Contracts to Burn: How Long-Term Fossil Fuel Contracts and Power Purchase Agreements Lock In Pollution

December 10, 2020
public domain
Joseph Daniel
Senior Energy Analyst

Many companies that own power plants have signed contracts that obligate the utility to burn fossil fuels. The carbon in those contracts is the subject of a new UCS analysis: Contracts to Burn. Here to provide a fresh take on an outdated utility practice is Ashtin Massie, a research associate at UCS and the research lead on this project.

The clean energy transition has some strong momentum right now, and removing obstacles that hinder the transition will allow us to see the benefits of renewable energy much more quickly. One such obstacle that slows down the transition to renewables? Contracts that lock in companies to burn fossil fuels for years to come.

Lucky for you, this just so happens to be the subject of a new UCS analysis, “Contracts to Burn: How Long-Term Fossil Fuel Contracts and Power Purchase Agreements Lock In Pollution, Harm Consumers, and Slow the Clean Energy Transition.”

Locking in fossil fuels

Long-term contracts to buy fossil fuels and burn them for power obligate utilities and other power providers to rely on fossil fuels well into the future. Affiliate transactions, which are agreements between subsidiaries of the same parent company or between a parent company and one of its subsidiaries, are subsets of long-term fossil fuel contracts and have similar outcomes.

All of these agreements essentially guarantee that utilities and power providers that sign onto them will be buying and burning fossil fuels for years to come, even when cheaper and cleaner energy sources are available. That “lock-in” means more air pollution, more carbon pollution, and potentially higher costs for households and businesses.

Historically, fuel and power contracts were signed for periods ranging from a few years to a few decades, usually at a discount, in order to protect against future fuel and power price volatility and guarantee a steady supply of each. But any perceived benefits of long-term fossil fuel contracts have some real and serious downsides.

Contracts to buy and burn fossil fuels lock-in heat-trapping gases and other pollutants for long periods of time. For a detailed list of emissions resulting from contracts at the power-plant level, see the report Appendix.

We project that existing contracts to buy and burn fossil fuels in the United States could create up to 5.4 billion tons of carbon dioxide (CO2), 3 million tons of nitrogen oxides (NOx), and 3.7 million tons of sulfur dioxide (SO2) by 2050, primarily resulting from contracts to buy and burn coal. That means they can be bad for our health, our environment, and the climate.

Long-term contracts for fossil fuels can have hidden costs

Discounts often motivate utilities and other power providers to sign long-term fossil fuel contracts, but whether these discounts amount to any significant savings over the length of the contract is questionable. With renewable energy prices plummeting, locked-in power prices (even at a discount) for fossil-fuel-derived power need to be analyzed on a case-by-case basis to determine if they do indeed provide the savings they once did.

In our new analysis, we explore numerous cases in which fossil-fuel contracts, over the long run, end up costing power providers hundreds of millions of dollars in additional costs that could have been avoided by procuring fuel or power from the wholesale market (without a contract in place) or from renewable sources instead. Additional costs can come from expensive and restrictive take-or-pay provisions in fuel and power contracts, which create additional charges for parties when they don’t take the minimum quantity of fuel or power that’s being provided in their contracts.

Similarly, settlements and legal fees from exiting a contract early, an action some parties have deemed essential despite the contentious process that generally results from doing so, can end up adding millions of dollars more onto the total price tag of a contract. These additional costs could have been avoided if no long-term contract had been signed.

Long-term contracts for fossil fuels create inflexibility in our power supply.

Long-term fossil fuel contracts limit the energy choices for the contracting parties. Some contract clauses can include capacity limits on the amount of power independently procured from distributed renewable sources, for example. Similarly, “take-or-pay” provisions can cause parties to settle for the power or fuel provided in their contract, when cleaner and more affordable options may be available elsewhere, since the additional charges resulting from take-or-pay provisions make switching fuel or power sources incrementally more expensive.

And if the decision to leave a contract arises, some contracts can require as much as 20 years’ notice to exit, further limiting a power provider’s options in procuring clean alternatives to the fossil fuel power they are contractually obligated to purchase.

Getting beyond lock-in

The fact that some utilities have found it worthwhile to pay millions of dollars in fees to exit their fossil fuel contracts illustrates how long-term contracts for fossil fuels are no longer good deals for consumers. And they certainly aren’t good news for our environment.

This practice of signing long-term contracts for fossil fuels needs to be examined more as we move further into the clean energy transition. By scrutinizing existing contracts and encouraging decision-makers to avoid signing or approving any new, restrictive long-term contracts involving fossil fuels, we can clear additional hurdles that are keeping dirty fuels in our power sector at the expense of clean energy and pave the way for clean energy transition.

About the author

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Joseph Daniel is a senior energy analyst and manager of electricity markets with the Climate & Energy program at the Union of Concerned Scientists. In his role, he serves as the primary point person for coordinating UCS’s utility regulatory work at state public utility commissions, independent system operators, and the federal energy regulatory commission.