Dark Green Spread vanishes in U.S.: time for carbon cap and trade?

For the first time in nearly seven years, the prices of coal and natural gas have converged closely enough to make gas-fired power generation more attractive than coal in carbon-constrained electricity systems such as those covered by the Regional Greenhouse Gas Initiative (RGGI). These are the conditions that supporters of carbon cap-and-trade schemes dream about. The problem is, the prices won’t stay similar for long.

Why does this matter? Similar coal and gas prices are the only way cap-and-trade can realistically prompt a large-scale shift from coal to gas in power generation. Gas emits less carbon than coal. If generating companies have to pay for the carbon they emit, and there’s little difference between the fuel cost of gas and coal, then coal is at a disadvantage. But now is the only time in recent years that the fuel costs have been this close.

When they diverge again, how will they diverge? My bet is that natural gas will head back up to beyond US$5 per million British Thermal Units (mBtu), which is in the low range of where it has been since 2002. Coal, which has hovered around US$2 per mBtu since 2002 but which increased to $2.24 in January 2009, will stay at the higher price.

At that price spread, a tonne of carbon in a cap-and-trade market will have to cost above $18.70 to overcome the Dark Green Spread, which is the difference between the marginal costs of operating coal- and gas-fired power generators in carbon-constrained markets. And that’s assuming both of the following.

1. All coal generators are operating at 34 percent efficiency and burning Powder River Basin coal, which emits carbon at a rate of about a kilogram per kilowatt hour.
2. All natural gas plants operate at 55 percent thermal efficiency.

The most recent carbon allowance auction under RGGI established a clearing price of $3.51 per tonne. There’s no actual trading yet, but the initial lenient RGGI cap will produce a similarly lenient carbon price when trading does start—which is the whole reason cap and trade is so popular with politicians. Any national U.S. scheme will have similar lenience designed into it: there will be a lot of political pressure from coal states to make it so. This means that when the coal–gas fuel price spread regresses back to the normal curve of the last seven years, it will actually be more economically advantageous to generate power with coal.

None of this will come as any surprise to those who have followed the European Emission Trading Scheme (ETS). The Dark Green Spread has narrowed lately in Europe too, and for the same basic reason: falling gas prices because of the recession.  Prior to this narrowing, coal-based companies in the ETS were making a killing: their price advantage over gas in deregulated power markets was always decisive, even with their proportionally higher carbon costs.

We’re in an easy shoulder season right now. That will change with the first heat wave.