What Utilities Need to Know to Survive Obama's Clean Power Plan

Below is a preview of Gelber & Associates’ White Paper. The paper focuses on the risks and market opportunities resulting from federal initiatives to manage Carbon Dioxide (CO2) emissions from stationary sources. If you are interested in receiving a full version of the offering please follow this link to provide some quick contact details and a version of the White Paper will be sent to the email provided. 

By Gary Scoggin and Arthur Gelber, Gelber & Associates

Executive Summary

On August 3, 2015 President Obama and the EPA announced the Clean Power Plan (CPP). Gelber believes that this, along with other Federal efforts to reduce CO2 emissions, will create a lasting impact from the Obama administration. This paper does not take a position on the merits, burdens, or necessity of the CPP. Instead, this paper examines the likely outcomes from CPP in the creation of state regulated carbon markets and how these markets will impact the utilities that operate within these markets. One result of CPP is that coal burning states, such as Missouri, will be market short CO2 credits while low-coal burning states such as New York will be market long CO2 credits. The CO2 market structures and rules will be designed by the state regulatory bodies but the required compliance action will be the burden of power plant owners and operators. At this time, Gelber believes that the probability of mandated CO2 reductions is high enough to warrant action for state regulations and utilities. State regulators need to develop a plan or risk a heavier handed approach from the Federal Government. Power generators especially need to organize and engage with their state commissions, industry peers, and internal decision-makers so that market rules and structures are designed in a manner to best achieve cost-effective compliance.

1. Background: The Clean Power Plan

The Clean Power Plan is a cornerstone of the Obama Administration’s approach to reduce CO2 emissions. The plan was published in the Federal Register on October 23, 2015 and is an integral part of the US climate change commitments made at the recently concluded UN Climate Conference held in Paris.

The plan functions by creating limits on CO2 emissions at the state level. States are required to meet certain targets beginning in 2022 with final compliance by 2030. The state targets can be expressed on either a rate basis (measured in tons-CO2/MW-generating capacity) or on a mass basis (tons-CO2). Each state must submit a compliance plan to EPA by November of 2016, although a two-year extension is available. The EPA has also proposed a model federal plan that can be used as the basis for a state plan or in lieu of state plan should one not be developed.

A feature of the Clean Power Plan is language that enables CO2 emissions trading as a compliance tool. The CPP allows the creation of cap and trade markets (without calling them that) that can be formed within a state or across multiple states. Part of Gelber & Associates’ job is to read the tea leaves. We currently believe that the CO2 management initiatives will go forward and that, with few exceptions, compliance will be achieved through trading-based systems because they generally offer the most cost-effective solutions.

3. Trading Mechanisms in the CPP

The Clean Power Plan, as well as the model federal plan, contains numerous features to enable CO2 emissions trading. As mentioned earlier, the CPP federal plan includes trading under either a rate-based program or a mass-based program. Under the mass-based program, the state would then initially distribute allowances under those state budgets to affected power plants based on historical generation (See Insert Calculation: The Math Behind Calculating the Emissions Allocation Gap for a description of how this could work and how we have calculated the resulting allowance gaps). In creating a market designed in this fashion, EPA is drawing on its experience in other emissions abatement structures such as the Acid Rain Program under Title III of the Clean Air Act.

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To see #4-9, request the full report here.

10. Economic Factors in CO2 Pricing

Carbon markets in general tend to follow the overall economy. Figure 2 below illustrates how this is true for the EU.

Cost projections for carbon emissions under the CPP vary. If each state is taken in isolation, there will likely be substantial state-to-state differences for the value of emission allowances. One study projects market costs to vary widely between states. From as low as zero to as high as $26.00 per ton. The Texas grid operator ERCOT predicts that carbon prices in its interconnect to be around 22.50 per ton [1]. These state to state differences provide a driver for interstate trading arrangements.

The US Chamber of Commerce estimates that the cost to the economy of the CPP (not necessarily the market price of carbon) will be around $50 per ton in 2030 after peaking at $317 per ton in 2021.

In contrast, the EPA, in its Regulatory Impact Analysis of the proposed CPP rule, forecasted 2030 carbon compliance costs of $28 per short ton (ranging from zero to $106 per ton depending on the state).

The EPA also looked at regional compliance approaches where states could work cooperatively to reduce costs. The regional approach raised prices for some states and dramatically reduced costs for others; it forecasted average costs of $29 per short ton in 2030. Gelber & Associates will look at and forecast CO2 market pricing in more detail on a client by client basis and in a future white paper.

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Figure 2: The relationship of carbon prices and economic growth

12. Trading as an Ingredient in Long-Term Planning

States and operators should seriously consider the essential role of emissions trading, when developing a plan for meeting CO2 reductions. Emission markets can be designed and implemented in a large variety of ways, some of these to the detriment of some operators. The creation of the California power markets around the year 2000 caused unintended harmful outcomes to numerous operators due to faults in the design.

There are two things that operating companies should be doing at this point:

  • Participate in the design of state or regional emissions market architecture. This includes interacting with state regulators, peer groups, and interested parties overseeing the features of CPP market design. Be an advocate to educate state officials and help them avoid detrimental market design features.
  • Brief the company’s internal resource planners, environmental staff, management, and executives on the CPP market design and forward looking pricing expectations.

The ability to recover capital and operating costs will be a major component in shaping a particular company’s CPP compliance strategy. We plan to write more about the rate-base issue in a later paper. In the meantime, Gelber & Associates would be happy to discuss this on a customized basis.

Gelber’s trading and design understanding, along with our intimate knowledge of the utility business and the regulators who have oversight of it, prepares us to assist operators with these tasks.

13. Conclusion

The Clean Power Plan (CPP) is an integral part of the US climate change commitments. It creates a challenge for all electric utility operators and will lead to the restructuring of many businesses and the closure of many assets. Fortunately, the plan as written includes the opportunity for market-based compliance mechanisms. Experiences in other emissions markets show that through proper design and efficient use of these mechanisms, utility operators can reduce their compliance costs and create a valuable potential profit center.

If you are interested in receiving help with this complex and opaque arena or simply wish to read the White Paper in its entirety, Gelber is happy to provide insight. Feel free to contact us. A full copy of the white paper can be found here.

[1] The ERCOT analysis also included the impacts of coal-fired plant closures due to other concurrent environmental regulations.

Greg Melon