A “Utility Only” Cap on Emissions?

The Senate must consider several important issues before designing an electric power-only emissions trading program.

There’s been a lot of chatter of late about the Senate designing a greenhouse gas (GHG) reduction program for the electric power sector – so called “utility only” – as opposed to a broader program like the one passed by the House last year that covers most sectors of the U.S. economy. If the Senate goes this route, there are important issues that must be considered if the U.S. is going to come anywhere close to cutting total emissions by 17 percent below 2005 levels by 2020, President Obama’s commitment to the international community, and set the foundation for deeper cuts in the future. Here are three key points to keep in mind:

• Reducing U.S. emissions at least to 17 percent below 2005 levels by 2020 and more than 80 percent below 2005 levels by 2050 will almost certainly require a combination of an emissions trading program, federal and state regulatory authority already in place, and new policies and measures.

• Emissions from electric power account for about a third of total U.S. GHG emissions.¹ The fewer sectors covered under an emissions trading program such as utility only, the more important it will be to preserve existing state and federal authorities (such as EPA regulations) and to use complementary policies (such as appliance and vehicle standards) to achieve overall national emissions reduction goals.

• The design of an electric power-only emissions trading program must be ambitious and environmentally robust to play a meaningful role in meeting reduction targets and in establishing a solid foundation for a national GHG reduction framework that can be ramped up over time.

This post will focus on what is required to achieve meaningful near- and long-term national GHG emissions reductions. This is just one area that matters in the construction of a comprehensive approach to the energy and climate challenges the country faces. There are other important issues to consider in the design of an electric power-only cap, such as how to distribute allowances, how to protect consumers, whether to allow non-electric power sources to opt in to the program, and how to manage the oversight of the emissions trading market.

The following are three key interconnected issues that are critical to strong policy design when it comes to achieving significant GHG reductions:

1. Setting the cap on the electric power sector
2. The role of cost-containment provisions (such as offsets and price collars)
3. Addressing emissions in uncapped sectors

1. Setting a sufficiently robust and achievable cap on electric power

When setting the cap on electric power emissions, it is important to keep in mind that the tighter the cap, the fewer reductions you need to achieve through other policies. Recent analyses project that CO2 emissions from the electric sector will be more than 3 percent below 2005 levels in 2012 without any regulations due in part to energy efficiency and renewable energy programs enacted over the past few years and also the recent decline in economic activity. Therefore, if the U.S. is to reduce its emissions by at least 17% by 2020, then greater reductions beyond business as usual are needed from the electric sector. Here is why a strong cap is desirable and achievable:

• Emissions are currently well below 2005 levels. EPA reports that 2008 electric power emissions were already 2 percent below 2005 levels. The EIA projects that current electric power emissions are approximately 7 percent below 2005 levels and will likely rise slightly to 4 percent below 2005 levels by 2012. A utility-only cap should be set to include emission reductions that have already been achieved.

• The electric power sector is capable of achieving substantial GHG reductions. The Electric Power Research Institute (EPRI, the electric industry’s research and development organization) estimates that the sector is capable of achieving reductions of 20-27 percent 2005 levels by 2020 and 41-58 percent below by 2030 using existing and cutting edge technologies. This finding is consistent with EPA’s analysis of the American Power Act (Kerry-Lieberman), which found that the electric power sector would achieve reductions of 24 percent below 2005 levels by 2020 and 44 percent below by 2030 under reasonable allowance prices with a minimal impact on consumer electric bills.

• Emissions reductions in the electric power sector are cheap relative to other sectors. The same EPA study found that in 2020, 66 percent of projected total economy-wide reductions below 2005 levels in 2020 under the American Power Act (Kerry-Lieberman) occurred in the electric power sector (see Figure 1). This shows that for a given allowance price you’ll get more reductions from electric power than other parts of the economy.

Figure 1: EPA Analysis of the American Power Act (Source: EPA Appendix, page 71)

• A number of old and inefficient power plants that do not have any pollution controls might be shut down in the coming years. As of 2009, there was over 55 GW of coal-fired power plants over 50 years old in operation in the U.S.² Many of these plants do not have any appreciable pollution control equipment. Some analysts have suggested that new rules to improve air quality, reduce emissions of toxic pollutants, and ensure proper disposal of ash could cause these old uncontrolled units to retire.³ Any retirement could generate additional GHG reductions beyond what’s been projected in recent analyses.

• Setting a long-term cap establishes regulatory certainty and sets the stage for a broader program. Regardless of the stringency of reduction targets, the cap should establish a long-term pathway for reductions out to 2050. This helps utilities plan and drives investment in low carbon technologies. In addition, it allows the electric power sector program to serve as the foundation for a broader emissions trading program in the future if and when additional sectors are brought under the cap. Caps that level off or expire in future years could cause significant uncertainty for regulated entities, most of which must make investment decisions with multi-decade time horizons. A long-term reduction schedule can also set the stage for deeper GHG reductions from the economy as a whole.

2. Careful use of cost-containment provisions

First, it’s important to note that the whole point of emissions trading is to harness the market to generate emission reductions at the lowest possible cost, so additional cost-containment measures should be considered carefully. A price ceiling set in the form of a strategic reserve or safety valve at too low a level would miss opportunities to achieve reductions from under the electric power cap, where affordable abatement options are widely available. This would also inhibit the deployment of new clean energy technologies.

Allowing large amounts of offsets for compliance would yield a similar outcome. Since the electric power sector already has substantial abatement opportunities on its own, a case could be made that only small amounts of offsets are needed for cost containment in an electric-only program. If significant amounts of offsets are allowed, the cap should be made more stringent to achieve even greater reductions.

The overall demand for offsets will be much lower under an electric power-only program as compared to an economy-wide approach (because there is a smaller system-wide compliance obligation). In the meantime, the potential supply of low-cost offsets is large. At a price of $5, up to 2 billion tons of offsets (domestic and international) could be available in 2015 based on EPA data.⁴ This is roughly equal to the total 2008 GHG emissions from the entire electric power sector.

Large uncapped sectors such as transportation and industry should not be allowed to generate offsets under an electric power sector program. Given the abundant supply of offsets available internationally and from the agriculture and forestry sectors, additional offsets from transportation and industry are probably not needed for cost-containment. If these sectors were eligible to generate offsets they would almost certainly become accustomed to receiving payments for making voluntary GHG emissions reductions. This would make it more politically and practically difficult to implement more stringent regulations and/or emissions caps on these sources in the future. It would also be difficult to determine whether or not such reductions would have been done anyway to meet existing and pending regulations, calling into question the additionality of offsets from these sources. A broader, more inclusive cap or other regulatory mechanisms will ultimately be needed to achieve economy-wide emissions reductions on the order of 80% below 2005 levels by 2050; voluntary measures will not be sufficient to achieve this objective.

3. Reducing emissions in uncapped sectors through the preservation of current federal and state authority and additional complementary policies.

Given the limited coverage of an electric power-only cap, other policies must be pursued to achieve reductions in uncapped sectors. Existing executive and state authority can play a significant role in making up the difference. The addition of new complementary policies will almost certainly be necessary.

Following the precedent of prior legislation, any changes to the existing regulatory authorities of EPA or the States should be replaced with new rules and regulations that protect public health and welfare to an equal or greater degree. Removing or significantly delaying the use of current EPA authority will make it difficult to reduce emissions outside of the electric power sector cap, and thus decrease the likelihood of achieve substantial national GHG reductions.

The states have played a significant role in establishing and testing standards and systems for controlling GHGs. Ultimately, preserving states’ rights to reduce GHG emissions and decarbonize their economies, especially in uncovered sectors, will complement any federal effort to reduce GHGs. Furthermore, it could make it easier for other states to achieve reductions from capped sources, and could help spur important technology and policy innovations for meeting long term environmental and economic development goals.

In addition to an electric power cap and existing federal and state authority, complementary policies will be critical to achieving near and long-term national GHG reduction goals. Tackling GHG emissions will require the consideration of an array of policy options, such as:

• Building codes for energy efficiency and appliance efficiency standards.
• Retrofit programs for existing buildings, thus reducing emissions, saving homeowners and businesses money and creating jobs.
• Requiring metropolitan planning organizations and States to conduct and implement low-carbon transportation plans; making federal funding for transit programs contingent on effective implementation.
• Investments in renewable and energy efficiency in the industrial sector through revolving loans and grants.
• A robust cap on the consumption of hydrofluorocarbons.
• Performance standards for large capped and uncapped stationary GHG sources such as factories, refineries, landfills and coal mines.
• A robust renewable energy portfolio standard to drive investment in clean electricity generation.