Global Warming: Can We Find Common Ground? | Cinergy 2004 Annual Report

Ms. Furey is senior director of Fitch Ratings’ global power group. Her responsibilities include the analysis and ratings of electric utilities, energy marketers and wholesale electric generators. She has worked in commercial banking and bond insurance, most recently with MBIA, where she analyzed energy companies and structured finance transactions.

Rittenhouse: Are you seeing greater public awareness on environmental issues?

Furey: Yes, there is a growing interest in environmental issues. In particular we are getting a good deal of calls from many investors, the media and environmental groups about emissions trading. Two things have happened and these are noted in the report I wrote for Fitch with Rajat Sehgal, The Status of Environmental Regulation, dated October 2004. First, the discussion today is no longer about whether global warming exists; it’s about the significance or extent of global warming. Second, global warming is no longer just a topic of discussion among scientists and environmentalists. It is now on the radar screen of part of the mainstream financial institutions, such as insurance companies and institutional investors.

Institutional investors, such as public pension plans and investment funds of faith-based organizations, appear to be most interested in global warming. These groups have socially responsible investment criteria. They want to fulfill their social desires and make money at the same time. They need to take care of their retirees. One institutional investor of note is the investment fund of the Presbyterian Church USA.

Rittenhouse: Still, I find that most mainstream investors, including institutional investors, are not really concerned or focused on the issue of global warming.

Furey: Most institutional investors haven’t focused on global warming because there is no federal regulation of carbon dioxide (CO₂) in this country at this time. Fitch does not anticipate such regulation for the next one to five years. As a result, there is a mismatch between company planning horizons and investor horizons. Utility companies have to build baseload power plants that have useful lives of roughly 60 years. If they want to start construction in 2008, they must plan now for those facilities. In other words, the utility construction cycle and investor’s time horizons are totally different. Most institutional investors turn their portfolio over every two years or less. There are times when even Fitch’s analysis may not include projections further out than five years.

Insurance companies have a much longer time horizon. There have been instances of people being denied flood insurance based on concerns that water levels may rise due to global warming.

Rittenhouse: How does this mismatch of investor and company planning horizons affect the planning and construction of major power plants?

Furey: The issue is really about what kind of plant will be built? Will it be a Pulverized Coal (PC) plant or an Integrated Gasification Combined Cycle (IGCC) coal plant? IGCC plants are expected to greatly reduce sulfur dioxide (SO₂), nitrogen oxides (NO_X) and mercury emissions. They burn coal more efficiently and as such have lower CO₂ emissions than conventional coal plants. However, if it comes down to cost, IGCC plants cost more to build and the technology is relatively new.

While Fitch believes that we will probably have a carbon law at the federal level in five years, the fact is that we do not have one now. Without regulatory certainty, many companies may not obtain the support they need for building a more expensive plant than one that uses more proven technology.

There’s also the issue over carbon sequestration. The industry will need an economically feasible way to sequester carbon. In other words, it will need a way to strip out CO₂ and then inject and store it in geologic formations or other places. There is some limited research in this area. IGCC plants do not necessarily sequester carbon, however, it is expected that they will be more easily retrofitted for sequestration equipment as compared to a PC plant.

The problem is companies that can develop carbon sequestration technology don’t have a real incentive to accelerate that development at this time. They need to know when there will be laws in place that will require generators to buy their technology. So there’s no real incentive for this technology at this time. About a year ago, Wisconsin Electric proposed building an IGCC plant, but their state regulatory commission didn’t approve it. They didn’t agree with the company’s assessment as to the future environmental cost benefits of building a more expensive plant today.

Rittenhouse: Are you seeing actions at the state level that would help people gain more certainty in estimating the cost of CO₂ reductions so they could plan for the future?

Furey: A group of eight governors in the Northeast wants to reduce carbon emissions by 2010. We expect that sometime this year, they’ll propose regulations that all eight states can adopt in common. Currently, Massachusetts has laws regulating CO₂ emissions on power plants as does New Hampshire. California has carbon reduction rules for vehicles. The focus has primarily been on regulating greenhouse gas emissions (GHG) from power companies since they are the largest emitters. But many people in the industry want to see comprehensive regulation that applies to all sectors.

Rittenhouse: How will this affect electric power prices?

Furey: Initially, carbon regulation efforts will affect prices in the Northeast. As I mentioned before, there probably will be carbon reduction rules in place in eight northeastern states. Additionally, we may see higher power prices for the power imported from Canada. Having signed the Kyoto Protocol, they have to comply with the new regulations. The Province of Ontario has announced plans to shut down 7,700 megawatts of coal-fired capacity. Currently, regulation of power industry pollutants is fragmented. This creates uncertainty for companies and challenges their ability to effectively plan capital expenditures. I believe that Cinergy mentions the need for comprehensive federal law that addresses all pollutants.

Rittenhouse: I’ve heard that companies who are proactive in complying with regulations may benefit by acting early.

Furey: Yes, that was true with regards to being proactive with the phasing in of SO₂ compliance. For example, the U.S. EPA allocates each company a certain number of “allowances” under the Clean Air Act. For each allowance, a company gets to emit (in the case of SO₂) a ton of the pollutant. If companies accelerate their emission reductions, they will have allowances that they can sell to others. They can also decide to bank these so they can use them in the future.

Many in the industry believe CO₂ regulation will establish a system that also phases in increasing reductions over time. Some companies are concerned that if they reduce emissions before a definitive federal law is in place their reduction schedule will be based on the lower emissions levels at the time the law is enacted. They won’t get credit for the efforts and expense they had made to reduce CO₂. Other companies believe that they will be rewarded for early compliance. I happen to think that from a management perspective, being proactive is a positive attribute across the board. Companies will be better prepared if they are looking out for a problem before it happens. When you are acting, your competitors will be reacting. This will put you ahead.

Rittenhouse: How well are these markets working?

Furey: Markets for SO₂ and NO_X both work. The EPA verifies the amount of pollution at its source. Because companies are required — at least for SO₂ and NO_X — to put in verification equipment, I don’t really know how anyone could game that system unless they can tamper with the equipment. At this point in time, the markets have not been robust or liquid enough to have a lot of people entering the market just to trade. For SO₂ and NO_X, sulfur is the more liquid market and there are days when things just aren’t traded. In the report we did, I mentioned Cantor Fitzgerald and some other entities that are trading SO₂ and NO_X allowances. The Chicago Climate Exchange will act as a clearinghouse and has started selling SO₂ futures. They’re going to have a committee that will actually determine a price for days when there are no trades on the exchange.

Rittenhouse: Once you get the liquidity, you’ll get more transparency and with more transparency, the market becomes even more liquid and robust. Is that right?

Furey: I believe that carbon is most conducive to large-scale trading mainly because buying a carbon credit in this country from somebody in Russia does have the required environmental effect. What you’re doing with carbon has an effect on the global climate. The difference is that the potential impacts of SO₂ and NO_X are more regional.

Rittenhouse: Do you favor this cap and trade approach to reducing emissions?

Furey: First, I believe that the emissions trading approach to CO₂ is going to help companies make better investment decisions. That’s what we learned from the trading of SO₂ emissions. The cap and trade program has been very effective. The reduction in SO₂ emissions actually exceeded what the EPA predicted. Companies benefit because this program sets price signals that helps them better plan their capital expenditures. Companies can choose between investing in equipment to meet the SO₂ reductions; they can decide to shut down a plant if that is more economical or they can buy emissions credits.

Rittenhouse: So there are already cap and trade systems in place for SO₂ and NO_X. And now we have trading going on in the European Union for carbon.

Furey: We trade carbon here in the United States on the Chicago Climate Exchange. Members agree to reduce carbon by a certain amount per annum and can buy and sell carbon credits on that basis. I am aware of only two U.S. utilities that are members of the exchange, American Electric Power and TECO Energy. The companies who join believe we’ll have carbon limitations down the road. They also think there will be a cap and trade program so they are buying credits now when they are very cheap. Carbon credits cost only $1 per ton in the United States compared to about $10 to $12 dollars per ton in Europe. Some industry participants have estimated that the market could eventually be in the trillions of dollars.