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Hybrid Energy Innovations 2015

On June 2, the U.S. Environ­mental Protection Agency (EPA) released its long-awaited proposed carbon-dioxide (CO2) emissions standards for existing fossil fuel units under Section 111(d) of the Clean Air Act. The EPA’s Clean Power Plan sets an overall goal of power sector CO2 emissions reductions by 2030 of 30% below 2005 levels, or about 18% below 2012 levels. The resulting U.S. fleet-average CO2 emissions rate in 2030 will be about the same as the emissions rate of a typical gas combined-cycle plant.

The standards are state-specific, varying widely according to how much opportunity the EPA has judged is available within each state to mitigate emissions, using existing technologies for CO2 abatement. According to the EPA’s projections, 48% of the total national reductions will be achieved in only six states, with 19% of the total national reduction achieved in Texas alone (compared to its approximately 11% share of total national electric production).

However, several other states have larger percentage reduction goals than Texas, while a few have standards so close to current levels that they have little or no need to participate. This regional variation in strength of the emissions standards, as well as an understanding of how the targets were set in relation to the prevalence (or lack) of renewables already in each region, will be important for wind and solar developers in formulating their responses to the new guidelines (assuming the rule survives political and litigation challenges).

Considerable flexibility is granted to the states as to how they pursue and achieve the standards, with no preference given to direct controls or emissions restrictions; fuel or technology substitution; expanded renewable portfolio standards (RPS); or clean energy credits exchanged within a larger, multi-state or regional transmission organization region. States also have the option to convert their rate-based standard into a mass-based standard, if they can show that the mass-based approach would result in equivalent total state emissions. The policy choice to use state-specific mechanisms versus regional, market-­based, cooperative mechanisms will also have a material impact on the economic attractiveness of renewables, especially where there are substantial differences between neighboring states in their ease of developing more renewable resources.

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A brief review

The basis for the emissions reductions in the proposed rule is the EPA’s review of the Best System of Emissions Reductions (BSER) for reducing carbon emissions from existing electric generating units (EGUs). In its review, the EPA considered a wide range of potential measures, including both improvements to the plant itself and “outside the fence” options that would reduce fossil fuel plants’ dispatch. Specifically, the EPA selected four “building blocks” as the BSER: coal heat-rate improvements, re-dispatch of existing generation from coal plants to gas combined-cycle plants, increased renewables and new or retained “at risk” nuclear generation, and increased energy efficiency deployment.

In Figure 1, we illustrate the formula for calculating the emissions standard and the relative impact of the building blocks on an aggregate national basis.

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Applying the EPA’s proposed BSER on existing fossil fuel power plants results in large differences across the states in their CO2 emission standards and corresponding total reductions required by 2030. We demonstrate the state-by-state targets in Figure 2 by showing the states’ 2012 fossil EGU rates (the aggregate height of the columns) and the impact of each building block in reducing the emissions rate to the states’ 2030 standard (the lowest gray bar). The relative impact of each building block depends on the state’s current generation mix and the EPA’s proposed energy efficiency investments and regional renewables targets.

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For example, the impact of the assumed coal heat rate improvements is largest in states that have lots of coal-fired generation, while the potential for coal-to-gas dispatch switching is greatest in states that have both a number of existing (or under construction) gas combined-cycle plants that could increase their capacity factors and substantial generation from coal-fired power plants that could be displaced. These BSER factors may differ considerably across adjacent states, causing some that have similar initial emissions to have very different targets (such as Kentucky and Illinois).

 

Counterintuitive nuances

There are many economic questions that must be addressed as states and industry participants develop comments on the proposal and as they evaluate how different compliance options would affect their expected costs, risks and flexibility in meeting the new standards. The complexity of the rate calculation and enforcement options will create a challenge for entities as they assess these questions. A few of the potentially counterintuitive aspects of the proposed rule include the following:

The state-by-state standards do not directly indicate relative compliance burdens. First, the standards are defined in terms of a counterintuitive emissions “rate” that includes fossil generation in the numerator and fossil plus selected non-fossil supply and demand resources in the denominator. This means, for example, that states with little fossil generation can achieve relatively large “rate” reductions through small percentage increases in renewable generation or energy efficiency. Second, because some states will have more low-cost carbon abatement opportunities than others, compliance costs will not be proportional to required reductions.

The standards are based on numerous simplifying assumptions that contribute to target reductions that may diverge from what is readily possible. In estimating the reductions each state can achieve, the EPA assumes, for example, that all states within a region have the same renewable generation potential. They also assume implicitly that all nuclear plants are at the same risk of retirement.

The rule treats some zero-carbon resources asymmetrically. Compliance with the standard will be measured in a way that does not count retention of most existing, zero-­emitting nuclear or hydro resources the same as other existing renewables, new renewables or new energy efficiency investments. This could distort investment and retirement decisions and raise compliance costs. However, states will have the flexibility to adopt compliance programs that restore a more symmetric treatment and reflect CO2 abatement benefits from all resources.

Compliance goals are based solely on the location of generation, not the ownership or use of its output. This is understandable as a means to specifying state standards, but it complicates compliance for utilities with generation in several states or generation not predominantly located in the same state as its load centers. This could affect the appeal of multi-state solutions.

 

Implications for renewables

The proposed rule will clearly benefit the owners and developers of existing and new wind resources, as well as other types of non-carbon resources. However, these opportunities for new development will grow as most or all states are likely to consider introducing or expanding an RPS requirement as a major component of their implementation plans. Meanwhile, new and existing renewables alike will benefit from the relatively improved economics, compared to fossil fuel, which may face either a rate requirement or carbon allowance costs. However, the opportunities are likely to vary greatly by state and region. We present an initial indication of the relative benefits and opportunities across states in Figure 3, which provides regional summaries of the existing wind resource base across states, ordered by decreasing wind capacity in each region and the corresponding EPA estimates of marginal CO2 costs in the year 2030 under no-cooperation and regional cooperation scenarios.

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Note that within each region, there is a wide range of installed wind, and this range barely corresponds (inversely) to the EPA’s estimated carbon marginal costs. If it is possible to expand regional renewables up to the levels in the states with more capacity already (which also was assumed in setting the BSER standards), then renewables should be an important part of the carbon abatement solution. Also note that these widely differing, state-specific marginal costs collapse fairly strongly around $30/ton for CO2 (right axis) when cooperative solutions are pursued.

The ability of existing and new wind developers to capture this implied economic value will depend not only on the underlying resource and market fundamentals in each state, but also on existing resources’ unique contractual arrangements, as well as on the details of the state implementation plans. For example, existing suppliers with merchant exposure to the energy market could realize significantly boosted profits from the likely $10/MWh-$35/MWh increase in wholesale energy prices that would materialize under a carbon allowance trading program with prices in the range projected by the EPA in the year 2030. However, existing wind (or even more so existing hydroelectric and nuclear) may realize no economic benefit under the rules if states opt to meet the requirements under a regulated portfolio approach or other approaches that would introduce differential treatment between new and existing zero-carbon resources.

In sum, these proposed standards are a meaningful step toward controlling CO2 emissions, with a wide range of possible mechanisms for how to respond and material economic significance to renewable generation. However, the rule and its metrics are necessarily complex and likely to be controversial.

The industry will need to do careful analysis of the pros and cons of alternative solutions in order to assist the states in submitting their implementation plans in 2016 and 2017. w

 

Kathleen Spees is senior associate and Frank Graves is principal at The Brattle Group. Spees has expertise in wholesale electric energy, capacity, and ancillary service market design and price forecasting. She can be reached at kathleen.spees@brattle.com. Graves specializes in regulatory and financial economics, especially for electric and gas utilities, and in litigation matters related to securities litigation and risk management. He can be reached at frank.graves@brattle.com.

RPS Fulfillment

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