The release of the IPCC Synthesis Report earlier this month underscores the need for swift and aggressive action to combat climate change. With the shifting control of Congress, answering that call becomes more of an uphill battle.
One saving grace is that it will be hard for Congress to completely block the Clean Power Plan (CPP), which aims to reduce greenhouse gas (GHG) emissions from the power sector, while Obama is still in office. This is because the CPP regulates CO2 emissions from the power sector under the Clean Air Act. The House and Senate can vote against the plan, but stopping the rule would require a full two-thirds majority vote to amend the Clean Air Act (or invoke the Congressional Review Act).
In this environment, the Clean Air Act has its advantages. In particular, it creates an opportunity to steer climate change regulation through a hostile Congress. But working within this statute to reduce GHG emissions from the power sector is posing some real challenges. One key complication is that the delegation of regulatory power under the Clean Air Act does not mesh so well with inter-state coordination of electric power systems.
The Clean Air Act meets modern day power markets
Under the Clean Air Act, the federal government has the authority to establish minimum standards that states must meet (both through statute and regulation). States are generally free to choose any regulatory approach so long as those goals are attained.
Under the proposed Clean Power Plan, the EPA has established state-specific CO2 emissions standards. The bottom of each bar in Figure 1 represents the standard. The top of each bar represents the state’s emissions rate in 2012. Colors denote the contributions of alternative emissions reduction options to targeted reductions: heat rate improvements (HRI), redispatch to natural gas combined cycle (NGCC), preserved generation from nuclear, renewables, and end-use energy efficiency.
Figure 1: State-specific reductions in CO2 emissions rates under the Clean Power Plan
(Source: Data are reported in the EPA Goal Computation Technical Support Document- Appendix 1 and 2).
States have the freedom to choose how they actually meet these targets. This gives states the flexibility to pursue whatever strategies they can find to minimize compliance costs.
Back in the day when CAA emissions regulations were more prescriptive and electricity was distributed by vertically integrated monopolies (typically limited to a single state), state-level coordination of compliance with power sector regulations meshed well with the state-level scope of power sector operations. But things have changed. For one thing, the Federal Energy Regulatory Commission (FERC) has been successfully promoting the development of large scale (multi-state) integrated transmission systems. This has resulted in much more geographically integrated power networks.
The graph below provides some sense of the extent to which power flows from one state to another. This figure shows (total retail sales – total generation) as a share of total retail sales (all measured in MWh) by state in 2012 as reported by the EIA. Positive shares denote net importing states, negative shares denote net exporters. For example, exports in Wyoming (measured as net electricity generation less sales) are almost two times the electricity sold in the state.
Figure 2: Electricity sales (MWh) in excess of generation (MWh) as a share of sales (MWh) by state in 2012 (source: EIA)
FERC’s success in fostering regional integration of power markets has conferred important benefits including improved operating efficiency and electricity market performance. But one regulator’s triumph can be another regulator’s headache…
What’s the problem?
Interstate power flows have some problematic implications (from the perspective of the environmental regulator working within the Clean Air Act). In a recent blog post, Jim Bushnell points to one important problem that arises when states in the same integrated power market face different emissions standards. Think California and Arizona. Figure 1 shows that California faces a relatively more stringent standard than neighboring Arizona. Increasing the flow of power exports from Arizona to California could offer a means of bringing both states closer to compliance without delivering real emissions reductions.
There is another related but different complication. Interstate power flows give rise to a kind of “compliance externality” because investments in renewable energy and energy efficiency in one state can affect the compliance status of other states.
Consider, for example, a state that exports a lot of electricity (such as Wyoming). Wyoming has some of the highest wind power potential of any state. Suppose Wyoming expands investment in new renewable generation as part of its compliance strategy. To the extent that this increase in renewables generation crowds out fossil fuel production in neighboring states, Wyoming will incur the costs to deploy renewables whereas a neighboring state (or states) will enjoy some the compliance benefits that the associated emissions reductions confer.
Similar issues can arise with energy efficiency. Consider, for example, a state that purchases a lot of power from out of state (such as Maryland) that converts to a mass-based standard. To the extent that demand reductions from efficiency programs in Maryland reduce demand for electricity imports, Maryland’s investments in efficiency programs will be reducing emissions elsewhere.
The economic solution
Economists have thought long and hard about externality problems and how to mitigate them. One classic solution (highlighted in this blog post) involves defining and assigning property rights to the externality. Along these lines, the EPA has proposed allowing a state to take credit for out-of-state emission reductions related to renewable energy generation. This would require tracking transfers of renewable electricity generation across state lines and measuring the associated avoided emissions – a non-trivial accounting exercise.
Going back to the economist’s bag of externality internalization tricks, an alternative approach combines or merges the externality-relevant activities into one firm or unit. From a purely economic perspective, coordinating regulatory compliance at a regional market level makes a ton of sense: the number of affected parties (i.e., states in a regional market) is small and costs of coordination should be relatively small given that regional entities have already been established to coordinate regional power system operations.
Implementing this elegant textbook solution is not so straightforward under the Clean Air Act; the EPA does not have the authority to require states to join together and form regional implementation programs. The only way to thread this needle is to make regional coalitions the most attractive compliance option for states. This is a really important needle to thread. If the EPA can find ways to facilitate interstate coalitions under the proposed Plan, interstate power flows can be put to work for – versus against – cost-effective and meaningful emissions reductions.