By: Jae Seung Lee
What’s the impact of the United States’ exit from the climate agreement and its new energy policies?
On June 1, 2017, US President Donald Trump announced the US’s exit from the Paris Climate Agreement, an agreement signed within the United Nations Framework Convention on Climate Change (“UNFCCC”) to mitigate greenhouse gas. Even though there has been no other withdrawal, the United States’ exit raised concern among the signatories. Kyoto Protocol, the predecessor adopted in 1997 to stabilize temperature and cut emissions, failed to bring major carbon emitters to the table for a binding climate treaty. It was a landmark accomplishment of global efforts to reduce carbon emission. However, the protocol lost its power following the withdrawals of countries with most carbon emissions due to ‘economic’ reasons. Because of the similarities between the two treaties, the US’s exit may trigger other developed nations’ exit.
Furthermore, in stark contrast to the current global trend of fighting climate change, the current US government plans to continue to ease the relevant regulations. The Clean Power Plan (“CPP”), proposed by the Environmental Protection Agency (“EPA”) under the previous administration to meet targets of the Paris Agreement, has been stalled by the current administration’s effort to revamp the coal mining industry. The CPP’s proactive measure, which enforces utilities to build new renewables, has been met with fierce opposition from the coal industry. Scott Pruitt, the former administrator of the EPA, argued potential benefits of its repeal amount to 33 billion dollars. While many believe these rollbacks have come at an alarming speed, given that the earliest possible effective date of the exit is November 2020, the impact of these new policies may not be substantial in short term.
The current administration’s actions are not without opponents, however. On the day of the US’s official withdrawal, a bipartisan coalition of governors formed the United States Climate Alliance, a forum where states committed to reducing greenhouse emissions can work together to uphold the principles of the Paris Agreement. Most of the states, except some coal-heavy states in the Midwest and Deep South, are likely to meet or exceed emissions requirement for the CPP unless there are price hikes of natural gas, which makes oil more attractive. State-level legislation calling for more renewable energy, cheaper natural gas, and improvements in solar/wind utilities will encourage more green investment.
To add to the issue, in December 2017, President Trump signed a new bill, the Tax Cuts and Jobs Act. Cutting the corporate tax rate from 35% to 21%, the new tax law boosted after-tax profits by reducing the tax liabilities of all companies. While many companies gain from this cut, it will cause damage to the renewables market because of its unique investment structure: tax equity.
Improving efficiency and profitability contributed to the growth of the renewable energy market; in the U.S., this is largely due to tax equity financing. Tax Equity investors passively own renewable projects and gain federal and state income tax benefits with a small return of cash flow. Moreover, these investors are distinct from other equity investors because they cannot be involved in project level management except for downside cases. Flip structure, as its name suggests, enables them to take active control when the project underperforms.
There are two available tax credits: Investment Tax Credit (“ITC”) and Production Tax Credit (“PTC”). ITC is an upfront tax credit against the capital expense used to build a project, and PTC, popular for wind projects, is a tax credit based on the amount of electricity the project produces. Both became less attractive to investors after the tax cut because companies now have fewer tax liabilities. Also, PTC is scheduled for phase-out in 2021. Consequently, the tax reform will be a significant blow to renewable projects’ sponsors looking to raise capital.
Wind may take a hit from decreasing tax credits, yet, there seems to be a new promising sign of growth through offshore wind. Due to their location in the ocean, the construction cost of offshore turbines was initially very expensive; that said, the price has decreased substantially over the last decade, and they generate more electricity compared to onshore wind turbines due to higher wind speed. Hence, offshore wind farms are becoming more and more attractive.
Relative to the history of offshore wind energy production in Europe, the United States is almost two decades behind. Such a large gap stems from different financing schemes; European policies such as the Feed-in Tariff and Contract for Difference induce more investment by minimizing risk exposure, a limited amount of tax equity discourages investors in the US. In 2018, Europe installed 2.6 GW of new offshore wind capacity, of which 85% is attributed to the United Kingdom and Germany. Europe now has 105 offshore wind farms with 18.5 GW capacity. In contrast, the first U.S. commercial offshore wind farm, Block Island Wind Farm near Rhode Island, is only 30 MW and began operating three years ago.
However, starting with new legislation in Northeastern states, the U.S. has been slowly gaining momentum. In 2016, Charlie Baker, a Republican governor of Massachusetts, signed an energy law that requires utilities to procure 1.6 GW from offshore wind farms in the next 10 years. The construction of 1.6 GW projects is estimated to generate a total of $1.4 billion to $2.1 billion. Anticipating similar economic benefits, other states, including New York and New Jersey, have joined the fray.
The Bureau of Ocean Energy Management (“BOEM”), an agency within the U.S. Department of the Interior, is supportive of these new projects. BOEM has successfully executed lease sales in New England, Virginia, Maryland, New Jersey, New York, and North Carolina since the inception of its renewable energy programs. The Department of Energy has also projected continued growth in this sector: 3 GW, 22 GW and 86 GW for 2020, 2030 and 2050, respectively.
Apart from its impressive track record in renewables, the United States is a leading natural gas producer. Natural gas supplies one-third of domestic primary energy and is a primary heating fuel for half of US households. Due to soaring demand of the international market, the U.S. is building more Liquefied Natural Gas (“LNG”) export terminals. With more LNG terminals built in Louisiana, Texas, Maryland, and Georgia, the country will double its export capacity by the end of 2019. This will make the U.S. one of the three largest LNG exporters. Its vast deposit of shale gas and rapidly increasing export capacity prompted more competition among global competitors: Qatar and Australia. Uncertainty due to China’s 10% tariff on U.S. LNG caused a delay of investments in the facilities; however, global demand of LNG is projected to increase consistently, and other major LNG importers such as Japan and South Korea will continue to purchase U.S. LNG to appease the U.S. during its trade wars.
Hydraulic fracturing (“Fracking”) largely contributed to a dramatic increase in gas production. Fracking has cut energy production cost, thereby offering lower energy prices. Recent roll-back of its strict regulations will boost the production even more. As natural gas only produces 50 ~ 60% less carbon monoxide than coal when it is burned at an energy plant, it is considered to be a decent alternative for coal and petroleum. As a result, its share of the domestic energy mix has increased rapidly, and it is the largest among the mix as of today.
Despite its advantages, the natural gas industry prompted environmental concerns. The most controversial one is fracking. It made the resource accessible and secured a significant amount of energy, but it uses an excessive amount of water, may trigger earthquakes, and poses risks of leaking chemicals to drinking water or air. Some energy researchers argue that the carbon footprint of liquefying the gas and transporting it with pipelines and vessels may be bigger than the one of coal. Natural gas is indeed a stable source of energy that relatively emits less carbon, but it remains a fossil fuel nonetheless.
Incentive-driven corporations pursue profit maximization. In a Wood Mackenzie study, rates of return of conventional energy projects are found to be much higher than those of recent renewable projects. Oil explorations’ IRR is 8 to 15%, and North American onshore production’s return is 33% on average. These are much higher than the returns of renewables, which are 5% and 7% in wind and solar respectively in a developed country. At least for now, it seems reasonable for large energy conglomerates to pursue what they have been doing well.
Quantifying positive and negative externalities in the energy industry is very difficult. Like fracking, revolutionary methods of using resources can create another problem. Natural gas is deemed to be a bridge fuel from carbon-intensive petroleum to eco-friendly energy, but it is also blamed for detaining transitions to renewables. Tax credits, which guarantee revenue to make renewables’ long-term contracts attractive, thereby reducing carbon emissions, can phase out anytime soon if Congress does not approve its extension. Ironically, technological innovations and environmental policies put the industry on the horns of a dilemma. Conflicts between interest groups hinder society from realizing greater initiative of improving the environment and producing sustainable energy. It is now more than ever for policymakers to consider not only economic benefits but also health and welfare for future generations.
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