Darker Days for Carbon Reduction? Consider Shadow Pricing

WASHINGTON—A new paper posted by Resources for the Future (RFF) begins by underscoring that an uncertain regulatory environment for the carbon-reduction plans of power plants has been introduced via the Trump administration’s pronounced intentions to make key policy changes, such as not implementing the Obama administration’s Clean Power Plan (CPP). But according to the paper’s author, RFF Visiting Fellow Joseph Kruger, companies still can take prudent steps to manage risks from emissions by incorporating “shadow prices” for carbon into their future plans.

In “Hedging an Uncertain Future: Internal Carbon Prices in the Electric Power Sector,” Kruger writes: “The basic premise of internal carbon pricing is that companies use a price of carbon in their strategic plans and models to explore future scenarios and to observe changes in the relative economics of potential investments or deployment of resources.”

According to the report, such a process already has been formalized for some utilities through integrated resource plans (IRPs) submitted to public utility commissions. These plans are now used by many electric utilities and their state regulators to meet future energy and peak-capacity demand through a mixture of supply- and demand-side resources. Many states require regulated utilities to project the costs of potential future regulations in their IRPs, and US companies in the electric power sector presently employ a wide variety of carbon prices in these plans and in other strategic planning analyses.

Kruger notes that an alternative approach to pricing carbon developed by the federal government has been adopted by a few states: The Social Cost of Carbon is an estimate of the future damages from climate change and the marginal benefit from avoiding these damages. (A recent presidential executive order disavowed the current version of the Social Cost of Carbon, stating that it was “no longer representative of government policy.”)

Kruger concludes that with the Trump administration opposed to using the CPP to reduce CO2 emissions, it is unclear whether the next round of IRPs will reflect this policy in their internal carbon prices. But states and utilities with a longer-term view of climate science and policies may want to continue hedging regulatory risks and may decide to assume carbon prices based on policies that go well beyond carbon emission reductions required by the CPP.

The paper offers recommendations and data helpful to policymakers, companies, and investors looking to navigate the uncertainties about future greenhouse gas policies and continue reducing carbon-associated risks.

Read the full report: Hedging an Uncertain Future: Internal Carbon Prices in the Electric Power Sector.