-i

# REPORT TO THE LEGISLATURE

ON EMISSIONS REDUCTION PROJECTS

UNDER MINNESOTA STATUTES 216B.1692

Submitted by the

Minnesota Public Utilities Commission

March 2008-ii

## REPORT TO THE LEGISLATURE

ON EMISSIONS REDUCTION PROJECTS UNDER MINNESOTA STATUTES §216B.1692



# Introduction

In 2001, Minnesota Statutes §216B.1692, Emissions Re duction Rider, was enacted The statute

allows a utility to file with the Public Utilities Commission (Commission) for a rider to collect, outside of a general rate case, the costs of emissions reduction programs utilities choose to pursue, if the programs meet certain qualifications in the statute 1 . Projects needed to comply with new state or federal air quality standards (such as the Regional Haze Rule, Clean Air Interstate Rule, and Clean Air Mercury Rule) or as a corrective action as a part of any state or federal enforcement actions are not eligible for recovery under this rider.

In 2006, the sunset date for §216B.1692 was ex tended from June 30, 2006 to December 31, 2013 and cost recovery provisions were expanded, in conjunction with the adoption of the Mercury Emissions Reduction Act [Minn. Stat . §§216B.68-.688], discussed below.

In 2006, Minnesota Statutes §216B.682, Mercury Em issions Reduction Plans, and Minnesota Statutes §216B.683, Cost Recovery and Financia l Incentives, were enacted. Section 216B.682 requires Minnesota Power and Xcel Energy to submit pl ans most likely to result in the reduction of mercury emissions by ninety percent at their largest coal-fired electri c generating units. In addition, the Act requires the Minn esota Pollution Control Agency (P CA) to evaluate these plans and the Commission to review, evaluate, and approve these plans.

Section 216B.683 expands the cost recovery prov isions of § 216B.1692 to include cost recovery for utility mercury reduction pl ans and for other emissions re duction activities undertaken along with the mercury reductions, even if those other emissions reductions are needed to comply with

federal or state laws or actions.

1 In 2003, the legislature clarif ied that the three projects comp rising the primary proposal filed with the Commission in July 2002 by Xcel En ergy, known as the Metropolitan Emissions Reduction Project (MERP), qualified under §216B .1692. [First Special Session 2003, Chapter 11, Article 3, Section 12.]-iiiSubdivision 7 of §216B.1692 direct s the Commission, in consultation with the Commissioners of Commerce and Pollution Control Agency, to submit a report to the legislature which discusses:

(1) the number of participati ng public utilities; (2) the total cost of each proj ect and any associated incentives; (3) the reduction in ai r emissions achieved; (4) rate impacts of the cost recovery mechanisms; and (5) an assessment of the effectiveness of th e cost recovery mechanism in accomplishing power plant emissions reductions in excess of those required by law.

This report discussed the items re quired above, as we ll as related items associated with the 2006 Mercury Reduction Act.



# Summary of Emissions Reduction Projects

Xcel - King, High Bridge and Riverside Plants

Xcel Energy was the first utility to file unde r Minn. Stat. §216B.1692. In July 2002, Xcel Energy filed its proposed metropolitan emissions re duction plan (MERP) with the Commission. (Commission docket number E-002/M-02-633) 2 Xcel’s primary proposal consisted of changes to

three of its coal-fired el ectric generating plants.

Allen S King Plant, Bayport: Xcel proposed to install new emissions control devices on the King plant to significantly reduce emissions and to rehabilitate elements of plant equipment to extend the useful life of the pl ant until at least 2032. Generation capacity at the site would be increased by 60 MW. The King Plant project has been completed and the plant and went into service in July of 2007.

High Bridge Plant, St. Paul: Xcel proposed to demolish the existing coal plant and replace it with a natural gas-fired combined cycle pl ant. This would increase generation capacity at the site by 268 MW. The High Bridge pr oject is scheduled for a May 2008 commercial operation date.

2 Public copies of all filings cited in this report are accessible via the Commission’s web page ( www.puc.state.mn.us ). Click on “eDockets & eFiling” under Quick Links. On the eFiling home page, click on “Search documents” (left margin ). On the Search Documents page, enter the last two sets of digits in th e “Docket Number” boxes; e.g., for MERP enter (02) under “Year” and (633) under “Number”. Click on “Search.” Chose document of interest and click on “Public” in left margin.-ivRiverside Plant, Minneapolis: Xcel proposed to replace th e existing coal-fired units 6 and 7 with a natural gas combined-cycle plant. This would increase ge neration capacity at the site by 79 MW

. The Riverside project is well underw ay and is scheduled for completion in May 2009.



### Xcel – Sherco 1 and 2

In December of 2007, Xcel submitted a revised proposed Emissions Reduction Plan for Units 1 and 2 at its Sherco facility. (Commission docke t number E-002/M-07-002) Xcel has indicated

that it intends to submit in ear ly 2008 a rate rider petition pur suant to section 216B.1692. Xcel expects the projects to be completed in the 2012 -2013 time-frame. Xcel states that while the projects will affect several diffe rent emissions, a primary goal of the plan is to control mercury, and therefore proposes that the pl an be recognized as its Merc ury Emissions Reduction Plan for those units as well. This project also will e xpand generating capacity by about 69 MW from the

units.



### Minnesota Power – Laskin Units 1 & 2 and Taconite Harbor

On October 14, 2005, Minnesota Power (MP) file d its Arrowhead Region Emission Abatement Plan (AREA) plan. (Commission docket numbe r E-015/M-05-1678) MP proposed to install technology to reduce the amount of nitrogen oxides (NO

x ) emitted from both generators at the Syl Laskin Energy Center (Laskin) and to reduce NO

x , sulfur dioxide (SO 2 ) and mercury (H g ) emitted from the three generators of the Taconite Harb or Energy Center (Taconite Harbor). Neither project was expected to change any plant’ s generating capacity [Laskin, 100MW; Taconite Harbor; 225MW].

On March 27, 2007, MP reported that the status of these projects:

Laskin Unit 2 has been retrofitted and was placed back in service in November 2006.

Laskin Unit 1 has been retrofitted and was placed back in service in April 2007.

Taconite Harbor Unit 2 was placed back in service in mid- 2007. MP plans to retrofit the second unit in the spring of 2008 and th e third unit in th e fall of 2008.



# Summary of Mercury Emission Reduction Projects

Minnesota Power – Boswell Unit 3

In October of 2006, MP filed its Boswell 3 E nvironmental Improvement Plan and Rider.-v- (Commission docket numbers E-015/M-06-1501 & E-015/ M-07-1430) This was the first filing to be considered by the Commission under the Merc ury Emissions Reduction Act. This plan

involves retrofits to reduce emissi ons through application of mercur y control technology and Best Available Control Technology for NO

x , SO 2 , and PM. This filing was made under Minnesota Statutes §216B.6851, Utility Option. MP proj ects an in-service date of late 2009.

Xcel – Sherco Unit 3 and King Plant

In December of 2007, Xcel filed a proposed Mercur y Emissions Reduction Plan for Sherco Unit 3 and the King Plant. (Commission doc ket numbers E-002/M-07-1601 and E-002/M-07-1602, respectively) Xcel plans to inst all sorbent injection systems in th ese plants. Xcel is anticipating completion by December 2009 and D ecember 2010, respectively.



# Discussion of Topics Listed in §216B.1692, Subivision 7

A. The Cost of Each Project and Associated Incentives

Xcel - MERP

Xcel Energy originally estimated that the total capital cost of its three-project MERP proposal would be $1.04 billion. Under th e settlement agreement approved by the Commission in March of 2004, the total capital cost benchmark for the th ree projects was estimated to be slightly under $1 billion, broken down as follows:

King: $381,560,000 High Bridge: 394,840,000 Riverside: 212,785,000 Total: $988,785,000

In an October, 2007 filing, Xcel estimated that capital costs for the King Plant are about $44 million over budget; the High Bridge Plant is exp ected to be about $48 million under budget; and the Riverside Plant is expect ed to be about $30 million ove r budget. Under the 2007 tariff approved for the MERP, Xcel is to reduce its return on equity for exceeding budgeted costs and can receive a greater return on equity for co mpleting work under budget. In its October 2007 filing, Xcel proposed to adjust the return on equi ty associated with these projects in a manner consistent with the approved tariff provisions.



### Xcel – Sherco Units 1 & 2

The project-related capital costs for the two units are estimated to be $1.1 billion; $517 million for-viUnit 1 and $542 for Unit 2.

MP - AREA

In its initial filing, MP estimated that the AREA plan will require an investment of $53.9 million, plus $4.07 million annually for operation and main tenance. The Commission capped MPs rate rider for the projects at these estimated levels.

Subsequent filings by MP provided the following information regarding the capital and O & M costs of the project completed thus far:

Description Laskin Unit 2 Laskin Unit 1 Taconite Harbor

Unit 2 Total

Capital $2,622,000 3 $1,878,000 $24,700,000 4 $29,200,000 Operations &

Maintenance $36,000 $36,000 $1,400,000 $1,472,000

Total $2,658,000 $1,914,000 $26,100,000 $30,672,000



## Mercury Emission Projects:

MP – Boswell Unit 3

The project-related capital cost s are estimated to be $203 million and operations and maintenance costs to be $11.6 million. MP is recovering cost s for the project through the Boswell 3 Rider to the expected year-end 2009 in-servi ce date. MP did not propose a performance-based incentive.

Xcel – Sherco Unit 3 and King

The project-related capital cost is estimated to be $9 million (i.e., $4.5 million for each project); and $9.3 million ($5.5 million for Sherco and $3.8 million for King) for operations and

maintenance.

3 Laskin Unit 2 capital cost is 17.5 percent high er than initially projec ted by MP. This is due to slightly higher than expected installation co sts. MP noted that experience gained on Unit 2

will allow installation on Unit 1 to offset the increased costs of Unit 2.

4 This total includes capital costs for faciliti es and system common to all three Taconite Harbor units. Consequently, it is higher than the $16,508,000 per unit capita l cost MP initially

estimated. Per unit costs on Units 1 and 3 are expected to be corre spondingly lower. This total

also includes costs of addr essing the PCA’s concerns about particulate matter.-viiAs regards all projects, fuel costs continue to be somewhat of an unknown factor. Natural gas prices, in particular, have dem onstrated volatility and a clear upward trend. Coal prices are less

volatile but are also exhi biting an upward trend.



## B. The Reductions in Air Emissions

Xcel - MERP

In its December 30, 2002 report, as update d on February 21, 2003, the PCA estimated the emissions reductions to be expected from the primary MERP project:

SO 2

tons/ y ea r NOx

t ons/ y ea r PM 10

tons/ y ea r CO 2

tons/ y ea r CO

tons/ y ea r Pb

lbs/ y ea r Hg

lbs/ y ea r

Current

Emissions 34,178 24,206 954 6,545,727 860 266 232

Change in

Emissions -31,880 -22,017 -610 -813,603 -50 -60 -178

Percentage Change -93.3 -91 -64 -12 -1 -22.5 -76.0

The PCA, using the Commission’s externality valu es out to 2040, estimated that the MERP plan

environmental and health benefits were in the $200 to $500 million range. The PCA further

stated that these numbers understa te the actual environmental and he alth benefits, because they do

not include the value of reductions in such ot her pollutants as fine particulate matter (PM 25 , acid rain, ground level ozone, regional haze and mercury.

As of early 2008, the King plant is completing startup and performing compliance tests as required in its air emissions permit issued by the PCA. Reports will be submitted to the MPCA and compliance with air emission limits w ill be demonstrated by 2009. Current operating

information from the NOx and SO 2 continuous emissions monitors indicate that the required reductions are being achieved.

Xcel – Sherco Units 1 & 2

The table on the following page provides Xcel’s estimate of reductions to be expected from the project from its December 2007 filing:-viiiAnnualized

Emissions SO 2 Tons/yr NO

x Tons/yr CO 2 Tons/yr PM Tons/yr H g Lbs/yr
Before 13,050 11,600 9,900,000 920 610
After 5,460 7,450 10,200,000 750 80 Sherco Change -7,590 -4,150 300,000 -170 -530

CO 2 Offsets -300,000 Total Project Changes 0

Percent Reduction 58% 36% 0% 18% 87%

Efficiency gains are expected to increase capac ity by approximately 70 MWs. These estimates have not yet been reviewed by the PCA.

MP - AREA

In its January 2006 report, the PCA estimated th e following emissions reductions from the MP AREA project:

SO 2

tons/ y ea r NOx

tons/ y ea r PM

tons/ y ea r PM 10

tons/ y ea r Hg

lbs/ y ea r Current

annual

emission from the two plants 7,138 5,694 398 443 94

Emissions

after retrofits 3,589 1,949 398 443 25.8

Percent

reduction 50% 66% None None 72%

The PCA estimated benefits incorporating inform ation from recent federal benefit estimates for the Clear Air Act reduction program. That examina tion indicates that, to the extent benefits can be quantified, AREA’s benefits ap proximate, and most likely exceed, the projected costs. Parties to the proceeding supported this conclusion. Th e PCA expressed some concern that the method MP proposed to reduce SO 2 emission is likely to increase emi ssions of fine particulates (PM).

MP recently reported to the Commission that NO

x reduction goals are being realized. The company also reported that SO 2 reductions at the Taconite Har bor project have been less than anticipated and that the company has taken steps to improve performance. Also, MP reported that mercury reductions at the Taconi te Harbor project have not me t expectations and that the company is working with the technology vendor to determine solutions. In the meantime, MP has pursued alternative approaches fo r mercury removal. Final results on these alternative approaches are not yet available. MP indicated that it pl ans to file a complete status report with the-ixCommission in March of 2008.



## Mercury Emission Projects:

MP – Boswell Unit 3

MP and MPCA expect these retrofits to achie ve a 90% reduction in mercury emissions.

Xcel – Sherco 3 & King

Xcel estimates the sorbent injection technology will reduce mercury emission by 81 to 90 percent on a fuel basis, or 77 to 88 percent on a flue ga s basis, for the Sherco uni t; and 87 to 90 percent on a fuel basis, or 58 to 69 percent on a flue gas basis, for the King Plant.



## C. The Rate Impacts of the Cost Recovery Mechanisms

Xcel - MERP

As noted above, the capital costs of these projects are projected to be close to $1 billion. The following chart shows the projecte d dollar amounts to be collect ed through the Environmental Improvement Rider for seven y ears, starting in 2006.

Rate Rider Revenue Cumulative Increase over

Present Rates

2006 $ 33,716,199 1.8 %

2007 $ 68,737,013 3.6 %

2008 $ 99,787,345 5.1 %

2009 $ 111,097,977 5.5 %

2010 $ 107,048,196 5.2 %

2011 $ 102,811,979 5.0 %

2012 $ 9 8,756,777 4.7 %-xCollections from Xcel ratepayers started in 2006, with commencemen t of work on the King Plant. For 2006, the estimated rate impact was $0.00126 per kWh, or about $11.40 for the year for a residential customer using 750 kWh a month. It was noted at that time that this amount was expected to increase as work on the other proj ects advances. Xcel’s October 2007 filing provided

information on the costs for 2008 and reflected work on all three projects. Xcel estimated the Environmental Improvement Rider for 2008 at $0.00291 per kWh, or about $26.26 for the year for a residential customer using 750 kWh a month.

Xcel – Sherco Units 1 & 2

Xcel’s estimate of the rate effect s of its proposal are as follows:

Year Revenue Requirements ($000) Rate Impact ($/kWh) Average Annual Rate Impact for

Residential

Customer

($/year) Average Rate

Increase (%)

2009 $1,302 $0.000039 $0.36 0.0

2010 $19,484 $0.000576 $5.16 0.7

2011 $30,784 $0.000898 $8.04 1.0

2012 $66,986 $0.001928 $17.40 2.1

2013 $117,613 $0.003350 $30.12 3.5

2014 $139,768 $0.003939 $35.40 4.1

2015 $134,326 $0.003744 $33.72 3.8

MP - AREA

MP originally estimated the cost of thes e projects at $53.9 million for capital costs and $4.07 million annually for operation and maintenance. Wh ile the financial consequence to customers of the AREA Plan will vary over time, MP estimated that the rider for the completed project will

increase the cost of electr icity for an average househol d no more than $11.40 annually.

Subsequent filings by MP have provi ded the following cost information:-xiYear Revenue Requirements ($000) Rate Impact -

Residential

($/kWh) Average Annual Rate Impact for

Residential

Customer

($/year) Average Rate

Increase (%)

2006 $4,831 $0.00048 $4.08 0.7 2007 $9,476 $0.00094 $8.04 1.3 2008 $13,426 $0.00133 $11.40 1.85

Recent information filed by MP indicates that the average annual rate impact for an MP

residential customer for the work done so fa r is $5.64 as of June 30, 2008 (a 0.91% increase).



## Mercury Emission Projects:

Xcel – Sherco 3 & King

Xcel estimates the average rate impact of the Ki ng project for a residential customer will be $0.06 per month; for the Sherco Unit 3 project, the im pact for an average residential customer is expected to be $0.10 per month.

MP – Boswell Unit 3

MP estimates an average increase for a resi dential customer of $1.15 per month (2.24%) for 2008, $1.70 per month (3.32%) for 2009, and $3.44 per month (6.7%) in 2010.



## D. An Assessment of the Effectiveness of the Cost Recovery

Mechanisms

The cost recovery mechanism for stand-al one emission reduction projects under §216B.1692 provides for a utility to recover costs of voluntary initiatives to reduce emission levels, initiatives which they would not otherwise be required to undertake at all or at least woul d not be required to do as soon or as completely. Therefore, it is l ogical to assume that the existence of this cost recovery provision was effective in influencing the scope and timing of Xcel’s MERP and MP’s AREA projects.

The cost recovery mechanism for mercury reduction projects under §216B.683, provides for a utility to recover the costs of a mandatory program to reduce mercury emissions. Whether the-xiiexistence of a cost recovery mechanism for a mandatory program has a significant influence on the program is more problematic to determine. The existence of this cost recovery mechanism may have influenced the timing of MP’s mercury reduction plan for Boswell 3, since it was filed earlier than the December 31, 2007 date required by the statute, and possibly had some influence on the scope of the program..

It is likely that the existence of both of these rider provisions would influence the timing of potential rate case filings. The capital costs a nd on-going expenses associat ed with emissions and mercury reduction programs are significant, and a ssurance of recovery of prudently-incurred expenditures in a timely manner is certainly important to the covered utilities.

It is important to recognize that the special rate ri ders incorporated in Minn esota Statutes Sections 216B.1692 and 216B.683 join a number of special recovery mechanisms in Minnesota statutes. There are currently at least 18 di fferent special cost recovery m echanisms required or allowed by Minnesota statutes that permit utilities to adjust their rates outside of a general rate case. The number of such mechanisms has increased signifi cantly in the last several years, with no fewer

than five new ones enacted as part of 2007 legislation alone.

The theoretical rationale for such special rate mech anisms is to allow recovery of costs outside of a utility’s control (such as the fuel clause adjustment) or of the costs of publicly mandated programs or objectives (such as renewable energy standards) which may not have been reflected already in existing utility rates. These mechan isms allow companies to increase rates without having to go through a full rate case review, and t hus to begin to recover the costs more quickly from their ratepayers. They also reduce the fi nancial and business risk for the utility, which should be accounted for in a general rate pro ceeding. However, under these cost recovery mechanisms, utilities recover new or increased specific costs without a review of the

reasonableness of their overall rate s. In a rate case, all costs (i.e., those that increase as well as

those that decrease ) are considered in arriving at a just a nd reasonable overall leve l of utility rates for recovery from ratepayers

In evaluating these special recovery mechanis ms, the Legislature has the difficult task of balancing the potential benefits that such rate riders may enable versus the potential costs to ratepayers and the resultant marginalization of the Commission’s overall ra te-making processes. Before granting new special recovery authority or broadening the scope of existing recovery riders, the Legislature should take great care to assess whether such measures are really necessary or likely to be effective in achieving desired goals.