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Carbon In Electricity Markets

Price transparency will drive GHG reductions.

Fortnightly Magazine - August 2009

Political pressure to deliver comprehensive national greenhouse-gas (GHG) reductions is intensifying under the Obama Administration. These reductions will result from legislation, accelerated action by the Environmental Protection Agency (EPA) or both. While 2008 saw considerable debate on the structure and stringency of national GHG legislation, either Congress or the EPA (through the authority granted to it by the 2007 Supreme Court ruling in Massachusetts v. EPA 1) likely will enact comprehensive GHG regulation in 2009 or 2010. The likely legislative outcome will be a market-based approach, with the cornerstone being a cap-and-trade system for CO 2 emissions.

President Obama proposes to reduce GHG emissions to roughly 14-percent below 2005 levels by 2020, and to approximately 83-percent below 2005 levels by 2050. The Waxman-Markey American Clean Energy and Security Act of 2009 proposes a similar decarbonization of the U.S. economy by 2050. Together, these proposals provide a clear indication of likely future emission-reduction targets. Both proposals advocate a cap-and-trade structure as the principal policy mechanism—as do most other proposed GHG-reduction measures with similar targets for emission reductions.

Regulatory action isn’t limited to the federal government. As of April, 2009 almost half of U.S. states are in the process of creating and implementing GHG regulations that feature cap-and-trade mechanisms. For example, the final scoping plan for California’s Global Warming Solution Act (AB32), published in October 2008, includes a cap-and-trade system as the central mechanism to achieve the state’s GHG-reduction goals. The Western Climate Initiative (WCI), an organization comprised of seven states (including California) and three Canadian provinces, is designing a regional carbon market scheduled to begin operations in 2012. Northeastern states have commenced a cap-and-trade program under the Regional Greenhouse Gas Initiative (RGGI). Midwestern states, through the Midwestern Greenhouse Gas Reduction Accord (MGGA), are designing a carbon-trading system that likely will come online in the next few years, as is the state of Florida.

How such limits will be administered is in large part a function of the current structure of the power generation market. At one time the electricity industry was a network of vertically integrated operations managing all aspects of energy production and delivery, from generation to transmission to distribution. However, the structure of the electric industry has changed dramatically in the last 10 to 15 years. The Federal Energy Regulatory Commission (FERC) has issued a number of orders designed to open wholesale generation markets to competition, and has promoted institutional structures to facilitate such competition. 2 In addition, nearly half of all states have restructured electricity markets at the retail level in order to promote competition.

While the restructuring still is evolving, it has resulted in competitive suppliers owning approximately 40 percent of today’s installed generating capacity. 3 More dramatically, competitive suppliers have built approximately 80 percent of the

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