GHG Rules May Mean Nuclear Windfall Profits in Wholesale Markets

February 6, 2009

Energy Washington

Industrial and retail consumers are planning to warn members of
Congress that climate change legislation putting a price on carbon willproduce billions of dollars in windfall profits for existing nuclear
generators within wholesale markets because of the markets' pricing
mechanism, a concern that comes atop consumers' other complaints that
wholesale markets produce "unjust and unreasonable" prices.

Sources say the issue may not be well understood by members of Congress
who aren't familiar with the way wholesale electricity market prices
are set, a concern that one Senate staffer says could be valid, although
some lawmakers and their staff are likely to be familiar with the issue.

The carbon cost and windfall potential issue is coming to the fore in
the wake of a new, first-of-its-kind study that concludes climate
legislation could increase electricity prices in the PJM Interconnection
anywhere from $7.50 per megawatt hour (MWh) to $45/MWh in 2013,
depending on specific scenarios.

The study was sent to FERC, members of Congress, and others and was
"undertaken to help inform decisions of our members and the
discussions in Washington and elsewhere," according to a release by
PJM, the largest U.S. grid, covering 13 states and the District of
Columbia,

In its January 28 study, "Potential Effects of Proposed Climate
Change Policies on PJM's Energy Market," PJM analyzed how different
carbon prices would affect wholesale electricity prices. The study
relied on "the leading legislative proposals of the 110th Congress,"
together with EPA and Energy Information Administration carbon price
projections ranging from $10 to $60 per ton and typical residential
electricity use of 750 kilowatt-hours per month. Market-wide increases
in power costs would range from $5.9 billion to $36 billion, the study
concluded.

Sources describe the study as important because it shows the PJM market
clearing price * and by extension, the clearing price in other similar
markets * could increase substantially under climate legislation. But
the study wasn't designed to address the issue of how prices could be
inflated by nuclear generator windfalls, they say.

"The analysis is basically correct" in defining the rising costs
that will face PJM, says a state consumer advocate official who had
closely read the study. "But what's interesting is that a lot of
that money just goes to the existing nuclear units who don't have any
carbon compliance costs." While it is understandable that electricity
consumers would have to pay a lot of money to reduce carbon, the problem
is that, in PJM and other wholesale markets, existing nuclear units will
be paid "for no reason" because all generators receive the same
market clearing price, even if they have no added carbon cost, this
source says.

"What PJM shows is what's the increase [from climate legislation]
in the market clearing price," which gets paid to everyone operating
within the hour for which the price is set, "and that will always
include the nuclear units because they have the lowest production
costs," creating a windfall for those generators that will amount to
billions of dollars. That problem cannot be corrected under the way
rates are set today in wholesale markets, the source says.

However, there are ways to address the issue in carbon legislation,
depending on how Congress allocates allowances under a cap-and-trade
system. The windfall issue would be affected by whether the allowances
are auctioned or given away for free, who they are allocated to, where
the point of regulation is, and other related issues. Legislation has to
take into account the fact that wholesale markets will create windfall
profits for nuclear generators since the legislation won't change the
way PJM and other operators set prices, the source says. It is also up
to the states to decide if they want to intervene to change the result
of windfall profits to non-emitting sources or whether it's a
"reasonable result," the source adds.

"My concern is that people don't realize that a lot of this money
(the added costs for carbon controls) won't be used to clean up the
environment, but will just add to the profits of existing nuclear
units" in Pennsylvania, Illinois, and other PJM states with large
amounts of nuclear generation, the source says.

Key issue for Congress

"This is a key issue for Congress," the interplay between the cost
of carbon emissions and the different energy market structures in the
United States, the source says, noting that the problem doesn't exist
in regulated states, where utilities incur costs and charge customers
for those costs. If they don't have carbon control costs, they don't
get paid for that, unlike in wholesale markets where all participants
are paid the market clearing price.

"Congress has to understand that we have two very different market
structures across the country, and the impact of what they do [in
legislation] is very different" depending on the structure, the source
says. Consumer advocates, public power utilities, industrial consumers
and others will have to make the point to Congress as lawmakers design
legislation.

A source with the National Association of Regulatory Utility
Commissioners (NARUC), representing state regulators, says the issue has
been brought to the attention of a NARUC climate change task force at a
meeting in early January. While NARUC has not yet taken a position on
the matter, it is on the group's agenda. Moreover, the potential for
windfall profits within wholesale markets prompted NARUC to adopt a
resolution on climate change principles that calls for any emission
allowances allocated to the electricity sector under a carbon
cap-and-trade program to be given to regulated local distribution
companies, including vertically-integrated utilities, distribution
utilities, rural-electric co-operatives, municipal distribution systems,
and other such entities. Even in PJM, local distribution companies are
regulated.

A source with large industrial consumers suggests PJM might have issued
the study as "a sort of a preemptive public awareness campaign" to
avoid being blamed for future price increases that are out of their
control. This source says the study results are not a surprise since
natural gas and coal are "on the margin" and set the locational
marginal prices that all generators receive. While natural gas is a
relatively low carbon fuel, and the need for allowances to cover
emissions will not be as great as for coal, the price of natural gas is
expected to increase significantly as boilers switch to the cleaner fuel
in response to any mandated cap on emissions, the source explains. Thus
consumers get hit with a double whammy because the price of allowances
gets added to coal and higher market prices for natural gas. Meanwhile,
the source adds, owners of the nuclear plants get a huge windfall
because they will automatically get paid prices set by either coal or
natural gas.

The study does not run any scenarios to simulate the expected
volatility of allowance prices under a cap-and-trade regime. European
experience (and the structural nature of allowance trading in general)
will likely produce "prices" that swing all over the place.
Customers may not be comforted by the "average" increases and future
"Provider of Last Resort" contracts will have to include a hefty
risk premium to account for the price volatility, the source says,
adding, "Certainly business and industrial customers will get hit very
hard."

In response to inquiries, Jeanne Fox, President of the New Jersey Board
of Public Utilities, issued the following statement: "Although it's
important to evaluate the direct costs of a cap-and-trade program to
reduce greenhouse gas emissions, that's only a part of the picture. We
can implement other energy policies that will cut emissions while
helping to ease prices and improve reliability. For that reason,
Governor [John] Corzine's Energy Master Plan outlines essential steps
to increase New Jersey's energy efficiency and conservation, reduce
our peak demand for electricity, and build clean electric generation
locally -- serving both our environmental goals and our energy needs."

Fox added, "While we will continue to review PJM's data to see if
it provides insight that might help improve our plan, I am confident
that New Jersey is on a course that will provide for our future energy
needs, control costs and reduce emissions."