The CEPP is Not a Clean Energy Standard
And the differences could undermine the program.
[Today’s blog is a joint effort of Severin Borenstein, James Bushnell, Steve Cicala and Ryan Kellogg]
The Clean Electricity Performance Program (CEPP) is the most prominent aspect of the energy and climate provisions in the still-under-development reconciliation bill. Previously, we and others have raised questions and concerns about how exactly the CEPP would work. Since more specifics emerged about a month ago, we have spent a lot of time working through the implications of those details.
Repeatedly, the CEPP has been described as a “budget-based clean electricity standard (CES),” in effect, a national version of a renewables portfolio standard (RPS) that would also credit other forms of low-carbon electricity production. These types of policies – sometimes called intensity standards (such as an RPS or a low-carbon fuel standard) – have come under criticism from some environmental economists, many of whom argue for the superiority of carbon pricing.
This historical debate – pitting proponents of intensity standards against those holding out for a carbon tax – has often been portrayed as one of pragmatists working to get a decent, if not fully efficient, policy adopted versus economic purists for whom only carbon pricing would do. This historical debate has had the unfortunate effect of making it easy to dismiss concerns about the CEPP with “there go those economists again, trashing anything that isn’t carbon pricing.”
But this framing is wrong. The CEPP, as currently configured, is not a CES that has been tweaked so it could be passed through the budget reconciliation process. The CEPP creates a suite of incentives for load-serving entities (LSEs) that are quite distinct from those of a CES. These differences in incentives open up a variety of channels for gaming and unintended consequences that could lead to large government expenditures without inducing large-scale substitution of new, clean energy supply for fossil-fueled generation.
CEPP’s Up-Front Incentives Make It Different
The key distinction starts with the magnitude and timing of the clean-energy incentives. Under a “normal” intensity standard (like an RPS), an LSE – a utility or other retail provider – is rewarded for procurement of clean energy every year. For example, currently a renewable energy credit (REC) might sell for about $10 per MWh, and any renewable electricity source, new or old, can earn this value for each MWh it produces from a renewable source. The CEPP, however, does not provide subsidies for procurement of all clean energy production but instead makes a one-time giant-sized grant of $150 per MWh for “newly purchased” clean energy. That is, in the year an LSE increases its clean electricity procured to at least its target level, it gets $150 per newly purchased clean MWh. But then it receives no further compensation for that clean energy in future years. LSEs that fail to meet their clean energy growth target are penalized $40 per MWh for any shortfall.
The CEPP’s intent to make large, one-time grants for “new” clean energy makes it in some ways more like an up-front clean energy investment tax credit (ITC) than a CES (putting aside the distinction that ITCs typically reward clean energy capacity rather than energy itself). We’ve been told that the decision to go for the large up-front grant was motivated by a concern that, had the CEPP been structured like a standard CES, sources coming online toward the end of the 10-year program would only earn a year or two of subsidies. But unlike an ITC that is paid directly to developers of new energy supply, the CEPP’s grants are payable to LSEs for newly procured clean energy.
This large, one-time grant to LSEs, along with a sequence of associated design elements, creates perverse incentives that will result in less new clean energy at higher cost.
For example, while $150/MWh was an acceptable level of subsidy, it was deemed to be too severe a penalty. So an LSE’s failure to meet the CEPP’s clean energy growth targets would be penalized at only $40/MWh. The asymmetry between the $150 grant and the $40 penalty has already been identified as creating an incentive for gaming via trades of clean energy between “short” and “long” LSEs, particularly during the last years of the program. These kinds of trades would let “long” LSEs earn grants for procuring clean energy from other, noncompliant “short” LSEs, rather than for actually building new clean power. This problem would be dramatically worsened if penalties were removed altogether — a potential change to the CEPP now under discussion.
Incentives to Deliberately Waste Energy
However, there is another fundamental problem with the current design that has gotten less attention. The $150/MWh subsidy amount is so much greater than the current extra cost of clean energy – a gap that will widen over the next decade as renewables get even cheaper – that it creates an incentive to expand energy use in order to grow the MWh’s getting subsidized.
Here’s how it would work: Say that the current cost of clean energy is $70/MWh, and a grant-eligible LSE has 100 MWh of customer consumption (load) per year for which it is currently buying no clean energy. The LSE could buy 100 MWh of clean energy at a cost of $70/MWh, and since it would be buying the power “for the first time” it would be paid $150/MWh for all 100 MWh in the first year and would net $80/MWh, or $8,000 total in that first year. The LSE would now be 100% clean! Under the program’s rules, once it increases its clean energy percentage it has an incentive to keep that percentage high, or else it pays penalties. So hopefully it would want to keep buying clean energy after that first year to avoid those penalties. So far, so good!
But why stop at 100 MWh? What if the LSE set up a bitcoin operation (or some other new load) that used an additional 100 MWh, bumping up its total load to 200 MWh? It could now procure 200 MWh of clean energy, again making an extra $80/MWh from the grant-minus-cost difference, and bank $16,000. The LSE is still 100% clean! Actually, it is kind of 200% clean, even though half of the electricity is wasted. And this problem would be much bigger at scale than just $16,000: the annual industrial load alone in the U.S. is about 1,000,000,000 MWh, not 100 MWh.
Now here’s how the LSE could turbocharge the strategy. After the first year, when the grants stop, it could sell off the extra 100 MWh of clean energy to some other LSE that would also be buying it “for the first time.” And it would send over the bitcoin operation along with the clean energy, dropping its load back to its normal 100 MWh. Then the second LSE runs the same operation for one year before sending the package off to yet another LSE. So instead of paying the $150/MWh one time for a new clean energy source, the program ends up paying for it over and over again. All for energy that was created and then wasted to collect grants.
This kind of behavior is surely not what the CEPP architects had in mind, but it is behavior that the CEPP makes profitable for LSEs or even for large industrial customers. In fact, bitcoin start-ups are already partnering with LSEs (including in rate-regulated areas) or buying coal plants outright to power their operations and arbitrage wholesale electricity prices.
Economists usually complain that clean energy standards pay people to buy more clean energy, when what we really want is for them to buy less dirty energy. Most of the time, this distortion is small enough that it doesn’t create big inefficiencies. But by cranking up the “buy clean” incentive for supposedly new clean energy purchases, the CEPP takes an arguably modest incentive problem and transforms it into a really big problem.
Building a Better CEPP
The solution need not be to trash the whole idea and say carbon tax or bust, especially given all of the work that has gone into building coalitions that support this type of program. There is a simple change that turns the CEPP into what it has already been publicly described as, an actual budget-based clean energy standard. Pay a smaller incentive, but make it apply to every clean MWh every year. Instead of having a $150/MWh “one time” grant and a $40/MWh “every year” penalty, there could be, for example, a $15/MWh subsidy and $15/MWh penalty earned or paid on every MWh long or short of the target every year. If some LSEs insist that the penalty is too harsh, then rather than make the penalty smaller and create clear gaming opportunities, adjust the target so that LSEs are less likely to be penalized and more likely to earn grants, while still giving them strong incentives to increase their clean energy share.
There are many ways to get to the drastically lower-carbon electricity system that is the imperative. And a well-designed CEPP could definitely be one of them. A group of experts recently argued that the CEPP’s target of growing clean power by 4% per year would be feasible. However, an evaluation of the technical feasibility of 4% growth is not an analysis of the CEPP or its likely outcomes. The latter requires considering how firms will most profitably respond to the program’s incentives. It is, after all, the profit motive that makes subsidies and penalties powerful tools for expanding clean power generation. Unfortunately, the current CEPP has significant design flaws that could greatly undermine its effectiveness in getting us to where we need to go. Now is the time to ensure that the program’s incentives are consistent with its goals.
Keep up with Energy Institute blogs, research, and events on Twitter @energyathaas.
Suggested citation: Borenstein, Severin, Bushnell, James, Cicala, Steve, Kellogg, Ryan. “The CEPP is Not a Clean Energy Standard” Energy Institute Blog, UC Berkeley, October 4, 2021, https://energyathaas.wordpress.com/2021/10/04/the-cepp-is-not-a-clean-energy-standard/
What I, and maybe others, am missing is affirmation the policy has no way of one-time assigning the $150 incentive? In so far as this is an up front ITC, how is it the case we do not have multiple ITC claims on the same resource? I don’t understand how LSE’s volleying “new” clean power cannot be tracked for whether the resource they are claiming is new, or not. I get how the policy is structured around the procurement side, but another example would be EV tax credits. There, the procuring party gets the credit, and we don’t have problems with double-dipping once a car has been titled.
So, do watts need a “title” to fix CEPP’s double-dipping?
thanks Christopher. We *would* have a problem with double dipping on EV tax credits if the same car could be claimed for tax credits each time it changed hands. And the cars would change hands constantly. But, you can only get the tax credit on a new car. The problem is that the tax credit here is not for the “car” but for the “mileage”, that is the MWh. the equivalent of the EV tax credit would be assigning the compensation based on new capacity coming online. But the CEPP explicitly does not do that, as I mentioned below, presumably because the intent is to also assign value to continuing production from incumbent clean energy, particularly nuclear.
In the WECC, the WREGIS appears to easily track the RECs with the MWHs. It seems this is just a case of adding a registry to the resources being used to claim the credit.
That said, if there is resistance to that option, then I would say that the intent is to explicitly double dip by the parties involved while obscuring that fact from the public, and no amount of economic rationale for a “better” system will solve the desire for excess subsidies.
I assume that by “current cost of clean energy is $70/MWh” you mean the cost of a REC or ZEC is $70. Wouldn’t that be an unlikely clearing price for ZECs given the current CEPP incentives? Shouldn’t they trade at something closer to $150?
Thanks Harrison. Actually, no, we do mean the cost of the energy. Though for the first part of the example it makes more sense as the cost of a ZEC. The point is when one is engaging in the load expansion game, you just have to have marginal load that can be served at a total cost less than the grant.
James – sounds like Democrats in DC are borrowing from CPUC’s “misplaced incentives” playbook. Question: Adam Stein of Breakthrough Institute writes:
“Policymakers in California remain committed to shuttering Diablo Canyon, the last operating nuclear power plant in the state. Those policymakers should consider that, in addition to the $3.9 billion it will cost to decommission the plant and more than $400 million in the form of increased electricity rates to replace jobs and support the nearby community, closing Diablo Canyon this decade will cost between $500 million and $1.5 billion in CEPP penalties and foregone federal payments.”
Is that your take on it as well? If so, seems like the question becomes “Can PG&E, and/or its customers, afford to close Diablo Canyon?”.
Disclaimer: I haven’t read much of the 2,645-page reconciliation bill. In fact, I haven’t read any of it, and don’t plan to.
I see the gaming concern. Would a lighter touch solution be to track new clean energy and only allow it to receive 1 payment?
Thanks Nate. Yes, the alternative that you and Rich McCann suggest, doing this with subsidies on the supply side rather than the demand side would make a lot of sense for building new renewables. But part of the goal seems to be to support incumbent clean energy, including nuclear. Supply-side subsidies would not accomplish that, though some people have commented to us that there are plenty of other subsidies for nuclear that are in the bill separately. I have not followed that.
I’m confused on this–your blog discusses incentives for “new” energy, but then there appears to be a goal of supporting existing clean energy. Perhaps that’s the crux of the problem–is Congress trying to disguise existing clean energy as “new” energy? The incentive structure doesn’t seem to be the problem as much as the underlying goal covering legacy investment costs.
Thank you for this timely, important and constructive analysis. Anticipating and correcting for unintended consequences is critical if we have hope of making real and sustained progress toward achieving clean energy goals.
I think this continues to misunderstand the math of the CEPP. First of all, the *cost of renewables* you cite is an (absurdly high, even unsubsidized by tax credits) LCOE-equivalent (i.e. average cost over the life of a plant at 30-40 years). The payment is a one-time payment. Those are not comparable numbers… and normalizing one (the CEPP payment) for the other (LCOE, especially once normalizing for actual clean energy costs) quickly turns your math on its head.
Secondly, the way CEPP is written is not to *incentivize new clean energy MWh* as your LSE example supposes. It is to *incentivize delta percentage points of load served by clean energy MWh year over year*. So if the second LSE added 100MWh load at 100% renewables, that would not necessarily result in the gaming of the system you’re describing, although there may be some circumstances different from what you described that would be.
Also, your $15/MWh payment or penalty *is in all likelihood what a 10-year stream of payments of the normalized payment/penalty would look like to a clean energy provider*.
It’s seriously worth chatting through this more at your leisure.
thanks Justin. This is a blog, not the detailed math, which we have also done. Yes we do use a high LCOE of renewables, but the math is even more overwhelming in support of this gaming if you use a low value, such as $30 per MWh.
Yes, it is a one-time payment, but the way the bill is written there is a clear game one can play shuffling the “new” clean energy from one retailer to the next. The fact that it is a *change* in percentage points doesn’t change that at all. And the fact that there are some circumstances in which it might not induce gaming is not really reassuring. There are clear circumstances in which it would. Bitcoin mining is one example of how to crank up load, but there are plenty of others.
Yes, $15/MWh is about equal to the annual amortized value of a one-time payment of $150/MWh in the first year. Our point is that doing it the latter way creates perverse incentives that firms will exploit.
Before the 2000-01 California electricity crisis, Jim and I warned of the dangers of market power in electricity markets and published papers on it. The modelers dismissed it because their model showed low prices. But their models did not account for the incentive to game the market. Models that don’t include gaming, don’t find gaming. We need a program that is resilient to firms trying to make as much money as they can. Otherwise it just won’t work.
“Bitcoin mining is one example of how to crank up load, but there are plenty of others.”
I’m doubting that LSEs are going to crank up Bitcoin mining to gain load. So I’m interested in the other ways to crank up actual load in relatively short order. I’m at a loss to imagine those other than maybe incenting more grow lights! But any of these would require a new rate schedule or a rate discount that would have to pass regulatory review muster.
Thanks Rich. Your inability to imagine ways this could be gamed reminds me of the comments Jim Bushnell and I heard in the late 1990s when our analysis suggested wholesale electricity prices could be driven above $250/MWh by withholding power from the market. Many people doubted that we could ever see prices that high, and we got many skeptical responses to the idea that a generator would intentionally reduce output in order to drive up prices. It turns out, entrepreneurs who want to make money can be very imaginative.
As for games one could play without bitcoin, in a retail choice state, you could just build any kind of energy intensive production technology. Then you successively go to each retail provider with a package of the renewable power you have procured or built and the demand for your energy intensive factory. After one year, you take both the power and the demand to a different retail provider, who again gets $150/MWh. There are far more than 10 retail providers in Texas, so you could easily do that every year with the same load and the same renewable power.
It is a bit more challenging in a traditional vertically integrated IOU situation, but any sort of large load that is mobile will work. Bitcoin mining in railcars or semi trucks is a winner. But I think it would also be doable with batteries that you charge in one service territory and then move across to another service territory to discharge. We’ve only spent one day trying to figure out how one might do this. I am sure that imaginative entrepreneurs could come up with many other possibilities.
As for a new rate schedule or rate discount, that may be a problem in California where the regulators are highly supportive of a zero-GHG initiative, but there are many parts of the country where regulators or muni/co-op operators are not. An entrepreneur could approach them with a load/clean generation package offered on the condition that the entrepreneur get some of the rents from the deal and the LSE gets to keep some of the rents, which the LSE could then pass through to its customers. Sounds like a win-win, except for the federal government and the environmental impact.
The point is that before setting something like this in stone in legislation someone should be stress testing it to see how firms trying to make as much money as they can will exploit it. It is pretty clear to me that has not been done for the CEPP, or if it has been done, the people who wrote the actual plan did not pay attention to the findings.
The easiest fix in the legislation would seem to be defining ““newly purchased” clean energy” more narrowly to be direct transactions with generation resources, and to disallow transactions with LSEs.
The penalty doesn’t seem so imbalanced–the incentive is one time while the penalty is annual, so comparing $150/MWH (Is this total MWH over some period of time or a representative annual output?) to $40/MWH annual over some period of time may not apples to oranges. I think this intricacy needs more explanation here.
I’m not sure where the “phantom” load would come from to justify a higher purchased would come from. It could induce beneficial electrification, which would be a good thing and shouldn’t be discouraged. But even if that’s not the case, it can be fixed by requiring LSEs showing that they have the additional load to justify the purchase in its forecast. Further, many (most?) LSEs have some form of oversight on procurement that inhibits them from overprocuring to a certain extent (although that hasn’t always worked well, e.g., California IOUs overprocurement of renewables in the 2010-2015 period despite the evidence that loads had flattened and CCAs were exiting.)