Fortunes in Cap-and-Trade

I got this today from an industry newsletter that I receive via email. Basically explaining how a large nuclear power producer in the US will make a small fortune off of the future carbon credits cap and trade system. Hydro Quebec will be poised to be in the same situation with any surplus power that they sell into the open market. Including markets they obtain through US interconnections through New Brunswick. This underlying reason is that nuclear and hydro don't produce greenhouse gases as defined by the "clean energy" regulations and because most older hydro stations can get on the grid at a fairly low price, they get the going market rate as higher priced producers get on the grid to meet demand. And remember, many beg to differ on whether hydro is clean, and that can be found on an earlier post. The flipside of the article, is that the current going rate is only $3/tonne. So maybe those dirty old fosil plants won't have much to worry about after all. Happy Reading folks.



Fortunes in Cap-and-Trade November 25, 2009 Written by : Richard Schlesinger

"Although the electric industry has endorsed the concept of cap-and-trade as the least onerous approach to carbon regulation, at least one major company endorses it with unalloyed enthusiasm. Exelon not only supports the idea, it stated in a second-quarter conference call to analysts, which it posted to its Web site, that it expects to see a "$1.1 billion and growing annual upside to Exelon revenues from implementation of Waxman-Markey." Is that number real or simply wishful thinking? Does Exelon know something that's escaped the rest of us?

Actually, if one makes a couple of assumptions, the potential earnings boost is very real. Here's how it works. Exelon's 17 nuclear plants, the largest nuclear fleet in the country, generated just over a record 132 million megawatts-hours of power in 2007. That's fact. Assumption number one: The Senate follows the House and passes an unchanged version of the Waxman-Markey bill.

At the start of the program, about 85 percent of the permits would be given away. Over time, the percentage of free permits would decline. About 15 percent of the permits would be auctioned off to begin with, and that percentage would increase over time. What concerns us is the value of these permits, because that value translates into increased costs for generation. Which brings us to assumption number two: The EPA estimates that during the early years of the program, a permit to emit one ton of CO2 would cost approximately $15.

In the unregulated markets where Exelon operates, the price of power is set by the last power plant dispatched to meet demand. In the Philadelphia area, for instance, one of Exelon's markets, the last power plants to be dispatched tend to be gas-fired plants, according to Hugh Wynne, senior research analyst at Sanford C. Bernstein & Co. On average, Wynne said, gas-fired plants emit one-half ton of CO2 per megawatt-hour generated. Assuming the EPA's estimate of $15 per ton, that means an incremental cost for gas-fired plants of $7.50 per megawatt-hour.

Coal plants emit twice the carbon as gas-fired plants, or one ton per megawatt-hour generated. In order to level the playing field, Waxman-Markey grants coal-fired plants a half-ton of CO2 for free for every megawatt-hour produced. In other words, coal- and gas-fired plants would each incur an additional cost of $7.50 per megawatt-hour. All things being equal, that means the price of power sold into unregulated markets would rise by $7.50 per megawatt-hour.

Multiply Exelon's nuclear generation of 132 million megawatt-hours by the price increase of $7.50 per megawatt-hour and -- voila! -- you get a revenue increase of $990 million. Call it a billion dollars. As time goes on and the carbon cap gets smaller, the price per ton should rise accordingly.

Tim Winter, utility analyst at Gabelli Funds, noted another possible boon to companies with nuclear fleets. Certain coal-fired plants, particularly those older plants that operate inefficiently, could find that once the price of carbon allowances goes beyond a certain point, the price of power might fall below their cost of producing it. In that case, the plant would shut down, tilting the supply/demand equilibrium, creating a shortage of power, and pushing the price of power even higher. Again, Exelon, as the lowest-cost producer in the Northeast, would benefit.

Many Variables

So Exelon, as the low-cost producer, would benefit from the increased price of power under a cap-and-trade scheme, which helps to explain the company's enthusiasm for cap-and-trade. One would expect that companies such as Florida Power and Light and Entergy, with nuclear capacity and markets that are, at least in part, unregulated, would share Exelon's enthusiasm.

And so they do. Brent Dorsey, director of corporate environmental programs for Entergy, endorses cap-and-trade as a "good first step" in regulating greenhouse gas emissions, although from a strictly environmental perspective, he would rather see a shorter timeline than Waxman-Markey proposes. FPL Group's chairman and CEO, Lewis Hay, endorses cap-and-trade, adding, "The sooner we can establish a price on carbon dioxide, the sooner we can tackle climate change and begin the transition to the clean-energy economy of the 21st century." And the sooner FPL can enjoy the benefits of an increase in the cost of power cap-and-trade would deliver.

But even non-nuclear facilities could benefit under this scenario. Assuming the relative prices of gas and coal remain as they are, the extra cost incurred by coal should encourage companies that can to shift more of their production toward gas, thus increasing margins.

While utilities may be motivated to switch to cleaner burning fuels, some doubt they will be inspired to actually trade the credits. Edward Tirello, managing director and senior power strategist for Berenson & Co., is one such person. "The big money will be made by those that put up the capital, trading folks like Goldman Sachs and Morgan Stanley."

But any kind of trading assumes a price that makes any risk involved worthwhile. And although the EPA assumes a price of $15 per ton during the early years of the program, the market doesn't support that price, at least not today. The limited experience gleaned from the small volume of trading that's taken place so far, such as what the Regional Greenhouse Gas Initiative has sponsored, certainly doesn't come even close -- $3 a ton last spring.

The political odds are also at play here, meaning no bill has yet to pass. So the forecast by Exelon remains, at this point, wishful thinking. Whatever profit actually materializes will depend on the price the market sets for carbon, and on whether cap-and-trade ever becomes more than a theoretical scheme to address the issue of global warming."

More information is available from Energy Central:

Cap and Trade Is Not Enough: Adopt Carbon Emissions Portfolio Standards, EnergyBiz, Jul/Aug 2009

Flaws in Carbon Principles - We Don't Need Financial Engineering, EnergyBiz, March/April 2009

Carbon on the Block - Industry Watches RGGI, EnergyBiz, Jan/Feb 2009

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EnergyBiz magazine is the thought-leading, award-winning publication of the emerging power industry. This article originally appeared in the November/December 2009 issue.