Energy Probe

(May 05, 2010) A recent article in the Toronto Star, “Time to revisit the dreaded carbon tax” is riddled with some highly inaccurate reporting.

To start, the article says: “Last month, three of the world’s biggest per-capita emitters of greenhouse gases—America, Australia and Canada—put their key environmental pledges on hold until further notice…”

This is completely untrue. Neither the US or Canada put their pledge on hold. The US commitment to cut GHGs 17% from 2005 levels by 2020 is in the bag, given regulations that are currently in place combined with normal capital stock turnover rates. I explain this in slide 20 in this presentation.

US “cap and trade” bills are trade protectionist measures that are always laid on top of emission reduction-driving regulations. All of the regulations required to achieve the US target are in place now and incorporate emission trading (slides 9 through 16).  All Congress has not yet done is added the trade protection element to the mix.

I anticipate that the US cap and tax bill will become law before the end of 2011.

I am more concerned about Canada, which has not backed off our Copenhagen commitment but has not yet put in place the suite of product standard-type regulations required to ensure we keep that commitment.

Australia is another, very weird story.

Before Rudd became PM, the Aussie federal bureaucracy created a customized Australian GHG inventory with inventory does not comply with any commonly accepted GHG accounting methods.  You can review this inventory by going here and clicking on “National Greenhouse Gas Inventory”. If this is the inventory one uses to quantify Rudd’s GHG reduction commitment, Australia has very little work to do to keep its Kyoto commitment. This inventory puts Aussie GHGs at 597 MM TCO2e/year in 2007 and 553 MMTCO2e in 2008, compared to 546 MM TCO2e/year for the 1990 base year.

However, using the official UNFCCC GHG reporting methods, Australia’s 2007 GHGs actually totalled 825.9 MM TCO2e/year, compared to a 453 MM TCO2e/year 1990 baseline.

There never was any way that Australia could keep its Kyoto/Copenhagen commitments using any internationally-recognizable GHG inventory accounting methods. I cannot explain why Rudd and his bureaucrats thought they could pull off this scam of appearing to make a significant commitment but not really doing so by using an unique and illegitimate national GHG accounting approach.

In Copenhagen Rudd learned that no other nation would accept this play. This is the primary reason he was compelled to back down from his pre-election commitment.  I understand that Rudd did not comprehend the inventory accounting game the bureaucracy was playing when he made his original commitment or even when his party passed the Kyoto Protocol into domestic law after he was elected. It was only recently that he became aware of the actual situation he was in.

The article also says: “…three of the world’s biggest per-capita emitters of greenhouse gases  America, Australia and Canada…”

In 2008, Canada ranked 16th in per capita GHG emissions from energy consumption, the US ranked 13th and Australia ranked 12th.  I am not sure that most readers would equate ranking 16th to “world’s biggest”. Among the top 50 per capita GHG emitters, only 12 (including Canada and the US) have committed to reduce GHGs between 2008 and 2020. Only 2 of those with commitments regiated higher per capita GHGs from energy use than Canada in 2008.

EU member states have committed to cut aggregate GHGs only 2.7% from 2005 actual levels by 2020, compared to Canada’s commitment to cut GHGs 17% from the same base year.

Among the top 50 per capita emitters, Canada was one of only 8 nations that reduced GHGs/person between 1997 (when the Kyoto Protocol was created) and 2008 (the last year for which full data is reported).  The majority of EU member states, including carbon-taxing states, realized increases in per capita GHG emissions between 1997—when they signed the Kyoto Protocol and 2008.

The fact is that the GHG “cap” that the EU member states agreed to in Kyoto in 1997 was 14% ABOVE actual 1995 GHG levels for the member states.

Canadian negotiators unwisely committed to cap Canadian GHGs at 13% below 1995 actual levels, in the fact of Europe’s adoption of a “cap” that allowed EU member states to grow GHGs 14% from a comparable baseline. Many observers unwisely equate European compliance with their Kyoto “cap”—which allowed for aggregate GHG growth—with emission reductions. This is a significant error.

The article implies that a carbon tax, or “putting a price on carbon”, is the most effective and essential measure to achieve emission reductions. I have documented in many previous articles that energy consumption taxes have proved highly inefficient mechanisms for incenting energy demand changes. That is why no EU member state has adopted or increased its reliance on carbon taxes since 1999.

More importantly, financing income tax cuts through energy tax increases shifts tax burden from the rich to the poor, and from the private sector to the public sector. Hospitals, schools and universities do not pay income taxes but do pay energy taxes. The most dramatic and direct impact of the “green shift” in EU nations has been large increases in mandatory health care premiums and payroll taxes, made necessary by the shift of overall tax burden from the private sector to the public sector.

Aldyen Donnelly, May 05, 2010

(April 19, 2010) The carbon prices outlined in this news article are consistent with the idea that high-emitting power generation and industrial facility operators will pay whatever it costs to operate existing plants through the end of their normal, pre-carbon tax, expected lives. If we assume no early plant retirements, the marginal cost of complying with the WCI 2020 target ranges between $30 and $80/TCO2e.

In many cases, however, the least cost compliance strategy will be the early write down of power plants and industrial facilities.

Most of the US’s top-10 power utilities (on a sales volume basis) operate existing facilities that deliver less than US$8/TCO2e in returns (share value plus dividends) to shareholders, annually. But it will cost at least $34/TCO2e to cut emissions in these low value plants. So their least cost compliance option is to retire existing plants ahead of the currently planned end of their operating lives.

If it costs, say, $13 per TCO2e reduced to shut-down already aged coal-fired power plants (up to $8/TCO2e reduced to write off the plants’ current market value and $5/TCO2e reduced to finance decommissioning costs, amortizing capital expenditures over the 20 years of emissions—the minimum estimated operating lives of replacement, lower-or-zero-emitting power supply), and to generate a return on the new supply, we have to secure the equivalent of an additional $3 to $5/TCO2e reduced ($2 – $8/MWh) increase in the price of power, then the marginal cost of carbon does not exceed US$21/TCO2e between now and 2030.

The above theoretical write-off and replacement cost estimates are actually HIGH relative to many of the 10 largest power companies operating coal-fired generation capacity in the US at this time. You can verify this statement by reviewing large US power utility annual and environmental reports.

Then let’s look at what write off costs should be at the complete other end of the power industry spectrum. For example, PG&E is one of—if not THE—least carbon intensive power suppliers in the US. So the cost of writing off PG&E’s fossil-fired plants and power purchase agreements (PPAs) should give us a signal as to the maximum price carbon should hit in a rationally regulated and operating carbon market. (You can sownload PG&E’s annual report here).

If you assume you can buy the whole company—all of its assets and power supply contracts—for a 25% premium above the current share value, and add in the cost of retiring all of the company’s long-term debt, we face a one-time cost of $36 billion. Only 8% of the power PG&E supplies originates at coal-burning plants and 39% originates at gas-burning plants. These sources currently combine to discharge just under 29 MM TCO2e/year. The rest of the power that PG&E supplies comes form nuclear, hydro and low impact renewable sources.

To over-simplify, let’s just assume that all of PG&E’s production assets and PPAs have the same book value (generate the same contribution to earnings)/MWh of output. If we were to buy and then write off PG&E’s carbon-emitting assets, amortizing that cost over 20 years (the operating lives of the assets I build to replace the high-GHG supply), we get a cost per tCO2e reduced of US$29.48/TCO2e. This estimate is likely high, given the assumptions I made to keep the analysis simple.

In a rational world, the highly efficient PG&E gas-fired assets are among the last assets that would be retired in the US to achieve any given GHG target. But if these assets were written off TODAY, the cost of that relative young and efficient plant write-off is well under US$30/TCO2e.

This means that under any rational GHG regulatory context, the real cost of carbon in the US should be well under US$30/TCO2e, well beyond 2030.

When I look at the annual reports of AEP, Southern Electric, Arizona Public Service, Constellation, the Edisons and other utilities that operate sizeable fleets of older, high-emitting plants, even after considering replacement costs, I have a very difficult time forecasting carbon prices in excess of US$17/TCO2e through 2020, unless we proceed down an irrational and unnecessarily inefficient regulatory path. Of course, it is always possible that WCI is estimating the price of irrational regulation!

Any price of carbon exceeding $30/TCO2e (in 2010 $s) over the next 20 years will derive exclusively from politically-motivated and inefficient carbon quota allocations and/or tax measures, combined with market incumbents’ use of the quota regime to block new market entrants, slow down innovation rates and to artificially inflate carbon and electricity prices.

Note that all market participants in the US SO2 and EU ETS CO2 market do currently use the new market power derived from their free emission quota allocations—combined with mandates that oblige new market entrants to buy quota at market prices—to erect substantial barriers to new entrants and to maintain artificially high power prices given the decommissioning costs and replacement value of their operating power production assets. Over 80% of the “turnover” of emission certificates in these markets is in the form of “swaps”, because no entity that holds perpetually bankable SO2 or carbon quota actually sells it, in perpetuity, to a third party unless they are under extreme financial distress. On the ground, we call these quota swaps “leases”.  In a properly regulated exchange-based market, the market value of swaps would be reported at a $0 market value, not the marked-to-market price that is currently reported in the US SO2 and EU ETS CO2 markets at this time.

This low US compliance cost finding should be of major concern to the government of BC, because below $30/TCO2e, costing real reduction opportunities in BC’s reported GHG inventory are few and far between. So BC’s inclusion in the WCI marketplace eventually translates into BC electricity rate-payers exporting WCI carbon taxes to California rate-payers.

The reason the marginal cost of reducing GHGs in BC is so high is that every energy intensive sector operating in BC is already much more efficient than its California counterpart. The WCI-agreed regulatory strategy rewards regions with low cost reduction opportunities (the regions with the largest stocks of old plant and equipment) at the expense of regions that are already more efficient producers of energy and carbon-intensive goods and services.

Aldyen Donnelly, April 19, 2010