Off to my sister-in-law’s graduate school graduation from Stanford; have a great weekend! LK
This morning the Environmental Protection Agency released its report on new source review (NSR). NSR is a feature of Title 1 of the Clean Air Act, under which new power plants or refineries would have to meet more stringent abatement technology standards. Under interpretations of the Clean Air Act (that may have gotten stricter over the 1990s), existing facilities have to meet those requirements if they upgrade, but if they make only small, routine changes, those changes do not trigger NSR. One of the most contentious aspects of this regulation is the definition of an upgrade.
Clearly, then, where you draw the line for interpreting maintenance exclusion versus upgrade, and how bright that line is, matters a great deal for whether or not an electric plant or a refinery has an incentive to upgrade its facilities to more energy-efficient or less polluting technologies. This issue of regulatory uncertainty is paramount in determining whether or not further investment is going to take place. Electric plants and refineries have to balance the operational flexibility they require to respond to unanticipated changes in supply or demand with the choice of whether to invest in an upgrade that may or may not trigger a NSR. The conclusion of the report states that
“With respect to the maintenance and operation of existing utility generation capacity, there is more evidence of adverse impacts from NSR. Credible examples were presented of cases in which uncertainty about the exemption for routine activities has resulted in delay or cancellation of projects which sources say are done for the purposes of maintaining and improving the reliability, efficiency and safety of existing energy capacity. Such discouragement results in lost capacity, as well as lost opportunities to improve energy efficiency and reduce air pollution … “
“Our findings in this report ratify a longstanding and broadly-held belief that parts of the NSR program can and should be improved. For example, we conclude above that changes to NSR that add to the clarity and certainty of the scope of the routine maintenance exclusion will improve the program by reducing the unintended consequences of discouraging worthwhile projects that are in fact outside the scope of NSR.”
This issue raises two very important points about the economics of NSR. First, one of the environmental group participants is cited as stating that it does not “believe that there is sufficient information to conclude that NSR is a primary factor driving decisions to invest or not to invest in capacity.” Whether or not NSR is a primary factor driving investment decisions is irrelevant; what matters is whether or not at the margin the presence of NSR induced firms to delay or avoid investments that would have increased energy efficiency and reduced emissions. The environmental group cited is concerned about the magnitude of the effect of NSR on the investment decision, when it’s the sign of the effect (more investment, less investment, or no effect) that’s important. (note: this kind of logical error is the sort of thing that drives us economics professors batty.)
Second, where you draw the line does not influence investment decisions as much as how bright the line is. In other words, regulatory uncertainty can lead to substantial delays in or avoidance of new investment, because when it comes to environmental regulation many firms are risk averse.
Does the existence of NSR change investment decisions at the margin? If it does, does that effect result in increased, decreased or unchanged emissions? Those are the core questions. The report indicates that NSR does change investment decisions for existing facilities, but that the overall effects on emissions reductions that have not happened are small. Those effects are concentrated in pollutants not covered by existing cap-and-trade programs.
The EPA wrote seven recommendations to accompany the report; four of these seven were proposed in 1996 and are in the process of being implemented:
* A simplified application process for pollution control and prevention projects
* Plantwide applicability limits (PALs) to offer plants more operational flexibility and regulatory certainty
* Clean unit operational flexibility
* Changing the calculation of the actual emissions baseline away from the existing 24-hour full running capacity baseline
Three new recommendations are
* Clarification and simplification of the definition of routine maintenance, repair and replacement
* Enable companies to “debottleneck” their facilities through a streamlined process
* New, simplified criteria for aggregation of multiple simultaneous projects
For more information on these recommendations, see the EPA’s NSR website.
This report reflects the importance of trying to achieve as much emission reduction as makes economic sense, at as low a cost as possible; when I teach environmental economics I call this the “value for money” approach that lies at the core of economics and human decision-making. NSR may create environmental benefits through emissions reduction, but can we achieve those (and more) reductions at lower overall cost through changing the implementation of NSR? The recommendations in this report suggest that this “more value for money” approach is possible.
A Bloomberg story on the report is available here.
California politicians, and others who want a clear, black-and-white, well-controlled, orderly world for electricity markets, are not going to like this. Federal Energy Regulatory Commission Pat Wood pointed out today that some wash trades might be legitimate. Electricity generators operate with pretty stringent delivery commitments because of the nature of electricity — it can’t be stored, and with an alternating current system like we have, system balance is crucial to the reliability of the grid. What that means is that to achieve system balance, which is done with transactions occurring every ten minutes, sometimes generators may have to buy and sell electricity simultaneously with another party. That’s a wash trade of the type that got the CEOs of CMS and Dynegy to resign last month. Other energy companies also used wash trades as a price hedge, which is another volatility-reducing benefit that wash trades can serve when used responsibly. Boy, it sure messes up a neat, pat concept of regulation of electricity markets to have something that can be abused be an essential part of keeping the juice coursing through the grid at more stable prices …