Policy Innovation Economics Aug 3, 2012
The Low Cost of Capturing Carbon
A climate-friendly technology may be cheaper than we thought
Scientists have been telling us for years that continuing to release carbon dioxide into the atmosphere will have catastrophic effects on our climate.
And in this country, much of the CO2 emitted comes from producing electricity. According to the United States Environmental Protection Agency, electricity generation was responsible for about 40 percent of the economy’s total CO2 emissions in 2010.
“If you look at the energy industry, the biggest players are the coal-fired and natural gas power plants, because they produce almost 70 percent of the electricity,” says Özge İşlegen, an assistant professor of managerial economics and decision sciences at the Kellogg School of Management. But because alternative energy technologies are relatively costly, we will continue to use fossil fuel–generated electricity. “On the other hand,” she says, “there is a greener technology for these kinds of power plants, which is called carbon capture and storage technology.”
Using this type of technology, commonly known as CCS, to reduce CO2emissions has been put forth as part of a cap and trade or carbon tax system. Policies such as the American Clean Energy and Security Act, which passed the U.S. House of Representatives in 2009 but died in the Senate, have been under consideration for many years.
“One of the biggest arguments of opponents is that this kind of bill might actually devastate the economy and there might be a huge financial toll for the energy consumers,” İşlegen says. But according to her research with her colleague Stefan Reichelstein, a professor at Stanford University, implementing carbon capture technologies in coal-fired power plants would cost a lot less than we think.
CCS technologies have the potential to reduce CO2 emission from the power plants by as much as 85 percent. However, installing these devices costs money. If a carbon tax or cap and trade policy is introduced, power plants will have to pay for the amount of carbon they emit anyway. But how much the companies have to pay for the CO2 they let off will dictate when exactly they put in CCS devices, İşlegen says. At what price will they actually switch to greener technologies?
According to the calculations of İşlegen and Reichelstein, the break-even point for coal-fired power plants would be approximately $30 per tonne of CO2. This is much lower than the price predicted by other studies, including the 2007 McKinsey & Company study, “Reducing Greenhouse Gas Emissions: How Much at What Cost?”, which said that power plants would convert to CCS technologies only at $50 per tonne.
And ultimately, the price for implementing CCS technology would be passed along to the consumer. İşlegen and Reichelstein found that at this break-even price, the retail electricity prices will increase by about 30 percent. “This of course is not a small amount, but it’s small compared to other studies that claim that electricity prices may double if a cap and trade or carbon tax were to be introduced,” İşlegen says.
“Also, under rate-of-return regulation, electricity prices are set to cover the firm’s historical accounting cost. This means electricity prices will increase gradually if utilities receive emissions allowances for power plants constructed prior to the introduction of a climate policy.” These are conservative estimates, İşlegen says. “We used high prices for introducing CCS technology, and despite that we were able to find these relatively low numbers.”
“Natural gas power plants by themselves emit half of the emissions of coal-fired power plants, so they are actually cleaner from the beginning, without introducing the green technology,” İşlegen says.
In contrast, they found that the break-even price would be about $60 per tonne of CO2 for natural gas power plants. There are two reasons this number is higher than the break-even point for coal-fired power plants.
“Natural gas power plants by themselves emit half of the emissions of coal-fired power plants, so they are actually cleaner from the beginning, without introducing the green technology,” İşlegen says. “Therefore you need to increase the permit price so high such that the natural gas power plants will want to switch to greener technology.” The second reason is that it is more technically difficult to add CCS technology to natural gas power plants, and harder labor equals higher cost.
İşlegen and Reichelstein also calculated what would happen if both fossil fuel sources are available in a particular location, asking when we would switch over from the dirtier coal-fired power plants to natural gas power plants. The result was a carbon price of about $20 per tonne of CO2. So even when CCS is available, it is cheaper to first change to natural gas.
“And then if the carbon price gets any higher, CCS becomes more profitable,” İşlegen says. She is quick to point out, though, that this $20 switchover point is based on natural gas prices from two years ago. Since then, natural gas prices have dropped significantly due to sharply increased shale gas production in the United States, and now this point would be even lower. But İşlegen and Reichelstein set up their models with such price fluctuations in mind.
“We basically put forward a framework in terms of calculating the effect of policy on the electricity prices. Given that there are many changing parameters during this time, you can plug the numbers into our model,” İşlegen says. Using their formulas, it is possible to calculate an approximate CO2 permit price where it will be cost effective to implement a technology change. “A similar framework can be established for other kinds of power plants or production plants,” she says.
Right now, the only place where CCS technology will soon be a reality is in the FutureGen project, a cooperative project between private firms and the Department of Energy to make a near zero-emissions coal-fired power plant. It is slated to start construction later this year in Meredosia, Illinois.
“The problem is, a commercial-sized demonstration power plant is really, really expensive, and therefore many companies have to combine their effort with the government,” İşlegen says. And only then will they be able to demonstrate that CCS technology can actually work. “Demonstration projects like FutureGen and research projects exploring the economics of ‘clean’ technologies are essential in guiding the debates on climate change policy.”
Related reading on Kellogg Insight
Buy Coal? Purchasing the dirty fossil fuel could help fight climate change
Timing Is Everything: The duration of climate agreements influences their success
And the Poor Get Poorer: The economics of higher global temperatures
Islegen, Ozge and Stefan J. Reichelstein. 2011. “Carbon Capture by Fossil Fuel Power Plants: An Economic Analysis.” Management Science. 57(1): 21-39.
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