INTERVIEW: Alan H. Richardson by Chris Trayhorn, Publisher of mThink Blue Book, May 14, 2007 Energy & Utilities: Lets start by taking a look at the state of the electric utility industry marketplace as it relates to congressional debates over reducing carbon dioxide emissions. Alan Richardson: Congressional action on climate change will have a huge impact on the electric utility industry. Most APPA members of APPA acknowledge the scientific reality that human activity contributes to climate change as well as the political reality that Congress is going to deal with the issue in some fashion. The APPA has endorsed a set of principles that we think must be included in any legislation that Congress enacts. For example, we believe that any legislation should apply to all sectors of the economy; place an enhanced and economywide focus on energy efficiency; consider the financial impact on consumers; preserve a diverse mix of fuels for the generation of electricity; and take into account the impact on the economy and jobs within the U.S. There are a few options that Congress might use to limit greenhouse gas emissions. One is the cap-in-trade approach, where the government would set an allowance of a number of metric tons of carbon that could be emitted into the atmosphere, and then if youre short you buy allowances from others, and if youre long you sell. Another alternative is to impose a tax on carbon that ramps up over time until its more painful to pay the tax than it is to find alternatives to emissions reductions. Straw polls of my members suggest they find a tax approach much easier to administer and more equitable. And its more compatible with the idea that you need an economywide program that doesnt put all the burden on one sector of the economy, electric utilities, just because thats the easiest one to deal with. The method Congress selects will affect the industry in a couple of ways. If theres a carbon tax, costs will increase to reflect this fact. Its going to increase the cost of doing business for every utility that generates electricity using fossil fuels. But it will also affect other segments of the economy, such as individuals who drive their automobiles and have to pay a little bit more for gasoline. If Congress selects a cap-in-trade approach, we need to create a new market for emission allowances. For electric utilities in some regions, this market will be superimposed on top of complex wholesale electric markets set up by regional transmission organizations or independent system operators. Weve been very concerned about the dysfunctionality of those wholesale markets and the relative ease with which they can be manipulated. More important, the prices were seeing in those markets are not what we would expect to find in truly competitive marketplaces. For example, the last unit of generation needed to meet electric load at any point in time sets the market clearing price for all other generation sold at that time. If emission allowances must be purchased in order to generate that last bit of electricity, then the cost of those allowances will increase the cost of all other generation. So tying back to the climate change issue, one of the many things that concerns us about the cap-in-trade approach is the superimposition of a new market for carbon emissions on top of these organized wholesale markets, making the whole process that much more complex, difficult to manage and more costly for all consumers. E&U: What has restructuring achieved in terms of lowering prices and providing incentives to invest, and how has restructuring affected American businesses and consumers in terms of prices and access to a reliable supply of electricity? AR: There were great promises of lower rates, better service and more innovation through restructuring the markets and getting the regulators out of the way. Over the past several years, a number of studies have purported to show that, indeed, those results have been achieved. Some of these studies show billions of dollars of savings for consumers. My members havent seen those savings. In fact, if anything, they are experiencing higher costs for wholesale power. The APPA commissioned Northeastern University Professor of Economics John Kwoka to look at the validity and accuracy of those studies and the conclusions reached. His analysis found that none of the studies withstood scrutiny and that policy makers should not be relying upon those results when they decide whether consumers are better or worse off under restructuring. As far as reliability, some observers have suggested that restructuring has adversely affected operational reliability because power generators are focused almost exclusively on profits. There may be some truth to that, but there is another problem, particularly in these organized markets, and that is the failure of investors to come forward to build the new generation or transmission infrastructure necessary as we move further into this century. The markets simply have not been providing the kind of incentives to investors that were predicted at the outset, and now weve got concerns about whether there will be enough generation to meet tomorrows needs. Therefore, public power systems that historically relied upon the market are now realizing that it isnt producing what they thought it would and what the economists thought it would, and there is a tremendous push within my membership to move forward with building new generation on their own. E&U: How did Congress address the electricity marketplace in its umbrella Energy Policy Act of 2005? AR: It did a number of things, some of which are perhaps a little contradictory. You can look at certain parts and say the Energy Policy Act supported the promotion of competition in the electric utility industry, at least in the wholesale markets, while other parts of the Act suggest Congress isnt ready to rely solely on competition to set rates and protect consumers. Congress repealed the Public Utility Holding Company Act on the assumption that it was an impediment to competition and investment in new facilities. Were not necessarily seeing investment in new facilities now, but instead, were seeing acquisition activity among entities that previously would not have been allowed to enter the electric utility industry in the first place. Consider the private equity firms that are attempting to purchase Texas Utilities (TXU). These venture capitalists see opportunities to acquire utilities. The typical VC pattern is strip and flip buy companies, strip them and sell them at a profit. This may be profitable, but it is not suitable for an industry as critical as the electric utility industry. Repealing the Holding Company Act has allowed introduction of new players into the electric utility industry whose interests are not likely to be consistent with the best interests of electric consumers. E&U: What is FERC doing to meet its congressionally mandated mission to ensure electricity rates are in fact just and reasonable? AR: Well, they recognize that that they have this responsibility, but its not clear whether they are exercising it to the fullest extent possible. We would like to see them be more active in examining the relationship between prices paid for power on the wholesale market and the actual cost of production. The commission is assuming that competitive wholesale markets will produce results that meet the statutory definition of just and reasonable. If we were dealing with widgets or oranges, that might well be the case. Competition usually does produce that kind of result for those kinds of commodities. But the electricity marketplace is fundamentally different. Electricity isnt really a commodity; its more of a phenomenon. It is a necessity for which there is no substitute, and there is a limited number of sellers. It is difficult to rely on competition under these circumstances. The commission needs to be looking at this more carefully, and we have been encouraging it to do so. E&U: Are higher fuel costs the explanation for higher electricity rates? AR: Thats another one of the arguments that has been used to justify the increased prices being charged in RTO- and ISOmanaged wholesale markets. We have taken a close look at this issue. Its clear that fuel costs have risen and that rising fuel costs do increase the cost of generating electricity. But its not clear that higher fuel costs alone are responsible for the higher prices that are being paid, particularly in the organized markets. As I mentioned earlier, the methodology for setting the price in these organized markets is a single-bid clearing price auction the last generator to be dispatched to meet the load within a particular area sets the price for all other generators. High-cost natural gas-fired generation is frequently the last generation unit dispatched and the cost of that generation sets the price for lower-cost generation from coal or nuclear plants. E&U: What lessons are we learning from Europe about its marketplace approach to CO2 reduction, and how do we apply those lessons to U.S. policy to hold down electricity costs? AR: I hope were taking time to learn lessons from Europe. Theyve employed a very complicated cap-and-trade approach, and theres a great deal of momentum here in the U.S. behind cap-and-trade too, particularly on Capitol Hill. There are about 12,000 emitting sources that are subject to the European Union (EU) cap right now, accounting for about 50 percent of carbon emissions. That leaves another 50 percent that are not covered by the cap-and-trade program. Its hard to slow, stop and reverse emissions of greenhouse gases if you are only dealing with half of total emissions. We can avoid this problem in the U.S. if Congress endorses our principle that any legislation must cover all emitters in all sectors of our economy. Another problem in the EU is that theres no single monitoring or enforcement source to make sure those with allocations are abiding by the allocations, that they are emitting no more than allowed to emit by law or that they are purchasing allowances when necessary. There were also too many allowances given out in the EU when the cap-and-trade approach was first introduced, meaning they were allowing more emissions than they should have and the price fluctuated wildly as a consequence. And there were some costly mistakes for consumers. For example, some of these allowances were given away free to electric utilities that turned around and calculated the price of the emissions in the marketplace and added that price to the power they were selling to consumers. They got a windfall at the expense of consumers. If Congress does embrace a cap-and-trade approach, it should protect against behavior such as this. E&U: It sounds like we can learn from the mistakes of the EU experience as well as any smart things theyre doing. AR: Many people say this whole capand- trade approach is similar to what we used for controlling sulphur dioxide several years ago. Youll hear the argument that we did it for acid rain, we can do it to reduce greenhouse gas emissions to address climate change. But with acid rain, we had a relatively discrete number of emitting sources, mainly stationary power plants. We had technology available for putting things on the end of the combustion cycle that would capture the SO2 , and weve been able to monitor how well that technology works. Plus, we had the EPA, a federal agency that was able to enforce the emissions limits. Even under these conditions, however, some companies tried to game the system. As mentioned, the EU has a multitude of emitting sources. The U.S. will have to deal with the same problem if we go to a cap-in-trade approach with CO2 . Well have thousands and thousands of emitting sources and no clear way of ensuring that theyre abiding by the rules. Then we have the question of how those allowances will be allocated. You can bet the infighting will be fierce in Congress as various industries scramble to make sure they get their allowances. But since there will be an absolute limit on the number of allowances, for every winner, there will also be a loser. E&U: As it legislates CO2 policy, what kinds of considerations must Congress take into account in relation to the electric power grid and how the marketplace is currently organized? AR: Energy drives our economy. But we dont yet know how to capture and store carbon on a commercial scale, and there are many, many questions that must be answered. Environmental policy and technology must proceed in tandem. Congress shouldnt set emission targets that simply cannot be met. Much research, development and deployment of potentially promising technologies will be required in our search for answers. Congress should ensure adequate funding for these activities. Congress should measure alternative means of mandating emission reductions, based on how simple, efficient and equitable they are. From my personal perspective, this suggests a greenhouse gas tax rather than a cap-and-trade approach. And as far as the electric power marketplace is concerned, Congress should take into account what the consequences for consumers will be if they do decide to superimpose an emission allowance market on top of the RTO- and ISO-managed wholesale electric markets. Filed under: White Papers Tagged under: Utilities About the Author Chris Trayhorn, Publisher of mThink Blue Book Chris Trayhorn is the Chairman of the Performance Marketing Industry Blue Ribbon Panel and the CEO of mThink.com, a leading online and content marketing agency. He has founded four successful marketing companies in London and San Francisco in the last 15 years, and is currently the founder and publisher of Revenue+Performance magazine, the magazine of the performance marketing industry since 2002.