Issues: Oil & Energy

WHO BEARS THE RISKS?

Today's electric utilities typically hold geographically defined monopolies over both electric distribution and generation, and recover all or most of their costs through regulated prices charged to customers who lack realistic access to other suppliers. Whenever these utilities have found it necessary to reduce pollution emissions, any associated costs could simply be passed through to captive customers without affecting the utilities' net revenues. This practice often converted individual electricity customers into uncompensated and involuntary insurers of the generators' environmental liabilities. As a result, society unwittingly has tended to overinvest in costly cleanups and underinvest in cleaner alternatives.

State and federal regulators are now restructuring the electric industry, with support from most affected parties and much of the industry itself. The old generation monopolies are disappearing, and utilities are losing any ability to shield their power plants from competition or to secure guaranteed cost recovery for pollution-related costs. In competitive generation markets, the competitors must recover their costs in the marketplace itself; price regulators will not be available to provide any supplementary assistance. Increasingly competitive markets will make environmental risks more visible and force explicit decisions on who will bear them. If the power plant owner wants to shift that risk to someone else, compensation will be required. Even where utility monopolies persist temporarily, regulators will not be likely simply to pass these risks on to customers.^[6] And new federal guarantees of open access to transmission systems ensure that owners of dirtier plants cannot block newer, cleaner entrants from access to power markets.

How much all this matters for investors depends vitally on two questions: what are the most significant and plausible unrealized sources of environmental risk, and how substantially do power suppliers vary in their relative exposure? The rankings that accompany this report supply some initial answers; the explanations follow below.

Carbon Dioxide Emissions: The Climate Stabilization Imperative

No issue on the environmental agenda will have more profound implications for the electricity industry than global warming. For those who had viewed global warming as a hazy theory that could be safely ignored, the international scientific community issued a loud wake-up call late in 1995, when the most comprehensive and authoritative assessment ever undertaken concluded that "the balance of evidence suggests a discernible human influence on global climate."^[7] In other words, global warming has begun, and humans are at least partly responsible. The assessment by the Intergovernmental Panel on Climate Change (IPCC) goes on to document the likely adverse impacts on human health and the environment, including the spread of infectious disease, and more frequent and intense heat waves, wildfires, drought, and storms. The IPCC also predicts that global warming will cause widespread disruption of natural ecosystems, fundamentally altering the composition of one-third of forest areas around the world and damaging critical wildlife habitat.^[8]

Our collective obligation to heed such warnings is clear. The United States Senate has ratified the United Nations Framework Convention on Climate Change, making it part of our national law. The treaty establishes an ultimate objective of stabilizing "greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous [human] interference with the climate system." The commitments in the treaty are to be reviewed on a regular basis in light of this objective, until stabilization is achieved. And no one disputes that stabilizing greenhouse gas concentrations in the atmosphere ultimately will require significant reductions in emissions. The treaty's structure and provisions will generate sustained pressure to create and strengthen emissions controls over the years ahead.

The latest illustration came in July 1996, when Undersecretary of State for Global Affairs Timothy Wirth noted in his official statement to the Climate Convention Parties in Geneva that "the science calls on us to take urgent action." Buttressed by the scientific findings of the IPCC, the United States is now calling for the Climate Convention to be strengthened by negotiating "an agreement that sets a realistic, verifiable and binding medium-term emissions target."^[9] This is a major shift in U.S. policy, compared with the previous non-binding aim of returning greenhouse gas emissions to 1990 levels by the year 2000.

The world's environment ministers assembled in Geneva in July of 1996 and, spurred by the new U.S. position, adopted a declaration endorsing the IPCC report as a basis for urgent action and instructing representatives to accelerate negotiations on a legally binding agreement to be adopted by the December 1997 meeting scheduled for Kyoto, Japan. This Ministerial Declaration goes beyond previous high-level statements in three important respects. First, it strongly endorses the IPCC conclusions, rejecting complaints by some industry lobbyists and OPEC countries. Second, it concludes that the continued rise in greenhouse gas concentrations will lead to dangerous interference with the climate system. This is highly significant in that the Climate Treaty commits Parties to the objective of avoiding "dangerous" climate change. Third, the Declaration calls for "legally binding" objectives for emission limitation and reductions (binding targets and timetables).

These very recent developments indicate that, while the level and timing of mandatory CO2 emission reductions are still being debated, no one can prudently plan on continuing to pour CO2 into the atmosphere with impunity. Investing in lobbyists rather than emission reductions may work for a year or two, but ultimately it is a losing proposition. While scientists and politicians can still be found who dispute the need for remedial measures, none has offered to indemnify emitters or their investors for the potential costs of continued inaction. Both the emitters and their investors need hedging strategies far more potent than stubborn denial.

Disparities In Suppliers' Exposure To Risks Of Carbon Dioxide Emissions

Electrical supply is diverse in its sources and in its carbon dioxide emissions. No, or virtually no, emissions accompany investments that create additional kilowatt-hours through energy efficiency improvements or renewable energy resources like wind, solar, geothermal and hydropower facilities.^[10] While nuclear power does almost as well, its other liabilities are likely to swamp this advantage. At the opposite end of the scale is conventional coal-fired generation, which averages more than two pounds of carbon dioxide per kilowatt-hour (or 1.6 million tons per year from a medium-sized 250 MW plant). Compared to coal, natural gas and oil are lesser but still substantial emitters; they produce 44 percent and 16 percent less carbon dioxide per kilowatt-hour, respectively, than coal-fired power plants of equivalent efficiency. New gas-fired plants typically widen the gap still further by beating their coal-based competition in the efficiency with which they convert heat into electricity.

If U.S. carbon-dioxide emissions costs were to rise from zero today to $20/ton -- at or below levels already adopted for some purposes in Norway and Sweden -- the annual financial liability for that 250 MW coal-fired plant would be $32 million (about two cents per kilowatt-hour, which rivals the gross revenues that the plant could earn in today's competitive wholesale power markets, when carbon dioxide emissions incur no costs whatsoever).^[11] Escaping all liability, under this scenario, would be kilowatt-hours from energy efficiency, and renewable and nuclear sources. Gas and oil would be in intermediate positions.

In considering the political feasibility of such a tax or emissions charge, it is important to recall the growing international pressures to shift tax burdens away from income and toward consumption; Spain, Sweden and Denmark are among the nations that recently have combined cuts in payroll or income taxes with increases in energy taxes.^[12] In Minnesota, the Chairman of the House Tax Committee proposed in 1996 to reduce payroll and property taxes by $1.5 billion annually by the close of a five-year phase-in period, and to make up the lost revenues with new taxes on carbon dioxide emissions (the legislature did not act on the bill this year, and it is scheduled for reintroduction in 1997).^[13] A recent letter by the Presidents of the National Association of Manufacturers, the American Petroleum Association, and others warned of possible energy taxes equivalent to at least $35 per ton of carbon dioxide in response to emerging global climate concerns; under that scenario, the electric industry as a whole would face annual liabilities in excess of $60 billion.^[14] Of course, the objective here is not to predict the timing or form of emissions controls or incentives, but rather to draw attention to where the risks fall and how they can be reduced.

Notes

6. See, e.g., Massachusetts Electric Company v. Department of Public Utilities, 419 Mass. 239, 246 (1994) ("if it reasonably appears that the current emission of a power plant in lawful amounts will be affected in the foreseeable future by a prohibition, new restrictions, costly regulation, or pollution penalties or taxes . . . the [public utility commission] has the authority as a rate regulator to consider the appropriateness of avoiding that reasonably foreseen change and requiring that the utility pursue a course likely to be less costly to ratepayers in the long term"); R. Cavanagh et al., Utilities and CO2 Emissions: Who Bears the Risks of Future Regulation?, 6 Electricity Journal 64 (1993).

7. Intergovernmental Panel on Climate Change, Climate Change 1995: The Science of Climate Change (Cambridge University Press, 1996). While coal and oil interests have led an effort to distract attention from the IPCC's findings by questioning the procedures used in finalizing the report, the response of the scientific community has been unequivocal: far from representing any impropriety, the changes made between the draft and final report were nothing more than the peer review process at work. The U.S. official statement at the Geneva meeting commented that the IPCC's critics were "naysayers and special interests bent on belittling, attacking and obfuscating climate change science."

8. Intergovernmental Panel on Climate Change, Climate Change 1995: Impacts, Adaptations, and Mitigation (Cambridge University Press, 1996).

9. Statement of Timothy E. Wirth, Undersecretary for Global Affairs, on behalf of the United States of America, Second Conference of the Parties, Framework Convention on Climate Change (Geneva, Switzerland, July 17, 1996).

10. We intend no blanket endorsement of such resources, of course; large-scale hydropower in particular carries numerous environmental liabilities that are independent of its greenhouse-gas profile.

11. Carbon tax data are taken from Frank Muller, Mitigating Climate Change: The Case for Energy Taxes, 58 Environment 12, 17 (March 1996).

12. These developments are reported in the Wuppertal Bulletin on Energy, February 1995, Wuppertal, Germany.

13. See "Minnesota Bill Would Target Carbon Emissions, Shift Taxes," Wind Energy Weekly, February 26, 1996, p. 2 (describing the Economic Efficiency and Pollution Reduction Act of 1996, authored by State Representatives Ann Rest and Steve Morse; the proposal includes the use of $80 million in revenues from the new carbon-dioxide tax for low-income fuel assistance and weatherization programs).

14. Letter from Jerry Jasinowski, Charles DiBona and Thomas Kuhn to the Members of the American Energy Alliance (August 7, 1996). These industry leaders predict that meeting the current Administration's climate commitments would require, at minimum, "taxes of $125 to $170 per metric ton of carbon," which is equivalent to about $38-51 per ton of carbon dioxide.