|Reduce and Cap Carbon Dioxide from Fossil Fuel Fired Electric Power Generating Facilities (Rev. C17)
|Ended on 4/9/2018
Comments on the proposed emission trading rule
William M. Shobe, Professor of Public Policy
University of Virginia, April 8, 2018
Executive Directive 11 essentially directs the Virginia Department of Environmental Quality to establish regulations limiting C02 emissions from larger electric power plants and to use the Regional Greenhouse Gas Initiative (RGGI) allowance trading program as a compliance flexibility mechanism for enforcing those regulations.
The overall structure of the regulation appears to be appropriate for Virginia’s case and is consistent with our using the RGGI compliance mechanism. The one key weakness of this draft rule is in the setting of the cap. DEQ has made a series of serious errors in estimating business-as-usual emissions. These errors result in a cap in 2020 that is approximately 4 million tons per year too high. The appropriate level of the initial cap should be 30 to 31 million tons rather than the proposed 33 to 34 tons. The specific errors include:
These errors are large and all operate in one direction, making it appear that Virginia should have a higher cap. DEQ needs to lower the proposed cap so that it is consistent with available data.
Output-based updating of allowance allocations (9VAC5-140-6215. CO2 allocation methodology)
Model runs using both IPM (ICF) and Haiku (Resources for the Future) show that output-based updating of allowance allocations helps reduce the “leakage” of emissions from under the cap while retaining incentives to shift generation away from high-emitting sources. The mechanism is straightforward. Free allocation of allowances acts as an implicit subsidy for the generation of electricity by granting to ratepayers the market value of the stream of allowances. Generators take this grant into account when calculating their marginal cost of generation and so can maintain relative competitiveness with the generators in the rest of the PJM region. This prevents generation (along with its emissions) from migrating out of Virginia and into the uncapped portions of PJM.
Output-based allocation seems the appropriate choice given the potential for leakage of emissions into the rest of PJM.
Consignment (9VAC5-140-6430. Consignment auction)
Consignment auction of allowances have two key advantages over direct allocation. First, by enhancing liquidity in the auction, requiring consignment probably improves price discovery in the RGGI market. There may also be a subtler mechanism at work. The act of consignment and the resulting requirement that Virginia utilities purchase back what they need may make allowance prices more salient to market players and the generators, in particular. Professors Holt and Shobe at UVA have tested the performance of consignment auctions in laboratory experiments. Although these results are not yet published, they do provide preliminary evidence that consignment auctions improve price discovery in emission markets.
The second benefit of consignment auctions is that they monetize the value of the grant of allowances to the generators, that is, they establish a clear market value of the grant. This allows the State Corporation Commission (SCC) to easily establish whether allowance value is being transferred to ratepayers rather than being retained by generators. Given the value of the free grant of allowances, it is critical that ratepayers be protected from generators pocketing the value of allowances. The consignment auction helps make this possible.
Emission containment reserve
In every emission market established to date, allowances have been over-allocated at first. In the case of RGGI, the cap has been reduced dramatically due to the initial over-allocation. Even after the initial allocation, costs often fall faster than the cap leading to lower than expected allowance prices. As I will argue in the next section, the proposed rule continues this pattern of over-allocation, since DEQ has set the initial cap too high. This makes the ECR an important backup mechanism for ensuring that our emission reductions will be greater, if the costs of achieving those reductions fall well below expectations.
DEQ has substantially overestimated business-as-usual emissions over the next 15 years. This makes achieving the reductions for a given cap level appear much more expensive than they really are. DEQ’s analysis is not off by just a little, it is grossly in error. The agency has provided an analysis that is inconsistent with facts that were readily available to the agency at the time it did its analysis. What is more, the bias is clearly in one direction, overstating the emissions that would occur in the absence of this rule. This, in turn, overstates the cost of achieving a given reduction.
Another fact about server farm demand is relevant. Many firms building server farms want to cover their energy demand with renewable generation and the firms are increasingly insisting that the generation be local. Google, for example, now claims to be powered by 100% renewable energy. And just last month, Microsoft announced that it has purchased about 350 MW of a 500 MW facility planned for Spotsylvania County for completion in 2019 and 2020. (Keeping in mind that this 500 MW facility doesn’t exist in any of DEQ’s baseline scenarios.) Server farm demand cannot account for the growth in fossil fuel emissions assumed in DEQ’s faulty analysis.
A simple exercise shows how damaging this mistake is to DEQ’s analysis. DEQ’s two reference cases make different assumptions about 2017 total generation: 96,786 for RC1 and 93,305 for RC2. At the time DEQ did this analysis, there was zero chance that demand would be as high as assumed in RC1, but this is consistent with the general pattern of unsupported and erroneous assumptions in its analysis. Actual generation for 2017 was 93,500 GWh.To be very conservative, we take the higher of the two 2017 generation estimates from DEQ’s reference cases, 96,786 GWh (even though it didn’t actually happen) and increase it at 1% per year. The resulting generation profile shows that DEQ’s assumed generation is in excess of any reasonable expectation by 3,600 GWh per year by 2020 and 10,500 GWh by 2031. If you assume that each GWh displaces half coal and half natural gas, then each 1,000 GWh is associated with on the order of 1 million short tons of C02. In light of this, it is clear that DEQ’s analysis has grossly overestimated BAU emissions. Combined with the solar PV analysis, the 2020 emission overestimate is on the order of 4 million tons of C02 per year.