Electricity Restructuring and Regional Air Pollution Karen Palmer Dallas Burtraw Discussion Paper 96-17-REV2 July 1996 Resources for the Future 1616 P Street, NW Washington, DC 20036 Telephone 202-328-5000 Fax 202-939-3460 © 1996 Resources for the Future. All rights reserved. No portion of this paper may be reproduced without permission of the authors. Discussion papers are research materials circulated by their authors for purposes of information and discussion. They have not undergone formal peer review or the editorial treatment accorded RFF books and other publications. -ii- Electricity Restructuring and Regional Air Pollution Karen Palmer and Dallas Burtraw Resources for the Future July 1996 RESEARCH SUMMARY This paper investigates the regional air pollution effects that could result from new opportunities for inter-regional power transmission in the wake of more competitive electricity markets. The regional focus is important because of great regional variation in the vintage, efficiency and plant utilization rates of existing generating capacity, as well as differences in emission rates, cost of generation and electricity price. Increased competition in generation could open the door to changes in the regional profile of generation and emissions. We characterize the key determinant of changes in electricity generation and transmission as the relative cost of electricity among neighboring regions. In general, low cost regions are expected to export power generated by existing coal-fired facilities to higher cost regions. The key determinant of how much additional power would be traded is the uncommitted electricity transfer capability between regions, including its possible future expansion. The changes in emissions of NO x and CO 2 that result are modeled as a function of the average emission rate for each pollutant in each region, coupled with assumptions about the extent of displacement of nuclear or coal-fired generation in the importing regions. Finally, we employ an atmospheric transport model to predict the changes in atmospheric concentrations of nitrates as a component of particulate matter (PM10) and NO X in each region (but not changes in ozone), as a consequence of changes in generation for inter-regional transmission. In the year 2000, we estimate national emission changes for NO X could increase by 213,000 to 478,900 tons under the scenarios we think most likely, compared to the baseline. Under our benchmark scenario, we find national emissions of NO X would increase by 349,900 tons. The changes in NO X emissions should be considered in the context of an expected decrease in annual emissions nationally of over 2 million tons that will result from full implementation of the 1990 Clean Air Act Amendments over the next few years. The increase in emissions that we estimate serve to undo a small portion of the expected improvement in air quality that would occur otherwise. Nonetheless, these changes would yield relative increases in atmospheric concentrations of particulates with measurable adverse health effects. We estimate the consequences for increased national CO 2 emissions will range from 75 to 133.9 million tons. Our benchmark suggests an increase of 113.50 million tons, equal in magnitude to about 40% of the reductions needed by the year 2000 under the Climate Change Action Plan. Our estimate of NO x emission changes is less than other studies, with the exception of the FERC EIS, primarily because we explicitly take into account capacity constraints on inter-regional transmission and use different emission rates. Our estimate is greater than the FERC EIS because we allow for a portion of the power generated for inter-regional transmission to meet new demand stimulated by an anticipated decline in price. Second, we allow a portion of imported power to -iii- back out higher cost nuclear rather than fossil baseload. These are important economic changes that we believe will characterize a more competitive industry, and which point toward potentially more significant environmental consequences than recognized in the FERC EIS. Because we focus on increased generation from coal facilities, we characterize our findings as a worst case interim outcome under restructuring. However, we also think it is the most likely result of increased competition resulting from industry restructuring over the next few years. Our estimated emission changes are compared with those of previous studies in Table 13. The features of these various studies are summarized in Table 1. Our analysis of alternative scenarios yields considerable variation in the predicted levels of emissions and where they occur. This leads us to offer our results with caution, and to have less confidence in the outcomes of previous studies because of the sensitivity of results to the variety of factors that we think important. One of the central questions in the restructuring debate concerns what would happen to air quality in regions neighboring those where generation may increase, with special concern focused on potential changes in the Northeast. We find the changes in pollutant concentrations resulting from changes in NO X emissions (excluding secondary ozone changes) would be substantially greater in regions where generation is increasing than in neighboring regions. The region likely to experience the largest adverse changes in air quality resulting from changes in generation is the Ohio Valley (the ECAR power pool region). For instance, in our benchmark scenario, the population weighted changes in atmospheric concentration of nitrates is 2-3 times as great in the Ohio Valley and the Southeast (SERC) as in the Mid-Atlantic region (MAAC) and 3-4 times as great as in the Northeast (NPCC). These results are reported in Tables 11a and 11b, and illustrated graphically in Figure 2 of the conclusion. The likelihood of adverse impacts on NO X and nitrate concentrations in some regions as a result of restructuring suggests the need for a policy response to ensure that electricity restructuring does not lead to significant environmental degradation in any one area. If these changes merit a regulatory response, the regional variation in effects, and various sources of uncertainty about effects that may result, suggest the need for a flexible policy. One flexible approach that would ensure that changes do not lead to significant environmental degradation in any one area, while also avoiding unnecessary investments where emission changes do not occur, would be an intra-regional cap and trade program for NOx emissions from electric utilities. However, such an industry- specific program should be eclipsed if a more comprehensive program can be implemented by EPA permitting cost savings from inter-industry trades. Key Words: air pollution, electricity restructuring, transmission JEL Classification No(s).: L94, Q25, Q28 -iv- Table of Contents Research Summary ii I. Introduction 1 II. Existing Literature and Unanswered Questions 4 III. The Model 12 Power Trading 14 Generation and Demand 16 Emissions 16 Air Quality 17 Assumptions in and Justifications for Our Analysis 19 IV. Observations from PREMIERE Simulations 25 Power Trading and Generation 25 Electricity Demand and Implications for Prices 27 NOx Emissions 29 Atmospheric Transport and Air Quality 33 Emissions of CO 2 40 V. Conclusion 42 Appendix A: Key Omissions, Biases and Uncertainties Affecting Estimates of the Level of Additional National NO x Emissions in Our Benchmark Scenario 49 Appendix B: Illustration of Health Effects 51 References 56 Electricity Restructuring and Regional Air Pollution Karen Palmer and Dallas Burtraw ✝ I. INTRODUCTION Electricity generation contributes significantly to air pollution in the U.S. Power plants currently are responsible for about 33 percent of all nitrogen dioxide (NO 2 ) emissions, 70 percent of all sulfur dioxide (SO 2 ) emissions and over one-third of the greenhouse gas emissions (e.g. carbon dioxide, CO 2 ) in the U.S. While SO 2 emissions are capped at a national level which will fall dramatically in the coming years (as Title IV of the 1990 Clean Air Act Amendments is fully implemented), future emissions of other air pollutants from the electricity sector are less certain. Much of this uncertainty stems from the fundamental changes taking place as federal and state regulators open up the industry to more competition in generation and, in some states, retail sales as well. The environmental implications of increased competition in electricity markets and the associated "restructuring" of the industry depend on how electricity sellers and buyers respond to the opportunities created by a more open industry structure. For example, greater access to the transmission grid would provide generators that have excess capacity with the ability to sell to previously inaccessible distant markets; so emissions from these generators could rise while emissions in the purchasing region could fall. If competition leads to lower electricity prices, then ✝ The authors are both Fellows in the Quality of the Environment Division at Resources for the Future. They are indebted to Erin Mansur for outstanding assistance, and to Douglas R. Bohi, David H. Festa, Dale Heydlauff, Gordon Hester, Alan J. Krupnick, Mike McDaniel, Henry Lee, Steven L. Miller, Paul R. Portney, and members of the Stanford Energy Modeling Forum (EMF-15) for helpful discussions and comments. Direct correspondence to: Resources for the Future, 1616 P Street, NW, Washington DC 20036. -2- Palmer & Burtraw overall demand for electricity could rise. This could, in turn, result in higher overall emissions from electricity generation. On the other hand, more competition in generation may accelerate investment in low-cost, relatively clean gas combined cycle or combustion turbine units leading emissions in the aggregate from the electricity sector to fall in the long run. The vast uncertainty concerning the effects restructuring will have on technology and fuel use in electricity generation, growth of transmission capacity, electricity prices and electricity demand makes analysis of the environmental impacts of restructuring difficult. Ideally, we would like to know what restructuring will mean along all of these dimensions before attempting to model or predict what it will mean for the environment. However, the anticipated changes in the industry go well beyond the bounds of current experience upon which any model would be based. Therefore, we simplify the task by focusing on one prominent aspect of the restructuring debate— the regional changes in emissions likely to stem from inter-regional power trading and their regional effects on the environment. The regional focus is important because of great regional variation in the vintage, efficiency and plant utilization rates of existing generating capacity, as well as differences in emission rates, cost of generation and electricity price. Subject to regional constraints on transmission capacity, open access transmission promises to serve as an equilibrating factor with respect to differences in capacity utilization and costs. Average emission rates in each region, on the other hand, may become more disparate if — as some predict — regions with relatively less utilized, older and "dirtier" capacity increase the utilization of their least utilized, oldest and dirtiest units. If this occurs, air quality in these regions is likely to decline. This environmental degradation may be offset to some degree by the economic Electricity Restructuring and Regional Air Pollution -3- rewards of increases in plant utilization. However, one of the central questions in the restructuring debate concerns what would happen to air quality in neighboring regions. A seemingly perverse outcome, from a national perspective, could occur if pollution from the supply region were transported long distances and led to a net decline in air quality in both regions. This paper addresses these issues by focusing on the changes in generation that could result from new opportunities for inter-regional power transmission in the wake of more open transmission access. We explicitly model the capabilities of the existing inter-regional transmission system and its possible future expansion. In addition, we employ a reduced-form version of an atmospheric transport model to predict the changes in atmospheric concentrations of various pollutants in various regions as a consequence of changes in generation for inter-regional transmission. Though we focus primarily on the air quality impacts of changes in NO X emissions on regional ambient concentrations of NO X and particulates, we also analyze implications for CO 2 emissions. It is important to note that we do not account for the effects of changes in emissions on ozone formation or transport. To do so would involve considerably greater effort due to the nonlinear aspect of ozone chemistry. However, we expect relative changes in NO X emissions and ambient concentrations to provide an indication of relative changes in ozone. 1 Furthermore, although ozone is of important concern to attainment of National Ambient Air Quality Standards, 1 One reason this may not be strictly true is that increases in NO X emissions may reduce ozone concentrations in the local area around the source of those emissions, even as it contributes to increased ozone concentrations at more remote locations. We conjecture that the large area of the regional aggregation in our analysis probably overwhelms the local ozone scavenging phenomenon, so that on average relative changes ozone concentrations may follow relative changes in NO X concentrations. However, this conjecture should be subject to scrutiny. -4- Palmer & Burtraw the environmental and health literatures suggest that the lion's share of economic costs of air pollution are captured by measuring changes in particulate concentrations. In an appendix we provide an estimate of these economic costs. Our analysis focuses on increased generation activities precipitated by greater access to inter-regional transmission facilities to distant markets, as is likely to result from FERC Order 888 (April 1996) on open transmission access. However, we do not limit our consideration to the environmental effects of the FERC Order. Competition at the retail level is likely to lead to even more power trading. Our findings are consistent with the scope of competition, be it wholesale or retail, that would lead to a maximum amount of inter-regional power trading subject to transmission capacity constraints. The next section of this paper provides a discussion of the recent literature on the potential environmental consequences of restructuring. Section III describes our own efforts to model inter- regional power transmission and its potential air quality impacts. In Section IV, we report the results of this modeling effort. In Section V, we summarize our results and prioritize issues for further research that should inform the public policy. In Appendix A, we provide a table of significant uncertainties, omissions and biases we identify in our analysis. In Appendix B, we illustrate some of the health effects that may result from these changes. II. EXISTING LITERATURE AND UNANSWERED QUESTIONS Few studies have been conducted that attempt to analyze or predict the environmental effects of electric utility restructuring. The largest and most ambitious analysis to date is the FERC's Environmental Impact Statement (EIS) of its 1995 Open Access NOPR, which subsequently became Electricity Restructuring and Regional Air Pollution -5- FERC Order 888 (FERC 1996). This study, prepared by ICF Inc., uses a detailed national electric utility forecasting model, the Coal and Electric Utilities Model (CEUM), in concert with EPA's air quality model (UAM-V), to conduct a sophisticated analysis of the environmental effects of Order 888 only. The study compares the post-888 utility sector emissions and air pollution concentrations to those in a base case wherein transmission access for wholesale power trades is granted on a case- by-case basis through existing FERC procedures. The primary environmental concern addressed in the study is increased NO x emissions and their implications for ozone concentrations. 2 The study concludes that "the proposed rule is not expected to contribute significantly" to the pre-existing ozone problem in the Northeast (FERC, 1996, p ES-11). The major problem with the EIS is its limited scope. By incorporating expanding competition into its baseline scenarios, the EIS primarily addresses the environmental consequences of accelerating the transition to more open and competitive wholesale markets through a general rulemaking. In comments on the draft version of the EIS, the Center for Clean Air Policy (1996a) suggests that the impact of restructuring on NO x emissions in 2005 may be understated by as much as 400,000 tons, which would constitute an eight percent increase in NO x emissions relative to a base case with no restructuring. However, in the final EIS FERC compares implementation of order 888 to a base case absent incentives for productivity change created by allowing transmission access on a case-by-case basis (specifically no improvements in fossil plant availability and no drop in reserve margins over time) and they find national NO x emission increases of roughly one-third that magnitude. 2 Other concerns including SO 2 , TSP and CO 2 emissions and visibility effects were also addressed. -6- Palmer & Burtraw The EIS has other methodological weaknesses that limit its usefulness. The study makes some questionable and potentially inconsistent assumptions about transmission capacity. The study adopts recent estimates of inter-regional transfer capabilities from the North American Electricity Reliability Council (NERC) 3 and incorporates currently planned increments to transmission capacity; however, it assumes that there will be no change in transmission capacity as a result of increased transmission access in its primary analysis. 4 This is troubling because the rule requires that transmission-owning utilities expand their transmission systems as necessary to accommodate requests for transmission access. Moreover, opening up the transmission grid is likely to increase the opportunity cost of transmission capacity as open access places more demands on this fixed resource. This could create incentives for upgrading capacity, both through construction of new lines and through efficiency improvements in the existing system. 5 Such incentives are more likely to arise when electricity is priced at opportunity cost and transmission service providers face competition from neighboring systems or from potential entrants. 6 The EIS and Order 888 also 3 These estimates have been derated by 25 percent to account for the impact of simultaneous power transfers not reflected in the NERC estimates. This assumption is questioned extensively in comments by the Center for Clean Air Policy (1996a) and the U.S. Environmental Protection Agency (1996), both of which suggest that the NERC inter-regional transfer capability estimates are constructed under conservative assumptions and, therefore, may understate the true capability of the existing transmission system to transfer power. 4 The EIS incorporates some scenarios that include expanding transmission capacity over time. However, the FERC makes this assumption for both the base case scenarios and the increased competition scenarios. The FERC explicitly dismisses suggestions that the proposed rule will lead to expansion of transmission capacity. They argue that as long as transmission continues to be a regulated monopoly, incentives to increase transmission capacity will be no greater under the proposed rule than they would otherwise be. 5 For instance, new power electronic controllers that form the basis of flexible ac transmission system (FACTS) technology hold the potential to increase the capacity of particular transmission lines by as much as 50% while reducing stability problems throughout the grid. Douglas (1994), 11. 6 Loopflow problems will limit incentives to expand transmission capacity since the transmission-building utility will not be able to capture the benefits of its new investment which accrue to everyone who is attached to the interconnected grid. Bohi and Palmer (1996) suggest that this disincentive to invest in the grid will be smaller under wholesale competition than under retail competition. [...]... imposed by inter -regional power transfer capabilities and available generating capacity in exporting regions The model also simulates the air pollution impacts of changes in emissions that result The model has five basic components: power trading, generation -13- Electricity Restructuring and Regional Air Pollution and demand, emissions, air quality and health effects The health effects component is described... differences between regulated electricity prices and competitive electricity prices reported in Berkman and Griffes (1995) These authors suggest Electricity Restructuring and Regional Air Pollution -29- that competition could lead to a 31% electricity price decline in MAIN and price drops as great as 50% in New England.23 NOx Emissions The extent to which increased inter -regional power trading leads to additional... (1995b), Table 25 Electricity Restructuring and Regional Air Pollution -17- the national emissions cap for SO2 we limit attention here primarily to changes in NOx emissions, and secondly to changes in CO2 emissions Air Quality The air quality component of PREMIERE translates changes in emissions of NOx and SO2 to changes in ambient concentrations of NOx and nitrates (NO3/HNO3), SO2 and sulfates (SO4)... Methods and Assumptions in Studies of Air Quality Effects of Electricity Restructuring FERC EIS* Scope Regional Generation Treatment of Transmission Demand Effect Nuclear Effect Investment Effect Emissions Air Quality Effects Regional Air Quality Methodology CCAP Rosen, et al Lee and Darani Palmer and Burtraw National Transmission access (Order 888) only Census regions Single utility AEP National Restructuring. .. transmission capacity reflect this -15- Electricity Restructuring and Regional Air Pollution Figure 1 Figure is available from authors at Resources for the Future -16- Palmer & Burtraw Generation and Demand The Generation and Demand component of the model is premised on the assumption that where cost or price differences exist between regions, there is ample demand in the importing region to exhaust... expanded transmission scenarios in the FERC EIS 20 EPA (1996) footnote 16, p 31 -21- Electricity Restructuring and Regional Air Pollution The key determinant of the direction of trade — which regions act as exporters and which as importers — is the cost of electricity generation within a region relative to the cost in neighboring regions We exercise the model using three different estimates of electricity. .. 0.0000 0.0000 0.0000 0.0005 0.0000 0.0000 0.0006 0.0015 Electricity Restructuring and Regional Air Pollution -19- air pollution in areas away from the source of emissions, at the regional level we find the greatest source of emissions affecting pollutant concentrations in any region are its own emissions However, one can see that significant pollution comes from other regions This is particularly true... industrial electricity demand that they report indicate that these classes of customers exhibit elastic demand for electricity Therefore, we adopt -0.3 as the overall elasticity of demand for electricity 14 FERC estimates that Order 888 will result in savings to consumers of between $3.8 and $5.4 billion per year which amounts to between a 1.9 and 2.7 percent drop in the average price of electricity. .. changes in air quality, and their economic cost III THE MODEL We have developed a simulation model of power trading and associated air pollution effects called PREMIERE (for "Primary Regional Environmental Model in Electricity Restructuring" ) The objective of the model is to take the greatest possible advantage of all economic power trading opportunities, subject to limits imposed by inter -regional power... the scope of this paper Also, the additional electricity trading that we model is likely to be a mix of short run energy transactions and longer-run capacity contracts In the case of the latter, power trades would be based on a more long-run price concept such as the long-run avoided cost of electricity generation Electricity Restructuring and Regional Air Pollution -23- to a high of 69 percent in SERC . components: power trading, generation Electricity Restructuring and Regional Air Pollution -13- and demand, emissions, air quality and health effects. The health. Effects 51 References 56 Electricity Restructuring and Regional Air Pollution Karen Palmer and Dallas Burtraw ✝ I. INTRODUCTION Electricity generation contributes