With the Clean Air Act Amendments of 1990 (CAAA) come many complex decisions for electric utilities. By now the majority of utilities have decided how they will comply with the clean air guidelines and acid rain program limits, at least for Phase I. But for those utilities that have selected coal switching as the preferred method of complying with the law, the task gets more complicated. Burn expensive low-sulfur coal and bank or sell allowances? Or burn just enough low-sulfur coal to meet the rules, and no more? Or perhaps burn high-sulfur coal and buy allowances on the open market?

Choices, options, and strategies abound.

Emissions Limits

Phase I of the CAAA required a sulfur dioxide (SO2) emissions reduction at many of the largest emitters beginning January 1, 1995. Phase II requires further reductions beginning January 1, 2000. The annual level of emissions for Phase I is approximately 2.5 pounds per million British thermal units (MMBtu). Phase II further restricts SO2 emissions, to approximately 1.2 pounds per MMBtu.

Title IV of the CAAA provides utilities with flexibility in selecting compliance methods. One such method of flexibility is the opportunity to trade emission allowances. For every ton of SO2 emitted at an affected unit, one allowance is consumed. Each utility must carry sufficient allowances to cover its annual level of emissions at affected units by the end of each year.

By now one would expect that most utilities have already determined the range of sulfur content for coal to be burned in each particular unit. This range can be affected by individual state laws or requirements, by precipitators or technology, and so on. However, within this range utilities retain the oppotunity to innovate in devising a least-cost approach of mixing and matching coal sulfur content to the price of allowances in order to develop the least-cost compliance methods.

The CAAA promotes a free-market approach to SO2 emission allowance trading. This approach encourages innovation by those utilities that have selected coal switching as the preferred method of complying with the CAAA, whether for one unit or for all units. One such innovative approach would be to integrate the cost of emission allowances in the coal bid evaluation process.

Coal Bid Evaluation

As coal bids are received, utilities typically evaluate price, ash, moisture content, chlorine, sulfur, and the like. Sulfur, beginning January 1, 1995, becomes more critical. An allowance will have a value. This value could climb as high as $2,000 (a penalty) or fall as low as the incremental cost of producing an allowance from a respective unit. The value could lie anywhere in between, determined by the free-market allowance trading.

The value of an emission allowance can be directly tied to the sulfur content of the coal being evaluated for purchase. This relationship is true especially in the case where coal switching is the preferred method of compliance. For units that are planning to coal switch, generally one pound of SO2 input to the boiler equipment will equal approximately one pound of SO2 output from the boiler equipment. As far as the Environmental Protection Agency is concerned, compliance coal is any coal plus or minus emission allowances that allows the respective unit and utility to meet its compliance obligations.

It would appear that either the coal companies or the utility could bundle allowances to satisfy sulfur variations in the coal being purchased. This is why it is so important to be flexible and innovative in coal versus allowances decisions. Consider the following example:

Assume that an electric utility operates only one generating unit subject to the CAAA rules. It decides to employ coal switching to comply with the CAAA, beginning January 1, 1995. Because of state emission laws and operational constraints, the utility determines that it can burn coal in its plant falling within a range of sulfur emissions between 2.5 pounds SO2 per MMBtu as the lower emission limit and 5.2 pounds SO2 as the upper limit. It might be assumed, then, that a coal with an average SO2 emission of 2.5 pounds per MMBtu marks the best choice to qualify under Phase I. But this isn't necessarily the case.

Keeping in mind that the two primary concerns are least-cost operations and meeting the provisions of the CAAA, any coals providing emissions between 2.5 and 5.2 pounds SO2 per MMBtu could be used. This range assumes, of course, that all other criteria, such as ash and chlorine, have been met. For simplicity's sake, assume the utility has solicited coal bids allowing the coal suppliers to offer coals between 2.5 and 5.2 pounds SO2 per MMBtu. Two bids are received:

s Bid No. 1: 2.5 lbs SO2, valued at 125.00 cents per MMBtu delivered.

s Bid No. 2: 5.0 lbs SO2, valued at 99.00 cents per MMBtu delivered.

The evaluation question becomes: Is the 5.0 pound SO2/MMBtu coal equivalent to, cheaper than, or more expensive than the 2.5 pound SO2/ MMBtu coal, when one considers together both the cost of coal and the cost of emission allowances?

The first step is to determine the quantitative difference in physical SO2 emissions (5.0 lbs minus 2.5 lbs = 2.5 lbs). Next, determine the difference in unit cost (heat equivalents) between the two coals (125.00 cents minus 99.00 cents = 26.00 cents). This calculation indicates that the utility must pay a 26-cent premium per MMBtu to garner an SO2 reduction of 2.5 pounds per MMBtu.

The second step converts the SO2 premium to an emission allowance cost. One emission allowance represents 2,000 pounds of SO2 emissions. Consequently, the 26-cent premium must be divided by the 2.5-pound difference in actual emissions between the two coals to arrive at an equivalent cost per pound of SO2 of 10.4 cents. Then multiply this 10.4-cent figure by 2,000, producing a representative allowance cost of $208.00.

In this example, if emission allowances in fact sell for $208.00, the costs of the two coals are effectively equivalent, when integrated with clean air compliance. Thus, assuming that market prices for SO2 emission allowances fall below this figure of $208.00, the utility should find it cost-effective to purchase and use the 5.0-pound coal rather than the low-sulfur 2.5-pound variety. Of course, sufficient allowances would need to be purchased, furnished by the coal supplier, or used from the utility's emission allowance bank to make the 5.0-pound coal equivalent to the 2.5-pound coal from an emissions standpoint.

By contrast, if the price of SO2 emissions should fall to $150.00, the 5.0-pound coal would carry a comparative effective cost of 117.75 cents per MMBtu, making it 7.25 cents cheaper per MMBtu than the

2.5-pound coal with the lower sulfur content, when integrated with CAAA compliance needs.

A Workable Plan

Using this strategy, any utility that has selected coal switching as its method of compliance may be able to take advantage of varying levels of sulfur content in coals that it uses for Phase I and Phase II of the CAAA.

This approach is very dependent on the price and availability of allowances. But it provides an opportunity for the utility to use its coal procurement strategy to bundle packages of coal and allowances that will potentially lower fuel costs. The aggressive high-sulfur coal producer also has an opportunity to make sales that otherwise may not be available. t

David A. Spainhoward serves as corporate planning specialist for Big Rivers Electric Corp., Henderson, KY. David E. Schultz, P.E., also at Big Rivers, is manager of bulk-power sales and corporate planning.

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