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The Change in Profit Climate

How will carbon-emissions policies affect the generation fleet?

Fortnightly Magazine - May 2007

Any climate policy is almost certain to target the electric-power industry, which is responsible for about 38 percent of U.S. carbon dioxide (CO 2) emissions. Said policy especially would affect coal-fired power plants, which contribute about 82 percent of the electric power CO 2 total. How would various policy options change the economic value of current and proposed generation assets? The answer to this question could affect the rapidly evolving generation mix profoundly, particularly at a time when utilities are planning to add more than 60 GW of carbon-intensive coal plants.

Determining the impacts of climate policy on the electric-power industry, however, is a complex problem that requires considering both regional diversity and the linkages among markets for fuel, power, and emissions. In particular, imposing a cost penalty on CO 2 emissions from electricity generation would affect the net revenues of various types of power plants very differently. As these differences become more apparent, the value of current generating assets could rise or fall dramatically, and significantly alter preferences among investment options for future generation.

To examine this complex issue, EPRI has developed an analytical framework for assessing the economic impacts of climate policy on the electric power industry, and has applied the framework to determine how specific CO 2 emission penalties would affect existing and proposed power plants. 1,2 The primary goal of this analysis is to assess potential risks of CO 2 policy for both fossil-fired and non-CO 2-emitting electric generation, and to put these risks into perspective with another key risk—uncertain natural gas prices. A second goal is to understand the cost-effectiveness of reducing CO 2 emissions from the electric-power sector in the near term, while the generation fleet is relatively fixed and natural-gas prices are high.

Follow the Cash Flow

Imposing a price on CO 2 emissions can increase greatly the operating costs of fossil-fuel generation. The size of the increase for a particular power plant will depend on both the type of fuel used and the plant’s efficiency. The effect can be significant: Over the lifetime of a coal-fired power plant, a CO 2 emission penalty of $10 per ton could have a present value approximately equal to the overnight-investment cost of building the plant. Higher operating costs, however, do not tell the whole story. From a cash-flow perspective, what matters most is how a plant’s dispatch costs compare to market prices. Specifically, for some types of plants, net revenues actually may increase if rising wholesale-power prices exceed higher production costs, while other plants may experience sharply diminished revenues. Net revenues are needed to cover fixed operations and maintenance, depreciation, and recovery of the cost of capital.

The process of how emission penalties affect electricity market prices and net revenues for different types of generation is illustrated in Figure 1, which presents a simplified three-plant example. When there is no emissions penalty, the natural-gas