ScienceLast June, the U.S. Environmental Protection Agency proposed a rule to limit carbon dioxide emissions from existing U.S. power plants. A new article published in Science magazine on 14 November 2014 and co-authored by CEEPR Director Christopher R. Knittel examines how key design features of the proposed rule might affect its environmental effectiveness, and offers recommendations to help minimize the economic costs of compliance.

Designated the “Clean Power Plan”, the proposed rule sets out state-specific emission rate-based goals which – according to the Administration – will reduce emissions from the power sector 30% below 2005 levels by 2030. In their analysis, the article’s authors draws attention to challenges arising from the rate-based approach to defining emissions reduction targets. Unlike the failed climate bills introduced in earlier sessions of Congress, the Clean Power Plan does not mandate specific emission reduction levels. Instead, compliance requirements are expressed as an emissions ratio, that is, in terms of CO2 emissions per unit of generated electricity (lbs/MWh). As a result, states can bring down their average emission ratio by increasing production of low-carbon electricity, allowing compliance without actually reducing emissions. According to the article’s authors, this can result in a perverse incentive to expand electricity generation. Because energy efficiency improvements can count towards compliance, they also warn against overestimating efficiency gains and thereby weakening the standard.

From an economics perspective, Knittel and his co-authors praise the proposed rule’s flexibility regarding the location of emission reductions and the compliance options available to states. When setting the standard for each state, the EPA considered a range of demonstrated methods for reducing emissions, including heat rate improvements at power plants, increased electricity generation from natural gas, expansion of renewables, and demand-side energy efficiency programs. Yet states can also use any other approach that helps reduce emissions per unit of electricity generated, allowing them to reflect changing market conditions and technological innovation as well as regional developments. What is more, the plan allows cooperation across state borders during implementation, opening up additional opportunities – such as emissions trading – to reduce compliance costs.

But the article’s authors also point out that it remains unclear whether states will actually harness this flexibility to meet reduction goals at least cost. In regional electricity markets, where electricity generation is dispatched through regional grid interconnections that span multiple states, effective coordination between states will be critical to leverage the Clean Power Plan’s efficiency potential and avoid a patchwork of regulatory incentives and divergent operating cost that ultimately distorts the electricity market and raises the overall cost per ton of emissions reduced. Consequently, in their conclusions, the authors urge the EPA to play a stronger facilitating role in the final rule, with additional guidance on how states can harmonize their implementation plans and compliance obligations to avoid unnecessary costs.

(November 2014)