Investment and Fuel Choices with the Prospect of Greenhouse Gas Policy

1.  Investment and Fuel Choices with the Prospect of Greenhouse Gas Policy Dallas BurtrawSenior Fellow, Resources for the Future 27th Annual Bonbright Center Electric and Natural Gas Conference October 3-4, 2007 Disclaimer: These views are my own.  Road map for presentation What is AB 32 -- Goals Road map for presentation What is AB 32 -- Goals

3. To give you an idea of the importance of cost effectiveness in the carbon policy context Pollutant cap and trade programs create a new intangible asset - an �emission allowance� �valuable b/c total emissions are capped. SO2 trading program was first nationwide example�(mention planets) NOx SIP Call to cal elec sector NOx emissions in 5 summer months in east� Reducing carbon emissions by 34% --roughly what would be necessary to achieve Kyoto target domestically -- $450 billion annual asset value.. More than 2 orders of magnitude larger than earlier experience� Even a more modest program, like a program that targets a modest (6%) reduction in carbon emissions in the elec sector will produce an intangible asset with an annual value that is 10* that of the NOx or SO2 program (Neptune) Note that for this modest program asset value (which varies depending on allocation method) is the size of total capitalization of Duke Energy Illustrates that carbon allowances are extremely valuable and how these allowances are allocated could have a huge effect. Will now focus on Neptune. To give you an idea of the importance of cost effectiveness in the carbon policy context Pollutant cap and trade programs create a new intangible asset - an �emission allowance� �valuable b/c total emissions are capped. SO2 trading program was first nationwide example�(mention planets) NOx SIP Call to cal elec sector NOx emissions in 5 summer months in east� Reducing carbon emissions by 34% --roughly what would be necessary to achieve Kyoto target domestically -- $450 billion annual asset value.. More than 2 orders of magnitude larger than earlier experience� Even a more modest program, like a program that targets a modest (6%) reduction in carbon emissions in the elec sector will produce an intangible asset with an annual value that is 10* that of the NOx or SO2 program (Neptune) Note that for this modest program asset value (which varies depending on allocation method) is the size of total capitalization of Duke Energy Illustrates that carbon allowances are extremely valuable and how these allowances are allocated could have a huge effect. Will now focus on Neptune.

4. The Previous SO2 Trading Program Aimed at 50% Reductions

5. Why Carbon is Special�

6. Regional Differences Are a Huge Challenge to Federal Policy

7. Regional Differences Matter Significantly Total Cost ($):  capital + FOM + fuel + VOM + poll.allowances [Au] Variable Cost Ordering ($/MWh): fuel + VOM + poll.allowances Price ($/MWh): Regulated Price = Average Cost = (Total Cost � Production) => Price [Au] > Price [GF] Competitive Price = Variable Cost => Price [Au] = Price [GF]

8. Distribution of Costs to Electricity Generating Firms in Competitive Regions under Original NCEP/Bingaman Proposal This figure shows how this policy affects the value of firms (on a per kW of capacity basis). So under the policy how does value per kW change. Upstream allocation is essentially an auction and Free Allocation is historic. See that most firms lose with an auction of all allowances, but some do win. When all allowances are given away for free all firms win. This analysis focuses on firms in competitive regions. Assumption is that regulated firms will be �made whole� by regulator due to average cost pricing.This figure shows how this policy affects the value of firms (on a per kW of capacity basis). So under the policy how does value per kW change. Upstream allocation is essentially an auction and Free Allocation is historic. See that most firms lose with an auction of all allowances, but some do win. When all allowances are given away for free all firms win. This analysis focuses on firms in competitive regions. Assumption is that regulated firms will be �made whole� by regulator due to average cost pricing.

10. Electricity Price Effects of Allowance Allocation Depends on Electricity Regulation ($14.50 /ton CO2 in 2015) How are consumers affected by the two allocation approaches. Note that under an auction, prices go up in both regulated and unregulated regions. However with free allocation prices are flat or even can go down in regulated regions, but always go up in competitive regions. Distribution of change in electricity price sorted by regulated and competitive regions under two approaches to allocation. Panel A represents upstream allocation (no allocation to electricity sector) and Panel B represents free allocation to electricity sector. Only customers in regulated regions benefit from free allocation. Distribution of costs among generators under upstream allocation (no allocation to electricity sector) and free allocation to electricity sector. The data includes the holdings in competitive regions of 81 firms. How are consumers affected by the two allocation approaches. Note that under an auction, prices go up in both regulated and unregulated regions. However with free allocation prices are flat or even can go down in regulated regions, but always go up in competitive regions. Distribution of change in electricity price sorted by regulated and competitive regions under two approaches to allocation. Panel A represents upstream allocation (no allocation to electricity sector) and Panel B represents free allocation to electricity sector. Only customers in regulated regions benefit from free allocation. Distribution of costs among generators under upstream allocation (no allocation to electricity sector) and free allocation to electricity sector. The data includes the holdings in competitive regions of 81 firms.

11. Electricity Price Effects of Allowance Allocation Depends on Electricity Regulation ($14.50 /ton CO2 in 2015) How are consumers affected by the two allocation approaches. Note that under an auction, prices go up in both regulated and unregulated regions. However with free allocation prices are flat or even can go down in regulated regions, but always go up in competitive regions. Distribution of change in electricity price sorted by regulated and competitive regions under two approaches to allocation. Panel A represents upstream allocation (no allocation to electricity sector) and Panel B represents free allocation to electricity sector. Only customers in regulated regions benefit from free allocation. Distribution of costs among generators under upstream allocation (no allocation to electricity sector) and free allocation to electricity sector. The data includes the holdings in competitive regions of 81 firms. How are consumers affected by the two allocation approaches. Note that under an auction, prices go up in both regulated and unregulated regions. However with free allocation prices are flat or even can go down in regulated regions, but always go up in competitive regions. Distribution of change in electricity price sorted by regulated and competitive regions under two approaches to allocation. Panel A represents upstream allocation (no allocation to electricity sector) and Panel B represents free allocation to electricity sector. Only customers in regulated regions benefit from free allocation. Distribution of costs among generators under upstream allocation (no allocation to electricity sector) and free allocation to electricity sector. The data includes the holdings in competitive regions of 81 firms.

12. When Might Auction Matter to Efficiency?

13. Broader Public Policy Rationale? Economics literature broadly finds there are significant efficiency advantages to auctioning emission allowances. What does this model rule look like?What does this model rule look like?

14. 4. Limits of Political Support for Price Instruments �Americans� Evaluations of Policies to Reduce Greenhouse Gas Emissions�  (Stanford Univ./RFF/New Scientist Magazine survey, June 2007) - The US public has a clear preference for action in the electricity sector.  - Preference for standards over cap and trade or taxes. �Nathan Cummings Foundation Global Warming Survey� (American Environics/EMC, September 2007) - Americans continue to be extremely anxious about the cost of energy. - Investment in clean technology is most popular.

15. 5. Access to Capital Industry Argument: Auction takes investment capital that is needed for new investment away from sector.

16. Regulatory Principle� One can expect pass through of compliance costs for federally mandated environmental policy. So, in principle, should regulated firms be indifferent to auction or free allocation?

17. Regulatory Practice� Regulators under pressure to restrain prices. When prices increase too much, other cost items come under greater scrutiny. Allowance price fluctuations could lead to need for spikes in cost pass through.

18. Volatility in Emission Markets

19. Symmetric Cost Management Equilibrium Measures Renewable includes only wind, geothermal, land fill gas. Biomass changes are constant across all runs. This formulation underestimates the influence of the policy design on renewable generation because biomass plays an important role. Note also that if biomass cofiring is included, then renewable generation actually increases.Renewable includes only wind, geothermal, land fill gas. Biomass changes are constant across all runs. This formulation underestimates the influence of the policy design on renewable generation because biomass plays an important role. Note also that if biomass cofiring is included, then renewable generation actually increases.

20. Prescription� Federal guidance on cost recovery? Allocation to load? By what formula: Consumption? Emissions? Generation? Population? Apportionment to states? Symmetric Safety Valve? Phase in the auction over time?