The outlook for aligning federal electricity policy and state climate policy shifted markedly over the last month.

On April 16, the Federal Energy Regulatory Commission (FERC) rejected rehearing requests on its minimum offer price rule (MOPR), which forces state-subsidized power generators to bid into electricity markets at an administrative estimate of their unsubsidized level. Just two days earlier, a coalition of competitive power generators, trade associations and the R Street Institute requested that FERC hold a forum on carbon pricing in wholesale electricity markets.

Although neither effort formally acknowledged the other, their linkage is key to mending the erosion of energy federalism, while harmonizing state environmental policy and federal electricity policy around market principles.

Importantly, FERC's ruling clarified that MOPR will not apply to voluntary renewable energy credits and the effects of the Regional Greenhouse Gas Initiative (RGGI) — the predominant CO2 cap-and-trade system used by states. This refines the applicability of MOPR to green industrial policy (e.g., mandatory renewable portfolio standards, nuclear zero-emission credits) and clarifies that it does not apply to voluntary private behavior and environmental policy (i.e., emissions-based policies).

This, combined with the scope of the petition, presents an opportunity to differentiate environmental policy from green industrial policy. This distinction is imperative to rationalize climate policy in intervention-prone states.

Unsustainable status quo

Even with MOPR clarification, the status quo simply isn't sustainable. Although immediate effects will be muted because FERC grandfathered existing subsidies, the multi-year outlook for an escalating combination of state green industrial policy with MOPR layered on top could easily drive billions in additional costs.

To put a finer point on this unbearable ultimatum to states, the head of the Maryland Public Service Commission declared recently that state-federal tensions have reached "an all-time high."

The first alternative path is that states opt-out of competitive electric capacity markets to avoid MOPR. MOPR-hit states like Maryland, New Jersey and Illinois are seriously considering this but the costs of doing so appear steep.

Conceivably, this could motivate a shift to a more efficient Texas-style "energy-only" model without capacity markets, but it's more likely to result in an inferior state-run capacity procurement mechanism.

Another option is that states voluntarily curtail green industrial policy to avoid triggering MOPR. However, momentum for such policy has only grown in recent years, with over 500 clean energy laws enacted in 2019 alone.

Despite mounting costs, some in the hundreds of dollars per ton of carbon avoided, intervention-prone states will not change course without a better alternative that guarantees emissions cuts. One is right under their noses: most states adversely affected by MOPR participate in RGGI, for which competitive electricity markets lower compliance costs.

But RGGI or another market-based alternative must be politically rewarding, which requires overcoming the low literacy level in statehouses of the benefits of emissions pricing in place of green industrial policy. A new federal-state dialogue would sure fit the bill nicely. 

The third option is that MOPR either gets overturned in the courts or FERC initiates a walk-back. Many original MOPR proponents now recognize that MOPR is more likely to undermine competitive markets than save them, and if that private conversion grows, then a graceful MOPR retreat becomes more appealing.

Adding constructively to this conversation is a forthcoming paper by Todd Aagaard and Andy Kleit in the Electricity Journal. The piece appreciates why FERC felt compelled to pursue MOPR — noting that the objective of "leveling the playing field" is laudable — but that penalizing state-subsidized generation to do so stems from flawed logic and creates poor policy consequences.

Whether voluntary or involuntary, a rollback of MOPR should coincide with advancing the conversation on the consequences of subsidies and the benefits of emissions pricing to replace them.

Petition response

Over the last month, grid operators and states have welcomed the request of the carbon pricing petition. Among the lead proponents are Maryland and New Jersey, who are also the most vocal in opposition to MOPR.

This is a huge opportunity for FERC to repair relations with key states and establish a forum for harmonizing the state-federal nexus to drive carbon reductions in the most cost-effective, innovation-inducing manner. MOPR is many things, including an infringement on states' rights and bad economic policy, but a threat to rational climate policy it is not.

Fascinatingly, the petition was warmly received by consumers but met a cool reception from most environmental groups. Holding all else constant, layering carbon pricing atop the smorgasbord of subsidies and mandates would be cost-additive and not in consumers' interests.

But a dialogue that legitimizes carbon pricing as harmonious with competitive electricity markets may also delegitimize subsidies and mandates. That may prompt a pivot from green industrial policy to emissions pricing, which would benefit the economy, consumers and climate innovation.

This explains the support for the petition provided by the Electricity Consumers Resource Council, which said that a "Discussion of carbon pricing should be approached as a next step towards a more economically rational carbon policy in the electricity sector, one whose increased efficiency above the status quo can benefit consumers ... However, if less efficient policies are not on the table, adding a carbon price in FERC jurisdictional electricity markets may increase costs and leave consumers worse off." 

This perspective contrasts sharply with a critical block of the environmental left, which has become skeptical of market mechanisms and favors a renewables-forcing policy agenda. For example, the Sierra Club's response to the petition was that "carbon pricing could become a distraction and, at worst, a potential source of preemption of state policy tools that have been effective in driving renewable growth." 

However, decades of environmental economics research demonstrates that 1) the market failure is underpricing of emissions not overpricing of clean energy and that 2) additional interventions under a binding cap-and-trade program achieve no emissions reductions; they merely reallocate them in a more expensive manner.

In short, the petition response reveals the gulf between renewables-only advocates and climate pragmatists. Now it's a question of how to translate it into actionable policy.

Next steps

Holding a carbon pricing forum could be easily misconstrued, which presents quite a political risk if held mere months before the election. We cannot ignore the topic that makes conservatives cringe; some view FERC's authority as capable of instituting a top-down carbon pricing regime.

It goes without saying that doing so would be a tremendous stretch of Congressional intent under the Federal Power Act, not to mention the politics of making FERC a de facto climate regulator. Yet if framed consistent with the petitioners' request, this conference would identify why that's the wrong policy path and reduce the likelihood that FERC would ever pursue it.

Instead, FERC would proactively engage states on how to make bottom-up carbon pricing — initiated by elected state officials not DC bureaucrats — more efficient, with an eye toward cultivating healthier markets. This serves as a pathway to move beyond green industrial policy and, by extension, MOPR.

Conservatives should be confident that a proper framing for this conference will lead to a dialogue conducive to economic freedom and advancing federalist values.

Ironically, the best way to leverage carbon pricing as a MOPR exit strategy may be to disassociate them from initial public forums. Conflict resolution often starts with identifying where parties agree before getting into the more contentious elements.

For example, excluding MOPR was the only way to unite the parties that jointly filed the carbon pricing petition, who generally fall into three camps on MOPR and the subsidies it applies to: support for MOPR and opposition to state subsidies (competitive generators), opposition to MOPR but support for state subsidies (renewables industry) and opposition to both MOPR and subsidies (R Street institute, which is a position shared by leading consumer interests).

Plus, given the concerns of the environmental left, injecting MOPR into the petition framework would be a distraction from discussing the merits of emissions pricing. A subnational carbon pricing discussion that touches on the interactive effects with other state policies — an area of growing research — will be all that's necessary to naturally give rise to the conclusion that emissions pricing carries economic and environmental benefits if it displaces subsidies. This is a necessary precursor to any MOPR avoidance vehicle.

Given acute political constraints, it may be preferable for FERC to frame a forum that simply seeks to harmonize federal electricity policy with state environmental policy. A more technical implementation framing for regional carbon pricing elements would be "safe" and still accomplish many of the same objectives.

For example, this could showcase the research insights of Resources for the Future (RFF), which has examined a host of technical issues for implementing carbon pricing in New York's electricity market. RFF's research on interactive effects also shows that forms of carbon pricing can drive the price of nuclear and renewable subsidies — the lead policies in the MOPR crosshairs — to zero.

A formal or informal MOPR exit strategy is far more likely to succeed if FERC appreciates the pitfalls of MOPR, while states understand the anti-competitive effects of subsidies and that better alternatives to emissions reductions exist. That takes open, extended dialogue.

FERC has made clear via MOPR what state policies it views as incompatible with markets. Now it's time to examine what is compatible and rebuild trust in energy federalism.