EPA's CO2 Rule and the Back Door to Cap & Trade

• Significant differences in EPA's proposed state CO2 targets for the power sector are reviving interest in cap & trade as a way to reduce compliance costs.
• This compounds the EPA plan's controversy and raises serious concerns about how the resulting revenue would be used.

Earlier this month the US Environmental Protection Agency released for comment its proposal for regulating the CO2 emissions from existing power plants. It follows EPA’s emissions rule for new power plants published late last year but takes a different, more expansive approach.  If implemented, the “Clean Power Plan” would reduce US emissions in the utility sector by around 25% by 2020 and 30% by 2030.

One of its most surprising features is that instead of setting emissions standards for each type of power plant or mandating a single, across-the-board emissions-reduction percentage, it imposes distinct emissions targets on each state. Based on analysis by Bloomberg New Energy Finance, some states could actually increase emissions, while others would be required to make deep cuts. The resulting disparities have apparently triggered new interest in state and regional emissions trading as a means of managing the rule’s cost.

Although emissions trading has become more controversial in recent years, it proved its worth in holding down the cost of implementing previous environmental regulations, such as the effort to reduce sulfur pollution associated with acid rain. It works by enabling facilities or companies with lower-than-average abatement costs to profit from maximizing their reductions and then selling their excess reductions to others with higher costs. The desired overall reductions are thus achieved at a lower cost to the economy than if each company or facility were required to reduce its emissions by the same amount.

Although the Clean Power Plan doesn’t require that states establish such emissions trading markets, its lengthy preamble includes a discussion of existing state greenhouse gas “cap-and-trade” markets in California and the Northeast. It also points out that measures to comply with the new rule may generate benefits in the markets for conventional pollutants, including those for the recent cross-state pollution rule. Administrator McCarthy also mentioned the benefits of multi-state markets in her speech announcing the new rule.

A patchwork of cap and trade markets across the US, including the addition of new states to mechanisms like the Regional Greenhouse Gas Initiative (RGGI), might help mitigate some of the cost of complying with 50 different CO2 targets. However, it would still be a far cry from the kind of economy-wide, comprehensive CO2 cap-and-trade system once contemplated by the US Congress.

Cap and trade was an idea that had gained significant momentum and even begun to appear inevitable, prior to the onset of the financial crisis in 2008. To supporters, it looked like a better way to limit and eventually cut greenhouse gas emissions than through command-and-control regulations. And the price it would establish for emissions would be based on the cost of achieving a desired level of reductions, rather than being set arbitrarily, as a carbon tax would be, without any guarantee of actual emissions reductions. Opponents viewed it as an unnecessary or unnecessarily complicated drag on the economy and a tax by another name, coining the pejorative term “cap-and-tax”.

Although early US cap-and-trade bills were bipartisan, including one co-sponsored by Senator McCain, the 2008 Republican Presidential nominee, the debate over cap and trade took on an increasingly partisan tone in a period of widening polarization on most major issues. The Waxman-Markey climate bill, with cap and trade as a major provision, was narrowly passed when Democrats controlled the House of Representatives in 2009, but various Senate versions failed to attract sufficient support, even when Democrats held a filibuster-proof supermajority in that body. The chances of enacting cap and trade legislation effectively died when a Republican won the vacant Senate seat for Massachusetts in January 2010. However, viewing this as a purely partisan divide is simplistic, at best.

Aside from opposition by key Senate Democrats, including one whose campaign included a vivid demonstration of his stand against Waxman-Markey, the versions of “cap and trade” debated in 2009 and 2010 bore little resemblance to the original idea. Waxman-Markey was a 1400-page monstrosity, laden with extraneous provisions and pork. Its embedded allocation of free allowances strongly favored the same electricity sector now being targeted by EPA’s Clean Power Plan, at the expense of transportation energy, for which low-carbon options remain fewer and more costly. It would have created a de facto gasoline tax, while yielding fewer net emissions reductions than a system with a level playing field. Subsequent bills, such as the Kerry-Lieberman bill in 2010, took this a step farther, removing transportation fuels from cap and trade and effectively taxing them at a rate based on the price of emissions credits.

Along the way, national CO2 cap-and-trade legislation evolved from a fairly straightforward way to harness market forces to deliver the cheapest emissions cuts available, to a mechanism for raising and redistributing large sums of money outside the tax code. In some cases that would have been done directly, such as in the gratifyingly brief Cantwell-Collins “cap-and-dividend” bill, or as indirectly and inefficiently as in Waxman-Markey. It’s no wonder the whole idea became toxic at the federal level.

Although emissions trading for greenhouse gas reduction came up short in the US Congress, it took hold elsewhere. The EU’s Emissions Trading System (ETS) is an outgrowth of the Kyoto Protocol’s emissions trading mechanism, which was included largely at the urging of the US delegation to the Kyoto climate conference in 1997. The ETS is focused on the industrial and power sectors and covers 43% of EU emissions. It has experienced significant ups and downs over the sale and allocation of emissions credits.

Cap and trade also emerged as a preferred approach for some US states seeking to reduce their emissions. California’s emissions market was established via a provision of the 2006 Climate Solutions Act (A.B. 32), and RGGI currently facilitates trading among 9 mostly northeastern states. The relatively low prices of emissions allowances in these systems–particularly in RGGI, which has traded in the range of $3-$5/ton of CO2–suggests that they may still be capturing low-hanging fruit in the early phases of steadily declining emissions caps. Their effectiveness at facilitating future low-cost emissions cuts is hard to gauge, because they also don’t exist in a vacuum.

Except for Vermont, all of the states involved have renewable electricity mandates that by their nature deliver more prescriptive emissions cuts. These markets have also been implemented in a generally weak US economy, which has constrained energy demand, and against the backdrop of the shale revolution, which has yielded significant non-mandated emissions reductions. Nor have these state and regional approaches to cap and trade entirely avoided the debates over how to spend their substantial proceeds that plagued federal cap-and-trade legislation.

For many years my view of cap and trade was that if we needed to put a price on GHG emissions, this was a better, more efficient option than an arbitrary carbon tax, or other top-down method. My experience analyzing more recent “cap-and-trade” legislation left me with serious doubts about our ability to implement a fair and effective national cap-and-trade market for CO2 and other greenhouse gases within the current political environment. Whether on a unified basis or in aggregate across many smaller systems, the enormous sums it could eventually generate are simply too tempting to expect our legislators and government agencies to administer even-handedly.

Whatever its potential benefits and pitfalls, I can’t help seeing cap and trade as a distraction in the context of the EPA’s proposed Clean Power Plan. Even at its most efficient, cap and trade couldn’t render painless the wide disparities of a plan that would require Arizona to cut emissions per megawatt-hour by more than half, and states like Texas and Oklahoma to cut by 36-38%, while Kansas, Kentucky, Missouri, Montana and even California cut by less than a quarter–and under some scenarios might even increase their overall emissions. Cap and trade would merely be a footnote on the scale of transformation the EPA’s plan envisions for the US electricity sector.

A different version of this posting was previously published on Energy Trends Insider.

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.

Will Russia's Gas Deal with China Block Other Suppliers?

• The recent natural gas deal between Russia and China involves volumes comparable to the gas production of the US Gulf of Mexico.
• Barring a major economic slowdown, meeting China's projected growth in gas demand will require this Russian gas, more LNG imports, and China's own shale gas.

 

$400 billion deals aren't announced every week--even by heads of state--although the new natural gas supply agreement between Russia and China had been in the works for some time. However, the crucial element of price apparently wasn't agreed until a negotiating session that lasted until 4:00 AM, Shanghai time. "Our Chinese friends are difficult, hard negotiators," said President Putin. They certainly waited for the right moment, with Russia pressed by sanctions in the aftermath of its annexation of Crimea.

The numbers are all impressive: After investing more than $50 billion in gas field and pipeline development in Eastern Siberia, Russia will sell 38 billion cubic meters (BCM) of gas per year to China for 30 years, and China will reportedly invest $20 billion for gas infrastructure and market development within its borders. Deliveries are set to start in 2018 and could eventually ramp up to 60 BCM/yr.

To put that in perspective, 38 BCM/yr equates to 3.7 billion cubic feet (BCF) per day. That's on par with the entire natural gas production of the Eagle Ford shale formation in south Texas, or the federal waters of the Gulf of Mexico.  Of greater relevance is that it's also nearly twice the output of Australia's Gorgon LNG project, which is expected to begin production in 2015. So from the perspective of the regional gas market and alternative supplies, this is a very significant quantity of gas, especially with a number of new Australian LNG projects under development or consideration.

As of 2012 China's gas market was already the largest in Asia, ahead of Japan, based on BP's annual Statistical Review of World Energy. This deal represents 27% of China's current gas demand, so it's tempting to conclude that squeezing Russian gas into China must come at the expense of other potential suppliers. If China's gas market were mature, such a zero-sum view could not be ignored, particularly by marginal LNG projects in Australia, Indonesia and the US that have not yet begun construction.

Competition with Russian gas could also impede development funding and access to infrastructure for China's nascent shale gas industry. The US Energy Information Administration's 2013 global survey of technically recoverable shale resources found that China could have over a quadrillion cubic feet--1,115 TCF--of shale gas in the ground, or nearly twice as much as the US. Yet China's progress in tapping this resource has been slow, and hardly a week goes by without another article explaining why it will be difficult if not impossible for others to replicate the US shale gas boom any time soon.

The growth of demand will largely shape the competitive environment for gas in China. In 2012 natural gas accounted for less than 5% of the country's total primary energy consumption, compared to 13% for Taiwan, 17% for South Korea and 22% for Japan, none of which are significant gas producers. From 2007-12 China's gas market grew at a compound average rate of 15% per year. In their just-released Medium-Term Gas Market Report, the International Energy Agency (IEA) forecasts China's gas demand growing by 90% by 2019, while their latest World Energy Outlook anticipated it tripling by 2025 and quadrupling by 2035, eventually reaching 11% of energy consumption. Achieving that would require the equivalent of ten gas deals the size of this one.

That outcome isn't a certainty, for many reasons. Having all that gas turn up at the right time poses a massive logistical and capital investment challenge, and China's economy might slow further. Meanwhile, the price implied in the media coverage of the Russia/China deal is around $350 per 1000 cubic meters ($10 per million BTUs) or more than double the current US wellhead price. That's a lot cheaper than most of the LNG delivered to Asia, but it won't outcompete Chinese coal on economics alone, and it won't jump-start new, gas-reliant industries the way the US shale gas revolution is beginning to do.

The scale of market development implicit in the IEA's forecasts for China would require a substantial expansion of gas-fired power generation, which in any case is the logical complement to China's aggressive expansion of wind and solar power installations. It also entails a significant shift from solid and liquid heating and cooking fuels to gas, where at least in the case of liquids, $10 gas would have the edge over products derived from $100 oil. It might even encompass gas-based distributed power generation using fuel cells, which is still in its infancy in the US. Such developments will benefit all potential suppliers, not just Russia.

It's also worth considering what this deal means for Russia. While many reports have suggested it provides a counterweight to Russia's dependence on the European gas market, that's really only true in a financial sense. The deal represents a major growth opportunity for Gazprom, Russia's majority-state-owned natural gas company, but this isn't the same gas that now supplies the EU. It will mainly be production from new gas fields. The potential upside for Russia may depend on its ability to leverage the infrastructure built for this deal into a larger gas network for supplying growth throughout Asia--in competition with US and other LNG projects eyeing that market.

"Milestone" is an over-used term, but it fits this deal. If the parties can iron out all the remaining details and proceed to construction and ultimately delivery, it could prove to be a key step in giving gas a much bigger role in fueling Asia's growth. That would have important environmental benefits, in both mitigating the air pollution in Asia's major cities and reducing carbon emissions, perhaps by enough to bend the curve of the region's greenhouse gas growth.

 

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

IEA's Roadmap for Low-Carbon Electrification in a "Golden Age" of Gas

• The IEA's latest Energy Technology Perspectives report provides a roadmap for the long transition to sustainable energy, as well as a report card on its progress.
• It also highlights the tension between the value of natural gas in decarbonizing the current energy mix, and longer-term expectations for phasing out its use.

Last month the International Energy Agency released its latest Energy Technology Perspectives (ETP), a technology roadmap extending out to mid-century, with a major focus on the increasing electrification of global energy against a backdrop of climate change. It may also shed some light on the options for achieving the emissions cuts in the US Environmental Protection Agency's proposed CO2 regulations for power plants.

This is turning out to a big season for climate-change-related reports. The ETP arrived just a week after the US National Climate Assessment, which followed the latest volume of the IPCC's Fifth Assessment Report on climate change. The ETP caught the attention of renewables-oriented news sites for its characterization of natural gas as, "a transitional fuel, not a low-carbon solution unless coupled with carbon capture and storage (CCS)."

That might seem to contradict the general tone of IEA's earlier "Golden Age of Gas" scenario, though when that study was released in 2011 it, too, included caveats about the limitations of gas in reducing greenhouse gas emissions. From that standpoint, the new ETP is no more negative about gas than the relatively rosy (for gas) Golden Age scenario was, and in fact sees gas supporting both "increasing integration of renewables and displacing coal-fired generation."

The IEA's press release for the ETP highlighted the growth of electricity as a major energy carrier, particularly in the developing world, increasing from 17% of final global energy consumption in 2011 to 23-26% by 2050. However, it also noted, "While this offers many opportunities, it does not solve all our problems; indeed it creates many new challenges."  Among other things, that alludes to the fact that while renewables such as wind and solar power have been growing rapidly, so has coal use, with the result that, as the ETP launch presentation put it, "the carbon intensity of (energy) supply is stuck."

The emissions benefits of electricity displacing oil from transportation and other fossil fuels from industrial, commercial and residential uses will be largely negated if power generation does not also shift towards lower-emitting sources such as nuclear, hydropower, geothermal, wind and solar power. The "2DS" scenario that received far more attention in the IEA's rollout than the ETP's other two scenarios, provides the prescription and justification for that transition. However, it's important to realize that the 2DS case is not a forecast or prediction; it's what scenario experts might call a "normative scenario"--one that the authors hope to encourage, rather than expect to occur.

2DS reflects the official stance of most member countries of the IEA and links to the low-emission "450" scenario in the agency's current World Energy Outlook. Both are predicated on creating a 50% chance of limiting the average global temperature increase due to climate change to 2°C (3.6°F), compared to pre-industrial conditions. That is generally thought to require keeping the atmospheric  CO2 concentration below 450 ppm (0.045%). In their launch presentation for this report, as in other recent reports, the IEA sounded the alarm that this goal may be slipping out of our grasp. April's monthly CO2 average exceeded 400 ppm for the first time since measurements began, and it is growing at around 2 ppm per year.

The IEA makes a good case that the rapid energy transition described in their 2DS scenario is feasible and economically beneficial, despite its $44 trillion price tag, providing substantial future savings in fuel costs, or more modest ones on the discounted cash flow basis on which most investments are premised. However, they are equally candid that reaching this goal will require significantly greater commitments and actions than countries have already made--or than I would assess to be politically feasible in the current global environment.

Renewables may be on-track, but many other aspects of the low-carbon transition aren't. That's especially true for new nuclear power, post-Fukushima, and carbon capture and sequestration (CCS) on which 2DS counts for 7% and 14%, respectively, of emissions reductions through 2050.

It's worth recalling that the main scenario in the World Energy Outlook was not "450", but rather the less-restrictive "New Policies" scenario, which appears to correspond to the middle "4DS" technology scenario of the ETP. (The WEO also includes a status quo "Current Policies" scenario.)  In that context we must not let the appealing outcomes envisioned in 2DS obscure the emissions-reducing benefits of natural gas in the world we are still likelier to inhabit, based on current trends, than the one we might desire.

Only under the rapid replacement of fossil fuels by renewables and nuclear power and CO2 sequestration assumed in the 2DS/ "450" scenarios would it be true that, "After 2025...emissions from gas-fired plants are higher than the average carbon intensity of the global electricity mix; natural gas loses its status as a low-carbon fuel." Presumably in the ETP's other two scenarios, that crossover would not happen until much later, if at all.

Gas is thus still a crucial bridge to a lower-carbon world, and it will not lose that status until we have made much more progress in reducing energy-related emissions than seems likely in the near future. While I certainly wouldn't bet against the continued growth of renewable energy, the slow progress of the other elements of decarbonization leaves a vital role for gas to help fuel the beneficial electrification of energy that the IEA has highlighted, for multiple decades.

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