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Power Sector Emission Caps: Environmental and Economic Design Goals

California Public Utilities Commission April 19, 2007

Richard Cowart

The Regulatory Assistance Project

RAP is a non-profit organization providing technical and educational assistance to government officials on energy and environmental issues. RAP is funded by US DOE & EPA, several foundations, and international agencies. We have worked in 40+ states and 16 nations.

Richard Cowart was Chair of the Vermont PSB, Chair of NARUC’s Energy & Environment Committee, and of the National Council on Electricity Policy. Recent assignments include technical assistance to RGGI, the New York ISO, the California PUC, the Oregon Carbon Allocation Task Force, and to China’s national energy and environmental agencies.

State and regional power sector carbon caps

RGGI -8 to 10 states

California & Oregon

Together, their carbon profiles exceed most nations.

How to evaluate the options? Cap-and-trade design criteria

1. Coverage and environmental integrity2. Costs to power consumers3. Societal costs – promoting low-cost

solutions, especially energy efficiency4. Administrative simplicity5. Legal limitations and challenges6. Coordination with other states and

possible federal system

Acid Rain cap-and-trade– What’s different now?

US Acid Rain program – universally recognized success. NOx and CAIR build on this model.

GHG situation is different:The best low cost solutions are not at individual

smokestacksNor in the fuel supply -- we don’t have low-

carbon coalPower markets, utility structures have changed

Ask: what did the Acid Rain program do for energy efficiency?

(1) Coverage &Environmental Integrity

Does the system have environmental integrity?

Will it ensure reductions in the real world? Does it cover all relevant emissions?

AB 32 -- All emissions associated with serving California electric load

Is the system vulnerable to “leakage” – substitution of emissions outside the cap?

California and Oregon load-side caps are intended to bring power imports into the capped system

Improves coverage, reduces leakage, but requires rules to properly assign emissions to power imports

(2) Consumer Power Costs How much does it cost power customers

for a given level of attainment?

Wrong assumption: Power generators lose money under cap and trade

Design really matters hereOptions to consider:

Generator-side cap with free allocationGenerators must buy allowancesLoad-side cap – LSEs get a carbon

budget, manage portfolio within a cap

Most generators make money with free historic allocation

Windfalls to generators ? US Congressional Budget Office: “Producers would have to

receive only a modest portion of the allowances to offset their costs from a cap on carbon emissions, because they would be expected to pass a large share of those costs on to consumers.”

RGGI study (by RFF): With free allocation in a source-based cap, consumers pay much more than the cost of adding clean resources to the mix

UK Parliament: EUTS is creating windfall gains for generators in the UK;

Similar results in Germany, Netherlands: “Under all scenarios considered, power prices turn out to increase

significantly due to CO2 emissions trading.” (--Sijm, Neuhof, and Chen May 2006)

Citigroup Analysis of the Impact of the EU Carbon Market on European Utilities

(up to 2007)

Lowering consumer power costs: two options

Require generators to purchase allowancesRGGI “consumer allocation”Prices rise, but some portion can be

returned to ratepayersLoad-side cap:

Likely to be the lowest-cost solution, since generators face neither an auction cost nor an opportunity cost for carbon

This should be modeled for California

(3) Societal CostsDoes the cap system promote investment in

low-cost GHG reduction options?

The main purpose of cap and trade is to reveal and capture low-cost reductions

Some improvements (e.g., heat rate) can be made at power plants, but

Low-carbon generation costs more, while End-use efficiency is the lowest-cost way to

reduce power sector GHGs. SO: lowest social cost will come from a

system that promotes customer efficiency

What does it cost to avoid a ton of electric CO2 ?*

Resource option

CO2 intensity (tons/MWh)

Cost per MWh

Cost per ton avoided

Coal .92/MWh $40 NA

Gas .45/MWh $55+ $30+New Nuclear big debate $70+ to ?? $30 to +??

Wind low $75 $38

PV low $180+ $152+

Efficiency low $30 (-$11)*Generation cost data (except nuclear) from EPRI (“Generation Technologies in a Carbon-constrained World,” 2005, assuming gas at $6MMbtu); EE data from Efficiency Vermont. For the point made here the precise numbers are not critical.

What happens if we double efficiency spending in RGGI?

Extensive modeling* for RGGI found:Carbon credit prices drop 25%Need for new fossil capacity drops 33%Customer bills drop 5% to 12%And – even greater EE investments (quite

attainable) would yield greater savings

*IPM model runs by ICF Consulting using EE portfolios developed by ACEEE

Lesson from experience: EE programs are more powerful than rate increases

Economic theory: just raise the price of power DSM reality: Programs are needed to

surmount market barriers to efficiency $ spent through smart programs will

deliver at least 5x the efficiency savings of $ spent through higher prices

Key conclusion: Build efficiency support into program architecture.

BUT: Generators don’t deliver efficiency, some other avenue is needed

RGGI answer: The Consumer Allocation

Allocate up to100% of initial credits to consumer representatives (eg, distribution utilities, Efficiency Utility)RGGI MOU - state minimum commitment is 25% Most states will be higher – Vermont law is 100%; NY

& MA draft rules now at 100%; CT, NJ may follow Generators need to purchase allowances, recycling the

windfall revenue BACK to consumers PUCs supervise use of the $$ for benefit of consumers Best result: focus these $ on investments that lower

carbon (EE &RE) Results: lower cost per ton avoided, lighter macro-

economic impact >> quicker progress in reducing GHG emissions

(4) Administrative simplicity

Goal: Simple rules, easily measured compliance

Difficult criterion to meet for US states or regions – leakage requires regional measurements and attributions

Rules for flexibility devices, auctions and offsets can be complex

Different sectors CAN be treated differentlyPower sector can differ from transportation, fuel

oil, steel & cement

(5) Legal IssuesDoes it satisfy the requirements of AB32, the

commerce clause, and other mandates?

AB32 requires meaningful accounting for imports (hard to envision this without actually capping/trading those tons)

But CA cannot directly regulate or tax out-of-state sources And the commerce clause of the US constitution forbids

even facially-different treatment of out-of-state sources

Load-based system satisfies these standards Hybrid systems (smokestack cap for CA plants,

something else for imports) raise thorny legal questions Many seemingly good ideas are not legally possible

Auctions raise legal issues too – Agency authority, Treasury receipts, political appropriations process

(6) Coordination with other systems and possible national system

Trading with RGGI, European system?“A ton is a ton” even if systems are differentBut integrity is key – leakage, price caps can

undermine value of CA credits

Should California’s system be designed to anticipate federal preemption? Yes – and we know what that will beNo – we don’t know what it will be, and it may

permit alternative approaches anyway

Conclusion: The three main issues

Environmental integrity – does the system cover the whole sector & ensure real reductions? (= minimal leakage)

Power price effects – how much do consumers pay to improve the sector’s carbon footprint?

Societal cost – how well does the cap system encourage delivery of low-cost, low-carbon resources ?

Concluding notes The art of cap and trade design is evolving – RGGI,

EUTS, Oregon, California are taking new approaches and learning from implementing older onesRGGI consumer allocation is a major innovation, not

previously expectedToo early to impose a single model on all states or all

power markets CPUC approach to cap-and-trade for power and

natural gas builds on CA market conditions, and experience with energy efficiency and portfolio management .

For more information…

“Another Option for Power Sector Carbon Cap and Trade Systems – Allocating to Load”

(May 2004)

“Why Carbon Allocation Matters – Issues for Energy Regulators” (March 2005)

“Addressing Leakage in a Cap-and-Trade System: Treating Imports as Sources”

(November 2006)

“Why A Load-Based Cap?”(March 2007, with Julie Fitch)

Richard Cowart, Regulatory Assistance Project Posted at www.raponline.org

Email questions to RAPCowart@aol.com