Have You Scrubbed Your Congressman Today?

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by Michael R. Goldman, PowerAdvocate

The lack of clear environmental emission standards is causing the power generation industry to miss taking advantage of low commodity prices. Without regulatory certainty surrounding the emission of SO2 and NOX, many large, capital-intensive, environmental retrofit projects will not go forward soon. As most regulated utilities are able to pass major capital costs to ratepayers through increased electricity prices, consumers will lose when new regulations that force utilities to construct sophisticated environmental technologies finally emerge.

The Bush administration's biggest emissions effort, the Clean Air Interstate Rule (CAIR), was enacted by the Environmental Protection Agency (EPA), whose authority to issue such regulations has been questioned. The type of regulations that must emerge for projects to go forward should come from Congress—not the EPA—to cut implementation time and give utilities an opportunity to contract for new projects while raw material prices remain low.

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Despite CAIR's December reinstatement, there still is little regulatory certainty regarding federal emissions standards. The U.S. Circuit Court that reversed its earlier vacatur of CAIR remains convinced the rule is flawed and will not allow it to go unchanged indefinitely. The EPA must decide to alter CAIR or to scrap it and formulate a new rule that takes into account the court's concerns. Additionally, the Bush administration's Clean Air Mercury Act also was vacated, but it never was reinstated. Any revision to these rules will take several years. New regulations will emerge, but it is a matter of when and the stringency.

Utility companies acknowledge that stricter regulations will be forthcoming. After the vacatur of CAIR, one of the original plaintiffs, Duke Energy, lobbied to reinstate CAIR because of its environmental benefits. Ameren mentioned in its most recent 10-K that existing and future federal regulations could lead to billions in additional costs. During her confirmation hearing, EPA Administrator Lisa Jackson explicitly singled out nongreenhouse gas air pollution as a priority during her tenure at the EPA. She highlighted emission reduction as a top concern for herself and President Barack Obama.

The current regulatory ambiguity will cost ratepayers in the long run. Eventual higher overall material costs will lead to more expensive environmental projects, and these costs will filter down to electricity end users. A majority of states have not deregulated the power generation industry, allowing companies to enjoy monopolies in specific markets in return for price controls. If a utility company needs to undertake large capital projects such as the construction of a selective catalytic reduction (SCR) system to remove NOX or a scrubber to remove SO2, it can apply to the governing public utility commission for an electricity rate increase to recoup its costs. The sizes of those costs are significantly lower now than in recent history.

If CAIR-replacement legislation requires scrubbers at every plant instead of allowing emission-allowance trading, its timing will play a large role in the associated costs. Currently there are some 200,000 MW of unscrubbed U.S. coal power generation. Given an estimated average cost of $500 per kilowatt to build a scrubber, PowerAdvocate estimates these costs could escalate to $530 per kilowatt by next year's end. If new federal legislation is not produced until the end of next year, then the difference in cost of retrofitting the rest of the coal fleet from now until then could be nearly $6.2 billion. Furthermore, if new regulations do not emerge until the middle of 2011, additional costs could total $9.2 billion. Because the Washington, D.C., Circuit Court specifically cited the ability to trade allowances as a reason certain states were unable to comply with CAIR, it is reasonable to think that new regulations will be of the command and control type. A similar situation exists with SCRs. If legislation that required all coal-powered generation facilities that do not currently use an SCR to retrofit their plants emerged by the end of next year, the additional costs would be some $5.1 billion. If that legislation was not promulgated until the middle of 2011, the additional cost could be up to $8.6 billion. Electricity consumers will bear most of these costs.

Moody's estimates that if a price of $20 is put on a metric ton of emitted carbon dioxide, it will cost the utility industry an additional $48 billion (see Figure 1). A delay in government action to regulate SO2 and NOX could cost utilities an extra $18 billion. That is approximately $60 extra per person in the United States on top of the $660 per person it would cost to retrofit the remaining coal fleet with environmental controls.

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States that choose to institute their own stringent requirements are running into regulatory hurdles. A new Pennsylvania law that was meant to introduce strict mercury-emission limits is being challenged because potential new federal regulations could be more stringent than the state's and impose undue financial hardship on utilities if they were forced to add more equipment later. Unclear federal requirements directly impact states' abilities to formulate their own regulations. In a statement given to SNL Energy, Reliant Energy explicitly stated that regulatory uncertainty is a main reason it will not add a sulfur oxide scrubber to its Shawville, Penn., plant.

With no firm federal or state regulations, most utilities cannot go forward reasonably with large capital projects. Utilities are forced to wait and see what new regulations emerge.

To compound the problem, once new regulations are put forth there will be a lag time between the finalization of any new rules and when companies must meet the new regulations. Utilities will be given sufficient time to meet new standards, but this potentially could allow commodity prices a chance to rebound significantly.

In a Jan. 17 letter to The New York Times, former EPA Administrator Stephen Johnson said one of the biggest issues with CAIR was that it was promulgated by the EPA and not through Congressional action. A new law with enumerated emission standards coupled with achievable timelines would provide the utility industry with the certainty necessary to undertake large capital projects. A main challenge brought against CAIR was the accusation that the EPA had gone beyond the authority granted to it by the Clean Air Act in formulating this regulation. If Congress passed new laws that gave the EPA the regulatory ability to impose a market-based SO2- and NOX-reduction system, many of the objections that derailed CAIR would subside.

By passing a new multipollutant law now, the administration could satisfy several constituencies. Environmentalists would be pleased with the impacts created by immediate reductions in criteria pollutants. People concerned with possible negative economic impacts of regulations would be mollified that low commodity prices would heave down project costs. One of President Obama's closest economic advisors, Larry Summers, repeatedly has expressed concern that new emission regulations could hamper the U.S. economy. Acting now could minimize the negative economic impacts, but the key is timing.

With approximately half of the nation's electricity supply coming from coal, it will be necessary to continue burning coal for the foreseeable future. To continue to burn coal and mitigate health hazards, emission-control systems must be placed on as many plants as possible. Some utilities are considering closing coal-fired plants or reducing the number of hours they run to meet state consent decrees regarding emission standards instead of installing emission controls because of cost and regulatory uncertainty. In March, Midwest Generation revealed in its 10-K that it is considering closing some of its coal-burning plants for this reason. According to the 10-K, “Midwest Generation may ultimately decide to comply with [Illinois state mercury, NOX and SO2 emission] requirements by shutting down units rather than making improvements.”

Switching from coal to other fuel sources could prove costly for utility customers. The most likely alternative fuel source in the short term is natural gas. The New York Times has reported that electricity rates from natural gas generated-power plants can be up to 40 percent more expensive than from coal plants in some parts of the nation. After moderating the past few months, natural gas prices might be on the rise again as President Obama's proposed budget eliminates certain tax deductions for domestic natural gas production and proposes some new taxes, as well. The ratepayer loses.

It is critical that new legislation emerges now while commodity prices remain at dramatically lower levels than last summer's highs. Falling commodity prices, especially steel, copper and aluminum, have caused the price inputs for environmental retrofit projects to drop. As of the end of February, copper was down more than 60 percent since summer 2008, with aluminum down 58 percent, nickel down 55 percent, carbon steel down 52 percent and stainless steel down 35 percent. These cost reductions are significant. Steel by itself can represent some 15 percent of the cost of a total scrubber project. Hypothetically, the reduction in steel could cause a 7.5 percent reduction in overall project costs—not an insignificant figure given that these projects often run into the hundreds of millions of dollars.

According to the PowerAdvocate capital cost indices, the costs for a wet scrubber project have declined significantly during the past two quarters (see Figure 2). With raw materials forecasted to decline the next few quarters before they stabilize and rebound, the time to contract for new projects is now. PowerAdvocate has observed many successful instances where utilities negotiated lower prices for engineered equipment, the target prices or lump sum prices for EPC work because of lower input prices. These opportunities, however, will be short-lived. As soon as commodity prices begin to rise, vendors unlikely will be amenable to price reductions.

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With low commodity prices, almost any type of contract is likely to yield savings. If EPCs are calculating their fees off of a percentage of material costs, the dual impact of lower material prices and lower EPC fees is clear. Additionally, contingency fees calculated off of total project value or material costs will be substantially lower now. Any new contracts should make sure there are de-escalation clauses in addition to escalation rates.

In a struggling economy, it is essential that electricity costs remain low, but environmental issues cannot be ignored. A simple solution to both problems is for Congress to pass clear, workable emission standards that utilities can act upon in a timely manner. The opportunity to achieve significant costs savings is diminishing, so action is required now.

Author

Michael Goldman is an energy business analyst at PowerAdvocate with an emphasis on environmental technologies. He received his bachelor's degree from the University of Wisconsin and his master's degree from the Johns Hopkins University. Reach him at michael.goldman@poweradvocate.com.

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