406 Dirksen EPW Hearing Room

Hon. Kyle E. McSlarrow

Deputy Secretary, United States Department of Energy

Mr. Chairman, I am pleased to appear before you today to discuss the Administration’s National Energy Policy and to discuss why we think Clear Skies is a critical component of the President’s strategy to confront our energy and environmental challenges.


Though it is often overlooked, the President’s National Energy Policy directed the Administrator of the Environmental Protection Agency to work with Congress to propose legislation that would establish a flexible, market-based program to significantly reduce and cap emissions of sulfur dioxide, nitrogen oxide, and mercury from electric power generators. The President’s National Energy Policy concluded that, as our energy needs grow, additional innovations would be necessary to continue improving our environmental conditions. The success of the Clean Air Act Acid Rain program in promoting innovation and emission reductions is well known – especially by Members of this committee - and served as the template for the Clear Skies legislation now before this Committee.


We are pleased that the Senate is now considering a comprehensive energy bill reported out of the Senate Energy committee, and commend Chairman Domenici and the members of his committee for acting so swiftly. And, we commend you, Mr. Chairman, and this committee for moving aggressively to consider the Clear Skies legislation.


Introduction and Outlook

Over the past century, we have witnessed the power of energy to drive global economic development. In the 1970s, we learned firsthand how energy shortages and resulting high prices can compromise economic growth and the quality of life to which Americans have grown accustomed. Clearly, the availability of reliable, affordable energy is critical to sustained economic growth.


We have a series of long-term energy challenges that require action now. These challenges are present along the entire energy continuum, affecting crude oil, refinery products, natural gas, electricity generation and transmission, the environment, and economic growth.


The Nation’s Power Industry


To understand the need for Clear Skies, it is important to understand the current make-up of the Nation’s electric power industry. The U.S. power-generating sector remains the envy of the world. On any given day, approximately 5,000 generating plants can make available up to 900,000 megawatts of electricity for virtually every home and business in the country. Fossil fuels supply about 70 percent of the Nation’s requirements for electricity generation. Coal, alone, accounts for more than 50 percent of the electricity Americans consume. Primarily because of the power sector’s use of abundant supplies of American coal and natural gas, consumers in the United States benefit from some of the lowest cost electricity of any free market economy.


U.S. Electricity Generation by Fuel


America’s economic progress and global competitiveness have benefited greatly from this low cost electricity. Electricity is an essential part of America’s modern economy. While the Nation has made dramatic progress in “decoupling” overall energy consumption from economic growth, increased economic activity remains closely linked to the availability of affordable electric power – and is likely to remain so well into the future.


The Nation’s demand for electricity is projected to grow significantly over the next 22 years. Between now and 2025, the United States will likely have to add between 446,000 and 656,000 megawatts of new generating capacity to meet growing demand. This is equivalent to adding the entire power generation sectors of Germany and Japan, combined, to the U.S. power grid. Concurrent with this dramatic – and capital intensive – expansion of the Nation’s power fleet, power generators will also be called upon to make new investments in pollution control technologies to meet tightening environmental standards. Over the past 25 years, America’s electricity utility industry has invested billions of dollars in advanced technologies to improve the quality of our air. Each year, a substantial portion of normal plant operations costs – again amounting to several billions of dollars a year – are associated with operating installed technologies that reduce air emissions.


The investment has returned dividends. By installing new technologies to capture tiny particles of fly ash, the power industry has significantly improved air quality by dramatically reducing particulate matter. The power industry has also installed sulfur dioxide controls on more than 90,000 megawatts of capacity as part of a successful effort that has cut SO2 emissions substantially since 1970. Most of the nation’s coal-fired plants have also installed nitrogen oxide controls that have helped make initial NOx reductions. In short, advanced technology – given the time to mature and be deployed – can be effective.


Technological improvements have permitted the Nation’s power sector to continue generating relatively low cost power and, at the same time, use the energy resources America has in most abundance. America’s use of coal, for example, has actually tripled since 1970 even as our air has become cleaner. Advanced technology also offers a pathway toward the prospects of achieving even greater reductions in air pollutants in the future.


At this point, let me review long-term energy trends – with a focus on natural gas and coal – which should help illustrate our challenges. My comments here are based on analyses prepared by the Department of Energy's independent analytical arm, the Energy Information Administration, in its Annual Energy Outlook 2003 (AEO 2003). All statistics are based on EIA’s reference case scenario for the year 2025, which assumes current laws and regulations, including the Eastern U.S ozone SIP call, but not future regulations, such as those to implement the new Clean Air Act ozone and particulate matter standards or the mercury MACT standard. The reference case also assumes continued improvement in energy consuming and producing technologies, consistent with historic trends.


Natural Gas Trends


The natural gas share of electricity generation is projected to increase from 17 percent in 2001 to 30 percent in 2025. By 2025, total natural gas consumption is expected to increase to almost 35 trillion cubic feet, which will amount to 26 percent of U.S. delivered energy consumption. Industrial consumption – the largest natural gas-consuming sector - is expected to increase by 3.4 trillion cubic feet over the forecast, driven primarily by economic growth. Combined consumption in the residential and commercial sectors is projected to increase by 2.6 trillion cubic feet between 2001 and 2025, driven by increasing population and healthy economic growth, and accompanied by gradually rising prices in real terms. Natural gas remains the overwhelming choice for home heating throughout the forecast period. Natural gas consumption in the generation sector doubles by 2025 due to lower capital costs, higher efficiencies, lower construction lead times, and lower emissions.


In the short term, domestic natural gas prices are expected to remain high in 2003 and are at risk for significant volatility through at least the next 12 to 18 months. EIA estimates that the current natural gas storage level is the lowest on record for this point in the annual cycle. As long as temperatures remain at or below normal this summer, natural gas storage levels should rise sharply over the coming months. But if this summer is hotter than normal, natural gas prices would jump as cooling demand would compete with the need to build storage inventories. A large rebound in the economy, poor results from the ongoing increase in natural gas drilling, or a continued tight oil market might also spur volatility.


On that note, drilling for natural gas expected to increase substantially, but a fourth U.S. LNG terminal is expected to open this year at Cove Point, Maryland, and a Kern River Pipeline extension from the Rockies to the West Coast opened earlier this month--greatly increasing the capacity to move gas from a key producing area. In

In2004, declining oil prices should ease natural gas prices, and strong natural gas drilling should increase productive capacity through the end of the year.


Domestic gas production is expected to increase more slowly than consumption over the long-term forecast, rising from 19.4 trillion cubic feet in 2001 to 26.8 trillion cubic feet in 2025. The national average wellhead price is projected to reach $3.90 per thousand cubic feet, in 2001 dollars, by 2025.


Increased U.S. natural gas production through 2025 is projected to come primarily from unconventional sources and from Alaska. Unconventional gas production increases by 4.1 trillion cubic feet over the forecast period - more than any other source, largely because of expanded tight sandstone gas production in the Rocky Mountain region. Annual production from unconventional sources is expected to account for 36 percent of production in 2025, compared to 28 percent today. An Alaska natural gas pipeline is projected to begin flowing gas to the lower 48 States in 2021, reaching 4.5 billion cubic feet per day in 2023, with further expansion beginning in 2025. In 2025, total Alaskan gas production is projected to be 2.6 trillion cubic feet.


Conventional onshore non-associated production is projected to increase by 1.2 trillion cubic feet over the forecast, driven by technological improvements and rising natural gas prices. However, its share of total production declines from 34 percent in 2001 to 29 percent by 2025. Non-associated offshore production adds 560 billion cubic feet, with increased drilling activity in deep waters; however, its share of total U.S. production declines from 22 percent in 2001 to 18 percent by 2025. Associated dissolved production declines by 800 billion cubic feet, consistent with a projected decline in crude oil production. Lower 48 associated-dissolved natural gas is projected to account for 8 percent of U.S. natural gas production in 2025, compared with 15 percent in 2001.


A key question facing producers and policymakers today is whether natural gas resources in the mature onshore lower 48 States have been exploited to a point at which lower discoveries per well eliminate the possibility of increasing - or even maintaining - current production levels at reasonable cost. Depletion has been counterbalanced historically by improvements in technology that have allowed gas resources to be discovered more efficiently and developed less expensively, have extended the economic life of existing fields, and have allowed natural gas to be produced from resources that previously were too costly to develop. In EIA’s projection, technological progress for both conventional and unconventional recovery is expected to continue to enhance exploration and reduce costs. However, there is a significant debate within the industry itself as to whether this will occur.


The difference between U.S. natural gas production and consumption is net imports. Net imports of natural gas, primarily from Canada, are projected to increase from 3.6 trillion cubic feet in 2001 to 7.8 trillion cubic feet in 2025. Net imports contributed 16 percent to total natural gas supply in 2001, compared to an expected 22 percent in 2025. Almost half of the increase in U.S. imports is expected to come from liquefied natural gas (LNG). By 2025, EIA expects expansion at the four existing terminals and construction of three new LNG terminals.


Growth in pipeline imports from Canada partly depends on the completion of the MacKenzie Delta pipeline, which is expected to be completed in 2016 and expanded in 2023. Net imports from Canada are projected to provide 15 percent of total U.S. supply in 2025, about the same as in 2001. Mexico is projected to go from a net importer of U.S. natural gas to a net exporter in 2020, as an LNG facility begins operating in Baja California, Mexico, in 2019, predominantly serving the California market. By 2025, the United States is expected to import about 350 billion cubic feet of natural gas from Mexico per year.


Coal Trends


The share of electricity generated from coal is projected to decline from 52 percent in 2001 to 47 percent in 2025 as a more competitive electricity industry invests in less capital-intensive and more efficient natural gas generation technologies. Nonetheless, coal remains the primary fuel for electricity generation through 2025, and EIA projects that 74 gigawatts of new coal-fired generating capacity will be constructed between 2001 and 2025.


EIA’s analysis here does not incorporate a projection of several Clean Air Act programs that could have a significant impact on the use of coal such as the mercury MACT. Although this rule has not been proposed, based on requirements of the Clean Air Act it is designed to require the control of mercury on a source by source basis by the end of 2007, which could be very costly and cause an even greater decline in the share of electricity generated by coal.


EIA projects growing domestic consumption over the forecast horizon, and projects a simultaneous reduction in real coal prices to generators by approximately 12 percent by 2025. Average annual coal consumption is projected to increase by 1.3 percent per year between 2001 and 2025. As domestic coal demand grows, U.S. coal production is projected to increase at an average rate of 1.0 percent per year.


The decline in prices is driven by the expectation of continued improvements in labor productivity, and the continued market expansion of western coal, which has a lower minemouth price than eastern coals. As western production makes further inroads into markets traditionally supplied by eastern coal, the average heat content of the coals produced and consumed will drop as well, reflecting the lower thermal content per ton of western than eastern coals.


President Bush’s National Energy Policy


We long ago ceased to fully provide for our petroleum needs domestically, and though most of our current natural gas demand can be met with North American production, the trend here is also toward a greater share for imported natural gas. And coal, our most abundant energy resource, is actually projected to reduce its percentage share of electricity generation.


We are often at the mercy of events and decisions over which we have often limited—and sometimes no —control. When winters and summers are mild; when all refineries or pipelines are online; when supply from abroad is abundant and reliable; when prices are reasonable, we do not feel this dependency. However, when almost any one of these factors breaks down, markets react instantly, and we face the higher prices and volatility that have become by now an almost certain cyclical phenomenon.


These trends are a concern.


President Bush recognized that to prevent these problems from becoming a permanent, recurring feature of American life, we needed a long-term plan for energy security that would promote reliable, affordable and environmentally sound energy for the future.


President Bush’s National Energy Policy, released in May, 2001, reflected a few, fundamental principles. First, we need to maintain a diversity of fuels from a multiplicity of sources. Second, we should seek opportunities for increased investment, trade, exploration and development, which are increasing every year, far beyond the traditional markets of the last 50 years. And third, we should focus on research and development on initiatives that seek long-term solutions to our energy challenges, as we have done with energy efficiency, renewables, hydrogen, fusion, and nuclear energy, as well as the recently-announced zero-emission FutureGen coal project.


While these initiatives hold enormous promise for the future, we recognize the need for immediate actions to address the nation’s growing energy demand. Clear Skies figures prominently on this list. I’d like to mention just a few of the actions currently underway, particularly those focused on ensuring adequate supplies of natural gas and electricity.


To increase and diversify domestic supplies of natural gas, the Administration, among other actions, has streamlined the process by which permits are granted for important energy projects, such as pipelines and refineries, and accelerated the leasing of non-restricted Federal lands where environmentally appropriate.


The Administration is encouraging new gas well investment by allowing for access to high quality resources and growth in pipeline delivery capability. We recognize that recoverable resources tend to be more difficult to develop and produce because the U.S. is a mature producing area. This increases ultimate supply costs, which requires ever increasing prices to be economically viable. A number of locations, such as portions of the Rocky Mountain area and the eastern Gulf of Mexico, are currently unavailable to exploration and development even though they are expected to contain substantial volumes of recoverable natural gas.

Interstate pipelines have been expanding delivery capacity, but additional expansions are needed to satisfy expected market growth. In 2002, 54 interstate pipeline projects were completed, adding about 12.8 billion cubic feet of capacity per day throughout the U.S., and proposals for expansions in 2003 through 2005 have been announced for a number of pipelines. The gas pipeline network has grown extensively over the past decade to meet the increasing demand for gas and to accommodate diversified gas sources. Regulatory lags in obtaining authorization for expansions of pipeline capacity are being addressed by initiatives at the Federal Energy Regulatory Commission (FERC) aimed at streamlining this approval process.


The Administration also strongly supports the construction of a commercially-viable Alaska natural gas pipeline as a critical part of our energy security portfolio.


The National Energy Policy also highlighted the growing need for attention to the nation’s electricity markets and infrastructure. The Administration’s overarching goal is to ensure that Americans have abundant, affordable, clean and secure electricity supplies, and we strongly believe that Clear Skies is a key component of meeting this goal, as is a comprehensive energy bill that includes a sound electricity title to modernize our Nation’s antiquated wholesale electricity laws.


The Administration believes that there really is only one viable policy choice: we must complete the transition to effective competition in wholesale power markets.


Well-functioning markets will, we believe, lead to lower costs for consumers and businesses. But there is more than simply the benefit of lower prices. A well-functioning market brings its own rewards. As confidence is gained that the system is reliable and capable of coping with high-demand for electricity, there will increasingly be less need for restrictive and prescriptive regulation. And that is the point when much-needed investment is likely to be attracted -- investment in new technologies, and in improved generation and transmission facilities that produce additional energy and environmental benefits.


When the opposite is true – when uncertainty reigns, when reliability is questioned, when prices seem detached from market forces – investment vanishes.


The present uncertainty in the wholesale electricity market is not simply affected by policy choices that center on transmission assets and market designs. The uncertainty extends to the generation of electricity itself. That is why it is important to provide greater regulatory certainty about the kinds of investment choices that the generating industry will have to make over the next two decades.


We believe that the President’s Clear Skies proposal does just that.


S. 485 Clear Skies Act of 2003


In 2000, 39 percent of the total energy consumed in the U.S. was for power generation. Since 1975, total U.S. energy use has grown by about 1.1 percent per year, while GDP and electricity consumption have grown by nearly 3 percent per year. We project future electricity growth to be somewhat less, below 2 percent per year, but it is clear that electricity is either the fuel of choice or fuel of necessity for many applications.


Our electric power is among the lowest in cost of any free market society. Low cost electricity is part of America’s competitive edge in international markets. Cheap power translates to prosperity and available resources to overcome problems in many areas unrelated to energy but essential to our quality of life. A major reason that electricity in the U.S. is relatively inexpensive is that roughly one-half of our generation comes from coal.


S.485, the Clear Skies Act of 2003, is a multi-pollutant, market-based cap and trade program that will reduce power plant emissions of sulfur dioxide (SO2), nitrogen oxides (NOx) and mercury by approximately 70 percent from today’s levels--and do it faster, with more certainty, and at less cost to American consumers than would current law.

Flexibility of compliance choices, maintenance of fuel diversity, and the cost savings passed on to consumers through lower electricity prices are among the benefits of the approach taken in Clear Skies, particularly when compared with other proposals that support more stringent targets, shorter compliance periods, or command and control regulatory approaches. The cap-and-trade system of emission reductions used in S. 485 should translate into reduced impacts on fuel markets—in particular, coal and gas—than equivalent emission reductions achieved through other approaches.


The Clear Skies Act substantially expands one of the most successful Clean Air Act programs – the Acid Rain Program – and reduces the need to rely on complex and less efficient programs. Power plants would be allowed to choose the pollution reduction strategy that best meets their needs (e.g., installing pollution control equipment, switching to lower sulfur or mercury coals, buying excess allowances from plants that have reduced their emissions beyond required levels). And like the Acid Rain program, Clear Skies includes banking provisions, enabling companies to save unused allowances for future use. The result would be significant nationwide human health and environmental benefits; certainty for industry, states and citizens; energy security; and continuing low costs to consumers.


S. 485 establishes a coordinated timeline for control of major emissions that provides adequate time to attract investment funds and avoids premature retirement of working capital. The patchwork of existing and soon-to-be-implemented regulations under the Clean Air Act, coupled with the delays bred by continuous litigation over them, has created enormous uncertainty for utilities, co-ops, and municipal generators. This uncertainty has curtailed investments in technology that would reduce emissions at existing plants and prevented numerous new facilities from coming online. Clear Skies provides industry with the time needed to attract capital necessary to reduce emissions without jeopardizing energy security.


Energy Impacts of Clear Skies


It is difficult to quantify what the cost or energy impacts will be if multipollutant legislation is not enacted. The EIA “baseline” includes all future legislation and regulations that have been specified, but does not include regulations that have not yet been promulgated. We know that in the absence of S. 485, mercury regulations will be promulgated by December 2004. But we do not know what those regulations will require; that knowledge will come only after a lengthy rulemaking process. We can anticipate that additional reductions in SO2 and NOx will be required to attain ambient air quality standards for fine particulate matter. But we do not know what those regulations will be. We can anticipate additional regulations to reduce regional haze, but again, we do not know what those regulations will require.


What we should be concerned with is this: uncertainty, delay, and litigation are not likely to produce greater environmental benefits; they instead are likely to lead to more costly solutions, and they risk affecting the energy fuel mix in ways that are unwarranted and unforeseen.


Although we have not contrasted Clear Skies to this unknown regulatory future, we have compared it to a future predicated on current control programs. Under Clear Skies, natural gas consumption, which is projected to increase from 23 to 35 trillion cubic feet of gas in our baseline projection to 2025, increases to 36 trillion cubic feet per year in 2025. However, we do not project that a significant change in natural gas supply is needed due to the implementation of Clear Skies. Wellhead natural gas prices follow the baseline pattern, after decreasing from the unusually high prices that occurred in 2001.

Clear Skies helps maintain coal as an important fuel source, thereby avoiding excessive pressure on natural gas prices. In our baseline projection, coal consumption would increase about 38 percent through 2025. Under S. 485, we project approximately a 26 percent increase.


EIA projects that electricity prices will be lower throughout the projection period than in 2001, for both the baseline scenario and under S. 485. The effect of the emission reductions is roughly a 0.3 cent per kilowatt-hour price increase above the baseline in 2025.


One of the concerns we have is in the ever-increasing reliance on natural gas for generation of electricity. As I have noted previously, this is primarily a function of efficiency and costs, but because our marginal supply of natural gas will increasingly come from imported LNG we should be concerned that we not place too much stress on natural gas supply by forcing a level of fuel switching from coal to gas that leads to higher volatility and higher prices. Natural gas supply as a low-cost and reliable source of electricity is not automatic – one has only to witness the winters of 2000-2001, and 2002-2003 to see the point.


In both the near and long term, the price of a commodity like natural gas is determined by the interaction of supply and demand. However, the determinants of supply and demand in the near term can be quite different than the factors that determine prices in the long term. In the near term, factors such as weather related increases in demand, storage levels, productive capacity at the wellhead, and disruptions in supply lines can be paramount because of the difficulty of quickly increasing the number of producing wells. Long-term market conditions, however, depend more on such factors as


? the ability of markets to respond to price increases with adequate investments in new wells;

? continuing availability of alternative fuels for generation;

? a viable market for imported gas;

? the continued development of new technologies; and

? emissions reductions required under future regulation


The difference in what affects natural gas prices in the near term versus long term has important policy implications. We have to recognize that in the short run it is hard to do much about natural gas supply. From the time natural gas prices spike, the industry rule of thumb is that it takes 6-18 months for production to increase. And, unlike oil, there is currently no large international spot market in liquefied natural gas to moderate gas supply scarcity.


The elasticity of natural gas demand plays a significant role in price volatility. Because many users cannot switch to alternative fuels quickly, demand tends to be more inelastic in the short run. Inelastic demand means that small changes in demand lead to significantly higher prices than under less inelastic demand. Demand becomes less elastic as electric generators or industrial users lose their ability to switch to another fuel or as any user loses the ability to reduce consumption in response to higher prices.


It is, therefore, critically important that we maintain a balanced diversity of fuels to provide low-cost and abundant electricity. And the key to this is that we not assume that all policy objectives can simply be achieved with unlimited reliance on natural gas.


The Role of Research


One of DOE’s fundamental missions is the advancement of energy-related technology. I would be remiss if I did not emphasize again that the projections I have presented today assume only a continuation of historic trends in technology evolution. We have the ability to change those trends through dramatic technology improvements. We intend to do exactly that.


The President has launched a suite of relevant technology initiatives: FreedomCAR and the Hydrogen Fuel Initiative (the hydrogen/fuel cell vehicle and infrastructure program), FutureGen (a program to develop a zero-emission coal-based power plant, coproducing low-cost hydrogen and sequestering CO2), and fusion electric power plants. Success in these areas will dramatically change the energy, economic, and environmental future of the Nation.


The future role of coal in our energy mix may also be highly sensitive to the success we have in our program to improve Integrated Gasification Combined Cycle (IGCC) technology, an inherently clean way to produce power from coal. This technology has already been demonstrated at commercial scale, but additional support is being provided by DOE to enhance its efficiency, reduce technological risk, and drive down capital costs. In addition, as I mentioned earlier, we are also pursuing R&D targeted specifically on one of the tougher challenges in Clear Skies – mercury control.




In conclusion, we believe that Clears Skies, which provides a range of benefits – improved health, cleaner air, and economic efficiency - is the best approach to address our dual energy and environmental challenges. Clear Skies avoids the more serious economic consequences of other approaches to cleaner air and provides market-based flexibility to the energy sector. Clear Skies, combined with our many other efforts to develop new, reliable, and secure sources of energy, will deliver significant environmental protection. It will help us to achieve our national goal of abundant, affordable, and clean sources of energy by maintaining fuel diversity and by providing greater regulatory certainty.