Power Prices and Resource Choices in a Carbon-Regulated Environment

UNIVERSITY OF TEXAS SCHOOL OF LAW

2008 CARBON AND CLIMATE CHANGE

AUSTIN, TEXAS

APRIL 25, 2008

ROBERT W. GEEPRESIDENT

GEE STRATEGIES GROUP LLC

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Overview

• Current demand and infrastructure outlook for electric sector

• Competing analyses over the price and economic impact of compliance with cap-and-trade controls over greenhouse gas emissions (GHG)

• Outlook for resource choices depending upon availability of emerging technology

• The potential role of retail rate regulators over federal cap and trade price mitigation

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Current Outlook: Electricity Demand Expected to Escalate, Necessitating More Generation Capacity

• Electricity sales will grow 1.4 percent annually through 2030 (Energy Information Administration 2007 Annual Energy Outlook)

• Peak demand will grow by 19 percent, or 141 GW, from 2006 through 2015 (North American Reliability Corp.)

• 258 GW of new generation capacity required by 2030 to meet new demand and replace retired capacity (EIA)

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Utility Capital Expenditures Growing in an Escalating Cost Environment

• Economic growth and aging infrastructure will require major capital expenditures over the next two decades

• Edison Electric Institute Survey: from 2006 – 2009, $31.5 billion to be invested in transmission

• 13,000 miles of new transmission added by 2015 -- 6.1 percent increase in total miles of installed extra high-voltage between 2006 and 2015 (NERC)

• Materials and labor costs in generation and network infrastructure have escalated

– From January 2004 and January 2007, prices increased rapidly. Costs for steam-generation boilers, transmission facilities and distribution-grid equipment rose by 25 percent to 35 percent

– No cost abatement currently envisioned Source: Greg Basheda and Marc Chupka, Sticker Shock, Public Utilities Fortnightly (December 2007)

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Supply Resource Choices with Current Technology Under a Carbon-Constrained Scenario

Source: E.Spiegel & A. Begosso, Coal’s Black Future, Public Utilities Fortnightly (March 2008)

• Because gas-fired generation has set marginal cost of power today, natural gas prices influence choice of supply options

• If carbon “penalty” is low,but gas prices high, conventional coal is competitive

• If carbon penalty high, and gas prices high, nuclear becomes competitive

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What’s Will Be the Electric Price Impact of Carbon Regulation Compliance Under Cap & Trade?

• It depends on . . . . . .

• Whether CO2 regulation is sector specific (e.g., utilities only) or economy wide

• One’s estimated carbon “penalty” or cost

• Future costs of various resource technology options and when will they be available on commercial terms

• Whether CO2 emission allowance is auctioned or awarded at no cost and which entity receives it

• Who you ask

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The Battle of the Consulting Firms: How Difficult or Easy will Carbon Control Compliance Be?

• Analysis done by McKinsey/Conference Board

• McKinsey study challenged by CRA International

• CRA Refuted by Union of Concerned Scientists

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McKinsey/Conference Board Study• Analyzed 250+ opportunities to reduce US GHG emissions by 2030

• Did not factor adoption of any specific policies (carbon cap, mandates, or incentives), or consumer responses resulting

• US emissions of 3 to 4.5 billion gigatons of CO2 could be reduced by 2030 using tested approaches and high-potential emerging technologies

• Based on wide array of options available at marginal costs of >$50/ton w/lower net costs to economy if energy efficiency gains realized

• Almost 40 percent of reductions realizable at “negative” marginal costs, paying for themselves

• Example: Greater efficiency in buildings-and- appliances and industrial sectors could offset 80 percent of projected demand by 2030

• Carbon Capture & Sequestration (CCS) offers less than 11 percent of potential reduction

• Requires strong, economy-wide action in near future, including $1.1 trillion in additional capital expenditures

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CRA’s critique of McKinsey

• Premised on “engineering” potential and related costs, net of benefits, but not market response of individuals and organizations to public policies and economic incentives contained in federal and state legislation

• Examines only a single year in the distant future (i.e., 2030) and therefore provides no insight for developing 5- or even 10-year strategies in 2008

• Fails to consider the complications associated with interrelated macro- and micro-economic effects of carbon control limits

• Under CRA’s assessment of Lieberman-Warner bill:

– Marginal cost of CO2 abatement will be $55 per ton in 2015, $85 per ton in 2030, and $280 per ton in 2045 (in constant 2007 dollars); therefore, McKinsey $50/ton benchmark is too low

– Growth in GDP will be 1.5 percent lower by 2015, and 2 percent lower by 2045 from “business as usual” case

– Wholesale electricity prices will be 50 percent higher by 2015, and 80 percent higher by 2045

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Union of Concerned Scientists: CRA’s Analysis Fails to Consider. . .

• The costs of global warming, such as increased flooding, the demise of the New Hampshire ski industry, and reduced forest productivity

• Cost savings from investments in increased efficiency, which would curb power usage

• Economic gains from technological innovation in response to carbon caps and other policies

• Additional benefits from combating global warming, including strengthened national security, lower trade deficits, less air pollution, and reduced health care costs.

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The EPRI “Prism” (Based on EIA Early Release Reference Case 2008)

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1990 1995 2000 2005 2010 2015 2020 2025 2030

U.S

. Ele

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TechnologyEIA 2008 Early Release Reference Case (12/07)

Target

Efficiency Load Growth ~ +1.2%/yr Load Growth ~ +0.75%/yr

Renewables 60 GWe by 2030 100 GWe by 2030

Nuclear Generation 20 GWe by 2030 64 GWe by 2030

Advanced Coal GenerationNo Existing Plant Upgrades

40% New Plant Efficiency by 2020–2030

130 GWe Plant Upgrades

46% New Plant Efficiency by 2020; 49% in 2030

CCS None Widely Deployed After 2020

PHEV None10% of New Vehicle Sales by 2017;

+2%/yr Thereafter

DER < 0.1% of Base Load in 2030 5% of Base Load in 2030

Source: EPRI

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Two Resource Scenarios with Differing Technology Expectations

*Economy-wide CO2 emissions capped at 2010 levels until 2020 and then reduced at 3%/yr

Source: EPRI

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Wholesale Power Prices Under “Limited” versus “Full” Technology Portfolio

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2000 2010 2020 2030 2040 2050

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Limited

Full

Source: EPRI*Real (inflation-adjusted) 2000$

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Observations from “Prism”

• Achievement of “Full Portfolio” option rests heavily on:– Successful timing of commercial availability of emerging technology (i.e.,

carbon capture and sequestration, smart grid, et al.) – Successful nuclear expansion at competitive costs

• Demand reduction an essential option under either scenario – Under “Limited Portfolio”, will require much greater commitment– Likely to include demand destruction

• Unsuccessful realization of any of these elements could aggravate resource adequacy and escalate price pressure

– Example: “Limited Portfolio” contemplates increased reliance on natural gas

– Power prices likely subject to greater volatility and global competition for LNG

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EPA’s Assessment of Compliance Costs

• Study issued 14 March 2008, upon request of Senators Lieberman and Warner to evaluate impact of S.2191(Lieberman-Warner Climate Security Act of 2008)

• Some assumptions:– CCS is viable by 2015 and that by 2035 has been deployed in 30

percent of all coal plants– Nuclear power generation increases by 150 percent between 2005

and 2050

• Will be updated later this year after EIA’s issuance of 2008 Annual Energy Outlook, which will include the impact of the Energy Independence and Security Act of 2007

• EIA analysis of S.2191 expected shortly

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EPA’s Assessment (con’t.)

• From Senators Lieberman and Warner’s Press Release (the “Good News”):

– US gross domestic product (GDP) grows by 80 percent from 2010 to 2030 or 1 percent less than w/o bill

– Average annual per-household consumption in the US grows by 81 percent from 2010 to 2030, or 2 percent less than the growth w/o bill

– Emission allowance prices are $22/ton in 2015 and $46/ton by 2030

– Increases in average US electricity prices materialize slowly and gradually, attaining level only 18 percent higher than the 2005 level after 40 years

• But EPA itself notes (the “Less Favorable News”):

– While GDP increases by approximately 97 percent from 2007 levels by 2030 and 215 percent by 2050, estimated annual reduction in GDP ranges from $238 billion to $983 billion in 2030 and between $1,012 billion and $2,856 billion in 2050.

– Electricity prices are projected to increase 44 percent in 2030 and 26 percent in 2050

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Retail Rate Regulators: Seeking a Role in Price Mitigation

• Perspective of state retail regulators toward federal carbon controls (if adopted):

– Carbon controls be economy wide w/appropriate transition period

– Sufficient certainty created to ensure the financing of needed energy infrastructure consistent with the achievement of the environmental objectives

• If cap & trade adopted, want price mitigation mechanisms and oversight of allowance benefits :

– Find allowance auctioning to be most efficient mechanism to achieving emission reduction goals, but considers no-cost allowances to be appropriate transitional tool

– Prefer assigning all allocated no-cost allowances available to the electricity sector to local distribution companies (LDCs) providing a regulated local distribution function for end-user customers

– Desire cost-containment measures to be included in any cap-and-trade mechanism to minimize abrupt changes in the cost of compliance

Source: NARUC Resolution on Federal Climate Legislation and Cap-and-Trade Design Principles, Adopted November 14, 2007

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Retail Rate Regulators (con’t.)

• Lieberman-Warner assigns no-cost allowances to “fossil fuel-fired electric power generating facilities” with electric utilities getting a 19 percent share at the outset, phased out by year 2031

• At odds with state regulators’ position who want assignment of allowances to LDCs to be able to pass through allowance benefits to ratepayers, or use for demand-side management programs

• Regulators are sensitized to rate impacts being compounded owing to additional costs from utilities’ cap ex programs

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Conclusions

• Divergence of projections of carbon control effect on power prices and economy signals absence of consensus among key stakeholders

• Difficult to estimate impacts extending over decades

• Even more difficult estimating timing and commercial availability of emerging technologies

• New slogan for everyone:

“If they come. . . you will build it.”

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Robert W. GeePresidentGee Strategies Group LLC7609 Brittany Parc CourtFalls Church, VA 22304U.S.A.703.593.0116703.698.2033 (fax)rwgee@geestrategies.comwww.geestrategies.com