jackson wrote in a memo to her staff.

While this may be the first time the US EPA has acknowledged the potential damaging impacts of climate change, the U.S. Supreme Court ruled two years ago that carbon dioxide is a pollutant under the Clean Air Act and declared that the EPA can regulate it. What has changed is that the EPA is now responding to the Supreme Court mandate.  While this may simply reflect acknowledgement by the EPA of the need to comply with the U.S. Supreme Court’s mandates, many observers view the Endangerment finding as a mechanism through which the Obama Administration will spur legislative action. In fact, there already has been legislative action, in the form of the American Clean Energy and Security Act (ACES), proposed by Representatives Henry Waxman and Edward Markey, now in hearings before the House Energy Committee and expected to be out of committee by Memorial Day.

A choice between regulation and legislation
Markey (D., Mass.) responded to the EPA finding by saying: "It's now no longer a choice between doing a bill or doing nothing," said the lawmaker, who will hold four days of climate change hearings next week before the formal drafting of a bill begins the last week of April. "It is now a choice between regulation and legislation." 

White House officials have been explicit that President Obama prefers a legislative approach to curbing global warming. The White House will dispatch senior officials to the hearings on the Waxman-Markey proposal.  The proposal would cap carbon emissions and sell tradable permits covering carbon dioxide emissions.   

The threat of the EPA regulating CO2 under the Clean Air Act has also rallied major generators around supporting cap and trade legislation this year.  FPL, Duke, NRG, Exelon, and PSEG have all joined the "Climate Change Alliance" urging near-term legislation.  It is the first time I've seen generators with such divergent views and stakeholder interests agree on anything. 

With the Obama administration, both houses of the US Congress, and many of the largest US generators all pushing for cap & trade legislation, and the urgency of finding an alternative to regulation of CO2 through the Clean Air Act, the likelihood of such legislation being enacted has never been greater. There are nonetheless significant issues to be resolved.

Caps, auctions, and unresolved issues
One of the biggest concerns is whether the CO2 allowances required to meet the the caps will be allocated based on current CO2 emissions relative to the caps or auctioned, or some combination of the two mechanisms. A pure auction mechanism would heavily favor generators with substantial nuclear and/or gas-fired generation and impose high costs on generators with coal-dominated fleets.  Of note, both the Waxman-Markey and the Obama budget proposal require a 20 percent reduction from 2005 levels by 2015 and an 80 percent reduction by 2050. For more detail on issues around auction vs. allocated mechanisms, refer to this recent article in Power Engineering. 

In ordinary times, I might predict an initial reliance on allocation, so as to “level the playing field” between generators and focus incentives on incremental CO2 reductions, since any pure auction would place a far heavier burden on generators with large amounts of coal-fired capacity. As we know, however, these are not ordinary times. There is a large political motivation to capitalize on climate change as a means of either addressing the budget deficits associated with recent government investments in stimulating the economy and rescuing failing financial institutions (and the U.S. automotive industry, but I don’t even want to go there).

 A pure CO2 allowance auction with the caps associated with current proposals would raise hundreds of billions of dollars of revenue.  Proponents of such an approach suggest that if the revenue is invested wisely, it can augment current efforts to stabilize/stimulate the economy, create large numbers of “green jobs,” and jumpstart efforts toward minimizing the potential impacts of climate change. Of course “invested wisely” is a big caveat, and if my former career as an energy economist taught me anything, it is the truism that if you placed all the economists in the world end-to-end they still would not reach a conclusion.”

 But the one conclusion that I believe all economists would agree upon is that any policy resulting in the shuttering of substantial existing coal-fired generation would have massive impacts on the aggregate costs of meeting our electricity needs and commensurate impacts on the US economy, given that electricity is the largest single input to our national economy. 

Cap and trade impacts on consumers are exaggerated
On the other hand, I believe that the impact of a federal CO2 cap & trade program on end-user electricity costs is often exaggerated. I use the term “costs” as opposed to “rates” intentionally. The combination of expanding DSM and energy efficiency programs, new state regulatory mechanism that “decouple” revenues from kWh sales (intended to reward utilities for promoting DSM and efficiency programs), combined with the fact that higher electricity prices promote customers to use less electricity mean that electricity customers of all sorts will be meeting their electricity needs more efficiently. Amory Lovins, founder of the Rocky Mountain Institute once drove home the point that electricity rates are not the primary issue by saying what we really want is “not electricity itself, but a reliably cold beer and a reliably hot shower at the minimum possible cost.”

Another source of confusion in this debate is that of equating CO2 increases in the cost of generation with the ultimate impacts of prices to end-users.  Generation comprises only 30-40 percent of the end-use cost of electricity, with the remaining costs being comprised of transmission, distribution, customer service, and administrative overhead. Thus even a $15-$25/ton CO2 allowance price that effectively doubles the cost of coal-fired generation would still result in less than a 25 percent increase in electricity rates. And CO2 allowance costs in the initial years of a federal cap and trade program are expected to be more in line with current allowance prices of less than $5/ton in the current Regional Greenhouse Gas Initiative or Chicago Climate Exchange markets.  So the rate impacts in the first few years of a federal program would likely be in the 5-10percent range. This is still significant, but not catastrophic.     

CO2 as a unifying factor
Returning to the original topic of how the threat of the US EPA regulating CO2 under the Clean Air Act is uniting parties that have historically been at odds with respect to emissions regulation, NRG Energy’s President and CEO, David Crane, this week applauded Chairman Waxman of the Energy and Commerce Committee and Chairman Markey of the Energy and Environment Subcommittee on their ACESA legislation draft.

 “Climate change may be the defining challenge for our generation, and we are running out of time to address it responsibly. I have long believed that leadership is the key to making progress on climate change, and with this draft legislation, Chairmen Waxman and Markey are showing true leadership. I am especially encouraged that they are reaching out to all members of the Committee for broad support and input on this critical issue.”
I will be talk more about these developments as they unfold at NeuCo’s Users Summit June 7-10th in Newport, Rhode Island in the session on emissions regulation that I am sharing with Alison Simcox from the EPA.

www.neuco.net

www.theoptimizationblog.com

www.twitter.com/neucoboston