Secular Trends, Environmental Regulations and Electricity Markets

The confluence of several pending environmental rulemakings will require billions of dollars of investment across the industry and changes in the operation of facilities. These changes may lead to retirement of some facilities, and there has been much debate about their potential effects on electricity reliability. Only very exceptional circumstances would trigger supply disruptions; however, the changes may affect electricity prices, the generation mix, and industry revenues. Coincident with these new rules, expectations about natural gas prices and future electricity demand growth are changing in ways that also will have substantial effects on the industry. This paper addresses these two sets of issues using a detailed simulation model of the U.S. electricity market. The findings suggest that recent downward adjustments in natural gas prices and electricty demand projections have a substantially larger impact on electricity prices and generation mix than do the new environmental rules.

For several decades, U.S. electricity production has been dominated by coal, which accounts for just under half of electricity produced in 2011 and more than twice as much as any other fuel or technology. The use of coal has helped to keep electricity prices low in many parts of the country, but it also has contributed importantly to emissions of several criteria and hazardous air pollutants, making the electricity sector an important target of EPA regulations. The most recent round of such regulations, including the Cross State Air Pollution Rule and the Mercury and Air Toxics Standards, will require billions of dollars of investment in pollution controls and changes in the operation of facilities. There has been much speculation and some analysis of how these regulations in particular are likely to affect the viability of coal-fired generators, the cost of electricity, and the future mix of fuels for electricity supply.

Coincident with these new rules, projections of natural gas prices and electricity demand growth are changing in ways that also will have substantial effects on the industry. Recent technological innovations that have enabled extraction of natural gas from shale formations also have reduced natural gas prices and changed the economics of electricity generation in a way that favors natural gas and disadvantages coal. Lower natural gas prices tend to reduce electricity prices, thereby lowering revenues to all sources of electricity supply, including electricity generated with coal. Concurrent lowering of electricity demand projections as a result of the lingering recession and greater adoption of energy efficient technologies also have a price and revenue dampening effect.

In a new RFF discussion paper, Dallas Burtraw, Karen Palmer, Anthony Paul, and Matt Woerman address these two sets of issues using a detailed simulation model of the U.S. electricity market. Their findings suggest that recent downward adjustments in natural gas prices and electricity demand have a substantially larger impact on electricity prices and the generation mix than do the new environmental rules. Moreover, write the authors, “The one area where regulations matter more than secular trends is emissions....Regulation does affect emissions from regulated sources in important ways and apparently with little disruption to the sector, especially in comparison to the normal disruptions associated with a changing world.”