COGENERATION: The Regulations Affecting
it and its Primary Problems.
by
Dale Tillery
00453
The recent sharp increase in the price of fossil fuels
has forced industry to search for methods which will reduce
their generation expense.
The search has lead to a reju-
vented interest in cogeneration; however, the pursuit of
cogeneration has created unique problems.
The United States government views the dependence on
fossil fuels as a threat to our national interest.
To re-
duce our dependence on fossil fuels, the government has
tried to structure a regulatory system which aims to encourage the use of cogeneration while avoiding damage to public
utilities.
The growth of cogeneration has stimulated debate in
several areas.
One area of debate involves the financial
incentives and disincentives for industries interested in
utilizing cogeneration.
Utilities have voiced opposition
to cogeneration and have erected barriers to its implementation, thus drawing strong criticism from cogeneration
supporters.
A dispute exists concerning whether cogenera-
tion facilities should be large and centralized or small
and decentralized.
States will play an important role in cogeneration
and are just beginning to grappel with the problems presented, and to discover the benefits available.
Finally, with the change in administration, a glimpse
of cogeneration1s future may be obtained by examining the
present administrations policy concerning cogeneration.
00454
-1-
On April 20, 1977, President Jimmy Carter made a speech
1
in which he coined the term cogeneration.
President Carter
defined cogeneration as "the production of electric power and
other forms of useful energy - such as heat or process steam 2
from the same facility.'8
For legislative purposes, coge-
neration is defined as "(i) electric energy, and (ii) steam
or forms of useful energy (such as heat) which are used
3 for
industrial, commercial, heating, or cooling purposes."
The process President Carter referred to as cogeneration is not a new concept.
Before being termed cogenera-
tion, the process was known as "in-plant generation,"
"by
4
product power," or "total energy system."
Fifty years ago,
the United States produced close to twenty five percent of
5
of its own energy through cogeneration;
however, the large
drop in the cost of electric energy and the improvement in
the availability of reliable electric energy has caused a
decline in energy produced 6by cogeneration to about four percent of its energy output.
Cogenerated energy is generally produced by one of two
commonly used methods.
One cogeneration process is referred
to as a topping cycle.
In a topping cycle, fuel is burned
to produce electricity and the heat from the generation
7
system is used to meet thermal heating requirements.
other commonly used method is a bottoming cycle.
The
In a bot-
toming cycle, fuel is burned to produce heat for the industrial
00455
-2process or thermal needs (ex. smelting or kiln baking).
8
The
exhaust heat from, the industrial process is then used to
generate electricity.
These systems are most beneficial when
an industry has a high heat requirement and high utilization
9
of the industrial process.
The use of cogeneration is viewed as one way to reduce
our dependence on fossil fuels by being more efficient in our
fuel use.
The overall United States utility fuel efficiency
rating is twenty nine percent and with improvements in tech10
nology it may be improved by one or two percentage points.
Cogeneration offers vast improvements in fuel efficiency
without any new technology."
By moving the locus of gene-
rating plants close to thermal energy users and interconnecting them with the electric.grid, efficiency ratings of
eighty percent are attainable which is two and one half to
12
three times greater than the present efficiency ratings.
The potential benefit from the use of cogeneration
could be quite significant.
Aside from the afore mentioned
efficiency improvement, it is estimatedvthe use of cogeneration could eventually save as much as two million barrels of
13
oil a day.
One estimation claims wide use of cogeneration
could reduce fuel use in 1995 by seventy thousand barrels of
oil a day, fifty nine billion cubic feet of gas a 14
year, and
two hundred and three billion cubic feet of coal.
Another
report asserts, a coal burning generator's efficiency can
-14be increased from thirty three percent to eighty five
15
percent.
Sweden has reduced its fuel loss through heat
16
waste, to forty seven percent, by cogeneration.
Cogene-
ration could make a similar reduction in the United States'
17
present sixty eight percent fuel loss due to heat waste.
The basic legislative policy regarding cogeneration
is stated in the Public Utility Regulatory Policies Act of
18
1978 (PURPA).
PURPA broadly defines a cogenerator as
a facility which produces "electrical energy" and "steam or
forms of useful energy (such as heat) which are used for
IS
industrial, commercial, heating, or cooling purposes."
Under PURPA congress has granted the Federal Energy Regulatory Commission (FERC) the authority to promulgate
regulations which would accomplish PURPA1s broad goals for
encouraging the sale and purchase of electricity from
20
cogenerators and small power production facilities.
FERC's regulations have established standards which
must be met in order for a facility to qualify as a cogenerator or a small power producer.
Generally, a facility
qualifies as a cogenerator if it meets operating
and
21
efficiency standards and ownership criteria.
The parti-
cular operating and efficiency standards applicable depend
upon whether the facility is a topping or bottoming cogene22
rator.
The ownership criteria does not allow a facility
to be owned by a person primarily engaged in the generation
00457
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or sale of electricity.
The ownership requirement is
intended to prevent cogenerators from being owned by utilities;
therefore, no more than fifty percent of the facilities
24
equity interest can be held by a utility.
FERC's regulations, which were promulgated to achieve
congressional policies regarding the purchase and sale of
electricity between cogenerators and a utility under
section 210 of PURPA, requires the utilities to deal fairly
with cogenerating facilities.
In the area of rate setting
for purchase of power, the regulations require utilities to
make data available
from which the utility's "avoided cost"
25
may be derived.
The regulations clearly require electric utilities to
26
purchase energy from cogenerators;
however, a utility is
not required to purchase a qualifying facility's electric
energy if the utility can demonstrate the energy would cost
27
more to purchase than it would to produce.
The utility
must also notify the state utility commission and the
28
cogenerator of its decision not to purchase energy.
Utilities are prohibited from discriminating against
cogenerators; however, the utility can not be required
29
to pay more than the "avoided cost" for purchases.
The
state regulatory authorities may allow rates below "avoided 30
cost" if it is deemed sufficient to encourage cogeneration.
The regulations contain a list of factors which should be
31
considered when determining "avoided cost."
00458
-5Utilities must providet upon request by a cogenerator,
supplementary power, back-up power, maintenance power, and
32
interruptible power
unless the utility can prove it would
be unduly burdened or it would be unable to render adequate
33
service to its customer.
Utilities are also obligated to
sale to a cogenerator any energy and capacity requested by the
34
cogenerator.
FERC's regulations expressly state that a
utility's rates shall not discriminate between a cogenerator
35
and the utility's other customers.
In setting rates for
these services, the utility may not assume all interconnected
cogenerators will simultaneously transfer produced energy or
36
transfer their energy during the utilities peak hours.
The utility must also take into consideration any possible
coordination of the cogenerator1s production period with
37
the utility's production schedule.
The utility must interconnect with a qualifying cogenerator upon the facility's request; however, the qualifying
38
facility is obligated to pay any interconnection costs.
The reasonable cost of interconnection is to be determined
39
jointly by the utility and the state utility commission.
In the event of an emergency, a cogenerator may be
required to provide energy or capacity to an electric utility;
although, the cogenerator and the utility may set the terms
of an emergency sale by contract.
The regulations also allow
the utility to discontinue purchases and sales of energy
w4oy
-10to cogeneration facilities during emergencies if the sale
discontinuation is non-discriminatory or the purchase would
40
contribute to the emergency.
FERC's regulations delegate to the state utility
commissions the responsiblity of determining standards
41
for the safety and reliability of interconnected facilities.
The state commissions are also required to implement rules
and regulations governing disputes, between cogeneration
facilities and electric utilities, concerning the utilities'
rates for purchase or sale of42
energy, interconnection cost
or system emergency disputes.
The regulations specifically exempt qualifying cogeneration facilities from incremental pricing under the Natural
Gas Policy Act of 1978.
The qualifications for the ex-
emption are basically the same as the qualifications a cogenerator must meet under section 201 through 207, with added
efficiency standards tailored for the various
types of
43
cogeneration facilities being operated.
The qualifications
for the exemption generally do not affect new cogeneration
facilities because they are employed solely to achieve
efficiency; however, older cogeneration plants should take
heed of these requirements.
FERC's requlations also exempt cogeneration and small
power production facilities from certain provisions of the
Federal Powerft.ct,the Public Utility Holding Company Act,
00460
-14and state laws or regulations pertaining to the rates of
electric utilities, and the financial and organizational
44
regulation of electric utilities.
Problems in these
areas are generally easily avoided; however, if confronted
with such a problem, consult the specific exemption under
the particular act or state law in question.
The guideline for the creation of incentives for
cogeneration was to structure a system which would create
a price high enough to encourage the generation and sale
of electricity by industries, but low enough to benefit
45
the utility and its other customers.
To make cogeneration attractive, regulations were
promulgated to insure a reasonable return on a cogenerator1s
sale of electricity.
created PURPA.
In pursuit of this goal, congress
Section 210 of PURPA dictates that the
purchase rate of electricity, from cogeneration facilities,
shall not exceed the incremental cost to
46 the electric
utility of alternative electric energy.
The policy
mandated by Section 210 of PURPA has come to be known as
"avoided cost."47
A utility's "avoided cost" is computed by taking
capacity and energy cost, which a utility would incur in
order to meet a particular demand, and compare that cost
with the cost the utility would incur by purchasing the energy
to meet the particular demand from a qualifying cogeneration
00461
—s—
facility.
The amount the utility must pay for the energy
is the cost the utility avoids by purchasing and not pro48
ducing the energy.
The factors to be considered in
arriving at the "avoided cost" has been left to the state
49
power commissions.
"Avoided cost" encourages cogeneration
because it assures the industrial producer of power a rate
of return
which is often above the rate charged for the
electricity purchased from the utility by the industry.
If an industry pays close attention to a utility's rate
structure, it may gain an additional benefit under Section
210 of PURPA.
sale provision.
Section 210 contains a simultaneous purchasePursuant to the purchase-sale provision,
the electric utility purchases all of the cogenerator's
electrical output and then sales to the cogenerator all
the cogenerator's electricity requirements at the regular
50
commercial or industrial rate.
The utility must give the
cogenerator the option of a simultaneous purchase-sale
agreement or an agreement which provides 51
for the purchase
of the cogenerator's excess electricity.
The effect of the purchase-sale agreement is to encourage the use of cogeneration in a situation where the
utility's "avoided cost" of purchasing electricity is lower
than its industrial electricity rate in addition to the
incentive to cogeneration when the utility's "avoided cost"
of acquiring alternative electricity is greater than its
00462
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industrial electricity rate.
In addition to the legislative incentives for cogeneration, there are tax incentives for cogeneration.
The
present tax structure allows cogenerators to take advantage
of a ten percent investment tax credit plus an eleven percent energy investment tax credit for the full value of the
project.
The effect of the tax law is to allow the taxpayer
to claim a twenty one percent tax credit (twenty one percent
of the total cost of the project) against his taxes even
if the taxpayer does not finance the total project himself
53
but instead borrows the money.
Another potential financial incentive to cogeneration
is the use ofvexempt municipal bonds.
The scenario calls
for waste heat produced by municipal solid waste processing
facilities to be converted into electricity.
The necessary
construction and interconnection of a cogeneration facility,
which would be owned by a public power authority, could be
financed by tax exempt bonds.
This facility would then
provide an industrial firm with 54
a portion of the cogeneration
facility's production capacity.
In order to retain the
tax exemption, the industrial firm would have to restrict
its purchased capacity to under twenty five percent of the
facility's capacity and its annual payments could not equal55
nor exceed three percent of the annual debt service amount.
The major disincentive to cogeneration is the large
00463
-10capital expenditure which is required to enable an industry
to develope a cogeneration system compatible with the industry's
56
need.
Supporters of cogeneration have clammered for invest-
ment incentives which allow industries to produce on site
electricity cheaper than central station produced electricity
cost to purchase.
After the year 1990, the use of natural gas or petroleum
may be prohibited in any existing major fuel burning installation; furthermore, the use of natural gas or petroleum,
as a primary energy source in a new installation, is prohibited according to the Powerplant and Industrial Fuel Use
57
Act (PUA).
It is possible for a cogenerator to obtain an
exemption, from the PUA regulations, by demonstrating the
benefits of cogeneration can not be obtained
without using
58
oil or gas in the industrial boiler;
however, the exemp-
tion does not alleviate the need for a large capital expenditure because cogeneration equipment must be purchased whether
the boilers burn oil, gas, or some alternative fuel.
Industry has voiced concern because they are now faced
with the problem of making a large capital expenditure to
convert their present facilities to cogeneration facilities
or to make a capital expenditure for changing its present
system over from a natural gas or petroleum
59 system to an
alternative primary energy source system.
In most
instances, an industry using natural gas or petroleum fired
00464
-10boilers can be operated on coal; as a result, the industry's
60
equipment must either be converted or replaced.
The present cost of implementing a new-coal fired
steam plant amounts to about fifty to seventy five percent
61
of the cost of an industrial facility.
To make matters
worse, the conversion to a coal burning facility does not
make the facility a cogenerator.
To convert the new coal
burning facility to a cogenerator, the industry must incur
62
an additional expense of ten to twenty percent.
The
additional ten to twenty percent investment may be readily
absorbed by an industry if the industry opts for total
plant renovation or if the concerned plant is currently in
the planning or construction stage; however, if the business
capital resources are marginal and the business only wants
to convert its existing equipment to coal, or another
alternative primary energy source, then the additional ten
to twenty percent expenditure for cogeneration equipment
may be cost prohibitive without some form of financial
assistance.
Even industries with the financial ability to
make the switch to cogeneration are reluctant to do so
because they prefer to invest their capital funds into
projects which increase productivity and expand the business
Businesses often demand a higher rate of return on a
cogeneration investment than they do on a production
investment, since cogeneration does not increase productivity
00465
-10In an attempt to overcome the financial burden, supporters
of cogeneration have suggested:
an accelerated write-off for
cogeneration equipment, all tax concessions apply to all the
equipment associated with the cogeneration investment and
64
not merely the boiler of the turbine generator,
a guaranteed
twenty year loan,at a favorable and contained market interest
rate>covering up to ten to fifteen percent of the incremental
investments, the restrictions which regulate a utility's rate
of return on investment be eliminated to encourage cooperation
between utilities and industries, and utilities should be
allowed to enjoy the same tax credits and
65rights to an ujjregulated profit as industrial cogenerators.
Many utilities oppose cogeneration.
Their opposition
stems from a fear of competition in the field of supplying
power. Utilities have structured their rate schedules and
procedures in a manner which discourages potential cogene66
rators.
The obstacles have taken the form of unrealistically high prices for backup and supplemental power and
higher minimums and prices to industries which produce their
67
own power.
Some electric utilities have imposed absolute
prohibitions on the transmission of cogenerated power, to
the user facility, across the utility's transmission system
or private lines and also restrict cogenerators from the
general industry rate schedule.
Cogenerators also face
resistance in the form of regulations preventing competition
00466
68
between utilities in a utility's franchised ares.
The utilities fear is perhaps not justifiable, but
understandable when one considers the economic pressure u r > k
which they labor.
On one hand, utilities are regulated to
a two to three percent return on its assets and on the other
hand they are restricted to an eleven percent return on the
utilities equity.
A utility needs a continuous and even
expanding cash flow to continue making investments; thus,
the purchasing of electricity from an industrial producer
halts the utility's inflow of cash.
The reduction of cash
flow reduces investment opportunities; therefore, because
of the regulation placed on utilities return, they can not
6
make money by simply buying and selling electricity.
Cogeneration also presents a threat because it could realistically curtail an electric utility's output in a market
where industrial implementation of cogeneration is significant.
In light of these circumstances, one can readily perceive
utilities find it in their best interest to discourage
cogenerators.
Utilities complain that cogenerators are given special
incentives and thus, an unfair competitive edge.
Utilities
believe cogenerators should be subjected to the current
utility tax rates.
Utilities charge cogenerators
should also be subjected to regulations which require the
utilities to open their financial records and restrict their
70
finances.
In the present structure, cogenerators are
00467
-14exempted from the restrictions placed upon utilities.
Qualified cogenerators are not to be considered an electric
utility; they are exempt from state regulations which
control a utility's finances and rates, and they are generally
71
exempted from the Federal Power Act's jurisdiction.
There are basically two types of cogenerating facilities:
large, centralized cogeneration facilities, usually owned and
operated by utilities, which supply a number of closely
located industries; and small cogeneration facilities which
are owned by, located on, and supplies energy for a particular
industry's needs.
Currently, there is a debate with
supporters on one side arguing the location of cogenerators
should be large and centralized, and supporters on the
other side claiming small decentralized cogenerators sould
be encouraged.
Supporters of large centralized cogenerators claim
decentralization will not necessarily lead to autonomy
and flexiblity in the cogeneration market.
Presently,
large cogeneration facilities
72 are more efficient than
smaller scaled facilities;
therefore, the larger more
efficient cogenerators coold sale their electricity or steam
at a cheaper rate and eventually the smaller facility
would be unable to compete.
With the reduction of competi-
tion, would come a contraction in the market place, and the
expected autonomy and flexibility associated with small,
00468
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decentralized facilities would not appear.
Small cogenerators, the opposition claims, would
have problems in maintaining a stable client relationship
because the loss of a single large customer could gravely
affect the future of a small cogenerator.
The fear of a
breakdown at the small cogenerator, which can not realistically assure backup power, may discourage potential customerstomers who would select larger facilities which
74
could best allow for such a crisis.
Supporters of large cogeneration facilities claim
scale efficiencies also place small cogenerators in a
difficult position to compete.
Scale efficiencies are
best explained by an example of their application.
If a
business's size can be increased by ten percent, with less
than a ten percent increase in total costs, it is said to
have a scale efficiency.
Large cogenerators are said to
have favorable scale efficiencies in the areas of: generating
equipment, fuel supply,
fuel storage and handling, and
75
pollution control.
It is claimed decentralization leads to a waste of
resources by encouraging many on site generators, which
require additional construction, fuel, maintenance, and
operating cost, which
could be avoided by one centrally
76
located facility.
With the inevitable conversion from fossil fuels to
00469
-10coal, the United States will be faced with the problem of
the generator's emissions affect upon the environment.
Large
cogenerators are said to best protect the environment because
of the more efficient combustion system, better emission
77
controls, and taller stacks.
A series of federal, state, and local taxes artifically
inflate a large cogenerators electricity price above, a small
cogenerator, even though large cogenerator's produce elec78
j^V
tricity or steam cheaper.
Large cogenerators arguevthe
present complex tax structure should be eliminated in favor
of a simplier, more equitable structure which taxes a producer
on its electrical output.
The proposed tax77structure would
apply to both small and large cogenerators.
The proponents of small, decentralized cogeneration
facilities make a distinction between the use of cogeneration
for the production and sale of electricity,
and cogeneration
8Ci>
for the production and sale of steam.
The supporters
of small, on site cogeneration facilities often agree, that
public utilities, with their large, centralized plants, are
best suited for supplying electricity.
The supporters
recognize the great demand for electricity and^need for
reliabiability are best achieved by allowing public utilities
a monopoly in the field of electricity; however, the supporters
contend steam, as a product, is different from electricity.
Steam can only be economically sold to locations within a
470
30
7169 L.Ed.2d 744, at 750.
72
Id at 751.
73Id.
74103 Cal.App.3d 34, at 40.
7569 L.Ed.2d 744, at 752.
76Id at 752.
77Id at 761.
7850 L.W. 4580 (1982).
79Id at 4582.
80
Id
81 Id
82 Id
83Id
84Id
85Id
at
at
at
at
at
at
4581.
4582.
4583.
4585.
4585-4586.
4586.
Id.
87Id.
88 Id.
89Id at
90Id at
91
Id.
92
Id at
93Id at
4586-4587,
4587.
86
4587-4588.
4588, 4592.
00471