State Policy Options for Protecting the Environment, Keeping Electricity Affordable and Reliable, and Powering State Economies

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1 State Policy Options for Protecting the Environment, Keeping Electricity Affordable and Reliable, and Powering State Economies November 1, 2007 Paul Loeffelman, Director Environmental Public Policy 614/

2 Company Overview 5.1 million customers in 11 states Industry-leading size and scale of assets: Asset Size Industry Rank Domestic Generation ~38,300 MW # 2 Transmission ~39,000 miles # 1 Distribution ~208,000 miles # 1 Source: Company research & Resource Data International Platts, PowerDat 2005 Coal & transportation assets Control over 8,000 railcars Own/lease and operate over 2,600 barges & 51 towboats Coal handling terminal with 20 million tons of capacity 20,000 employees 38 Billion USD total assets 2 Coal 67% AEP Generation Portfolio Gas 24% AEP enjoys significant presence throughout the energy value chain Nuclear 6% Hydro 2% Wind 1%

3 Current State Policymaker Interests Ensuring electricity remains affordable, reliable and secure from domestic sources Addressing rising electricity demand Moderating electricity price increases Sustaining the engine of economic growth Increasing environmental protection 3

4 Retail Cost Per kwh & Percent of Coal Generation 4

5 New Policy Needs Supporting clean energy development Financing options Investment recovery Tax incentives Supporting carbon capture and storage Supporting carbon allowances in a cap and trade program Allocation to emitters Help companies retain capital Not auctioning or granting them to non-emitters 5

6 Clean Energy Development Projects approved as in the public interest, reasonable and necessary and for economic development and not least cost test Pre-approval of pre-construction and construction investments for generation and transmission Enhanced rate of return on investment Cash return of construction while in progress (CWIP) at weighted average cost of capital (WACC) and return on and of investment No look back for prudency; no post in-service for prudency review 6

7 AEP Toolkit for Developing State Clean Energy Policy October 15, 2007 AEP report (updates July 2007 draft) on state policy precedents for financial incentives and indemnification to rapidly build advanced coal fueled generation plants AEP PowerPoint presentation: Protecting the Environment Keeping Electricity Affordable and Reliable and Powering State s Economies AEP state clean energy development concept bill One-page summary of the concept bill 7

8 State Investment Recovery Policy Examples Investment Recovery Indiana (Code Section for advanced coal and renewable generating facilities, for no look back provision) Kentucky (Code Section 278) Arkansas (Act 755) Virginia (SB 1416) Cost Reductions (e.g., tax credits) Many States See AEP research report 8

9 State Investment Recovery Policy Examples State Cost Recovery Financing Assistance Tax Credits Regulatory Waivers Grants Alaska Arkansas Colorado Florida Illinois Indiana Kansas Kentucky Minnesota Montana New York Ohio Pennsylvania Tennessee Texas Virginia West Virginia Wyoming 9

10 Technology Path Forward Advanced coal plants will be built when approved by public utility commissions. IGCC integrates commercially developed technologies first installation at commercial scale Carbon capture and storage (CCS) technologies with first of a kind demonstrations at existing plants, subject to approval by public utility commission Gasification carbon capture technology has been commercially proven in chemical plant applications but not IGCC applications. Ability to power CTs with high-h 2 must be demonstrated Geologic Storage technology requires the most development Monitoring technology and standards need to be developed Geologic Storage feasibility must be demonstrated Regulatory permitting framework must be defined CCS technology can be more rapidly deployed when states are willing to accept the risk associated with advancing promising technology that has not been proven at commercial production scale, by providing project developers with assurances that their investments will be contemporaneously recovered. 10

11 Carbon Capture and Storage IOGCC model legislation and regulation fundamental premises Regulation of CO2 geological storage should be left to regulation by the states, rather than USEPA Storage of CO2 in geological formations should not be viewed as waste disposal No recommendations about how CO2 should be constrained. 11

12 IOGCC CCS Legal and Regulatory Guide Property Rights Experimental Projects Commodity vs. Waste Covered Facilities Trust Fund User Fee Cooperative Agreements EOR Projects Liability Release Right of Access Permit Transfer Permit Requirements 12

13 Additional Provisions States Should Consider Addressing A more efficient means of acquiring property rights related to a CCS project Use of eminent domain under the new statute be tied to PSC issuance of a certificate of need The siting of pipelines related to CCS projects Address pipeline siting through a new regulatory program or only by allowing the PSC to authorize the use of eminent domain as the result of the issuance of certificate of need A more comprehensive liability transfer mechanism Liability transfer extend beyond a transfer of regulatory responsibility and include a transfer of common law and statutory liability 13

14 A Reasonable Approach to Climate Legislation Reductions and Timing---Moderate with Adequate Lead Times for long run improved technology choices Scope of Program---Economy Wide Flexibility of the Program---Trading, Banking, Unrestricted Offsets, Early Action Credits Allowance Allocation And Other Cost Issues--- Low auctions and safety valve International Linkage 14

15 It Matters How CO 2 Emissions Are Regulated Many policy design provisions can be chosen (examples in appendix), but which ones Are the most effective at the lowest cost Wont divert capital from constructing new facilities to retrofitting the current fleet Setting a cap and trading allowances under the cap is most effective and economical traditionally Under existing cap and trade programs for SO 2, NO x and mercury, the emitters receive allowances Some proposals for CO 2 cap and trade policy are for all allowances to be put up for auction, so emitters would be required to buy them Cost to reduce emissions will be much higher 15

16 Increase in Customer Electricity Costs Due to Allowance Auctions $3.0 $2.5 $2.0 Annual Increase in Electricity Costs (in Billions of Dollars) No Auction 25% Auction 50% Auction 100% Auction $billions $1.5 $1.0 $0.5 $- FL GA IN KY MO OH 16 Based on a 20% reduction in electric sector GHG emissions with CO 2e reductions/allowances costing $20/ton

17 Appendix Background and Reference Materials 17

18 American Families Pinched By Rising Fuel Costs 18

19 High Increases in Demand Urgently Requires New Generating Capacity Growth and Retirements Spur Need for Additional Capacity (335 GigaWatts Projected to be Added Over ) GigaWatts New Capacity Retirements 19 Source: US DOE/EIA 2004 Annual Energy Outlook

20 20 Electricity Fuel Costs

21 Coal-Fired Path Toward Near- Zero Emissions Pounds Per Million Btu Sulfur Dioxide Nitrogen Oxide U.S. Average 2004* 0.16 Clean Air Interstate Rule Clean Air Interstate Rule Existing IGCC (Permit Level) USC w/prb New IGCC Projection * Estimate Source: EPA s Clean Air Markets database; EIA 2004 Annual Energy Outlook; GE Energy; SFA Pacific. Near-Zero FutureGen Goals

22 AEP s long-term CO 2 reduction commitment Existing Programs Existing plant efficiency improvements Renewables 800 MWs of Wind 300 MWs of Hydro Domestic Offsets Forestry 0.35MM $500K/year Over 63MM trees planted through MM tons of carbon sequestered International Offsets Forestry projects have resulted in 1MM tons of carbon sequestered through 2006 Chicago Climate Exchange New Program Additions Timing: Implement during 2007 to take effect/receive credits by 2011 Methods MWs of Wind PPAs: 2MM tons/yr Domestic Offsets (methane): 2MM tons/yr Forestry: Tripling annual investment to increase to 0.5MM tons/yr by 2015 Fleet Vehicle/Aviation Offsets: 0.2MM tons/yr Additional actions to include DSM and end use energy efficiency, biomass and power plant efficiency: 0.2MM tons/yr AEP s reductions/offsets of CO2: : 31 MMT By 2010 (proj.): Additional 15 MMT AEP s reductions/offsets of CO2: 2011+: 5 MMT/YEAR 22

23 AEP s climate position AEP supports a reasonable approach to carbon controls in the US AEP has taken measurable, voluntary actions to reduce its GHG emissions and will support a well-thought out US mandate to achieve additional, economy-wide reductions Climate change is a global issue and AEP supports the US taking a leadership role in developing a new international approach that will address growing emissions from all nations, including developing countries such as India and China A certain and consistent national policy for reasonable carbon controls should include the following principles: Comprehensiveness Cost-effectiveness Realistic emission control objectives Monitoring, verification and adjustment mechanisms Technology development & deployment Regulatory or economic barriers must be addressed Recognition provided for early action/investment made for GHG mitigation Inclusion of adjustment provision if largest emitters in developing world do not take action A reliable & reasonably-priced electric supply is necessary to support the economic well-being of the areas we serve 23

24 AEP Climate Strategy Our strategy includes: Proactive on GHG policy - IETA, EPRI, Pew Center, e8, etc. Science/technology R&D - FutureGen, Carbon Capture and Sequestration, EPRI, MIT, etc. Taking voluntary action now (e.g., Chicago Climate Exchange (CC), EPA Climate Leaders and SF-6 Program, Asia-Pacific Partnership, DOE1605B, BRT Climate Resolve) - Demonstrating voluntary programs can work and setting policy precedents thru CC Recent Awards/Recognition Climate Leader EPA 2005 Climate Protection Award; 2004 SF-6 Award CERES Climate Strategies 2006 Top Score Electric Cos. 24

25 AEP Climate Strategy More actions to reduce or limit GHGs: Advanced clean coal plants: Integrated gasification combined cycle (IGCC), ultrasupercritical pulverized coal, and FutureGen Retirement of less efficient capacity Emission offsets (e.g., forestry, methane) Renewables (e.g., biomass firing, wind) Supply and demand side management 25

26 Background on Allowance Allocations and Auctions Allowance = Right to emit a ton of emissions. Each year allowances must be surrendered to cover annual emissions of an emitter. Most programs (EPA s SO2 and NOx, CAIR and CAMR, EU CO2 etc.) allocate allowances (at no cost ) to generators. Emission allowance auctions have been used infrequently in programs. To the extent they have been employed, they have amounted to 5% or less of total allowance supply. Some have argued that allowances are a net financial asset and could result in windfall profits to generators and other sources and therefore should be auctioned rather than allocated. New York, Connecticut and others in the RGGI states have proposed large 100% auctions. These will be first of their type, market experiments. 26

27 Trading Example: AEP Savings from Auction Purchases During , AEP bought 0.76 MM per ton for $100 MM Purchased allowances displaced scrubber and fuel switching roughly estimated to cost an average of $400 per ton. Thus, AEP s auction purchases reduced costs ~ $200 million $350 $300 $250 $200 $150 $100 $50 $0 Total SO2 Reduction Costs (MM$) Estimated Higher Cost SO2 Reductions Cost of Actual Auction Purchases 27

28 AEP Objectives in Participating in CC Opportunity to set public policy precedents (e.g. market trading approach with all greenhouse gases and all reduction types counted) Central part of overall climate change strategy to meet the President's voluntary plan Learning opportunity from market & competitors Value as socially-responsible investment Opportunity to do so at a relatively low cost Incorporates greenhouse gas risks in capital and O&M decisions (through CO2 price), promoting cost-effective reductions (examples in past several years): Plant efficiency improvements Retirements/mothballing old gas steam & coal units Nuclear availability improvements Forest management and forestry projects SF-6 leakage reductions Wind plant development and purchases 28

29 Free Allocation to Emitters Does Not Increase Profits Example: Co. Emits 100 Tons, Receives 80 No-Cost Allowances (i.e., 20 % Reduction). Surrendered/ Returned to EPA Beginning of Year Allowances 80 Tons Allocated CO Tons Year End Allowances 80 Tons 29 Net Emission Reduction/Liability 20 Tons Thus, Allocation to Emitters Does NOT Create a Net Asset or Windfall because of the Liability of Complying with the CO 2 Cap. In fact, except for non-fossil generators, NET LIABILITY

30 Chicago Climate Exchange Overview An unprecedented voluntary greenhouse gas emission reduction and trading pilot program administered by 100+ companies and organizations Total member emissions = About 240 MM metric tons CO 2 equivalent (~ 4% US CO 2 emissions) Member commitment to reduce GHG emissions below a baseline (average levels): *Extension Period 1% in % in % in % in % in 2007* 4.5% in 2008* 5% in 2009* 6% in 2010* AEP Info: Current Baseline = 155 MM metric tons (adjusted for divestitures) Reduction or offset of about 46 MM metric tons of CO 2 during : Reduced 29 MM Tons AEP one of 14 founding members and first to commit to extension period. 30