Economic Impacts of Implementing a Regional SO 2 Emissions Program in the Grand Canyon Visibility Transport Region Prepared for: Western Regional Air Partnership Market Trading Forum Prepared by: ICF Consulting January 2000

2 Volume II Overview of Analytic Framework and Inputs to REMI Detailed Discussion of Economic Impacts Agenda

3 Volume II Overview of Analytic Framework and Inputs to REMI

4 Volume II Regional economic impacts were analyzed using REMI’s Policy Insight Model. A10-region, 53 sector version of REMI’s model was acquired to simulate the regional economic impact of regional SO 2 reduction policies at the state level for the the nine GCVTC states and the single tribal region. Key drivers to REMI were derived from the economic modeling using ICF’s IPM. Regional Economic Impact

5 Volume II Key inputs to REMI derived from IPM are: –Non-fuel expenditures resulting from the policy Total Capital Investment Annual incremental cost –Changes in wholesale electricity prices –Changes in fuel production and consumption –Net revenue from permit allocations. All impacts from IPM were characterized by state, sector and year. Key Inputs to REMI

6 Volume II Key Drivers: Non-Fuel Expenditures Non-fuel Compliance Costs (by state and sector) Incremental Capital Investments Incremental Annual Fixed and Variable O&M Expenditures from Installation of Equipment (scrubbers, new generation or retrofits) Capital expenditures are split between construction and equipment purchases Regional Purchase Coefficients (RPC) in REMI determines allocation of expenditures across regions REMI allocates regional expenditures by sector and input mix. Secondary effects are on household income, wages, prices, Annualized Cost (by State and Sector) Net Change in annualized production costs = change in revenue+change in annual capital and FOM+Net fuel cost changes+net permit revenues Electric generators pass-through unrecoverable cost changes or excess revenues to shareholders > Share ownership - national and distributed based on household income Other sectors experience decreased profitability due to increased production cost > Sectors that compete regionally pass-through costs via to producers and consumers > Sectors that compete nationally experience a change in market share

7 Volume II Annual Incremental Cost Annual incremental costs, projected by IPM, denote the compliance cost of the policy and are incremental to the base case. Annual incremental cost consist of changes in capital investment and changes in variable and fixed operating cost. Annual incremental costs affect the regional economy in two main ways. – Non-electric industries that compete nationally experience a decrease in competitiveness, while non-electric industries that compete locally change their product price. Electric generators pass through unrecoverable cost changes or excess revenues to shareholders. – Capital investments spur construction and increase equipment purchase.

8 Volume II Incremental Annual Cost in 2013 (millions 1997$)

9 Volume II Incremental Annual Cost in 2018 ( millions 1997$)

10 Volume II Annual Incremental Cost (Continued) Sources located in AZ, CO and WY bear most of the cost (primarily capital investment costs) associated with the command & control scenario because a large share of the BART-eligible sources are located in these states. Sources located in CA realizes lower costs in 2013 and 2018 under the trading scenarios because of the lower level of repowering of existing oil/gas steam units relative to the Baseline.

11 Volume II Annual Incremental Cost (Continued) Similarly, sources located in CO and WY realize lower costs in 2013 under the trading scenarios relative to the baseline because repowering of existing ICI boilers is postponed in anticipation of the policy in 2018.

12 Volume II Trading Cases – Incremental Cost for GCVTC States in 2018

13 Volume II Incremental Annual Capital Cost in 2013 ( millions 1997$)

14 Volume II Incremental Annual Capital Cost in 2018 ( millions 1997$)

15 Volume II Key Drivers: Changes in Wholesale in Electricity Prices Electric Distribution Companies Changes in electricity prices affects industrial, commercial and residential customers. Changes in wholesale electricity prices affects utility revenues and shareholder profits. Commercial/Industrial Users of Electricity Changes in electricity prices for the commercial/industrial sector affects the cost of raw material inputs. Non-electric sectors that compete regionally are able to pass-through input cost changes to their consumers. Sectors that compete nationally experience a change in competitiveness relative to other regions. Residential User of Electricity Changes in electricity prices affects residential consumers as change in Consumer Price Index (CPI) and purchasing power Changes in CPI directly affects real after-tax wage rate, and has indirect effects on migration, labor force and government services.

16 Volume II Wholesale Electricity Prices Projected changes (relative to the baseline) in wholesale energy prices from IPM are used to derive changes in retail energy prices paid by residential, commercial and industrial sectors. We assume competitive market conditions where changes in wholesale energy prices are the only price impacts observed by end users under a policy. Any unrecoverable costs are absorbed by shareholders; revenues in excess of costs are passed on to shareholders in the form of increased dividends.

17 Volume II Wholesale Electricity Prices (Continued) Wholesale energy prices in IPM represent the variable cost of the marginal generating unit and simulate continuously clearing competitive electric generation markets. Electricity prices only change if the variable cost of production of the marginal unit changes. Electricity price impacts in the command & control scenario are small relative to the trading scenarios because capital investment (which does not directly influence variable operating cost) dominate the compliance strategy under the command & control scenario.

18 Volume II Wholesale Electricity Prices (Continued) Since fuel costs (which directly influence variable cost of operation) dominate incremental cost under the trading scenarios, electricity price impacts under the trading scenarios are relatively more pronounced. Decline in electricity prices in 2013 represent inter- temporal tradeoffs in anticipation of the policy in 2018.

19 Volume II Wholesale Electricity Price Impacts 2013

20 Volume II Wholesale Electricity Price Impacts 2018

21 Volume II Fuel Mix Impacts in REMI Fuel Production and Consumption Changes in the value of coal produced Changes in the value of gas consumption by the electric utility and non-utility sector Changes in fuel expenditures by sector and region is modeled as a change in dividends for public-utility sector companies and as production costs for non- public utility sector Companies Coal Change in the value of coal produced affects the mining sector in REMI Gas REMI determines the share of gas consumption that is produced within a particular region

22 Volume II Fuel Production & Consumption

23 Volume II Impacts on Coal Markets Coal prices and coal production in IPM are endogenously determined in IPM and are based on coal supply curves. Coal revenues increase under the trading scenarios. The total increase in the GCVTC region is less than a percent (0.7 %) in 2018 under the Environmental scenario. Coal revenues decline under the Command & Control scenario. The total decline in the GCVTC region is less than a percent (0.5 %) in 2018.

24 Volume II Impacts on Coal Markets Trading Scenarios Although coal-based generation (and coal consumption) decreases in the 9 states GCVTC region in the Trading scenarios, coal production in the same 9 state region increases. Revenues from coal production from the 9 states region increases as the SO 2 reduction requirement becomes more stringent across the trading scenarios. Increase in coal revenues is largely due to increased exports of western coals to other parts of the country.

25 Volume II Impacts on Coal Markets Trading Scenarios (Continued) Increased demand for western coals is offset by decreased demand for coal from other regions of the country, predominantly the mid-west. Increased export of western coal to other parts of country reflect: –Decreased demand for coal in the GCVTC region. –Less stringent national SO 2 cap due to SO 2 reductions in the GCVTC region. This leads to increased coal generation in the rest of the country.

26 Volume II Impacts on Coal Markets Command & Control Scenario Under the command and control scenario coal revenues in the GCVTC region declines. Command & control is a capital intensive program that does not lower coal purchases in the GCVTC region: –Coal consumption increases slightly in the GCVTC region. –Increased coal demand in the 9 state region is largely the result of additional new coal capacity.

27 Volume II Impacts on Coal Markets Command & Control Scenario (Continued) Increased coal demand in GCVTC region: –Puts upward pressure on western coal prices and plants capable of receiving non-western coal switch away from western coal. –Decline in export of western coal to other parts of the country leads to a decline in coal production in the western states. Production cuts in the western states are balanced by production increases in the Appalachian region.

28 Volume II Coal Revenue Impacts by State in 2013 (millions 1997$)

29 Volume II Coal Revenue Impacts by State in 2018 (millions 1997$)

30 Volume II Gas Consumption Change in gas consumption is relatively small under the Command & Control scenario because the policy does not create incentives to shift to natural gas. Gas consumption increases with the stringency of the trading program because increased generation from gas is a significant compliance strategy.

31 Volume II Gas Consumption by State in 2013 (millions 1997$)

32 Volume II Gas Consumption by State in 2018 (millions 1997$)

33 Volume II Permit Trading Impacts in REMI Revenue Impacts from Allocations Allowance allocation is compared to projected emissions to determine net allowance position by sector and geographic area Revenue impacts from allocation depend on net allowance position and permit price Non-Tribal Revenue impacts from allocations for sectors that compete regionally flows through as changes in dividends for shareholders Revenue impacts from allocations for sectors that compete nationally flow through to the production cost of that sector Tribal Revenue impacts from allocation to tribal areas flow through as changes in tribal government expenditures.

34 Volume II Allowance Allocation Revenues Revenues (or expenses) from net allowance sales (or purchases) represent the net position of each state given the initial distribution of allowances and projected emissions. Data on the distribution of allowances by sector and state were provided by MTF participants. Allowance prices and the emissions in each state were projected by IPM. A state sells allowances if its allocation exceeds its emissions and buys allowances if its emissions exceeds its allocations.

35 Volume II Allowance Revenue Impacts in 2018 (millions 1997$)

36 Volume II Detailed Discussion of Economic Impacts

37 Volume II Economic Impacts For the purposes of this analysis, three indicators of economic impacts are reported: –Employment, –Gross regional product, and –Real personal disposable income.

38 Volume II Review of Key Assumptions Sectors that compete regionally are able to flow through changes in production cost to prices. Sectors that compete nationally are unable to flow through production cost increases to price and pass-through these changes to shareholders (as changes in profits). Electric utility sector operates in a competitive regional market. To the extent that price increases are reflected in wholesale electric prices, they are recovered. Excess recovery or under-recovery are flowed through to shareholders. Shareholders are distributed across the country and are approximated by the distribution of personal income. On this basis, approximately twenty percent of the shareholders are estimated to be located in the nine western states and tribal region.

39 Volume II Economic Impacts for GCVTC States in 2013 Note: Totals might not match due to rounding.

40 Volume II Economic Impacts for GCVTC States in 2018 ChangesMinorityMTFEPA Environ- mental Command & Control Employment-926-1,418-1,434-7, GRP (Million 92$) Real Disp Pers Inc (Million 92$) % ChangeMinorityMTFEPA Environ- mental Command & Control Employment GRP Real Disp Pers Inc Note: Totals might not match due to rounding.

41 Volume II Regional Economic Impacts Changes in the three economic indicators are positive in 2013 and negative in 2018 by a similar order of magnitude. The magnitude of the changes in the three economic indicators are all very small, with no change in an economic indicator being larger than 0.05 percent at the regional level. Impacts on the three economic indicators are relatively small because the cost of the SO 2 reduction policies are all relatively small. Even the highest cost of $274 million to all sectors is well under one percent of the total production cost of the electric utility sector alone.

42 Volume II Command & Control Scenario Economic impacts from the command and control scenario are positive in 2013 and comparable to the EPA trading scenario. Increased economic activity in 2013 under the command and control scenario reflects the surge in capital investment that begins in The one-time surge in employment in 2013 is primarily due to capital investments under the command and control scenario. Employment levels decline with some lag.

43 Volume II Command & Control (Continued) Economic impacts in 2018 under the command and control scenario, however, are negative, but of a more modest magnitude. Command and control scenario is a capital intensive program primarily affecting the electric utility sector. Because under the command and control scenario most costs impacts are capital, electricity price impacts in competitive markets are relatively small.

44 Volume II Command and Control Declines in gross regional product and real personal disposable income occur in 2018 under the command and control scenario after positive impacts in For the command and control scenario, the longer- term economic equilibrium would be expected to approach pre-policy levels due to the fact that the policy reflects a one-time shock to the region that does not systematically alter the non-utility sectors. Shareholders of the utility sector continue to bear the costs of the policy. However, these effects are distributed nationally, with, of the nine state area, only California bearing a significant share of this impact.

45 Volume II Trading Scenarios All trading scenarios yield an overall increase in all three economic indicators in 2013, and an overall decrease in the economic indicators in The dampened decline in gross regional production in 2018 under the EPA scenario represents the lagged effects of EPA trading scenario, unlike the other trading scenario, has no incremental cost in 2013.

46 Volume II Trading Scenarios Impacts (Continued) Economic impacts from the environmental scenario are greater than the other trading scenarios because in these scenarios nationally competing, non-utility sectors bear a larger portion of the compliance cost relative to the other trading scenarios. Thus, they loose competitiveness and market share with attendant impacts on employment, wage rates, and household income. The Environmental Scenario also has the lowest level of capital investment, lower than the Base Case, thus employment impacts are largest.

47 Volume II Trading Scenarios Impacts (Continued) California bears a large share of the impacts in employment, GRP and income relative to other states.This is primarily due to its relative size. California is the largest of the nine states, in terms of employment, income and output. –Income was used as the proxy for shareholder distribution. Sixty-six percent of GCVTC utility shareholders are assumed to be located in California. –GCVTC electric utility shareholders realize a loss in income when increased electric utility expenditures due to the policy are not recovered through electric prices. –California experiences a larger than average increase in electric prices which increases the cost of production for all other industries.

48 Volume II Trading Scenarios Impacts (Continued) In addition, the mix of industry in California affects the relative impacts. –Many of the industries located in California compete nationally and are not able to pass through the increased production cost from higher electricity prices. –These industries because less competitive as a result of the the increased production cost from electric price increase. –Loss of competitiveness leads to lower output, resulting in lower employment, reduced income and lower gross regional product.

49 Volume II Impact on Gross Regional Product in 2013 (millions 1992$) StateMinorityMTFEPA Environ- mental Command & Control AZ CA CO ID24478 NM NV OR UT WY Tribal Total

50 Volume II Impact on Gross Regional Product in 2018 (millions 1992$)

51 Volume II Impact on Employment in 2013 (Number of Workers) StateMinorityMTFEPA Environ- mental Command & Control AZ ,5951,041 CA7621,1351,0781,9061,027 CO , ID NM NV OR UT WY ,005 Tribal Total1,9693,7454,1837,8014,471

52 Volume II Impact on Employment by State in 2018 (Number of Workers) Command & Control StateMinorityMTFEPA Environ- mental AZ , CA-963-1,775-2,197-4, CO ID ,2471 NM NV OR , UT WY Tribal Total-801-1,413-1,429-8,

53 Volume II Impact on Real Disposable Personal Income by State in 2013 (millions 1992$)

54 Volume II Impact on Real Disposable Personal Income by State in 2018 (millions 1992$)

55 Volume II Sensitivity Analysis Regional economic impacts are sensitive to assumptions about the recovery from ratepayers of compliance cost borne by the electric generating industry. We assumed that retail prices reflect competitive prices in wholesale markets based on marginal energy costs. Thus, revenues in excess of production costs accrue to shareholders. However, an alternate assumption that the electric utility sector may be able to fully recover its costs through price flow-through to end user has a more extended impact on the regional economy.

56 Volume II Sensitivity Analysis (Continued) Under this alternate assumption of guaranteed cost recovery, the production cost of other sectors, using electricity as an input, increases. The following three slides detail the regional economic impact of a command and control scenario for 2013 and 2018 under these alternate assumptions regarding cost recovery.

57 Volume II Economic Impacts by State Sensitivity Analysis

58 Volume II Economic Impacts by State Sensitivity Analysis

59 Volume II Economic Impacts by State Sensitivity Analysis

60 Volume II Conclusions Change in employment, gross regional product and disposable income are by state, and may appear to be more significant if the economic impacts are concentrated within the certain localities of a state. The modeling framework was constructed to report at the state level. Employment, gross regional product and disposable income increase just before a policy takes effect and decrease after the policy takes effect. Changes in employment, gross regional product and disposable income represent anticipated fluctuations in economic cycle due to policy.