THIRD QUARTER 2010
Letter to clients
I n one form or another, the government has always
guided resource planning. The last several years saw
renewable power investors seeking an array of valuable
federal investment tax credits, cash grants, and loan guaran-
tees. The result was an historic development boom in wind
turbines and solar panels. The subsidies also extended to
carbon-free non-renewable sources, with even nu-
clear developers considering new sites on the “Government is looking for regulatory nesses, public interest
heels of the federal loan guarantees. But these
incentives are scheduled to expire, as early as the alternatives with
end of 2010 in the case for the federal cash grant.
Rather than continuing to rely on short-term federal stim-
uli, the government is beginning to reach into its policy
toolbox for regulatory alternatives with longer-lasting im-
pacts.
This regulatory effort began to grow last year at the EPA,
when it issued the draft endangerment
finding declaring greenhouse gases to be a
public health threat and, as a result, the
EPA’s clear intent to regulate carbon diox-
ide emissions. The EPA then followed its
landmark finding with a series of proposed
regulations targeting fossil fuel-fired genera- DAI
tion, the most notable being the “Coal
Ash” Rule, the Transport Rule, and the
Tailoring Rule.
The unintended consequence of such a
rapid succession of proposals is an enor-
mous cloud of uncertainty. It’s not simply the staggering
breadth of these regulations, which cover everything from
coal ash disposal practices to emission reductions of SO2,
NOX, and greenhouse gases (including CO2), that makes
investors reluctant. There is still an open question about the
specific approaches ultimately adopted under each proposed
rule.
For example, the proposed “The unintended consequence
Coal Ash Rule contains two enormous cloud of uncertainty” question is whether these compliance-related
distinct approaches, one of
which carries a very large
consequence for coal combustion byproducts disposed in
landfills. The proposed Tailoring Rule targets “large”
sources first, but that threshold seems to be subject to
change. And the Transport Rule contains what is perhaps
the widest spectrum of approaches, ranging from unre-
stricted market-based cap-and-trade programs to direct con-
trol. In each instance, the current forms of the draft rules
introduce large bands of uncertainty for compliance costs.
The courts will also have a say since lengthy legal battles
typically follow major EPA rules like the ones proposed this
year. States, busi-
organizations, and in-
longer-lasting impacts” dustry groups have
already challenged
EPA’s recent proposals and many expect that this round of
lawsuits will take several years to resolve. Some of these chal-
lenges have even been filed prior to knowing the final form
of the regulation. Which of these proposed regulations will
be vacated entirely (e.g., Clean Air Mercury Rule) or re-
manded back to the EPA (e.g., Clean Air Interstate Rule)?
Will these recent regulatory proposals sig-
nal the “last call” to Congress to pass a cli-
mate change bill?
While these battles rage in the courts, de-
velopers are quickly coming to terms with a
significant shift in the cost structure of
power production — a significant upward
shift. Regardless of the policy vehicle (after
all, Congress can still pass legislative alter-
natives), there is agreement among market
participants that generation costs will in-
crease for marginal price-setting generators
under future emission and waste controls. Collectively, the
cost to comply with these policies will inevitably raise the
long-term generation costs to coal-, oil-, and — albeit it to a
lesser extent — natural gas-fired generators.
Since zero-emission technologies are not subject to these
costly compliance requirements, they capture
higher long-term profit margins from operating
is an in the power markets. The underlying economic
increases in energy prices will be high enough to
stimulate the investment in low-emission sources without
the need for the array of financial incentives currently pro-
vided. If CO2 emission reduction (and the corresponding
compliance cost) is the biggest hammer in the policy tool-
box, how high must allowance prices be to attract renewable
resource additions without perpetual tax credits?
 third QUARTER 2010
Letter to clients
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Source of Forecasts: U.S. Dept. of Energy Annual Energy Outlook , 1984 - 2010 California Hurricane
$15.0
Hurricane Andrew Power Energy Katrina Global
FERC Order 836
Markets Crisis Recession
Gulf War I
$12.5 Deregulate
Gulf War II

$10.0
$/MMbtu

$7.5

$5.0 Henry Hub Spot Price

$2.5

$0.0
1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Natural gas prices are notoriously volatile. Events such as legisla-
tion and weather patterns contribute to a degree of uncertainty
that frustrates industry planning. Many a bold prediction has been
— and will continue to be — proven wrong.
Many prediction errors have emerged from truly a final thought
random phenomena such as hurricanes. But
many prediction errors have emerged from failures to fully grasp
growth in either demand or supply. Forecasts can be self-defeating
as well. A forecast of low prices may cause market participants to
plan greater future consumption, negating the low prices and vice
versa.
New concerns such as the prolonged drop in natu-
Postscript
ral gas demand, the long-run effects of the Gulf
spill, and the role that shale will have on supply
will only add to the uncertainty. Forecasting may
be thankless, but it is absolutely necessary. The key is not to pre-
tend that errors do not exist, but rather to study what those errors
could be and incorporate that insight into your planning.