EPA's New CO2 Rules Create Opportunities for Natural Gas, for Now

• EPA's proposed rule for reducing CO2 emissions from power plants could increase natural gas demand in the utility sector by as much as 50%, at the expense of coal.
• Cutting emissions by regulation rather than legislation entails legal and political uncertainties that could hamper the investment necessary to meet EPA's targets.

Earlier this month the Environmental Protection Agency announced its proposal for regulating the greenhouse gas emissions from all currently operating US power plants. Unsurprisingly, initial assessments suggested it favors the renewable energy, energy efficiency and nuclear power industries--and especially natural gas--all at the expense of coal. However, the longer-term outcome is subject to significant uncertainties, because of the way this policy is being implemented.

EPA's proposed "Clean Power Plan" regulation would reduce CO2 emissions from the US electric power sector by 25% by 2020 and 30% by 2030, compared to 2005. Although it does not specify that the annual reduction of over 700 million metric tons of CO2--half of which had already been achieved by 2012--must all come from coal-burning power plants, such plants accounted for 75% of 2012 emissions from power generation.

It's worth recalling how we got here. In the last decade the US Congress made several attempts to enact comprehensive climate legislation, based on an economy-wide cap on CO2 and a system of trading emissions allowances: "cap and trade." In 2009 the House of Representatives passed the Waxman-Markey bill, with its rather distorted version of cap and trade. It died in the US Senate, where the President's party briefly held a filibuster-proof supermajority.

The Clean Power Plan is the culmination of the administration's efforts to regulate the major CO2 sources in the US economy, in the absence of comprehensive climate legislation. Although Administrator McCarthy touted the flexibility of the plan in her enthusiastic rollout speech and suggested that its implementation might include state or regional cap and trade markets for emissions, the net result will look very different than an economy-wide approach.

For starters, there won't be a cap on overall emissions, but rather a set of state-level performance targets for emissions per megawatt-hour generated in 2020 and 2030. If electricity demand grew 29% by 2040, as recently forecast by the Energy Information Administration of the US Department of Energy, the CO2 savings in the EPA plan might even be largely negated. EPA is banking on the widespread adoption of energy efficiency measures to avoid such an outcome.

Since we have many technologies for generating electricity, with varying emissions all the way down to nearly zero, many different future generating mixes could achieve the plan's goals, though not at equal cost or reliability. Ironically, since coal's share of power generation has declined from 50%  in 2005 to 39% as of last year, it could be done by replacing all the older coal-fired power plants in the US with state of the art plants using either ultra-supercritical pulverized coal combustion (USC ) or integrated gasification combined cycle (IGCC). 

That won't happen for a variety of reasons, not least of which is EPA's "New Source Performance Standards" published last November. That rule effectively requires new coal-fired power plants to emit around a third less CO2 than today's most efficient coal plant designs. That's only possibly if they capture and sequester (CCS) at least some of their emissions, a feature found in only a couple of power plants now under construction globally.

It's also questionable how the capital required to upgrade the entire US coal generating fleet could be raised. Returns on such facilities have fallen, due to competition from shale gas and from renewables like wind power with very low marginal costs--sometimes negative after factoring in tax credits. Some are interpreting EPA's aggressive CO2 target for 2020 and relatively milder 2030 step as an indication that the latter target could be made much more stringent, later.

So while coal is likely to remain an important  part of the US power mix in 2030, as the EPA's administrator noted, meeting these goals in the real world will likely entail a significant shift from coal to gas and renewable energy sources, while preserving roughly the current nuclear generating fleet, including those units now under construction.

If the entire burden of the shift fell to gas, it would entail increasing the utilization of existing natural gas combined cycle power plants (NGCC) and likely building new units in some states. In the documentation of its draft rules, EPA cited average 2012 NGCC utilization of 46%. Increasing utilization up to 75% would deliver over 600 million additional MWh from gas annually--a 56% increase over total 2013 gas-fired generation, exceeding the output of all US renewables last year--at an emissions reduction of around 340 million metric tons vs. coal. That would be just sufficient to meet the 30% emissions reduction target for the electricity demand and generating mix we had in 2013.

The incremental natural gas required to produce this extra power works out to about 4.4 trillion cubic feet (TCF) per year. That would increase gas consumption in the power sector by just over half, compared to 2013, and boost total US gas demand by 17%. To put that in perspective, US dry natural gas production has grown by 4.1 TCF/y since 2008.

EPA apparently anticipates power sector gas consumption increasing by just 1.2 TCF/y by 2020, and falling thereafter as end-use efficiency improves.  Fuel-switching is only one of the four Best System of Emission Reduction "building blocks" EPA envisions states using, including efficiency improvements at existing power plants, increased penetration of renewable generation, and demand-side efficiency measures. The ultimate mix will vary by state and be influenced by changes in gas, coal and power prices.

I mentioned uncertainties at the beginning of this post. Aside from the inevitable legal challenges to EPA's regulation of power plant CO2 under the 1990 Clean Air Act, its imposition by executive authority, rather than legislation, leaves future administrations free to strengthen, weaken, or even abandon this approach.

Since EPA's planned emission reductions from the power sector are large on a national scale (10% of total US 2005 emissions) but still small on a global scale (2% of 2013 world emissions) their long-term political sustainability may depend on the extent to which they succeed in prompting the large developing countries to follow suit in reducing their growing emissions.

A different version of this posting was previously published on the website of Pacific Energy Development Corporation.

A Nuclear/Gas Alliance?

As I was scanning the news of the last few days I was intrigued by a headline featuring the CEO of the largest owner/operator of nuclear power plants in the US, Exelon Corp., extolling the virtues of natural gas and advocating an increase in its output. That might not sound earth-shattering, especially considering that Exelon also owns a fleet of natural gas-fired power plants with combined output equivalent to several nuclear reactors, unless you are convinced that nuclear and gas are engaged in a tooth-and-nail competition to supply America's future electricity needs. However, it's certainly attention-getting for Mr. Rowe, whose company recently acquired the substantial wind-generation business of John Deere, to go on record opposing clean-energy subsidies for a range of low-emission technologies.

The main message of Mr. Rowe's address at the American Enterprise Institute was apparently that Congress shouldn't interfere further with markets, regulations and technologies that he sees already being sufficient to reduce carbon emissions and clean up the air. Yet while I'm usually reluctant to read too much into remarks I wasn't present to hear, I do think it's possible to infer an alternative strategic dynamic to the nuclear vs. gas narrative that I have encountered in a number of blog postings in the last few years, particularly since shale gas production took off and the anticipated nuclear renaissance in the US encountered resistance. Because it's uncommon to hear CEOs touting their competition, I think it's safe to conclude that Exelon views nuclear and gas as complementary--a view I share--rather than competing for the same segment of the market.

It also sounds like Mr. Rowe sees gas and nuclear competing with coal, which makes eminent sense in the context of environmental policy and typical grid power-dispatch curves. Competition between nuclear and coal was especially obvious when both were viewed as enhancing energy security and before concerns about greenhouse gas emissions had become mainstream. And as recently as a few years ago, when most forecasts anticipated declining US gas production and rapidly increasing imports of LNG, yielding even more volatile natural gas prices, coal-fired power plants were the principal large-scale alternative to both new nuclear and gas-fired capacity. Today's emphasis on emissions, combined with next-generation reactor technology, gives nuclear an edge over coal in baseload for locations where communities are comfortable with the technology, while gas has a more than a 2:1 lead over coal in planned new generating capacity and seems likely to do even better in terms of capacity actually built, due to its substantial lifecycle environmental advantages.

It's also possible to envision a future grid relying mainly on nuclear for baseload power and natural gas for flexible power, without the need for any coal generation at all. Moreover, with the addition of smart grid technology and new long-distance transmission, that combination should provide a very hospitable environment for much larger increments of renewable energy. Gas-fired backup power remains the best enabler for incorporating intermittent generation from wind and solar power, particularly when these technologies are combined in installations such as Florida Power & Light's new hybrid solar/gas power plant in southeast Florida. That seems like a much more realistic approach than the notion of an all-renewable grid based on energy storage, even if storage technology were to become more effective and much cheaper. (Storage has a key role to play in the future grid, but I believe it will be used mainly for short-term buffering and for storing the cheapest off-peak power from any source, rather than as dedicated storage for renewable power.)

The biggest potential obstacle to this scenario is growth, or the lack of it. In a US electricity market that is barely growing at all, in contrast to the steady 2% or so per year expansion in demand from 1997-2007, and with renewables given the first shot at satisfying any growth in a majority of states, the only opportunity that looks big enough for both nuclear and gas-fired power to cooperate on is coal displacement. Yet if you agree with Mr. Rowe that "carbon legislation is dead", it's a lot less certain that coal would go away fast enough for the combination of gas and nuclear he is promoting to become the de facto future. It remains to be seen whether the market, together with an increased emphasis on local pollutants--excluding CO2--under the Clean Air Act will be sufficient to squeeze out a coal industry that, along with its numerous stakeholders, will not depart without a fight.

Whither Cap & Trade?

Just a year ago it seemed a near-certainty that the US would eventually adopt some form of cap & trade mechanism for greenhouse gases (GHGs). After repeated failed attempts to pass cap & trade legislation in the Senate, the House of Representatives narrowly passed the Waxman-Markey bill, HR-2454, and the Senate was expected to follow, bolstered by a filibuster-proof Democratic majority and urged on by a popular new President. Then came the divisive debate over healthcare legislation, the off-year election of Republican Scott Brown in Massachusetts, Climategate, and an oil spill that among other things derailed the latest bi-partisan (tri-partisan?) Senate climate bill. Today, the prospects for climate legislation remain highly uncertain, while the clock runs out on the current Congressional session. And if all that weren't enough, the EPA has just issued new regulations covering interstate emissions of conventional air pollutants that could effectively terminate the highly-successful sulfur-dioxide market upon which cap & trade for GHGs was based. Can cap & trade survive these travails, and should it?

Time will tell whether Waxman-Markey represented the high-water mark of cap & trade in the US, or if the hiatus since then has merely been a pause in a long process of refining and ultimately adopting this approach. Heaven knows W-M was a highly-imperfect vehicle for cap & trade, with its allocation of emissions allowances skewed to the highest-emitting sector and with hundreds of pages of extraneous provisions that could set up all sorts of unintended or undesirable consequences. The last year has also seen a proliferation of variations on cap & trade that call into question the original formulation of an economy-wide cap on emissions implemented by means of requiring emitters to purchase allowances from a gradually-shrinking national pool of emissions credits, with the proceeds doled out by Congress for purposes including clean energy R&D and deployment, deficit reduction, and mitigation of the impact on consumers and selected businesses. The Cantwell-Collins bill, for example, proposes returning most of the allowance revenue directly to consumers, while the Kerry-Lieberman bill would exclude the transportation fuels sector from cap & trade, but impose on it a sort of carbon tax based on the price of traded allowances. Both of these approaches have complex pros and cons, and as with original cap & trade their effectiveness at reducing emissions without imposing crippling costs on the overall economy depends critically on their detailed provisions, negotiated exceptions, and how they would actually be implemented.

Cap & trade has also come under fire on more fundamental grounds. Some critics have questioned the desirability of creating a vast new financial market for emissions when the shortcomings of other financial markets have caused so much harm, while others have suggested that investing in innovation to make low-carbon energy and efficiency much more cost-effective has greater potential to reduce emissions in a world in which developed-country emissions are being eclipsed by those in developing Asia.

Against this backdrop EPA Administrator Jackson's repeated assurances that she prefers legislated cap & trade to enforcement under the Clean Air Act have become increasingly divorced from reality. Her agency's determination to proceed with enforcement next year if no bill is passed, coupled with its newly-issued rules for power-plant pollution, serve mainly to remind the market that emissions allowances are not a new form of fiat currency, with intrinsic value backed by fractional reserves and the full faith and credit of the US government, but a fragile construct, the value of which can be eroded or erased at the whim of this and other regulators or the courts. Today's Wall St. Journal describes the impact of the new air pollution rules on the SOx market. Any potential participant who imagines that something similar couldn't happen to a future greenhouse gas allowance market is not paying attention.

So despite the apparent enthusiasm of the majority party's Senate caucus for enacting some kind of comprehensive climate and energy bill this year, presumably including elements of cap & trade, we're left with serious questions about whether this is an idea whose time has come and gone. From my perspective, putting a price on GHG emissions is still an essential step if we're serious about reducing them by more than the amounts that have resulted from the inadvertent combination of the recession, cheap natural gas, and existing incentives for renewable energy and efficiency. Cap & trade still has significant theoretical advantages over an arbitrary carbon tax as a means of imposing such a price, but as we've seen the likelihood of cap & trade being enacted in such a pure form seems low in the messy world of US politics--perhaps as low as the chances of a pure and simple carbon tax.

The odds against cap & trade look long at this point. Realistically, the time left for bringing a full-blown climate bill to a vote in the Senate is measured in weeks, rather than months, before the dynamics of the mid-term election campaign take over. Notions of passing an energy-only bill and then grafting on Waxman-Markey's climate provisions via a House-Senate conference committee seem even less likely to produce a mechanism that could survive the political upheaval that the mid-terms appear likely to produce. Nor should anyone be considering the last-gasp option of trying to pass climate legislation in a lame-duck session after the November election. As the Congressional Budget Office recently determined, any sort of controls on emissions are likely to reduce overall US employment--"green jobs" notwithstanding--so getting this right must be treated as more important than just getting something through before the current window closes. I will be watching developments in the weeks ahead with great interest.

Tell California No

One of the most eagerly-awaited environmental decisions of the year is currently in the hands of the new Administrator of the Environmental Protection Agency. California has requested a waiver under the Clean Air Act to regulate CO2 as a pollutant from cars, based on the Supreme Court decision in Massachusetts v. EPA that confirmed that the EPA had the authority to regulate greenhouse gases. When I examined this issue in late 2007, I expected California to prevail in its request, and I still do. That doesn't mean, however, that there are not compelling reasons why it shouldn't. I can't think of a better signal the Obama Administration could send concerning the new federal direction on climate change than telling California, "Thanks for keeping the torch burning, but we'll take it from here."

There are two good reasons to turn down California's request to regulate tailpipe emissions, which would result in a de facto standard for Corporate Average Fuel Economy (CAFE) much more aggressive than the federal standard enacted by the Energy Independence and Security Act of 2007. The first reason is unlikely to gain traction, because frankly this boat has already sailed. I mention it only because I still believe it has merit. Simply put, based on engineering principles, the Supreme Court was wrong to designate CO2 as a pollutant, and any extension of the Clean Air Act (CAA) to cover it is based on a misunderstanding of the origins of this greenhouse gas.

Although it's widely accepted that CO2 emissions are a primary cause of climate change, that doesn't make CO2 a pollutant. Too much CO2 is bad, but then so is too much water, if you are drowning or standing downstream of an approaching flood. That doesn't make water a pollutant. CO2 emissions are not the result of a fuel impurity or a byproduct of combustion in engines and boilers, like the smog-forming pollutants the CAA was designed to regulate. It is a fundamental, inescapable consequence of all combustion and many natural processes, and the vast majority of it is recycled into plants and rocks, or dissolved in the oceans. The steady accumulation of the small remaining excess in the atmosphere creates the central problem in global warming. Unfortunately, we can't eliminate CO2 from car exhaust with filters, catalytic converters, additives, or more intensive fuel refining, but only by changing the way cars use energy, and by changing the way we use cars. That goes well beyond any reasonable interpretation of the intent of the CAA, though I suspect this point is no longer of any concern to policy makers.

What ought to be of great concern to policy makers is another, more pragmatic reason to turn down California's request, and by extension that of the thirteen states that wish to opt in to the California standard. Climate change is a global problem, and the science of predicting its local consequences is still in its infancy. Managing our greenhouse gas emissions must ultimately be addressed globally. Until that happens, they need to be tackled at the largest level of aggregation available, because the consequences of climate change will affect us all, directly or indirectly, and because the industries and consumption patterns involved in reducing emissions are so fundamental to the economy. Changing them will require resources and innovation on a national scale. I know that California is larger than many countries--I used to trot this point out regularly when I lived there--but that does not alter the nature of its connection to and interdependence with the rest of the country. In particular, while California has a few bits and pieces of the US car industry, in the form of an assembly plant or two, some parts suppliers, and design centers, the primary impact of its regulation of CO2 would be felt not in the Golden State, but in states such as Michigan, Ohio, Kentucky, Alabama and North Carolina. The effect on interstate commerce and the absence of overridingly unique local impacts should put regulation of CO2 explicitly within the purview of the federal government, not the various states.

A little more than a year ago I reluctantly conceded that California's desire to regulate CO2 from cars was justified by application of the notion of "lead, follow, or get out of the way," in the absence of any immediate prospect of the federal government's taking that lead with respect to climate change. The election has drastically altered those circumstances. It is inconceivable that the Obama Administration, with strong majorities in the Congress, will fail to enact sweeping federal measures to address climate change urgently and aggressively. It looks very likely that we'll have cap & trade within the next year or two, and if tighter CAFE standards are part of the solution--though I remain skeptical of their efficacy without a strong price signal to drive consumer behavior--they should cover the whole country, not just a few states. If we want Detroit to invest in emissions-reducing technologies, then it must have a national market for them. It ought to be instructive that Europe has done precisely that with a tailpipe emissions standard for the whole EU, not member by member.

Administrator Jackson has promised an "impartial review" of California's request, complete with public hearings. Her decision should follow the public comment period that will apparently end April 6. I hope that her finding will signal the end of a long period in which states were forced to blaze the trail on climate change, but can now yield leadership back to the federal government that must speak with one voice in the negotiations toward a global climate agreement in Copenhagen, this December.