Mr. Chairman and members of the Subcommittee, I am privileged to appear today on behalf of TXU and participate in this Subcommittee’s ongoing review of S. 485, the Clear Skies Act. I applaud the comprehensive nature of the Subcommittee’s hearing process for S. 485, and I hope that you will find my statement today on electric generator capital investment decisions helpful during your continued deliberations.

TXU supports President Bush’s efforts to reduce SO2, NOx and mercury emissions through a three pollutant framework such as that used in the Clear Skies Act. However, if the Clear Skies Act is to avoid harmful fuel switching, the Clear Skies legislation must base Phase I mercury limits on “co-benefits” (i.e., that level of mercury emission reduction that results from meeting SO2 and NOx emission limitations) and should not mandate controls on carbon emissions. Only under these conditions can the Clear Skies Act meet the goal of promoting long-term planning certainty for the electric generator sector and achieving significant reductions in emissions of NOx, SO2 and mercury.

My statement today will first discuss the general approach used by TXU and other electric generators to analyze capital investment decisions relating to emission control equipment. Typically, this approach includes identification of all potential compliance options, including shutting down power plants and switching fuels, and an extensive long-term cost/benefit analysis for each compliance option.

The second part of my statement will focus specifically on TXU’s selection of the SO2 and NOx controls necessary to meet current state and federal emissions requirements. It has been critical that TXU accurately estimate both the cost and effectiveness of the available control technologies. Notably, TXU’s efforts to significantly reduce NOx and SO2 emissions as required by Texas law and the Texas State Implementation Plan under the Clean Air Act have been extraordinarily successful, resulting in early compliance with all applicable mandates in 2003.

Finally, my statement will address the capital investment analysis that would be employed by TXU to evaluate the emission reductions proposed in the Clear Skies Act legislation, where mercury controls are expected to be the key planning issue. Currently, there is no commercially demonstrated control technology for mercury and the technologies used in pilot projects have achieved inconsistent results at extreme expense, especially for lignite. Because meeting the Clear Skies Act SO2 and NOx limits will require significant capital investment by electric generators, adding a requirement for unproven and expensive mercury control technology could result in very costly fuel switching by coal-fired plants. Fuel switching would contribute to price spikes in the natural gas market that would impact not only the electric generator sector, but also consumers and many industries that use natural gas as a raw material or feedstock. The Phase I mercury emission reduction contained in the bill needs to be set at the SO2 and NOx “co-benefits” level, which is not expected to result in significant fuel switching by electricity generators.

Even if the Phase I mercury emission reduction contained in the bill is revised and set at the SO2 and NOx “co-benefits” level, meeting the Phase II mercury level of 15 tons in the year 2018 is wholly a bet on future technology. Such uncertainty presents significant investment capital planning problems for electric generators, and may very well overwhelm an electric generator’s capital investment analysis for the Phase I SO2 and NOx limits. Moreover, the mercury emission controls would not significantly reduce global loading of mercury--the Environmental Protection Agency has stated that U.S. electric generators comprise less than one percent of the global mercury emissions.

General Approach To Capital Investment Decision-making For Emission Controls

By way of background, TXU is a major energy company with operations in North America and Australia. TXU manages a diverse energy portfolio with a strategic mix of over $30 billion of assets.

In its primary market of Texas, TXU’s portfolio includes 19,000 megawatts of generation with a fuel mix of coal/lignite, natural gas/oil, nuclear power and wind. TXU serves five million customers in North America and Australia, including 2.7 million competitive electric customers in Texas where it is the leading energy retailer.

TXU’s commitment to environmental excellence is well-demonstrated. The Company is one of the nation’s largest coal/lignite generators, yet TXU's SO2 emission rate in 2001 was 21% below the national average (52 electric generation companies had higher SO2 emission rates than TXU in 2000). Similarly, while TXU is the 8th-largest generator of electricity in the nation, the Company’s NOx emission rate in 2001 was 18% below the national average (61 electric generation companies had higher NOx emission rates than TXU in 2000). Additionally, TXU’s CO2 emission rate in 2001 was 8% below the national average and TXU has implemented the largest voluntary greenhouse gas reduction program among all the investor-owned electric generation companies in the United States.

The first step in an electric generator’s capital investment analysis for emission controls is to identify all viable alternate investment scenarios for compliance with a new emissions standard. During this step of the investment analysis, the alternate investment scenarios can range from:

* Attempting a smaller level of capital investment for emissions control technologies at a power plant--but typically a smaller investment in control technologies results in a significant loss of electricity production capacity at the power plant; * Committing to significant levels of capital investment for emissions control technologies in order to achieve the least possible loss of electricity production capacity at the plant; * Fuel switching at a power plant; or * Closing down a power plant, losing all the generating capacity at that power plant but avoiding new capital investment.

Next, the company will calculate the total economic cost of each alternative over the lifetime of the power plant, taking into account any income associated with each alternative. This is a detailed net present-value analysis that, among other things, requires accurate information on the operational costs of a particular control technology and its performance in reducing emissions over the remaining life of each power plant. Specifically, this long-term economic cost analysis of each alternate investment scenario will focus on:

* The amount of capital investment needed up-front and known to be needed in the future; * The operating expenses associated with the current capital investment and known future capital investment; * The overall operating expenses of a power plant under the alternative investment scenario (this might include the purchase of emissions credits); * Whether the alternative investment scenario has operating restrictions that would reduce the production of electricity (and thus reduce income); * The potential income, if any, from the alternative investment scenario (this might include the sales of emissions credits or byproducts generated by the emissions control equipment).

Armed with the net present value figures, and the pro-forma financial statements related to the net present values, the company will evaluate the financial impacts of each alternate investment scenario against any potential financial constraints faced by the company, such as borrowing limits, debt covenants, or limits on financial ratios. From this process, the company will select a viable alternative investment scenario with the highest overall economic value.

Capital Investment Decisions Relating To Existing SO2 and NOx Requirements

It may be helpful to review briefly TXU’s capital investment decision-making process for SO2 requirements under the Clean Air Act’s acid rain program, and for NOx reductions required under Texas state law. Both of these capital investment decision-making processes used the general framework discussed earlier, but each also had unique factors that shaped the analysis. Critical to both types of evaluation, however, was the availability of accurate information on the costs and effectiveness of the available options for emissions control equipment.

For example, under the federal acid rain program, SO2 reductions were achieved by a two-phased national cap without additional mandatory plant-by-plant restrictions. Accordingly, TXU and other affected electric generators could assess decisions over their entire fleet of power plants, choosing investments and controlling those plants where emissions reductions made the most economic sense. For its capital investment analysis, TXU developed alternate investment scenarios using options available throughout its entire portfolio of lignite/coal fueled units while maintaining compliance with local SO2 emissions limits.

The primary control technology used to achieve significant reduction of SO2 emissions is called a “scrubber.” To a lesser extent, fuel switching to a low sulfur subbituminous coal can also reduce SO2 emissions. In its analysis of SO2 control equipment investment options, TXU found a wide, plant-by-plant variation in the cost of scrubbers, mainly due to different plant designs. Variations in cost were dependent on factors such as existing control equipment and available space in the plant configuration for installation of a new scrubber. In certain instances, elaborate plant modifications would be required to withstand the impact of increased scrubbing. Installation deadlines also significantly impact the cost of installation. Other key drivers in TXU’s analysis were the operating costs of the scrubbers, and whether the scrubbers could be expected to perform at planned removal rates for the life of the facility.

TXU’s decision-making process for compliance with the acid rain program was enhanced by our knowledge of well-tested scrubber technology, coupled with accurate information on the annual operational costs for such equipment. Using this information, TXU could develop precise alternate investment scenarios and compare the scenarios to other compliance strategies, such as purchase of emission credits in the open market.

There are nine coal-fired units in the TXU fleet, five of which are scrubbed, accounting for 61% of our coal-fired generation. The cost estimate for installing scrubbers at the four remaining coal-fired units is approximately $400 million.

In contrast to TXU’s experience with the acid rain program, the NOx controls required to meet Texas’ state NOx limits involved a much more complex analysis of alternate investment scenarios. Under a Texas state law adopted in 1999, electric generators in Texas were required by May, 2003 to achieve a 50% reduction in NOx emissions from certain of its plants, as compared to 1997 emissions. TXU and other generators also faced deadlines for achieving other NOx reduction targets in various Texas regions to meet the State Implementation Plan requirements under the Clean Air Act. Additionally, TXU was required to achieve a 25% reduction in SO2 emissions from certain of its plants. TXU achieved all those NOx and SO2 reductions, plus more, ahead of schedule. Accordingly, TXU’s experience in developing a capital investment plan to meet the Texas NOx limits may be instructive as to what electric generators would face under the Clear Skies Act.

Generally, two factors increased the complexity of TXU’s capital investment analysis relating to the Texas NOx requirements:

* First, in contrast to the SO2 scrubber analysis, there were many different NOx technologies that could potentially achieve reductions at each power plant. This probably holds true for the NOx emission limitations contained in the Clear Skies Act as well. * Second, rather than fleet-wide emission limit (as in the SO2 example), TXU was required to comply with no less than five different localized or regional NOx limits for its power plants.

This increase in the number of variables complicated the alternative investment analysis. Additionally, localized and multiple regional NOx limits degrade the market for NOx emission allowances, reducing the ability of the NOx emission allowance market to reduce overall compliance costs.

TXU will spend approximately $230 million to complete the NOx retrofits required in order to comply with State regulations, through 2005.

Although somewhat more complicated than the SO2 acid rain program alternative investment analysis, the analysis of TXU’s NOx alternative investment scenarios was again aided by our knowledge of well-tested, proven removal technologies and accurate information on the annual operational costs for such equipment. Under the federal acid rain program and the Texas state NOx limits, TXU has committed hundreds of millions of dollars for capital investment in control technologies. However, the company made that commitment after an extensive economic analysis, with relative certainty of the reductions it expected to achieve.

Potential Additional Capital Investment Under The Clear Skies Act

TXU supports a three pollutant framework such as that used in the Clear Skies Act. However, if the Clear Skies Act is to avoid harmful fuel-switching, the Clear Skies legislation should not mandate controls on carbon emissions and must base Phase I mercury limits on “co-benefits” (i.e., that level of mercury emission reduction that results from meeting SO2 and NOx emission limitations). Only under these conditions can the Clear Skies Act meet the goal of promoting long-term planning certainty for the electric generator sector and achieving significant reductions in emissions of NOx, SO2 and mercury.

As introduced, the Clear Skies Act contains the following schedule for reductions in SO2, NOx and mercury emissions:

The Clear Skies Act contains major reductions in SO2 and NOx emissions when compared to today’s emission levels. Achieving these reductions will require an unprecedented number of state-of-the-art emission controls. With the significantly increased number of emission controls being installed, an electric generator’s capital investment analysis must now also include dealing with limitations on the amount of emission control equipment that can be installed at any one time, based on system reliability requirements for the availability of power plants, as well as the shortage of trained professionals that perform such installations and the manufacturing capability to handle a major surge in orders for emission reduction equipment.

Appropriately, the Clear Skies Act does not regulate carbon emissions. Carbon is not a regulated pollutant under the Clean Air Act, nor should it be. Presently, carbon reductions are costly and complex. Given these circumstances, TXU supports the voluntary carbon reduction goals established by the President, as well as funding additional research concerning carbon emission reduction technologies.

However, the mercury provisions of the Clear Skies Act legislation may cause fuel switching by electric generators in order to meet emissions limits. Currently, there is no commercially demonstrated control technology for mercury. Several pilot tests have used activated carbon injection technology, but much remains unknown with that technology and it appears to be prohibitively expensive.

Accordingly, the Environmental Protection Agency’s initial position was that the Clear Skies Phase I mercury limit of 26 tons in 2010 would not require a power plant to install mercury-specific emissions controls--the Phase I mercury limit could instead be met solely by the amount of mercury removed as a “co-benefit” of the SO2 and NOx emission controls installed under the Clear Skies Act. There is now considerable doubt as to whether the Phase I mercury limit can be met through such “co-benefits”. If the Phase I mercury limit cannot be met by “co-benefits”, power plants must in the near term install unproven and expensive mercury-specific emission control technology, or fuel switch.

Given the already significant capital investment required of electric generators to meet the Clear Skies Act SO2 and NOx limits, the Phase I mercury emission reduction required by the bill should be revised and set at the SO2 and NOx “co-benefits” level, as was initially suggested by the Administration. It is important to remember that, even if the Clear Skies Act Phase I mercury level is revised and set at the SO2 and NOx “co-benefits” level, meeting the Phase II mercury limit of 15 tons in the year 2018 is a bet on future technology.

The lignite coal used by TXU and other electric generators faces additional hurdles with regard to mercury removal. The mercury content of lignite is higher than that of bituminous or subbituminous coal. In addition, the combination of mercury and other constituents in lignite coal is believed to be more difficult to remove using the pilot-tested activated carbon injection technology. The lack of a demonstrated emissions control technology could result in fuel switching for lignite-powered plants, if not plant closings.

This high level of uncertainty with regard to mercury emissions reductions from lignite-powered coal plants requires that TXU factor its approach for compliance with the 2018 Phase II mercury levels into the planning and decision-making process for the Phase I SO2 and NOx levels. That result occurs because TXU’s different compliance options for Phase I (for example, continued use of lignite with scrubbers or, alternatively, fuel-switching for the SO2 limit) may have very different implications for meeting the Phase II mercury levels. This decision tree is outlined at Figure 1.

*Assumes Phase 1, Mercury Limits Are Set at True Co-benefits.

In summary, the lack of a demonstrated emissions control technology for mercury prevents accurate long-term planning by the electric generating sector. Companies have no idea of the long-term costs associated with mercury removal technology or the effectiveness of the technology once it is installed. This situation is in sharp contrast to the SO2 and NOx analysis discussed earlier, and significantly complicates the capital investment analysis.

Conclusion

TXU supports President Bush’s efforts to reduce SO2, NOx and mercury emissions through a three pollutant framework such as that used in the Clear Skies Act. However, if the Clear Skies Act is to avoid harmful fuel switching, the Clear Skies legislation must base Phase I mercury limits on SO2 and NOx “co-benefits” and should not mandate controls on carbon emissions. The Phase II mercury limits beyond “co-benefits” need to be predicated on the existence of a viable, commercially available mercury emission control technology. Only under these conditions can the Clear Skies Act meet the goal of promoting long-term planning certainty for the electric generator sector and achieving significant reductions in emissions of NOx, SO2 and mercury.