New emissions regulations create uncertainty for utilities

Combined Federal-State-Market System under pressure to achieve reductions

CAMBRIDGE, Mass. — April 14, 2004 — As 11 states prepare for the start of a new summertime program for controlling nitrogen oxide (NOX) emissions from electric power utilities, new federal rules for NOx, sulfur dioxide (SO2) and mercury emissions are moving the U.S. toward its largest-ever investment in air pollution control equipment.

However, yet-to-be-settled debates over scope and timing will determine much of the new policies’ ultimate costs and effectiveness, according to Clearing the Air: Scenarios for the Future of US Emissions Markets, a new study by Cambridge Energy Research Associates (CERA).

The new NOX rules, beginning May 31, 2004 and implemented as an emissions trading program in which companies may buy and sell emissions allowances, will cover a total of 19 Eastern U.S. states. In these states, an unprecedented level of investment in new NOX controls has poised power companies to reduce NOX emissions by as much as a third below the level required in 2004.

“This short-term over-investment by industry will maintain downward pressure on NOX allowance prices and will lessen the impact to power markets,” said CERA study director Robert LaCount.

Companies have already announced more than $7 billion of planned investment in new NOX and SO2 pollution controls over the next decade, just the beginning of what would be required under the new rules according to the CERA study.

The next round of policies will force more complicated and expensive investment decisions for the power sector than the projects announced thus far, the study found.

“Because the power industry’s pollution control standards are the net result of federal legislation, EPA regulations, emissions trading markets, state requirements and case law from a multitude of lawsuits, a large and diverse set of forces is attempting to drive environmental decision-making in this system,” said CERA study director Robert LaCount.

“This is producing an historic level of uncertainty about air quality policy among industry participants, regulators, policymakers and investors,” he added.

The implications for which both the industry and policymakers need to be prepared, according to LaCount, include:

**Fundamental changes to the SO2 and NOX emissions markets that could alter the attractiveness of new investment and operating economics;

**Higher levels of industry-wide pollution control investment over much shorter time periods than previously experienced in the U.S.;

**Pressure on profitability in many portions of the existing U.S. power generation fleet, with implications for future capital availability, investment levels and fuel-selection and market-location strategies;

**Increased complexity and expense in complying with more stringent emission restrictions.

“A number of key debate, decision-making and implementation thresholds on the near-term calendar will provide indications as to the long-term direction of policy development and the marketplace response,” LaCount said. The probable signposts include:

**The tenor and sources of comments filed regarding the EPA’s proposed Interstate Air Quality Rule and the Utility Mercury Reductions Rule emissions standards;

**The level of continued effectiveness in the NOX emissions market as it is expanded to 11 additional states;

**Sufficiency of progress in developing mercury emission control technologies;

**Administration and industry responses to opposition to the EPA’s proposed mercury regulations from ten state attorneys general and 49 Senators;

**Significant changes in relative natural gas and coal prices and available supplies;

**Progress of more than 30 new emissions requirements proposed in 13 states;

**Trends in states’ filing of petitions with the EPA for relief from SO2 and NOX transport restrictions, such as North Carolina’s recent filing targeting power plant emissions from 13 states.

“By understanding how the power business landscape might change as a result of the interaction of varying environmental requirements with technology, market forces, and investment needs, industry participants can develop appropriate strategic and investment responses across the electric power value chain,” LaCount said.

“Recognizing evolving environmental trends will be critical to the success of strategies, and can help participants understand strategic implications of capital allocation, investment attractiveness, barriers to entry, risk profiles, and expected returns,” he concluded.

Cambridge Energy Research Associates (CERA) is a leading advisor to major North American and international companies, financial institutions and organizations, delivering strategic knowledge and independent analysis on energy markets, geopolitics, industry trends and strategy.

CERA is headquartered in Cambridge, Mass., and has offices in Beijing, Calgary, Mexico City, Moscow, Oakland, Paris, Sao Paolo, and Washington, D.C.

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