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Electricity: New Environmental Rules and the Electricity Industry — Lots of Fuss or Real Impacts?

By Bob Shively, Enerdynamics’ President and Lead Instructor

 

Update! On December 30, 2011, The United States Court of Appeals for the D.C. Circuit issued its ruling to stay the CSAPR pending judicial review. This means the CSAPR rules discussed below cannot go into effect until further ruling by the court.  For more details, see our blog at http://blog.enerdynamics.com/2012/01/09/court-halts-implementation-of-new-csapr-power-plant-emissions-rules/.

 

New regulations on power plant emissions in the U.S. have the potential in 2012 to dramatically affect markets. Barring last-minute action by Congress or the courts, the Environmental Protection Agency (EPA) will implement the new Cross-State Air Pollution Rule (known as CSAPR), which will significantly increase limitations on sulfur dioxide (SO2) and nitrous oxide (NOx) emissions in 28 states in the Eastern and Texas interconnects. Meanwhile, California is set to implement regulation of greenhouse gas emissions.

These new regulations have the potential to significantly impact:

  • the order in which generation will be dispatched
  • the price of electricity in wholesale markets
  • the economics of keeping some older coal power plants in service
  • the ultimate cost of electricity to consumers

They may also result in rising natural gas prices due to reduced competition with coal.  Following is an examination of what the new regulations will do and how will they impact the energy business.

 

Cap and Trade Regulation

Both new rules will utilize a regulation methodology called “Cap and Trade.”  This method is designed for flexibility in allowing the marketplace to determine the most efficient ways of meeting an emissions cap set by the regulator. (If you are unfamiliar with how Cap and Trade works, read about the details of Cap and Trade in our recent blog post titled “What Is Cap and Trade?”)

The Cross-State Air Pollution Rule

CSAPR originates from the 1990 Clean Air Act and takes the place of proposed regulations from the George W. Bush Administration, regulations which were rejected by the courts.  The CSAPR rule is designed to reduce the amount of SO2 (which causes acid rain) and NOx (which causes smog) that upstream states send across state borders.  The rule implements more stringent limits on emissions using four separate and distinct cap and trade programs[1]:

  • beginning in January 2012 there will be an annual SO2 program covering 16 “Group 1” states in parts of the Midwest and Northeast[2]
  • a separate annual SO2 program covering 7 “Group 2” states in the Southeast, parts of the Midwest and Texas[3]
  • a seasonal NOx program covering covering 25 states
  • an annual NOx program covering 23 states

Allowances are allocated to power plants based on historical generation.  Allowances can be traded within the state where the plant is located and across state lines among states within each program group.  However, trading across state lines is limited to about 18% of a total state’s allowances.  Penalties for not having enough allowances to cover emissions are applied at both the power plant and the state level.  If compliance is not met on a statewide level, then all non-complying power plants in that state will be penalized by reducing future allowances. The various programs are applied to different states depending on the EPA’s evaluation of where environmental issues exist.  The following map indicates where each program applies:

                        (source: www.epa.gov)

Overall, the new regulations cover 28 states in the East, Southeast, Midwest and in Texas.  Western states are not covered. When implemented, the new limits will significantly reduce the amount of emissions allowed in covered states:

Program

% reduction in 2012 compared to 2010 levels

% reduction in 2014 compared to 2010 levels

Group 1 SO2

18%

57%

Group 2 SO2

18%

24%

Annual NOx

9%

15%

Seasonal NOx

29%

33%

 

California Greenhouse Gas Cap and Trade Program

Meanwhile, in California a new greenhouse gas Cap and Trade program will go into effect in 2012, with emission limits applying to the year 2013[4]. Unlike the CSAPR, California’s program will be applied to large industry and power plants.  California will reduce the amount of allowed greenhouse gas emissions by 2% in 2013 compared to year 2012 with further reductions of 2% in 2014, and then 3% annually from 2015 to 2020. 

Electric utilities will receive free allowances based on historical electric usage by their customers, with allowances covering about 90% of historic emissions. Thus, utilities will be short allowances for about 10% of historic emissions plus the amount represented by the annual cap reduction.  Since the California program is a state-only program, all allowance trading is only within the state. However, utilities are allowed to attain additional offsets for up to 8% of allowance needs[5].   And the program has been developed to allow for future trading with other conforming programs such as the newly authorized Quebec cap and trade program.

Unlike CSAPR, which uses annual compliance requirements, the California program will use three-year compliance periods to allow for annual variations.  Penalties for non-compliance include that for every instance of non-compliance during a period, a participant is required to provide four future allowances.

How Energy Companies Can Comply

Clearly the new rules have significant enough financial penalties that energy companies will have to reduce emissions of the regulated substances. There won’t be enough allowances available in the markets for participants to simply buy their way out by trading.  Reductions can be achieved by:

  • generating less power (meaning greater use of energy efficiency on the customer side)
  • switching generation from more polluting to less polluting power plants
  • moving to lower sulfur coal in the case of SO2 regulations
  • making investment in existing power plants to reduce that unit’s emissions (depending on the pollutant being controlled this could mean investments to increase power plant efficiency or could mean investments in emission control technology[6])

Certainly the new regulations will persuade vertically integrated utilities to encourage increased efficiency efforts among their end-use customer bases.  But in states like Texas that have gone to retail competition, the generators are no longer integrated with the load-serving entities and will not have this option.  In states with a mix of coal and gas-fired generation, reductions can be achieved by using less coal-fired generation and running the gas plants for more hours during the year. 

In the longer term, utilities and generation companies will make investment decisions based on the new rules.  Companies with coal units need to decide whether to invest in these units to reduce emissions from their units, or close the units and replace the generation with less-polluting alternatives like natural gas or renewables (and in the long-term maybe new nuclear units).  In California, where there is no coal power (although imported coal power makes up at least 10% of the power consumed), utilities must move away from importing coal-fired power and consider efficiency improvements to gas units so as to reduce their carbon emissions.  Without any off-the-shelf technologies to control greenhouse gas emissions from power plants, utilities can only reduce emissions by using less power through energy efficiency, improving the efficiency of gas units, or moving from gas to renewable power. (Presently there seems to be no desire for new nuclear power in California.)

 

What Impacts Might These New Rules Have?

The impact these new regulations may have is significant.  Numerous parties are complaining and challenging the rules in the courts.  But it appears that both the new CSAPR and California greenhouse gas rules will go into effect January 1, 2012.  So what might this mean?

In the short term:

  • the need to obtain allowances will increase the cost of both coal and gas-fired generation in the affected CSAPR states, but it will proportionately impact coal more since coal generation emits more pollutants per MWh generated
  • in California, the cost of gas generation will go up; importing of coal generation will either end or the cost of imported coal power will rise significantly
  • in many markets, output of gas-fired generation will significantly increase, while coal-fired generation output will decrease
  • utilities will be strongly incented to develop effective energy efficiency programs
  • the cost of wholesale power will rise as sellers will have to cover their cost of obtaining allowances (or, if they have been allocated allowances for free, sellers will increase their price to cover the opportunity cost of not selling their allowances to someone else)
  • natural gas prices may go up since more gas will be used by generators and since the cost of the competing fuel – coal – will go up

 

In the longer term:

  • investment decisions will be made based on the new rules
  • energy efficiency will become a new industry mantra as will load shifting to avoid use of highly polluting peaking power plants
  • newer more efficient coal units will be upgraded as necessary to reduce emissions
  • older, less efficient coal units will be retired; (a recent survey by the AP organization suggested 68 coal plants may be closed[7])
  • more new gas-fired power plants will be built, as will more renewable projects
  • utilities will spend considerable capital dollars to implement the changes; utilities will complain, but paradoxically their earnings will go up with the new capital investments
  • utilities will have to file rate cases to cover the new capital investments, and they will get pressure from regulators and customers to hold down costs in other areas to compensate for rising rates
  • regardless, costs of power will go up somewhat although how much is highly debatable
  • at some point, the U.S. will have to reexamine the question of whether to build new nuclear units

 

Despite some of the rhetoric heard, the industry will keep the lights on.  And in the longer term we will see significant movement toward energy efficiency, load shifting and cleaner electric generation technologies.  These will all be real impacts as will be the cost of this transition to consumers. Whether such cost will be merely somewhat significant or will be very large remains to be seen.


References and resources:

[1] For more details, see http://www.epa.gov/crossstaterule/index.html and the presentation at http://www.epa.gov/crossstaterule/pdfs/CSAPRPresentation.pdf

[2] States included in Group 1 are Illinois, Indiana, Iowa, Kentucky, Maryland, Michigan, Missouri, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia, and Wisconsin

[3] States included in Group 2 are Alabama, Georgia, Kansas, Minnesota, Nebraska, South Carolina and Texas

[4] For a summary of the California program see http://www.arb.ca.gov/newsrel/2011/cap_trade_overview.pdf and for more details see http://www.arb.ca.gov/cc/capandtrade/capandtrade.htm

[5] Offsets are mechanisms whereby parties outside of a regulated industry reduce their own greenhouse gasses and verified reductions can be converted to allowances under specifically defined circumstances.

[6] Examples of pollution control technology for SO2  include wet scrubbers, dry scrubbers and dry sorbent injection; and for NOx include low-NOx burners, modification of combustion processes such as flue gas recirculation, selective catalytic reduction, and selective non-catalytic reduction.  There are no off-the-shelf technologies to reduce greenhouse gas emissions in power plants.

[7] http://www.denverpost.com/search/ci_19576085

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