1. Background

This report responds to a September 12, 2006, request from Senator Norm Coleman for an assessment of a proposed clean energy portfolio standard (CEPS) that would require each retail electricity supplier to provide an increasing share of its sales from zero and low-carbon dioxide (CO2) emitting sources.  In June 2006, EIA provided analysis of an earlier proposal along similar lines.

Proposal Summary

This proposal applies to retail electricity suppliers with sales exceeding 500,000 megawatthours.  Smaller suppliers, accounting for 270 billion kilowatthours (7 percent) of electricity sales in 2005, are exempt.

Covered retail electricity suppliers must submit to the Secretary of Energy clean energy credits in proportion to their total electricity sales.  For each retail supplier, the number of clean energy credits required is either the specified share of sales during each phase of the program or the growth in electricity sales above their baseline, whichever is smaller.  For example, if the share required were 20 percent in a particular year, but a retail electricity suppliers sales had only increased ten percent above its baseline sales, its required share would be limited to ten percent.  Each retail electricity seller’s baseline is its average annual sales during the 2008 to 2011 period.

Suppliers earn clean energy credits for renewable electricity generation, generation from fossil plants employing CO2 capture and storage, new nuclear generation, and a limited amount of biologic sequestration.  Electricity generated from solar thermal, photovoltaic, wind, ocean, geothermal, biomass, solid waste, landfill gas, and incremental hydropower technologies is counted as clean energy and is eligible to receive full compliance credits.  Coal and natural gas plants that capture and transport their CO2 emissions to permanent underground storage formations receive credits in proportion to their total CO2 emissions.  For example, a coal integrated gasification combined cycle (IGCC) plant capturing 90 percent of its carbon emissions receive 9/10 of a credit for each kilowatthour of electricity generated.  Electric generation from new nuclear plants receives credits at the rate of one-half credit per kilowatthour of generation.  Additionally, renewable projects on Indian lands receive two credits per kilowatthour generated.  Biological carbon sequestration is eligible to earn credits to meet up to ten percent of the requirement.  Examples of this include carbon stored through tree plantings and forest preservation.  These sequestration programs receive 1,000 credits for each metric ton of carbon dioxide stored.  The proposal also allows participation in international offset programs and carbon trading markets.

Under this revised proposal, an escalating percentage of total electricity sales must come from clean energy generation beginning in 2015.  The required share of clean energy generation as a percentage of sales is:

2015-2019                   10 percent
2020-2024                   15 percent
2025 and thereafter      20 percent

The final requirements of this plan do not expire, unlike the previous proposal, which contained a 2030 sunset date.

Retail electricity suppliers are able to earn credits for future use by generating power with qualifying resources prior to the beginning of the program in 2015.  Electricity suppliers are also free to sell, transfer, or exchange their credits.  If a retail seller is not able to meet the standard, it may borrow from future anticipated credits, while submitting a plan ensuring future compliance, or it may buy credits from the program administrator.  Credits purchased from the program administrator cost 2.5 cents per kilowatthour in 2005 dollars, with an adjustment for inflation.

The proposal allows credits earned from meeting State renewable portfolio standards to count towards the minimum renewable generation requirement as long as the energy meets the definition of a clean energy resource described above.  Suppliers must still comply with the State renewable portfolio standard if it is more stringent than the Federal requirement.  Compliance credits earned toward State requirements, including through acquisition, payment of non-compliance penalties, or the use of financial compliance mechanisms (that is, “alternative compliance payments”) are valid for use in compliance with the Federal requirement.  Therefore, providers may pay more than the Federal allowance market price if they fail to reach the State-mandated share of clean/renewable energy.  If the State’s credit requirement exceeds the Federal requirement, the retailer may transfer the excess credits to an associated company.

Implementation Issues

EIA’s National Energy Modeling System (NEMS), which provides the projections in the Annual Energy Outlook, cannot represent all the provisions of the proposed CEPS.  For example, the proposal requires the Secretary of Energy to establish rules and procedures for implementing and enforcing the requirements.  This will necessitate the development of a system to establish unique sales baselines, monitor annual electricity sales growth, estimate the required level of qualifying generation, and ensure compliance for each retail electricity supplier in the country.  The required qualifying sales shares may differ for each supplier because of differences in their sales growth from the baseline period. For new, merged, or divested suppliers, or suppliers whose customer base simply changes, special procedures will be required for determining the appropriate baselines and incremental annual sales growth.  Given the frequency of companies’ recent history of entering and leaving the retail electricity marketplace, this process could require significant effort. 

In this analysis, it is assumed that all applicable suppliers’ sales grow at the same average annual rate each year.  Actual data, however, show that this is unlikely to occur, with some suppliers not growing and others showing negative growth.  Data reported for electricity suppliers between 2000 and 2004 show great diversity in sales growth.  Moreover, electricity restructuring has increased sales volatility, causing periods of rapid negative and positive growth, which are difficult to predict.  Although EIA models the requirement as the lesser of aggregate national sales growth from the baseline period and the percent of total sales on a national scale, each supplier is different.  Some suppliers’ sales will likely grow slowly enough that the proposed legislation will not require them to hold the share of credits as a percentage of total sales.  EIA cannot predict which requirement each company will have and, therefore, takes the lesser of the average national estimates for all providers. 

As noted, the proposal allows electricity suppliers to borrow clean energy credits against future compliance.  Specifically, the Secretary of Energy may allow retail suppliers to borrow excess future compliance credits with submission of a plan to ensure compliance with both current and future targets up to three years into the future.  The program administrator has discretion to extend the three-year borrowing limit where the plan specifies new nuclear generation as the proposed compliance option.  The borrowing option is not represented in this analysis.

Model Application

EIA made several simplifying assumptions to model the proposal.  Since the model does not represent individual electricity suppliers, EIA calculated a target share for aggregated electricity sales.  Suppliers with aggregate annual sales less than 500,000 megawatthours would remain at the 2005 level of 270 billion kilowatthours throughout the projection period.

The calculated minimum renewable generation requirement share is based on the lesser of the required annual percentage share of the prior years total sales or 100 percent of sales growth from the average 2008 through 2011 baseline using the Annual Energy Outlook 2006 reference case projections.  For the first 2 years of the program, the required annual percentage share of total sales is higher than incremental sales, therefore, the requirement is limited to the sales growth relative to the baseline period.

figure data

In the early action period between 2010 and 2015, electricity suppliers have the opportunity to earn credits before the first compliance period (2015-2019) begins.  A large number of credits are expected to be banked through 2015.  EIA projects generation of approximately 828 billion kilowatthours of eligible power during this five-year period.  This analysis assumes that suppliers use these credits to minimize compliance cost over the subsequent 15 years.  It was also assumed that biological sequestration would supply the ten-percent maximum share of credits allowed by the program. Marginal abatement curves for CO2 sequestration projects provided by the U.S. Environmental Protection Agency showed that nearly double the maximum allowable biological sequestration allocation would be available at less than half the average credit price, suggesting ample opportunities to utilize this mechanism, even given significant uncertainty in the estimates of sequestration opportunities and costs.  Figure 1 shows the qualifying generation requirement used in this analysis, which assumes uniform national growth rates, a 10-percent share accounted for by biological sequestration, and the utilization of early credits to reduce compliance costs.

This analysis does not address the potential impacts of issuing double credits for qualifying resources developed on Indian lands.  If such resources are developed, the amount of qualifying generation stimulated by the CEPS will be lower.  This report also does not consider the potential development of ocean energy technologies. 

This report, like other EIA analyses of clean energy and environmental policy proposals, focuses on the impacts of those proposals on energy choices made by consumers in all sectors and the implications of those decisions for the economy.  This focus is consistent with EIA’s statutory mission and expertise.  The study does not account for any possible health or environmental benefits that might be associated with reducing emissions or the siting implications resulting from changes in electric power sector capacity expansion plans.  

NEMS, like all models, is a simplified representation of reality.  Projections are dependent on the data, methodologies, model structure, and assumptions used to develop them.  Since many of the events that shape energy markets cannot be anticipated (including severe weather, technological breakthroughs, and geopolitical developments), energy markets are subject to significant uncertainty.  Moreover, future developments in technologies, demographics, and resources cannot be foreseen with certainty.  Nevertheless, well-formulated models are useful in analyzing complex policies, because they ensure consistency in accounting and represent key interrelationships, albeit imperfectly, to provide insights.