Discussio n draft

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## A Plan for Regulating Power Sector GHGs U nder CAA Section 111(d):

Developing and Implementing a Balanced, Effective, and Efficient Approach

NRG Energy

8/29 /13D iscussion draft

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1 

## Executive Summary

Reactions to the President’s plan for reducing greenhouse gas (GHG) emissions from existing power plants through EPA regulation range from full

- throated opposition to optimistic but unrealistic

pr oposals. The key to achieving the President’s goals is developing and implementing a truly workable middle ground approach before 2016. Such an approach should advance not only the GHG reduction goals outlined by the President, but also drive increased d eployment of clean energy resources, and mitigate the risk of derailment due to full blown legal and political opposition.

Clean Air Act Section 111(d) offers a narrow path for EPA and the states to achieve real GHG reductions while simultaneously accel erating the deployment of clean energy and enhance d energy efficiency. NRG supports a two

- part plan to realize these objectives. First , EPA’s guidelines should lay out a package of the core elements of a suitable compliance program. These core elements comprise readily achievable performance standards for fuel

- based sub

- categories of sources; robust trading of emission reduction credits

-- intrastate and interstate

-- across facilities and companies; and an alternative compliance payment or “safety valv e” to prevent excessively high compliance costs and to help fund state clean energy and efficiency initiatives.

In addition to this core compliance package, EPA should provide states a menu of voluntary clean energy initiatives that will provide additi onal GHG reductions, while simultaneously advancing other important goals, by providing additional clean energy incentives for energy efficiency; renewable energy deployment; and repowering or retirement of less efficient coal fired power plants. Togethe r, the core compliance package and the voluntary clean energy initiatives will:

• Lay out the most pragmatic, achievable and efficient path for state plans to achieve critical emission reduction goals, consistent with energy reliability;

• Increase investmen t in plant efficiency and cleaner fuels for underperforming units;

• Focus incentives on operating efficient plants more and inefficient plants of each fuel type less, reducing emissions at the lowest cost ;

• Encourage investment in new renewable energy, and advanced energy efficiency ; and

• Facilitate the voluntary retirement and repowering of high emission generation with cleaner, profitable replacement generation.

This balanced approach can achieve substantial emission reductions at a low cost to the over all

economy and
, importantly, to the regulated entities in the power sector itself. Low costs to the economy and to power companies are essential for political acceptability, stakeholder engagement and support, legal stability and enduring emission reduct ions. Above all, long

- term emission reductions depend on a regulatory approach that combines strong incentives for reducing emissions with the enhancement of energy companies’ ability to invest the hundreds of billions of dollars
needed to create a clean energy economy.D iscussion draft

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2 1. Introduction

Clean Air Act section 111(d) requires EPA to issue pe r forman ce standards for existing sources of otherwise unregulated dangerous pollutants
, but offers only limited guidance for the contents of such standards. The key statutory requirements are that:

a. The performance standards must be based on “the best system of e mission reduction ” that the EPA administrator, taking cost into account, determines has been adequately demonstrated; b. The rule must consist of a procedure, comparable to that used for State Implementation Plans (SIPs) under section 110, whereby each stat e develops and submits to the Administrator a plan that implements performance standards for affected existing sources; and

c. The Administrator has authority to prescribe or enforce plans in the event a State fails to do so.

It appears that EPA will likely b ase a Section 111(d) rule for existing power plants on several performance standards for CO2 emission rates per megawatt

- hour. At the same time, given the flexibility required to successfully implement such a standard across existing sources, EPA almost

c ertainly will have to look beyond a pure numeric standard and employ additional tools and measures for such a program to be implemented successfully and at a reasonable cost

. Fortunately, beyond a specific numeric limit that would be enforced uniformly in each state, Section 111(d) precludes few options while leaving open the door to a wide range of flexible tools EPA can use to enhance the success of the regulations . At the outset, we recommend EPA establish a basic package of core compliance elements to :

• Establish nation

- wide performance standards for GHG emissions by fuel

- type subcategory ;

• Promot e averaging, banking and trading of allowances across facilities and companies;

• Encourage and p rovide the mechanism for a robust interstate trading system; and

• C ap the price of compliance instruments at reasonable levels

.

T h is core compliance package would allow state plans to achieve a necessary regulatory compliance

program for existing facilities

. EPA should , however, go further and also lay out guidelines fo r clean energy initiatives that states could include voluntarily in their plans to realize additional cost

- effective opportunities to achieve or exceed the emission reductions required by EPA’s guidance . Such clean energy initiatives should include altern ative means of compliance based on the deployment of end

- use energy efficiency and renewable energy , as well as through targeted market

- based incentives for the retirement and replacement of poor

- performing coal plants.

This combination of a core co mpliance package and voluntary clean energy initiatives will allow states to readily and effectively achieve the goals of GHG reductions from existing facilities , at a low cost to regulated entities and their customers, while accele rating the deployment of clean energy

. P ower plants with emission s intensity greater than the relevant performance standard would have an incentive

to make commercially available and feasible improvements in fuel efficiency to meet the standard.D iscussion draft

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3 Plants for which such investme nts are excessively costly or infeasible would , in turn, be able to comply by purchasing emission reduction credits from plants that whose emission rates are below the standard. This additional increase in the marginal cost of operation f or the plants wit h the highest emission rates would lead to them running less, and their energy output being replaced by plants with lower emission

rates. This short

- run dispatch impact would directly reduce carbon emissions.

Meanwhile, p lants that run and earn less are less profitable to maintain, and hence are more likely to retire or repower to a more efficient, lower carbon technology. These long run incentives to retire, repower or replace less efficient plants, will lead to further emission reduction s from existi ng plan ts. Under our proposal, emission reductions will be further augmented by state plans that voluntarily include the clean energy initiatives suggested in the guidance. The net result will be even more emission reductions
, at a lower cost and with g reater potential public support than other more drastic approaches EPA may consider

.

2. Our Key Design Element Recommendations 1

In our view, an effective 111(d) regulatory approach will have two basic component s. The first is a set of
core elements that w ould inform all state plans, and the second is a set of additional voluntary compliance pathways that states could include in their plans voluntarily

.

A. Four c ore elements of EPA’s guidance

1. Empirically

- supported performance standards.

While market

- bas ed mechanisms provide for greater efficiency, the underlying performance standard levels will ultimately determine the cost of the program for regulated entities, their customers, and coal

intensive regions of the country. To hedge against costly price vo latility and high compliance costs that will undermine political and legal stability of the program, EPA should base the performance standard on a realistic, empirical assessment of the emission reductions that can be achieved through the best
emission red uction option that is commercially available, considering cost, and that is actually under the control of the covered emitters. Because existing plants have engineering, operating and cost characteristics distinct from those of state

- of

- the

- art new techno logies, the standards for existing plants must be distinct from those for new plants.

Key to the success of such standards will be to develop the strongest and soundest empirical basis for their deployment at a reasonable cost and in realistic quantities b y covered entities. In contrast, basing the standards on anecdotal or theoretical potential emission reductions would likely to lead to compliance costs far above those anticipated. For example, statistical estimates of historical heat rate improvements at coal plants may over

- estimate the availability of heat rate improvements and under

estimate their costs by assuming that past improvements can be repeated again at the same plants, or

1 Most of these features are consistent with the overall recommendations of the National Climate Coalition (NCC) for how EPA could regulate GHGs from existing power plants. NRG is a founding member of the NCC.D iscussion draft

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4 that improvements that work for a subset of plants will work at all p lants. If fewer emission improvements are available, and if they cost more than EPA assumes in setting the standard, the actual cost of meeting the standard will be higher

– and, in a market based system, potentially much higher

– than EPA anticipates. Excessive compliance costs would be devastating to a number of US power companies, and companies facing such uncertain and unhedg e able risks will natura lly be strongly opposed to a ny policy that could create such risks. For this reason, the standards sho uld be achievable at modest cost under today’s existing technologies, and should also be accompanied with the alternative compliance payment discussed below.

F urther , performance standards should be subcategorized, at a minimum, by fuel types (coal, gas, o il) to

ensure that no one fuel type is given standards that it cannot achieve using commercially available, cost

effective technologies, and to avoid massive transfers of wealth between different power companies and regions of the country. In particular, windfalls for natural gas fired fleets will do little to deploy advanced technologies but could lead to a rapid and unbridled switch to gas power plants, locking in another generation’s worth of fossil fuel dependency in the power sector.

Sub

- categorizati on is important, not just to avoid this result, but also because a single standard based on
the average of different fuel types’ emission rates w ould impose unacceptably costly compliance obligations on facilities and companies with more coal

- fired assets while transferring large amounts of their cash fl ow to gas

- fired power companies. S uch a cash outflow from coal

- intensive fleets w ould limit the ability of coal

- intensive companies to invest in the cleaner technologies they need to deploy to
survive and succeed in a low carbon future. Further, such an approach would increase the risks of such a rule being overturned by the courts, both because of the additional appeals it will induce and because of its deviation from the clear statutory requirement to base the standard on the best system of
emission reductions. 2

2. Tradeable credits and allowances

A tradable, emission rate

- based performance standard would require plants whose emission rates
exceed the standard to reduce their emission rate to the sta ndard (e.g., through heat rate improvements or co

- firing with a less carbon intensive fuel) or to buy emission

- rate reduction credits (ERCs) equal to the difference between the standard and their own emission rate, times their megawatt

hours of electricity production. Plants with emission rates below the performance standard could sell ERCs, based on the difference between the standard and their own emission rate, times the number of megawatt

- hours of production.

3

. An i nter

- state trading system

2 W e think it unlikely that Congress meant for the “best system of emission reduction” to include a regulatory regime under which Emitter A loses all their profits and renders their assets uneconomic by being required to send vast amounts of money to Emitter B or Service Provider C. A trading system should be used to minimize the cost of using the best system of emission reductions, not to define it.D iscussion draft

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5 Materia l emission reductions at moderate costs are the key to realizing true political and legal stability for the existing source rule. Lowest cost emission reductions are virtually certain to be achievable only through a broad market

- based system and therefore EPA explicitly should encourage SIPs that support efficient interstate trading of compliance instruments. This is particularly important for the many covered entities with facilities in multiple states , especially those states with competitive wholesale power markets that have been designed in response to federal government initiatives and requirements . The ability to trade and to average emissions and compliance across large, inter

- state fleets will reduce each company’s cost of compliance while also f acilitating more emission reductions, at a lower overall cost, than would be available under intra

- state trading alone. And a uniform regulatory system with interstate trading at least congruent with the federally regulated wholesale power markets
will h elp avoid economically perverse results that could result under a plethora of different state
mechanisms. 3

4. An appropriate cap for the cost of c ompliance

To further make the proposed rule more broadly acceptable and to avoid punitive and unintended

r esults, such as limiting the ability of coal

- based companies to invest in clean energy alternatives , EPA should also require SIPs to limit the risk of unacceptably high ERC prices and compliance costs by including an Alternative Compliance Payment (ACP), s imilar to that used in most state renewable energy portfolio standards. If ERC prices reach the ACP level, entities could comply by paying the ACP instead of buying additional ERCs. The ACP level should be tied specifically to an appropriate cost thresh old. 4

EPA should also assure states that any funds collected through a state’s ACP will be available to that state for purposes it deems appropriate for further reducing GHG intensity, such as further deploying clean energy and energy efficiency techno logies within the state. This will provide additional emission reductions, economic benefits, and accelerated maturation and cost reductions of clean energy and
efficient end

- use technologies.

B. A roadmap for voluntary compliance tools to realize addi tiona l GHG reductions

Reducing the emission intensity of existing power plants is an important step in reducing overall GHG emissions. But significant emission reduct ions will require a major increase in renewable energy production, end

- use energy efficiency , and in the retirement and replacement of the least efficient coal plants with far cleaner resources. For this reason, NRG recommends that EPA promote incremental

3 For example, proposals that would have different standard s for each state, based on each states average of gas and coal plant emissions, would allow an inefficient, high emission coal plant in a coal

- rich state to have lower compliance costs than a much more efficient, much lower emitting coal plant in a gas

- ric h state. This would give the dirtier coal plant a competitive advantage in both power and capital markets. We encourage EPA to avoid such results.

4 For example, if EPA’s empirical study shows that an average 10% emission rate reduction is available ac ross the US coal power plant fleet for a maximum cost of $ 15 per ton of reduced CO2 emissions, the ACP would be set at or near $ 15 per ton. This will assure a strong market incentive for making the kind of heat rate improvements identified in the empiric al study, while protecting against the crippling high prices that could result if emission rate reductions cost significantly more than the study predicted.D iscussion draft

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6 renewable energy, end

- use energy efficiency , carbon capture and sequestration and repowerin g of operating coal plants through a roadmap or guidelines for states that wish to voluntarily include such
initiatives in their 111(d) plans. S tate clean energy initiatives that comply with these guidelines might

serve as either an alternative to the cor e compliance package, or as complementary compliance
mechanism s in it

. We recommend the following key provisions in this

1. Promoting Energy Efficiency and Clean Energy

Allowing adequate alternative compliance options can increase incentives for deploying clean energy and efficient end

- use technologies, help avoid politically and economically excessive complian ce cost impacts on both covered entities and customers, and result in additional emission reductions overall. EPA, for example, could allow volunta ry state programs to generate additional ERCs that could be sold into the compliance market. These might include qualified indirect emission reductions in implementation options, including incremental renewable energy production, limited repowering of

coa l plants with low emitting natural gas and renewables, CCS, or additional improvements (beyond
business

- as

- usual and existing utility programs ) in end

- use energy efficiency.

EPA should ensure that such voluntary additional compliance measures meet stric t causation, attribution, measurement and verification and trading requirements, by providing guidelines SIPs must meet in order to be approved. These guidelines should include provisions for any ERCs generated by the voluntary compliance options to be tr aded on an interstate basis. This approach offers the potential for EPA and the states to develop appropriate ways to measure and certify indirect emission reductions, while encouraging additional market

- based developme nt of such resources. If these ini tiatives can be successfully demonstrated as satisfactory for compliance purposes, as well as commercially available and reasonable in cost
, EPA may be better able to fold such indirect measures into any future updates of the performance standards themselv es, as may be warranted, e.g., whenever the 111(b) rule for new power plants is itself updated.

2. Fostering an investment pathway for moving capital from coal to cleaner
alternatives

A ny plan the EPA is likely to consider will have the effect of shifting so me short

- run generation output from higher emitting to lower emitting resources . However, the political, economic and environmental optimum will best be achieved if the plan also includes ways to shift long run capital investment to actually replace exis ting high emitting sources with lower or zero emitting new resources. NRG proposes that the EPA use the 111(d) process to encourage states to include in their plan s provisions that will reduce the uncertainty about cost recovery for the voluntary replacem ent of operating coal plants with efficient gas technologies (and other forms of cleaner generation). This would induce more owners of marginal coal plants to retire and replace them with efficient gas or renewables voluntarily
, without distorting the ba lance of supply and demand in competitive wholesale power markets; and without undermining grid reliability.

Under such an approach, the EPA would encourage states to consider and, as appropriate, implement programs with the following key features:D iscussion draft

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7 • Power c ompanies that, prior to 2020, retire operating coal plants 5 and replace them with the least cost natural gas plant or other alternatives with comparable or better performance and emission characteristics, will be provided a fast

- track to cost recovery (for repowering of regulated coal plants) or the price certainty needed for project financing (for repowering of competitive coal plants).

• For regulated repowering projects that meet the above eligibility criteria, the fast

- track would be created by each state , in a manner consistent with the state’s integrated resource planning or a similar regulatory process.

• For competitive repower ing projects, cost recovery would be facilitated by state programs that require a suitable counterparty to enter into an agreemen t with the project, such as a ten year

cont ract

- for

- differences, which would provide it with sufficient price certainty to support project finance. The counterparty could be a utility, a consortium of utilities, a power agency or oth er entity able to ente r into such an agreement and to flow the cost and benefits of those purchases

to customers through a broad based “wires charge” or other competitively neutral mechanism.

This approach will help the power sector make wise investment choices in critically ne eded resources during a time of uncertainty and change, without mandates or federal expenditures. Several additional features would help assure the efficiency and effectiveness of the program:

o To ensure that this approach does not procure excess or unneed ed generating capacity, only operating power plants, which would produce substantial amounts of energy at projected gas prices, should be eligible, and their replacement cannot exceed the capacity, on a MW for MW basis, of the coal facility it replaces.

o Co st discipline could be enhanced by competitive procurement (for regulated utility repowering projects) and competitive market benchmarks (for competitive repowering projects).

Such a program should have extremely low incremental costs, in that it would lea d to the replacement of marginally economical or uneconomical coal plants with the most cost

- effective generation technology and fossil fuel available today.

4. Conclusion

The key suite of features recommended in this two

- part plan would create an effecti ve, low cost, simple and relatively uniform market based system for reducing the GHG intensity of the US power sector. It would focus the strongest incentive to reduce emissions on the least efficient power plants in both the coal and the gas fleets, whic h are precisely the units with the least economic value and the greatest emissions per unit of energy production. It would have a neutral to positive economic impact on more efficient and economically important power plants, assuring a moderate overall co st impact for coal

intensive companies and regions of the country. This approach should also produce material reductions
in GHG emissions. It would make the least efficient coal plants less economic relative to efficient gas

5 An appropriate definition of operation status will be necessary, e.g., plants that are in opera tion today and will produce substantial amounts of energy at forward market prices for power and natural gas, or that are deemed needed for reliability.D iscussion draft

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8 plants, and also incent incre mental investment in cleaner technologies. In the short run, this would
de crease the dispatch of inefficient coal plants relative to more efficient gas plants , and in the long run it would encourage their replacement by lower or zero carbon alternatives.

These pragmatic and effective steps to reduce GHGs from existing plants, while also nurturing additional energy efficiency and renewable energy deployment and the replacement of inefficient coal plants with lower emitting and flexible gas plants is also, in our view, l egally permissible under Section 111(d)
, should be attractive to and easy for states to implement, and can be implemented in ways that have a very modest impact on the cost and operating requirements of most power sector entities that would
b e regulated under it, including coal

- intensive companies and regions of the country. In light of the President’s and EPA’s intention to consult intensively with power companies during the development of the 111(d) rule, such a framework may help form a br oader consensus around appropriate approaches to regulating GHGs under the Clean Air Act.