Follow the money

Carbon costs and energy prices, NC edition

Posted by Sean Casten (Guest Contributor) at 5:07 PM on 04 May 2008

Read more about: carbon tax | climate | energy | greenhouse-gas emissions | business

As the most ardent Gristophiles know, this site is hosting a lively debate over the degree to which prices imposed on carbon emissions will impact energy costs.

To recap, if prices do impact costs, then a carbon tax provides an investment incentive. If they don't, then we need some carrots to go with the stick of a tax.

Hot off the presses comes this bit of news from Greenwire ($ub req'd):

Duke Energy Ohio is asking federal regulators to approve the transfer of its Ohio power plants to companies owned by North Carolina-based Duke Energy Corp. whose rates are set in a competitive market instead of by state regulators.

Why, you ask?

First, because the Lieberman-Warner boondoggle ...

... initially gives fossil-fuel power plants 19 percent of free allocations for greenhouse-gas emissions to help cushion the expense of curbing those emissions when a carbon cap is set. As the nation's third-largest carbon emitter, Duke stands to gain allocations worth hundreds of millions of dollars under that scenario.

And when you get hundreds of millions of dollars of gifts, you'd sure like to be able to convert it to cash. But here's the catch:

State regulators in traditionally regulated markets would not allow utilities that get free emission allocations to pass on pollution-reduction costs to customers. But utilities in competitive wholesale markets could conceivably take the free allocations and still pass on to their customers the full cost of cutting emissions -- a problem demonstrated in the European Union's cap-and-trade system. In Germany, for example, electricity prices jumped 25 percent while utilities earned extraordinary profits during the first trading period.

In fairness, this is not precisely the debate between Gar and myself, since this is not a story about whether carbon pricing will be passed through to prices, but rather whether carbon ~~gifts~~ allocations will be passed through in higher rates. But at core, it raises the same fundamental issues as to the degree to which regulated energy providers will be allowed to transfer costs (or gifts) through to their rate payers.

One last point: in fairness to Duke, spokesman Tom Williams says:

The filing and the timing of any consideration of climate legislation are totally unrelated.

Watch this space.

For story: Follow the money
4 Comments | Post a Comment

Ah.

Sean, it sounds like you're arguing something much narrower than you were arguing before. If the issue is "the degree to which regulated energy providers will be allowed to transfer costs (or gifts) through to their rate payers," then I buy your point: utility commissions won't allow massive price increases to be passed through, so in the face of carbon taxes regulated utilities will be stuck with massive costs and not much flexibility.

Before, though, it sounded like you were saying flatly: taxes on energy are not passed on to consumers. That's a broad and controversial statement, as you can tell from the protest it kicked up.

Maybe you really were making the broad argument. Or maybe you think the issue with regulated utilities is a big enough chunk of the climate policy puzzle that the arguments are equivalent. Could you clarify?

grist.org

by David Roberts at 5:15 PM on 04 May 2008

Taxes

And note that they seems to think that in unregulated markets they would have no problem passing on their costs - so you seem to be conceding that point. And even if you are not, it turns out that that in addition to every economist in the world thinking that carbon prices could be passed on, and in addition to most experts thinking carbon prices could be passed on, the utilities themselves seem to think in an unregulated market they can pass on carbon costs.

by Gar Lipow at 5:28 PM on 04 May 2008

It's a specific example of the general

This is frankly a more interesting story from Duke than Gar's & my little dust up, but the general point remains the same: there is no perfect one-to-one link between costs and prices, except in the very long term. (And as Keynes said, "in the long run, we're all dead".) Regulation is but one of the reasons why those costs do not directly transfer through, but the other issues I raised before remain valid (differential pricing between customers, competitive products, etc.)

Remember, the issue here is simply one of precision. If every dollar of cost increase leads to a precise dollar of cost increase, then a GHG policy needs no carrots, since sticks will magically become carrots through higher prices. If that precise formulation isn't true (or even if it's only partially, true - say, 50 cents gets passed through), then a GHG policy is providing an inefficient and inadequate investment signal.

The Duke story simply shows one way that could happen. (And remember, with 40% of our CO2 emissions coming from utilities, and more than half of our utilities regulated, even if this is the only sector where such inefficiency pricing is a problem, it's an enormous problem.)

by Sean Casten at 7:56 PM on 05 May 2008

No, Gar

The analogy is closer to the sulfur rules promulgated under the CAA, when grandfathered coal plants suddenly got windfall profits because they could compete against new, intrinsically cleaner plants that had to pay the price for sulfur reductions. Thus, we created a massive windfall profit to the dirtiest plants, giving them an incentive to run way more than a market ought to.

What Duke appears to be gambling is that the same thing will happen in power markets, whereby instead of putting a price on all carbon, we will only put a price on new carbon, thereby creating a massive windfall to power plants that existed before the controls went in. This is actually way worse than either of us are arguing, since it makes it prohibitively expensive to build a new, clean plant while simultaneously making it really profitable to run an old dirty one. Everyone loses. But note that the price increase there becomes a function not of carbon per se, but of a regulatory model that puts all the compliance costs (including capital recovery) on the new plants. That's not precisely your argument though, because those new plants aren't expensive just because of carbon controls. They're also expensive because they're new and have lots of capital to amortize.

The only way I know to prevent this is (a) by not allocating permits and (b) to provide carrots to ensure that the cheapest carbon reduction measures come on line immediately (and drive down the cost of compliance as supply comes on line), rather than waiting until the inevitable supply shortages drive down reserve margin. This is, indeed, what we're now seeing in power markets, where the old grandfathered coal could run a little harder each year, making the marginal cost too low to justify new plants even while environmental regs made it prohibitively expensive to build new plants. As we've chewed through that capacity factor, we are now getting set for massive price spikes... but this is for a set of reasons that are much more complex than just SOx/NOx rules. Duke's gamble is that we'll screw up carbon in the same way.

by Sean Casten at 8:05 PM on 05 May 2008
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