Is It A Market Failure, Or Failing To Allow A Market To Arise?

Lynne Kiesling

On Tuesday afternoon I attended a session at the annual NARUC meetings on the potential for IGCC Integrated Gasification Combined Cycle technology and impediments to investment and implementation. IGCC essentially is a process for turning coal into synthetic natural gas, which puts the coal through a gasifier, extracts pollutants like particulate matter and sulfur dioxide, and leaves a gas that can be used in the same way as natural gas.

This technology is important and has a lot of potential to address many potentially conflicting objectives. If you are worried about energy independence and want to reduce U.S. reliance on foreign energy supplies, IGCC can reduce the demand for liquefied natural gas (LNG) imports. If you are worried about high natural gas prices and believe that they will continue at around $6/million BTUs, then IGCC could provide a cost-effective alternative to natural gas. With natural gas prices around $6, even if you have to expend resources to gasify the coal it can be cost effective (if the presentations I saw today are realistic, and I think they are). If you are concerned about the environment, IGCC allows you to use even high-sulfur coal while producing very low emissions. I know of one chemical manufacturer that has been using IGCC for a while because of the combination of these features. Plus, one of the presentations on this session suggested the opportunity to sell 99.9% pure sulfur, which means that firms using IGCC can turn polluting waste into a revenue stream.

Yet the technology is sufficiently new and unproven that few IGCC facilities are being built. This slow adoption is a bit of a conundrum to the panelists I heard today, especially if you think about the possibility of basically bolting on a gasifier to an existing natural gas power plant. With high natural gas prices, the ability this technology gives you to substitute from expensive natural gas to synthetic gas from cheap coal should be very valuable.

One presenter in particular, David Berg from the DOE’s Office of Climate Change Policy, attributed this lack of investment to market failure. Apparently any time someone does not invest in a technology that looks beneficial but is high risk, thatís a market failure.

Hereís my first question: why is that a market failure? If investors attach a particular risk premium to a particular opportunity, and you donít like that risk premium or think that it is inaccurate, what makes that a market failure? Perhaps if you can show at a range of discount rates and over a range of risk preferences that the internal rate of return on the investment is positive, yet itís still not happening, then you can argue market failure.

But in both Mr. Bergís presentation and the subsequent presentation from Bill Rosenberg (JFK School of Government, Harvard University) (the link is to a pdf that discusses his 3-party covenant idea for investment financing), when they attempted to substantiate the claim of market failure, all of the factors they highlighted were regulatory barriers facing the investment market.

First, building IGCC plants typically costs more than alternative technologies, so often state PUCs hesitate to allow the costs to be incorporated into the rate base. How is that a market failure? Sounds to me like the application of the prudency standard for evaluating utility costs is the barrier, and is the transaction cost in this case.

Second, this technology is not as mature and proven as alternatives, so investors tend to go with others. How is that a market failure? It sounds to me like the way the world works, and the way the world has always worked. New technologies have always faced implementation hurdles when competing with more mature, known technologies. Why is IGCC relative to, say, pulverized coal technology any different from the steam engine relative to the water wheel in the late 18th century? New technologies compete uphill. Get over it.

Both Mr. Berg and Mr. Rosenberg advocate federal government loan guarantees to change the risk calculation of the potential investor. I have a simpler suggestion: if one of the valuable features of this technology is its cleanliness, let retail customers choose whether or not they want to buy power generated from clean technologies. If they value clean air, they should be willing to pay more for IGCC-generated power relative to pulverized coal-generated power. That customer willingness to pay should make the economics of the IGCC plant make sense, making it a more prudent investment.

It all comes back to customer choice and customer preferences. Itís unfair to them to leave their preferences out of the policy discussion, and out of the determination of the technologies that are used to generate the power that they purchase to fuel their various and diverse uses.

Itís also wrong to call something a market failure when the transaction costs that are preventing a market from behaving the way you think it should are the consequence of either regulatory constraints or risk preferences.


11 thoughts on “Is It A Market Failure, Or Failing To Allow A Market To Arise?

  1. I don’t know if it counts toward green power, and I suspect that since that certification varies across states that its inclusion would vary.

    I see a slippery slope problem — if we include IGCC as “green power”, then why not traditional natural gas? And that’s one of my criticisms of green power programs, renewable portfolio standards, etc. — they all end up being bureaucratic and fiddly.

  2. I’m surprised that the crowd hollering for “No blood for OIL!” has not embraced this alternative fuel source. With coal you would not have to worry about funding Joe Jihadi, and the extraction technology makes it much cleaner than burning the “raw” coal. Extra generated natural gas can go towards powering all of those Prius’s and other efficient cars. Well, you still have the problem of greenhouse-favoring carbon dioxide emissions, so maybe we just need to build more nuclear power plants.

    A bond issue should take care of financing some extraction plants. I would like to see some of the money that the President has earmarked for hydrogen go to IGCC, since it seems much more feasible in the short term than the “magic” hydrogen solution.

    The main question I have with going forward on IGCC concerns supply. Has the US tapped out it’s reserves of natural gas and has a significant need to import? Are our ports ready to process the quantities of liquified natural gas we need to make up the difference between future consumption and supply? Even if we do import, we still face the prospect of being held hostage (again) down the road.

  3. MarcV, I’ve got an analysis piece about to go up which addresses those points; the premise is that we need to cut petroleum and can’t depend on any increase in natural gas, so we turn in a big way to coal, wind and cogeneration (which squeezes more out of what we’re using anyway).  IGCC with cold-gas cleanup (H2S removal) also captures the CO2 produced in the gasifier, and this CO2 can be sequestered relatively easily should that be desirable.

    The one thing we don’t really want to do is make synthetic natural gas or gasoline a feature of such a program.  We can use syngas (roughly 63% CO, 37% H2) for most of the same purposes as CH4, and it’s cheaper and more efficient to make methanol from syngas than longer-chain hydrocarbons.  Any racing enthusiast will tell you that methanol makes perfectly good motor fuel.

    Regarding your questions:  The US is already importing huge amounts of gas from Canada, prices have risen steeply due to shrinking supply, and there is rising opposition to ports for LNG tankers.  We will face that same embargo situation as we do with oil if we go that way.

  4. You don’t mention it, but I have to assume that in order to build one of these plants, you have to go through a full scale enviromental permit process, including discovering that a species of worm in your valley is endagered.

    The NIMBYS and the NOPEs will come out in full force and explain that the facility is dangerous, the energy is not needed becuase people could conserve more if they would just learn to live like Bengali pesants, and we should be building renewable energy resources such as wind, solar and biomass (they will oppose those latter in other proceedings if and when necessary).

    You will be sued in Federal court, and the Federal Judge who has no idea of what any of these crazy people are talking about, will put the file over under the potted palm to work on rainy days, and go back to trying bank robbers and cocaine dealers.

    Interesting technology, yes. Uninteresting legal enviroment, more so.

  5. (Why was my first comment removed?  It puts Lynne’s reply to it out of context.  My e-mail address is public, there is no reason to do such things without contacting me about any problems.)

    Roger, I expect that such repowering projects can be done on the original “brownfield” sites.  Achieving 99+% sulfur removal, a high degree of NOx reduction and mercury abatement would please the locals everywhere I’ve been, and so would the construction jobs.

    I’m one of the people annoyed by Bush’s move to allow dirtier powerplants than previous regulations.  Every KWH made by an ultra-clean IGCC powerplant means less need for power from the dirtier ones; everybody wins.

  6. E-P,

    When you refer to “Bush’s move to allow dirtier powerplants than previous regulations”, I presume you are referring to the Clear Skies Initiative and are comparing it to Clinton-era NSR enforcement. The Clinton EPA did not change the NSR, they merely reinterpreted the extent of the changes which triggered NSR and used the courts to enforce the reinterpretation. EPA acknowledges that this NSR enforcement approach has delayed or effectively prevented minor improvements in efficiency and/or emissions in its efforts to force major plant overhauls. Clear Skies would actually achieve more, faster than this NSR approach, but it does not satisfy the regulators’ preference for command and control approaches to problem solving.

    EPA and EIA data also document that the operating rate and emissions from uncontrolled coal plants actually increased during the Clinton-era NSR enforcement regime. EPA refers to this as an “unintended consequence”, although it certainly was not unpredictable.

  7. E-P,

    When you refer to “Bush’s move to allow dirtier powerplants than previous regulations”, I presume you are referring to the Clear Skies Initiative and are comparing it to Clinton-era NSR enforcement. The Clinton EPA did not change the NSR, they merely reinterpreted the extent of the changes which triggered NSR and used the courts to enforce the reinterpretation. EPA acknowledges that this NSR enforcement approach has delayed or effectively prevented minor improvements in efficiency and/or emissions in its efforts to force major plant overhauls. Clear Skies would actually achieve more, faster than this NSR approach, but it does not satisfy the regulators’ preference for command and control approaches to problem solving.

    EPA and EIA data also document that the operating rate and emissions from uncontrolled coal plants actually increased during the Clinton-era NSR enforcement regime. EPA refers to this as an “unintended consequence”, although it certainly was not unpredictable.

  8. Ed:  Your presumption is correct.  However, your account of the chain of events is AFAIK incomplete, and thus misleading.  My understanding is more like this:Congress passed the language regarding New Source Review, assuming that the normal retirement of old plants would guarantee the reduction of pollution from the electric power industry.  Naively, Congress did not force a replacement schedule.The industry reacted to this by eliminating replacement and refurbishing plants instead.The Clinton EPA re-interpreted NSR to effectively force the cleanups on refurbishments as well as replacements, making the results more in line with the original Congressional intent (except for more lawyers involved).

    The Orwellian “Clear Skies” program allows the utilities to get into full compliance with the law without cleaning up nearly as much as a.) the original language required, b.) the Clinton-era NSR changes attempted to force, or c.) today’s technology allows.  With the current administration we’ll continue to suffer with pollution that could have been eliminated, with all the athsma deaths and toxic game fish that implies.  I don’t think that’s right, and I think Bush is despicable for painting it as progress.

  9. November 20, 2004 Fuel of the Future? Some Say Coal By SIMON ROMERO

    “If it’s such a great deal, then let them build the thing in California,” Mr. Bogard, 56, the owner of a pottery business, said. “I’m not sure if anyone involved with this realizes what a nightmare it is to have a plant spewing coal fumes go up in their backyard. This would simply destroy our life out here.”

    * * *

    Still, like Mr. Bogard, some of the people who came to Gerlach to distance themselves from the bright lights of the city are concerned over the potential environmental impact of a coal-fired plant. And they worry that a large industrial complex would ruin the aesthetics of a quiet natural swath of northern Nevada’s playa, or desert flats.

    * * *

    But it will not be without a fight. Environmentalists, working with some local residents, have begun marshaling opposition. “No matter how clean the technology for coal-fired plants, they still contribute to pollution by dumping tons of material in the air basins and beyond,” Susan Lynn, executive director of Public Resource Associates, a nonprofit organization that works on land policy issues, wrote in a recent letter to Nevada’s public utilities commission. Ms. Lynn also said that Sempra’s project would block opportunities for renewable energy companies in the area.

  10. November 20, 2004 Fuel of the Future? Some Say Coal By SIMON ROMERO

    “If it’s such a great deal, then let them build the thing in California,” Mr. Bogard, 56, the owner of a pottery business, said. “I’m not sure if anyone involved with this realizes what a nightmare it is to have a plant spewing coal fumes go up in their backyard. This would simply destroy our life out here.”

    * * *

    Still, like Mr. Bogard, some of the people who came to Gerlach to distance themselves from the bright lights of the city are concerned over the potential environmental impact of a coal-fired plant. And they worry that a large industrial complex would ruin the aesthetics of a quiet natural swath of northern Nevada’s playa, or desert flats.

    * * *

    But it will not be without a fight. Environmentalists, working with some local residents, have begun marshaling opposition. “No matter how clean the technology for coal-fired plants, they still contribute to pollution by dumping tons of material in the air basins and beyond,” Susan Lynn, executive director of Public Resource Associates, a nonprofit organization that works on land policy issues, wrote in a recent letter to Nevada’s public utilities commission. Ms. Lynn also said that Sempra’s project would block opportunities for renewable energy companies in the area.

  11. E-P,

    Even under the Clinton-era enforcement regime, plant owners could refurbish any component or components of a plant, and/or replace any component with an identical component without triggering NSR. What they could not do is replace any failed or worn component with a component which resulted in higher efficiency or reduced emissions without triggering NSR. Thus, plants which could have improved marginally in the refurbishment process were merely repaired and/or had parts replaced. Those that chose to try to marginally improve their plants paid the price in court, in the process convincing their peers to avoid any attempt at plant improvement.

    While it makes no sense, from an ownership or operating perspective, not to take advantage of potential plant improvements, it also makes no sense to fight the feds in court over marginal improvements when a loss means massive investment in an old plant with a relatively short remaining useful life.

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