TODAY’S STUDY: SETTING A STANDARD FOR NEW ENERGY

Clean Energy Standards: State and Federal Policy Options and Implications
November 2011 (Regulatory Assistance Project and Center for Climate and Energy Solutions)

EXECUTIVE SUMMARY

A transition from conventional fossil fueled electricity generation to clean energy offers several benefits—particularly the growth of new clean energy industries and associated jobs, diversification of energy supply, and reductions in the public health and environmental damages (especially from air pollution) associated with conventional electricity generation.

The current status of clean energy generation depends on how one defines clean energy. While there is no universally agreed upon definition of clean energy in the power sector, various stakeholders endorse some or all of the following as at least partially clean energy options: highly efficient natural gas combined cycle generation; fossil fuel use coupled with carbon capture and storage (CCS); nuclear power; renewables; and electricity savings from energy efficiency and conservation. These generation sources provide about half of U.S. electricity today. While market dynamics and current state and federal policies have led to recent growth in clean energy generation—such as the growth in renewable generation driven in part by state renewable electricity portfolio standards—projections for the power sector indicate that, absent significant new policies to promote clean energy, the status quo in terms of power generation will continue largely unchanged for at least the next quarter century.

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Given the benefits of clean energy and the dependence of substantial growth in clean energy generation on new policies, policymakers have lately turned their attention to the idea of a clean energy standard (CES). A CES is a type of electricity portfolio standard that would set aggregate targets for the level of clean energy that electric utilities would need to sell while giving electric utilities flexibility by: (1) defining clean energy more broadly than just renewables, and (2) allowing for market-based credit trading to facilitate lower-cost compliance. As a concept, a CES builds on the successful experience of the majority of states that have implemented renewable and alternative energy portfolio standards and draws on a history of federal policy deliberation regarding national electricity portfolio standards.

States could pursue new CES policies singly or jointly to create multi-state programs. State CES programs could complement existing state renewable portfolio standards, and a CES may be a promising option in states where more narrowly defined renewable electricity policies have had less appeal. A handful of states have already enacted electricity portfolio standards that have many of the attributes of a CES.

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The federal government could also enact a national CES. A federal CES has recently received bipartisan support, with several Republican Senators sponsoring federal CES proposals in the last Congress and President Obama endorsing a federal CES in his 2011 State of the Union address. While the prospects for near-term enactment of a federal CES are uncertain, a federal CES has received substantial attention and warrants close consideration by stakeholders.

This paper introduces stakeholders to the concept of a CES, explains how a CES works, describes the benefits that a CES can deliver, and explores federal and subnational options for CES policies. This paper also explores some of the nuances of CES policy design and the implications of different design choices. This discussion can help both state and federal policymakers, utility regulators, and other stakeholders decide whether a CES is an appealing option and to help state stakeholders understand the potential impacts of a federal CES on their states so that they might formulate and communicate federal CES policy design preferences.

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Several of the paper’s key points are summarized below.

• Absent significant new policies to promote clean energy, the share of total U.S. electricity generation obtained from clean energy sources will likely not increase by more than a few percentage points over the next 25 years.

• Substantial increases in clean energy generation can offer important benefits, including:

o Growth of new clean energy industries and associated jobs—e.g., wind turbine manufacturing, solar panel installation, and nuclear power plant construction;

o Diversification of energy supply to limit electric utilities’ and ratepayers’ exposure to fuel price volatility and regulatory risk associated with particular energy sources;

o Mitigation of environmental and public health impacts from electricity generation—including criteria and hazardous air pollutants, greenhouse gases emissions that contribute to climate change, and other impacts.

• A CES is a promising policy for spurring a transition to clean energy in the power sector. o As a type of electricity portfolio standard, a CES sets requirements for the percentage of electricity sales that must be supplied from qualified clean energy sources and allows electric utilities to demonstrate compliance via tradable credits that they earn themselves for their own generation or buy from other electric utilities or clean energy generators.

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o As a market-based policy, a CES can effectively increase clean energy generation and achieve associated benefits while offering substantial compliance flexibility for electric utilities thus minimizing impacts on electricity consumers.

o By broadly defining clean energy, a CES provides opportunities for utilities, states, and regions to exploit their unique mix of clean energy options.

o A CES program can build upon the success of existing electricity portfolio standards that a majority of states have already implemented, provided that the percentage targets are increased in proportion to the potential of newly eligible resources. If additional clean energy resources are allowed to qualify for an existing portfolio standard without increasing the targets, the mix of resources used to meet the standard and the resulting compliance costs may change, but the total amount of clean energy generation will not increase and the goals of the policy may not be furthered.

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o At the state and federal levels, CES policies have attracted bipartisan support, including CES proposals from President Obama and Republicans in Congress.

• CES programs enacted by the federal government or by states singly or in coordination could spur incremental clean energy generation and deliver associated benefits.

o Federal CES proposals have attracted bipartisan support in previous years, but it is not clear if or when legislation to create a federal CES will move forward.

o States have already proven themselves to be policy innovators with respect to renewable electricity portfolio standards, and states may seek to reap the benefits of clean energy for themselves by implementing new CES policies—either singly or as part of multi-state programs.

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o At least four states (Michigan, Ohio, Pennsylvania, and West Virginia) already have electricity portfolio standards that credit cleaner, non-renewable energy sources, and Indiana has a similar but voluntary program. These states offer several lessons for future state or federal CES programs, including:

 Utilities tend to comply with electricity portfolio standards by deploying the lowest-cost qualified resources, so policymakers may need to include special provisions in a CES if they hope to provide a meaningful incentive for less commercially mature and higher-cost technologies.

 Policymakers can design CES programs that have very modest impacts on electricity rates.

 A combination of factors—including the policy’s target and the types of energy sources that qualify—determine how much incremental clean energy generation a CES program will deliver beyond “business as usual,” and policymakers should consider the interaction of such factors in developing a CES to ensure the program can meet their goals for additional clean energy generation.

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• The net effects of a CES policy are a function of interrelated policy design decisions. Policymakers and stakeholders should understand CES policy design options and their interactions and implications. Policymakers and stakeholders might usefully evaluate a CES in terms of key criteria and think about implications of different policy design decisions in light of these criteria. o Effectiveness – What is the magnitude of the policy’s desired impacts?

 CES targets set the requirements for overall clean energy generation.

 The degree to which a CES delivers the benefits associated with clean energy depends on how policymakers define qualified clean energy under the program.

 Certain policy design options (e.g., exemptions for certain utilities and alternative compliance payments) can have the effect of reducing a CES program’s effective target for incremental clean energy deployment.

 Policymakers may include provisions in a CES to provide particular incentives to certain technologies—e.g., less commercially mature or higher cost ones—in order to reap particular clean energy-related benefits.

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o Cost-effectiveness – how efficiently does the policy achieve its intended aims?

 As a market-oriented policy, a CES is an inherently cost-effective program.

 Policymakers have several options for providing electric utilities with compliance flexibility under a CES (e.g., banking and borrowing of credits).

 In general, the more flexibility that utilities have for meeting clean energy targets (e.g., the more broadly clean energy is defined), the more cost-effective a CES program will be.

o Fairness – does the policy lead to any undue burdens or unearned windfalls for particular utilities, power generators, or regions and customers?

 Owing to a variety of factors, different electric utilities supply their customers with electricity from widely varying existing generation mixes. In addition, utilities, states, and regions have different cost-effective options for increasing clean energy generation (e.g., because of different renewable resource endowments).

 How policymakers set CES targets, treat new vs. existing clean energy generators, and define qualified clean energy sources determine how the effects of a CES program vary among different utilities, power generators, or customers.

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STATUS AND OUTLOOK FOR CLEAN ENERGY

Some context regarding the status and outlook for clean energy in the power sector can help inform the discussion of a CES. The following observations are of particular relevance:

• The United States currently obtains nearly half of its electricity from traditional coal-fired electric power plants (see Figure 1).

• Natural gas has dominated new capacity additions in the power sector over the past two decades, and renewables, particularly wind power, have seen strong growth in the last decade (see Figure 2).

• The latest projections from the U.S. Energy Information Administration (EIA) of “business as usual” trends for the power sector (from EIA’s Annual Energy Outlook 2011, AEO2011) suggest that the share of total U.S. electricity generation obtained from several clean energy sources is unlikely to increase by more than a few percentage points over the next quarter century.

• Absent a new energy policy, natural gas is projected to be the dominant technology choice for new electricity generation.Figure 3 ). 1This is projected to be the case even when taking into account sensitivity to such factors as forthcoming EPA regulations, natural gas prices, and extension of federal tax incentives for renewables (see

• A majority of states have adopted binding renewable and alternative energy portfolio standards to drive increases in clean energy generation (see Figure 4), but the expansion of such policies to new states may be slowing (see Figure 5).

• In the absence of supportive financial incentives and policies, renewables and other clean energy technologies (with the exception of energy efficiency technologies) are generally more costly than new natural gas combined cycle power plants, the least costly and cleanest fossil fuel technology (see Figure 6) for new capacity additions. Clean energy technologies may also face other challenges, as detailed in Appendix A.1.

The observations above suggest that, absent significant new policies to promote clean energy, the United States will not see a substantial shift toward clean energy.

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CONCLUSIONS

A transition from conventional fossil-fueled electricity generation to clean energy offers several benefits—particularly the growth of new clean energy industries and associated jobs, diversification of energy supply, acceleration of development and deployment of clean energy technologies, and reductions in the public health and environmental damages associated with conventional electricity generation. The current outlook for the power sector suggests, however, that absent significant new policies to promote clean energy the status quo in terms of power generation will continue largely unchanged for at least the next quarter century.

A CES holds promise as a policy for spurring growth in clean energy generation. As a concept, a CES builds on the successful experience of the majority of states that have implemented renewable and alternative energy portfolio standards and draws on a history of federal policy deliberation regarding national electricity portfolio standards.

The net effects of a CES policy are a function of interrelated policy design decisions. Policymakers and stakeholders should understand CES policy design options and their interactions and implications. Policymakers and stakeholders might usefully evaluate a CES in terms of key criteria – effectiveness, affordability, cost-effectiveness, and fairness – and think about implications of different policy design decisions in light of these criteria.