1. Power Prices and Resource Choices in a Carbon-Regulated Environment UNIVERSITY OF TEXAS SCHOOL OF LAW 2008 CARBON AND CLIMATE CHANGE AUSTIN, TEXAS APRIL 25, 2008 ROBERT W. GEE PRESIDENT GEE STRATEGIES GROUP LLC

2. 2 Overview Current demand and infrastructure outlook for electric sector Competing analyses over the price and economic impact of compliance with cap-and-trade controls over greenhouse gas emissions (GHG) Outlook for resource choices depending upon availability of emerging technology The potential role of retail rate regulators over federal cap and trade price mitigation

3. 3 Current Outlook: Electricity Demand Expected to Escalate, Necessitating More Generation Capacity Electricity sales will grow 1.4 percent annually through 2030 (Energy Information Administration 2007 Annual Energy Outlook) Peak demand will grow by 19 percent, or 141 GW, from 2006 through 2015 (North American Reliability Corp.) 258 GW of new generation capacity required by 2030 to meet new demand and replace retired capacity (EIA)

4. 4 Utility Capital Expenditures Growing in an Escalating Cost Environment Economic growth and aging infrastructure will require major capital expenditures over the next two decades Edison Electric Institute Survey: from 2006 – 2009, $31.5 billion to be invested in transmission 13,000 miles of new transmission added by 2015 -- 6.1 percent increase in total miles of installed extra high-voltage between 2006 and 2015 (NERC) Materials and labor costs in generation and network infrastructure have escalated –From January 2004 and January 2007, prices increased rapidly. Costs for steam-generation boilers, transmission facilities and distribution-grid equipment rose by 25 percent to 35 percent –No cost abatement currently envisioned Source: Greg Basheda and Marc Chupka, Sticker Shock, Public Utilities Fortnightly (December 2007)

5. 5 Supply Resource Choices with Current Technology Under a Carbon-Constrained Scenario Source: E.Spiegel & A. Begosso, Coal’s Black Future, Public Utilities Fortnightly (March 2008) Because gas-fired generation has set marginal cost of power today, natural gas prices influence choice of supply options If carbon “penalty” is low, but gas prices high, conventional coal is competitive If carbon penalty high, and gas prices high, nuclear becomes competitive

6. 6 What’s Will Be the Electric Price Impact of Carbon Regulation Compliance Under Cap & Trade? It depends on...... Whether CO 2 regulation is sector specific (e.g., utilities only) or economy wide One’s estimated carbon “penalty” or cost Future costs of various resource technology options and when will they be available on commercial terms Whether CO 2 emission allowance is auctioned or awarded at no cost and which entity receives it Who you ask

7. 7 The Battle of the Consulting Firms: How Difficult or Easy will Carbon Control Compliance Be? Analysis done by McKinsey/Conference Board McKinsey study challenged by CRA International CRA Refuted by Union of Concerned Scientists

8. 8 McKinsey/Conference Board Study Analyzed 250+ opportunities to reduce US GHG emissions by 2030 Did not factor adoption of any specific policies (carbon cap, mandates, or incentives), or consumer responses resulting US emissions of 3 to 4.5 billion gigatons of CO 2 could be reduced by 2030 using tested approaches and high-potential emerging technologies Based on wide array of options available at marginal costs of >$50/ton w/lower net costs to economy if energy efficiency gains realized Almost 40 percent of reductions realizable at “negative” marginal costs, paying for themselves Example: Greater efficiency in buildings-and- appliances and industrial sectors could offset 80 percent of projected demand by 2030 Carbon Capture & Sequestration (CCS) offers less than 11 percent of potential reduction Requires strong, economy-wide action in near future, including $1.1 trillion in additional capital expenditures

9. 9 CRA’s critique of McKinsey Premised on “engineering” potential and related costs, net of benefits, but not market response of individuals and organizations to public policies and economic incentives contained in federal and state legislation Examines only a single year in the distant future (i.e., 2030) and therefore provides no insight for developing 5- or even 10-year strategies in 2008 Fails to consider the complications associated with interrelated macro- and micro-economic effects of carbon control limits Under CRA’s assessment of Lieberman-Warner bill: –Marginal cost of CO2 abatement will be $55 per ton in 2015, $85 per ton in 2030, and $280 per ton in 2045 (in constant 2007 dollars); therefore, McKinsey $50/ton benchmark is too low –Growth in GDP will be 1.5 percent lower by 2015, and 2 percent lower by 2045 from “business as usual” case –Wholesale electricity prices will be 50 percent higher by 2015, and 80 percent higher by 2045

10. 10 Union of Concerned Scientists: CRA’s Analysis Fails to Consider... The costs of global warming, such as increased flooding, the demise of the New Hampshire ski industry, and reduced forest productivity Cost savings from investments in increased efficiency, which would curb power usage Economic gains from technological innovation in response to carbon caps and other policies Additional benefits from combating global warming, including strengthened national security, lower trade deficits, less air pollution, and reduced health care costs.

11. 11 The EPRI “Prism” (Based on EIA Early Release Reference Case 2008) Technology EIA 2008 Early Release Reference Case (12/07) Target EfficiencyLoad Growth ~ +1.2%/yrLoad Growth ~ +0.75%/yr Renewables60 GWe by 2030100 GWe by 2030 Nuclear Generation20 GWe by 203064 GWe by 2030 Advanced Coal Generation No Existing Plant Upgrades 40% New Plant Efficiency by 2020–2030 130 GWe Plant Upgrades 46% New Plant Efficiency by 2020; 49% in 2030 CCSNoneWidely Deployed After 2020 PHEVNone 10% of New Vehicle Sales by 2017; +2%/yr Thereafter DER< 0.1% of Base Load in 20305% of Base Load in 2030 Source: EPRI

12. 12 Two Resource Scenarios with Differing Technology Expectations *Economy-wide CO 2 emissions capped at 2010 levels until 2020 and then reduced at 3%/yr Source: EPRI

13. 13 Wholesale Power Prices Under “Limited” versus “Full” Technology Portfolio 0 20 40 60 80 100 120 140 160 180 200020102020203020402050 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 $/MWh* Index Relative to Year 2000 Limited Full Source: EPRI *Real (inflation-adjusted) 2000$

14. 14 Observations from “Prism” Achievement of “Full Portfolio” option rests heavily on: –Successful timing of commercial availability of emerging technology (i.e., carbon capture and sequestration, smart grid, et al.) –Successful nuclear expansion at competitive costs Demand reduction an essential option under either scenario –Under “Limited Portfolio”, will require much greater commitment –Likely to include demand destruction Unsuccessful realization of any of these elements could aggravate resource adequacy and escalate price pressure –Example: “Limited Portfolio” contemplates increased reliance on natural gas –Power prices likely subject to greater volatility and global competition for LNG

15. 15 EPA’s Assessment of Compliance Costs Study issued 14 March 2008, upon request of Senators Lieberman and Warner to evaluate impact of S.2191(Lieberman-Warner Climate Security Act of 2008) Some assumptions: –CCS is viable by 2015 and that by 2035 has been deployed in 30 percent of all coal plants –Nuclear power generation increases by 150 percent between 2005 and 2050 Will be updated later this year after EIA’s issuance of 2008 Annual Energy Outlook, which will include the impact of the Energy Independence and Security Act of 2007 EIA analysis of S.2191 expected shortly

16. 16 EPA’s Assessment (con’t.) From Senators Lieberman and Warner’s Press Release (the “Good News”): –US gross domestic product (GDP) grows by 80 percent from 2010 to 2030 or 1 percent less than w/o bill –Average annual per-household consumption in the US grows by 81 percent from 2010 to 2030, or 2 percent less than the growth w/o bill –Emission allowance prices are $22/ton in 2015 and $46/ton by 2030 –Increases in average US electricity prices materialize slowly and gradually, attaining level only 18 percent higher than the 2005 level after 40 years But EPA itself notes (the “Less Favorable News”): – While GDP increases by approximately 97 percent from 2007 levels by 2030 and 215 percent by 2050, estimated annual reduction in GDP ranges from $238 billion to $983 billion in 2030 and between $1,012 billion and $2,856 billion in 2050. – Electricity prices are projected to increase 44 percent in 2030 and 26 percent in 2050

17. 17 Retail Rate Regulators: Seeking a Role in Price Mitigation Perspective of state retail regulators toward federal carbon controls (if adopted): –Carbon controls be economy wide w/appropriate transition period –Sufficient certainty created to ensure the financing of needed energy infrastructure consistent with the achievement of the environmental objectives If cap & trade adopted, want price mitigation mechanisms and oversight of allowance benefits : –Find allowance auctioning to be most efficient mechanism to achieving emission reduction goals, but considers no-cost allowances to be appropriate transitional tool –Prefer assigning all allocated no-cost allowances available to the electricity sector to local distribution companies (LDCs) providing a regulated local distribution function for end-user customers –Desire cost-containment measures to be included in any cap-and-trade mechanism to minimize abrupt changes in the cost of compliance Source: NARUC Resolution on Federal Climate Legislation and Cap-and-Trade Design Principles, Adopted November 14, 2007

18. 18 Retail Rate Regulators (con’t.) Lieberman-Warner assigns no-cost allowances to “fossil fuel-fired electric power generating facilities” with electric utilities getting a 19 percent share at the outset, phased out by year 2031 At odds with state regulators’ position who want assignment of allowances to LDCs to be able to pass through allowance benefits to ratepayers, or use for demand-side management programs Regulators are sensitized to rate impacts being compounded owing to additional costs from utilities’ cap ex programs

19. 19 Conclusions Divergence of projections of carbon control effect on power prices and economy signals absence of consensus among key stakeholders Difficult to estimate impacts extending over decades Even more difficult estimating timing and commercial availability of emerging technologies New slogan for everyone: “ If they come... you will build it.”

20. 20 Robert W. Gee President Gee Strategies Group LLC 7609 Brittany Parc Court Falls Church, VA 22304 U.S.A. 703.593.0116 703.698.2033 (fax) rwgee@geestrategies.com www.geestrategies.com