Carbon Pricing and Better Market Signals Will Help U.S.


Rather than perpetuate the current uncertainties from the European Union and stalled domestic legislative/regulatory efforts to revitalize the failing Kyoto Protocol platform, we might need a clean slate in the U.S. to make progress towards the upcoming international greenhouse gas (GHG) negotiations in Paris in 2015. Prudent future planning for large energy users must incorporate a price assumption for CO2 emissions to evaluate resource investment decisions for electric generation assets with longer useful lives.

A fresh start
A better domestic regulatory approach might let markets discover prices for carbon and sustainability efforts which could elicit bipartisan support. For example, even a seemingly straightforward cap-and-trade system requires extensive government involvement and impacts price discovery by the setting of mandates, price collars, allocations of allowances and other similar provisions. This impedes the market’s organic pricing process—arguably the best way to address carbon and solve regional energy challenges worldwide. Countries could establish their own targets consistent with international norms and seek to achieve regional or hemispheric goals. Or, an even better approach might be built around a strategy devised by independent power producers for the management of a subset of options, such as mercury emissions and combined power and heat (CHP) projects. This approach would incentivize the right economic conduct in a free marketplace promoting accurate price discovery. To be most impactful, regulatory efforts should be structured on a hemispheric basis for the next decade (2020-30) and rolled up globally thereafter, encouraging regional partnerships for progress in the interim.

Under a fresh start where domestic regulations promote a free market approach, we could provide every stationary source and mobile source of GHG emissions an allowance of carbon per megawatt hour (MWh) or mileage per tank of fuel, or delivered power, heat or cooling content, no matter what the technology, fuel, age of plant, location or past carbon emissions levels. Exceptions could be provided for small commercial and industrial users to protect small business. Using various modeling techniques based on U.S. Energy Information Administration (EIA) data to verify total carbon emissions per unit, the U.S. could implement a strategy that sets a declining schedule for allowances over the next 10-20 years. The U.S. Department of Energy with EIA assistance could annually update the table of carbon values to correct for actual consumption levels of heat, fuel and electricity in the U.S. Rising heat or electricity usage would not increase the cap on carbon emissions. The market would decide thereafter how to limit and implement effective carbon management in the economy to meet national goals.

How it would work
Parity is key. A new biomass plant would get the same carbon allowance as a new or existing coal plant. The same for a wind installation or a new gas-fired plant. The market would determine the price valuation for the carbon allowances. Any improvements in efficiency boosting the miles per gallon or the MWh from a specific volume of fuel would increase available allowances for trading purposes. Additional efficiency improvements would be funded by selling extra carbon allowances on the open market. In this scenario, owners of the older, less-efficient plants using coal or oil face the true market-based costs of their carbon management strategy as determined by the market each year. Historical least-cost dispatch becomes “least-emissions dispatch” because the external costs of the environmental and emissions dumped into our ecosystems are now assessed. For these outdated plants, their choice becomes clearer—use clean coal technologies, use a different fuel, upgrade and increase efficiency, retrofit, alter the mode of operations from base-load operations, purchase carbon allowances, or close the facility. This decision would not be able to be postponed for old, stale plants until 2030; action would start in the marketplace a year after enactment of the new regulations. This will then launch a march to competitiveness, jobs recovery, efficiencies and energy infrastructure modernization. Expect changes to occur even in states using 19th-century fuels in facilities built in the 20th century, without the infrastructure necessary to compete and solve 21st-century challenges and problems. A united, national energy policy could emerge based on this fundamental policy reform grounded in sound economics and proper reflection of fossil fuel costs to our socioeconomic system.

The learning curve
All prior carbon pricing systems since the Kyoto Protocol have failed in their ostensible goal of environmental protection and carbon reductions. Our policymakers are ardently striving to find proper price discovery for the cost of removing carbon and other forms of degradation. But in all instances, the wealth transfer is generated to the older and worst carbon-polluting facilities, and older fossil allowances for convenience generate false cost savings. The best choices for the future are not made when allowances are provided by regulatory or government fiat based on continued levels of emissions. Right now allowances under trading schemes are provided for the favored; nothing of real economic or environment value is created, and minimal environmental benefits are achieved. The EU trading system has borne that lesson out, while newer U.S. trading models in California and New England seek to correct the issue.

Only 16% of allowances are directly transferred to end-use customers, others are only filtered through intermediaries or shareholders. This tends to transfer the economic rents to the utilities, as 40% of all world carbon suppliers consider those allowances as pass-through costs in their rates from customers, while retaining the rent values for their shareholders. In the U.S., many of these same utility power plants have already qualified for stranded cost recovery or the separate beneficial outcome of tax normalization. Market-based outcomes are foregone; and rent transfers have occurred with no improvement in the assets or infrastructure or competitive energy policies since 1978. The customer is not served: markets do not work properly and the customer effectively pays twice for the underlying generation assets and choices in carbon management made by the utility. Can the U.S. EPA achieve better objectives in rulemaking under its endangerment finding? We will soon find out in 2015.

A new path
Let’s not repeat the same errors from the EU carbon trading over the past decade. U.S. experiences with SOX, NOX, and mercury offer better guidance to build upon. We cannot afford to make this mistake in a global economy where developing country markets do not carry the burdens of such legacy decisions and ratemaking schemes. The accurate inclusion of costs for carbon are essential to strategic company planning, competitive products and market positions under a sound U.S. energy policy. U.S. products, strategies and solutions for carbon management will offer the innovation sought by companies and countries in the global marketplace for growth, innovation, and ideas to foster a better outcome for the capitalist business model.

CE3 Blog by Michael J. Zimmer, Executive in Residence & Senior Fellow, Ohio University; Edited by Elissa E. Welch, Project Manager, CE3