New York Considers Pricing Carbon in the Power Grid

There is a growing bipartisan consensus that a carbon tax could be the most effective way to immediately cut greenhouse gas emissions. A carbon tax is based on what’s called the social cost of carbon, which puts a dollar amount on the damage to the environment and public health caused by each additional ton of carbon that is released into the atmosphere. Recently, the Public Service Commission (PSC), which regulates utilities, and the New York Independent Systems Operators (NYISO), which manages the wholesale energy market that utilities purchase electricity in, have been studying the possibility of imposing a carbon tax in New York’s electricity market. Last week, they released a report updating the public on their progress, and the result is fascinating.

The way our electricity market operates, suppliers offer a price per megawatt hour ($/MWh) for the power they produce and utilities bid on that power, starting at the lowest priced power generator and continuing until every utility in the state has purchased enough electricity to meet the demand for that day. In NYISO’s proposal, each generator’s bid would include the cost of carbon emissions from their power generation, which would make renewable energy almost always cheaper than fossil fuels.

For example, let’s think about a utility that needs 20 megawatts of electricity choosing between a solar farm and a natural gas power plant. The solar farm bids $15/MWh for its 20 megawatts of electricity and the natural gas plant bids $12/MWh – under our current system the utility purchases its 20 megawatts from the natural gas plant. Now let’s implement NYISO’s proposal and assume that the social cost of carbon of one MWh of natural gas-produced electricity is $4. In this scenario, the solar farm bids $15/MWh, the natural gas plant bids $16/MWh, the utility buys its electricity from the solar farm, and New York’s carbon emissions are lower.

But there’s another wrinkle that makes this proposal even better for renewable energy. Utilities pay the same $/MWh to each generator that they purchase electricity from, with the price set by the most expensive electricity that is purchased (called the locational-based marginal price, or LBMP). At times when electricity demand is at its peak – think of a hot August afternoon – utilities often have to buy extra electricity from “peaker” plants that can very quickly generate electricity. Because they need to generate extra electricity so quickly, these plants tend to rely on burning oil, coal, and the dirtiest natural gas. So now let’s think of our last scenario with carbon pricing but include a coal-fired power plant in the middle of August. Now the solar farm bids $15/MWh, the natural gas plant bids $16/MWh, and the coal plant to meet that extra demand bids $35/MWh. The utility has no choice but to buy electricity from the coal plant (unless it wants to risk a summer blackout), but now for those two hours on the August afternoon the solar farm is paid $35/MWh. The carbon price incentivizes the development of renewable energy, including renewable energy that is specifically designed to meet peak demand and accelerates the phase-out of the dirtiest power plants on the grid.

Of course, this is all an oversimplification of the proposal. NYISO’s full report, available here, discusses how the carbon price would interact with the very successful Regional Greenhouse Gas Initiative, how the carbon price would be refunded to consumers, and how the price would be applied to energy like Canadian hydropower that is imported from outside New York’s borders. There are still outstanding questions before a carbon price can be applied to New York’s energy market, and even more questions to be answered before we could apply an economy-wide carbon tax, but NYISO’s proposal is a strong starting point.