The “Industry” economic sector of AB 32, the California Global Warming Solutions Act of 2006, is to receive very light treatment in reduction of greenhouse gases (GHGs) by 2020. Industry is shown in the Scoping Plan to reduce GHGs by only 0.3 MMTCO2/year (million metric tonnes per year). The other sectors combined are to reduce GHGs by 169 MMTCO2/year. The 0.3 is so small compared to the other sectors that one might wonder why the Industry sector gets off so lightly. But, there is more coming, we are assured by ARB.
One manifestation of what is to come is that the major industrial sites in California must undergo a site-wide audit for energy and toxic pollutants, conducted by state-approved, third-party auditors. Presumably, these auditors will be knowledgeable about the industrial site, its processes, energy use patterns, etc. The auditors are intended to discover and report to ARB on the many, perhaps myriad, ways that these industrial plants can and should modify their plants to reduce energy and thus reduce GHGs, and reduce emissions of toxic air pollutants.
One must admire the audacity of ARB, and the skill and knowledge of the auditors. Admiration is due to ARB because these industrial plants, especially the refineries, cement plants, and hydrogen plants, have for many years employed top engineers with decades of experience to acquire plant data, analyze the data, perform cost studies, and report on the feasibility of reducing energy consumption and regulated toxic pollutants. I should know, as I did exactly that during a good portion of my engineering career.
Perhaps ARB’s auditors will discover that there are, indeed, many potential projects to save energy in these plants, with energy reductions measured in the millions of BTUs per hour. That works out to many millions of tonnes CO2 per year. The engineers and management are well aware of such opportunities, and know exactly what they are, and where they occur. What the engineers and management also know is the cost to implement such projects. More importantly, they know how many years it would require to break-even on the capital outlay invested. The vast majority of such projects have break-even periods of 5, 10, 15, 20 years or longer. They remain un-built because a private company, in business to turn a profit, cannot afford to use its scarce and therefore precious capital on such low-return projects.
Typically, a private company in the refining business has only a certain amount of capital annually to allocate amongst many competing projects. This capital I refer to is not for maintenance, not for paying down debt, not for strategic acquisitions of other companies, but solely for spending on existing plants. All those other uses of capital are important, no doubt, but that is not the subject of this piece.
First, is stay-in-business projects. This may include installing equipment mandated by the many and varied state and federal regulations. For refineries, such examples come to mind as higher octane reformers when lead was no longer allowed in gasoline, or expensive hydrotreaters when sulfur was no longer allowed in diesel fuel, at least not more than 15 ppm. Also, aromatics extraction plants were required when benzene was no longer allowed in gasoline. Then, catalytic destruction devices for fired heater exhaust were required to remove or prevent the formation of nitrous oxides. Also, very expensive electrostatic precipitators to remove particulate matter from the exhaust stream of catalytic cracker regenerators were mandated. Another category is replacement of worn-out equipment. To stay in business, the refineries were required to invest in these things, and many others. Such stay-in-business funds spent were of course not available to spend on energy conservation projects.
As a sidebar, some refineries, approximately 150 in the U.S., were shut down over the past 30 years because the required capital infusion to stay in business was just too much. Those refineries were analyzed at length by their owners, who concluded there was no way such funds would ever break-even.
Next, after stay-in-business items, is discretionary spending. A company almost always (in my experience, it is absolutely always) has some capital spending opportunities that will earn a good return on investment. Such projects may break-even in as little as a few months, one year, or two years. Among the many duties of plant engineers is to evaluate the plant and submit to management a list of projects along with the expected break-even period for each project. The funds to build the list of projects invariably exceeds the money available. Therefore, when energy savings projects have break-even periods of 5, 10, 15 years or more, there is no economic justification to spend the scarce capital on those projects. There is rarely enough capital to spend on those projects that break-even in less than 2 years. Sometimes there is no capital for these at all. Therefore, the energy projects remain identified but not realized.
The US Department of Energy, DOE, recently had and may still have a program in which energy experts visited energy-intensive manufacturing sites across the country, audited those plants, and reported how much energy could be saved by investing capital. It is noteworthy that they did not report the capital required to achieve those savings, nor how many years were required to break even on those projects.
ARB's authority to mandate that a GHG-reduction capital project be installed may arise under the cap-and-trade provision, regardless of the break-even period required for that project. It is instructive that in other areas under AB 32, such as the Residential and Commercial sectors, a five percent investment criterion is employed. This likely means that when the net cash flows over 20 years are discounted at 5 percent per annum, then summed to break even with the investment, the project is deemed affordable. In simple terms, this requires an approximately 12 year break-even period. Yet, requiring a private-enterprise company to borrow money to install such projects will burden their company with additional debt. This will adversely affect their cost of borrowing future capital. In the alternative, the company could forego borrowing, and not invest in high-return projects on a dollar-for-dollar basis. This causes future earnings to suffer, placing the economic security of the enterprise in jeopardy. In either case, AB 32 energy audits will not be good for refining companies and other large industrial plants.
One bright spot from investing in GHG reduction projects in a refinery is that reductions beyond the mandatory amount can be sold in the carbon credit markets. The value of such carbon credits is not yet known, but have been trading at around US$30 per metric tonne rather recently.
The refining market in California is ordinarily finely balanced, with virtually no room for any refiner to fail in a business sense. The current economic crisis has decreased demand somewhat, but that will disappear as the economy improves.
Just a few short years ago, a refinery owned by Shell in Bakersfield was to be shut down as no longer economic. Such a hue and cry arose that a U.S. Senator became involved, and anti-trust charges were mentioned. The idea was that a shortage of products would result if the refinery were closed, and rapacious increase in prices paid by the hapless consumer due to a products shortage. The outcome was that Shell did not shut down the refinery, but eventually sold it. That refinery now is in bankruptcy proceedings, indicating that Shell was indeed correct that the refinery could no longer turn a profit. If and when other refiners find it unprofitable to continue with AB 32-mandated energy expenditures, what will the State do? Will California intervene again and forbid the closure of an unprofitable refinery? As to the bankrupt refinery in Bakersfield, will ARB mandate that they, too, install GHG reduction projects? Or, will they make more money in carbon credits simply by shutting down, thereby not emitting any GHGs?
This is about to get interesting. Very, very interesting, indeed.
Roger E. Sowell, Esq. Legal website is here.
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