B. Microeconomic Analyses of FUA

The effects of FUA were reexamined by ERA after it became apparent that the usefulness of the aggregate analyses were limited. In the first microeconomic analysis (reported in "An Assessment of Various Cost Test Levels on Different Types of Installations," dated May 8, 1980, Financial Analysis Branch, Office of Fuels Conversion, ERA), ERA used its limited experience with initial petitions submitted under the interim regulations to infer the broad classes of facilities (by size and application) that would be required to burn an alternate fuel, given both the effects of increasingly higher fuel price escalation rates and a substantially exceeds increment added to the price of oil. DOE found that:

(1) A $4/bbl addition1 to the current cost of fuel based on world oil prices2 would result in:

-virtually all new powerplants, except peakload units, having to use coal or nuclear power,

-most new industrial boilers at new sites having to use coal, and

-new, large industrial boilers replacing or expanding existing facilities and operating at least two shifts per day having to use coal.

(2) A $6/bbl addition1 would have a marginal impact ($2 over the above $4) resulting in:

-older existing coal-capable powerplants converting to coal, and

-new, industrial boilers replacing or expanding existing facilities and operating

'This addition to the cost of fuel as calculated in the FUA cost tests has two components, one attributable to the additive effect of the substantially exceeds cost premium. The other component is the present value of future increases in real fuel prices calculated as an annuity.

2 From a base price of $30 per barrel.

at least one shift per day having to use coal (given minimal site restrictions). (3) A $8/bbl addition' would have a marginal impact ($2 over the above $6) resulting in:

-new industrial boilers replacing or expanding existing facilities, operating one shift per day, and having an atypical capital cost and/or additional site restrictions, having to use coal, and -new industrial boilers with gasifiers opat erating continuously new sites, having to use lo-Btu coal gasification. This analysis is limited because of incomplete data and because ERA has not been able to quantify the amounts of imported petroleum which would be saved at each level of stringency. However, it does give some indication of what types of individual facilities would likely be impacted which could not be done by the aggregate analy

ses.

ERA performed the second microeconomic analysis using the same facilities data as was used in the first analysis (included in the public record for the proposed rulemaking) to evaluate the sensitivity of a petitioner's exemption domain to his real, after tax cost of capital. The contractor study (summarized at 44 FR 43222-23, July 23, 1979) which determined the 7.7% mean cost of capital for industrial firms indicated a standard deviation of 2.4%. Thus many of the firms sampled had real capital costs higher than 7.7% and would be penalized if constrained to the mean rate. The extent of this imposed penalty is illustrated in Figures 1 and 2. For example, a firm that is purchasing a large boiler and whose real cost of capital is 10% would be exempted at this rate when the boiler is operated at a capacity factor of less than 22% (Point A, Figure 1). If the firm was constrained to use the mean of 7.7%, however, the boiler would only receive an exemption if operated at a capacity factor of less than 18% (Point B, Figure 1).

While this analysis is also limited for the same reasons as the first microeconomic analysis, it does give an indication of the effect of allowing the petitioner to use his own cost of capital as the discount rate in the cost calculation.

C. Social Benefits of FUA

There are very real benefits to be gained for the United States by reducing petroleum imports. DOE's Office of Policy and Evaluation analysed the benefits of reduced oil imports as described in the preamble to the interim FUA regulations (44 FR 28955-56, May 17, 1979) under the headings "Oil Import Reduction Premium," "National Security Benefits," "Balance of Payments Benefits," and "Legal Emissions Under the Clean Air Act," incorporated herein by reference.

A completely different analysis has been substituted for the prior analysis and was performed so as to provide a fresh point of departure for the proposed rule. This analysis was based on the concept of a "social premium" as the most straightforward way of signaling the market place that imported oil costs more to the economy than its perbarrel price.

This new analysis is part of a continuing study being performed for general policy purposes in the Office of Policy and Evaluation (P&E) [Preliminary results of the analysis are reported in "The Energy Problem: Costs and Policy Options," dated May 23, 1980 (Staff Working Paper), Office of Gas and Integrated Analysis, Policy and Evaluation, Department of Energy. A copy of this paper is included in the public file.]. This preliminary analysis examined the energy problem in the context of high and uncertain prices, vulnerability to supply disruptions, and vulnerability to strategic threats of disruption used to gain foreign policy, military, or economic concessions by analysing three different world views with varying levels of risk of disruptions.

The major goal of the analysis was to quantify certain general policy conclusions: ⚫ that very large strategic oil stockpiles should be built rapidly if serious future disruptions are anticipated;

that contingency plans, such as a very high short term tariff, should be used to mitigate the cost of disruption if one occurs; and

⚫ that measures beyond deregulation of energy prices should be taken to reduce imports.

Only the quantification of this last conclusion, which is discussed below, is directly relevant to the substantially exceeds premium used in FUA.

For this social premium analysis, P&E relied in part on EIA forecasts which sug

gest that a five dollar increase in oil prices would reduce imports by a million barrels per day within seven years. This relationship between costs and import reductions was combined (in the P&E analysis of May 1980) with an examination of the benefits of varying levels of import reduction in several situations:

• different estimates of the risk of a disruption,

• different degrees of preparation to deal with a disruption through contingency plans and draw-downs from a strategic petroleum stockpile,

• differing amounts of common action by our allies, and

• other policies to promote import reductions such as natural gas deregulation, oil backout programs in the utility sector, and conservation programs.

In general, the analysis found that the premium level should be higher when there is a greater risk of disruption, less effective preparation to deal with a disruption, a higher level of oil imports, more cooperation among allies, or an inadequate package of other policies to promote import reductions. It also provided several overlapping ranges of estimates of the social premium, varying between $4 and $10.3 The appropriate range could be selected to suit a view on the risks of an import disruption based on answers to certain questions about long term energy policy, e.g., will we stockpile oil and develop contingency plans, will there be effective cooperation among our allies, etc. As all of these questions cannot be answered at this time, DOE has not yet settled upon a particular probabilistic estimate of the risks of disruption.

This P&E analysis did not attempt to reestimate separately the social benefits of balance of payments changes from reduced oil imports or the costs of increased legal air emissions under the Clean Air Act. The analysis did estimate the price effect from lower world oil prices (a result of decreased demand) and the benefits from decreased vulnerability to sudden supply disruptions (a result of decreased reliance on interruptible foreign supplies). The size of these particular components of the premium can be quite sensitive to specific conditions in the world petroleum market. However, the size of the aggregate premium is less sensitive to market conditions as influences on different components tend to be off-setting. The secu

3A $4 to $10 range would be the appropriate range if there were virtually no oil in strategic storage. A $2 to $6 range would be the appropriate range if there were several billion barrels of oil in strategic storage. At this time, ERA believes that the $4 to $10 range is the more appropriate.

rity component tends to be greatest when the price effect is smallest, and vice versa. If OPEC matches any U.S. demand reduction with decreased production in order to maintain prices, then the security component will be large. If OPEC maintains production, then the U.S. or its allies will continue to be dependent on OPEC oil and the security component will be small, but prices will necessarily fall in order for OPEC to maintain production levels in the face of reduced demand.

D. Decision Summary

There are three key decisions which will determine the impact of the FUA cost calculation regulation. These are:

• the allowed cost of capital rate,

⚫ the specification of future fuel prices, and • the level of the substantially exceeds premium.

1. Allowed cost of capital.

The Act requires exemption petitioners to employ the discounted present value of the best practicable estimates of the cost of using oil or natural gas compared to those of using an alternate fuel. Through an analysis of the preliminary data available at the time of the proposed rulemaking, ERA evaluated the impact of the real cost of capital on the circumstances (e.g., functional and use characteristics of the unit) under which an industrial boiler would be exempted from the FUA prohibitions. The results of this analysis (discussed above) indicated that imposition of a mean rate for the cost of capital would impose a significant burden on those petitioners whose rates exceed the mean values. Consequently, ERA has modified its position from that in the proposed rule and will allow petitioners to use either the previously specified cost of capital rates or the firm-specific rate as calculated by the methodology in Appendix I of the final rule (45 FR 53711-12, Aug. 12, 1980).

2. Specification of fuel prices.

To implement the statutory provision that exemption applicants compare the present value costs of using alternate fuel to those of using imported oil, ERA had to determine how to specify future fuel price behavior and how to equate natural gas to the mandated imported oil cost standard.

a. Future fuel prices. DOE, in consensus with other forecasters (45 FR 42192-9, June 23, 1980), believes imported oil prices will increase faster than inflation. ERA could propose a cost calculation which accounts for explicit increases in fuel prices in the future. Alternatively, ERA could propose that a single annuity value used to represent future increases in petroleum over coal prices, or a combination of these two approaches. ERA believes that use of an ex

plicit increase in prices is conceptually more precise than a single premium, which does not accurately account for the varying remaining lifetimes of existing facilities nor the impact of the different discount rates used for utilities and industrial firms.

ERA examined a variety of recent fuel price projections, those published by the DOE Energy Information Administration and two widely used private forecasting services-Data Resources, Inc. (DRI) and Wharton Econometric Forecasting Associates (Wharton).

As discussed in the preamble to the proposed cost calculation rule (45 FR 42192-6, June 23, 1980), ERA computed the equivalent premium associated with each forecast for a new industrial facility and found that these premiums ranged up to $13.75 per barrel. Because of the wide variation in these forecasts of future price behavior, ERA is adopting what it believes to be a reasonably conservative limit of a four dollar per barrel annuity added to the price of petroleum in combination with specific fuel price escalation rates based on the EIA "Medium Scenario" as the most appropriate to FUA implementation at this time.

b. Natural gas price. The statutory cost test requires a comparison of the cost of alternate fuel with the cost of imported petroleum and does not specifically mention how natural gas should be treated. The petroleum replacement product for natural gas is generally number 6 residual fuel oil, or in some instances, number 2 distillate. Since number 6 residual fuel oil is the more prevalent replacement product for natural gas and lower in price than number 2 distillate, ERA has priced natural gas equivalent to number 6 residual fuel oil in the final rule. ERA will continue to examine the ramifications of this decision, particularly as it impacts the FUA requirement for powerplants to be off natural gas by 1990.

3. Level of substantially exceeds premium. The preliminary analysis performed by the Office of Policy and Evaluation discussed earlier estimated that, in the context of varying levels of risk of disruption of oil imports, an appropriate social premium would range from $4 up to $10. This is estimated to be the value that should be associated with reductions in the level of oil imports. However, ERA has no reason to believe that the impact of imposing the full amount of the social premium in addition to the fuel price escalation factor (based on the EIA Medium Scenario) would result in significant additional oil imports savings.

4The premium is equal to an equivalent annuity added to the price of imported petroleum for a facility with a 40 year life and 7.7