BY ROGER D. STARK, WASHINGTON, DC

This fall, Congress will considerwhat promises to be the single mostimportant piece of energy legislation ofthe past thirty two years. Never mindthat it will be couched in terms of pol-lution emission reductions rather thanenergy policy, the fact remains that cli-mate change legislation will herald themost significant change in energy poli-cy since passage of the Public UtilityRegulatory Policies Act of 1978(PURPA).

PURPA created the non-utilitygeneration industry and then suf-fered death by a thousand cuts(many self-inflicted as a result of baddecisions taken by PURPA propo-nents). The Energy Policy Act of1992 included the first effort atreforming the Public Utility HoldingCompany Act (PUHCA) and madeinitial progress in promoting energyefficiency.

The Energy Policy Act of 2005effectively repealed PUHCA, but nei-ther the '92 or '05 Act changed thefundamental rules of play for fuelsand electric generation. Climatechange legislation promises to do just

that by requiring hydrocarbon fueledpower plants to pay for the right toemit carbon, and possibly othergreenhouse gases as well.

Passage of climate change legis-lation will signal the end of cost-freecarbon emissions and the beginning ofa legally imposed transition to a car-bon constrained economy. It is clearthat substantial change is at hand.

Much less clear is how wellexisting energy companies, whetherfocused on traditional fuels or renew-able resources, will adapt to the newenvironment.

THE STATE OF PLAYMuch ink has been spilled

debating whether “global warming” or“climate change” even exist. As a polit-ical matter, that battle has been won bythe proponents of climate change leg-islation. Although climate changeremains sufficiently complex to pre-clude simple analysis, the essence ofthe matter has devolved into two basicpropositions: that empirical dataundoubtedly demonstrates a trend ofsubstantial changes in climate patternscaused by human activity, and that therisks inherent in doing nothing andbeing wrong exceed the risks of doingsomething and being wrong.

THE CURRENT DEBATEThe current debate is about

what to do and how to do it. That dia-logue initially focused on the politics ofa carbon tax versus a “cap and trade”regime (i.e., “taxes bad”/“cap andtrade” less so). With a growing con-sensus that the carbon tax is politicallyuntenable, arguments have shifted towhether cap and trade is an economi-cally efficient way to level the playingfield between traditional fuels andrenewable resources, or is itself a tax.

CAP AND TRADEAgain, proponents of “cap and

trade” are winning this argument.Their opponents have failed to explainwhy higher priced energy necessarilyequates to a net loss of jobs and, in anyevent, why lost jobs should trump thelost lives and property caused by cli-mate change. Equally important, oppo-nents have failed to rebut basic argu-ments favoring cap and trade thatextend beyond environmental risks(e.g., that cap and trade will encourageenergy efficiency and increase U.S.energy security).

For these and other reasons,Congress is likely to adopt some form of cap and trade legislation thisFall. The final product will be heavilynego-tiated and likely to leave bothsides less than satisfied, but will nevertheless usher in the first statuto-rily-sanctioned nationwide carbon trading in U.S. history.

THE BLOWBACK FOR RENEWABLESThe prospect of climate change

legislation is already creating palpableeffects in the marketplace. Sponsors ofhydrocarbon fueled projects arereflecting carbon costs of more than$20 per ton (in 2006 dollars) in theireconomic models based on carbonmarket results to date.

Whatever else may be saidabout these cost estimates, theyreflect the widespread assumptionthat carbon pricing will increase thecosts of producing electricity with tra-ditional fuels.

By contrast, the renewable ener-gy industry continues to rely as muchon getting paid for what it doesn’t pro-duce—greenhouse gases—as for whatit does produce (clean energy). Thisremains problematic for a variety ofreasons.

First, there is no mechanism for

ensuring that renewable energy proj-ects receive the full carbon avoidancevalue of the electricity they generate.In fact, it may be argued that themonopsony power of electric utilities,combined with the nascent status ofcarbon markets, virtually guaranteethat renewable energy will receive lessthan full value for its contribution tocarbon mitigation.

Second, the energy market’sability to accurately reflect carboncosts in electricity prices is impairedby regulatory policies and marketpower. In states using “cost of service”regulation, for example, utilities willsimply pass along higher costs ofhydrocarbon based electricity to theircustomers.

Thus, higher electric prices willbe limited to a specific utility’s serviceterritory, while the benefits of carbonavoidance will reach much farther. Inaddition, most renewable energy proj-ects assign their carbon credits to theentity purchasing their power (typical-ly an electric utility). As a result,renewable energy sponsors lose thelong term upside value of carbon cred-its and electric utilities lack economic,as opposed to legally mandated, incen-tives to adopt carbon mitigating tech-nologies. Third, and most obviously,renewable resources are intermittentin nature. There is no assurance thatthe sun will shine, the wind will blowor even that the river will flow as in thepast. In many cases, the necessaryrenewable resources for generatingelectricity at a project’s full capacityare available less than 50% of the time.Nuclear energy, tapping into this prob-lem, is promoting itself as “greener”than hydrocarbon fuels and more reli-able than renewables.

Lower prices for oil and gasare further depressing the growth ofrenewable energy. Renewable energy

CARBON TIPPING POINT?

WORLD GENERATIONSEPT/OCT 2009 VOLUME 21-NUMBER 4WWW.WORLD-GEN.COM

Roger Stark is a partner with Curtis,Mallet-Prevost, Colt & Mosle LLP.

He is a co-leader of the Curtis teamacting as Program Counsel to the

Department of Energy’s LoanGuarantee Program.

economics have traditionally beenpredicated on the availability of bothtax credits and “tax equity” investorsthat can utilize such credits. In thecurrent environment, tax equity isexpensive or non-existent, and proj-ects that were economic with oilprices over $100/barrel are now sig-nificantly less so.

Equally important, the creditcrisis has severely limited access tolong-term debt for renewables andthus reduced the sponsor populationto a relatively small number of largeinstitutions with strong balance sheetstargeting above-market returns.

Thus, future hydrocarbon proj-ects are being burdened with higherproduction costs while renewableenergy projects fail to receive full valuefor their largely carbonfree energy. Inshort, barring a technological “gamechanger” (see below), energy priceswill increase in the wake of climatechange legislation, but the magnitudeof the price rise, and its effects onrenewable energy growth, may be lessthan desired by policy makers.

Three additional trends that willvector the transition to carbon capsdeserve consideration:

• ALLOWANCES.These carbon credits will be

allocated to major carbon emitters inthe cap and trade legislation. Watch forwhether allowances will be auctionedor given away, and how they are appor-tioned among competing emitters,(e.g. incumbents vs. independents).

• INTRA-INDUSTRY COMPETITION.Fuel suppliers (i.e. oil, gas and

coal companies) are looking to contin-ue their expansion into the renewablesspace, while electric utilities arebecoming more focused on R&D, tech-nological innovation and “smart grid”issues. Look for potential “crowdingout” of smaller companies.

• STRATEGIC TRANSMISSION.Governmental mandates for

expanding renewable energy (e.g.,renewable portfolio standards) will require expansion of the existingtransmission grid. Watch for higherreturns in transmission projects that simultaneously facilitate service to growing customer loadswhile supporting the growth of dis-tributed generation and renewableresources.

DEPARTMENT OF ENERGY LOANGUARANTEESTitle XVII of the Energy Policy

Act of 2005 authorized the Departmentof Energy (DOE) to provide loan guar-antees in support of “innovative” ener-gy technologies. In the immediateaftermath of Title XVII’s enactment,relatively few transaction applicationswere processed, and even fewerclosed. The Obama Administration hasnow taken the initiative on Title XVII,first by obtaining appropriations aspart of the economic stimulus legisla-tion passed early this year, and secondby enhancing DOE’s resources forprocessing and closing loan guaranteetransactions. A series of solicitationsfor electric generation projects usingboth innovative technologies and moretraditional renewable energyresources are contemplated, as well asone for electric transmission projects.

STRATEGIC IMPERATIVESWhile passage of climate

change legislation is by no meansassured, pressure from state andregional initiatives, not to mentionglobal pressure from Kyoto signato-ries, means that a carbon-constrainedU.S. economy in the near future is a

virtual certainty. By imposing a cost oncarbon emissions, carbon caps willpromote both increased efficiency andreduced emissions.

Technological improvementswill make renewable resources morecompetitive as well. The precise pat-tern and pace of technological “gamechangers” in these and other areas isas yet undetermined, but will necessar-ily become a fact of life.

That said, climate change legis-lation is no guarantee of success forrenewable energy. If current economicconditions and the advantages ofindustry incumbents persist, renew-able energy may harvest relatively fewimmediate benefits from this signalpolicy shift. On the other hand, break-through technologies tend to level theplaying field for renewable energy andtake the economic sting out of carbonmitigation.

With the economic incentivesflowing from carbon pricing, signifi-cant improvements in efficiency andtechnological innovation are mainly amatter of time, and we can look for-ward to an energy sector that is atonce more competitive and moreresponsive to environmental needs.

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