Energy Probe

(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

(April 15, 2010) Matt Horne of the Pembina Institute suggests that “careful design” will address the many real issues associated with the carbon tax about which Harvey Enchin deftly wrote a week earlier on the OpEd page of the Vancouver Sun.  Matt says: “Sweden provides and example of how governments can make carbon taxes work.”

Sweden was among the first nations to experience the serious phenomenon of the carbon tax-generated hole in government revenues. Sweden’s carbon tax shift translated directly into industrial job losses and capital investment flight. In the early years, carbon tax revenues consistently fell short of budget targets due to industrial business flight.

Between 1990 and 2008 (pre-global recession), jobs in Sweden’s goods producing sectors-agriculture, forestry, manufacturing, energy industries and construction-fell over 25%, compared to a 10.5% increase in Canada. Over that 18-year period, total employment across all sectors in Sweden grew only 2.4%, compared to 30.5% in Canada.  100% of the new jobs created in Sweden since the implementation of its carbon tax have been in the public sector.

De-industrialization explains 100% of the reduction in greenhouse gas emissions (GHGs) realized by Sweden since 1990.  In fact, given the reduction in industrial output and jobs, the national GHG reductions realized by Sweden is surprisingly small.

Sweden’s electricity and petroleum industries currently discharge 8% more GHGs within Sweden’s boundaries and 30% more globally than they did in 1990. This partly reflects that fact that in the mid-1990s, in an attempt to stem industrial job losses, Sweden ruled that all energy consumed “for the production of mineral oils, carbon fuels and petroleum coke”; in the production, transmission and distribution of electricity; by airplanes, ships and trains; and by “energy intensive business” (defined as a business for which energy costs account for 3% or more of total operating costs) is up to 100% exempt from all Swedish energy taxes not just carbon taxes.

Of course, while introducing these energy tax exemptions might have stemmed job losses in the targeted sectors, it just deepened the carbon tax hole in Sweden’s government revenue forecasts. And Sweden-home to 20% more petroleum product refining capacity than Alberta-now depends more on petroleum product exports to shore up its national economy than ever before.

When Matt Horne points us to Sweden’s careful carbon tax design as a model, is he advocating for exemptions for all of the large BC industrial consumers who would be energy tax exempt under Swedish law?

Sweden has tried to make up the carbon tax-related government revenue shortfall by disproportionately loading the new tax burden on small households and increasing payroll taxes, mandatory health and social insurance premiums, a path BC Premier Campbell has already started down.

Today, a small Swedish home that consumes less than1,000 kilowatt-hours (kWh) of electricity per year pays CAD$0.347/kWh, including taxes. But the large home that consumes over 15,000 kWh per year pays only CAD$0.176/kWh.  In other words, the large residential consumer gets almost 2,000 kWhs of service for the same price the small household pays for 1,000 kWhs. Large Swedish industrial customers who do not qualify for the tax exemption pay only CAD$0.097/kWh.

In presenting the Swedish carbon tax design as a model to British Columbians, is Matt recommending that our government disproportionately load the new tax burden on the smallest and lowest income-earning households, as Sweden has done?

Since hospitals pay carbon, excise and sales taxes on their energy consumption while power producers, oil refineries, airlines and other energy intensive Swedish businesses do not, the direct relationship between the carbon tax shift and increasing health care premiums is obvious.

Other labour tax increases are not directly related to carbon tax impacts.

But the Swedes—like many other governments—have found the only place they can mine for new government revenues, of late, has been the payroll tax accounts. Taxes on labour now combine to account for 33% of all Swedish government revenues (compared to 15% of all Canadian government revenues). Sweden’s carbon tax accounts for less than 3% of total Swedish government revenues.

Sweden’s very high payroll taxes discourage workers and dampen companies’ willingness to hire. Today, Sweden’s unemployment rate is 9.0%. This does not include the 5 – 8% of working age Swedes who are officially listed as “employed” but who do not work and collect permanent “sick leave”. In 2006, according to McKinsey and Co.,  “sick leave” payments to Swedes staying home from work accounted for 16% of all Swedish federal government expenditures.

Government spending accounts for 55.5% of Sweden’s GDP.

And this is what Matt and the Pembina Institute describes as “careful” tax system design?

Aldyen Donnelly, April 15, 2010