What Policies Should States Adopt to Meet EPA’s Newly Proposed Carbon Emission Goals?

Frustrated by a Congress unwilling to pass climate change legislation, President Obama has encouraged the U.S. Environmental Protection Agency (EPA) to use the Clean Air Act, last amended in 1990, to regulate green house gas emissions.  On June 18, 2014, the EPA published a set of proposed new regulations to govern carbon dioxide emissions from existing power plants or electric utility electricity generating units (EGU’s).

Proposed EPA Guidelines

The proposed guidelines contain no specific emission requirements for individual EGU’s. Rather the EPA establishes goals for average emissions per megawatt-hour (MWH) of electricity production in individual U.S. states, designed to achieve by 2030 a 30 percent reduction of total U.S. carbon dioxide emissions relative to 2005. States are free to choose which climate change measures they utilize to achieve the federally-mandated emission goals.

The goals have been set by the EPA as a result of an analysis of the potential reduction in emissions that can be achieved in each state at reasonable cost. The analysis is based on reductions possible from four “building blocks:” (1) an increase in the energy efficiency of existing coal plants; (2) switching electricity production from inefficient, high CO2 emitting coal plants to more efficient, low CO2 emitting natural gas combined cycle plants; (3) switching electricity production from fossil fuel plants to new no-carbon plants, including wind, solar, hydro, and nuclear plants under construction; and (4) reductions in electricity demand through demand management policy measures.

What are the Options?

Policies for achieving state goals could include market-oriented measures such as cap-and-trade and mandatory renewable portfolio standards (RPS). They could also include renewable incentives such as tax breaks and subsidized financing, and demand side management incentives.  All deserve careful consideration.

  1. Cap-and-Trade

    Nine Northeastern states have established a joint cap-and-trade market as part of the Regional Greenhouse Gas Initiative (RGGI). California has also established a cap-and-trade market. In both markets, the states mandate a cap on CO2 emissions year-by-year and auction allowances each year in amounts no greater than the amount of the cap. Revenues from the sale of allowances are used by the states to subsidize renewable energy research and low-carbon electricity production.

    Each fossil-fuel-fired EGU must purchase enough allowances to cover its CO2 emissions. The cost of the allowances can give a significant incentive to utilities to switch production from high-carbon-emitting fossil fuel EGU’s to low-carbon-emitting fossil fuel EGU’s (for example, from less efficient coal plants to more efficient coal plants, and from coal plants to natural gas plants). Thus a cap-and-trade market can help states take advantage of building blocks one and two under the EPA guidelines. The cost of the allowances also makes electricity from fossil fuel less competitive compared to electricity from no-carbon sources such as nuclear, hydro, wind, solar and other renewables.  Thus cap-and-trade can contribute to reductions in emissions envisaged by building block three as well as one and two.

  2. Renewable Portfolio Standards

    Mandatory renewable portfolio standards, which require electricity distributors to supply a minimum percentage of electricity from renewable sources, have been adopted by 29 U.S. states and the District of Columbia. For example, California has mandated that 33 percent of electricity sold in the state should come from qualified renewable energy sources by 2020. Interim percentages are established each year taking account of this goal.

    Distributors of electricity in the state are required to demonstrate each year that they have sourced the required percentage of their power from eligible renewable sources, either by producing renewable energy themselves or by purchasing renewable energy certificates (REC’s) from qualified renewable energy producers who are granted a REC for each MWH of power that they produce.

    Revenue from the sale of RECs provides an incentive for increased renewable energy production and thus can contribute to building block number three in the EPA guidelines. However, RPS does not provide incentives for fossil fuel electricity producers to switch from inefficient and higher emitting production to more efficient and lower emitting production, as envisioned by the EPA in building blocks one and two.

    Furthermore, RPS by itself may contribute very little to reducing carbon dioxide emissions as I demonstrated in a recent working paper for the Brookings Institution.  For example, an increase in renewable production that displaces production from a gas plant reduces emissions by about one-third as much as renewable production that displaces production from a coal plant.  However, the price of coal per million British Thermal Unit (Btu) in the U.S. is much lower than that of natural gas and therefore renewable energy is most likely to displace gas-fired production rather than coal production, unless coal producers have to pay for their CO2 emissions.

    In addition, increases in renewable energy production reduce the wholesale price of electricity available to non-renewable producers, while increasing electricity prices for consumers. Thus there is the risk that increased renewable production will lead to early retirement of nuclear plants to avoid the relatively high fixed operation and maintenance cost of such plants. The net result could be a zero reduction in CO2 emissions from increased renewable production.

  3. Renewable Incentives and Demand-Side Management

Renewable incentives suffer the same weaknesses as RPS. They do not contribute to the use of building blocks one and two and, unless combined with cap-and-trade, are likely to have relatively little effect in reducing carbon dioxide emissions. Demand-side management is likely to be a part of most, if not all, states because this is the only likely means of utilizing building block number four.

To Reduce Emissions, Cap-And-Trade is Key

Cap-and-trade can contribute much more to meeting the new EPA guidelines than RPS because it enables states to take advantage of reductions in emissions from the first three building blocks while RPS and renewable incentives only operate through building block three.

RPS without cap-and-trade is much less effective in reducing emissions than RPS combined with cap-and-trade. The combination can ensure that increased renewable production will displace inefficient, high-emitting coal production rather than low-emitting gas or nuclear production. The RGGI states (except for Vermont) seem to have recognized this fact by utilizing both RPS and cap-and-trade to reduce emissions.