The Clean Electricity Performance Program (CEPP) is a key part of President Biden’s energy and climate plans. It will steer utilities towards clean energy with incentives and penalties, and is still being designed. Severin Borenstein and James Bushnell at the Energy Institute at Haas, Steve Cicala at Tufts University and Ryan Kellogg at the University of Chicago warn that current proposals will allow utilities to game the system, resulting in less new clean energy at higher cost. The main problem is that the $150/MWh incentive is a one-off up-front payout and is too high, compounded by the fact that it’s not matched by the far lower $40/MWh penalty. It could also lead to utilities needlessly buying clean energy (because of that big incentive) only to waste it (e.g. by setting up bitcoin operations). The authors give examples of how these games would play out. Instead, the CEPP should pay a smaller incentive but make it apply to every clean MWh every year. When designing incentives and penalties, governments must carefully think through how firms will most profitably respond to them, say the authors.

The Clean Electricity Performance Program (CEPP) is the most prominent aspect of the energy and climate provisions in the still-under-development reconciliation bill. Previously, we and others have raised questions and concerns about how exactly the CEPP would work. Since more specifics emerged about a month ago, we have spent a lot of time working through the implications of those details.

Standards vs Carbon Pricing

Repeatedly, the CEPP has been described as a “budget-based clean electricity standard (CES),” in effect, a national version of a renewables portfolio standard (RPS) that would also credit other forms of low-carbon electricity production. These types of policies – sometimes called intensity standards (such as an RPS or a low-carbon fuel standard) – have come under criticism from some environmental economists, many of whom argue for the superiority of carbon pricing.

This historical debate – pitting proponents of intensity standards against those holding out for a carbon tax – has often been portrayed as one of pragmatists working to get a decent, if not fully efficient, policy adopted versus economic purists for whom only carbon pricing would do. This historical debate has had the unfortunate effect of making it easy to dismiss concerns about the CEPP with “there go those economists again, trashing anything that isn’t carbon pricing.”

The CEPP is not a “standard”

But this framing is wrong. The CEPP, as currently configured, is not a CES that has been tweaked so it could be passed through the budget reconciliation process. The CEPP creates a suite of incentives for load-serving entities (LSEs) that are quite distinct from those of a CES. These differences in incentives open up a variety of channels for gaming and unintended consequences that could lead to large government expenditures without inducing large-scale substitution of new, clean energy supply for fossil-fuelled generation.

CEPP’s up-front incentives make it different

The key distinction starts with the magnitude and timing of the clean-energy incentives. Under a “normal” intensity standard (like an RPS), an LSE – a utility or other retail provider – is rewarded for procurement of clean energy every year.

For example, currently a renewable energy credit (REC) might sell for about $10 per MWh, and any renewable electricity source, new or old, can earn this value for each MWh it produces from a renewable source. The CEPP, however, does not provide subsidies for procurement of all clean energy production but instead makes a one-time giant-sized grant of $150 per MWh for “newly purchased” clean energy. That is, in the year an LSE increases its clean electricity procured to at least its target level, it gets $150 per newly purchased clean MWh. But then it receives no further compensation for that clean energy in future years. LSEs that fail to meet their clean energy growth target are penalized $40 per MWh for any shortfall.

The CEPP’s intent to make large, one-time grants for “new” clean energy makes it in some ways more like an up-front clean energy investment tax credit (ITC) than a CES (putting aside the distinction that ITCs typically reward clean energy capacity rather than energy itself). We’ve been told that the decision to go for the large up-front grant was motivated by a concern that, had the CEPP been structured like a standard CES, sources coming online toward the end of the 10-year program would only earn a year or two of subsidies. But unlike an ITC that is paid directly to developers of new energy supply, the CEPP’s grants are payable to LSEs for newly procured clean energy.

Gaming the system

This large, one-time grant to LSEs, along with a sequence of associated design elements, creates perverse incentives that will result in less new clean energy at higher cost.

For example, while $150/MWh was an acceptable level of subsidy, it was deemed to be too severe a penalty. So an LSE’s failure to meet the CEPP’s clean energy growth targets would be penalised at only $40/MWh. The asymmetry between the $150 grant and the $40 penalty has already been identified as creating an incentive for gaming via trades of clean energy between “short” and “long” LSEs, particularly during the last years of the program. These kinds of trades would let “long” LSEs earn grants for procuring clean energy from other, noncompliant “short” LSEs, rather than for actually building new clean power. This problem would be dramatically worsened if penalties were removed altogether — a potential change to the CEPP now under discussion.

“Too big” incentives can lead to deliberately wasting energy

However, there is another fundamental problem with the current design that has gotten less attention. The $150/MWh subsidy amount is so much greater than the current extra cost of clean energy – a gap that will widen over the next decade as renewables get even cheaper – that it creates an incentive to expand energy use in order to grow the MWh’s getting subsidised.

Here’s how it would work: Say that the current cost of clean energy is $70/MWh, and a grant-eligible LSE has 100 MWh of customer consumption (load) per year for which it is currently buying no clean energy. The LSE could buy 100 MWh of clean energy at a cost of $70/MWh, and since it would be buying the power “for the first time” it would be paid $150/MWh for all 100 MWh in the first year and would net $80/MWh, or $8,000 total in that first year. The LSE would now be 100% clean! Under the program’s rules, once it increases its clean energy percentage it has an incentive to keep that percentage high, or else it pays penalties. So hopefully it would want to keep buying clean energy after that first year to avoid those penalties. So far, so good!

But why stop at 100 MWh? What if the LSE set up a bitcoin operation (or some other new load) that used an additional 100 MWh, bumping up its total load to 200 MWh? It could now procure 200 MWh of clean energy, again making an extra $80/MWh from the grant-minus-cost difference, and bank $16,000. The LSE is still 100% clean! Actually, it is kind of 200% clean, even though half of the electricity is wasted. And this problem would be much bigger at scale than just $16,000: the annual industrial load alone in the U.S. is about 1,000,000,000 MWh, not 100 MWh.

Now here’s how the LSE could turbocharge the strategy. After the first year, when the grants stop, it could sell off the extra 100 MWh of clean energy to some other LSE that would also be buying it “for the first time.” And it would send over the bitcoin operation along with the clean energy, dropping its load back to its normal 100 MWh. Then the second LSE runs the same operation for one year before sending the package off to yet another LSE. So instead of paying the $150/MWh one time for a new clean energy source, the program ends up paying for it over and over again. All for energy that was created and then wasted to collect grants.

This kind of behaviour is surely not what the CEPP architects had in mind, but it is behaviour that the CEPP makes profitable for LSEs or even for large industrial customers. In fact, bitcoin start-ups are already partnering with LSEs (including in rate-regulated areas) or buying coal plants outright to power their operations and arbitrage wholesale electricity prices.

Economists usually complain that clean energy standards pay people to buy more clean energy, when what we really want is for them to buy less dirty energy. Most of the time, this distortion is small enough that it doesn’t create big inefficiencies. But by cranking up the “buy clean” incentive for supposedly new clean energy purchases, the CEPP takes an arguably modest incentive problem and transforms it into a really big problem.

Building a better CEPP

The solution need not be to trash the whole idea and say carbon tax or bust, especially given all of the work that has gone into building coalitions that support this type of program. There is a simple change that turns the CEPP into what it has already been publicly described as, an actual budget-based clean energy standard.

Pay a smaller incentive, but make it apply to every clean MWh every year. Instead of having a $150/MWh “one time” grant and a $40/MWh “every year” penalty, there could be, for example, a $15/MWh subsidy and $15/MWh penalty earned or paid on every MWh long or short of the target every year. If some LSEs insist that the penalty is too harsh, then rather than make the penalty smaller and create clear gaming opportunities, adjust the target so that LSEs are less likely to be penalised and more likely to earn grants, while still giving them strong incentives to increase their clean energy share.

There are many ways to get to the drastically lower-carbon electricity system that is the imperative. And a well-designed CEPP could definitely be one of them. A group of experts recently argued that the CEPP’s target of growing clean power by 4% per year would be feasible. However, an evaluation of the technical feasibility of 4% growth is not an analysis of the CEPP or its likely outcomes. The latter requires considering how firms will most profitably respond to the program’s incentives. It is, after all, the profit motive that makes subsidies and penalties powerful tools for expanding clean power generation. Unfortunately, the current CEPP has significant design flaws that could greatly undermine its effectiveness in getting us to where we need to go. Now is the time to ensure that the program’s incentives are consistent with its goals.

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Severin Borenstein is E.T. Grether Professor of Business Administration and Public Policy at the Haas School of Business and Faculty Director of the Energy Institute at Haas

James Bushnell is a Professor of Economics at the University of California at Davis and writes for the Energy Institute at Haas

Steve Cicala is an associate professor in the Department of Economics at Tufts University and a Research Associate at the National Bureau of Economic Research

Ryan Kellogg is a Professor and Deputy Dean for Academic Programs, Harris Public Policy, University of Chicago

This article is published with permission

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