US Electric Utilities & IPPs Clearing the Air on EPA s Climate Change Regulations (Incl. Conf. Call Transcript) - PDF

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Global Research 12 June 2014 US Electric Utilities & IPPs Clearing the Air on EPA s Climate Change Regulations (Incl. Conf. Call Transcript) Call provides breakdown of carbon rule nuance by state To explore
Global Research 12 June 2014 US Electric Utilities & IPPs Clearing the Air on EPA s Climate Change Regulations (Incl. Conf. Call Transcript) Call provides breakdown of carbon rule nuance by state To explore the implications of the latest EPA existing-source proposed standards on CO 2 /GHG emissions, we hosted a call with Bill Bumpers, an Environmental Partner at Baker Botts. Broadly, the call emphasized rule implementation would vary substantially by state, with an emphasis on under-utilized gas assets, RPS standards, nuclear generation at risk, and alternatives to coal. While we remain bearish on timeline for implementation into the 2020's, the structure of the rules would have substantial impacts on underlying growth of renewables, meaningful acceleration of coal-to-gas switching, and expanded energy efficiency mandates. In the interim, we emphasize further conventional rules through the decade will continue to contribute to further coal retrofits and retirements, with a disproportionate emphasis on western coal. Equities Americas Electric Utilities Julien Dumoulin-Smith Analyst Michael Weinstein Associate Analyst Paul Zimbardo Associate Analyst Who wins under carbon rules? We think EXC remains the clearest beneficiary, with the structuring of the 'at-risk' nuclear generation pushing states to retain distressed nuclear units. Meanwhile, we suspect accelerated coal-to-gas switching, with an emphasis on fully utilizing the existing CCGT portfolio up to a ~70% level as benefitting CPN (although this latest twist makes the Southeast portfolio look substantially better in particular, which is pending a sale to LS Power). We suspect RGGI (eastern) and AB32 (California) markets will likely expand to adjacent states to facilitate rule implementation. This report has been prepared by UBS Securities LLC. ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 28. UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Conference Call Transcript The following are highlights from our call with Baker Botts. The comments below have been edited to improve grammatical clarity and provide enhanced context. Replay: Toll Free: Toll: Passcode: Speaker Bio: Bill Bumpers is an environmental partner in the Washington, D.C., office and heads the firm s global Climate Change Practice. Mr. Bumpers focuses on the Clean Air Act and climate change issues. He has an active environmental regulatory, litigation and transactional practice, representing electric generating companies, petroleum refineries, investment companies, electric generators and pharmaceutical and chemical manufacturers. He is regarded as a national authority on new source review issues affecting the electric generation and petroleum refinery industries. He previously served on the EPA s New Source Review Reform Subcommittee of the Clean Air Act Advisory Committee. He has written and spoken extensively on new source review and prevention of significant deterioration issues under the Clean Air Act. Mr. Bumpers also is a leading authority on climate change issues, including carbon trading mechanisms in the United States and internationally pursuant to the Kyoto Protocol. He has been involved with climate change issues since his work on energy policy and climate change as a graduate student in He represents companies involved with emission reduction projects in the United States pursuant to Climate Action Registry and American Carbon Registry protocols, as well as related CRT and emission reduction credit transactions. He has been involved in transactions involving Clean Development Mechanism (CDM) projects or Certified Emission Reduction (CER) sales in Malaysia, Indonesia, China, Liberia and Equatorial Guinea. He also represents companies involved in the capture and storage of GHG emissions and has helped pioneer the creation and sale of carbon storage rights in the United States. Mr. Bumpers also represents a wide range of companies on developing policy and regulatory issues in the United States and regarding the creation and sale of GHG legislative and regulatory policies in the United States. Operator: Ladies and gentlemen, thank you for standing by. Welcome to the UBS Electric Utilities Carbon Rules Conference Call. As a reminder, this conference is being recorded, Monday, June US Electric Utilities & IPPs 12 June 9, I would now like to hand the call over to UBS Electric Utilities Analyst, Julien Dumoulin-Smith. Please go ahead sir. Julien Dumoulin-Smith: Good afternoon everyone, and thank you for joining us on such a timely notice here. So Bill Bumpers is joining us again here. He is an Environmental Partner at the firm, Baker Botts and heads the firm s global climate change practice. We ve spoken with him before around a range of issues and this actually hits home directly to his expertise he s been involved with for seemingly 30 years on the subject, so he s a got a wealth of knowledge to draw upon and dig into the latest rules. He can also speak broadly about what and how much flexibility does the rule really provide to states. As usual, there are no accompanying slides and we will have time for Q&A at the end of the hour. So with that, I ll let Bill kick it off. He s got a lot to say today. So thank you Bill. Thank you Julien and thank everyone for tuning in. This is EPA s proposed Carbon Pollution Rule is an important, big rule. The guidelines themselves are 645 pages. There s a Technical Support document set that is another 600 pages and then there are approximately 3 or 400 pages of additional underlying supporting documents, which you have to get into the docket to get a hold of. I ve looked through all of the guidance the Technical Support documents at this stage, so today what I m going to try to do, is to provide everyone with a full understanding of what the basis of this rule is, how the EPA is structuring its proposal for addressing carbon pollution in the power industry, and then I m going to spend some time talking about some of the practical and legal implications and issues that result from this proposal. I m going to spend probably more time on that, than I will on the rule. At the end, we re happy to take questions to talk about some of the Technical aspects of the rule, as well as, what some of the implications are and how various regions and states may respond to this. This rule is proposed under Section 111D. Section 111 of the Clean Air Act is the New Source Performance Standard and US Electric Utilities & IPPs 12 June for the overwhelming majority of the rule that come out of 111, they are promulgated under Section 111B. They apply only to sources that are brand new, built subsequent to a proposed standard that the EPA set, which is applicable on a nationwide basis. Section 111B is a relatively obscure and seldom used provision. It applies only in the following circumstances: if a pollutant is not subject to a Natural, Ambien or Quality Standard, it s not subject to regulation under the Hazardous Air Pollutant Regulations of Section 112, but it is subject to a New Source Performance Standard, then EPA has directed under Section 111B to establish a procedure under which the states develop Performance Standards for existing sources. The direction to the administration is to set up a procedure under which the state can set performance standards for the existing sources, if those existing sources would be subject to Section 111B, if they were built new. So what I ve described is to say that EPA has under Section 111B jurisdiction over those sources that would be subject to 111B. As of today, the EPA has proposed 111B, New Source Performance Standards in the power industry, only for coal fired, new Natural Gas Combined Cycle and Natural Gas Fired Combined Cycle Generation. The statutory authority is under which the EPA is proposing this rule. Now let me describe what this rule is about. EPA has developed this Guideline, their guidance to the states under which they have gone out and established some Emission Goals, which they purport to make mandatory on the states. The way that this rule works, is as follows. EPA did in Step 1 an Analysis of the Fossil Fuel Fired Generation in each state, based on 2012 Generation, and that means all the Generation and the emissions associated with the US Electric Utilities & IPPs 12 June Generation, only from the Fossil Fuel Fired affected sources, that is, those electric generating units would be subject to 111B. Step 2, EPA looked to see what the efficiency improvement is that can be done on a unit by unit basis on these units. EPA made some pretty aggressive assumptions and in the end, seeks to get a 6% improvement in the heat rate from all existing Natural Gas and especially Coal Fired Electric generating units. So that s Step 1 what EPA called Building Block 1. Building Block 2 is in each state. The EPA looked at the amount of existing Natural Gas Combined Cycle Generation and they assumed that in each of those states, those natural gas fired combined cycle units could increase utilization up to a 70% Capacity Factor. They put a cap at 70% capacity factor and in a few natural gas cases, when they were coming up with their emission rates, they did not take the units all the way up to 70% capacity factor, because doing so would have eliminated what little coal was in a particular state, in which case, the shifted Generation was less than 70%. However, in most states where there is any significant coal, all of the Natural Gas Combined Cycle units, were presumed to go up to a 70% Capacity Factor. The Natural Gas Combined Cycle s share of Generation would decrease commensurately. If you apply those changes, that produces a particular emission rate from the existing fossil fleet, the EPA takes from there to go to Building Block 3. Building Block 3 analyzes and projects out to 2020 and to 2030 the amount of Renewable Energy Potential for each state. Now EPA took a more regional approach in this case, to look at the Renewable Potential and then essentially ascribe that potential to each state. They projected out the Renewable Capacity that each state could achieve starting in At this point, EPA actually for the first time considered the amount of Renewable Energy that already existed in projecting what could be built by US Electric Utilities & IPPs 12 June 2020. So effectively, they speed up the ramp up for Renewable Energy, if you re in a state that already had Renewable Energy. It is sort of a No good deed goes unpunished kind of an effect. They then increase that commensurately through By doing that, they increased the amount of zero emission generation that is produced in that state and therefore, lowered the Emission Rate Goal that EPA ultimately is trying to achieve. Then finally in Building Block 4, EPA assumes or projects some amount of End Use Energy Efficiency, which can be achieved in each state. They based this in part on Historical Analysis and some Demographic Analysis. They projected that a state can get between one and one and a half percent of Energy Efficiency Improvements for the period starting with 2020 and then going all the way through So the amount of Renewable Energy that gets credited back in the form of reduced Fossil Generation further reduces the Emission Rate Goal that EPA projects for each state. When you add all of these together, it is a significant reduction in the Projected Goal Emission Rate, which the EPA will impose on each state until this date to achieve by 2020, ramping down through One other sort of anomalous element which I have yet to figure out, is what they ve done and why they ve done it, I can t say yet. EPA included in Block 3 with the Renewable Energy Generation, what they call an At Risk Nuclear Adjustment. I ll give a quick explanation of what it does, but as I say, for the life of me I can t understand why they would do this. Essentially, the EPA identified existing Nuclear Generation that is so-called, At Risk, because of license expiration or US Electric Utilities & IPPs 12 June for economic reasons, that Nuclear Generation will go away between now and They did it, and now keep in mind, this is Existing Generation, which already has had an effect on the Fossil Generation that s used in each of these states. EPA then did an Analysis and said, For about $17 a kilowatt, these states are projected to be able to keep those at risk units alive and in the end they concluded that, The amount of At Risk Generation represents about 5.8% of all Generation in the country. For each state that has Nuclear Generation, they applied an adjustment in Block 3 to assume that they will get this 5.6% of total Generation back, even though it already exists, and therefore, further reduce the Emission Rate Goal in the out years. We can talk about that in detail later, if people have questions, but it s a nonsensical adjustment that simply takes credit for Nuclear Generation that may or may not be around in the future, but certainly exists today. So, in the end, this rule then comes up with an average emission rate, applicable to existing Fossil Generation. In each state, they project out an Emission Rate Goal that the state must achieve at the end by They are starting to achieve most of it by The impacts are highly desperate, so for example, in Washington State, this results in a 70% Reduction Requirement from 2012 and an average Emission Rate of 215 pounds per Megawatt Hour. I would just note that, in the EPA s proposal for the New Source Performance Standard, for brand new Natural Gas Combined Cycle units, the most efficient, cleanest, Fossil Generation that you can build, the Standard is a 1000 US Electric Utilities & IPPs 12 June pounds per Megawatt Hour. They are being very aggressive with the Actual Existing Generation. So, let me now talk about what are the practical and legal implications of this rule. From a practical standpoint, EPA selected when they started doing this Four Block Analysis to come up with their Projected Emissions Goal. They picked the year 2012 and that has several important implications. First, by using a single year, they have imported into this analysis, all of the single year anomalies that often happen in the electric industry. So for example, I know of several very large Coal Fired Generators, which during 2012 were offline for a significant amount of the year, because of either major outages, because they d had problems with it, or for other reasons where they were generating it far less than they would have had EPA looked over a three- or five-year averaging time period. Number 2 by selecting the 2012 baseline, EPA effectively discounts or eliminates a consideration of policies and measures that states and companies undertook to address climate change in the years previous. So, there are a number of states that have had, for example, Renewable Portfolios on the books for 10 years. All of that generation that was developed prior to 2012, is at best, eliminated from consideration and effect under this rule, but I think arguably what it does, is it penalizes those states and companies that were heavily involved in Renewable Energy, because they accelerate the total Renewable Energy Component required under this act. I m going to get back to this required on the act, because this rule does not actually require that anyone do renewable energy, energy efficiency or anything else, they simple must develop a plan that meets the end target. US Electric Utilities & IPPs 12 June So, the third is that they have taken a very big assumption about the ability of states to go wholesale towards a gas redispatch. As I say, there are some states in which the utilization of the Natural Gas Combined Cycle units are relatively low down in the 20-25% and the presumption that those units can automatically go up over the next ten years and operate at 70% Capacity Factor without having a lot of other implications is questionable. There seems to have been no apparent consideration of the fact that there are quite a few existing Natural Gas Combined Cycle Units that were built for specific purposes. In doing so, the companies took Utilization or Emission Limitations on those units to avoid either PFD or to avoid increment impacts under a NX Analysis or for other reasons. It s not going to be automatic or even obvious that those plants can simply eliminate those burdens to comply with this rule. If you do, you would have to go out and spend potentially hundreds of millions of dollars on additional Control Devices, for example, NX. If you did what they re projecting, if you were subject previously to an Emission Rate or Capacity Limitation, you would automatically trigger New Source Review Requirements, so you d have to go through a batch proceeding also for greenhouse gas emissions, which seems to skip their views on this. There s another interesting issue, which I know in a couple of states could be a problem. A lot of the natural gas capacity that has been built in the past five or six years, in some states was built primarily to support the very large increase in renewable energy that those states Renewable Portfolio Requirements have necessitated. So, when you have a high Renewable Portfolio Standard, the demand for Flexible Generation can ramp up and ramp US Electric Utilities & IPPs 12 June down quickly to deal with the variability of solar and wind when the sun stops shining or the wind stops blowing is pretty high. There have been a number of good analyses about the amount of over capacity that is required as the RPS levels start to get above 30%. It s pretty staggering how much that is. EPA doesn t seem to have analysed whether taking the existing natural gas combined cycle capacity up to 70% eliminates the critical analysis of natural gas capacity that can ramp up and ramp down in response to a Renewable Portfolio Standard. It is certainly the case that the existing coal fired units are really built and designed for basically utilization could not do that. They cannot ramp up quickly and ramp back down quickly. So that s an issue that s going to have to be analysed very quickly. While the EPA does discuss some of the concerns about long term natural gas and short term gas supply, all they say is, We think we ve given enough lead time that everybody can build as much gas as they need to address this issue, in the event that existing natural gas combined cycle units may not be able to get as much gas as we think they will be able to utilize. Now Julien in his introduction said that the states have been given much flexibility to implement these rules, and in some way that s true, but in the most important ways, it is not. When the EPA set these goals, they took into consideration and essentially confiscated for themselves the emission reductions that they projected are available from increasing Renewable Energy, from a shipping generation to a lower carbon intensive fuels, which means even shipping within coal units, to more efficient coal plants, although that s US Electric Utilities & IPPs 12 June largely been done, just as a matter of efficiency, but certainly moving to natural gas and any efficiency that is out there. So on the one hand, if they had set a reasonable target and said, You guys can meet it anyway you want, including those measures, but it had not taken that already into consideration in setting the very low standards, then the answer would have given them some flexibility. But EPA s idea of flexibility is, Well we think you can use all of these things and we re setting the target as if you do, but you don t have to do them. You can get the reduction through other means. So they ve essentially ar
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