To protect electricity consumers, prudent long-term planning and investing requires that utilities and their regulators estimate how future CO2 regulations will impact the cost of generating electricity. A recent proceeding before the Minnesota Public Utilities Commission demonstrates the challenges to estimating future costs and how parties tend to ignore and oversimplify the politics that will shape those regulations.
While political power may be shifting to politicians who support regulation, a number of more powerful political factors remain unchanged. These factors point to less costly restrictions on CO2 emissions.
State utility regulators and utility companies across the country are grappling with a tough question: How much will future state or federal carbon dioxide (CO2) regulations raise the cost of various types of electricity generation? In Minnesota, the Next Generation Energy Act of 2007 specifically directs the Minnesota Public Utilities Commission (PUC) to “establish an estimate of the likely range of costs of future CO2 regulation on electricity generation.” While difficult, estimating the possibility of future regulations and their likely cost are important to assure that today’s utility investments result in the most affordable energy solutions for consumers in the years to come.
This issue most often ends up being a question of investing in coal versus some other source of electricity. For many regions of the country, including Minnesota, coal-fired power plants generate electricity more reliably and at a lower cost than any other source of electricity. However, if the future cost of CO2 regulation increases the projected cost of coal-fired electricity too much, then other electricity sources such as natural gas or renewables might become a more affordable solution for electricity consumers.
When regulators and utilities consider long-term investments, the contested issues normally revolve around economic uncertainties. For instance, what will maintenance cost over the life of a wind mill farm? Or, how much will natural gas cost in five years? These questions primarily relate to product reliability and the forces of supply and demand. In this case, the question is much more political than economic: What can we expect Congress to do in the next four years?
Unfortunately, debates and deliberations over this issue rarely address the politics of actually passing CO2 regulations in a serious manner. Instead, utilities, regulators and their consultants strain to keep the question framed in more familiar economic terms. Consequently, the future cost of CO2 regulation is often entirely based on estimating what current congressional proposals would cost, a purely economic undertaking. This ignores whether such proposals are in fact politically feasible. When politics is considered, the analysis is usually limited to a simplistic headcount of Democrats supporting versus Republicans opposing.
Ignoring or oversimplifying the politics of regulating CO2 can lead utilities and regulators to overestimate future regulatory costs. This is because a number of powerful political factors, beyond simple party politics, suggest that passing costly CO2 regulations will not be easy or likely. The consequences of overestimating could be quite costly to electricity consumers if the estimates steer utilities toward more expensive and less proven energy sources.
This issue most recently played out before the Minnesota PUC in their review of Big Stone II, a proposed 500 to 580 megawatt coal-fired electric generating plant. This report begins with an examination of how the PUC and the parties in the Big Stone II proceeding went about estimating the future cost and impact of CO2 regulations. Being a recent and highly contested case, Big Stone II illustrates how utilities, regulators, consultants, and environmental groups currently ignore and oversimplify the politics of regulating CO2. This report then identifies eight political factors that tend to be ignored when estimating the likely cost of CO2 regulations. All of these factors weigh against high regulatory costs.
Assessing politics in the Big Stone II proceeding
Reviewing the prudence of Big Stone II proved to be a challenge for the PUC. After years of hearings and receiving file cabinets of documents in the record, the PUC last summer requested yet more information on three key issues from an outside consultant. Estimating the expected cost of CO2 regulations was one of these more bewildering issues.
It’s no surprise that the PUC and the parties arguing for and against Big Stone II struggled to price the political risk. It’s not like pricing other future events. The tools of the insurance actuary or economist don’t work well. Using reams of historical data, actuaries and economists can set a rather accurate price on a wide range of possible outcomes, from car accidents to drought to the price of natural gas. Politics doesn’t share the same sort of historical data. Landmark legislation doesn’t successfully pass all that frequently and, when it does, the occasion is often marked by a set of hard-to-compare circumstances. Consequently, predicting a political outcome is an incredibly imprecise undertaking.
Experts recommend establishing a range of possible carbon dioxide prices. To deal with the imprecision, most experts recommend that utilities and regulators like the PUC estimate a range of possible CO2 prices under future regulations and then testing Big Stone II across that range. The hope is that utilities will find one set of energy resources that provide a low-cost electricity solution across the entire range.
Because the immediate political risk arises from current congressional cap-and-trade proposals, estimates of the range of possible CO2 prices are usually based on the range of possible costs under these proposals. The America’s Climate Security Act of 2007 proposed by Sen. Joseph Lieberman and former Sen. John Warner (Warner-Lieberman) receives the most attention because it has advanced the furthest. Generally these proposals would cap the total allowable green house gas emissions for the country and allocate emission allowances to entities that emit green house gases. These entities can then trade the allowances among themselves. In theory, trading allowances enables emissions with high economic value to continue and reduces emissions with low economic value. The cost of these allowances is measured per ton of total CO2 emissions.
A number of different ranges were considered within the Big Stone II proceedings. In December 2007, the PUC set an interim range at $4 to $30 per ton of CO2 emissions as directed by state law.  The utilities generally followed the PUC’s range. The environmentalists intervening in the case most recently proposed a range between $15 and $45.  The environmental groups also highlighted Xcel Energy’s latest resource plans that set the range at $9 to $40.  The October 2008 report by the consulting firm Boston Pacific, commissioned by the PUC, set the range at $8 to $60. 
Xcel and Boston Pacific ranges fail to adequately account for politics. Recall that most ranges of costs of future CO2 regulations are based almost entirely on current proposals before Congress. Xcel and Boston Pacific’s ranges are no exception.
The Xcel Energy 2007 Resource Plan set a range based only on analyses of current congressional proposals. Without explaining why, Xcel contends that this range also encompasses the likely CO2 price of any future proposal. They then recommend the medium scenario in the range as most likely. To justify this, they simply reference the “ongoing changes in the political climate.” In other words, the politics is too messy to consider the issue too deeply.
Unlike Xcel, Boston Pacific also considers two additional factors when setting their range: utility resource plans and current market prices for CO2 allowances in existing cap and trade programs. Still, Boston Pacific devotes most of their analysis to estimating costs under recent congressional proposals, which suggests those proposals remained the primary factor in determining their range.
Of course, identifying the costs under various congressional proposals is incredibly helpful to developing a crude range of what is politically possible. However, what is possible does not necessarily translate into what is likely. It’s not uncommon for a member of Congress or state legislator to propose something knowing full well it has little to no chance of passing. Only the intervening environmental groups and the Big Stone II utilities offer any substantive analysis of the politics involved.
Environmental groups and utilities oversimplify the politics at play. When it comes to assessing political considerations, the environmental interveners offer the most substantive examination. To them, the political tea leaves are clear: A pricey cap and trade scheme will almost certainly pass in the near future. Their analysis can be narrowed down to essentially four arguments.  First, a number of regulators, large investment banks, and other sophisticated long-term planners account for CO2 risk when making investments, which reveals their belief in the likelihood of federal regulations. Second, polls show increasing public support for regulations that curb global warming emissions. Third, recent political events—including electoral gains by Democrats, the successful passage of emission regulations in many states, and the advance of federal cap-and-trade legislation—demonstrate that control is shifting to politicians who support aggressive emission regulations. Fourth, only higher CO2 prices will accomplish meaningful reductions in emissions.
In response, the utilities don’t dispute the likelihood of regulation; rather, they dispute the likelihood that future regulations will hurt Big Stone II’s economic viability.  To demonstrate that other utilities and regulators believe coal continues to be a prudent investment for ratepayers, they provide opposing examples of new coal plants that recently received regulatory approval. They point to the fact that most legislative proposals keep costs low for coal plants like Big Stone II through free CO2 allowances, the purchase of CO2 offsets on the private market, and allowance ceiling prices. They contend CO2 capture and sequestration will likely make coal a competitive energy source over the long term even under costly CO2 regulations. Further, power plants like Big Stone II will be more efficient than competing coal plants and thus more viable in a market with higher CO2 prices. To the larger political question, the utilities make a passing reference to how the current economic distress will impact future legislation and they cite a letter ten Democrats signed expressing serious concern over the economic impact of Lieberman-Warner.
These opposing arguments do not fully capture the political considerations that drive whether CO2 pricing will be on the low or the high end. The environmental interveners cherry-pick quotes, industry practices and poll results and offer a simplistic measure of today’s political climate based almost entirely on electoral results and election-year promises. The utilities also ignore an in-depth assessment of the politics and essentially limit their points to explaining how Big Stone II can be viable under just one political possibility, the Lieberman-Warner legislation.
The Big Stone II record just discussed ultimately reflects how extremely challenging it is to estimate the cost of future CO2 regulations and the tendency to ignore and oversimplify the politics that will shape those regulations. A more thorough review of the politics involved reveals a number of considerations that weigh in favor of a lower CO2 price.
Political considerations suggest less costly CO2 regulations
Though most people agree that some form of CO2 regulation will pass, the costs associated with future regulation remain dependent on a highly uncertain political event. Accounting for politics may appear futile. How do you gauge the volatile swings in America’s political mood—made even more volatile by the financial crisis—to predict a political outcome one, two, or even five years out? While there is certainly no precise way, certain political considerations and trends can offer a loose but helpful guide. The following list outlines a number of powerful political factors that, taken together, suggest that costly CO2 regulations are not likely to pass despite recent Democratic gains.
- Voters are highly sensitive to the price of energy and continue to show a preference for affordable energy versus other environmental priorities. It’s true that, as the environmentalist interveners argue in the Big Stone II record, opinion polls demonstrate that the public overwhelmingly supports regulating CO2 emissions. But this public support runs directly counter to the public’s sensitivity to energy prices. A survey of public opinion data by the liberal market research firm American Environics concludes that “concerns over higher energy costs could undercut action on energy or global warming.”  They reference one poll that shows 79 percent of voters reject increasing taxes on electricity to fund conservation. A cap on CO2 emissions is, of course, just another method to tax electricity.
This dissonance in public opinion likely reflects the public’s ignorance about the economic consequences of CO2 regulations. The American Environics report offers an important example to demonstrate how public support for environmental policies can change when the costs become clearer. Specifically, the report references California Proposition 87—a ballot initiative to tax oil production to fund clean energy alternatives. Initially, the public appeared to support a tax on oil production in the summer—61 percent according to a July 2006 poll —but ultimately rejected the proposal by nearly ten points when those opposing Proposition 87 effectively demonstrated that taxing oil production would raise gas prices. Most recently, a coalition of business and industry interests released an economic study that projects a regional cap and trade policy would increase electricity prices in Minnesota by 17 percent by 2015, reduce statewide consumption by $1.5 billion, and eliminate 21,000 jobs.  National studies show similar costs and consequences.  When the public becomes attuned to these costs, it will be difficult for lawmakers to implement costly CO2 regulations
- The present recession increases sensitivity to economic concerns over global warming regulations, which will likely delay and water down the passage of a CO2 cap or tax. Most experts, from market analysts to political insiders, agree that the recession will delay global warming policies.  For instance, Josh Margolis, co-CEO of CantorCO2e, and Abyd Karmali, global head of CO2 emissions at Merrill Lynch, are both reported to agree that a high-cost CO2 cap or tax will be delayed due to the financial crisis. 
This is precisely what happened at the recent United Nations climate change negotiations in Poznan, Poland. Just days after the negotiations, environmentalist groups were already crying foul over concessions given to industry to delay their emissions reductions.  German Chancelor Angela Merkel explained that these concessions were necessary to protect jobs as a recessionary period hits Europe. 
Not only will regulation be delayed, but even when the economy turns around, voters will continue to be sensitive to economic concerns. Voters will not easily forget the chaotic economic times we now face and, consequently, will continue to be sensitive to economic concerns. The present recession in no way compares to the depth of the Great Depression, but people will carry and act on the memory of this recession long after it’s over, just as those who continued to scrimp decades beyond the Great Depression.
- Passing landmark legislation is difficult even when one party controls most levers of power. Passing serious global warming regulations that impose high costs on energy production would arguably be considered a landmark piece of legislation. While not in the same league as civil rights legislation or the New Deal, it would likely carry similar stature as insurance reforms in the 1940s or welfare reform more recently. None of these reforms passed easily.
Failed legislation may be more instructive for the current situation. Consider the failure of broad-based health care reform under President Clinton in 1993. At the time each house of Congress held Democratic majorities and a Democrat sat in the White House. Nonetheless, the legislation failed when the public turned against it. Importantly, the public generally supported it in early polls before there was a full public debate on the merits. As just noted, expect public support for regulations that reduce CO2 emissions to fall as the public becomes aware of details. For one more example, consider that President Bush’s attempt to pass Social Security reform also failed at a time when supportive Republicans controlled Congress and the presidency. Clearly it takes more than party dominance to successfully pass legislation.
- Limiting CO2 emissions is the most costly CO2 abatement strategy and lawmakers will likely opt for less expensive options. In light of the current recession, it’s far more likely that lawmakers will pursue least-cost options first. A 2007 report by McKinsey & Company groups abatement strategies into five categories: Building and appliance energy efficiency; vehicle fuel efficiency and carbon intensity of vehicle fuel; targeted industrial sector measures; carbon sinks; and electric power production carbon intensity.   The last item on this list exacts the highest cost.  Consequently, market analysts predict that lower-cost efficiency and clean energy initiatives will be initiated first. 
- Lawmakers representing states disproportionately harmed by emissions regulations will continue to pose strong resistance. Economies in states with substantial coal production and usage would be severely weakened by costly CO2 regulations broadly applied nationwide. As a region the Midwest relies on coal for over 70 percent of its electricity, while New England relies on coal for only 15 percent of its electricity.  Wyoming, North Dakota, Indiana, Kentucky, and West Virginia all rely on coal for over 90 percent of their electricity.  Further, many communities in these states rely predominantly on the coal industry for jobs. Lawmakers should be expected to protect these economic interests from the economic upheaval costly CO2 regulations would bring. To support this point, the utilities in the Big Stone II record referenced a letter by ten Democratic senators who said they could not support a cap and trade bill that did not address their economic concerns. Point Carbon reports that this group of Democratic senators now numbers sixteen. 
- The history of environmental regulations demonstrates that lawmakers will likely “grandfather” a certain level of emissions, which will reduce the overall cost. Lawmakers generally don’t like to upset the established order and so they consistently grandfather preexisting behavior and investment decisions into new environmental regulations. For instance, the Clean Air Act, Clean Water Act, Coastal Zone Management Act, and the Toxic Substances Control Act all include grandfather clauses. In fact, Big Stone II benefited from a grandfather clause in the Next Generation Energy Act, which otherwise restricts the building of new power plants that, on net, increase CO2 emissions. While the environmental interveners in the Big Stone II record cite a letter from Sen. Barbara Boxer warning that they won’t escape regulation by building a coal plant ahead of legislation, the long political history of environmental regulations demonstrates that political expediency nearly always grandfathers prior practices and investments.
- Lawmakers will be hesitant to compromise our nation’s energy independence by replacing coal with natural gas. Voters place a high value on energy independence. According to recent polling, Public Agenda concludes that “energy independence is now clearly the public’s number one national security strategy.”  Opinion polls also suggest that voters value energy independence far more than global warming abatement. Fifty-nine percent of people surveyed identified “dealing with energy problems” as a top priority while 35 percent identified “dealing with global warming” in a January 2008 poll by The Pew Research Center for the People & the Press. 
The abundance of U.S. coal makes it a key component in promoting the nation’s energy independence. Depending on who you ask, coal can fuel our energy needs for 100 to 250 years.  The location of worldwide coal reserves also makes a difference. The United States, with 27 percent, holds the highest proportion of the world’s coal reserves, whereas the Middle East holds almost none.  If CO2 regulations make coal-based power too costly, the only current alternative for many utilities is natural gas or some mix of gas and renewables. Even without new regulations, the United States will soon need to begin importing natural gas. The Middle East and Russia happen to be the two most natural gas-rich regions in the world.  Using more natural gas will mean higher global natural gas prices, which will enrich their economies regardless of whether we actually import their fuel. Considering the lead role that coal plays in promoting energy independence, it’s unlikely that lawmakers will seriously curb its use. More likely, lawmakers will invest in technologies that promote efficiency and capture coal’s CO2 emissions.
- The fact that current energy subsidies favor coal over renewables suggests that the continued use and development of coal remains a top priority for lawmakers. Actions, of course, speak louder than political speeches and campaign promises. When it comes to subsidizing electricity production, lawmakers favor coal by a large margin. In 2007, coal received $3 billion of the $5.5 billion allotted for federal subsidies and support allotted to various fuel types for electricity generation.  In contrast, renewables received $1 billion. These lopsided subsidies reveal coal is a priority for lawmakers. Consequently, lawmakers should be expected to support future coal development on a number of fronts—from refined coal to CO2 capture and storage—in order to reduce the future CO2 price levied on coal.
Voter sensitivity to high energy prices, the current economic crisis, the difficulty of passing landmark legislation, a preference for cheaper CO2 abatement policies, resistance from states disproportionately harmed by emissions regulations, the history of grandfathering industry conduct, a commitment to energy independence, and a preference to subsidize the coal industry all represent political considerations deeply rooted in the fabric of America that cannot be written off because more Democrats are in power. These political considerations are by no means exhaustive. But, taken together, they represent a far more potent political force than simple party politics, and they point to a future with less costly CO2 regulations than many estimates assume.
Ignoring these political considerations will likely lead utilities and regulators to overestimate future CO2 regulatory costs, which could be costly for electricity consumers and the economy overall. This is because overestimating CO2 regulatory costs can lead utilities to unnecessarily transition toward more expensive energy sources that use less CO2. To protect consumers, utilities and their regulators need to pay closer attention to how politics will shape future regulatory costs. A fuller understanding of the politics will guarantee that utilities use more accurate assumptions when making long-term decisions.
-- Peter Nelson is an attorney and Policy Fellow at Center of the American Experiment. Center of the American Experiment is a nonpartisan, tax-exempt, public policy and educational institution that brings conservative and free market ideas to bear on the hardest problems facing Minnesota and the nation.
  The Minnesota Public Utilities Commission, Order Establishing Estimate of Future Carbon Dioxide Regulation Costs, MPUC Docket No. E-999/CI-07-1199 (Dec. 21, 2007).
  David A. Schlissel, Rebuttal Testimony to Boston Pacific Consultant Report, Joint Intervenors - Exhibit 50, MPUC Docket No. CN-05-619 (Nov. 6, 2008). The joint intervenors prior range was set at $8.23 to $31.43
  Xcel Energy, 2007 Minnesota Resource Plan, pp. 11-3 – 11-9 available at http://www.xcelenergy.com/COMPANY/ABOUT_ENERGY_AND_RATES/RESOURCE%20AND%20RENEWABLE%20ENERGY%20PLANS/Pages/2007_Minnesota_Resource_Plan.aspx .
  Craig R. Roach and Frank Mossburg, Report Responding to the Commission’s Inquiries on Emissions Costs, Construction Costs, and Fuel Costs, Boston Pacific Company, Inc, October 21, 2008.
  For the interveners’ analysis, see David Schilissel, et al., Synapse 2008 CO2 Price Forecasts, July 2008 available at http://www.synapse-energy.com/Downloads/SynapsePaper.2008-07.0.2008-Carbon-Paper.A0020.pdf ; Joint Intervenors’ Brief and Exceptions to the Administrative Law Judges’ Supplemental Report, MPUC Docket No. ET9/CN-05-619 (May 19, 2008); and Direct Testimony of David A. Schlissel, North Dakota Public Serve Comission Case Nos. PU-06-481 and PU-06-482 available at http://www.synapse-energy.com/Downloads/SynapseTestimony.2007-05.DRC.North-Dakota-Big-Stone-II-Prudence.07-018.pdf .
  For the utilities’ analysis, see Supplemental Prefiled Rebuttal Testimony of Thomas Hewson, MPUC Docket No. CN-05-619 (Nov. 6, 2008); Supplemental Prefiled Testimony of Ward Uggerud, MPUC Docket No. CN-05-619 (Nov. 6, 2008); and Applicants’ Brief in Support of Certificate of Need and Route Permits and Exceptions to the Second Report of the Administrative Law Judges, MPUC Docket Nos. CN-05-619 and TL-05-1275 (May 19, 2008).
  Jeff Navin, Energy Attitudes Summer 2007, American Environomics available at http://www.americanenvironics.com/PDF/EnergyAttitudesSummer2007.pdf .
  Mark Baldassare, Public Policy Institute of California Statewide Survey: Special Survey on the Environment (July 2006) at 18 available at http://www.ppic.org/content/pubs/survey/S_706MBS.pdf .
  CRA International prepared for Partners for Affordable Energy and coalition of Minnesota trade associations, organizations, and utilities, Economic Analysis of the Impact of a Regional Climate Policy on Minnesota, December 2008. This study assumed C02 allowance pricing beginning at $23 and escalating to $126 by 2050.
  For examples of national studies, see American Council for Capital Formation and the National Association of Manufacturers, Analysis of The Lieberman-Warner Climate Security Act (S. 2191) Using the National Energy Modeling System, March 2008; and William W. Beach, David Kreutzer, Ben Lieberman and Nicolas Loris, The Economic Costs of the Lieberman-Warner Climate Change Legislation, The Heritage Foundation Center for Data Analysis Report #08-02, May 12, 2008.
  See John M. Broder and Andrew C. Revkin, “Hard Task for New Team on Energy and Climate,” The New York Times, Dec. 16, 2008: A24; and Elizabeth Shogren, “Bad Economy Threatens Obama’s Climate Fix,” National Public Radio, Nov. 25, 2008 at http://www.npr.org/templates/story/story.php?storyId=97393883 .
  Point Carbon, “U.S. to Focus on Clean Energy Before Cap and Trade,” Carbon Market North America, Nov. 14, 2008.
  David Charter and Lewis Smith, “Green lobby cry foul as biggest polluters get more time to clean up,” The Times, Dec. 13, 2008.
  James Kanter and Stephen Castle, “EU leaders dramatically scale back their ambition on emissions,” International Herald Tribune, Dec. 12, 2008.
  McKinsey & Company, Reducing U.S. Greenhouse Gas Emissions: How Much at What Cost? (December 2007) available at http://www.mckinsey.com/clientservice/ccsi/pdf/US_ghg_final_report.pdf .
  Please note that CRA International published a highly critical analysis of the McKinsey findings arguing that it understated the costs and overstated the benefits of energy efficiency measures. Nonetheless, efficiency measures are still likely to be less costly than carbon caps. CRA International, Managing the Risks of Greenhouse Gas Policies, January 2008.
  See Point Carbon, “US to focus on clean energy before cap and trade,” Carbon Market North American, Nov. 14, 2008.
  Energy Information Administration, State Electricity Profiles 2006, DOE/EIA 0348(01)/2 (November 2007) available at http://www.eia.doe.gov/cneaf/electricity/st_profiles/sep2006.pdf .
  Point Carbon, “Congressional Aides Lower Expectations for U.S. Climate Bill,” Carbon Market North America, Dec. 12, 2008.
  Scott Bittle, Jonathan Rochkind, and Jared Bosk, Confidence in U.S. Foreign Policy Index, Public Agenda, Vol. 6: Spring 2008.
  The Pew Research Center for the People & the Press, “An Even More Partisan Agenda for 2008,” Survey Reports (Jan. 24, 2008) available at http://people-press.org/report/388/an-even-more-partisan-agenda-for-2008 .
  See The National Academies, Major Increase in Federal Research Needed to Determine Size of U.S. Coal Reserves and Meet Increasing Challenges in Mining Safety, Environmental Protection, News Release, June 20, 2007 available at http://www8.nationalacademies.org/onpinews/newsitem.aspx?RecordID=11977 ; and Statement of C. Lowell Miller, Director, Office of Sequestration, Hydrogen and Clean Coal Fuels, Office of Fossil Energy before the Committee on Energy and Natural Resources, U.S. Senate (Apr. 24, 2006) available at http://www1.eere.energy.gov/vehiclesandfuels/epact/pdfs/plg_docket/statement_lowell_miller.pdf .
  Energy Information Administration, Coal Reserves Current and Back Issues (Oct 29, 2007) available at http://www.eia.doe.gov/cneaf/coal/reserves/reserves.html .
  Energy Information Administration, World Proved Reserves of Oil and Natural Gas, Most Recent Estimates (Aug. 27, 2008) available at http://www.eia.doe.gov/emeu/international/reserves.html .
  Energy Information Administration, Federal Financial Interventions and Subsidies in Energy Markets 2007 (April 2008). Most coal support derives from the alternative fuel production tax credit subsidies for refined coal. When measured on a subsidy and support per unit of production, refined coal receives more benefits than any other fuel source, a $29.81/megawatthour subsidy compared to wind and solar subsidies measuring $23.37 and $24.34, respectively. While the Wind Production Tax Credit receives more media attention than refined coal tax credits, both credits were extended as part of the October 2008 TARP bill. Note that refined coal would not be able to fuel Big Stone II.