“I expect all the bad consequences from the chambers of Commerce and manufacturers establishing in different parts of this country, which your Grace seems to foresee…. The regulations of Commerce are commonly dictated by those who are most interested to deceive and impose upon the Public.”
– Adam Smith, 1785 letter. In The Correspondence of Adam Smith. (1)
The American Clean Energy and Security Act of 2009 (H.R. 2454, aka Waxman–Markey) was narrowly adopted by the House of Representatives on June 26. As has become standard practice, few legislators were familiar with the final 1,428-page bill, given all the horse-trading hours before the final vote.
Waxman–Markey was a low point in the political process, but what made passage possible was worse: highly organized support from some quarters of the electric utility industry and a lack of protestation from much of the rest.
Some industry parties believe that their lobbyists successfully watered down an extremely disruptive legislative draft to the point that the final was merely distasteful. But compared to killing the bill, which could have been done had the industry been so minded, getting “a seat at the table” resulted in passage.
I remember when “getting a seat” in legislative negotiations included infiltrating and defeating bad proposals. Today, it means ensuring your company gets a piece of the political pork. Such “rent-seeking” substitutes political capitalism for principled free-market capitalism and leaves virtually all of us poorer.
There are a variety of sections buried in the 1,428-page Waxman–Markey climate bill that clearly benefit a select few electric utilities. My post tomorrow will discuss which vendors and electric utilities are best positioned to greatly benefit by these legislative requirements should they become law.
The Winners (at our Expense)
A new study by the Energy Information Administration (EIA), Energy Market and Economic Impacts of H.R. 2454, reveals several very interesting, perhaps unintended, consequences that Waxman–Markey will have on the electric power industry. Requested by Chairman Henry A. Waxman of the Energy and Commerce Committee and Chairman Edward J. Markey of the Energy and Environment Subcommittee, the study integrated H.R. 2454’s provisions into their Reference Case 2030 of the National Energy Modeling System (NEMS) that was used to produce EIA’s Annual Energy Outlook 2009. (The year 2030 is the limit of NEMS analytic reach into the future.) Waxman–Markey extends out to the year 2050.
One of the key conclusions reached by EIA analysts was that the electricity sector of the economy will account for between 80% and 88% of the total energy-related CO2 emissions reductions through 2030.
Section 782 (page 863) of H.R. 2454 allocates the power generation industry only 43.75% of the emission allowances for the years 2012–2013, decreasing to 35% by 2016, and 7% by 2029. In essence, the power industry carbon reduction potential is considered the “low hanging fruit” where further reductions, after perhaps 2020, come at a much greater price because carbon reductions must then be extracted from other segments of the economy that are more difficult to track and control. There are about 1,470 coal plants in the U.S., and their emissions and location are reasonably well defined.
Given the heavier burden the electric utility business will carry in carbon reductions (assuming approval of similar legislation by the Senate (highly uncertain at this juncture) in the early years, the industry silence can only be interpreted as acquiescence once important changes and modifications to the H.R. 2454 discussion draft were completed.
Will this EIA study force the electricity industry to sharpen their negotiating strategy if and when the Senate ever takes up H.R. 2454? Was there a quid pro quo with the electricity industry? Here’s my view of seven possible intended consequences of Waxman–Markey that may explain the silence from electricity industry executives.
1. H.R. 2454 adds industry entry barriers. Deregulation of the energy markets over the past decade has led to a thriving merchant power industry, most of which are gas-fired combined cycle plants. Every independent system operator in the U.S. relies heavily on merchant generators to meet their daily electricity demand forecasts. Many of these merchant plants are conventional coal-fired steam plants, and more are in the active development queue. The price of constructing that next-generation merchant plant just went up because the price of allowance must now be factored into the plant’s pro forma.
H.R. 2454 requires that major U.S. sources of emissions obtain an allowance for each ton of carbon or its equivalent emitted into the atmosphere. EPA estimates that in 2005 dollars, these allowances will cost $13 in 2015 and increase to $26–27 by 2030. These allowance price estimates are consistent with estimates by the Congressional Budget Office. According to CBO, allowance prices in 2005 dollars will be $16 in 2015 and increase to $36 by 2030. The EIA report also states the “the lower prices in the range [of the price of allowances] occur in cases where technological options such as CCS and adoption of new nuclear power plants can be deployed on a large scale before 2030 at relatively low costs.” Therefore I believe that that price point of these allowance are surely understated in the coming years under the H.R. 2454 legislation.
Given the EPA/CBO allowance price predictions, what would the allowances cost a newly conceived merchant plant under H.R. 2454? A 500 MW coal-fired plant releases on the order of 3.5 million tons of CO2 into the atmosphere each year so the price of purchasing the necessary allowances in just a few years could easily add $75 million dollars to the plant’s price tag. Perhaps a lot more.
Here’s the rub. Existing electricity generators will receive allowances without cost under H.R. 2454, a company wishing to enter the electricity market space would have to purchase allowances on the open market in order to receive a permit to construct the plant. The only option would be to bare the costs of capturing and sequestrating some portion or all of the CO2. In either case, the costs of entering the electricity market become exorbitant effectively putting a “closed for business” sign on the industry door. New independently-owned coal-fired plant will never compete with fully-amortized coal plants. An existing fleet of base-load plants, regardless of their age, is a valuable asset. With a full compliment of allowances, those assets become priceless.
2. The distribution of allowances picks favorites. H.R. 2454 defines the allowance allocations across the economy as described above. Waxman–Markey also defines the distribution of allowances within the electricity industry as a 50-50 split based on historical emissions and retails sales of electricity. In 2008, nuclear power furnished 19.6% of the electricity used in the U.S. and therefore will lay claim to about 20% of the 50% or 10% of the allowances provided to the entire electricity industry industry. Allowances will be valuable if a utility needs to continue burning coal to make electricity in their regions. For utilities with a lot of nuclear generation, these allowances are a gift.
During a recent investor conference call, John Rowe, chairman and chief executive of Exelon, described his firm as:
“the best-positioned company in our industry to deal with a carbon-constrained world. Our carbon density, measured in tons of CO2 per megawatt hour, is the lowest of all the generating companies.”
Investment analysts at Bernstein Research project that Exelon’s stock price could reach $59 next year from its current price of about $45. That means that Exelon’s stock price could possibly increase over 30% should climate legislation become effective.
3. Hold onto your assets. Ever wonder why must utilities have avoided decommissioning aged and uneconomic coal-fired power plants? Going forward, the value of the allowances generated by closing the doors on plants built in the 1920s through the 1950s could be significant. Meanwhile, the challenge for utilities with these older plants is to justify their existence until carbon legislation becomes law. For some utilities, the value of the allowances and emissions offsets for future projects will exceed the value of the old plant. Don’t look for many older fossil-fueled power plants to retire any time soon.
4. Investment in the future. At the EPA and CBO projected allowance prices, the total annual value of the allowances created under the legislation ranges from roughly $70 to $80 billion in 2015 to $90 to $120 billion in 2030. Using allocations of those revenues as defined in the legislation, about $60 billion for carbon capture and storage (CCS) technologies will be made available through 2030. The investments in carbon capture and sequestration include $10 billion generated through a small “wires charge” on electricity generated through fossil fuels. Investments continue after 2025, with 5% of allowances being devoted to 5% to carbon capture and sequestration and 1.5% to research and development.
Given the fewer fossil-fueled plants that are likely to be built in the future under H.R. 2454, equipment vendors, utilities, consulting organizations, universities, and so on are realigning their organizations so as to be prepared to compete for the funds. Other than defense department programs, these programs would surely become the biggest and longest contracts in the U.S.
5. Early adopter bonus. H.R. 2454 provides monetary support to early adopters of CCS technologies. Power plants totaling up to 72 GW MW, with individual plants rated at least 200 MW, are eligible for allowance grants when retrofitting their plants with CCS systems that capture at least 50% of the CO2.
That may sound like a lot of plants, but there is mroe than 336 GW of coal-fired plants in the U.S., 62 GW of petroleum-fired, 449 GW of natural gas-fired for a total of 847 GW, or right at 85% of the nation’s total installed power generation capacity that qualify.
I believe these early adopter bonuses will quickly be swept up by those utilities that that have a solid balance sheet and are now actively investing in the development of CCS technologies. To the strong will go the bonuses.
6. A new club in town. Section 114 of H.R. 2454 directs the forming of the Carbon Storage Research Corporation (CSRC) that would provide monetary support for the deployment of CCS projects. CSRC would issue grants and assistance to support the demonstration of five commercial-scale CCS projects and other pilot-scale projects otherwise not eligible for funding. CSRC is authorized to adjust an assessment on fossil fuel-based electricity so the corporation generates $1.0 to $1.1 billion annually. Initial assessment rates are ¢0.043/kWh for coal, ¢0.022/kWh for natural gas, and ¢0.032/kWh for oil.
CSRC would be organized as an affiliate of the Electric Power Research Institute (EPRI) and must consult with Edison Electric Institution, American Public Power Association, and National Rural Electric Cooperative Association to appoint board members. Under the rules specified by H.R. 2454, the CSRC leadership must be elected by these groups including a group of owners/operators of fossil fuel-based power plants that collectively represent at least 20% of the electricity generation in the U.S. These organizations are expected to conduct a referendum among themselves with voting rights proportional to the amount of electricity generated. I think it’s reasonable to expect that many of the larger utilities in the U.S., especially those early adopters, will be well represented on this board.
7. Midwest ratepayers hit hard. The Midwest Climate Coalition–made up of 15 Midwest utilities, including Wisconsin Energy Corp. of Milwaukee and Alliant Energy Corp. of Madison–are lobbying hard to correct the penalties that HR 2454 applies to states that rely of low-cost coal-fired generation and the credits that will flow to utilities that rely on nuclear and other less carbon intensive generation. “We’re concerned that, under the current formula, Midwestern states would be subsidizing the customers of other utilities in some Western and Eastern states,” said Brian Manthey, spokesman for Wisconsin Energy (Milwaukee Journal Sentinel, August 22).
Alliant Energy Corp Chairman Bill Harvey was quoted in that same article:
“Utilities that are smaller and rely more heavily on fossil fuels would face a severe shortfall the first year of the program, and the shortfalls would only get worse with every following year. That is simply unfair and is bad public policy.”
Harvey went on to say that CCS projects will add hundreds of millions of dollars to the cost of generation electricity beginning in 2012. Harvey is one of just a hand-full of industry executives that have been vocal about the real cost of Waxman–Markey to ratepayers, both in the real cost of electricity to ratepayers but the flow of cash from coal-fired utilities to those that rely of nuclear power.
Dan Reidinger, a spokesman for the Edison Electric Institute, said H.R. 2454 was “designed to be fair, recognizing the facts that costs for all customers will go up under a climate policy.” Reidinger also noted that the formula has considerable support, despite concerns raised by some companies, because it give credit to companies that have already moved to invest in cleaner sources of energy production.
EEI speaks for its public utility members, not for merchant power producers. Wind generation in the U.S. was just 1.2% of total generation in 2008, with only a fraction of those plants owned by utilities. Nuclear generation was 19.6% last year with almost all of the 104 nuclear plants owned or controlled by utilities. You make the call.
My next post will review the status of interesting CCS projects and review which companies, utilities, and vendors that are expected to benefit most from the H.R. 2454. None of this is very pretty, but perhaps an open discussion of what happened behind closed doors well past the average American’s bedtime will better inform a debate that is about to see the white light of day.
(1) Adam Smith, 1785 letter. In The Correspondence of Adam Smith. 1974. 2nd ed., 1985. Edited by E. C. Mossner and I. S. Ross. Indianapolis: LibertyPress, 1987, p. 286.