This fall, Congress will consider
what promises to be the single most important piece of energy legislation
of the past thirty two years. Never mind that it will be couched in terms
of pollution emission reductions rather than energy policy, the fact remains
that climate change legislation will herald the most significant change
in energy policy since passage of the Public Utility Regulatory Policies
Act of 1978 (PURPA).
PURPA created the non-utility generation industry and then suffered
death by a thousand cuts (many self-inflicted as a result of bad decisions
taken by PURPA proponents). The Energy Policy Act of 1992 included the
first effort at reforming the Public Utility Holding Company Act (PUHCA)
and made initial progress in promoting energy efficiency. The Energy
Policy Act of 2005 effectively repealed PUHCA, but neither the '92 or '05 Act changed the fundamental rules of play for
fuels and electric generation. Climate change legislation promises to
do just that byrequiring hydrocarbon fueled power plants to pay for
the right to emit carbon, and possibly other greenhouse gases as well.
Passage of climate change legislation
will signal the end of cost-free carbon emissions
and the beginning of a legally
imposed transition to a carbon constrained
economy. It is clear that substantial change
is at hand.
Much less clear is how well existing energy companies, whether focused
on traditional fuels or renewable resources, will adapt to the new environment.
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Roger Stark is a partner with Curtis,
Mallet-Prevost, Colt & Mosle LLP. He is a co-leader of the Curtis
team acting as Program Counsel to the Department of Energy’s Loan Guarantee
Program. |
THE
STATE OF PLAY
Much ink has been spilled debating whether “global warming” or “climate
change” even exist. As a political matter, that battle has been won by
the proponents of climate change legislation. Although climate change
remains sufficiently complex to preclude simple analysis, the essence
of the matter has devolved into two basic propositions: that empirical
data undoubtedly demonstrates a trend of substantial changes in climate
patterns caused by human activity, and that the risks inherent in doing
nothing and being wrong exceed the risks of doing something and being
wrong.
THE CURRENT DEBATE
The current debate is about what to do and how to do it. That dialogue
initially focused on the politics of a carbon tax versus a “cap and trade”
regime (i.e., “taxes bad”/“cap and trade” less so). With a growing consensus
that the carbon tax is politically untenable, arguments have shifted to
whether cap and trade is an economically efficient way to level the playing
field between traditional fuels and renewable resources, or is itself
a tax.
CAP AND TRADE
Again, proponents of “cap and trade”
are winning this argument. Their opponents
have failed to explain why higher
priced energy necessarily equates to a net loss of jobs and, in any
event, why lost jobs should trump the lost lives and property caused
by climate change. Equally important, opponents have failed to rebut
basic arguments favoring cap and trade that extend beyond environmental
risks (e.g., that cap and trade will encourage energy efficiency and
increase U.S. energy security).
For these and other reasons,
Congress is likely to adopt some form of
cap and trade legislation this Fall. The final
product will be heavily negotiated and likely
to leave both sides less than satisfied, but
will nevertheless usher in the first statutorily-
sanctioned nationwide carbon trading in
U.S. history.
THE BLOWBACK FOR RENEWABLES
The prospect of climate change legislation
is already creating palpable effects in
the marketplace. Sponsors of hydrocarbon
fueled projects are reflecting carbon costs
of more than $20 per ton (in 2006 dollars)
in their economic models based on carbon
market results to date.
Whatever else may be said about
these cost estimates, they reflect the widespread
assumption that carbon pricing will
increase the costs of producing electricity
with traditional fuels.
By contrast, the renewable energy
industry continues to rely as much on getting
paid for what it doesn’t produce—
greenhouse gases—as for what it does produce
(clean energy). This remains problematic
for a variety of reasons.
First, there is no mechanism for
ensuring that renewable energy projects
receive the full carbon avoidance value of
the electricity they generate. In fact, it may
be argued that the monopsony power of
electric utilities, combined with the nascent
status of carbon markets, virtually guarantee
that renewable energy will receive less
than full value for its contribution to carbon
mitigation.
Second, the energy market’s ability to
accurately reflect carbon costs in electricity
prices is impaired by regulatory policies
and market power. In states using “cost of
service” regulation, for example, utilities
will simply pass along higher costs of
hydrocarbon based electricity to their customers.
Thus, higher electric prices will be
limited to a specific utility’s service territory,
while the benefits of carbon avoidance
will reach much farther. In addition, most
renewable energy projects assign their carbon
credits to the entity purchasing their
power (typically an electric utility). As a
result, renewable energy sponsors lose the
long term upside value of carbon credits
and electric utilities lack economic, as
opposed to legally mandated, incentives to
adopt carbon mitigating technologies.
Third, and most obviously, renewable
resources are intermittent in nature. There
is no assurance that the sun will shine, the
wind will blow or even that the river will
flow as in the past. In many cases, the necessary
renewable resources for generating
electricity at a project’s full capacity are
available less than 50% of the time. Nuclear
energy, tapping into this problem, is promoting
itself as “greener” than hydrocarbon
fuels and more reliable than renewables.
Lower prices for oil and gas are further
depressing the growth of renewable
energy. Renewable energy economics have
traditionally been predicated on the availability
of both tax credits and “tax equity”
investors that can utilize such credits. In
the current environment, tax equity is
expensive or non-existent, and projects that
were economic with oil prices over
$100/barrel are now significantly less so.
Equally important, the credit crisis has
severely limited access to long-term debt
for renewables and thus reduced the sponsor
population to a relatively small number
of large institutions with strong balance
sheets targeting above-market returns.
Thus, future hydrocarbon projects are
being burdened with higher production
costs while renewable energy projects fail
to receive full value for their largely carbonfree
energy. In short, barring a technological
“game changer” (see below), energy
prices will increase in the wake of climate
change legislation, but the magnitude of the
price rise, and its effects on renewable
energy growth, may be less than desired by
policy makers.
Three additional trends that will vector
the transition to carbon caps deserve
consideration:
• ALLOWANCES.
These carbon credits will be allocated to
major carbon emitters in the cap and trade
legislation. Watch for whether allowances
will be auctioned or given away, and how
they are apportioned among competing
emitters, (e.g. incumbents vs. independents).
• INTRA-INDUSTRY COMPETITION.
Fuel suppliers (i.e. oil, gas and coal companies)
are looking to continue their expansion
into the renewables space, while electric
utilities are becoming more focused on
R&D, technological innovation and “smart
grid” issues. Look for potential “crowding
out” of smaller companies.
• STRATEGIC TRANSMISSION.
Governmental mandates for expanding
renewable energy (e.g., renewable portfolio
standards) will require expansion of the
existing transmission grid. Watch for higher
returns in transmission projects that
simultaneously facilitate service to growing
customer loads while supporting the
growth of distributed generation and
renewable resources.
DEPARTMENT OF ENERGY LOAN
GUARANTEES
Title XVII of the Energy Policy Act of
2005 authorized the Department of Energy
(DOE) to provide loan guarantees in support
of “innovative” energy technologies. In
the immediate aftermath of Title XVII’s
enactment, relatively few transaction applications
were processed, and even fewer
closed. The Obama Administration has now
taken the initiative on Title XVII, first by
obtaining appropriations as part of the economic
stimulus legislation passed early this
year, and second by enhancing DOE’s
resources for processing and closing loan
guarantee transactions. A series of solicitations
for electric generation projects using
both innovative technologies and more traditional
renewable energy resources are
contemplated, as well as one for electric
transmission projects.
STRATEGIC IMPERATIVES
While passage of climate change legislation
is by no means assured, pressure from state and regional initiatives, not to
mention global pressure from Kyoto signatories,
means that a carbon-constrained
U.S. economy in the near future is a virtual
certainty. By imposing a cost on carbon
emissions, carbon caps will promote both
increased efficiency and reduced emissions.
Technological improvements will
make renewable resources more competitive
as well. The precise pattern and pace of
technological “game changers” in these and
other areas is as yet undetermined, but will
necessarily become a fact of life.
That said, climate change legislation
is no guarantee of success for renewable
energy. If current economic conditions and
the advantages of industry incumbents persist,
renewable energy may harvest relatively
few immediate benefits from this signal
policy shift. On the other hand, breakthrough
technologies tend to level the playing
field for renewable energy and take the
economic sting out of carbon mitigation.
With the economic incentives flowing from
carbon pricing, significant improvements in
efficiency and technological innovation are
mainly a matter of time, and we can look
forward to an energy sector that is at once
more competitive and more responsive to
environmental needs.
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