Because the Federal Power Act gives states authority over electric generation facilities to the exclusion of the federal government, and also because the CRC program would impose requirements on out-of-state sources similar to those imposed on interstate sources, this program should not run afoul of the dormant Commerce Clause restrictions on state programs. The U.S. Courts of Appeal for the Second and Seventh Circuits rejected dormant Commerce Clause challenges to the New York and Illinois ZEC programs. Likewise, California’s imposition of its low-carbon fuel standard on importers’ purchase allowances in order to level the playing field between in- and out-of-state sources withstood a Commerce Clause challenge. Similar challenges to CRC leakage control measures are likely to have the same result.
VI. Policy Variables and Prices
A. Policy Variables
The operation of a CRS program will depend critically on the policy parameters set forth in the legislation or selected by the Administrator to the extent empowered under the legislation. The level of the Average Emissions Target as compared with a state’s existing average emissions will determine the relative scarcity of CRCs and will affect both price and the resulting incentive to build new low-emissions generation and to retire or throttle back high-emissions generation. Because the Average Emissions Target will decrease with time, fewer CRCs will be created for each MWh of low-emissions generation, and each MWh of high-emissions generation will require the purchase of more CRCs. Other things being equal, this will reduce the supply of CRCs while increasing demand, thus driving up the price.
However, if the program works as intended, the price incentives will induce new low-emissions entrants in the market (increasing supply) and retirements or curtailments of high-emissions generators (decreasing demand). Other things being equal, these forces will reduce price. In addition, we anticipate rapid evolution and cost reductions in low-emissions generation technology, much as we have experienced with solar generation.
A price cap and floor seem necessary for several reasons. The net effect of the forces described in the prior paragraph will be difficult to predict with certainty, and all generators will value predictability. In particular, decisions to commit to construction of new generators will require a dependable revenue stream, and developers may look for long-term CRC sale contracts to provide certainty. While the cost of new low-emissions generation will provide a natural cap on the CRC value, development timetables will not be fast enough to prevent price swings. To provide an effective cap, the Administrator must be the seller of CRCs of last resort, and the Administrator’s reserve price will be an effective cap on the CRC price.
We suggested above that the initial Average Emissions Target should be selected to assure that CRCs are at least as valuable as RECs (or more) at the outset. While this would primarily be accomplished through the initial Average Emissions Target, setting a floor equal to 80% of the three-year average of REC prices (or perhaps 80% of last year’s price if prices have been steadily rising) would also serve to cushion the transition. Setting a floor price also ensures that CRCs provide a meaningful incentive to move to lower emissions generation and can assure support for nuclear and CCS. Where an existing RPS has a high separate target for SRECs, with a resulting high SREC price, legislators may wish to continue a form of solar set-aside that tapers off in five or 10 years. As noted above, the legislature may also wish to maintain ZEC floors. If the carbon price in the CRS is high enough, however, separate treatment may be unnecessary, and the hope is to move to a fully technology-neutral program.
B. Wholesale Electricity Prices
In an open wholesale market, such as exists in most RTOs and ISOs, the cost of the program would directly affect the energy market bids of generators but only indirectly affect the wholesale price. Low-emissions generators, as discussed above, are generally bidding at or near zero. Their bids will largely be unaffected by CRC revenues. On the other hand, fossil fuel generators would have a direct increase in per MWh costs and can be expected to raise their bids. Natural gas generators (at least older ones) are typically at the margin and set the market clearing price in most hours. As a first approximation, the rise in the wholesale price would be the rise in cost to gas-fired generators. The bids of coal-fired generators would be raised substantially more than those of gas-fired generators. This could simply result in coal plant margins being squeezed, or could result in an inversion of the typical past supply curve.
For example, as discussed above, in the PJM market, coal-fired generators currently occupy a lower bid tier than most gas-fired generation, although that has been changing at the margin because of low natural gas prices and increased efficiency of newer combined-cycle gas plants. A CRS program could accelerate that change and leave coal generation more frequently at the margin that sets the price. The actual increase in the wholesale clearing price then could be far lower than the increase in coal generation prices, though potentially somewhat higher than the increase in gas generation prices.
The situation in PJM, to continue the example, is somewhat more complex. The increase in bids in the state with a CRS program would not be matched in states that do not adopt a similar program. Policy measures discussed below will prevent out-of-state resources from competing unfairly with in-state resources but, other things being equal, in-state fossil fuel generators would become somewhat less competitive for exporting power and less likely to set (and raise) the price. Further, if all the segments of PJM’s multistate grid had unlimited transmission to and from other segments, a wholesale price increase would be spread equally over all the states in the PJM grid.
However, PJM’s grid has transmission constraints, which means that the locational price in a constrained zone may be higher than surrounding zones. Thus, the wholesale price rise occasioned by a CRS program may to some extent be borne in a local region of the state. Other RTOs’ and ISOs’ energy markets have variations in detail and “individual results may vary,” but there will be an overall tendency for some wholesale price rise that may be more concentrated within transmission-constrained areas.
Dispatch rules in non-RTO and ISO states generally follow a similar pattern but are based on actual variable costs, not bid costs. This “least cost dispatch” could be expected to have similar effects on generation costs to those described above. The incentives to build generation for vertically integrated utilities, however, are far more complex than for independent power producers in transparent markets.
C. Retail Electricity Prices
It is difficult to predict the all-in effect of the CRS program on retail electric prices in any one state. In most states, the cost of the RPS is passed through to retail purchasers in the form of a “public benefit charge” paid by all distribution customers. Where this is true, retail prices would be reduced by the aggregate amount of the current costs for REC purchases by retail sellers. As other low-emissions technologies become eligible for CRCs, the aggregate purchase payments for CRCs would be expected to increase (assuming the prices paid to sellers of CRCs are equivalent in carbon value to REC prices). However, these costs will be borne by high-emissions generators, and filtered through the wholesale price as described above.
The discussion above is obviously not a substitute for detailed modeling of specific markets. It suggests to us, however, that the assured reduction in retail prices from the elimination of public benefit charges to pay for RECs is reasonably likely to outweigh any increase in retail prices that follows from increased wholesale prices being passed through in retail prices. Further, this “comparative statics” result is likely to be overwhelmed over time by the transition to a cleaner generation fleet. Wind and solar generation have experienced dramatic price declines as technology has improved, and battery storage is currently experiencing similar declines, which will further enhance the effectiveness of solar generation.
We anticipate that CCS and other emerging zero-carbon generation and carbon reduction technologies will also emerge. To the extent that these technologies are able, with CRC support, to populate the low-priced end of the supply curve, they will tend to reduce wholesale prices, which will pass through to retail prices. Either more and more high-priced fossil fuel generators will drop out, reducing prices, or they will balance increased electricity use in other sectors without further price increases.
D. Comparisons to Other Programs
We believe that a CRS program can effectively support the transition to a carbon-neutral electricity generation sector. To make the transition, the program must provide a sufficient return both to support continued operation of legacy low-emissions generators such as nuclear and hydroelectric generators, at least until they can be economically replaced, and to support investment in new low-emissions generating facilities, including expansions of existing generators, such as occurs in the case of nuclear uprates. That return can come from a combination of sufficiently high wholesale electricity prices, capacity payments in markets that offer them, and subsidy payments for low- and non-emitting sources.
As discussed above, the CRS program will raise wholesale prices. The program will also provide a direct subsidy to all low-emissions generators. That subsidy is technology-neutral, and all that matters is fossil-based CO2e emissions. Biofuel generators would generally receive the same treatment as they receive under most RPS programs, and fossil plants with CCS, nuclear, and large-scale hydro would play on an equal footing with renewables.
We suggest that the combination of a subsidy to low CO2e emitters with an increase in wholesale prices will provide greater incentives to investment in non-emitting generation than other policy options. Traditional RPS programs increase retail price and thus create barriers to electrification of other sectors without providing any increase in the wholesale price. They also provide no subsidy to most of the largest existing sources of CO2e-free generation (nuclear and large-scale hydro) or to emerging alternative technologies. A cap-and-trade or tax program would impose additional costs on CO2e emitters, but the benefit to non-emitting generation would largely be limited to the increase in wholesale electricity prices. While that price increase could be expected to be somewhat larger than in a CRS, we do not believe that it would offset the benefit of the subsidy. The larger wholesale price increase would also further suppress demand for electrification. A CRS delivers on a balance of state goals.
VII. Relationship to Other Goals
A. Expansion to Other Economic Sectors
The CRS program we propose is in many respects an incremental step forward from existing RPS programs. The most economically efficient solution to reduce the risks of climate change would be to impose a single carbon price on all sectors of the economy combined with other programs to address market imperfections. Since the CRS program would be measured in CO2e, it could eventually be extended to other sectors of the economy.
The building and transportation sectors would be natural fits (measured in average CO2e per square foot, average CO2e per mile for passenger vehicles, average CO2e per freight ton-mile, etc.). Because most industrial sectors report GHG emissions in CO2e, these companies could also readily be added to the program, basing CRCs on the average CO2e emissions per unit of production. Adding industrial sectors would create additional encouragement for cogeneration and transition to biofuels, as well as product substitution and production efficiency. Extending the program to other sectors will also further encourage electrification of those sectors. It would reward companies that have already acted to reduce emissions and encourage investment in more efficient production that would further stimulate the economy.
A second way to expand the CRS program to other sectors is to make industries and activities that reduce carbon emissions eligible to receive CRCs. These additional CRCs would tend to reduce the value of CRCs and undermine other goals of the program within the electricity sector, and states considering their inclusion would need to weigh these alternative benefits. This can be accommodated by permitting creation of CRCs based on the negative emissions, just as with the CCS example described above. It could also include measures such as afforestation, soil sequestration of carbon, and reductions in otherwise unregulated emissions from agriculture. Both RGGI and California GHG auction-cap-and-trade programs permit limited creation of similar allowances.