PJM Interconnection is a regional transmission organization (RTO) that coordinates the movement of wholesale electricity in all or parts of 13 states and the District of Columbia. My colleage, Troutman Sanders attorney Peter Glaser, just sent around a memo on the impacts of EPA’s regulatory surge on electricity prices. The memo is based on PJM auction reports (here and here).

Peter’s memo is too juicy not to share with a wider audience. I reproduce it below with his permission. — Marlo 

Reality has interceded in EPA’s attempt to play down the impact of its train wreck regulations on the electric utility industry.  First came the widely reported news that Louisville Gas & Electric had filed for a 19% rate increase by 2016 to pay for the upgrades that the regulations will require.
 
Now, we have the results of the capacity auction that PJM just conducted for the 2014-15 capacity year.  The resulting capacity prices were about 4.5 to 8 times as high as prices paid in the last two auctions and 2.5 to 3 times as high as market analysts had predicted. 
 
According to PJM, most of this increase can be laid at the feet of EPA.  Based on PJM information, we calculate that the portion of the increase attributable to EPA will cost load (customers) in the PJM region $2-3 billion just in capacity costs and just for a one-year period (2014-15).  
 
Here are the details.

 
The PJM Capacity Auction
The PJM Interconnection is a FERC-approved regional transmission organization that manages the high-voltage electric grid and the wholesale electricity market that serves 13 states and the District of Columbia.  In PJM, the “Reliability Pricing Model” (or “RPM”) is a forward auction of electric generating capacity that occurs annually, three years ahead of the year for which capacity is procured.  PJM procures enough capacity to cover the anticipated demand for electricity in the region plus a reserve margin.  Generating units bid into the RPM auction based on their anticipated costs.  Every generating unit that clears the auction receives a capacity payment based on the market-clearing price, which is set by the marginal (i.e. most expensive) unit.  PJM then assesses the costs for those capacity payments on load (customers) in the PJM region. These capacity payments are in addition to payments that generators receive for the energy they sell from their generation.  
 
The May 2011 Capacity Auction
In May 2011, PJM conducted the capacity auction for the 2014/2015 capacity year.  Market analysts predicted the May 2011 auction would clear at moderately increased levels in comparison to the last two years (which cleared at $16 and $27 per megawatt/day, respectively).  Specifically, Macquarie Equities Research reportedly estimated that the RTO price would clear at $40.  Barclays Capital reportedly predicted the price would clear at $50.  Instead, PJM announced that the market clearing price skyrocketed to $125.   These results even surprised the analysts who watch these markets (See Platts Megawatt Daily, May 17, 2011, “PJM Capacity Market Stuns Market Analysts”).  In its report on auction results (see attached), PJM concluded that:
 
On March 16, 2011, the U.S. Environmental Protection Agency (EPA) issued a notice of proposed rulemaking in a proceeding to promulgate final maximum achievable control technology (MACT) emissions standards for hazardous air pollutants (HAP) from coal‐ and oil‐fired electric utility steam generating units, pursuant to section 12(d) of the Clean Air Act. A final rule is due by November 16, 2011.  Compliance from existing resources would be required approximately three years later, likely in early 2015, which implicates the 2014/2015 Delivery Year.
 
Compliance with increasingly stringent environmental regulations requires generation resources to install emission mitigation technology which increases the avoided cost offers of these resources. These increased costs were a significant contributor to the increase in clearing prices in the western part of the PJM RTO. The increasingly stringent environmental regulations had a two-fold impact on western PJM clearing prices: (1) generation resources affected by the increasingly stringent rules, the majority of which are located in the western part of the PJM RTO, could include the cost of investment needed to comply with the new regulations in their cost-based offer price and (2) the amount of offered MWs from generation resources decreased because the resource owners decided the resources were not viable to comply with future regulations and therefore will deactivate as opposed to installing equipment to comply with the new rules.
 
The Impact on the Clearing Price
• The May 2011 auction cleared over 142,000 MW of capacity for the unconstrained areas of PJM.
• The System Marginal Price (the basis for the market clearing price) was over $125 per MW/day.
• This represents an increase of over $97 dollars per MW/day over the clearing price from the last annual auction and a $75 increase from the price expected by Barclay’s. 
• PJM concluded that “60 to 80%” of the increase in generators bid costs in the May 2011 auction was due to environmental regulations.
• Even if one assumes that the market price would have cleared at higher levels than the last auction (e.g. the $50 price expected by Barclay’s), the proposed EPA Regulations just caused an increase in electric capacity prices of approximately $2-3 Billion for a one year period, in the PJM region alone. 
• Analysts have concluded that these prices are not “likely decline meaningfully anytime soon, and thus, we expect the clearing price levels to remain relatively elevated (versus the 2013/2014 auction) for the foreseeable future.”

Has the EU met its emission reduction targets under the Kyoto Protocol? Not if emissions associated with goods Europe imports from Asia are taken into account. So finds a study published this week in Proceedings of the National Academy of Sciences (PNAS).

The study, Growth in emission transfers via international trade from 1990 to 2008, calculates the net increase in global carbon dioxide (CO2) emissions resulting from developed countries’ imports of goods produced in developing countries. The study provides additional evidence of Kyoto’s futility, although the authors, a team of Norwegian, German, and U.S. researchers, don’t draw this conclusion and would likely deny it.

Some key findings:

• Global CO2 from the production of traded goods increased from 4.3 gigatons (Gt) in 1990 (20% of global emissions) to 7.8 Gt in 2008 (26%).
• Emissions from production of exports increased 4.3% annually, faster than the growth in global population (1.4% per year), CO2 emissions (2.0% per year), and GDP (3.6% per year), although not as fast as the dollar value of international trade (12% per year).
• Global emissions increased 39% from 1990 to 2008. At the regional level, emissions from developed countries (classified as “Annex B” countries in the Kyoto Protocol, with quantified emission limitations) largely stabilized, but emissions from developing countries (non-Annex B) doubled.
• However, territorial emission inventories don’t take into account “consumption-based emissions” — CO2 emitted in developing countries to produce goods consumed in developed countries.
• The “net emission transfers” via international trade from developing to developed countries increased from 0.4 Gt CO2 in 1990 to 1.6 Gt CO2 in 2008 — 17% per year average growth. 
• Developed countries ”imported” more emissions than they reduced domestically via efforts to comply with the Kyoto Protocol.
  • “For comparison, if the average emission reduction target for Annex B countries in the Kyoto Protocol (~5% reduction of 1990 emissions) is applied to CO2 emissions only, representing ~0.7 Gt CO2 per year, then the net emission transfers from non-Annex B to Annex B countries is 18% higher on average (1990-2008) and 130% higher in 2008.”
  • “Because estimated Annex B emission reductions from 1990 to 2008 are only ~ 2%, representing only 0.3 Gt CO2, the net emission transfers from the group of non-Annex B countries is 520% higher in 2008.”
  • “Collectively, the net CO2 emissions reduction of ~2% (0.3 Gt CO2) in Annex B countries from 1990 to 2008 is much smaller than the additional net emission transfer of 1.2 Gt CO2 from non-Annex B countries . . .”
• China’s emissions accounted for 55% of the growth in global CO2 emissions from 1990 to 2008. Chinese exports accounted for 18% of the growth in global emissions and for 47% of the growth in Annex B consumption-based emissions.
• Curiously, “International trade in non-energy-intensive manufactured products dominates the net emission transfers (accounting for 41% of the growth), despite the policy focus on energy-intensive manufacturing.”

In the discussion section of their paper, the authors observe that the increase in consumption-based emissions “may benefit economic growth in developing countries, but the increased emissions could also make future mitigation more costly in developing countries.” Right, but that has two obvious implications the authors do not mention: (1) Developing countries are unlikely to accept mandatory emission limits in the foreseeable future; and (2) Kyoto-like controls on developing country emissions could be harshly disruptive to global trade and investment.

The authors argue that the rapid growth in “imported” emissions is not a case of “carbon leakage” — the flight of capital, jobs, and emissions from countries with CO2 controls to countries lacking such controls. They find, for example, that “both the United States and European Union have had a large increase in net emission transfers, but only the European Union has a broad-based climate policy.”  

Undoubtedly multiple factors contribute to the rapid growth of China’s export sector. However, one factor boosting investment in China is low energy cost. A closely related factor is the regulatory certainty that Beijing will not slap a price on carbon in the policy-relevant future or erect political roadblocks to the development of energy resources and infrastructure. How very different is the political climate in the USA! 

America may not have a “broad-based climate policy,” but we have an EPA bent on ‘legislating‘ climate policy via the Clean Air Act, an EPA implementing a panoply of non-climate regulations with the same (or even greater) potential to suppress electric generation from coal, regional greenhouse gas policies, state-level renewable energy mandates, an environmental movement hostile to fossil fuels and natural resource development, politicians in Congress and the White House imbued with the same mentality, and countless NIMBY activists determined to block construction of all energy-related infrastructure.

The researchers, methinks, take too narrow a view of the policy-related risks that can cause or contribute to carbon leakage.