Our nation's heavy reliance on fossil fuels is a central obstacle to improving air quality and preventing catastrophic climate change. Clean, renewable energy resources—wind, solar, geothermal, biomass, and small hydro—are an attractive solution to this problem. The clean air benefits of renewable energy, however, generally go unrecognized by regulators, under-appreciated by consumers, and uncompensated by markets. A prime example of these problems is the fact that current air pollution control regulations do not allow renewables to participate fully in emissions trading applicable to the electric power sector.

Electric utilities are major culprits for several air quality problems. Utilities are responsible for 27% of nitrogen oxide emissions, two-thirds of sulfur dioxide emissions, and over a third of carbon emissions. As a result, they are a principle contributor to acid rain, smog, regional haze, mercury contamination, and global climate change.

Renewable energy is a key alternative to conventional electricity generation. The development of renewables could be stimulated by changes to the Clean Air Act's cap-and-trade programs. As Congress revisits clean air issues over the next several years, renewable energy representatives could push for statutory changes that reward renewable energy for the air quality benefits it provides.

Cap and Trade Programs and Renewables

Cap-and-trade programs, though controversial within the environmental community, are becoming a dominant form of air pollution control. Understanding them will help the renewable energy community learn how to reap deserving financial benefits from air quality regulation.

Cap-and-trade regulation begins with a limit on tons of pollutant (cap) that can be emitted in a given period and for a given region or sector. For the electric power sector, regulators then issue allowances (permissions to emit a ton of pollutant) to generators. There are many ways for regulators to issue allowances. These include auctions and generator-by-generator allocations based on applying a uniform emission rate (consistent with achieving the cap) to historical or projected generation (e.g. pounds/megawatt hour). An individual generator can choose to comply by limiting its emissions to the amount equal to its given allowances. It could also choose to emit less than the amount allowed, and sell off unused allowances to generators that need them-generators that do not hold enough allowances for their planned amount of emissions. Thus, cleaner generators reap financial rewards, and dirtier generators must pay a price for their higher emissions. The amount of money each allowance represents, and therefore the total financial reward for cleaner generators depends upon the demand for allowances, and the ability of generators to furnish spare allowances.

With changes in federal/state regulations, renewable energy facilities could receive allowances-a source of supplemental project revenues-in several ways. First, renewables could earn allowances based on the electricity they generate at the same rate as fossil-based electric power generators (i.e., so many allowances per megawatt-hour of production). Second, renewables could earn allowances based on an estimate of the pollution they actually avoid. (For example, photovoltaic systems can receive credit for avoiding pollution from "peaking" power plants with high emission rates that operate only during summer demand peaks.) Third, the regulator can set aside allowances for renewables as a percentage of total allowances offered to utilities.

The U.S. Environmental Protection Agency selected the last option, set-asides, in the first national emissions trading program, which tackled the acid rain problem. While the overall trading program succeeded in incorporating pollution control costs into electricity prices, the set-aside scheme failed to be an effective means of encouraging renewable energy.

Yet precedents set and lessons learned from that program can be used to structure future cap-and-trade programs so that they offer meaningful revenue opportunities for renewables. First, the value of allowances in the overall program was low, as utilities found inexpensive ways to reduce emissions. Thus, they did not have to scramble for extra allowances offered by the set-aside scheme. To compound the problem of low demand, the set-aside scheme offered allowances to renewable energy projects at a low rate per unit of energy produced-one allowance for every 500 megawatt-hours generated. Another difficulty was that the program offered allowances only to utilities, and not independent power producers who installed many renewable energy facilities. Finally, the statutory basis for the program did not anticipate electricity restructuring, since it contained conditions unique to a heavily regulated electricity sector.

Promising Financial Benefits

Based on projections of renewable energy generation in 2010 and using conservative estimates of allowance trading prices for multiple pollutants, this analysis estimates that a properly formulated cap and trade program could produce the annual financial benefits for renewable energy industries which are summarized in Table A.

Clearly the renewable energy industry has much to gain from securing and participating in a properly structured emissions trading program for the electric power sector. By 2010, the renewable energy industry could earn over $1.3 billion from sales of air pollution allowances, allocated to the industry by air quality regulators. Conversely, the industry has a lot to lose from defective cap-and-trade programs. A poorly constructed emissions trading program can actually deprive renewables industry of its ability to claim that energy production from wind, solar, biomass and geothermal reduces air pollution, while simultaneously making compliance easier for conventional power plants. This would weaken the environmental/consumer appeal of "green power."

Future Cap and Trade Programs

Several cap-and-trade programs are currently in the works. East of the Mississippi, an emerging NO_x trading program could include set-asides for renewables. In fact, several states have already set aside allowances, including Massachusetts, New Jersey, and New York. Ideally, regulators (typically state governments) should reserve up to 10-15% of allowances intended for utilities to renewables and energy efficiency.

Another cap-and-trade program could arise to control particulate matter and to reduce regional haze in national parks throughout the U.S. Finally, carbon dioxide trading could arise under the Kyoto Protocol on climate change. Though it faces determined political opposition, C02 controls, if properly structured could emerge as an important basis for emission trading revenues for renewable industry.

Recommendations

To achieve these objectives renewables industries could consider: forming coalitions (among themselves and with environmental groups); drafting legislative and rulemaking language; and, developing more detailed analyses of policy prescriptions and associated economic and environmental benefits.

This paper recommends the following actions to air regulators and legislators if they are considering ways to accord benefits to renewable energy.

• Encourage state efforts to adopt renewable set-asides in state and regional emissions trading programs to control ground-level ozone, attain particulate matter standards, and improve visibility in national parks.

• Reduce the sulfur dioxide cap to the level needed to full protect human health and sensitive ecosystems and, in a second step, reduce the cap again to reflect objectives for renewable energy development. The cap could be implemented through a generation performance standard with a direct allocation of allowances to renewables, or set-aside of allowances for renewables. Alternatively, Congress could fix the SO₂ cap-and-trade system to cure the limitations on who can earn credits and should extend the period in which credits can be earned.

• Replace pollutant-by-pollutant emission credit systems with a multi-pollutant trading paradigm that merges allocation, verification, and tracking systems for all pollutants in order to reduce administration and transaction costs.

Ensure that any CO₂ emissions trading scheme contains a cap that is tight enough to stimulate markets for renewable energy resources (either domestic or international) and that, in setting emission caps, lowers the tonnage allowed from fossil fuel generators by an amount based on projected electric power generation from renewables.

• Make renewables eligible to earn early reduction credits in any U.S. early reduction credit bill.

• Create a specific allowance allocation award or set-aside for renewables in any full-blown carbon cap-and-trade system.

• Encourage EPA to establish pilot programs with cooperating states that combine implementation of NO_x trading programs with any voluntary state climate change programs.

• Experiment with assigning emission allowances for aggregations of small and distributed renewable energy resources with a pre-approval process to provide project applicants with more certainty about the incentives to be awarded.

A Guide to the Clean Air Act for the Renewable Energy Community

Abstract
Message from REPP Staff
Executive Summary

1. The Clean Air Act and Renewables
2. An Introduction to the Clean Air Act
3. Emissions Trading Under the Clean Air Act
4. Future Cap-and-Trade Programs
5. Recommendations and Action Plan

copyright © 2000 by Renewable Energy Policy Project