Towards a North American Price on Carbon

In March of 2014, the Canadian Electricity Association released a major document entitled Vision 2050: The Future of Canada’s Electricity System. The document established that if we want to reduce carbon emissions in the most economical way, pricing carbon in the economy was the only way to go. And we must recognize our electricity system, and our energy system, is continental, not national. I spent the remainder of 2014 and into 2015 talking about Vision 2050, both in Canada and the US. In these talks, when speaking of carbon pricing, I would make the statement we could see a North American price on carbon as early as 2020. Roughly a year later, I stand by that statement, using the same caveat I did back then: it will all come down to the US Supreme Court.

The usual reaction to my statement has always been there is no way Congress will ever agree to pricing carbon. That is true as long as the default option is “do nothing”. What if the default option is implementing a truly unworkable plan which does not recognize either the physics or economics associated with our continental electricity system?

A few months after the release of Vision 2050, the US EPA released a draft regulation under section 111d) of the Clean Air Act (known as the Clean Power Plan) in response to an Executive Order signed by President Obama in July of 2013. While many people believe this was driven solely by President Obama’s climate agenda, there is more to it than that.

The US Clean Air Act came into being in 1963 and has had three major amendments (1970, 1977 and 1990). The 1990 amendment authorized programs for acid deposition control (acid rain), authorized controls for 189 toxic pollutants and modified provisions concerning National Ambient Air Standards. You will not find (or at least I couldn’t) reference to carbon dioxide (which is on the Canadian toxic substance list). By contrast, the Canadian government can establish regulations under the Canadian Environmental Protection Act, which it did a few years ago for coal fired electricity generation. Rather, the focus of the Clean Air Act is criteria air contaminants such as sulphur dioxide, ozone (and its precursors such as nitrogen oxides and volatile organic compounds), mercury and other pollutants which have a direct link between concentration in the ambient air and negative heath impacts.

In and of itself, the Clean Air Act doesn’t seem to either compel or enable the EPA to regulate carbon dioxide. Of significance, the Clean Air Act is built around National Ambient Air Quality Standards and provides the EPA to issue regulations when these standards are not being met. There are no air quality standards for carbon dioxide however, and given the global nature of carbon dioxide, it begs the question of if an effective local, regional or national air quality standard can be developed?

In the 2000s, the EPA was actually sued by a number of environmental groups for failing to regulate emissions of greenhouse gases. In 2007, the US Supreme Court decided the EPA could in fact use its authority under the Clean Air Act to regulate emissions that cause or contribute to air pollution that may endanger public health or welfare as they deemed greenhouse gases met the Act’s definition of an air pollutant.

I have some degree of sympathy for the EPA, because no matter what they do, or don’t do, they get sued by someone.

Effectively this meant the EPA was now required to develop regulations to control emissions of greenhouse gases. The EPA determined that their existing vehicle, the Clean Air Act was their best tool. New Source Performance Standards for both gas fired and coal fired generation were the first focus and a final rule was published in October 2015 under Clean Air Act section 111b). The performance standards for gas and coal fired electric generation are not as stringent as the Canadian standards now in place (as of July 1, 2015), but still would require some use of carbon capture for new coal fired units.

Dealing with existing units is a little more difficult. Section 111d) is a “catch all” provision which allows the EPA to establish standards of performance for any existing source for any pollutant for which air quality criteria have not been established. The basic process is for the individual States to develop a State Implementation Plan, but provides for the EPA to prescribe a plan for any State which doesn’t submit a “satisfactory” plan. Section 111d) also allows the state to consider the remaining useful life of the existing source in developing its plan, another term open to interpretation (in Canada, the federal regulation for coal-fired generators has set useful life at 50 years).

Legal challenges emerged very quickly after the final rule was published. At the heart of the issue is the amendments made in 1990 to the Clean Air Act. The language in the United States Code is from a House amendment which conflicts with the wording of the Senate amendment. On February 9, 2016, the US Supreme Court overruled a lower Court and ordered the EPA to halt enforcement of the plan until a lower court rules on the challenges to EPA’s authority to issue the plan under Section 111d). The Supreme Court ruling was 5-4, apparently split along “party” lines. There is no doubt final resolution will be up to the US Supreme Court, perhaps sometime in 2017 or 2018. A few days after the ruling, Supreme Court Justice Antonin Scalia died suddenly. A 4-4 split decision would have left the lower court ruling unchanged and the stay would not have been granted. Whoever replaces Justice Scalia, and that will be a very politically charged process, could have a significant impact on the final legal ruling on the Clean Power Plan.

While many people claim surprise that the stay was granted, they should not. Regardless of the politics at play, the reality is the Clean Power Plan comes with very large costs and the potential to dramatically change the US electricity sector. So what is the Clean Power Plan all about?

In general, regulations under the Clean Air Act require the states to create State Implementation Plans (SIPs) of how they will apply the regulation. If the SIP doesn’t meet the EPA requirements, then the EPA can impose an implementation plan directly. Therefore the Clean Power Plan is to be implemented by way of SIPs.

The starting point for EPA in releasing a draft version of the Clean Power Plan in 2014 was to assign each state an intensity or rate target (lbs per kwh) for electric generation within the state. Targets were set for 2030, with an interim target for 2020. Targets were established using four building blocks to achieve a best system of emission reduction (BSER). The four building blocks were:

Heat rate (efficiency) improvement of existing coal fired generation

Dispatching gas fired (natural gas combined cycle) generation ahead of coal (which ironically will make coal fired generation less efficient if not base loaded)

Continuing and expanding energy efficiency programs

Continuing and expanding renewable and non-emitting generation (which included keeping all existing nuclear units in service, and completing the five new units currently under construction.

The EPA received 4.3 million comments on the proposed plan. As a result, there were a number of changes and clarifications made to the final plan released in the second half of 2015, which indicated the EPA seriously considered the input it received.

A large concern of industry was the potential impact on reliability of the electricity system. EPA revamped their modeling and looked specifically at the three major interconnects (Eastern, Western, and Texas). This was important because the electricity system is not built or operated within states, but across states, and the largest power market in the Northeast, PJM, covers many states. The feasibility of 2020 interim targets was questioned, along with a number of technology related questions. And from a Canadian perspective, while it appeared there were no barriers to states including Canadian clean supply in their plans, it was not expressly considered.

The final plan incorporates a number of significant changes from the original proposal. States were given effectively two (interrelated) targets: one mass based, one rate based. Rather than 2020 targets, a “glideslope” was established starting in 2022 towards the 2030 target. Proposed model rules for trading (one for rate based, one for mass based) were published. And the four building blocks were reduced to three.

The first building block of heat rate improvements for existing coal fired plants remains, but the calculated improvement was reduced to reflect what would be more realistically achievable.

The second building block of maximizing the use of gas fired generation over coal was also modified to recognize the expected utilization had to reflect summer capacity is less than winter capacity (reality of thermodynamics).

End use efficiency was removed from the target calculations, but is still available as a state tool.

The renewable energy block remains, but the contribution of nuclear units was left out of the calculation, although still within the states’ tool boxes.

Of importance to Canadian utilities, imports of “clean” power from Canada can be used in state plans.

The plan still significantly reduces the role of coal in the US electricity system, and hence the legal challenges. This remains a very expensive plan, and there remain questions on maintaining the reliability of the grid as more base-load resources are removed, especially if each state decides to go its own way. The final rule also set new emission performance standards for gas and coal fired units in 2030 which are more stringent than the New Source Performance Standards established in the past year, including a standard for natural gas combined cycle units which cannot be met with current technology in normal utility applications.

But we must also recognize the significance of establishing trading rules, because in the end, the “simplest” way forward to meet the Clean Power Plan requirements is emissions trading. In fact, the process to this point has a lot of similarities to the original focus of the 1990 Clean Air Act amendments: acid rain, and the resulting trading program of sulphur dioxide allowances. It is in this area which I see the way forward to a North American price on carbon.

While the focus currently is on the electricity sector, the legal factors which have pushed the EPA to regulate greenhouse gas emissions are not limited to electricity sector emissions, but emissions from stationary sources. In other words, electricity is the first sector, not the only sector which will be subject to regulation.

Should the Supreme Court eventually confirm the EPA has the right to regulate under section 111d) of the Clean Air Act, and not require too many changes to the Clean Power Plan (some time in 2017 or 2018), then Congress faces a different “do nothing” option with respect to carbon pricing more broadly in the US. The logical approach would be to look at a broader application of pricing carbon in the US economy, rather than a patchwork of regulations and different approaches in a variety of states. Whether it is cap and trade or tax is not relevant at this point, it is the consideration of carbon in the economy in broader terms.

From an electricity sector perspective, all greenhouse gas emissions should have equal weight in terms of taking action. It does not make sense to deal with electricity emissions separately from say transportation. In many jurisdictions, switching to electric vehicles from internal combustion engines may increase emissions from the electricity sector, but result in lower overall emissions. The efficiency of the market can only be brought to bear if a common approach is taken with respect to carbon pricing.

So, the road to a North American price on carbon pretty much starts, or ends with the US Supreme Court.

To complete the picture, some discussion on Canada’s role in this is required (since my premise concerns establishing a North American price on carbon).

On February 12, 2016, the Energy Ministers from Mexico, Canada and the US signed a MOU (North American Memorandum of Understanding on Climate Change and Energy Collaboration). This was a follow on from another tri-national MOU signed in December 2014, which built upon a Canada – US MOU signed in September 2014.

While the Canada-US relationship in recent years was typically examined under the context of Keystone XL pipeline related decisions, the working relationship on broader energy issues between Natural Resources Canada and the US Department of Energy has been positive, especially as it related to electricity.

In 2014, the US Department of Energy conducted a Quadrennial Energy Review examining Energy Transmission, Storage and Distribution Infrastructure. The scope of the QER included consideration of the “North American” nature of our interconnected energy systems, to the point, one of the regional discussion sessions was held in Ottawa.

The Canadian government is now engaging the Provinces in a discussion on climate action (an outcome of both the last federal election and commitments made in Paris last December), with a First Ministers meeting set for March 3, 2016. From what has been stated so far in the media, it sounds like it will be more about setting up processes than agreeing to a program. Having watched the process unfold for the Council of the Federation (the Premiers) to develop a Canadian Energy Strategy, it does feel like we are going down that same road again, this time with Federal government involved (and potentially First Nations). I remain skeptical the Provinces can really unite around a truly common national objective (I have been told more than once I have this view because I am from Toronto).

At the same time, however, it is questionable as to why we would undertake significant action on carbon when our major trading partner has yet to. Perhaps ragging the puck (to use a good Canadian cliché) is the right thing to do until the US Supreme Court decides the way forward.

From a Canadian electricity sector perspective, a North American price on carbon will provide considerable economic opportunity. We have a very low emission sector today, which is getting cleaner day by day. A North American price on carbon would be good for the Canadian electricity sector, a patchwork of differing regulation and standards would not.

2020? Hard to see it happening earlier, but 2020 remains a possibility.