Can We Afford Climate Regulation?

Deck: 

Lawmakers are rushing a costly decision.

Fortnightly Magazine - December 2009

Freedom from fossil fuels, fluctuating energy costs, unclean air and climate change aren’t just dreams of the everyday environmentalist any longer. Much of the world and key industry leaders have acknowledged that human actions likely have contributed, in some measure, to the current state of our environment. And greenhouse-gas (GHG) emissions from electric generating plants represent a significant portion of the total. Clearly, all stakeholders, from electric generators to end-use consumers, must feel a responsibility to address this matter with thoughtful planning and effective solutions.

As we navigate the choppy waters of transition to a new model of operation in the electric industry that is driven, in part, by the need to better protect the world in which we live, an important question has been asked and debated: What will be the cost impact to end-use customers if lawmakers enact currently proposed federal legislation regarding carbon emissions? Unfortunately, the answer to that question is proving to be elusive with heated debate having raged for months. Cost estimates for climate legislation seem to be as variable as the models initially predicting the causes and effects of climate change itself.

Consumer Impacts

The U.S. House of Representatives on June 26, 2009, narrowly passed legislation known as H.R. 2454, The American Clean Energy and Security Act of 2009 (Waxman-Markey). Included in the legislation, among other things, is a cap-and-trade program whereby aggregate emissions from electric utilities, oil companies, large industrial sources and other heavy emitters must be reduced 17 percent below 2005 levels by 2020 and 83 percent by 2050.1

Not surprisingly, the legislation is meeting with certain resistance in the Senate and around the nation, and it’s not yet possible to predict what the final version of the bill might look like. Senators Kerry and Boxer recently offered their own version of legislation, one that increases 2020 emissions reductions to 20 percent and emphasizes strengthening the economy, largely by creating jobs in the renewable energy sector.2 It’s not altogether certain that legislation will be put to vote in 2009, as other issues—primarily health care reform—continue to consume much of the Senate’s time. However, at some point in the not-too-distant future, some form of legislation is expected to be implemented.

The total impact of proposed legislation is anticipated to affect consumers in many ways other than what will be reflected on their electric bills. This is in consideration of the expected cost increases for all other consumer goods and services as a result of carbon-reduction requirements.

A number of public policy voices state that climate legislation, such as Waxman-Markey, could be very bad for the U.S. economy with marginal actual environmental benefits. Some suggest the bill effectively would amount to the biggest tax in American history. Ben Lieberman of the Heritage Foundation believes the House-approved version, for example, will reduce cumulative U.S. gross domestic product (GDP) by $9.4 trillion between 2012 and 2035.3 And to add salt to that wound, climatologist Chip Knappenberger of New Hope Environmental Services says that emissions reductions as mandated by the House legislation likely would lower temperatures by only 0.09 degrees Fahrenheit—i.e., not quite 1/10th of a degree—by 2050, and thus won’t produce the desired long-term climate results.4

According to the Congressional Budget Office (CBO), the net impacts of the legislation will depend on household income levels, with lower income households footing less financial burden than higher income households.5 In fact, the CBO report states that those in the lowest income quintile actually are expected to realize a net benefit of $40 a year, while those in all other quintiles can expect to see average net costs of varying amounts of as much as $345 a year (individual customer usage will affect actual costs). The CBO report projects that the average U.S. household will see an annual increase of $165 to $175, approximately $14 a month by 2020, as a result of the cap-and-trade provisions of H.R. 2454.

Many observers believe the CBO report low balls the true cost, however. A July 2009 post by Investor’s Business Daily notes that, “the CBO’s own numbers do not compute.”6 The post further states that the report makes unrealistic assumptions and doesn’t consider the impact on GDP or of human and economic behavior.

Following its analysis of H.R. 2454, the Environmental Protection Agency (EPA) estimates that the proposed legislation will cost a U.S. household an average of only $80 to $111 a year over the period 2010-2050.7 But the analysis admits “there are many uncertainties that affect the economic impacts of H.R. 2454.” These uncertainties, the analysis states, include: 1) the degree to which new nuclear power is technically and politically feasible; 2) the availability of international offset projects; 3) the amount of GHG-emissions reductions achieved by the energy efficiency provisions of H.R. 2454; and 4) the impact of output-based rebates on energy-intensive and trade-exposed industries.8

Clearly, predicting the actual costs of addressing carbon issues is not an easy task.

Varying Electric Costs

Regarding the effects on electric utility costs specifically, the picture doesn’t appear to get much clearer. Generally, it’s believed that legislation might be most damaging to areas heavily reliant on fossil fuel, especially coal. The Electric Reliability Council of Texas (ERCOT) undertook an analysis in May 2009 of potential impacts and concluded that its residential customers could see an increase of $27 per month by 2013.9 With increased wind generation across the state or lesser demand as a result of higher wholesale costs, however, ERCOT believes this monthly increase could be somewhat less.

Some environmental critics argue that the ERCOT study failed to consider carbon offsets, energy efficiency or the impact of renewable energy beyond what’s already planned in the current bill, all of which should bring that cost down.

For El Paso Electric—a relatively small investor-owned utility serving 367,000 customers in west Texas and southern New Mexico—if the CBO report is assumed to be accurate and given the company’s demographic breakdown of income (with an approximate $35,000 per household median), the average residential customer could be expected to see a lesser overall economic impact than the national average—in the range of $11 a month per household. This amount is calculated based on El Paso Electric customers’ demographic distribution as estimated by the company’s load research department (see Figure 1).

While $11 a month might not sound like a significant increase, it represents roughly 16 percent of the average El Paso Electric residential customer’s monthly bill in a region where 52 percent of the households are in the lowest 2 quintiles of national average income.

If the ERCOT estimate is used as a starting point, and given El Paso Electric customers’ lower usage in comparison to the rest of Texas, it could be surmised that the utility’s customers can expect an average increase of approximately $14 per month by 2013 just for electricity (an approximate 20 percent increase). El Paso Electric’s energy mix, however, is different from that of most utilities in ERCOT (of which El Paso Electric isn’t a member) and that fact likely would affect the cost to customers.

The analysis gets interesting and costly when El Paso Electric looks specifically at its own situation. Using one reasonable set of assumptions, the company utilized a costing model that addresses the issue in three sequential pieces—energy efficiency, renewables and carbon emissions. Per the model, El Paso Electric predicts a potential and significant rate increase for customers of 44 percent, or approximately 4.5 cents per kWh by 2020—equal to about $25 a month. El Paso Electric modeled a scenario in which it would achieve a 2 percent energy efficiency gain and a 9 percent gain in installed renewables. The remaining 9 percent requirement (of the total 20 percent for 2020) would be met by making alternate compliance payments (ACPs) at $32 a kWh.

Based on the proposed House legislation, it appears that the more allowance penalties El Paso Electric pays, compared to installing or purchasing low-emitting energy, the less its total bill might be. That is, the expected ACP cost should be cheaper than new, low-emission resource installations. It’s not altogether clear how available and what the exact cost of credits and allowances will be, however, and it might be dangerous to assume that low-cost, alternative emissions mitigation will even be an option.

Renewables and Reason

One interesting sidebar to this discussion is that the cost of legislation actually might be more affected by renewable energy requirements than by emission reduction mandates. H.R. 2454 requires that by 2020 utilities must supply 20 percent of delivered energy from qualified renewable sources—wind, solar, bio-mass, certain hydro, etc.10 (Nuclear doesn’t qualify.) Utilities may achieve 5 percent to 8 percent of the total requirement via qualified energy efficiency gains.

In order to achieve such a target, however, and as an example, El Paso Electric seemingly must install, enter into power-purchase agreements or purchase credits or allowances for nearly 800 MW of renewable energy by 2020, in addition to what it currently plans for in its most recent Loads & Resources planning document (see Figure 2). This is a staggering amount, considering the company’s current peak native system demand is in the range of 1,550 MW.

Because of the renewable requirement, most anticipated GHG-emissions reduction mandates for El Paso Electric likely will be met already by virtue of having significantly more renewable, zero-emission resources installed or purchased.

In total, El Paso Electric estimates that the H.R. 2454 could cost the company roughly $2 billion more than it had planned to spend on capital generation investments over the next 10 years. To put that number into perspective, El Paso Electric’s total current plant-in-service is approximately $2.3 billion.11

Regardless of the methodology used for estimations, it seems safe to assume that climate legislation will cost end-user consumers in the years to come. The question is to what level that cost will climb. The company believes it must prepare itself, its regulators and its customers for a scenario in which rates might rise by perhaps 40 percent by 2020, directly related to the House version of legislation.

El Paso Electric understands, accepts and embraces its social responsibility to reasonably ensure an environmentally friendly model of operation. In fact, the company has a good start on that effort already. Its carbon footprint intensity from generated sources in 2008 was approximately 0.31 tons of CO2 per MWh, less than half the national average of 0.67.12 This is primarily because El Paso Electric’s energy mix is weighted heavily with nuclear and lightly with coal. In addition, by 2018 El Paso Electric plans to have replaced approximately 75 percent of its existing natural gas-fired local generating capacity with new, more efficient (and therefore less emission intensive) gas units.

From a legislative solution perspective, many utilities would prefer a mechanism that sets an absolute per-unit value on emissions limits in future years, rather than a requirement that all emitters reduce by a given percent, as required in the proposed cap-and-trade model, so that customers and utilities, such as El Paso Electric, aren’t effectively penalized for having a low carbon footprint already.

For example, if a limit of 0.50 tons per MWh were established as the national intensity target to be met by 2020, the resulting national emissions reduction could be on the order of 500 million tons of CO2 from electricity generation annually. Entities not meeting prescribed targets could be assessed an ACP commensurate with the overrun on a per-ton basis that’s returned to end-use consumers in the form of energy efficiency incentives. There might be other reasonable alternatives to a cap-and-trade structure as well.

Treading Cautiously

The underlying scientific intent of climate legislation is to provide future generations with a greener planet. But what really will be the price and the effect? What cost should consumers be asked to pay for an environmental benefit that might be difficult to measure? What will consumers find acceptable in terms of cost for a solution that, at best, might slow the onset of a climate-altering Armageddon, and, at worst, might have little if any actual environmental impact?

The struggle for El Paso Electric and others will be planning for, and realizing, a future vision that concurrently lowers GHG emissions, maintains system reliability and minimizes the burden on consumers and the economy. The U.S. utility industry has operated in much the same manner, with heavy reliance on fossil fuels, for the better part of the past century. Wholesale changes to that business model are inevitable but won’t be realized overnight, and clearly have the potential to be very costly to consumers if rushed to execution. As with all successful endeavors, thoughtful planning will be 90 percent of this effort.

So it seems only appropriate that continued rigorous debate prior to the passing of legislation is needed to ensure that the best interests of all stakeholders in this debate, and the environment, are ultimately served, and that end-user consumers in particular aren’t asked to carry a potentially crushing financial burden squarely on their backs. Can we afford to do anything else?

 

Endnotes:

1. See H.R. 2454, Section 702, p. 682.

2. See Kerry-Boxer bill draft dated Sept. 29, 2009, Section 702, p. 384.

3. See Testimony of Ben Lieberman before the House and Senate Western Caucus, July 30, 2009.

4. See Climate Impacts of Waxman-Markey (the IPCC-based arithmetic of no gain), May 6, 2009.

5. See The Estimated Costs to Households From the Cap-and-Trade Provisions of H.R. 2454, June 19, 2009.

6. See CBO Lowballs Waxman-Markey Cost, posted July 13, 2009 on Investors.com.

7. See EPE Analysis of the American Clean Energy and Security Act of 2009 H.R. 2454 in the 111th Congress, June 23, 2009, Slide 4.

8. Ibid., Slide 8.

9. See Analysis of Potential Impacts of CO2 Emissions Limits on Electric Power Costs in the ERCOT Region, May 12, 2009.

10. See H.R. 2454, Section 101, p. 31.

11. See El Paso Electric’s Form 10-Q for the quarterly period ended June 30, 2009, p. 1.

12. Calculated from United Stated page at www.carma.org.