Federal Climate Policy 103: The Power Sector

The power sector (also known as the electricity sector)—which includes the electrical grid system of power plants and lines that generates and distributes electricity to consumers—was responsible for about 25 percent of greenhouse gas emissions in the United States in 2019. Within the sector, coal-fired power plants produce 59 percent of emissions, natural gas power plants contribute approximately 37 percent, and the remainder of the emissions come from petroleum and other sources.

This explainer focuses on the tools that federal policymakers can use to reduce power sector emissions and mitigate the impacts of climate change. These tools include carbon pricing; clean electricity standards; renewable portfolio standards; tax credits; research, development, and demonstration; and direct regulations.

Over the past few decades, CO₂ emissions from the power sector have declined, due in large part to reduced power generation from coal in favor of cheaper natural gas and renewables. Looking to the future, several states have pushed for aggressive electrical system decarbonization strategies by requiring 100 percent zero- or low-carbon (or “clean”) energy within the next few decades.

The Basics

Carbon pricing can take the form of either a carbon tax, which places a tax on each ton of CO₂ emitted, or a cap-and-trade policy, in which total CO₂ emissions from the electricity sector are capped and allowances to emit are traded in a market. The explainers “Carbon Pricing 201: Pricing Carbon in the Electricity Sector” and “Carbon Pricing 301: Advanced Topics in Pricing Carbon in the Electricity Sector” outline the power-sector considerations and effects of a carbon price.

Benefits and Challenges

Carbon pricing policies tend to be an economically efficient method of reducing greenhouse gas emissions, relative to other policy options for reducing emissions from electricity, because they directly target emissions. By increasing the cost of high-emitting power generation, carbon pricing encourages a transition away from carbon-intensive fuels in favor of lower-carbon fuels and can incentivize reductions in electricity consumption.

However, carbon pricing can be difficult to implement politically, due to resistance to new fees and corollary increases in retail electricity prices, as electric companies typically pass costs through to ratepayers.

Key Considerations

One important consideration is how to use the revenues raised from the carbon price policy. Revenues could help offset the costs of the policy to consumers, either across the board or in a way that targets low-income consumers. Another option is to invest the revenues in other policy tools that further decarbonization goals, such as research and development for low-carbon technologies.

The second consideration is that a carbon price that targets the electricity sector can discourage electrification of other sectors of the economy, because electricity becomes more expensive with the policy in place. As such, special attention to newly electrified vehicles, buildings, and other loads—such as through separate, lower electricity rates for electric vehicles—could be necessary so that the carbon price does not discourage electrification.

Past, Current, and Proposed Carbon Pricing Policies

Several carbon pricing bills have been introduced in Congress, but historically, they have gained little traction. While no federal carbon pricing policy has come to fruition, several states have regional carbon pricing policies in place for electricity. For example, the New England states and California have had regional cap-and-trade programs for emissions from electricity in place for several years with success. The New York State grid operator also recently proposed incorporating a carbon price into its wholesale energy market.

The Basics

A clean electricity standard (CES) (a type of clean energy standard) is a market-based policy that requires a minimum percentage of electricity sales to come from “clean” energy resources. This percentage requirement typically increases over time until it meets a goal, such as 100 percent clean electricity sales. While the definition of “clean” can vary from policy to policy, the term typically refers to low-carbon or carbon-free attributes and is technology inclusive, meaning that any technology that meets certain emissions requirements can qualify for credits. As such, a CES can encourage the use of zero-emitting renewables, nuclear, and fossil fuel plants fitted with carbon capture.

Load-serving entities (LSEs), which distribute electricity to consumers, comply with the policy by procuring clean energy credits that are earned for each megawatt-hour of electricity produced by clean resources. Credits can be traded, which enables LSEs to meet the standard using the lowest-cost resources. The policy also could be designed for generators, rather than LSEs, to comply with the standard. (For more details on the role of generators and LSEs in electricity markets, read “Electricity 101.”)

Benefits and Challenges

A CES has many advantages over other policy options for decarbonizing the electricity sector. Because a CES is technology neutral in its definition of “clean,” more technologies can compete to meet the standard, which lowers compliance costs relative to a more traditional Renewable Portfolio Standard (discussed below). Additionally, a CES is structured similarly to Renewable Portfolio Standards used in most states today; therefore, a CES could be simpler to implement relative to other policy options.

A CES has some disadvantages relative to a carbon price, however. Unlike a carbon price, a CES credits clean electricity instead of taxing carbon-emitting electricity, and this crediting creates incentives to increase electricity generation. Therefore, the policy does not encourage energy efficiency or conservation to the same extent as a carbon price. Thus, a carbon tax can be a more efficient policy tool because it encourages emissions reductions from both reduced electricity consumption and cleaner electricity generation, which can lower the costs of achieving carbon goals.

Key Considerations

Key design considerations for a CES include how to set the federal standard, given existing state policies and existing resources. Some states, like California, already are pursuing 100 percent clean electricity portfolios, while others have not established clean energy policies and rely heavily on in-state fossil fuel resources for electricity generation. As such, a federal CES policy would have to ensure that the policy takes states’ existing resource portfolios into account when establishing targets, to avoid a scenario in which polluting states bear most of the costs of compliance, which would result in a transfer of wealth from polluting states to cleaner states.

Past, Current, and Proposed CES Policies

A few CESs have been proposed at the federal level, but none has passed. For example, Sen. Smith (D-MN) and Rep. Luján (D-NM) cosponsored the Clean Energy Standard Act of 2019 that requires 96 percent of electricity sales to come from clean sources by 2050. RFF analysis of the bill finds that the policy would have reduced emissions from electricity by about 10 billion metric tons, or by 61 percent, between 2020 and 2035. Other proposals, including the CLEAN Future Act and the Clean Energy Innovation and Deployment Act, have been introduced as well.

While no federal CES currently exists, some states have implemented versions of a CES. Massachusetts, for example, implemented a CES in 2017 that requires 80 percent of electricity sales to come from clean energy resources by 2050.

The Basics

A renewable portfolio standard (RPS) is a market-based policy that requires a portion of electricity sales to come from renewable energy sources, with the requirement typically increasing over time. An RPS is similar to a CES in that renewable energy generators earn renewable energy credits for every megawatt-hour of electricity generated, which can be traded.

Benefits and Challenges

RPS policies are already quite popular. Twenty-nine states and the District of Columbia have a mandatory RPS in place, and an additional eight states have a voluntary RPS in place. As such, the design and implementation of a federal RPS could be relatively straightforward in most of the country.

However, an RPS policy limits compliance to renewable technologies only and does not credit other carbon-free technologies such as nuclear plants; thus, an RPS may be more costly than a CES or carbon price in reducing emissions. Limiting the number of technologies that comply with the policy also can make it more difficult to achieve ambitious targets; thus, this type of policy is limited in its ability to significantly reduce emissions.

Key Considerations

Similar to those for a CES, key design considerations of an RPS include how to set the standard, how to treat existing clean resources under the policy, and how to ensure equitable impacts among states in the transition away from fossil fuels. Like a CES, a federal RPS can result in higher compliance costs for regions that are further behind in their pursuit of clean energy. As such, how to treat diverse regions in a federal policy is an important design consideration.

Past, Current, and Proposed Renewable Portfolio Standards

As stated above, the RPS is a popular policy tool among US states. These policies vary significantly in terms of stringency; some policies have modest goals, while others require 100 percent renewable energy within the next few decades.

Some federal RPSs have been proposed. In 2019, for example, former Sen. Udall (D-NM) introduced a bill that would have required 50 percent of electricity generation in the United States to come from renewable sources by 2035. Thus far, no federal RPS policies have passed in Congress.

The Basics

The tax code can be used to promote investment in clean energy technologies. Tax credits, such as those available for wind and solar projects, can take the form of an up-front credit on an investment, or a credit on energy generation from a particular resource. These types of incentives can improve the economics of renewable projects by reducing the high costs of building new power plants. Tax credits also can be used to encourage a variety of investments, including the development of low-emitting technologies and transmission investments needed to integrate renewables into the grid.

Benefits and Challenges

Tax credits have successfully encouraged investment in nascent technologies like wind and solar. Since renewable energy resources typically have very low operating costs but high up-front costs, tax credits that address these up-front costs can help a project attract financing from tax equity investors and improve the likelihood of it being built.

While tax credits can be effective at encouraging investment in clean resources, they do not work directly to reduce emissions or total electricity generation. As such, they are not as efficient at reducing emissions as a carbon price or CES policy.

Key Considerations

A key consideration for lawmakers designing tax credits is whether to make the credits technology specific or technology neutral. Both approaches have benefits and challenges for encouraging investment in clean energy resources. A technology-specific tax credit, such as the 45Q tax credit for carbon capture equipment, can encourage investment in a particular technology that society might value but that has higher capital costs relative to other technologies. However, a technology-specific tax credit could cost more than a technology-neutral approach, which would give credit to any technology that meets certain attributes (such as being carbon free). The technology-neutral approach enables many different technologies to benefit from the tax credit and reduces the costs of deploying clean resources relative to a more targeted approach. However, a technology-neutral policy could preferentially benefit existing low-cost technologies and miss the opportunity to encourage investment in costlier—but valuable—technologies. This challenge is true for any policy that takes a technology-neutral approach.

Past, Current, and Proposed Tax Incentives

As mentioned in this section, several tax credits exist for renewable resources like solar, wind, geothermal, carbon capture technologies, and others. In 2019, Sen. Wyden (D-OR) and colleagues introduced the Clean Energy for America Act, which would combine these many separate tax credits into a single, technology-neutral tax credit for resources that are at least 35 percent cleaner than average.

The Basics

Funding for research, development, and demonstration (RD&D) is a form of innovation policy that can support nascent or undeveloped technologies when the private market is not sufficient. This policy tool can help new technologies reduce costs and ultimately achieve commercial operation.

Benefits and Challenges

RD&D can reduce the costs of nascent clean energy technologies and help enable a smooth transition to a decarbonized electric system. RD&D can lead to more clean technologies becoming commercially viable—and enable the discovery of new technologies and forms of energy, such as hydrogen—which could both improve grid operations in the future and lead to lower costs of meeting emissions goals, as more technologies compete to provide carbon-free electricity. One potential challenge of this policy option is that it poses some risk, as RD&D may not lead to the desired technological advances and cost reductions.

Key Considerations

RD&D funding is limited; therefore, key considerations include wise allocation of funding among promising projects, consistent with decarbonization goals, along with careful monitoring of research progress. A consideration for policy design is that clear information remains unavailable about which technologies will be most successful in driving down emissions. RFF research is underway to estimate the impact of RD&D spending on reducing technology costs and, as a result, enabling emissions reductions.

Past, Current, and Proposed RD&D Funding

RD&D funding has been used frequently in the past to promote several technologies, including renewables such as solar and wind that are now competitive in the market.

The Energy Act of 2020, passed as part of the omnibus spending bill in December 2020, is an example of using federal RD&D spending to promote decarbonization of the grid. Some aspects of the legislation increase funding for geothermal, carbon capture and storage, direct air capture, advanced nuclear, and energy storage technologies. These technologies offer grid benefits and services unlike other resources used today; they have the potential to better support grid reliability and could reduce the costs of achieving carbon goals. These technologies can complement intermittent renewable resources to better integrate these resources into the grid, and they can enable fossil fuel plants to participate in a low-carbon future with carbon capture technology.

The Basics

The Federal Energy Regulatory Commission (FERC), which regulates wholesale electricity transactions, can help enable a clean energy transition in a few ways. FERC could direct regional grid operators to account for the cost of carbon emissions in wholesale energy markets, so that the lowest-carbon resources are used first to meet electricity demand. FERC also could promote decarbonization by redesigning wholesale markets to better enable long-term investment in renewables and complementary resources such as energy storage. Lastly, FERC could take a more active role in encouraging regional transmission planning and investment, to facilitate long-distance transmission of power from wind- and solar-rich regions of the country to population centers that consume electricity.

Benefits and Challenges

A major benefit is that regulatory changes from FERC can complement legislative efforts and improve the efficacy of a carbon pricing policy. However, while FERC has signaled that the agency is open to carbon pricing, the agency still needs a state or federal policy directive before implementing carbon pricing in the markets.

Key Considerations

When implementing the regulatory changes noted here, it is important to consider how certain changes will affect electricity market operations. RFF recently partnered with World Resources Institute to explore options for long-term wholesale market design that would enable deep decarbonization of the electricity sector, along with the associated challenges with those designs.

This explainer was featured in the 207th issue of Resources magazine.