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Op-Ed: If We Want Clean Energy, We Must Get Energy Prices Right

Garden State could become first in the US with the right mix of ‘carbon pricing and revenue recycling’

Frank A. Felder
Frank A. Felder

Those with a passion for clean energy, a desire for serious action on climate change, and the goal of re-establishing New Jersey’s energy and environmental leadership have compiled a long list of actions they find worthy of legislative mandate in anticipation of a new administration in Trenton next year. This list includes an energy efficiency standard, smart meters, programmable thermostats, an increase in the renewable portfolio standard, and out-of-market payments for in-state nuclear power plants.

Prior to the introduction of energy markets, the regulatory approach used to promote clean energy was integrated resource planning, or ‘IRP’. Utilities under the supervision of their regulators proffered plans that harmonized — at least in theory — the combination of conventional resources, energy efficiency, and renewables to achieve public policy objectives. In practice, IRP was challenging to implement well. It was both time-consuming and data- and resource-intensive. Moreover, if the utilities’ investments failed, ratepayers bore much of the financial consequence.

However, even IRP’s most ardent supporters do not think that legislators should be using this approach. The difficulty for legislators resides in specifying the efficient combination of energy efficiency, demand response and renewable energy (perhaps with side payments to nuclear units). Without the fact-finding and regulatory tools commonly used by utility commissions, legislators are even more likely to get the combination of solutions wrong. To cost-effectively achieve environmental outcomes by reducing the emissions associated with electricity and natural gas, each mandate must have the same reduction in environmental impact per dollar spent not just today, but over time. For example, getting the mix wrong in one mandate may result in having to pay $200 to reduce one ton of carbon dioxide when the same result could have been achieved for $20 using a different one.

Legislative resource planning suffers from another problem — it undercuts the efficiency of electricity markets. Legislative mandates put downward pressure on electricity prices by providing out-of-market payments. Not surprisingly, generation resources that are not receiving these payments are financially exposed and will, in turn, seek relief from the Legislature. This leads to a downward spiral where increasingly frequent and difficult economic decisions must be determined by the Statehouse resulting in each sector of the clean — and not so clean — energy industry appearing in Trenton asking for subsidies.

With the establishment of wholesale electricity markets in 2000, New Jersey ceased having to rely upon legislative resource planning. Wholesale electricity markets enable a market-based approach to achieving the policy objectives of clean energy. Instead of specifying the quantity of each method needed to meet the state’s energy needs and environmental objectives, this approach puts a price on the environmental externalities of producing electricity. Economists almost unanimously agree that if emission reductions are to be achieved efficiently, the environmental costs of greenhouse gas emissions and other pollutants should be reflected in the market price of energy.

Of course, including the social cost of greenhouse gases in energy prices will increase those prices. Mandates on the order that are being considered will also increase costs that will be reflected in electricity and natural gas rates or taxes. The key question is which approach is most likely to do so efficiently while simultaneously building a broad base and, therefore, sustainable political support.

Pricing greenhouse gases also has another advantage uncommon to mandates. It can generate revenue, either from a tax on greenhouse gases or emission allowance auctions. These allowances can be used both to offset higher energy prices, particularly for lower income families, and to reduce other taxes negatively affecting the economy. These strategies can also be used to create a fund to help mitigate the looming costs New Jersey will bear due to climate change. This idea of “carbon pricing and revenue recycling” is not new but it does solve the two conundrums of efficiently reducing greenhouse gas emissions and building the broad-based political support necessary to do so.

Moreover, a market-based approach puts the investment risk of offshore wind, solar power, nuclear power, etc. on investors, whereas mandates put the risk on ratepayers. It is necessary to revamp the state’s and region’s energy systems to achieve the 80 percent reduction in greenhouse gases required by the New Jersey 2007 Global Warming Response Act. The risk and rewards of the massive investments needed — some likely in emerging and new technologies — should belong with investors and developers, not ratepayers.

Although pricing greenhouse gases and recycling the associated revenue has been successfully implemented in several parts of the world, it has yet to be seen in the United States. New Jersey has an unprecedented opportunity to take the lead in creating a clean energy economy. Using these strategies can demonstrate the achievability of improvements to both economic efficiency and political support while providing a model for the rest of the U.S.

Frank A. Felder, Ph.D. is the director of the Center for Energy, Economic and Environmental Policy, Bloustein School of Planning and Public Policy, Rutgers University.

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