Research Improves State-Level Utility Regulation through Analysis of Regulatory Uncertainty and Long-Term Cost Impacts
This is the fourth installment in a 12-part series highlighting the environmental policy impacts of the Nicholas Institute for Environmental Policy Solutions over its first decade.
Since June 2014, electric utilities across the United States have been weighing how to comply with the U.S. Environmental Protection Agency’s (EPA) proposed Clean Power Plan (CPP) while hedging risks in a power market undergoing a sea of change due to rapidly shifting fuel economies. The stakes are high—decisions can effect consumers’ power costs and undermine emissions reductions efforts. And the choices entailed by the prospective regulation are both many and complex.
The CPP would regulate carbon dioxide emissions from power plants under section 111(d) of the Clean Air Act by establishing state-by-state emissions rate goals for affected fossil fuel–fired units, largely existing coal and natural gas combined cycle generators. A key element of the proposal is its flexibility mechanisms: states can achieve emissions reductions through a variety of actions, such as improving heat rates at coal plants, shifting generation from coal plants to gas plants that have fewer emissions, and engaging in “outside the fence” efforts—investing in renewable generation and energy efficiency programs, for example. States can also choose to trade emissions obligations with other states if it reduces their compliance costs, or they can convert the emissions rate-based goals in the CPP into mass-based targets to achieve additional flexibility.
Charting a course through this maze of options requires sophisticated modeling of long-term economic and environmental impacts in a landscape of energy market and regulatory uncertainty. The Nicholas Institute for Environmental Policy Solutions’ Dynamic Integrated Economy/Energy/Emissions Model (DIEM) was designed for just such a task. A macroeconomic simulation model of the global economy with a focus on U.S. energy, DIEM provides a detailed representation of regional electricity systems and is similar to the electricity model used in the EPA’s regulatory impact analysis of the CPP.
“DIEM runs are helping state officials, utilities, advocates, and other stakeholders understand the potential consequences of various state compliance plan frameworks,” said Jeremy Tarr, a climate and energy policy associate at the Nicholas Institute. “Because many states are not equipped to conduct sophisticated energy modeling, DIEM results play an important role in informing conversations about possible impacts on electricity costs, fuel diversity, and capital investments.”
After the CPP was announced, the Nicholas Institute began running DIEM to help regulators figure out how various compliance strategies might play out in the Southeast, which is in the midst of a dramatic shift in its generation mix. In 2000, only 6 percent of the region’s electricity came from natural gas, while nearly 60 percent came from coal. By 2012, gas generation had grown nearly six fold, while coal generation had decreased by nearly half. The regulators needed to know whether the CPP would accelerate these trends and how compliance costs could be minimized without sacrificing grid reliability or compromising utilities’ capability to meet emissions reduction targets.
The Nicholas Institute used DIEM to run a 48-state, 40-electricity market simulation to estimate changes in state-to-state electricity flows—essential when determining individual states’ compliance costs. According to Nicholas Institute senior economist Martin Ross, who developed DIEM, the simulation showed several ways that states could lower these costs.
“The modeling provides a clear picture of the benefits of engaging in some form of multi-state trading,” said Ross. “Regardless of the specific legislative mechanisms used to define it, this trading can significantly reduce costs associated with meeting the CPP’s goals.” For the nine states included in the Southeast trading region as designated for the simulation, costs are some 30 percent higher if the states do not trade with one another to take advantage of the most cost-effective emissions reductions.
Another way some states can minimize costs, according to the DIEM simulation, is to convert the emissions rate goals outlined in the CPP into mass-based goals that cover emissions from affected existing units (this switch could incentivize further savings by allowing utilities to take advantage of any emissions reduction approach that reduces generation costs.) The modeling indicated that the costs of achieving mass-based goals are 45 percent lower than those associated with equivalent rate-based goals. But it also showed that the cost benefits of mass-based goals are not distributed evenly across states: some states face costs higher than the regional average; others, costs lower than that average.
One notable finding of the analysis, said Ross, is the extent to which an emissions rate approach can lead to significant decreases in output from coal units, particularly in the early years of regulation.
“If states are concerned that a rapid phase out of coal could jeopardize the reliability of electricity supplies, they should consider adopting a mass-based approach to the CPP,” Ross said. “Our modeling shows that this approach lessens coal plant retirements and that the remaining units generate 50–100 percent more electricity than they would under a rate-based scheme.”
The Nicholas Institute’s analysis has also shed light on how the mass-based or rate-based choice affects the costs and deployment of the CPP’s two other flexibility mechanisms: renewable energy generation and energy efficiency investment. According to DIEM, at the prices estimated by the EPA’s analysis, energy efficiency is always a cost-effective method for reducing electricity demand and therefore emissions. Renewables are a different story.
“Right now they don’t play a large role in electricity generation for the Southeast,” Ross said, “but a rate-based approach to the CPP does provide some extra incentives for construction of solar and wind farms. On the other hand, adopting a mass-based goal tends to remove these incentives.”
Nicholas Institute researchers are continuing to use DIEM to model CPP compliance strategies. They note that exact requirements and permissible compliance options could change before the CPP is finalized and that additional emissions regulation may be on the horizon. DIEM simulations can capture those changes to identify the most promising options.
--Story by Melissa Edeburn