An ISO-based Carbon Emissions Cost Adder Approach

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1 An ISO-based Carbon Emissions Cost Adder Approach How Would It Work? P R E S E N T E D T O Harvard Law School Environmental Policy Initiative Webinar P R E S E N T E D B Y Judy Chang October 31, 2016 Copyright 2016 The Brattle Group, Inc.

2 Setting the Stage Some states have set goals of 80% reduction in greenhouse (GHG) gas emissions by 2050 To achieve high levels of GHG emission reduction, the power sector needs to be reformed and the work needs to start now, because: Investments (generation and transmission) made today will have a operational life of over 30 years Existing system and power markets have not been set up to internalize the cost of GHG or carbon emissions To achieve economy-wide GHG emissions reduction, the power sector needs to be decarbonized and much of transportation and heating/cooling needs to be supported by the clean electricity system If markets were to be used to facilitate timely decarbonization of the power sector, the costs of carbon emissions must be incorporated into the power plant dispatch So, how do we get there? 1 brattle.com

3 General Approaches to CO 2 Emissions Control Mechanisms Each mechanisms can be used by itself, but at times applied jointly to different sectors Description Advantages Disadvantages Cap and Trade EU countries, New Zealand, California, RGGI, Quebec, Kazakhstan, regions within China and Japan Administratively set cap on emissions, with allowances allocated or auctioned Emission quantity is fixed, price is variable (although often quantity can be adjusted in ways that provide price stability) More certainty in emission reductions Allowance tons or auction revenues can be used to achieve other policy objectives Offsets incorporated more easily Ability to link to other markets Prices subject to volatility and uncertainty (may deviate substantially from anticipated levels) Administrative complexity with many parameters to control price Carbon Price or Tax South Africa, British Columbia, Japan, Mexico, several EU countries Administratively set price on carbon emissions, most commonly assessed as a tax on fossil fuels Emission price is fixed, quantity is variable Price certainty Pricing can be based on the long-term cost of CO 2 that does not fluctuate over short periods Easier/faster implementation if agreement on pricing is achieved Some uncertainties on quantity of emissions reductions Natural extension of fuel prices/taxes Tax/fee revenues can be used to achieve policy objectives, or return to consumers Rate-Based Standards Clean Power Plan, Alberta, Shenzhen Administratively set cap on emission rates; or only regulate a portion above the cap Analogous to RPS and U.S. lowcarbon fuel standard Level of realized emissions tied to growth in underlying commodity demand (i.e. adjusts with economic growth) Uncertain emission reductions, uncertain and unclear price for CO 2 Dispatch inefficiencies if not uniform across region 2 brattle.com

4 CO 2 Pricing in Wholesale Electricity Markets Concept includes the following: Carbon Price (in $/metric tons) Price Setter: Market for emissions allowances (such as under cap-and-trade ) Regional market estimates a price trajectory that would help comply with regional policies Set administratively by a third party (government or stakeholders) Generators add a carbon cost adder in their generation bid offers (to be used in dispatching resources, based on emissions profiles and prices Generators are charged the per-unit carbon price for their emissions Dispatch that continues to minimize total cost subject to meeting reliability and emissions constraints The resulting market prices for electricity, paid by electricity customers, reflect the additional constraint Resulting revenues from the emissions can be returned to electricity customers (or otherwise used for meeting policy objectives) 3 brattle.com

5 Example: CO 2 Price Short-Term Effects Higher-emitting resources will incur higher CO 2 charges and become more costly on a per MWh dispatch basis Short-term effect will be to alter economic dispatch order of the various generators in ways that avoid CO 2 emissions Expected short-term effects: High-emitting resources dispatched less frequently than in a system without CO 2 charges Adjustments to generation dispatch to avoid high-emitting resources (e.g. avoid increased emissions from cycling; peaking DR may be more economic than some high-emitting gas/oil peakers) Energy prices increase but cost to load can be offset by CO 2 charge rebates and potentially more energy efficiency investments $45 Energy Price $85 Energy Price $0/ton CO 2 Price Load $50/ton CO 2 Price Load 4 brattle.com Fuel + VOM CO 2 Charges Coal plant becomes less economic, reducing CO 2 emissions Fuel + VOM

6 Example: CO 2 Price Long-Term Effects Lower-emitting and non-emitting resources will be more profitable and more attractive to investors than without a CO 2 price Will induce investments toward a lower-emitting generating fleet over time Expected long-term effects: Higher energy margins for existing clean energy resources that may otherwise retire Existing coal and high-emitting steam plants will face more financial pressure than without CO 2 price New wind, hydro, and energy efficiency will become more attractive investments than otherwise Long-run prices and costs: Energy prices can increase (due to higher CO 2 prices) or decrease (due to more entry of non-emitting resources with no fuel costs) $45 Energy Price $59 Energy Price $0/ton CO 2 Price The goal would be to ensure that the energy + capacity + clean energy payments will be high enough to support the policy objective of attracting investments in new non-emitting generation 5 Load $50/ton CO 2 Price Nuclear is retained, new hydro and energy efficiency entered into market. Load 5 brattle.com Fuel + VOM CO 2 Charges Fuel + VOM

7 A Few Complications. Carbon price certainty and sustainability The long-term effects will only be accomplished if clean energy investors can bank on the price of electricity to remain high enough to pay for the cost of clean energy Carbon price level Some regions (such as New England), the CO 2 price would have to be high enough for long enough to attract clean energy resources Policy makers and politicians have a hard time with perceived cost impact on consumers Uses of the carbon costs needs to offset price impact on consumers or ensure that clean energy is developed to meet the policy objectives Complex system issues need to be addressed, particularly how to manage electricity imports and exports across markets with different CO2 prices 6 brattle.com

8 A Few Words on New England Activities 7 brattle.com

9 Speaker Bio and Contact Information Judy W. Chang Principal, Director office direct Note: The views expressed in this presentation are strictly those of the presenter and do not necessarily state or reflect the views of The Brattle Group, Inc. Ms. Judy Chang is an energy economist and policy expert with a background in electrical engineering and 20 years of experience in advising energy companies and project developers with regulatory and financial issues. Ms. Chang has submitted expert testimonies to the U.S. Federal Energy Regulatory Commission, U.S. state and Canadian provincial regulatory authorities on topics related to transmission access, power market designs and associated contract issues. She also has authored numerous reports and articles detailing the economic issues associated with system planning, including comparing the costs and benefits of transmission. In addition, she assists clients in comprehensive organizational strategic planning, asset valuation, finance, and regulatory policies. Ms. Chang has presented at a variety of industry conferences and has advised international and multilateral agencies on the valuation of renewable energy investments. She holds a BSc. In Electrical Engineering from University of California, Davis, and Masters in Public Policy from Harvard Kennedy School, is a member of the Board of Directors of The Brattle Group, and the founding Director of New England Women in Energy and the Environment. 8 brattle.com

10 About The Brattle Group The Brattle Group provides consulting and expert testimony in economics, finance, and regulation to corporations, law firms, and governmental agencies worldwide. We combine in-depth industry experience and rigorous analyses to help clients answer complex economic and financial questions in litigation and regulation, develop strategies for changing markets, and make critical business decisions. Our services to the electric power industry include: Climate Change Policy and Planning Rate Design and Cost Allocation Cost of Capital Regulatory Strategy and Litigation Support Demand Forecasting Methodology Renewables Demand Response and Energy Efficiency Resource Planning Electricity Market Modeling Retail Access and Restructuring Energy Asset Valuation Risk Management Energy Contract Litigation Market-Based Rates Environmental Compliance Market Design and Competitive Analysis Fuel and Power Procurement Mergers and Acquisitions Incentive Regulation Transmission 9 brattle.com

11 Offices CAMBRIDGE NEW YORK SAN FRANCISCO WASHINGTON, DC TORONTO LONDON MADRID ROME SYDNEY 10 brattle.com

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