New Alberta Carbon Levy Methodology to Impact Thermal Generators and Electricity Prices

There have been so many changes announced lately to Alberta’s electricity market that it is difficult for AlbertaPowerMarket.com to provide each change with the attention it deserves. We have written about the proposed Alberta capacity market, Alberta’s Renewable Energy Program, and the recent changes to Alberta’s micro-generation rules. However, one proposed change that we have not yet tackled in any detail is the change coming in 2018 to the methodology used to calculate the carbon levy paid by Alberta’s thermal generators.

Before describing the change and its implications, let’s start with a high level explanation of the current carbon regime for thermal generation in Alberta – and by the way, it is not the new Alberta carbon tax you have been reading about.  Thermal generators in Alberta are considered large industrial emitters if they generate more than 100,000 tonnes of CO2 in a year. If so, they pay carbon levies under Alberta’s Specified Gas Emitters Regulation (“SGER”). SGER requires all large industrial emitters to pay $30 per tonne of CO2 emissions over a base threshold.  That base threshold is intensity based (emissions per MWh of generation for a thermal plant) and is calculated using a targeted improvement of 20% in that plant’s emissions intensity.  Note that the threshold is specific to each thermal plant, with the targeted improvement applied to a historical baseline emissions intensity for that plant.

An example calculation will help you better understand how this works – as words are sometimes not enough. A typical coal plant in Alberta has an emissions intensity of about 1 tonne of CO2 per MWh of generation. Of course, the newer supercritical coal plants in Alberta will have a lower intensity, but 1 tonne per MWh is an average – plus it makes our math easier. If that typical coal plant had no intensity improvements at all in 2017, then the coal plant would be required to make an SGER payment equal to 20% times 1 tonne times $30, or $6 for each MWh of generation.  There are alternative ways for the coal generator to comply with its SGER obligations, including making capital investments to improve its emissions intensity or purchasing emission offsets, but we can generally conclude that SGER currently imposes a maximum variable cost on coal generators of about $6 per MWh.

As noted above, SGER applies to all large industrial emitters, so Alberta’s large gas-fired generators also have SGER obligations. Of course, their baseline intensity level is lower so their SGER cost is less. For example, Alberta’s new 860 MW combined cycle Shepard Energy Centre that opened in 2015 has a baseline intensity of about 0.4 tonnes of CO2 per MWh. Thus, if it had no intensity improvements at all in 2017 its maximum SGER cost would be 20% times 0.4 tonnes times $30, or $2.40 per MWh.  That’s less than the typical coal plant but still a significant variable cost for that generator.

An important element of the current regime is that each generator essentially gets to emit 80% of its CO2 without any carbon levy under SGER because it is only the targeted improvement portion (20%) of the emissions that gets included in the SGER calculation. Of course this is more advantageous to the coal generator because it has the larger baseline CO2 emissions intensity. The net result is that the structure of the SGER regime gives the bigger emitting coal generator an unfair carbon advantage over the gas-fired generator who both compete with the other on price to have their power dispatched in Alberta’s power market.  However, this advantage is going to disappear because the methodology for calculating the carbon levy in Alberta will be fundamentally changed in 2018.

Alberta has announced, as part of it Climate Leadership Plan, that beginning in 2018 SGER will be replaced by a Carbon Competitiveness Regulation (“CCR”) that will require electricity generators to pay a $30 carbon price based on an electricity sector performance standard. The fine details have not yet been announced, but it is expected that the performance standard will be the CO2 emissions that would have been generated had the cleanest gas-fired plant generated the same electricity.  The cleanest gas-fired plant is believed to be the new Shepard Energy Centre referred to above.

So, now lets revisit our calculation to see what this change means for our typical coal plant. The new carbon levy calculation in 2018 for that plant will be the coal plant’s emission intensity of 1 minus the cleanest gas standard of 0.4 times $30, or $18 per MWh. This is a whopping 3 times the current $6 maximum SGER cost we calculated for 2017 using the current carbon levy methodology. Why is that? In simple terms, it is because under the new methodology our typical coal plant will only get to emit 40% of its CO2 for free; instead of the 80% it gets to emit this year for free. Note that the Shepard Energy Centre will likely have no carbon levy to pay under the new regime since it will be the operating standard against which all generators will be measured. This will give the Shepard Energy Centre and other lower emitting gas plants a financial advantage in their competition with coal generation to get their power dispatched in Alberta’s power market.

Coal generators will of course factor these increased carbon costs in the price at which they offer their power to the Alberta market; the increased variable carbon costs under CCR will be added to the variable fuel and other operating costs in setting Power Pool offer prices. We expect this will do two things. First, it will likely result in the lower emitting gas-fired power plants moving ahead of the coal-fired power plants in the Power Pool’s economic merit order as gas-fired power will now be cheaper to generate, such that those gas plants will be dispatched ahead of the coal plants in 2018 to meet Alberta load.   For example, Capital Power recently told its investors that it expects the Shepard Energy Centre to move ahead of Genesee 3 in the Power Pool’s merit order in 2018 if both were to be offered into the Power Pool on a variable cost basis.  Second, it will increase hourly Pool Prices in Alberta, i.e. electricity prices in Alberta will rise as a result of the increased carbon costs for coal generators under CCR.  One large coal generator recently estimated that the change in carbon methodology will increase average Pool Prices in 2018 by $7 to $8 per MWh.

We are seeing coal generators doing some things to prepare for this change. First, they have been busy trying to find ways to reduce the emission intensity of their plants by optimizing their plants and improving the quality of the coal they use to improve heat rates. For example, Capital Power has an internal initiative it calls its Genesee Performance Standard Program focused on reducing emissions intensity at its coal plants to reduce the impact of CCR.  Coal generators have also been stockpiling emission offsets under SGER.  They were likely pleased last week when the Province announced that this inventory of offsets will retain its full value under CCR. However, the Province did throw a wrench into some CCR compliance plans by announcing at the same time that, beginning in 2018, only 30% of a facility’s compliance obligations under CCR will be able to be met by the use of offsets.

Not surprisingly, all generators and other market participants are anxious to see the fine details for the new carbon methodology to be implemented in Alberta, including the form of CCR, so that they can better understand the impact that this fundamental change will have on electricity prices and their businesses. We called the Province yesterday to find out when this might happen and were advised that the first draft of CCR (or whatever it will be called) should be ready by the end of this month or in April and that we should expect a formal announcement at that time.  Hopefully this will include some consultation with market participants on the actual wording of the regulation.  AlbertaPowerMarket.com will be watching this closely and will post again on this issue once more information is released by the Province.

Kent D. Howie and Joelle Dudelzak

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