The Economist: Carbon confusion
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The Environmental Protection Agency (EPA) released a Clean Power Plan proposal aimed at cutting carbon emissions from the nation’s power plants. Reaction to the proposed rule has been all over the map (as expected). Much of the heated response--both for and against--has been somewhat overstated (also as expected). Here are a few salient facts.
The big top-line number appearing in many quotations and headlines is that the plan will result in a 30% reduction in carbon emissions from power plants. The key phrase which usually (though not always) follows is that the reduction is from 2005 levels. However, market forces and other clean air and related laws have already led to a significant reduction (a 15% drop between 2007 and 2012), with more expected to come with the scheduled retirement of a number of coal-fired generation facilities. Also, it is important to note that the entire electric power generation industry is responsible for about a third of greenhouse gas emissions, further diluting the actual percentage decrease.
Another data point that is misleading is the statement about electricity rates going down due to this rule. The idea is that by encouraging efficiency, the new regulations will reduce the amounts families spend for power. However, the likelihood that the gains in efficiency will outweigh the price increases the rule will involve is very, very small. The EPA estimates that the electric power industry will spend about $8.8 billion to achieve the plan’s goals. Some industry experts believe this figure will balloon to far more due to cost overruns, design challenges, and other problems with implementation. All of that, of course, is subject to many caveats and remains to be seen (the regulations won’t even be issued until next year).
Whatever the higher costs ultimately turn out to be, the majority of them will be passed on to consumers. In the regulated electric utility environment in place in a number of states, rates are set by a regulatory agency based on costs. As operations costs rise, rates rise. Even where competition is in place, such as in much of Texas, consumers should expect to pick up most (if not all) of the tab for needed investments. Electricity demand is fairly inelastic, meaning that customers tend to use the same amount even if the price changes. The major effect of increases in electric power rates is a hit to family budgets and business bottom lines and, hence, lower consumer spending and corporate activity.
The Clean Power Plan is designed to be implemented at the state level, meaning that each state would be charged with coming up with a way to meet target reductions. Any state-level initiative in the electric power industry is complicated by the fact that power is distributed through grids covering specific geographic areas which sometimes (but not always) align with state boundaries. In Texas, for example, most of the state falls under the Electric Reliability Council of Texas (ERCOT). However, the Panhandle and part of the South Plains, El Paso area, and parts of northeast and southeast Texas are all on different grids. It’s difficult and sometimes impossible for generation capacity on one grid to be used to supply power to another, and industry experts warn that the rule has the potential to cause instability or insufficiency in the power supply in some areas.
However, the proposed rule does allow several years for development of a plan, and another several years before it must be implemented. The handwriting has long been on the wall that regulations, rules, or laws were coming which would mandate lower emissions, and power companies have been factoring in this likelihood in their planning. Many of the coal-fired plants which would be shut down under the proposal are decades old--some up to 60 years old--and were nearing the end of their lifespan in any case. There are newer facilities designed and built to burn cleaner, and these would likely stay in operation for the time being.
The Plan is not an across-the-board or equal decrease, but rather a calculation based on the EPA’s analysis of states’ abilities to respond through measures such as retrofitting existing coal-fired plants, utilizing natural gas facilities to a larger extent, increasing renewable power, and improving efficiency. Texas is charged with cutting emissions by 39%, more than the next three states combined. The fact that Texas is expected to reduce emissions by such a large amount is ironic in that the Lone Star State is viewed as a model for market-based solutions to emissions issues. Part of introducing competition in the electric power industry within ERCOT involved improving emissions rates and boosting renewable energy. The framework has been very effective, with emissions down significantly and the state now the top wind energy producer in the nation by a large margin.
As a large natural gas producing state, Texas benefits from the increase in demand for natural gas stemming from the electric power generation industry’s transition away from coal. Nuclear power companies (several of which are located in Texas) also stand to benefit. The biggest loser may be the coal industry, which is a critical source of jobs and business activity to some geographic areas. Despite claims to the contrary, it is likely that electricity rates would also be pushed upward, affecting family budgets, corporate profitability, and industrial competitiveness.
Certainly, excessive pollution is undesirable for many reasons. Reducing emissions can improve human health and well-being and the environment. However, it is less clear that the Clean Power Plan is the best way to bring about this result. After studying the issue many times in the past, I have consistently found that the best and least disruptive path to reducing emissions comes in the form of a market-based solution whereby firms are incentivized to switch to cleaner options. The Clean Power Plan, however, is unlikely to yield efficient results from an economic perspective, leading to excessive disruption for a relatively small payoff.
Dr. M. Ray Perryman is President and Chief Executive Officer of The Perryman Group (www.perrymangroup.com). He also serves as Institute Distinguished Professor of Economic Theory and Method at the International Institute for Advanced Studies.