Cost of "Cap-and-trade" Reduction in CO2 Emissions Not so Dire According to Stanford Business School Research

STANFORD, Calif.--(Business Wire)--
There`s good news for supporters of the Waxman-Markey climate bill from Stanford
Graduate School of Business Professor Stefan Reichelstein. Although passed by
the U.S. House of Representatives in June 2009, the bill is expected to spur a
contentious debate in the Senate starting this fall. Opponents argue that the
bill`s proposed "cap-and-trade" system will take a high financial toll on energy
consumers and companies alike, and devastate the economy at a time the country
can least afford it.

According to research reported in today`s StanfordKnowledgebase Reichelstein and
doctoral student Ozge Islegen believe they have evidence to the contrary.
Reichelstein and Islegen have examined the financial impact of regulating
coal-fired power plants that produce carbon dioxide emissions under a
cap-and-trade system and found the financial burden to be much less than
previously projected.

"We were very pleasantly surprised with the results, especially in light of
previous cost estimates," said Reichelstein, Stanford Business School`sWilliam
R. Timken Professor of Accounting, who said that everyone agrees there will be a
price associated with regulating carbon emissions. "But after several dire
scenarios reported in the popular press, we became interested in measuring and
quantifying exactly what that cost would be."

They focused on three key questions. First, at what price for emission permits
would fossil fuel power plants, in particular coal-based plants, invest in the
new clean carbon capture and storage (CCS) technologies rather than buy such
permits on the open market? "If the world wants sizable reductions - say cutting
carbon dioxide emissions by 50% over the next 40 years - how high would the
price of the emissions permits need to go before electric power producers and
distributors would have a financial incentive to implement the new clean CCS
technologies?" asked Reichelstein.

Second, will CCS technologies actually keep the market price of such emission
permits reasonable? "In terms of carbon dioxide emissions, several sectors in
the economy - for instance the whole transportation sector - could achieve
sizeable reductions. How big a role CCS could play in keeping the market price
of emission permits say under $60 per metric ton of carbon dioxide, was
something we very much wanted to investigate," said Reichelstein.

And finally, how far are electricity prices likely to rise in the case where two
scenarios are both fulfilled: (1) if power generators are required to obtain
emission permits; and (2) if CCS technology is available on the terms currently
projected by engineering cost studies?

This last point is an important one. Although CCS technology has been documented
in a number of pilot projects, it has yet to be proven for large commercial
installations. FutureGen, an Illinois-based partnership of private firms and the
U.S. government, is attempting to certify CCS technology for a commercial-sized
coal-fueled power plant. If this is possible, then the cost savings possible by
implementing CCS should scale well.

The implications for the environment are huge. In 2007, U.S. carbon dioxide
emissions measured six gigatons. Roughly half of this came from fossil fuel
plants, with coal-fired plants alone emitting two gigatons of carbon dioxide
emissions. "The current projection for CCS technology is that it would clean up
the carbon emissions of fossil fuel plants by 85%," said Reichelstein. "That
would take us a long way toward achieving the emission cut goals being mentioned
in current public policy discussions."

For coal-fired plants, Islegen and Reichelstein find that the break-even price
for the adoption of CCS technology is just $25 to $30 per ton of carbon dioxide
emissions. Once the price of emission permits moves beyond that range, operators
of coal-fired power plants would find it advantageous to invest in CCS
technology rather than buy emission permits. This finding stands in contrast to
the conclusions of a widely quoted 2007 McKinsey & Co. study ["Reducing
Greenhouse Gas Emissions: How Much at What Cost?"] that predicted the price of
permits would have to reach $50 per ton before power plants would convert to
CCS.

The sheer magnitude of emissions from coal-fired power plants in the United
States and other parts of the world, most notably China, implies that the CCS
option could be a major force in keeping the market price of emission permits
relatively low. In connection with the Waxman-Markey climate bill, there has
been debate about the need for a "safety valve." Such a provision would require
the U.S. government to issue more permits if the price of existing permits
reached a certain threshold - say $75 per ton. "Our calculations suggest that
the CCS option may ensure that such safety valves would not be activated," said
Reichelstein.

Although the price of electricity for consumers could rise as much as 23% - not
an insubstantial amount - it`s significantly less than others have projected.
"We were actually quite surprised that the impact on electricity prices was that
small," said Reichelstein.

Furthermore, because of the way the energy industry is regulated in the United
States, it could take many years before the full brunt of a cap-and-trade system
would be felt. In most U.S. states, energy firms are reimbursed for their costs
plus an agreed-upon return on their investment. Given that the basis for their
costs is largely historical, consumer prices will go up much more slowly than in
unregulated markets. "The higher costs would only be gradually phased in, and it
would take 30 years for prices to rise to their new equilibrium levels," said
Reichelstein.

Yet there are many unknowns that enter into the picture. Because the current
legislative situation is so uncertain, very few new power plants are being
approved, either by regulatory commissions or investors. "People in the industry
are quite reasonably wondering if they should invest in a project with a useful
life of 40 to 50 years given the uncertainty of the regulatory situation, the
potential costs of permits, and the viability of new technologies," said
Reichelstein. Some industry observers worry that this may lead to energy
shortages, because the older plants are not only less efficient, but also they
have a higher chance of shutting down for unscheduled maintenance.

Overall, Reichelstein concluded that "the economics of the CCS option for fossil
fuel plant appears quite attractive."

"Given the urgency of the problems created by burning fossil fuels,
demonstration projects like the FutureGen project in Illinois are of crucial
importance for informing the ongoing public policy discussions," said
Reichelstein.

(This story reports on research at the Stanford Graduate School of Business and
appears in today`s Stanford Knowledgebase, the free monthly information source
for thoughts, ideas and research at the Stanford Graduate School of Business. To
dig deeper, visit:
http://www.gsb.stanford.edu/news/research/emissions_electricityprice.html?cmpid=kbpage&edition=09-oct.)

Stanford Graduate School of Business
Helen Chang, 650-723-3358
chang_helen@gsb.stanford.edu

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