In part 1, I outlined five questions that ought to be answered before we have any conversation about energy policy reform. Here is my answer to the first question: What are the primary existing regulatory barriers to the deployment of cleaner energy?

They are legion. But they can be lumped into three broad categories: utility policy, environmental policy, and out-dated policies. A brief discussion of each:

Utility policy:

Our utility policy is, in a word, outmoded. Established at the beginning of the 20th century to encourage the rapid, mass electrification of the country, it was never appropriate for the efficient operation of the system. (See here for a great DOE/EIA summary of how we got here.) It was designed to ensure that utilities had access to the capital they needed for growth, while at the same time creating a national, coordinated grid. We moved in fits and starts, but ultimately settled on a solution where electric service territories were granted via monopoly franchise to private, for-profit corporations. To ensure that those corporations could not abuse their monopoly power, they were forced to cede price-setting authority to their (typically, state) regulator who set rates sufficient to earn a ‘fair’ return on capital, but no more. It was a great system to electrify the country; we got a grid, utilities got access to capital markets and the costs were borne — to a large extent — not by taxpayers but by electricity consumers.

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Today, it is the single greatest obstacle to clean energy. With competition blocked, constrained and in some cases outright-prohibited on all but the most insignificant parts of the grid, the pressure utilities face to control their costs or improve their quality of service derive only from the competence and energy of their regulator. Meanwhile, with rates set based on capital cost recovery, utilities have spent the last century being rewarded for the construction of expensive, inefficient projects that maximize cost and ignore cost-control. When your dominant cost is fuel, and 40 percent of CO2 emissions come from fuel combustion in the power sector, the continuation of these policies amounts to nothing more than a decision to overpay for electricity so that we can emit unnecessary CO2. And to top it off, the fact that the price setting regulation is at the state level while environmental/grid reliability policy is typically at the state level means that there is virtually no regulator overlap between regulator-responsibility and regulator-authority.

Environmental policy:

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Our environmental policies in the U.S. have been established in a way that guarantees (a) perpetual conflict between environmental and economic responsibility and (b) that any actions mandated to reduce criteria pollution will increase CO2 pollution. Neither outcome is innate to environmental responsibility — they are simply the result of the way we have chosen to regulate. The basic problem with our environmental policy can be summed up formulaically as:

Pass/fail regulation + input-based standards = grandfathering + NSR

Pass/fail regulation:

This describes the paradigm that any permitted source cannot emit any more than X units of pollution–but provides no explicit reward for any reductions below that point. With no incentive to reduce emissions more aggressively, no one does. As well they shouldn’t, given the reality of input-based standards. These standards set pollution allowances in parts-per-million of exhaust; but exhaust volume is simply a surrogate for fuel combustion. Ergo, anything you do to reduce fuel use jeopardizes your air permit. And since efficiency is the only profitable way to reduce air emissions, these standards force businesses to meet their air permits only by sacrificing their profitability. Not surprisingly, we end up with a nation of D students.

Clearly, alternatives exist.  We could provide differential incentives to those who reduce pollution further, and could index pollution to units of useful output (e.g., parts per MWh), so as to recognize energy efficiency as a pollution control strategy. But we haven’t, and so we have created a regulatory paradigm where (a) the regulated entity knows that compliance will impose economic pain but (b) the regulator wants the latitude to continue to tighten standards. Hard to fault either party for those positions–and so we struck the compromise of grandfathering + NSR. Grandfathering says that once permitted, you can operate at that emissions level in perpetuity regardless of future reductions in allowable emissions levels. New Source Review (NSR) is the patch to ensure that grandfathering doesn’t get gamed, and stipulates that a grandfathered facility must come up to current standards if they make a major modification to their facility.

In practice, grandfathering means that old, dirty facilities get to keep running and sell products into markets where the prices are increasingly set by the marginal costs of new, cleaner (but more expensive) operators. Dirty plants get a bag of money, paid for by depressed profit margins on cleaner facilities. And all thanks to environmental regulations! Meanwhile, NSR treats energy efficiency investments as a major modification, ensuring that permitted facilities never modernize their plant, lest they lose their ability to operate. So our environmental policies serve both to erect an economic barrier to clean energy–by blocking new investments and by discouraging old plants from cleaning up.

Out-dated policies

This last category is a catch-all for a whole host of policies at the federal, state, and municipal level. They range from tax depreciation rules that skew investment away from efficiency to building codes that won’t let you put motion-sensors on hallway lights that may be needed in an emergency. They include grid-interconnection requirements that require you to step up to transmission voltage (only to step back down to serve a local load) to power plant operating laws that require no operators for systems that expand pressurized (explosive) natural gas but expensive operators for systems that expand pressurized steam.

To the extent there is a consistent cause of these laws, it is that they were written for another era and a different set of technologies that no longer apply–but have never been repealed. Individually, none of them are as significant as the utility and environmental issues identified above–but collectively, they create a massive transactional burden to anyone seeking to deploy energy technologies that are substantially different from those that were available in past eras when the laws were written.

This then raises the obvious question: if the laws are so obviously flawed, compromising both environmental and economic outcomes, why can’t we change them? The answer to that question is political … and the subject of my next post.