Putting the Carbon Proposal Into Perspective

 | Jun 02, 2014 | 4:35 PM EDT
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Today, the Obama administration did nothing more than offer a proposal to reduce carbon dioxide emissions. No legislation or regulation has been locked in. It will take a year before any rule is finalized. In the meantime, there will be adequate opportunities for states, utilities and other stakeholders to comment and help shape a final rule.

The Environmental Protection Agency's (EPA) proposed rule is 645 pages. There are interesting nuggets. Allow me to share five.

1. The EPA's proposed regulation is another nail in the coffin for coal.

For more, see Dan Dicker's piece. You can read it here.

2. From a policy perspective, the EPA's proposed regulation appears flawed.

If the administration's objective is to reduce carbon dioxide, then the EPA's proposed rule should focus on carbon dioxide. Instead, the proposal focuses on power plants.

The EPA's Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990-2012 argues that power plants produced 2,023 million metric tons of carbon dioxide in 2012. In the very same year, the transportation and industrial sectors produced 2,514 million metric tons, which is 25% more than power plants did (page 35). Yet the EPA's focus is on power plants, and it gives Vermont and the District of Columbia a free pass on carbon regulations, simply because they do not have any affected power plants (page 346 of the EPA's proposed rule).

Vermont and the District's economic activities contribute to the nation's carbon dioxide problem. They should join the rest of the nation and contribute to a solution.

3. The EPA's proposed rule is not as bad as first reported.

The EPA's proposed regulation uses 2005 as the benchmark. That year, the U.S. produced 5,700 million metric tons of carbon dioxide (not including territories). The EPA's 2030 target is about 4,000 million metric tons, which would be a 1,700 million metric ton reduction.

It turns out that 2005 was a peak year for carbon dioxide production. By 2012, the U.S. produced only 5,000 million metric tons. This amounts to a 700 million metric ton decrease, which has already occurred. The change from 2005 to 2012 represents 40% of the EPA's long-term objective. Consequently, 40% of the proposed regulation has already been achieved.

It appears that carbon dioxide production for 2013 and 2014 will be even lower than for 2012. As more renewable energy resources come on line in 2014, 2015 and later, less carbon will be produced. In addition, as old coal and natural gas plants retire for cross-border and other reasons, even less carbon dioxide will be produced.

It appears that the impact of the proposed regulation on the industry will be small. In addition, it appears the administration did not need a new rule.

4. The EPA's proposed rule is not as good as some hoped.

The EPA's rule is about carbon dioxide. It will be up to individual states to develop their own carbon policies. While the EPA's proposed targets were based on power plants, states can use other means to achieve carbon dioxide objectives.

Consequently, natural gas does not get a free pass. As long as a state meets the carbon dioxide objectives, it may elect to keep an efficient coal unit and retire an inefficient gas-fired plant. In addition, a state may block construction of new gas plants if those plants prevent it from achieving attainment.

Nuclear power gets a boost. The EPA's proposed rules arrive too late for existing fleets owned by Exelon (EXC), Entergy (ETR) and others. However, proposed rules assure that new nuclear units under construction by Southern (SO) and SCANA (SCG) will likely be completed. In addition, the rules may help NextEra Energy (NEE) finalize plans to build Turkey Point 3 and 4, which are new nuclear units planned for South Florida.

5. Incredibly, the EPA's proposed rule could actually help coal utilities.

For the last several years, NRG Energy (NRG) has been buying used coal plants. Today, it owns the nation's largest fleet of coal-burning power plants. While it may seem counterintuitive, NRG's coal plants could turn into cash machines. Let me explain.

First, when NRG bought its fleet, it expected to operate those plants for only a few years. After a short time, NRG planned to retire several units and book a reasonable return on investment.

When NRG bought its coal units, it got power plants and more. In addition to boilers and turbines, it bought air permits.

Today, air permits are difficult to acquire. In many states, the only way a company can acquire an air permit is to buy it from an existing holder.

NRG's air permits provide it with optionality. The company can sell them. It can use them to build new power plants. It can trade them. They also can use them to negotiate with state regulators.

Previously, NRG's permits were worth a bundle. Now, EPA's proposed rules make them worth more. NRG may emerge as one of the big winners. American Electric Power (AEP) may be another.

Taking everything into consideration, existing policies and recent court decisions may make the EPA's proposal redundant. By itself, the rule's impact on the utility industry may be minor.

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