UNS Energy Corporation. 88 East Broadway. Tucson, Arizona. On Behalf of Subsidiaries. Tucson Electric Power Company. UNS Electric, Inc. UNS Gas, Inc.

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1 UNS Energy Corporation 88 East Broadway Tucson, Arizona On Behalf of Subsidiaries Tucson Electric Power Company UNS Electric, Inc. UNS Gas, Inc. Submits Comments on Carbon Pollution Emission Guidelines for Existing Stationary Sources: Electric Generating Units, Proposed Rule, 79 Fed. Reg (June 18, 2014) To The Environmental Protection Agency Air Docket Attention Docket ID NO. EPA-HQ-OAR & Docket ID No. EPA-HQ-OAR Comments Submitted Electronically Via Federal erulemaking Portal

2 Table of Contents Executive Summary... 1 Impact on Prudent Planning... 4 Disparate Impact on Arizona... 5 Economic Impacts... 7 Comments on the EPA s approach for setting State goals... 9 Conclusion Introduction Solution for Arizona EPA s Proposed Rule is Counter to Prudent Planning The Proposed Rule Disproportionately Affects Arizona Economic Impact of EPA s rule on Arizona and TEP / UNSE Customers Comments on EPA s approach for setting State goals Building Block Building Block Building Block Building Block Conclusion Appendix A Appendix B UNS Position on Additional Comments PACE Global - Assessment of the Clean Power Plan Appendix C Arizona State University, W.P. Carey School of Business - Coronado and Springerville Generating Stations: An Economic Impact Study Appendix D Sargent & Lundy - Unit Heat Rate Improvement Study At Springerville Generating Station i

3 Executive Summary UNS Energy Corporation (UNS) respectfully submits its comments to the Environmental Protection Agency (EPA) regarding the proposed rule (Proposal) referred to as the Clean Power Plan (CPP). UNS Energy is the parent company of Tucson Electric Power Company (TEP), which owns and operates electric generation, transmission, and distribution assets and reliably serves more than 410,000 customers in southern Arizona. UniSource Energy Services, another UNS Energy subsidiary, includes two subsidiary utilities: UNS Gas, Inc. (UNSG), which provides natural gas to about 150,000 customers in northern and southern Arizona, and UNS Electric, Inc. (UNSE), which provides electric service to approximately 93,000 customers in northern and southern Arizona. TEP has been working to reliably and affordably diversify its generating portfolio. Over the next five years, the company plans to significantly increase its use of cost-effective energy efficiency, renewable power and natural gas-fired resources. By 2020, TEP will have reduced its reliance on coal-fired generation capacity by 32 percent and its carbon dioxide (CO 2 ) emissions by percent compared to current levels. This reduction will occur even through TEP is located in the desert southwest, where population growth is expected to continue. TEP s Energy Diversification Strategy (Based on 2014 Integrated Resource Plan) 1

4 The EPA s Proposal unnecessarily upsets this carefully balanced plan and would prove to be unworkable. As shown in the following chart, under the EPA s building block methodology, TEP would have to retire all of the coal-fired resources covered by the EPA s plan for Arizona by 2020 in order to comply with both the interim and final goals. TEP s 2020 Energy Mix Resulting from EPA s Proposal Distributed Generation Resources, 2% Energy Efficiency Programs, 10% Demand Response (DR), 0.02% Utility Scale Renewables, 4% Coal Generation, 15% Natural Gas/ Purchase Power, 69% As described further in our comments, the Proposal will cause significant economic harm to UNS customers, employees at the affected power plants and the communities where they live. The proposal also would create unnecessary reliability risks relating to electricity and natural gas service, especially when compared to TEP s plan, which achieves significant environmental benefits without those negative impacts. Notwithstanding the significant problems we see with the Proposal, UNS is interested in crafting a rule that achieves meaningful reductions in CO 2 emissions in a reasonable and affordable manner without compromising reliability. UNS has been working closely with the Arizona Department of Environmental Quality (ADEQ), the Arizona Corporation Commission (ACC) and other utilities over the past five months to explore possible changes to the rule that meet these objectives. TEP and UNSE are members of the Arizona Utility Group (AUG), which is offering a joint proposal (AUG Proposal) that would achieve a substantial CO 2 emission rate reduction while mitigating other adverse impacts that would result from the EPA Proposal. 2

5 The fundamental tenet behind the AUG Proposal is that the EPA is compelled both statutorily and by common-sense public policy to recognize and account for the remaining useful life of coal-fired power plants that are serving Arizona residents at a cost already incorporated in customers approved rates. In addition, the AUG Proposal emphasizes the lead role that states are afforded in establishing standards of performance under 111(d) 1, and clarifies that standards of performance for existing sources under 111(d) cannot be more stringent than corresponding standards for new sources under 111(b). In brief, the AUG Proposal achieves these objectives by: Adjusting the schedule for re-dispatch of coal plants to the later of: i. January 1, 2020, or ii. 40 years after initial commencement of operation, or iii. 20 years after installation of significant emission controls. Re-dispatching units under an enforceable requirement to retire or convert to natural gas as of the date of the retirement or conversion, but no later than January 1, Adjusting the natural gas combined cycle (NGCC) emission rate in the re-dispatch equation to new source performance standard of 1,000 lbs CO 2 / MWh. Allowing Arizona to establish the interim emission rate(s) and timing. Under the AUG Proposal, Arizona s interim goal emission rate is determined through the state planning process, and the final 2030 goal emission rate becomes 963 lbs CO 2 /MWh, as shown on the following chart: 1 42 U.S.C. 7411(d) 3

6 AUG Proposal and the Final 2030 Emission Rate UNS believes that the AUG Proposal satisfies the intent of Clean Air Act 111(d), while avoiding the EPA Proposal s significant threats to reliability, affordability and Arizona s economy. We strongly encourage the EPA to incorporate these changes in the final rule. Impact on Prudent Planning The Proposal is complex and affects many aspects of UNS business, including generation, transmission, distribution, resource planning, fuel supply, grid security, energy usage, rates and regulatory policy. In fact, the Proposal looks more like a resource planning rule than an environmental regulation. Because TEP is a vertically integrated utility and serves as a balancing authority, the steps it eventually would take pursuant to an Arizona plan to meet the rule s goals are complicated and might conflict with state resource planning rules and oversight particularly in the proposed timeframes. The Proposal s Building Block 2 (BB2) calls on load-serving entities in Arizona to significantly increase their reliance on existing natural gas-fired generation without any consideration of the ownership or operations of those units. TEP owns the vast majority of the generation and transmission resources it utilizes to serve its customers and cannot, without jeopardizing reliability, rely primarily on speculative wholesale power markets to provide the capacity and energy lost under the Proposal through coal plant closures. Furthermore, forced early retirements would result in stranded investments. Utility customers would be burdened with paying for both the stranded cost of closed coal-fired power plants as well as the cost to acquire replacement power. 4

7 Disparate Impact on Arizona The Proposal has a disproportionate impact on Arizona relative to other states, even though Arizona has a more balanced portfolio, as shown below, and has put in place aggressive energy efficiency and renewable energy standards to reduce greenhouse gas (GHG) emissions. 5

8 Under the Proposal, Arizona has the second highest emission rate reduction of all states. EPA Proposed CO 2 Emissions Rates for Arizona and Other States State 2012 Rate 2030 Goal Reduction from 2012 Washington % Arizona 1, % S. Carolina 1, % Oregon % New Hampshire % Arkansas 1, % Georgia 1, % New York % New Jersey % Colorado 1,714 1,108 35% New Mexico 1,586 1,048 34% Utah 1,813 1,332 27% Notwithstanding the EPA s insistence that the renewable energy and energy efficiency targets used to set the interim and final state goals for the states provide flexibility, the magnitude and timing of that flexibility for Arizona is wholly insufficient to compensate for the massive and immediate changes called for under BB2. Arizona would be required to achieve 90 percent of its total emission rate reduction less than three years after the approval of its state plan. EPA Proposed CO 2 Emissions Rate Reduction Goal for Arizona 6

9 Furthermore, the Proposal would result in Arizona losing the diversification of resources it has developed over the past several decades. This diversification, shown in the chart below, is an important component of providing affordable, reliable energy to customers in Arizona. Arizona Energy Mix (Historical & Projected under the EPA s CPP) Economic Impacts The EPA s cost effectiveness evaluation significantly underestimates the true economic impact of its Proposal. The EPA estimates that substituting electricity from an existing NGCC unit for electricity from an average coal-fired steam electric generating unit (EGU) would be approximately $30 per metric ton. [79 FR 34857] However, EPA does not provide any information about the range of cost effectiveness as it would apply at the source (i.e. the EGU level). Since the EPA is establishing goals for each state as binding emission guidelines [79 FR 34897], at a minimum they should calculate cost effectiveness values ($/metric ton) for each state. UNS estimates that the cost-effectiveness of the Proposal for Arizona (based on compliance with Arizona s interim and final goals) is at least $122/metric ton. The EPA used modeling to estimate the cost of various levels of re-dispatch. Some aspects of the modeling and the EPA s overall approach raise questions about the resulting cost estimate. Specifically: The EPA s Base Case shows Arizona becoming a net importer of capacity and energy. The EPA ignores individual unit ownership and other firm commitments that limit the availability of individual units for re-dispatch. 7

10 EPA s turn-down constraints do not accurately reflect the operational or economic realities of operating a large, coal-fired unit at a low capacity factor. The most glaring error in the EPA s cost estimates is its failure to consider the remaining book value of assets that are forced to retire early. In TEP s case, recovery of the book value for retired coal-fired power plants essentially doubles the cost of compliance with the Proposal. These combined costs will have a significant impact on retail rates. Estimated Cost Impacts Under the Proposed Rule Cost Impacts Under the Proposed Rule By 2023 Replacement Resource Capacity Costs $1.1 Billion Stranded Costs due to Early Coal Plant Retirements $739 Million Rate Impact 31% UNSG customers would also be impacted by higher costs of service driven by a combination of higher gas commodity costs, transportation price increases, and storage development costs. The impact of gas commodity price increases alone, assuming an average increase in Henry Hub pricing of $1.35/MMBtu between 2020 and 2030, would be $18 million annually, totaling $200 million for 2020 through Finally, the EPA s cost effectiveness evaluation did not take into account the financial impacts to communities that are reliant on the direct and indirect economic contribution from nearby coal-fired power plants. The forced closure of the Springerville Generating Station (SGS) and Coronado Generating Station (CGS), both of which are located in Apache County, Arizona, would have devastating economic impacts: Apache County could lose 2,700 jobs and $600 million in annual gross state product. Over half of Apache County s property tax value could be eliminated, including two thirds to three quarters of the property tax value that supports the local school districts. With limited alternative employment opportunities, the associated exodus of plant employees from the region could potentially result in a drop in housing values, shuttering of local businesses, and closing of schools as the remaining population is left with the full financial burden of schools, medical centers, library districts, fire districts, etc., currently borne by the utilities and their employees. CGS and SGS employ 218 and 332 full time equivalent (FTE) staff respectively. Taking into account direct, induced and indirect impacts, CGS and SGS contribute to approximately 4,000 jobs per year, nearly 70 percent of which are located in Apache County. 8

11 Comments on the EPA s approach for setting State goals Clean Air Act 111(d) directs the EPA to establish a procedure for states to submit plans establishing performance standards for existing sources; it gives the states broad discretion to develop such plans. However, through the building block approach presented in the Proposal, the EPA presumes the authority to impose binding emission rates on each state, thereby usurping the states broad discretion. The EPA s proposal specifically, its interim and final emission rate goals for Arizona do not adequately address remaining useful life and other factors unique to Arizona. The EPA s BB2 results in a complete re-dispatch of Arizona s affected coal capacity (approximately 3,891 MW) to natural gas combined cycle plants, under the false assumption that states or utilities plan for anticipated loads and resources using data averaged over an annual basis. However, utilities like TEP and UNSE are required to provide firm capacity resources to meet the peak hour anticipated load while also maintaining adequate reserve margin. In 2012, TEP relied on up to 350 MW of firm market-based capacity to meet its peak summer load requirements. By 2020, under a business-as-usual scenario, TEP s projected capacity shortfall will be nearly 800 MW; under the Proposal, that shortfall would increase to more than 1,500 MW. To evaluate the likely impact of the EPA s BB2 on Arizona, the AUG hired PACE Global (PACE) to conduct an independent power market analysis. Results of the PACE modeling show that utilities in Arizona would need to build approximately 2.3 GW of new natural gas capacity as a direct result of the Proposal. Due to the time it would take to develop this generation and the transmission to deliver it, UNS believes that reserve margins in Arizona would drop below required levels in the early part of the compliance period, as shown in the chart below. 9

12 Projected Arizona Reserve Margin Deficiencies Resulting from the Clean Power Plan The PACE analysis projected: Nearly $2 billion of incremental capital investment in new natural gas generation will be required through 2030, exclusive of capacity expansion for load growth. More than $3 billion of utility investments would be stranded in 2020 due to premature retirement of coal plants. A 40 percent increase in fuel and purchase power costs. An increase in Arizona natural gas demand from approximately 546 million cubic feet per day (MMcf/d) in 2015 to 2,088 MMcf/d by This demand would exceed existing pipeline capacity as early as 2022, because existing natural gas capacity is nearly fully subscribed during peak hours. Natural gas reliability in Arizona could be compromised due to the short time available to demonstrate firm demand, secure necessary permits and build the natural gas pipeline expansions that would be needed to accommodate increased demand, as well as the risk of a prolonged disruption to one of the pipelines serving Arizona. The increase in natural gas consumption directly attributable to the Proposal would result in significant price increases. At the Henry Hub, these increases would average approximately $1.35 per million British thermal unit (MMBtu) and surge as high as $2.00/MMBtu at times. A complicating factor associated with this natural gas capacity build-out is the expected difficulty in permitting new natural gas EGUs given the proposed strengthening of the National Ambient Air Quality Standard (NAAQS) for ozone. TEP anticipates that much of the new natural 10

13 gas generation needed to replace the coal that is retired will need to be located in eastern Pima County, which will likely become a non-attainment area under the revised standard. Assuming the required air quality permits can be attained, the permitting will take considerably more time. The EPA conducted modeling using IPM to demonstrate the achievability of the proposed interim and final goals for each state. UNS is concerned that the IPM model may not be well suited to make the intended demonstration given the following shortcomings in the model: IPM is not equipped to perform detailed technical studies that include stability analysis. IPM assumes a regional transmission organization (RTO) structure that does not exist in Arizona. IPM uses a simplified transmission model that does not consider parallel flows and applies a stylized six segment load duration curve versus hourly chronological load. The lack of comprehensive reliability studies is a significant concern that calls the validity of the results into question. Detailed analysis, using complete Western Interconnection models derived from Western Electricity Coordinating Council (WECC) base cases will be necessary to establish the resulting new total transfer capacity values, system operating limits and Interconnection Reliability Limits, and to identify other operating constraints. This work will be complex and time consuming. The North American Electric Reliability Corporation (NERC) conducted an analysis of the potential reliability impacts of the EPA s proposed rule and found a number of reliability concerns regarding increased reliance on natural-gas-fired generation. The AUG asked PACE to conduct an independent power market analysis of an alternative coal unit retirement scenario. The alternative scenario represents a gradual reduction in Arizona coal-fired generation capacity between 2017 and 2030 (very similar to the AUG Proposal), considering the remaining useful life of the respective units. This alternative scenario results in an interim goal emission rate of 1,119 lbs CO 2 /MWh, and a final goal of 942 lbs CO 2 /MWh. The alternative scenario addresses the most problematic impacts of the EPA s proposed building block approach (reserve margin, electricity and natural gas reliability) by providing ample time to plan for and make necessary infrastructure improvements while still achieving a meaningful CO 2 emission rate reduction of 34 percent between 2012 and In addition, the alternative provides the following benefits: Capital expenditures for new natural gas generation are reduced by nearly $2 billion; Fuel and power purchase costs are reduced by nearly $18 billion; Stranded investments are reduced by more than $3 billion; and 11

14 The percentage of Arizona s generation coming from natural gas in 2030 falls from 65 percent to 51 percent, thus maintaining a reasonable level of resource diversity. Under Building Block 3 (BB3) of its Proposal, the EPA reduces each state s CO 2 emission rate goal using projected regional renewable energy growth and 5.8 percent of each state s existing nuclear generation, purportedly to account for nuclear generation at risk of early retirement. UNS supports the EPA s regional approach to accounting for renewable energy and its decision that all renewable energy in place as of the compliance date should be counted toward compliance with the states goals. UNS believes that renewable energy should be counted at the point of delivery in terms of meeting state goals. While UNS also believes it would be appropriate to exclude nuclear power completely, UNS supports a proposal being offered by Arizona Public Service Co. (APS), operator of the Palo Verde Nuclear Generating Station. APS has proposed that nuclear generation should not be part of the goal calculation but could serve as a component of the state s compliance with the goal if the plant s capacity factor exceeds an industry-wide historical threshold. Although Building Block 4 (BB4) of the EPA s Proposal is intended to account for energy efficiency, its design would not allow TEP and UNSE to realize any benefit from the aggressive energy efficiency standards currently in place in Arizona. The EPA s Proposal reduces Arizona s CO 2 emission rate goal by applying 1.5-percent incremental annual energy savings increases starting in After 2020, the final year covered by Arizona s standard, we anticipate incremental annual energy savings will begin to diminish. It is unlikely, after having already achieved significant savings under the standard by 2020, that we would be able to continue achieving savings at such a high incremental rate. In addition, there is considerable uncertainty regarding the EPA s approval of the evaluation, measurement, and verification (EMV) methods currently employed under the Arizona standard, potentially reducing the credit available under the state s 111(d) plan. The EPA proposes that each state s affected coal-based EGU fleet could achieve, on average, a 6 percent improvement in heat rate under Building Block 1 (BB1), leading to a corresponding 6 percent reduction in CO 2 emissions. Notwithstanding the fact that BB2 in the Proposal calls for all Arizona coal-fired plants to retire by 2020, UNS hired Sargent and Lundy (S&L) to conduct a heat rate improvement study at SGS, which by itself represents 42 percent of Arizona s total coal-fired generation capacity. The table below, which compares S&L s case study results with the EPA s assessment, clearly demonstrates that the EPA s analysis grossly inflates the potential for heat rate improvements. 12

15 Available Heat Rate Improvements for Springerville Generating Station Heat Rate Improvement Potential Unit 1 Unit 2 Unit 3 Unit 4 S&L assessed % heat rate improvement potential through "best practice" 0.93% 0% 0% 0% EPA assessed % heat rate improvement potential through "best practice" % 3.04% 3.30% 2.15% S&L assessed % heat rate improvement potential through "equipment upgrades" EPA assessed % heat rate improvement potential through "equipment upgrades" 1 Estimated by using EPA s bin model on each of the Springerville units. 1.80% 0% 0% 0% 2% 2% 2% 2% Conclusion While we appreciate the EPA s desire for uniformity in its proposal to reduce CO 2 emissions from affected EGUs under Clean Air Act 111(d), this one-size-fits-all approach employs a flawed methodology, seeded with false assumptions, that has resulted in a fundamental misrepresentation of Arizona s electricity supply and delivery system. The EPA s Proposal would place grid reliability at risk while increasing energy costs and inflicting significant economic damage on Arizona communities. These severe impacts are avoidable. Arizona utilities have developed an alternative approach that achieves a meaningful CO 2 emission rate reduction for Arizona in an affordable manner. This same approach could be applied consistently across the nation without significantly affecting the EPA s stated CO 2 emission reductions while simultaneously rectifying the unique inequities that would occur in Arizona under the Proposal. UNS strongly encourages the EPA to incorporate this balanced approach in its final rule. 13

16 Introduction UNS Energy Corporation (UNS) respectfully submits its comments to the Environmental Protection Agency (EPA) regarding the proposed rule ( Proposal ) Carbon Pollution Emission Guidelines for Existing Stationary Sources: Electric Utility Generating Units, June 18, 2014 [79 FR 34830], otherwise referred to as the Clean Power Plan (CPP). UNS Energy is the parent company of Tucson Electric Power Company (TEP), which owns and operates electric generation, transmission, and distribution assets and reliably serves more than 410,000 customers in southern Arizona. UniSource Energy Services, another UNS Energy subsidiary, includes two subsidiary utilities: UNS Gas, Inc. (UNSG), which provides natural gas to about 150,000 customers in northern and southern Arizona, and UNS Electric, Inc. (UNSE), which provides electric service to approximately 93,000 customers in northern and southern Arizona. TEP and UNSE generate electricity using a combination of fossil fuels and renewable resources, both of which factor into the EPA s proposed emission guidelines. Therefore, they have a direct interest in the issues addressed in the proposed rule. UNSG also has a direct interest in the rule, primarily through reliability impacts associated with its natural gas supply. TEP has been working to reliably and affordably diversify its generating portfolio. Over the next five years, the company plans to increase its use of energy efficiency, renewable power and natural gas-fired resources while reducing its reliance on coal-fired generation capacity by 32 percent. By 2020, these changes will reduce carbon dioxide (CO 2 ) emissions by percent compared to current levels, while making effective use of TEP s existing infrastructure and controlling costs to protect the local economies of the communities where TEP operates. These changes, however, cannot be implemented without some additional cost. TEP s resource plan is the most cost effective approach to meeting customer demand in light of existing environmental requirements. 2 Both TEP and UNSE submitted their 2014 Integrated Resource Plans (IRPs) to the Arizona Corporation Commission (ACC) on April 1, The resource plans were presented in a number of public workshops. 3 On November 7, 2014, Commission Staff recommended acknowledgement of both resource plans. 4 As shown in TEP s 2014 IRP, by 2020, TEP will have reduced its reliance on coal-fired generation capacity by 32 percent and its carbon dioxide (CO 2 ) emissions by percent compared to current levels. TEP will accomplish this through a planned coal reduction strategy that reduces its reliance on coal-fired 2 Regional Haze Rule (40 CFR ); Mercury and Air Toxic Standards (40 CFR part 63 subpart UUUUU) and other environmental requirements pptx

17 generation while minimizing rate impacts on its customers. As shown in Chart 1 below, TEP plans to offset its reliance on coal with investments in efficient natural gas generation, renewable resources and energy efficiency. 5 The ACC is expected to officially acknowledge the resource plans in the first quarter of Both TEP s and UNSE s 2014 IRPs are available on TEP s website. 6 Chart 1: TEP s Energy Diversification Strategy (Based on 2014 IRP) The EPA s Proposal upsets this carefully balanced plan and would prove to be unworkable. In addition, the proposed rule is inconsistent with changes made in response to other EPA actions and risks stranding those investments, as described further below. As shown in Chart 2 below, under the EPA s building block methodology, TEP would have to retire all of the coal-fired resources covered by the EPA s plan for Arizona in order to comply with both the interim and final goals. Under this scenario, TEP s reliance on natural gas would increase from 28 percent to 70 percent by The remaining 15 percent reflects TEP s ownership in the Navajo Generating Station and the Four Corners Power Plant, both located on Native American land and covered under a separate rulemaking. 7 5 TEP s 2014 IRP assumes compliance with Arizona s current Renewable Energy Standard (RES) and Energy Efficiency Standard (EES). Arizona s RES target is 10% by 2020 and the Arizona EES targets 22% by Both targets are based on a percentage of retail sales Carbon Pollution Emission Guidelines for Existing Stationary Sources: EGUs in Indian County and U.S. Territories Multi-Jurisdictional Partnerships; 79 Federal Register 65482, dated November 4,

18 Chart 2: TEP s Energy Mix Resulting from EPA s Proposal Distributed Generation Resources, 2% Energy Efficiency Programs, 10% Demand Response (DR), 0.02% Utility Scale Renewables, 4% Coal Generation, 15% Natural Gas/Purchase Power, 69% As described further in our comments, the Proposal will cause significant economic harm to UNS customers, employees at the affected power plants and the communities where they live. The Proposal also would create unnecessary reliability risks relating to electricity and natural gas service. There are several other aspects of the Proposal that UNS believes should be changed in the final rule. Because many of those issues are being address in comments from other stakeholders, UNS is not presenting detailed comments on those provisions. A list of issues is provided in Appendix A. UNS comments will be focused on demonstrating the impact of the Proposal on our operating subsidiaries and offering changes to the rule that recognize the benefits of reductions without compromising reliability or creating severe economic hardship for our customers. Solution for Arizona Notwithstanding the significant problems we see with the Proposal, UNS is interested in crafting a rule that achieves meaningful reductions in CO 2 emissions in a reasonable and affordable manner without compromising reliability. UNS has been working closely with the ADEQ, the ACC and other utilities over the past five months to explore possible changes to the 16

19 rule that meet these objectives. While UNS reserves its right to appeal any final rule in court, 8 UNS would prefer a fair and reasonable rule over the uncertainty of litigation. UNS subsidiaries TEP and UNSE are members of the Arizona Utility Group 9 (AUG), which also is filing comments on the Proposal. The AUG comments present details of a joint proposal (AUG Proposal) that would achieve a substantial CO 2 emission rate reduction while mitigating other adverse impacts that would result from the EPA s Proposal. The AUG Proposal reflects the EPA s request that any changes to the rule need to be made from the context of the Proposal. The fundamental tenet behind the AUG Proposal is that the EPA is compelled both statutorily, and by common-sense public policy to recognize and account for the remaining useful life of coal-fired power plants that are serving Arizona residents at a cost already incorporated in customers approved rates. In addition, the AUG Proposal emphasizes the lead role that states are afforded in establishing standards of performance under 111(d), and clarifies that standards of performance for existing sources under 111(d) cannot be more stringent than corresponding standards for new sources under 111(b). Specific language incorporating these concepts is presented below. 1. For purposes of goal setting under BB2: a. Redispatch from coal-fired EGUs to natural gas combined cycle (NGCC) EGUs should occur upon the later of any of the following: i. January 1, 2020; ii. 40 years after initial commencement of operation; or iii. 20 years after commencement of operation of major pollution control retrofit, such as selective catalytic reduction (SCR), flue gas desulfurization (FGD), or baghouses at any EGU if installation occurred prior to issuance of the final 111(d) rule, or after commencement of operation of selective non-catalytic reduction (SNCR) or electrostatic precipitators (ESPs) at an EGU owned by a small utility as defined by the Federal Energy Regulatory Commission (FERC) if installation occurred prior to the first year of the compliance period (i.e., 2020). 8 UNS is a member of the Utility Air Regulatory Group (UARG) who is also providing comments on the rule. UNS supports UARG s comments, including those comments that challenge provisions of the rule on legal grounds. 9 The Arizona Utility Group is an ad hoc, unincorporated association of individual electric utilities, including for purposes of this request, Arizona Electric Power Cooperative, Arizona Public Service Company, Salt River Project Agricultural Improvement and Power District, Tucson Electric Power Company, and UniSource Energy Services. 17

20 b. For coal-fired EGUs that either shutdown or convert to natural gas-fired operation, redispatch would occur as specified in an applicable implementation plan or enforceable Title V permit, provided that such commitment is entered prior to the effective date of the final rule and the date of shutdown or natural gas conversion is prior to January 1, c. Coal-fired EGUs that do not redispatch prior to January 1, 2030 under paragraphs 1.a or 1.b remain coal-fired EGUs for purposes of calculating the Interim and Final Goals. 2. For purposes of goal setting, when redispatching to NGCC, a rate of 1,000 lbs CO 2 /MWh should be used, consistent with the most stringent standard in the EPA s proposed New Source Performance Standard for EGUs. 3. The State should establish the Interim Goal in its State Plan based upon EPA s building block approach as modified by paragraphs 1 and 2 above. Incorporating these changes, Arizona s interim goal emission rate is determined through the state planning process, and the final 2030 goal emission rate becomes 963 lbs CO 2 /MWh, as shown on Chart 3 below: Chart 3: AUG Proposed Revision to Interim and Final Goal for Arizona Salt River Project Agricultural Improvement and Power District (Salt River Project or SRP) conducted an analysis of the impact the AUG Proposal would have on each state using a 18

21 database developed and maintained by The Brattle Group. SRP s analysis concluded that, although these changes would result in later re-dispatch of coal-fired units in a limited number of additional states, the overall impact across the entire universe of affected units is small. UNS believes that the AUG Proposal satisfies the intent of Clean Air Act 111(d) while avoiding the EPA Proposal s significant threats to reliability, affordability and Arizona s economy. We strongly encourage the EPA to incorporate these changes in the final rule. EPA s Proposed Rule is Counter to Prudent Planning The Proposal is complex and affects many aspects of our business including generation, transmission, distribution, resource planning, fuel supply, grid security, energy usage, rates and other regulatory policy. Understanding the ultimate effect of this rule on the company requires unraveling the interrelationship of these disparate impacts. At a minimum, the rule will require an abrupt change in course from our current, carefully considered planning. It has the potential to completely transform our business with vast and potentially dire economic consequences. Despite our best efforts to understand the rule s impact on our company, there are likely ramifications we have not identified. UNS has not had sufficient time to formulate detailed comments on certain issues that have been identified as problematic, which include but are not limited to the Notice of Data Availability [79 FR 64549], rate to mass conversion [79 FR 67406], 2012 Baseline, and other issues. UNS may submit additional comments to the EPA as additional details concerning the rule s impact are more fully understood. The Proposal aims to achieve its objective of lower CO 2 emissions, not by controlling emissions at the source as is typically done, but rather by forcing a shift in the type of resources used to serve electric retail customers. It is, in effect, a resource planning rule. Utilities have different means of resource planning, both from a legal structure and economic perspective. Because TEP is a vertically integrated utility and serves as a balancing authority, the steps it eventually would take pursuant to a state plan to meet the rule s goals are complicated and might conflict with state resource planning rules and oversight particularly in the proposed timeframes. The Proposal seems to work under the assumption that a state (or the load-serving entities within a state) have full legal authority and operational capability to dispatch any generating and transmission resources within the state to serve existing and future load obligations. BB2 calls on load serving entities in Arizona to significantly increase their reliance on existing natural gas-fired generation without any consideration of the ownership of those units, existing legal commitments of various units, financial consequences related to the shift from currently owned generation, and without adequate consideration of natural gas pipeline capacity and electric transmission constraints. 19

22 As a vertically integrated utility, TEP has been able to consistently and successfully meet the primary expectation of the ACC providing safe, affordable, and reliable electric service to our customers. TEP owns the vast majority of the generation and transmission resources it utilizes to serve customers. This direct-ownership model has benefitted customers in several important areas, including enhanced system reliability and rate stability. TEP has achieved and maintained greater electric system reliability utilizing direct control over its generation and transmission assets for the benefit of its customers. Furthermore, limiting exposure to volatile market conditions has resulted in more stable and predictable rates over the last two decades. Unfortunately, the Proposal, and the modeling used to support it, misrepresents the interconnected grid as a single open market; its implementation would jeopardize TEP s ability to continue to meet state regulatory expectations. The Proposal would effectively reduce TEP s direct control over its generation and transmission assets, in favor of shifting Arizona s generation resource reliance to merchant-based resources 10. Whatever form the final rule takes, TEP must continue its resource planning activities, under the purview of the ACC, to meet the needs of its customers. In fact, under the ACC s IRP rules, load serving entities must rely on firm capacity resources for meeting load requirements. 11 In the planning process, TEP cannot rely primarily upon the speculation that wholesale power markets will have excess capacity to provide for the capacity and energy lost through coal plant closures. This is because other states and utilities will be developing their own resource plans to comply with the rule s mandates and TEP simply will not have the luxury of time to wait for those plans to unfold in the hope that a cost effective power market develops. While TEP and UNSE have and will continue to enter into long-term power purchase agreements (PPAs) as an appropriate portion of their overall resource portfolios, relying on PPAs to replace the generation lost through retirement of Arizona s coal-fired power plants has limitations for the following reasons: PPAs are bilateral agreements and, as such, risk default, potentially leaving TEP/UNSE without an anticipated resource. PPAs are generally subject to additional regulatory procurement processes that require additional lead time and higher costs. 12 Power procured through a PPA must be matched with transmission capacity to deliver that power to the load center, and such capacity does not currently exist. 10 Under EPA s goal setting methodology for Building Block 2, the proposed rule results in 100% of TEP s affected coal fired EGU capacity being displaced by natural gas combined cycle (NGCC) resources that are not owned or under contract by TEP. 11 ACC Decision No , May 8, A.A.C. R

23 The problem for jurisdictional utilities results from the increased risk associated with recovery of PPA-related expenditures through prudency reviews. The lack of cost recovery certainty will most likely result in less-than-optimal financing arrangements and increased customer costs as compared to existing coal-fired electricity generation assets. This result could lead to regulatory denial of PPAs, giving rise to new regulatory proceedings to determine whether the actions of the jurisdictional utilities were prudent, including consideration of the economic consequences to customers from prematurely retiring coal plants. This regulatory dilemma subjects TEP and its customers to unnecessary and potentially costly economic risk. TEP has made significant investments in coal-fired plants and related equipment in order to provide safe, reliable and cost-effective electric service to its customers in Arizona. This investment was premised upon TEP s opportunity to earn a reasonable return of and on its capital. Arizona is a cost of service jurisdiction. Thus, utility rates are determined after consideration of costs, including capital costs required to provide electric service to customers. A critical component in establishing rates is determination of a reasonable Return on Investment (ROI). Although numerous factors are considered in this determination, there can be no doubt that certainty of cost recovery is an important component. Recovery of costs associated with generation and transmission assets utilized to provision electric service coincides with investor expectations. The introduction of increased risk and uncertainty regarding cost recovery can subject a utility to increased financing costs. Under a cost of service scenario, additional costs are ultimately borne by ratepayers. Increased risk associated with an overreliance on marketbased generation can have an adverse impact on TEP s ability to earn a reasonable return on its investment. The unfortunate effect of a lower ROI can be unfavorable financing terms, which result in higher utility rates. These adverse consequences can be avoided by not relying too much on a volatile electric generation marketplace. Prematurely retiring used and useful electric generation assets would be an unreasonable and costly consequence of the EPA s Proposal. Furthermore, forced retirements are certain to result in stranded investments (unrecovered book value on assets that are retired prematurely). It is critically important to recognize the obvious: investment made on behalf of customers simply does not disappear by virtue of promulgation of a new rule. Such investment is made under a regulatory compact whereby a utility is entitled to recover its reasonable costs incurred to provide electric service to its customers. Unfortunately, the Proposal would require that customers pay both for the stranded cost of retired coal-fired power plants as well as their replacements, including new capital investments 21

24 and/or increased market power costs. This result is harsh, avoidable and unnecessary in light of other available options, including structural flexibility and timing options, both of which could serve to mitigate the adverse impacts associated with the rule and avert what is potentially a regulatory taking. The Proposed Rule Disproportionately Affects Arizona The proposed rule has a disproportionate impact on Arizona relative to other states, even though Arizona has a more balanced portfolio (as shown in Figure 1, below) and has put in place aggressive energy efficiency and renewable energy standards to reduce greenhouse gas (GHG) emissions. Figure 1: Arizona Energy Mix in Comparison to Other States Arizona was among the first states to adopt renewable portfolio requirements 13 in 1994, which were replaced in 2006 with the current Renewable Energy Standard and Tariff (REST). 14 The 13 Arizona Corporation Commission Decision No , June 1, 1994; 14 Arizona Corporation Commission Decision No , November 14, 2006; 22

25 REST calls for TEP, UNSE and other regulated utilities to supply 15 percent of their retail load through renewable resources by In 2010, the ACC adopted the Energy Efficiency Standard, 15 which calls for TEP and UNSE to increase the savings realized through approved energy efficiency programs each year until the cumulative savings reach 22 percent by The EPA seems to imply [79 FR 34833, 34834, 34853, 34865, 34897] that these aggressive programs provide Arizona with an ability to achieve the second highest emission rate reduction of all states. Table 1: EPA Proposed CO 2 Emissions Rates for Arizona and Other States State 2012 Rate 2030 Goal Reduction from 2012 Washington % Arizona 1, % S. Carolina 1, % Oregon % New Hampshire % Arkansas 1, % Georgia 1, % New York % New Jersey % Colorado 1,714 1,108 35% New Mexico 1,586 1,048 34% Utah 1,813 1,332 27% Notwithstanding the EPA s insistence that the renewable energy and energy efficiency targets used to set the interim and final state goals for the states provide flexibility, the magnitude and timing of that flexibility for Arizona is wholly insufficient to compensate for the massive and immediate changes called for under BB2. Due to energy market circumstances completely unrelated to greenhouse gas emissions or climate change, Arizona has a large amount of NGCC generation capacity (9,856 MW). The supposed availability of those plants apparently convinced the EPA that all affected coal-fired power plants in Arizona can be replaced by NGCC by As shown in Chart 4 below, Arizona would be required to achieve 90 percent of its total emission rate reduction less than three years after the approval of its state plan Arizona Corporation Commission Decision No , August 10, 2010; Arizona Administrative Code (AAC) R , effective January 1, Assuming EPA finalizes the rule in June 2015, Arizona submits a state plan by June 2016, and EPA finalizes that plan by June There are several factors that could cause those schedule milestones to be missed. 23

26 Chart 4: EPA Proposed CO 2 Emissions Rate Reduction Goal for Arizona Contrary to the EPA s stated objective of maintaining an affordable, reliable, and diverse energy mix [79 FR 34832], the Proposal would result in Arizona losing the diversification of resources it has developed over the past several decades. This diversification, shown in the Chart 5 below, is an important component of providing affordable, reliable energy to customers. 24

27 Chart 5: Arizona Energy Mix (Historical & Projected under the CPP) In terms of resource diversification and an all of the above energy strategy, Arizona is a model state. 17 The EPA s Proposal would erode that benefit by concentrating Arizona s resource portfolio on natural gas. Given the historical swings in natural gas prices and availability, coupled with the absence of natural gas storage in Arizona, that is risky proposition; it should not be the mandate under the Proposal. Over the last 70 years, Arizona has developed a balanced and diversified system to deliver safe, reliable, and affordable energy. The state s utilities already are transitioning to a less carbon-intensive system of providing energy. However, the EPA is requiring the state to fundamentally reshape its system in five years. Such a drastic shift will have serious reliability and cost implications for Arizona residents historical energy mix based on EIA data for the state of Arizona. The 2020 Business as Usual (BAU) forecast assumes historical capacity factors but is adjusted for additional renewable resources in order to comply with Arizona s Renewable Energy Standard (REST) and includes planned Arizona coal reductions associated with Regional Haze mandates. The 2020 EPA Clean Power Plan reflects 100% reduction in coal resource based on EPA s building block methodology. The Navajo Generating Station is excluded from all of the results above. 25

28 Economic Impact of EPA s rule on Arizona and TEP / UNSE Customers The EPA s cost effectiveness evaluation significantly underestimates the true economic impact of its Proposal. For the re-dispatch from coal to NGCC generation, the EPA estimates that substituting electricity from an existing NGCC unit for electricity from an average coal-fired steam EGU would be approximately $30 per metric ton. [79 FR 34857] The wording of this section is somewhat misleading, as it implies that EPA s analysis is based on re-dispatch at a representative, albeit hypothetical, coal-fired EGU to a representative NGCC EGU. In reality, EPA used the Integrated Planning Model (IPM) 18 to assess the costs of re-dispatch [79 FR 34864]; therefore, $30 per metric ton represents an average cost across the entire modeling domain. This is an important distinction, as the best system of emission reductions (BSER), including the cost effectiveness component, must be applied at the source level defined as any building, structure, facility, or installation which emits or may emit any air pollutant. [42 USC 7411(a)(6) If there is significant disparity in cost effectiveness among affected units within a source category, EPA has the option to subcategorize source categories, as it has done in the past. The Proposal does not provide any information about the range of cost effectiveness as it would apply at the source level, probably because the EPA uses an electricity-sector-wide approach to determining BSER. Notwithstanding the legality of such an approach, since the EPA is establishing goals for each state as binding emission guidelines [79 FR 34897], it should, at a minimum, calculate cost effectiveness values ($/metric ton) for each state. From that data, the EPA would be able to evaluate if its chosen BSER is truly cost effective; from that, it could then determine if adjustments or sub-categorization is warranted. UNS estimated the cost effectiveness of the Proposal for Arizona using a method similar to the EPA s method. 19 UNS used the results of modeling performed by PACE Global to compare the total cost and total emission reductions associated with compliance with the EPA s building block approach to a reference case. Based on this comparison, UNS estimates that the cost - effectiveness of the Proposal for Arizona (based on compliance with Arizona s interim and final goals) is at least $122/metric ton. UNS believes that this is a conservative cost-effectiveness estimate, as PACE did not run a true business as usual case (i.e. absent the Clean Power Plan). Furthermore, the UNS estimate of $122/metric ton is not a direct comparison with EPA s estimate of $30/metric ton, as EPA s estimate was limited to only the re-dispatch building block. If the UNS cost-effectiveness estimate was limited to the re-dispatch component of the Proposal, the value would likely be higher EPA GHG Abatement Measures TSD, June 2014, pp