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The Costs of Going Green

Carbon costs will reshape the generation fleet and affect retail rates.

Fortnightly Magazine - June 2009

to include the cost of fuel on consumer bills. Some states oversee fuel purchases to ensure utilities are making them efficiently, but in essence, this cost is one that consumers bear on a dollar-for-dollar basis, with that cost represent-ing an additional component of the cost-of-service ratemaking algorithm. That is, the cost of carbon will impact the average cost of rates by raising the cost of generation that emits CO 2.

In competitive wholesale markets, however, if CO 2 allowances cost $20/ton, and that increases the cost of generation from natural gas and coal, then whenever gas is on the margin, the price for all generation in the market receives that price. Thus, in competitive markets, the price of CO2 has a more universal effect on all consumers when CO 2-emitting sources are on the margin compared to cost-of-service markets.

The DOE’s Energy Information Administration reports that on average, nationwide, the cost of power delivered to residential consumers was about 10 cents/kWh in 2007, including the cost of generation, transmission and distribution. In a cost-of-service state, if the cost of existing coal generation rises 2.5 cents/kWh due to CO 2 allowance costs (at $25/ton), and coal provides half of the generation in the United States, this factor alone would increase the cost of electricity by 1.25 cents/kWh, or about $137/year if average residential consumption is 11,000 kWh/year. If natural gas generation provides 20 percent of the need, the cost of CO 2 allowances would add another 0.5 cents/kWh, or $55/year, for a total of $192. This is an increase of 17.5 percent in the total electricity bill. Those areas with more coal generation, such as much of the Midwest and Western States, would experience higher increases.

In competitive wholesale states, however, the impact could be less or more. Every hour that natural gas is on the margin, the distribution utilities at wholesale and the consumers at retail will pay the higher CO 2-affected cost for all generation, including natural gas, coal, wind, and nuclear. In the hours (perhaps off-peak) when coal is on the margin, the same dynamic is in force—all generation will receive the higher CO 2-adjusted wholesale cost of power, and all the energy that consumers buy will cost more as a result. If, on the average, natural gas is on the margin 75 percent of the time and coal is on the margin 25 percent of the time, and allowances cost $25/ton, then the weighted average increase in all kilowatt-hours is 1.375 cents/kWh, which would increase rates by $151, or 13.7 percent. If, however, the split is 40/60 ( i.e., coal on the margin 60 percent of the time), the weighted impact would be 1.90 cents/kWh, for an annual impact of $209, or 19 percent. Clearly, the more often coal is on the margin, the higher the impacts on consumer rates and bills, at least until generation owners build capacity that doesn’t emit CO 2 on the margin.

Regardless of the regulatory approach, it’s clear that when adding the cost of CO 2 control to the