Utility Automation & Engineering T&D - Strict limits will force air pollution cuts and keep coal dominant, study says

CAMBRIDGE, Mass., November 22, 2004 -- Strict new state, regional and federal air emissions requirements will force significant shifts in utility strategies and coal distribution patterns -- and will require utility investments of up to $64 billion to achieve large reductions in sulfur dioxide (SO2), nitrogen oxides (NOX) and mercury emissions by 2020, according to a new study by Cambridge Energy Research Associates (CERA).

A combination of existing Clean Air Act requirements, state actions and court-ordered consent decrees will require tighter emissions limits around 2010, with a second round of reductions between 2015 and 2018, according to CERA's "Clearing the Air: Scenarios for the Future of US Emissions Markets" report.

"The key issue is not whether emissions standards will be tightened, but rather the timing and stringency of new standards," said Robert LaCount, CERA director and the report's author. "Under virtually all future scenarios, the power sector will face large required reductions in SO2, NOX and mercury emissions, high SO2 allowance prices and significant capital investments in flue-gas desulfurization (FGD) installations for controlling SO2 and selective catalytic reduction (SCR) installations for controlling NOX." Most scenarios also include some form of mandatory CO2 policies, he added.

Coal Implications
According to Clearing the Air, coal will remain the dominant fuel source for power generation for the foreseeable future. "CERA believes under any scenario to 2020, coal will remain the preeminent fuel for power generation, but that changing emission policies will result in significant shifts in coal distribution patterns, pushing generators with retrofitted FGD equipment toward lower-cost sources of coal," according to LaCount.

Operators of retrofitted coal plants have much less incentive to pay a sulfur premium, while plants without FGD will continue to value the premium for low-sulfur coal. Shifts in the balance between plants with and without FGD retrofits will create new competitive dynamics in coal-purchase behaviors and pricing, the CERA study found.

"In general, increased installations of FGD will result in Northern Appalachia (NAPP) and Illinois Basin (ILB) coals taking market share from lower-sulfur and higher-cost Central Appalachia coal. The degree to which this shift occurs depends largely on the timing of FGD retrofits in the Midwest and Southeast and responses by low-sulfur coal producers and transporters from the Powder River Basin," according to Clearing the Air.

Although new mining capacity will be needed to meet increased demand for NAPP and ILB coals, new investment is not guaranteed because coal companies are reluctant to commit the amount of capital necessary to open new mines without a long-term commitment from consumers. Similarly, many coal consumers appear reluctant to offer the long-term contracts that would encourage opening new capacity. As a result, a complicated transition period is approaching for the industry where producers and consumers will be challenged to coordinate the timing of critical investment decisions for power plant retrofits and new mining capacity.

Policy Structure Effects
Although significant utility investment in environmental upgrades occurs in all scenarios outlined in Clearing the Air, the structure and timing of new policy implementation will greatly influence investment strategies. "Whether it's trading of mercury credits or incentives for early SO2 reductions, various policy options provide significantly different benefits, risks and competitive considerations for different players in the North American power value chain," said LaCount.

"Power generators' recovery of environmental costs and selection of optimal environmental strategies is closely linked to the regulatory structure applied in various markets, which is not static. Therefore, matching the timing of environmental implementation with regulatory developments will be critical for companies, both financially and strategically." Compliance strategies will also be highly dependant on changes in fuel markets, power markets, competitor actions and energy policies, all of which are moving targets, he added.

Investment Requirements
Tighter environmental policies will generate a substantial Third Wave of environmental retrofits at coal-fired power plants, following the first wave targeting SO2 emissions under the U.S. EPA's Acid Rain Program established under the 1990 Clean Air Act Amendments and Second Wave requirements under EPA's NOX SIP Call initiated in 1998, according to Clearing the Air. Following the first two waves, FGD and SCR retrofits are operating on roughly one-third of U.S. coal-fired capacity. Depending on the scenario that actually occurs, the capital investment for Third Wave retrofits ranges from $28 billion to $64 billion by 2020, with FGD accounting for a majority of that amount. "Although this level of capital investment will challenge the balance sheets of many generators, efficient coal plants will remain highly competitive versus natural gas-fired generation ," LaCount said.

The CERA analysis also found that the effects of new emissions requirements will have very different impacts for plants across the country but that increasingly stringent pollution control requirements do not always reduce the value of coal-fired generation capacity. "The value of larger efficient coal plants can increase rather than decrease because capital investments in controls such as FGD can enable some plants, particularly those located in the eastern U.S., to reduce operating costs by switching to higher sulfur coals that are lower in cost. Additionally, increases in electricity prices and the value of allowance allocations can offset the increase in costs." according to Clearing the Air. "All of these factors are critical in assessing the impacts of future environmental policies, especially potential CO2 requirements," said LaCount.

Other Findings
Other key findings from this scenario-based study include:
-- States and regional organizations representing states will remain key forces for shaping future environmental policy.
-- Investment in flue gas desulfurization (FGD) targeting reductions in both SO2 and mercury emissions will dominate total investment and result in a substantial increase in the marginal cost of reducing SO2 emissions.
-- Increasingly stringent environmental requirements will not force the retirement of many coal plants, and the value of efficient, large coal-fired power plants may actually increase rather than decrease with stringent environmental programs.
-- Cost recovery mechanisms for environmental investments vary significantly across the United States and will directly affect each power company's optimal compliance strategy.
-- The economic risk associated with climate change policies cannot be measured strictly by the total coal-fired assets or CO2 emissions in a company's portfolio.
-- The competitive interface between coals will shift more toward costs rather than sulfur content.

"Clearing the Air: Scenarios for the Future of US Emissions Markets" is a CERA multiclient study offering a range of insights that indicate the short- and long-term directions of U.S. emissions markets-sulfur dioxide (SO2), nitrogen oxide (NOX), mercury, and carbon dioxide (CO2)-and the strategic implications for the electric power sector. Information about purchasing copies of the completed study is available from Mike Banville, (617) 866-5352 or mbanville@cera.com.

About Cambridge Energy Research Associates
Cambridge Energy Research Associates (CERA), a subsidiary of IHS Energy, is a leading advisor to international energy companies, governments, financial institutions, and technology providers. CERA (www.cera.com) delivers strategic knowledge and independent analysis on energy markets, geopolitics, industry trends, and strategy. CERA is based in Cambridge, Massachusetts, and has offices in Beijing; Calgary; Mexico City; Moscow; Oakland, California; Oslo; Paris; São Paolo; and Washington, DC.

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