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Carbon Wargames

U.S. utilities gain strategic insights by playing out a carbon-constraint scenario.

Fortnightly Magazine - December 2007

obviously complicating their efforts at compliance. Second, while capital of course had an economic cost, capital markets remained sanguine throughout the period of play and indulged company investment plans. The brakes that such a market might have imposed on overly ambitious investment plans never were applied. In the real world, technology uncertainties and rating agencies might reasonably be expected to restrain investment to a considerable degree.

The industry’s generation portfolio changed significantly between 2009 and 2030 (see Figure 3) . During this 21-year span:

• Net capacity increased by 45 percent;
• Renewable generation increased from less than 1 percent to 18 percent of the total portfolio;
• Coal remained stable as new investment balanced retirements. However, coal-based emissions declined significantly due to CCS retrofitting; and
• Significant investment occurred in IGCC and nuclear.

Prices roughly doubled in both Coal Land and Gas Land, with most of the increase occurring during the first rush-to-compliance stage. The sharp, temporary increase observed in Move 2 resulted from an exogenous spike in the price of natural gas. While this exogenous development had only a temporary impact under the circumstances designed into this particular game, it served to demonstrate the vulnerability to world price movements of a wholesale-power market heavily dependent on natural gas generation.

Additionally, simultaneous actions by several players collectively reshaped market circumstances with each move. This served to mitigate the success of any single player’s strategy. The tendency to follow similar build cycles led to excesses in capacity. Similarly, a uniform move toward compliance through generation investment rather than through purchase of emissions credits left players in a situation where each had a surplus of allowances to sell, with no industry buyers. (A cross-industry market in allowances was assumed, which permitted players to unload their allowances at a discount.)

Real-World Dynamics

No single game offers a sound basis for prediction. The time constraints of game play, the inevitable sketchiness of competitive information, the simplifying assumptions employed in the particular game, and the number of variables that each team nonetheless must manage, yield results unique to any particular game. Future iterations of this or similar games might yield significantly different outcomes.

The current game does suggest, however, that significant reductions in industry-wide carbon emissions are feasible, at least under favorable technology assumptions. The financial consequences for the industry are disturbing, and multiple-player interaction will be an important strategic factor in companies’ calculations.

Several additional dynamics emerged in the game.

• Retail rate shock: Retail price increases varied by region and by company. At the low end, real increases averaged only 0.2 percent a year compounded—a relatively modest increase, although a reversal of the real-price decline U.S. consumers have experienced, and have become used to, over the past 20 years. At the high end, real increases exceeded 5 percent a year compounded. This level of increase, experienced particularly in those regions where coal plants initially set the marginal cost of power, would pose significant regional economic concerns, impacting particularly the energy-intensive industrial base currently located in coal-dominant regions.

In the real world, an effect of