Energy Regulation Legislation Stalled for Now

 

Takeaway

  • Investors need to know the new rules before they will make new investments in the electric power industry
  • The recession reduced the need for new power plants, but when the economy recovers, demand is expected to pick back up

Branko Terzic, Regulatory and Policy Leader in Deloitte’s Energy & Resources

Branko Terzic, Regulatory and Policy Leader in Deloitte’s Energy & Resources Recently I had a conversation with Branko Terzic, the Regulatory and Policy Leader in Deloitte’s Energy & Resources group.

Q. You're an expert on what's going on in terms of regulation and legislation. Let's start by talking about the Lieberman-Kerry bill. It looks like Congress is converging on what has been described as a “cap and trade” system, rather than a tax. What do you see as the advantage of a cap and trade system?

A. The Senate bill has cap and trade because the House bill that it’s supposed to reconcile with (the Waxman-Markey bill) has cap and trade. This way when they go into conference, they are easier to reconcile. In terms of the benefit of cap and trade, versus a tax, the electric power industry is familiar with cap and trade with respect to NOx and SOx and other pollutants and so they already understand how the markets work it’s something that they can mechanically handle well and conceptually handle well. As you know, politicians have an aversion to raising taxes, at least directly. Consequently, since the additional cost of CO2 in the form of emissions permits to electricity is an indirect tax instead of an explicit tax you don't have Congress directly raising taxes. Having said that, opponents of cap and trade call it cap and tax.

Q. For this legislation to have any teeth for it to appreciably change carbon output it has to raise prices enough to curtail consumption; is that correct?

A. Yes, in order to curtail consumption on the basis of consumer pass-through, it would have to have some significant cost increases. As you know, people don't use energy their devices do. After the 1970s and '80s, it took about five to six years for the capital equipment to be changed out and to reflect the higher energy cost.

Q. In the case of consumers, you might turn back your thermostat. But, the bigger savings will come when you buy a new air conditioner, when you buy a new natural gas furnace, when you buy a new refrigerator with the new higher efficiency rating. Even for industry, it will be when they buy new equipment or install insulation or do something else to lower their costs. But all of that generally requires capital investment, rather than changes in operations. So, we've got a new bill, electricity prices are going to be increasing over time, and people will anticipate that and buy more energy efficient appliances and use more insulation and so on.

A. That’s assuming consumers see the right price signals in the right format. One of the ways that can be accelerated is in areas that introduce smart metering and real-time pricing where you don't have an average price per kilowatt hour during the day. In those areas, consumers will be able to more quickly feel the effects or see the benefits of conservation because they'll see a much higher impact, based on time of day and other factors. They can more easily use that information to change their behaviors to increase energy efficiency. This ability to inform consumer behaviors will mostly be a function of state public service commissions allowing additional capital investment into the rate base for smart meter and the smart tariffs which have to accompany the smart meters. One would hope that they would have real-time pricing to match the ability of the meters to actually bring consumers that information.

Q. I believe that another feature of the new bill is a set of various subsidies for alternative energy. To what extent are we subsidizing R&D, which will (for example) improve the efficacy of solar cells, rather than using direct subsidies on the use of alternative energy, like tax credits on solar installations?

A. There is funding for clean energy research and development, advanced vehicle technologies and advanced manufacturing. So there are some pieces in this bill that would go toward the use of technologies like smart meters. Of course, there was some in the stimulus package, as well. There is $18.5 billion to increase the innovative technology loan program, which is the nuclear bill. There's carbon capture and sequestration funding. There's additional research and development funding in the bill. There's infrastructure funding of electrification of the improvement of the highway system, electric vehicle funding. So the bill has, you know, quite a bit of different funding. There are tax benefits that may be extended and may be added to the bill, as well. The bill does not contain a renewable portfolio standard or a renewable electricity standard, which is an interesting omission.

Q. Can you be a little bit more specific about the renewable energy standard?
 
A. The Kerry-Lieberman bill does not have a renewable energy standard or renewable portfolio standard, but the House bill, I believe, did. So that will be one of the things that, if Kerry-Lieberman passes the Senate, would then have to be reconciled with the House bill. Standards for renewable energy or portfolio standards are already in place in about 27 states where, if you are the provider of electricity in that state, it is required that a certain percentage of the power that you acquire be from renewable sources, whether or not there is cheaper conventional power available. So, for example, in states with those laws, as a utility in that state, you might have to buy 15 percent of your power from solar or wind, even if there is a very low cost coal fired or natural gas fired or nuclear generation available. The discussion is whether there will be a federal portfolio standard that will supersede the various state standards.

Q. What would be your guess on the likely outcome of this process? Do you think we will have new legislation by the end of the summer? What would you expect it to look like, if so?

A. Based on discussions with people here in town, the bill has a low probability of passing between now and the end of this Congressional term. In any case, should something pass in the Senate, they're going to have to reconcile that with the House bill when the two houses get together. At this point in time, given what's going on in energy, what's going on with legislation having to do with pulling back the EPA, the fact the Senate will be tied up in a contentious Supreme Court nomination, financial services reform, climate legislation dropped way down on the local priority. You know, the Pew Trust people did a survey recently where they asked people to rank 20 issues. Climate change was the twentieth. The consensus of people I talk to is that we’re not going to get an energy bill by the end of the summer and if you don't have one by the end of the summer, starting after Memorial Day, you've got the entire Congress out campaigning for reelection. My guess is that probably comprehensive climate change legislation will not survive this year and we will have to start all over again with a new Congress in January of 2011.

Q. It's likely that the new Congress will have more Republicans than the current Congress, which means that the Democrats are going to have to collaborate more with Republicans to get anything through. Do you think that's likely to happen?

A. Well, yes. I think it's likely they will collaborate. There are enough Republican energy business leaders out there who want more certainty in our energy policy. These are some of the leaders at some of the large utilities who have been calling for climate change legislation, calling for a cap-and-trade program. They'll still be around. And there's just a lot of talk in town that may be bringing the Republicans around that if it's too difficult to make capital investment decisions in the electric power industry today without some notion of what are the rules I'm going to operate under.

It's very difficult to estimate the running cost of a new coal-fired power plant or even a natural gas fired power plant if you don't know whether you're going to include the cost of carbon in future calculations. It's very difficult for the companies to make the economic analysis, and it's very difficult for the regulators who have to approve most of these power plants that are built to make any decisions. If you propose a nuclear power plant, which is a very high capital cost, that power plant looks much more attractive with a higher carbon cost than it would otherwise.

Certainly on the electric power industry side, the companies have to make capital decisions; because they have the responsibility of delivering reliable electricity in the future, no matter what the environmental or other laws are. It's very difficult to make those decisions if you have no idea what the law will be, what form it's in, what the details will look like. You can't even model that. My prediction is that there's going to be pressure on the Republicans to show more leadership on energy legislation after the elections and do their jobs and seriously look at Democrat-proposed legislation, make their modifications, and then vote up or down because it's in the national interest.

Maybe comprehensive climate change legislation won't go through, which was the original Obama intent. But there's a very large consensus from the utility industry that they can live with and they can operate under a cap-and-trade system. They could work with it and would like to go ahead, have Congress set it up, and then they can get on with it. The recession has delayed the need for new power plants. It's given us a breathing period. Otherwise, with a warmer than average summer, every part of the United States would be vulnerable to brownouts and blackouts because we have delayed construction of new facilities. Because we had negative growth in electricity sales and demand the last two years, we've been able to dodge the bullet. But if the economy picks up as we all hope it does, we're going to have to build new power plants. We need to know what the rules of the game are in order to attract the capital to be able to finally build those units.

Q. With the Republicans taking a more active role in drafting the legislation, do we expect, whatever comes out, nine to ten months from now, to look considerably different than the Kerry-Lieberman bill?

A. I think it will be similar to the Kerry-Lieberman bill, because the Kerry-Lieberman bill was crafted when Lindsey Graham was still on it. When he dropped out, I don't think they changed it dramatically. And so I think it has enough in there that is supportable and realistic that makes decent policy. No bill is going to be perfect, and we all have our quirks and preferences. The bill compromises over where the funding should go. It doesn't answer the most difficult questions, though, of how allocations will be made within the sectors and where the allocations will go. These are things that are left in the bill to the future EPA or other agencies. But I generally prefer that Congress give legislation or state legislators broad guidelines and let the agencies hammer out the details.

Disclaimer

The views expressed are those of the author and not necessarily The University of Texas at Austin.
 

About The Author

Sheridan Titman

Walter W. McAllister Centennial Chair in Financial Services, McCombs School of Business

Sheridan Titman is a professor of finance at The University of Texas at Austin and a research associate of the National Bureau of Economic...

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