From: Rick Counihan <RCounihan@enernoc.com> To: Gina McCarthy/DC/USEPA/US@EPA, RobertJ Wayland/RTP/USEPA/US@EPA, Melanie King/RTP/USEPA/US@EPA, Cindy Huang/DC/USEPA/US@EPA Cc: David Brewster <DBrewster@enernoc.com>, Don DiCristofaro <DDiCristofaro@enernoc.com>, Rick Counihan
<RCounihan@enernoc.com>
Date: 10/10/2012 02:17 PM Subject: Critique of Calpine Study on Air Impacts in PJM

All,

In its comments to the docket in EPA-HQ-OAR-2008-0708 the Calpine Corporation appended a study by the Analysis Group purporting to show that preventing emergency generators from participating in PJM’s capacity market would lead to air quality improvements. EnerNOC hired NERA Economic Consultants to critique that study. I am attaching the critique and we will be prepared to discuss it at our meeting tomorrow.

Don’t hesitate to contact me if you have questions in the meantime.

Cindy,

Please circulate to other EPA staff as appropriate.

Thank you and see or hear you tomorrow.

Rick Counihan – Vice President Government Affairs EnerNOC, Inc. | 717 Kennebec Ave. | Takoma Park MD 20912
415.517.1861
rcounihan@enernoc.com www.enernoc.com EnerNOC - get more from energy

This email and any information disclosed in connection herewith, whether written or oral, is the property of EnerNOC, Inc. and is intended only for the person or entity to which it is addressed. This email may contain information that is privileged, confidential or otherwise protected from disclosure. Distributing or copying any information contained in this email to anyone other than the intended recipient is strictly prohibited. (See attached file: enernoc rice jf.pdf)

# Evaluation of the Calpine Report on theReliability and Emission Impacts of RICEBased Demand Response in PJM

Prepared for EnerNOC

Jonathan Falk
Vice President

October 10, 2012NERA Economic Consulting



### QUALIFICATIONS

Mr. Falk has worked in NERA’s Energy and Environment practice for the last 28 years. In that time he has performed numerous environmental analyses and worked extensively in all three eastern capacity markets. He served as a consultant in the design of the ISO-NE capacity market, both consulted and testified before FERC regarding the NYISO capacity market, and has testified before FERC on aspects of the PJM Capacity market. He has also published articles on the use of demand response (DR) in capacity and energy markets. He has modeled both the environmental and capacity market implications of various market designs. He has undergraduate and graduate degrees in economics from Yale University.

This Report was prepared on behalf of EnerNOC for submittal to the U.S. Environmental Protection Agency in connection with Docket No. EPA-HQ-OAR-2008-0708, related to National Emission Standards for Hazardous Air Pollutants for Reciprocating Internal Combustion Engines; New Source Performance Standards for Stationary Internal Combustion Engines.Introduction and Summary of Conclusions

NERA Economic Consulting 1 

## I. Introduction and Summary of Conclusions

We have been asked by EnerNOC to evaluate the argume nts in Paul Hibbard’s August 2012 report sponsored by Calpine Corporation (the “Calpine Report”). 1 That report has two central conclusions. The first claim is that eliminating all reciprocating internal combustion engine (RICE)-based demand response (DR) from capacity markets would have no impact on power system reliability. The second claim is that the resources used to replace that lost capacity would result in lower system-wide emissions of four pollutants: SO 2 , NO
x , CO 2 , and mercury (Hg). It should be noted at the outset that neither the Calpine Report, nor our critique of it, has anything to do with the emissions of the RICE-based DR units themselves. Instead, the Calpine Report, and our critique, are devoted to a different proposition—that the resources that would replace the RICE-based DR units in the capacity market, if the final rule does not allow RICE-based DR, would themselves produce less pollution over the hours they operate in the energy market than the resources they displace at the margin.

There is no evidence in the Calpine Report that allows either of these claims to be reliably
asserted.

With regard to the first claim, we agree that if RICE-based DR is banned from participating in capacity markets, then the lost capacity would be replaced by something . However, what would be replaced in this case is the capacity, not necessarily the reliability, of the lost units. In fact, there are both reliability advantages and disadvantages to RICE-based DR, which make it unclear whether a MW-for-MW replacement of RICE-based DR with different resources would actually increase or decrease reliability. The Calpine Report fails to support the proposition that elimination of these resources would have no impact whatsoever on actual power system reliability.

With regard to the second claim, an analysis like the Calpine Report, which considers only pollutant-reducing scenarios of eliminating certain DR resources without even considering pollutant-increasing scenarios should not be relied upon by the EPA in its deliberations.

The bias in the Calpine Report has a very simple cause. It assumes that RICE-based DR would be replaced by a combination of natural gas-fired combined cycle (NGCC) units and wind power. But there are many other replacement options, all of which are ignored in this study and all of which will either neutralize or reverse the study’s conclusions. For example, the actual replacement capacity in PJM, which is the only market considered by the Calpine Report, could come from canceled retirements of coal plants, coal plants with pollution control upgrades,simple cycle gas peakers and/or increased imports of power from MISO, an even more coaldependent market. The specific type of replacement capacity for DR needs to be studied, not assumed, or there is no value in the results obtained.

1 “Reliability and Emission Impacts of Stationary Engine-Backed Demand Response in Regional Power Markets,” Dated August 2012 and submitted to the EPA in connection with Docket No. EPA-HQ-OAR-2008-0708.Introduction and Summary of Conclusions

NERA Economic Consulting 2 Moreover, for two of the four pollutants considered, SO 2 and NO
x , the claim is almost certainly wrong because of the existing national and local cap programs for these pollutants. The Calpine Report actually admits this in a footnote but ignores this fact in the text. For the other two pollutants, there are good reasons to believe that the claim is either overstated or actually reversed: denial of RICE-based DR participation in PJM’s capacity market could actually increase the output of CO 2 and Hg if replacements come from sources other than NGCC and
wind.

Even if the assumptions of the Calpine Report are correct and substantial emission improvements in at least some pollutants would be achieved, what are the costs to achieve these improvements? Under the mechanism by which organized capacity markets procure resource adequacy, every existing capacity resource would be paid more in order to induce marginal suppliers of capacity to enter the market. Thus, while the price of capacity might, for example, increase by $10,000 per MW-year to induce some plants to come online to replace the lost capacity from RICE-based DR, that $10,000 per MW-year would be paid to every existing owner of capacity, making this a very expensive way to hypothetically reduce emissions.

Finally, we note that the Calpine Report argues against EPA’s proposed national rule through an examination of only one electric power system, PJM, and mentions in passing that it feels that this system is typical. Even if PJM is typical in some ways, the heterogeneity of the nation’s electric power systems means that the geographic effects of this rule will vary widely from place to place. In California, for example, RICE units do not provide DR at all, so there would be no impact there. In addition, the specific types of resources (e.g., wind, canceled coal retirements, etc.) that would replace RICE-based DR would vary from market to market. In New York and New England, the proportion of coal-fired generation is too low for the substitution of new generation to have much effect. In traditional vertically integrated markets, the replacement strategies for RICE-based DR will be whatever the regulatory process mandates. As we argue here, the Calpine Report should not be taken as reliable even for PJM. A fortiori , it would be wrong to extrapolate its results for the country as a whole.

Overall, we find that the Calpine Report is simply unpersuasive.

− While there may be no reliability change from the loss of RICE-based DR and the substitution of other resources, there is no guarantee that would occur.

− What is substituted for RICE-based DR is assumed, not demonstrated. Other logical candidates for substitution could decrease, increase, or have little to no effect on system-wide emissions.

− Only two of the four pollutants in the Calpine Study have any reasonable possibility of being reduced even if the substitution assumed by the Calpine Report is correct.

− The Calpine Report does not opine at all on the costs of achieving the environmental gains it purports to estimate. The costs of achieving these gains are likely to be quite large, since all generators are paid to induce small changesDR, Reliability and Reliability Procurement Processes

NERA Economic Consulting 3

by a few generators, and those costs per ton increase as the amount of RICEbased DR that would need to be replaced increases.

− Whatever merits the study might have in PJM, the results can certainly not be reliably projected to the rest of the country.



## II. DR, Reliability and Reliability Procurement Proc esses

Section 2 of the Calpine Report is devoted to demons trating that changes in DR availability to support power system reliability will not actually change observed reliability. We agree that if RICE-based DR is banned from participating in capacity markets it will be replaced by something . To say that is simply to admit the underlying motivation for the proposed rule in the first place – RICE-based DR is providing a vital service, and vital services must be replaced with something. If some resource cannot provide capacity/reliability, some other resource will take its place. But where, as in PJM, the reliability is provided through a market for capacity, what will be replaced is the capacity, not the reliability.

The Calpine Report describes this process fairly well. The PJM capacity market assumes that all MWs of capacity in a given zone contribute to reliability in direct proportion to their expected availability at the system peak period. Thus, 5 MW of RICE-based DR at the system peak will be replaced adequately (according to the PJM construct) with 5 MW of a gas generator 2 or about 35 MW of wind power. 3 This is a pretty good approximation of the reliability attributable to a particular resource, but it is far from perfect, as the Calpine Report correctly states. 4

The Calpine Report goes on to opine, however, that DR is inferior for reliability purposes, leaving the distinct impression that the replacement resources would yield better observed reliability, although they make no attempt to quantify it. In fact, there are both advantages and disadvantages to RICE-based DR which make it unclear whether a MW-for-MW replacement of RICE-based DR will increase or decrease reliability. For example, RICE-based DR is dispatchable – it can be requested on demand of the system operator. Wind power, which in three of the Calpine Report’s scenarios provide one-third of the replacement capacity and around half of the emissions benefit, is not dispatchable and is therefore inferior as a reliability resource. RICE-based DR resources are much faster ramping than the typical combined cycle generator. But perhaps the most important positive attribute of RICE-based DR is its location. The topology of the network often means that at a time of disruption, generation which is closer to load is easier to use to keep the system stable. This simple principle leads to many local reliability constraints which can be better relieved by a net load reduction at a particular location than by

2 Assuming the gas generator and the RICE-based DR have equal probabilities of availability in the peak period. In fact, MW for MW offered, as we show below, DR is probably more reliable since it consists of aggregations of small distributed units.

3 Wind power is assumed to have an availability of only about 13 percent at the system peak unless explicitly tested otherwise.

4 Calpine Report, page 7, last full paragraph.DR, Reliability and Reliability Procurement Processes

NERA Economic Consulting 4 generation at a distance. RICE-based DR is by definition located at a load point on the grid and thus has performance benefits to grid operators which cannot be directly duplicated by more
distant resources.

Another advantage of RICE-based DR from a reliability perspective is the fact that it consists of numerous small units. One hundred 1 MW generators have far lower outage variability than one 100 MW generator. This leads to a resource that system operators can count on. For example, in actual PJM DR events that occurred this year on July 17 th and 18 th , during an east coast heat wave, the performance of DR resources (both curtailment and emergency generators) dispatched by PJM was over 100% of nominated capacity each day. 5

This is not to say that RICE-based DR has only advantages. Limitations imposed on the number of dispatches and on the number of contiguous blocks of hours that must be supplied are disadvantages of this resource from a system operation perspective. Some of this could be addressed through better product definition, but this is not the place to have that debate. 6 From EPA’s perspective, the important issue here is that the Calpine Report’s conclusion that reliability will be unaffected by the exclusion of RICE-based DR from the provision of reliability is unsupported. The effects need to be measured , not asserted.

Until one knows where the particular resources are located, this measurement is impossible. Since Hibbard doesn’t even know how many emergency generators are currently providing DR, he cannot possibly know where they are located. And for RICE-based DR resources, their
location may provide additional sub-zonal reliability benefits beyond those included in the zonal assessment of MW on which reliability procurement processes depend.

Unfortunately, the only way to know that is to model the specific, concrete resources added against the specific resources that would be replaced. Thus, we cannot in fact be confident that replacement of the lost capacity from an organized market perspective will in fact replace the very thing those markets are meant to provide, reliability, on a one-for-one basis. While we agree with Hibbard that the PJM capacity market will meet its targets for reliability resources, it is unclear whether or not they will achieve the same level of reliability.

In summary, we agree that the reliability procurement process will ensure that an artificial reduction in offered capacity from some set of resources (RICE-based DR in this case) will be counteracted by procurement of other resources which would not have been available to provide capacity but-for the artificial reduction. We do not agree that the net impact on the ultimate

5 http://www.pjm.com/~/media/committees-groups/committ ees/mic/20121010/20121010-dsr-hot-day-report-july-17-18-
2012.ashx

.

6 In fact, PJM is continuously assessing Limited DR targets to ensure that, from a reliability perspective, there is no adverse impact of such resources. PJM will not allow Limited DR resources to constitute more than a certain fraction of its overall procurement. This constraint ensures that resource adequacy is preserved. Therefore, any unit with greater availability than RICE-based Limited DR will simply result in more reliability (at a higher price) than is actually needed.Replacement of RICE-Based DR

NERA Economic Consulting 5 output, reliability, will be unchanged, and we have reason to believe that local reliability would in fact be lower in this case; but this is a fact-intensive exercise for which no general conclusions are possible.



## III. Replacement of RICE-Based DR

So we agree that RICE-based DR, if denied status as a capacity resource, would be replaced by something. But what, and at what cost? Hibbard assumes that the replacement will consist of some mix of wind-powered generators and NGCCs.

The mechanism by which the lost RICE-capacity will be replaced in PJM is reasonably clear. Capacity prices in PJM will rise, giving added return to every unit in the PJM market that can provide capacity. Some marginal units that were previously uneconomic would become economic with this added revenue and those units would replace the lost RICE capacity. Hibbard assumes that the replacements will all be NGCCs and wind because those units predominate in the PJM queue to be considered as new units to meet increased demands. However, other mechanisms can replace DR without any use of the new unit queue at all. The actual replacement capacity could come from canceled retirements of coal plants, coal plants with pollution control upgrades, simple cycle gas peakers and/or increased imports of power from MISO, an even more coal-dependent market.

These other possibilities to Hibbard’s assumption that the incremental capacity will be either all NGCCs and/or wind can, in fact, reverse his conclusions. Most prominent of these is deferred coal retirements. Hibbard’s methodology used the SNL Financial list of coal plant retirements and assumed that all of the retirements in that database will occur exactly on schedule. But these schedules are not fixed in stone. Any future retirement can be reversed as circumstances warrant and such reversals have happened many times in the past.

Consider, by way of example, the case of Big Sandy, a coal-fired PJM unit with 1,060 MW of capacity in two units. According to the SNL database, both are scheduled for retirement in 2014. But as recently as April 2012, the 800 MW Big Sandy 2 unit was scheduled for a scrubbing retrofit. The decision to schedule Big Sandy 2 for retirement is probably a decision that could go either way based on a host of considerations to which we are not privy, including expectations about future natural gas prices, capacity prices, and the future of MACT and CSAPR regulations. It is not unrealistic to think that an increase in projected PJM capacity prices stemming from the removal of RICE-based DR from the capacity stack would enable Big Sandy to profitably perform the retrofits to meet 2015-16 MACT standards and run for another 20 years.

Using this plant alone, were Big Sandy’s retirement in 2014 to be delayed owing to higher capacity prices, the Hg findings of the Calpine Report would be roughly reversed. Data suggestReplacement of RICE-Based DR

NERA Economic Consulting 6 that Big Sandy alone is responsible for about 0.14 tons per year of Hg. 7 This alone is greater than the annual change for Hg calculated in the Calpine Report.

The fact that Big Sandy would have to reduce Hg emissions to 1.2 lbs. per trillion BTU under MACT is in fact dependent on MACT surviving the various court challenges in its current form. If Big Sandy closes, the reduction in Hg will happen irrespective of what happens to the MACT regulations. If the change in capacity prices causes the decision on Big Sandy to shift, Hg emissions at the MACT rate will continue into the indefinite future, clearly raising total
emissions. 8

We do not know in fact if a change in capacity payments in PJM will be large enough to impact a decision on Big Sandy. But the Calpine Report gives a probability of zero to this happening and every other planned retirement in the SNL database being canceled or delayed. This database currently lists almost 5,000 MW of future coal retirements in PJM. These decisions depend on a host of factors. But if the EPA believes that the announced proposed retirements of coal plants in the face of MACT requirements represent a victory, and that making the incremental investments like fiber screens to allow continued operation of an obviously higher polluting technology represents only a partial victory, then denying RICE-based DR the ability to provide capacity in PJM, or any other capacity market, represents a potential net environmental loss.

Deferred retirements (ignored by Hibbard) are not the only possible source to replace RICEbased DR. Another obvious source of replacement is simple cycle peaking units, which are intended to operate only small fractions of the year. If the lost capacity were replaced by peaking units, the results of Hibbard’s analysis are hugely overstated, although there might (or might not) be a small net positive change. This is because new efficient peaking units still run very few hours, and will tend to displace other peaking units at the margin, whose Hg contributions are already low, and whose CO 2 contributions are much closer to theirreplacements than is true of more baseload generation. If peakers are built to replace RICEbased capacity, the net impact is probably close to zero.

Third, while the Calpine Report assumes that new NGCCs and wind will provide new energy displacing “dirtier” marginal energy, marginal energy (and capacity) could also be provided by imports from “dirtier” adjoining areas, in particular from the Midwest, which has a higher percentage of coal in its generation fleet and substantial unused coal generation capacity. Increased exports of coal power to PJM could clearly reverse the Calpine Report’s results.

7 2005 emissions of 281 pounds given at http://www.sourcewatch.org/index.php?title=Big_Sandy _Plant

.

8 Big Sandy in 2011 used 59.2 trillion BTUs of fuel. (Source: SNL database). Thus, assuming MACT standards emerge unscathed from current litigation; its Hg output would be reduced to about 71 pounds per year, assuming that the relatively low capacity factor of 2011 applies. If energy prices pick up, however, as are forecast by DOE, and Big Sandy ran at an 81 percent capacity factor as it did as recently as 2004, legal emissions could total as much as 83 pounds per year. Given a scenario 4-adjusted estimate of about a 57 pound per year improvement (provided in section V below and in the Appendix), a shift of this plant alone to active service would switch the results, even given MACT.SO2 and NOx

NERA Economic Consulting 7 Higher prices in PJM could also defer retirements of coal units in the Southeast with increased production and exports to PJM.



## IV. SO 2 

## and NOx

The Calpine Report calculates reductions for SO 2 and NO
x even though those pollutants have emissions set at nationally binding caps. In a footnote (repeated again for the discussion of individual pollutants) the report says this:

In this Report, I will refer to this effect as increasing or decreasing emissions. However, for pollutants that are controlled under an existing emission cap and trade program across all states in the region in question (in the case of the analysis in this report, SO 2 and NO
x ), the level of actual emissions would presumably be unchanged over time, subject to the cap. In this case, what changes are the complexity and/or cost of meeting the compliance obligations associated with the emissions cap. [Calpine Report, footnote 16]

First, we agree that the emissions for these two pollutants will probably not change. What we are unable to see is how this is not the end of the matter. If Hibbard’s analysis is correct for these pollutants, then the cap system would allow for additional emissions somewhere else in the system, resulting in no net change in emissions. These additional emissions could come from more intensive utilization of existing units, deferrals of environmental retrofits, and/or substitutions of cheaper dirty power for more expensive clean power.

It is unclear what “complexities” or “costs of compliance” that Hibbard has in mind. Frankly, we see none. And if we’re going to start measuring “costs of compliance” under the Hibbard framework, we need to start with the change in zonal capacity costs large enough to induce new entry. This “cost of compliance” to consumers will undoubtedly swamp whatever changes need
to be made to restore Base Case level emissions of SO 2 and NO
x .

Indeed, to the extent that there is a “cost of compliance” issue, it is the artificial mandating of one sort of capacity to provide the environmental benefits which means there must have been some sort of inefficiency in the aggregate cost of producing the cap. The resources which substituted capacity for RICE-based DR were themselves not efficiently providing emission reductions or they would have been economic before. Thus, the aggregate change in costs to provide the cap-level of emissions must become correspondingly higher, i.e., provided less economically than was being provided before.

We, of course, grant that for the RICE-based DR units themselves, their emissions are not, for the most part, probably subject to any cap requirements. But this is not an independent critique from the conclusion that the EPA has already drawn that the amounts of pollution emitted by the DR generators are not sufficiently significant to justify their replacement in the provision of vital grid reliability services. The EPA summary of emission reductions for stationary RICE, as presented in Table 1 of the EPA Notice of Proposed Rulemaking dated June 7, 2012 (see pageWind

NERA Economic Consulting 8 33825, Federal Register, Vol. 77, No. 110), shows an insignificant increase in pollutants for combustion ignition engines for the proposed rule from the 2010 final rule.



## V. Wind

While the Calpine Report discusses in great detail t he mechanism by which NGCC units displace more-polluting resources at the margin, the lion’s share of emissions displacement in the report is actually from wind. We can see this in his results by comparing Scenario 1 and Scenario 4. These two scenarios are identical except that Scenario 1 has 33 percent of the replacement capacity coming from wind and Scenario 4 has 0 percent of the replacement capacity comingfrom wind. We can use these two scenarios to show the relative efficiency of wind power vis-àvis NGCC units in generating Hibbard’s results. 9

We find that the relative efficiency of wind power is 5.8 for CO 2 , 2.8 for Hg, 2.7 for SO 2 and 2.2
for NO
x . Hibbard argues that his all-NGCC case is “least plausible given development interests.” He doesn’t say what he means by this, but we are quite certain it is just the opposite. Wind power is sharply derated for capacity purposes because wind is non-dispatchable. In PJM, the current average wind unit is credited with only 0.13 MW per MW of rated capacity. 10 Thus, a wind generator receives only about one-eighth the per-MW return from the capacity market that a fossil-fueled plant receives. Since the mechanism by which the additional capacity would be derived is per MW of capacity offered, wind units are much less likely to fill the capacity gap induced by termination of RICE-based DR capacity than are other units. A wind unit needs to be eight times closer to the boundary of profitability to be induced to build by a larger capacity payment, all else equal.

The Calpine Report’s scenarios 1-3 all have one-third of the replacement capacity coming from wind. Since the economics of the replacement mechanism makes this highly unlikely, none of these Scenarios is nearly as likely, so far as the mechanism of replacement goes, as Scenario 4. Unfortunately, Scenario 4 still assumes that half of all DR is RICE-based. Thus, to form a reasonable estimate of total results, we need to adjust Scenario 4 to reflect the lower level of RICE-based DR assumed in Scenarios 2 and 3. We show the results of such an analysis in Table 1. Scaling Scenario 4 down to the lower displacement effects of Scenario 3 (Column 5 in Table 1), we get very small reductions in every pollutant, with reductions of 0.6 percent in CO 2 and 0.8 percent in Hg 11 (Column 6 in Table 1).

9 Using the equation: Wind Improvement per MW/NGCC Improvement per MW = 3*[Scenario 1 Reduction/Scenario 2 Reduction] - 2, derived in the Appendix.

10 PJM Manual 21, Appendix B, H.

11 This uses the simple proportional methodology described in the Appendix.Customer Impacts

NERA Economic Consulting 9

Table 1: Adjusting Low RICE-based DR Cases to All-NGCC Replacement Produces Minimal Improvements (in tons)

All NGCC Adjustment (3) (2)/(1) Adjusted to

All NGCC (5) (3)x(4) Base

Emissions (6) Percent

Reduction (7) (5)/(6) Scenario 1 (1) Scenario 4

(2) Scenario 3 (4)

CO2 -271,529,969 -104,321,928 0.3842 -82,267,366 -31,607,157 5,436,229,964 -0.6%

SO2 -450,982 -288,692 0.6401 -135,740 -86,893 106,613,586 -0.1%

NOx -240,080 -168,253 0.7008 -78,799 -55,224 4,962,285 -1.1%

Hg -1.56 -0.98 0.6282 -0.46 -0.29 36.86 -0.8%

Source: Columns (1),(2),(4) and (6) Taken from Calpine Report, Table 1

This result is still overstated given the fact that it assumes 100 percent NGCC replacement with no simple cycle peakers or coal retirement deferrals or retrofits, and therefore should be considered an upper bound. Note also that the wind power impacts are highest for the pollutants not affected by caps, particularly CO 2

. Thus, for the two pollutants that are potentially affected, the unlikelihood of wind replacement has the biggest negative effect, even by Hibbard’s calculations, on the only pollutants the policy could impact.



## VI. Customer Impacts

As mentioned above, the mechanism by which RICE-base d DR will be replaced is highly indirect and inefficient. The only way to replace the lost DR for reliability purposes in PJM is to have the price of capacity rise high enough to induce market entry. All existing generators would be paid more, not just those who replace the lost RICE-based DR capacity. While we cannot precisely estimate the costs to customers without undertaking much more extensive analysis, it is easy to show with simple examples that customers could easily pay very high costs relative to the benefits achieved. Most of this money is simply transferred from customers to existing generators, which is why the costs are so high.

Comparing Scenarios 1-3 which are identical except for the assumed level of RICE-based DR, we note an interesting feature of the Hibbard results. The higher the level of RICE-based DR, the lower the efficiency of Hibbard’s proposed replacement effect. Thus, while the level of DR in Scenario 3 is only 20 percent of the level of DR replacement in Scenario 1 (10 percent versus 50 percent of installed DR capacity: 10/50 = 20 percent) Scenario 3’s benefits are about 30 percent of Scenario 1 in every pollutant. Given Hibbard’s methods this makes sense, since as more and more replacement for the RICE-based DR is added, the chances that the replacement capacity displaces other more efficient units rises. This in turn means that the higher the actual use of RICE-based DR in the current mix, the less efficient will be the improvements. Thus the cost per ton of pollutant saved increases fairly sharply as this method is used to reduce emissions; the aggregate cost of capacity itself must be rising as the replacement need increases,Estimating the Real Effects of RICE-based DR Replacement

NERA Economic Consulting 10 and the emissions savings are decreasing. It is impossible to know without a detailed look at the Hibbard results, but it is quite possible that the reduction in CO 2 and Hg are being achieved at a far greater marginal cost than other methods of achieving the same reduction.

Let’s take a simple example to demonstrate this effect. PJM has about 165,000 MW of capacity clearing annually in its auction. In the early period, under Scenario 1, about 7,500 MW of assumed RICE-based DR must be replaced. Currently, these resources are paid about $136/MW-day, leading to a payment of about $50,000/MW-year. Suppose prices had to increase by $10,000/MW-year in order to induce an additional 7,500 MW of capacity to be supplied. Then consumers would be paying 165,000 MW x 10,000 $/MW, or $1.7 billion annually to achieve an annual benefit of about 27,000,000 tons of CO 2 . This is a cost of $60/ton of CO 2

. This is far above the rate such reductions could be purchased in current markets. This is only the average cost. The marginal reductions in CO 2 cost much more. Using a simple linear interpolation from Scenario 4 to Scenario 1, while the average reduction in Scenario 1 is 35,000 tons/MW, the marginal reduction is only 26,000 tons/MW. Thus, the marginal reductions cost consumers over $80 per ton reduced. 12

By contrast, Regional Greenhouse Gas Initiative (RGGI) auctions have achievable reductions in
CO 2 for under $2 per ton. 13 Thus, the achieved savings are highly unlikely to be economic.

The actual price change from the elimination of RICE-based DR might not be $10,000/MW-year. The calculations necessary to figure out the change in prices required to induce added capacity are difficult to perform. But a savings to consumers of $1.7 billion in PJM is not unreasonable.

PJM’s market monitor calculated that elimination of all demand resources (both DR and energy efficiency, but the vast majority of this capacity in PJM is currently DR) would increase capacity payments to generators by $11.8 billion in the 2013/14 delivery year alone. 14 The effects are not linear, but eliminating half the DR (the assumptions of Hibbard’s Scenario 1) would certainly make an estimate of $1.7 billion per year reasonable.



## VII. Estimating the Real Effects of RICE-based DR
R eplacement

Rather than merely assuming that lost capacity in PJ M would be replaced by a mix of NGCCs and wind, an analysis to estimate the total effects of the removal of RICE-based DR from the

12 Calculations presented in the Appendix.

13 See, for example, http://www.rggi.org/docs/MM_2011_Annual_Report.pdf

.

14 Analysis of the 2013/2014 RPM Base Residual Auction Revised and Updated, September 2010, p. 52, http://www.monitoringanalytics.com/reports/Reports/2 010/Analysis_of_2013_2014_RPM_Base_Residual_Auction_20090920.p
dfConclusion

NERA Economic Consulting 11 capacity stack would need to be conducted. Such an exercise would be immensely challenging, however, because we would be trying to estimate the hair-trigger effect of changes in capacity price on the actions of independent market participants who have access to far more accurate data on their individual situations than we possess. Yet, such an exercise, however imprecise, would be of far more value to the EPA than the sort of analysis presented in the Calpine Report, which substitutes implausible assumptions for what is in reality a very difficult economic analysis.



## VII. Conclusion

Actually forecasting a net change in power system re liability and emissions from the elimination of RICE-based DR is a difficult task. For the units themselves, EPA has already decided that the
effects are de minimis. The Calpine Report tries to argue that there would be important emission benefits from the units that would replace these RICE-based DR units for reliability purposes. However, the effects are clearly overstated and may well have the wrong sign. For SO 2 and NO
x , the existence of binding caps makes it quite unlikely there would be any change at all. It would be possible to make an estimate of impacts on the other pollutants, but any such estimate must consider not only the possibility of bringing in new clean capacity, but also delaying the retirement of old dirty capacity or increasing net imports. Given its inefficiency in providing capacity, wind will almost surely not be the winner of this process. Of the other obvious candidates, namely deferred coal retirements, induced coal retrofits in lieu of retirement, increased imports, single cycle natural gas peakers and prematurely installed new baseload or mid-merit generation, it would require actual analysis, rather than assumptions to determine the most likely outcome. The emissions implications of these various replacements (and others that might also exist) are quite different. The Calpine Report presents one end of the spectrum in terms of the most benign environmental consequences rather than a balanced analysis.NERA Economic Consulting 12



## Appendix

Calculations used in this paper

1

. Efficiency of Wind Replacements vs. NGCC Replacements

Let Si be the total estimated improvement from the replacement of M MW of DR in Scenario i. Let W be the reduction per MW of Wind added and let N be the MW Reduction per MW
of NGCC added. Then

S1 = M x [W/3 + 2N/3]

S4 = M x N

Then S1/S4 = [W/N +2]/3, so W/N = 3 S1/S4 -2

2. Adjustment of Scenario 4 to reflect lower levels of RICE-based DR

S4 adjusted = S4 x S3/S1

3. Hg Calculations for Big Sandy

59.2 trillion BTU x 1.2 pounds/trillion BTU = 71 pounds

71 pounds x 81 percent capacity factor/69 percent capacity factor = 83 pounds

S4 adjusted Hg = 0.98 tons x 0.46 tons/1.56 tons = 0.288 tons = 577 pounds over ten years = 57.7 pounds per year

4. Marginal Effects

Use a log-log regression to estimate a constant-elasticity model using as data the CO2 reductions in Scenarios 1-3, starting with a base of 15,000 DR MW. This creates the following equation:

Reductions = 364,696 x MW reductions 0.7388

Then using the derivative of power functions the marginal effect at a 7,500 MW DR reduction is calculated as 0.7388 x 364,696 x 7500 -0.2612 = 26,198

The average effect is just 271,529,969/7500, or 35,460, over 35% higher than the marginal
effect.

Since the total annual bill for the replacements is 165,000 x $10,000/MW-yr, and the annual reduction over the ten year period is roughly one-tenth the cumulative reduction, we can then derive the other figures of $1.65 billion/27,000,000 tons for $60.76 per ton on average and $81.21 per marginal ton at a 50 percent reduction in DR.