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Economic Currents

Keep up to date with the latest UHERO news.

Should regulators fear bond-rating agencies?

It seems that our political and administrative leaders worry about the bond rating agencies. Their fear is understandable. The cost of capital looms large in all manner of infrastructure projects, and the cost of that capital depends on how risky investors perceive repayment to be.

The cost of capital also looms large for our investor-owned electric utility. HECO has a lot of capital to finance, some of it through corporate bond issues. It is also the sole “off-taker” for many independent power producers, so its financial health may affect the borrowing costs of these counterparties.

This worry was one predictably raised in response to a bill, now on Governor Ige’s desk, that would force the Public Utilities Commission to:

“…establish performance incentives and penalty mechanisms that directly tie an electric utility revenues to that utility’s achievement on performance metrics and break the direct link between allowed revenues and investment levels.

What does this mean?

It helps to know a bit about the convoluted underbelly of utility regulation. Here in Hawaii, and I believe every other state with investor-owned utilities, Public Utilities Commissions (PUCs) set an allowed revenue that utility companies can collect. That revenue comes from a formula that looks something like the following:

Fuel + Purchased Power + O&M + (Capital Investment) x (Allowed Rate of Return)

The utility has to justify these costs to the PUC, which it must approve. Most costs are basically a pure pass through to customers. The utility makes its profit, enough to provide dividends to shareholders, in basically two ways:

  1. 1. It can try to cut operation and maintenance costs and pocket the savings, although it may lose that allowed revenue in the next rate case.
  2. 2. The allowed rate of return on capital.

If the allowed rate of return exceeds what the utility must pay in dividends to shareholders and/or interest rate payments, then utilities have a perverse incentive to tilt everything it does toward maximizing its own capital investment. The only check on the prudency of its investments is the PUC, which must approve most such expenditures.

The good thing about this strange profit mechanism is that, because it basically guarantees that the utility will earn a return on its investments, it’s quite easy for utilities to sell stock and bonds to finance the investment. All of which brings us to the bill on the Governor’s desk and our leaders’ fears of bond-rating agencies.

The bill tries to eliminate this perverse incentive, which basically rewards the utility for maximizing costs, by instead setting revenue based on performance metrics – outcomes that measure value to the utility’s customers and the larger community. These can be anything from measures that show better operation of its power plants to save costs, higher customer satisfaction, and better pollution outcomes.

Performance adjustments already exist in a limited form, but to my knowledge, performance outcomes are not used as the main source of return for any utility. The bill pushes for an unprecedented break from the status quo, and I gather that the Governor is worried (after very intense lobbying by certain interests) that if he signs the bill, HECO’s stock price and its bond rating could be punished by Wall Street.

So, two questions:

  1. 1. Is this fear of bond-rating agencies well justified?
  2. 2. Regardless of bond-rating fears, is this a good bill?


First, I think bond-rating fears are overblown. I don’t believe the bill casts reasonable doubt on the idea that the utility will be allowed to make a reasonable return on its investments. It just says that we need to break the “direct link” with capital investments. All manner of corporations easily raise capital monies with debt and equity issues under the expectation of an indirect link between the investments they make and the value of what they produce with those investments. I think it’s clear that this is the bill’s intent.

More pointedly: the PUC must, due to Supreme Court precedent, allow the utility an opportunity to make a fair return. If I were reading this bill the wrong way – and I think it’s clear that I am not – and the bill were to unfairly keep HECO from making a fair return, it would be quickly struck down by the courts. Wall Street knows this. The bond-rating agencies know this.

Incidentally, HECO’s stock price is up relative to a standard utility index since the bill passed the legislature.

Besides, bond rating agencies have a famously poor track record of predicting anything. (Anyone recall AAA stated-income mortgaged-backed securities?) The academic literature indicates that ratings changes mostly follow the market, with a long lag. Below is a graph from an early classic paper on the link between bond rating changes and stock market returns. It shows that upgrades follow good performance and downgrades follow bad performance. But the upgrades and downgrades have no apparent effect – or possibly even a countervailing effect — on returns after the rating change.

Source: Pinches and Singlelton, Journal of Finance, 1978

The literature shows that bond yields bear a similar relationship with rating changes. Some papers seem to show a subsequent effect for small firms with persistently low-rated corporate debt. But the size of the effect is small.

I’m not the only economist who is cynical about the bond rating agencies. Paul Krugman has noted how markets shrugged after US and Japanese debt got downgraded.

So, don’t fear the bond-rating agencies. Instead, look squarely at fundamentals. Which brings us to the second question: Is this bill a good idea?

Economists have long criticized rate-of-return regulation given its perverse incentive to maximize capital investment and the difficulty of the PUC in policing every investment decision. Here in Hawai‘i, our PUC has famously difficult staffing issues due to limited funding and a revolving door between them, the utility and other interests. Unsurprisingly, the utility pays higher salaries. It’s a challenging dynamic, to put it politely.

Worse, rate-of-return regulation gives the utility no incentive to find innovative solutions. If there is any advantage to having an investor-owned utility rather than a municipality or cooperative like KIUC (Kaui‘i’s electric utility), it is that they should have strong incentives to control costs and find innovative solutions to problems. Rate-of-return regulation undercuts that advantage.

This bill comes at a time when innovative solutions are increasingly important, capital investment is about to explode, and regulation is increasingly difficult. These changes are happening due to rapidly changing technologies and our transition toward 100% renewable energy. These changes expand the scope for innovation to better integrate and manage the variability of sun and wind resources. Many if not most of these opportunities involve investment by customers and independent power producers. Under rate-of-return regulation, these third-party investments can be efficient, but may be explicitly or implicitly resisted by the utility since they displace their own capital investment and source of profit. In other words, rate-of-return regulation causes more problems today than it has in the past.

So, the spirit of this bill is right on target.

The gaping hole in this bill is what it excludes: specific performance metrics that would replace rate-of-return and provide the new source of the utility’s revenue allowance. It kicks these details to the PUC.  Getting these metrics right for the utility of the future is critical. It’s also largely unchartered territory.

The PUC, of course, knows about all of these issues and could make all of these changes unilaterally. It doesn’t need this bill to change the way it determines the utility’s allowed revenue.  And just the other day the PUC opened a docket on performance-based regulation. The timing of the docket’s opening and the Governor’s decision about whether or not to sign this bill is unlikely a coincidence.

The PUC is telling Governor Ige: Don’t sign the bill! We got this!

But do they?

We have a laudable PUC and Consumer Advocate. These agencies are underfunded and overworked, and I think it is clearly evident that despite all the pressures they face, they do work tirelessly for the public interest. They are not captured by the utility.

But I do fear that the regulatory process is largely captured by the utility industry and the armies of consultants and vested interests that travel the country to testify on their behalf. And while change can occur within this process, it is slow. Very slow. With regard to this particular feature of regulation – the excessively high rate of return on the utility’s own capital investment – there appears to be a universal intransigence. To my knowledge, no PUC in the country has accomplished more than a tiny reduction in the allowed rate of return, much less a complete removal of the direct link and full reliance on performance metrics.

So, I gather that the PUC, and the utility, worry about how this law would constrain them. It would force profound change between now and January 2020 when the bill would go into full effect. That’s not much time to completely reinvent the utility’s revenue model. The standard process does not normally invoke that much change so quickly.

While I can understand why the PUC feels this is a risky bill, I fear that the risk is greater if we do not change fast enough. HECO’s costs are rising and technological change is relentlessly advancing, giving customers more options. The utility is pushing hard for grid upgrades that are expensive, but could become obsolete if enough customers leave the grid. A grid defection death spiral could be near.

The larger risk is a mountain of stranded assets, combined with punishingly high electricity prices for the most vulnerable customers—renters who cannot defect. This risk is also the State’s risk, since it may be on the hook for a bailout if the PUC approves investments in assets that quickly become obsolete. (I am told that the State probably would not be on the hook legally, due to this precedent, but the end game here would be ugly regardless.) And political leaders who enabled the catastrophe will, of course, have to answer to voters.

We can’t kick this can anymore. We have to act. This bill isn’t ideal—it doesn’t tell us the right performance metrics that would better align the utilities incentives with the public interest. But it does force us to make these hard choices soon.

- Michael Roberts
UHERO Research Fellow and Professor of Economics


Linking land and sea to inform ahupua‘a (ridge-to-reef) management in Hawai‘i – NSF Coastal SEES

Posted March 19, 2018 | Categories: Blog, Project Environment

A community member from Haʻēna, located on the windward side of Kauaʻi (see Fig 1A), said “come” as she offered her hand inviting me in. I stepped into the forming circle of the pule (prayer), and we stood together silently listening to an oli chanted by a local kupuna (elder) (see Photo 1A). This moment blessed the opening of a public hearing which eventually led to the passage of rule package of Haʻēna Community Based Subsistence Fisheries Management Area (CBSFA) in mid-2015. The significance of this event cannot be understated. This was the first time in the U.S. state of Hawaiʻi that local-level fisheries management rules based on indigenous Hawaiian practices were recognized. Among these rules, a marine refuge (Makua Pu‘uhonua) was designated in the sheltered lagoon of Makua reef to protect a key fish nursery area (see Fig 1B). That same year, the community of Kaʻūpūlehu, located on the leeward side of Hawaiʻi Island (see Fig 1A), initiated a law implementing a 10-year fishing rest period known as ‘Try Wait’ (see Photo 1B). This resulted in the protection of the entire coral reef fringing reef area (see Fig 1C).

Figure 1. Hā‘ena and Ka‘ūpūlehu ahupua‘a location. (A) Location of Hā‘ena and Ka‘ūpūlehu ahupua‘a on Kauaʻi and Hawaiʻi along the main Hawaiian Island chain, with island age and the direction of the prevailing north-east tradewinds and ocean swell indicated. Land use/cover and marine closure/fishing rest area are shown for (B) Hā‘ena and (C) Ka‘ūpūlehu.

Photo 1. (A) Pule at Haʻēna prior to the public hearing for the CBSFA package rules, (B) Gathering at Kaʻūpūlehu prior to the public hearing for the ‘Try Wait’ fishing rest area.

These two communities embody a cultural renaissance that seeks to revive customary management approaches, such as pono fishing practices, kapu (traditional closures), and the ahupua‘a (ridge-to-reef) approach in Hawai‘i to protect terrestrial, freshwater, and marine resources. Both communities initiated these marine closures to protect fish species that feed on algae (herbivorous fish). Without these herbivorous species, algae blooms can cover the reef when excess nutrients flow into the sea from the land. By eating the algae, these protected fish create space for new corals to settle and ensure the persistence or resilience of the reefs. Resilience has been defined as the capacity of an ecosystem to cope with disturbances without shifting to an alternative state, while maintaining its functions and supporting human uses. These local communities are also interested in a better understanding of how land-based sources of pollutants from golf courses, lawns and cesspools affect their marine ecosystems. Even with healthy herbivorous fish populations, these pollutants take a toll on coral reefs, especially with increases in ocean temperature and acidity as a result of climate change. It is important to these communities, and the health of all marine ecosystems, to ensure that future planning takes these impacts into account to promote coral reef resilience to climate change.

Ridge-to-reef management has been widely advocated to foster coral reef resilience, though the degree to which managing land-based pollutants can benefit coral reefs varies among places. In an effort to promote coral reef resilience to climate change, we adopted the traditional ahupua‘a framework to study the effect of existing coastal development on coral reefs and support the restoration of community-based management in Hawai‘i and other Pacific islands. In addition to their engaged communities, we focused on these two locations because they are very different in terms of human coastal development and natural coral reef structure. Hā‘ena is mostly rural with a number of private residences along the coast (see Fig 1B). Kaʻūpūlehu is both commercially and residentially more developed than Hāʻena, with two large luxury resorts, a golf course, and several private residences along the southern end of the coast (see Fig 1C). The powerful waves in Hā‘ena have over time carved wider and shallower reef flats and produced shallow lagoons protected from the swell by well-developed reef crests. In comparison, the coral reefs of Ka‘ūpūlehu are younger and form a relatively narrow fringe on the steep slope of that island.

Effective ridge-to-reef management requires improved understanding of land-sea linkages and tools to evaluate the effects of land (e.g. nutrients carried through groundwater) and marine drivers (e.g. wave power and reef topography) on coral reefs. To accomplish this, we developed a framework to link land to sea through groundwater and identify areas on land to manage human-derived nutrients and promote coral reef resilience (see Fig 2). We applied this framework in Hā‘ena and Ka‘ūpūlehu ahupua‘a, to compare outcomes from these different places and inform place-based ridge-to-reef management.

Fig 2. Linked land-sea modeling framework. Based on (A) climate, groundwater, and nutrient concentration data, (B) groundwater flow and nutrient concentrations were modeled. (C) Nutrient flux from anthropogenic drivers were added to the background nutrient flux. (D) A land-sea link was created by sub-dividing the groundwater model domain into ‘flow tubes’ ending at pour points along the shoreline. (E) The coastal discharge models used the groundwater flow and nutrient flux and GIS distance-based models to generate the land-based driver grid data. (F) The wave model and bathymetry data were coupled with (G) GIS-based models to generate the marine driver grid data. (H) The coral reef predictive models were calibrated on coral reef survey data. (I) Outputs were: (1) response curves, (2) maps of benthic and fish indicators, and (3) a linked land-sea decision-support tool.

Geologically older and exposed to the trade winds, Hā‘ena receives high rainfall, resulting in steeply eroded cliffs, with high surface and groundwater flow (see Fig 3A). Geologically younger and located in the rain shadows of Mauna Loa and Mauna Kea mountains, Ka‘ūpūlehu is very dry and barely eroded, resulting in low surface flow and high groundwater flow (see Fig 3B). More rain in Hā‘ena means that nutrients are more diluted (less concentrated) than Ka‘ūpūlehu which is much drier. Our groundwater models showed that groundwater in Ka‘ūpūlehu has high levels of nitrogen from natural sources. At Hā‘ena, most nutrients come from natural processes due to abundant rainfall and groundwater flow. The key sources of human-derived nutrients were wastewater from houses on cesspools at Hā‘ena and the golf course and wastewater from the injection well at Kaʻūpūlehu.

Fig 3. Illustration of the groundwater system at Hā‘ena and Kaʻūpūlehu. (A) Hā‘ena is located on old, wet, wave exposed coast of Kauai, (B) Kaʻūpūlehu is young, dry, and wave sheltered.

To measure the resilience of the coral reefs at each location, we looked at four benthic groups and four fish groups based on their ecological roles and cultural importance to the communities. The benthic groups were crustose coralline algae (CCA), hard corals, turf, and macroalgae. CCA and corals are active reef builders which provide habitat for reef fishes. CCA also stabilize the reef in high-wave environments. Abundant benthic algae can be a sign of high nutrients or low numbers of herbivorous fish, which can harm coral health through competition for space. Algae-eating fish identified as important by the communities (e.g., surgeonfishes and parrotfishes) were modeled based on their feeding modes and ecological role: (1) browsers, (2) grazers, and (3) scrapers.

Our coral reef models showed that high wave power at Hā‘ena has shaped the living community of the reefs which are dominated by CCA and turf algae with many grazers and less scrapers (see Fig 4A). Makua lagoon area is an exception where corals are able to grow, sheltered from powerful waves by a well-developed reef crest. In contrast, low wave power in Ka‘ūpūlehu has resulted in coral dominated reefs with high turf and many grazers and scrapers (see Fig 4B). Our coral reef models also showed that land-based nutrients from groundwater can increase benthic algae, suppress coral and CCA, and decrease numbers of locally important fish at both sites.

Fig 4. Illustrations of the coral reefs. Coral reef community in (A) Hā‘ena and (B) Kaʻūpūlehu.

Coral reefs in Hā‘ena seem less susceptible to nutrient inputs from coastal development because they benefit from dilution and mixing, due to high freshwater and wave power. Hā‘ena is rural with limited development or agriculture, so most of the nutrients come from natural processes, with the exception of land areas to the east of the ahupua‘a where nutrients are largely human-derived (see Fig 1B). These areas that contribute high human nutrients lie upstream from the protected reef fish nursery at Makua. We identified this reef as vulnerable to algae blooms and coral bleaching due to the nearness of human-derived nutrient sources, limited mixing from shallow depth and low wave power, and abundant corals and turf algae (marked in red in Fig 5A). To promote coral reef resilience to climate change, Hā‘ena community can focus on upgrading cesspools in the priority areas that we identified, located upstream from Makua (located in blue zone in Fig 5A).

On the other hand, Ka‘ūpūlehu coral reefs seem more vulnerable to nutrient inputs from coastal development due to high levels of background nitrogen in the groundwater and limited dilution and mixing from low rainfall and wave power. Additionally, Ka‘ūpūlehu’s plentiful coral cover is prone to coral bleaching. Based on our findings, the community can focus on not increasing phosphorus inputs from the wastewater injection well (located in the pink zone in Fig 5B) to reduce the vulnerability of coral reefs located downstream (marked in green tea in Fig 5B). In addition, the community can help foster resilience of their coral reefs (marked in red in Fig 5B) by ensuring that environmentally sound practices are continued when fertilizing the golf course, particularly in the land areas located upstream from Uluweuweu bay and Kahuwai bay (located in blue zone in Fig 5B). This will also help to protect the water quality of a culturally important groundwater spring (Wai a Kāne) that was identified by the Ka‘ūpūlehu community in Kahuwai bay (Fig 1C).

Fig 5. Coral reef areas vulnerable to land-based nutrients and priority land areas at Hā‘ena and Ka‘ūpūlehu. (A) Hā‘ena and (B) Ka‘ūpūlehu coral reef areas vulnerable to nutrients (nitrogen and phosphorus) combined with the priority land areas with the highest human derived nutrients and therefore, where management action should focus on managing wastewater and fertilizers practices.

This research shows that place matters! Different environmental conditions make place-based solutions essential. Second, protecting herbivorous fish is key for coral growth and recovery. Last but not least, efforts to protect coral reefs need to address nutrient inputs from golf courses and cesspools. Using this framework, we located coral reefs vulnerable to land-based nutrients and linked them to areas on land where limiting sources of human-derived nutrients could prevent increases in benthic algae and promote chances of coral recovery from bleaching. Following on this research, we used this framework to assess the three human factors most relevant to these communities and across Hawai‘i more broadly: coastal development, fishing and climate change. More to come!

Note: This work was funded by the NSF Coastal SEES and formed a chapter of my PhD dissertation at the Department of Natural Resources and Environmental Management (refer to the published article at https://doi.org/10.1371/journal.pone.0193230). The NSF Coastal SEES project Principal Investigators were: Tamara Ticktin (UHM Botany), Kim Burnett (UHERO), Stacy Jupiter (Wildlife Conservation Society, Melanesia), Alan Friedlander (UHM Biology and National Geographic), Tom Giambelluca (UHM Geography), Mehana Vaughan (UHM NREM), Kawika Winter (National Tropical Botanical Garden), Lisa Mandle (Natural Capital Project, Stanford), and Heather McMillen (NREM). Special thanks to the researchers who contributed to this work, in particular Robert Whittier, Kostantinos Stamoulis, Leah Bremer, Natalie Kurashima, and Cheryl Geslani. Many thanks to a collaborating artist, Sophie Eugène, for the illustrations and the Integration and Application Network, University of Maryland Center for Environmental Science (ian.umces.edu/symbols/) for the marine symbols. I would like to also thank Tamara Smith for editing this piece. Finally, we are grateful to our community and landowner partners in Kaʻūpūlehu and Haʻēna who inspired this research and made this project possible.

- Jade Delevaux
Geospatial scientist in the Department of Geology & Geophysics. School of Ocean and Earth Science and Technology


Makena Coffman appointed to Climate Change Commission

UHERO congratulates Makena Coffman on her appointment to Honolulu's Climate Change Commission. The goal of the commission is to assess potential impacts of climate change on Hawaii, and to provide policy makers with recommendations to address these impacts.

Makena Coffman is the co-director of Project Environment, UHERO Research Fellow, and Professor of Urban and Regional Planning.

Bringing multiple values to the table in local decision making – NSF Coastal SEES

“Want to carry one up?” the natural resource management team with Limahuli gardens in Haʻēna, Kauaʻi asks us as they hand out potted endangered plant seedlings before our hike up the trail toward one of their native forest restoration areas. We arrive 30 minutes later to the first restoration plot and are amazed to see an oasis of diverse native plants in a broader sea of mostly non-native forest. Restoration like this provides many benefits including biodiversity, cultural value, watershed protection, but it can also be expensive. Limahuli gardens, like so many natural resource managers around the State, face decisions around where and how to invest limited conservation resources. In an effort to cost-effectively restore a larger area of forest that provides a suite of ecological and cultural (ie biocultural) benefits, managers at Limahuli are pioneering careful consideration of multiple restoration strategies, including hybrid restoration with native and culturally useful non-invasive introduced species.

Limahuli restoration area

On the other side of the Hawaiian Islands, we have the rare opportunity to spend time in the Kaʻūpūlehu dry forest restoration project in North Kona, Hawaiʻi Island, a highly successful community-based effort to restore the most threatened ecosystem in the world. Many of the community members who work here are from cattle ranching families. They see tremendous value in mixed use landscapes including native forest and pasturelands, but worry about encroaching urban development. In this context, landowners across the State, including Kamehameha Schools, face decisions about the future of pasturelands, including the right mix of continued pasture, forest restoration and other land use options like coffee or restoring to agroforestry (a once prominent land use in the region).

NSF Coastal SEES team members Tamara Ticktin and Shimona Quazi enjoy the smell of blooming Aiea plants in the Kaʻūpūlehu dry forest.

Measuring keiki recruits in the stewarded dry forest.

Pasture bordering forest in high elevation areas in Kaʻūpūlehu

Real-world decision contexts like these have spurred a growing body of research striving to shine light on the ways that land management decisions influence societal well-being. Huge strides have been made to operationalize inclusion of the ‘value’ of land into decision making. Yet, this body of work largely remains siloed between those focusing on the biophysical and monetary values and those focusing more broadly on socio-cultural values. This division precludes a pluralistic set of values being included in decision-making in a meaningful way.

Over the past 3 years, UHERO, through an NSF Coastal SEES project – “Linking local ecological knowledge, ecosystem services, and community resilience to environmental and climate change in Pacific Islands”—has been part of a transdisciplinary team of researchers who have worked closely with landowners and communities in several study sites, including Haʻēna and Kaʻūpūlehu to bridge this divide.

In Haʻēna we worked alongside Limahuli reserve manager, Kawika Winter and his staff, to explore the costs and benefits of 3 restoration strategies: 1) restore to a state before rats were introduced (pre-rat); 2) restore to a pre-European state; and 3) restore using a mix of native and culturally useful non-invasive introduced species (hybrid scenario). Within each scenario, we evaluated the restoration costs alongside the benefits in terms of native and endemic species of plants restored, resilience (measured by functional diversity), and cultural value of plants restored. Cultural value was assessed based on a framework of past and current use based on community workshops and the long-term experience of managers working in the area. Interestingly, we found that the hybrid scenario provides important ecological benefits in terms of restoring a resilient mix of native species while also supporting a variety of culturally useful plants at a cost much lower than the other restoration strategies. While conservation of endangered species requires additional strategies, hybrid restoration offers a cost-effective way of scaling up restoration that can also provide important cultural and community benefits.

Variation in environmental and cultural benefits across three different restoration scenarios.

In Kaʻūpūlehu, we worked alongside Kamehameha Schools and the Kaʻūpūlehu community to evaluate potential futures of pastureland. We considered the management costs and environmental (biodiversity, groundwater recharge, fire risk), cultural, and economic outcomes of four future land use scenarios on a large cattle ranch: 1) retain pasture; 2) restore native forest; 3) restore agroforest; and 4) convert to coffee. Unsurprisingly we found that no one land use was the best on all metrics assessed, and that cultural value (assessed using participatory, deliberative methods and an indigenous cultural values framework) was very high in all land uses except for coffee (which is not an important land use in the immediate area). Similar to Haʻēna, we found that the agroforestry scenario (a hybrid forest) offered the greatest potential in terms of multiple benefits, including economic return. Yet, it is pasture which currently provides some of the highest cultural value in terms of local knowledge and cultural connection to place. Rather than providing clear answers to Kamehameha Schools about the “best” way forward, our research provided a way to bring multiple values, including cultural and environmental values, to the table in a concrete way.

Tradeoffs and synergies among different values with land use options in North Kona.

Integrating and including diverse values into decision-making is challenging, but critically needed around the world. We see no better place than Hawaiʻi to continue to work with on-the-ground managers to move this forward to contribute to more sustainable and resilient decisions. As an extension of our work in Kaʻūpūlehu and Haʻēna, we are now collaborating with a local non-profit Kakōʻo ʻŌiwi in Heʻeia Oʻahu to consider the multiple benefits of loʻi restoration through time. More to come!

Note: The NSF Coastal SEES project Principal Investigators were: Tamara Ticktin (UHM Botany), Kim Burnett (UHERO), Alan Friedlander (UHM Biology and National Geographic), Tom Giambelluca (UHM Geography), Stacy Jupiter (Wildlife Conservation Society -Fiji), Mehana Vaughan (UHM NREM), Kawika Winter (National Tropical Botanical Garden), Lisa Mandle (Natural Capital Project, Stanford), and Heather McMillen (NREM). Special thanks also to project researchers and graduate students who carried out much of this work, including Puaʻala Pascua, Shimona Quazi, Natalie Kurashima, and Christopher Wada. Finally, we are grateful to our community and landowner partners in Kaʻūpūlehu and Haʻēna who made this project possible.

- Leah Bremer 
UHERO and Water Resources Research Center Assistant Specialist


Bringing together energy and climate change policy

We hear a lot about Hawaii’s Renewable Portfolio Standard (RPS) which requires 100% of the utilities’ net electricity sales to come from renewable sources by 2045. Subsidies, rapidly declining solar panel costs, and high electricity prices have led to the proliferation of distributed rooftop solar photovoltaic (PV). By the end of 2016, roughly 1 out of 7 occupied housing units on Oahu had a solar PV system (City and County of Honolulu, 2017; ACS, 2017). Integrating increasing amounts of intermittent renewable energy, including utility-scale solar and wind, presents a challenge for electricity grid operators since at any moment supply must equal demand. While it is easy to get wrapped up in how to enable more cost-effective renewable energy on an outdated grid, designed for centralized generation and a one-way flow of electricity, I’d like to step back for a moment and remind ourselves of the rationale for renewable energy policies to ensure we meet our policy objectives and, towards that end, are using the appropriate policy instruments.

Like the U.S., Hawaii relies heavily on fossil fuels to meet its electricity needs (see Figure 1 for Hawaii’s generation mix in 2016).1 Since fossil fuels are a depletable resource, the transition to renewable energy is theoretically inevitable absent any policy intervention. It is the speed of transition that is inefficient from a social perspective due to the presence of environmental externalities (Gillingham and Sweeney, 2010).2 The damages from greenhouse gas (GHG) emissions are spillover costs not reflected in current market prices for fossil fuels. As a result, there is both more fossil fuel consumption than socially optimal and the transition time to renewable energy is slower. Basic economics tells us that the best way to mitigate climate change is to “get prices right” by imposing a tax equal to the marginal damage cost of emissions or apply emissions trading.3 Such market-based incentives are less costly and allow for more flexibility than traditional command-and-control policies in which uniform standards (ambient, emissions, or technology) must be met by affected sources. The marginal damage cost of GHG emissions can be given by the "social cost" of carbon—the per unit present value of the total damages from carbon dioxide (CO2) emissions or alternatively the benefit from emissions abatement.

Figure 1. Hawaii’s Electricity Generation Portfolio, 2016.

Source: EIA, 2017.

Instead of a broad carbon tax, most of the focus in Hawaii has been on taxing the barrel of oil. This of course also discourages fossil fuel use; however, the barrel tax we have is quite modest so its major impact is as a source of funding. As only $1.05 per barrel is levied—and this excludes aviation fuel and fuel sold to a refiner—it does not capture the full externality cost. And the dirtiest fuel, coal, is also currently exempted.4 We also rely on policy instruments like the RPS or subsidies for renewable energy, which though they likely reduce carbon, not necessarily at least-cost.5 These policies were not founded on the basis of environmental impacts (namely climate change), but instead were primarily driven by affordability6 and a stronger local economy.7

To address climate change specifically, we have a separate policy, Act 234 (2007), which requires Hawaii to reduce its GHG emissions to 1990 levels by 2020. The statewide GHG limit is 13.66 million metric tons of carbon dioxide equivalent (MMTCO2e), excluding air transportation and international bunker fuel emissions and including carbon sinks. In response, GHG rules were established for the electricity sector in 2014; facilities emitting over 100,000 tons of CO2e per year (excluding municipal waste combustion operations and municipal solid waste landfills) are required to reduce emissions by 16% from 2010 levels in 2020. Partnering across the 20 affected facilities is allowed to achieve cost-effective emissions reduction.

Figure 2. GHG Emissions Inventory, 1990 and 2007.

Source: ICF, 2008.

Figure 2 shows Hawaii’s 1990 and 2007 GHG emissions inventory—the most recent inventory to date.8 It shows that the electricity sector produces approximately 30% of GHG emissions. Other sectors matter too, especially transportation. By focusing on economy-wide GHG emissions reduction, coupled with the appropriate policy instrument to meet the policy objective, not only will it encourage more renewable energy in the electricity sector, but it will also facilitate coordinated efforts in other sectors. For instance, ground transportation comprises many individual actors, which together account for 14-18% of emissions. It is also the fastest growing sector (38% increase between 1990 and 2007). Emissions from ground transportation have likely continued to increase despite increased fuel efficiency and the growth of electric vehicles (EVs) in recent years.9 This suggests that even if the electricity sector were to comply with or exceed the 16% reduction, the growth of ground transportation likely outpaces the decline in the electricity sector; without coordinated state action we may not meet Act 234.10

Climate change policy offers a potentially economy-wide approach that can align multiple policy goals—whether it is more affordable, locally produced electricity or the electrification of transportation. An economy-wide carbon tax also means that the same $/ton cost would be levied on gasoline. While there is a federal gasoline tax of 18.4 cents/gallon and a state gasoline tax of 16 cents/gallon (EIA, 2017), this does not necessarily amount to the full externality cost of pollution.11 With the proper price signals, getting more EVs on the road will happen without any other overarching goals or mandates in the transportation sector. Whereas federal Corporate Average Fuel Economy (CAFE) standards increase the fuel efficiency of new vehicles, they do not encourage people to drive less. A carbon tax would target both vehicle purchase and driving decisions for new and used vehicles. Moreover, a carbon tax offers the opportunity to address distributional impacts. Carbon taxes are perceived to be regressive because fuel comprises a greater share of spending for low-income households. However, mandates are more regressive than a revenue-neutral carbon tax which can redistribute revenues to taxpayers by cutting other taxes (e.g. payroll, personal income, and corporate taxes) or through direct payments (flat “check in the mail”).12

Lastly, a carbon tax would also address flaws in today’s current energy policies. For instance, the 100% RPS, as currently calculated, does not translate into Hawaii generating all its electricity from renewable sources since distributed rooftop PV is counted in the numerator (renewable generation) but not in the denominator (total electricity sales). As calculated, only electric utilities are subject to the law. The gas utility and other large commercial customers who install their own generators are not part of the picture, perhaps prompting large customers to switch to gas or defect from the grid entirely. Instead of devising an amended metric to close such loopholes,13 stronger GHG policy—a carbon tax to either complement or replace the RPS—would align statewide goals and avoid the consequences of any “leakage” across sectors.

A carbon tax could also help to make good on the goals of Hawaii’s energy efficiency portfolio standards (EEPS). In contrast to an RPS which targets the supply-side, the EEPS focuses on electricity consumption, calling for a 30% reduction by 2030, equivalent to 4,300 gigawatt hours based on a 2008 baseline forecast of electricity consumption in 2030. Measuring progress according to the design of the standard is extremely difficult without a “counterfactual”—that is, electricity consumption absent any energy efficiency savings. In addition, similar to CAFE standards in the transportation sector, some efficiency gains are offset by increased consumption (a rebound effect). There are also many individual actors, some regulated by the Public Utilities Commission, and others, unregulated. An economy-wide carbon tax would incent fossil fuel conservation by all. Note also the volumetric surcharge design to support energy efficiency programs currently presents regressive impacts.14

There’s a lot of background activity around compliance with Act 234 on the horizon with affected facilities submitting their updated emissions reductions plan and the DOH updating and developing GHG inventories and projections. As we move forward, we should consider not only working towards compliance in one year but in perpetuity. This blog post has highlighted the critical link between our broader energy goals and how climate change policy and its policy instruments can enable us to reach those objectives. Maybe Act 32 (2017), which commits Hawaii to meeting some of the principles and goals laid out in the Paris Accord, will be a way to keep us on track. But without any specifics as to how we are to achieve such reductions—through a carbon tax or otherwise—it is largely symbolic. It’s time for a comeback in energy and GHG policymaking.

- Sherilyn Wee 
UHERO Affiliated Researcher


1Though the composition of fossil fuels differs; in the U.S., natural gas and coal comprise roughly 30% each and nuclear, 20% in 2016 (EIA, 2017).

2Yet with technological advances and the discovery of new reserves, it could also be argued that the supply of fossil fuels are “nearly limitless.” In either case, without correcting for the market failure, the transition would be to slow to mitigate the impacts of climate change (Covert et al., 2016).

3For instance, the Regional Greenhouse Gas Initiative, is an electric sector cap-and-trade program between nine Northeastern States.

4See Act 73 (2010), Act 107 (2014), and Act 185 (2015).

5Emissions reduction depends on the generation source displaced and on increased consumption due to reduced prices. Murray et al. (2014) show tax credits have a small impact on GHG emissions, and in some cases, emissions increase. Palmer and Burtraw (2005) show that neither a production tax credit or an RPS leads to as high of and as cost-effective a reduction as a cap-and-trade program.

6Note low cost and renewable energy is often incorrectly regarded as synonymous; such treatment depends on context (e.g. PV versus non-PV customers) and the procurement of renewable energy sources (benefit from low-cost utility-scale renewables is shared amongst all customers). Also, if Oahu’s coal plant—the cheapest source of energy at around 3 cents/kWh—were to go offline (power purchase agreement to expire in 2022), energy costs would increase dramatically.

7See HB1464 (2009) and HB623 (2015).

8The Department of Health (DOH) is in the process of updating prior GHG inventories and developing new GHG inventories for 2015, 2016, and 2017.

9There are 6,490 EVs statewide, comprising less than 0.01% of all registered passenger vehicles as of October 2017 (DBEDT, 2017).

10Contrary to the Department of Health’s (2014) statement that “these rules will ensure that the state returns to 1990 GHG emission levels by 2020 as required under Act 234, 2007.”

11GHG emissions are a global pollutant and therefore global damages should be accounted for.

12See for example David and Knittel (2016) and Levinson (2016) on fuel economy standards.

13In the 2017 legislative session, the Department of Business Economic Development and Tourism (DBEDT) for the second time, proposed to amend the RPS calculation to correct for this error (see SB906, HB1040).

14As a per kWh charge, customers who are able to reduce or offset their energy use through energy efficiency and distributed PV pay a lower dollar amount than customers who do not have access to such technology. The expansion of distributed PV puts a greater burden on these (generally) lower-income customers.

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