Texas Wind Projects

Texas wind projects

December 01, 2002
By James Scarrow
A program enacted just last year in Texas to encourage the generation of electricity from renewable energy has helped fuel a boom in the installation of wind projects in that state. Wind farm developers and policymakers in other parts of the country can learn valuable lessons from the Texas experience.

Proliferation of RPS Programs

In recent years, a growing number of states have adopted renewable portfolio standards — called “RPS” — requiring electricity retailers within the state to supply a minimum percentage of retail load with electricity generated from qualified renewable energy sources, such as wind, biomass and small-scale hydro. Eleven states, representing about one-third of total US electricity consumption, now have some form of RPS program. Other states are actively considering instituting such programs.

Each state RPS program is unique. However, each program addresses six large issues. They are 1) the types of resources that qualify as being “renewable” (for example – hydropower projects over a certain size are usually excluded), 2) the ultimate goal to be attained, often expressed as a percentage of the state’s total retail load, 3) a phase-in schedule, 4) the manner in which electricity retailers are allocated responsibility for achieving the goal, 5) whether renewable energy credits can be traded among retailers in order to achieve compliance, and 6) the penalties for noncompliance.

Texas RPS Program

The Texas RPS program was adopted in 2001 in conjunction with the opening of the state’s retail electricity market. The RPS calls for 2,000 megawatts of new renewables to be installed by 2009, with interim goals of 400 megawatts for years 2002 and 2003, 850 megawatts for 2004 and 2005, and 1,400 megawatts for years 2006 and 2007.

To achieve this goal, each electricity retailer in Texas is allocated a specific number of megawatt hours of renewable energy for which it is responsible, based on the retailer’s share of the statewide electricity retail market. The allocations are made assuming a capacity factor of 35%. (The capacity factor represents the actual output from a facility relative to its maximum potential output over the same period of time. Because of the intermittent nature of wind, a capacity factor of 35% for a wind farm is typical.) As such, the state-wide RPS requirement of 400 megawatts of new renewables capacity for calendar year 2002 translates into 1,226,400 mWhs of load that must be supplied with qualified renewable energy for that year (400 mW x 8,760 hours/year x 35%). An electric retailer in Texas having a 5% share of the state’s retail electricity market would therefore be responsible for 61,320 mWhs.

The Electric Reliability Council of Texas, or “ERCOT,”  administers the state’s renewable energy credit program, which is the mechanism through which retailers achieve compliance with RPS requirements. Under this program, ERCOT distributes renewable energy credits, or “RECs,” each quarter to certified generators of renewable energy. Each REC represents all of the renewable attributes associated with 1 mWh of renewable electricity production. The generators can sell the RECs to other retailers or to other third parties, who can then choose to use, sell or bank the RECs. In this way, the renewable “attributes” of the energy are unbundled from the commodity electricity. Accounts administered by ERCOT track the accumulation and transfer of RECs. RECs expire in three years if not otherwise retired before then.

No later than March 1 of each year, beginning in 2003, ERCOT will allocate among electricity retailers the statewide REC requirements for the previous calendar year. The retailers then have until March 31 to procure any additional RECs they may need to meet their obligations for that year. If the retailer fails to meet its requirement by retiring the necessary number of RECs, then it is subject to a fine of up to $50 for each mWh by which it fell short.

Gusher of Wind Projects

The Texas RPS program, in combination with a federal tax credit of 1.8¢ a kWh for wind producers, resulted in a Texas-style gusher of wind projects. In 2001 — the first year of the Texas program — 915 megawatts of newwind power projects were installed in Texas, representing more new wind generation than had ever been installed in the entire country in any other year, according to Randall Swisher, executive director of the American Wind Energy Association. The rate of new wind farm installations slowed in late 2001 and early 2002 as a result of the expiration of the federal production tax credit in December 2001. However, with the extension of the tax credit in March 2002, installations picked up again and the Texas Public Utilities Commission expects an additional 500 megawatts of new wind installations to come on line by the end of 2002.

REC Trading Activity

At the same time that wind farm construction in Texas was setting records, the secondary market for RECs was getting off to a slow start. Trading in RECs opened in July 2001, but very few transactions were entered and REC prices hovered at around $4/mWh. Light trading and low prices continued through the remainder of 2001 and into the beginning of 2002. Then, as the RPS program’s first settlement date of March 31, 2003 approached, both REC prices and the volume of REC transactions began to rise steadily.

From March through October 2002, the price of RECs rose more than 400%, from about $4/mWh to $17/mWh, according to Randy Lack, senior broker and principal of Emission Credit Brokers Inc. Lack said some experts believe that REC prices could be headed to $40/mWh by March 2003, before prices are expected to drop back down as additional capacity is installed in coming months.

At today’s price of $17/mWh, the price of RECs — which, it should be remembered, does not include the price of the electricity but only its renewable attributes — is approaching 50% of the price of peak power on the Texas spot market. Put another way, the market value of RECs in Texas currently represents about one third of the overall commercial value of the renewable energy product. According to Lack, approximately 200,000 mWhs of RECs were traded in October 2002 and trading activity is expected to remain high through March 2003.

Notwithstanding expectations that REC prices will drop next year, it is difficult to predict future REC prices with any certainty. While the near-term supply of renewable energy sources in Texas is known to a fair degree of accuracy, as is the number of RECs required each year to meet RPS program goals, other variables affecting prices are less understood. First, there currently are four electricity retailers in Texas that give their customers the option of selecting a “green choice” plan through which the customer pays a premium rate in exchange for the retailer’s commitment to purchase more renewable energy than otherwise required by the RPS program. As these four — and perhaps additional — retailers market green energy, there will be an increased demand for renewable energy, which will tend to drive REC prices higher. Nobody knows what the demand for green power will turn out to be, nor the precise way in which such demand would result in REC price increases. Second, just because additional wind farms are being built in Texas does not mean that all of the associated RECs will be available in the market. As with any other tradable commodity (particularly a relatively thinly-traded one), owners of large blocks of RECs could elect to keep them out of the market in order to support prices. Indeed, one broker suggested to the NewsWire that the presently high price of $17/mWh for RECs is due in part to such “market-maker” behavior.

REC “Offtake” Agreements

The ability of wind farms to sell RECs as a product separate from electricity means that wind farms might be financed based not only on revenue from power offtake agreements (and production tax credits), but also from the sale of RECs, either through long-term sales agreements or by selling RECs on a “merchant” basis.

Interviews conducted by the NewsWire indicate that in each of the eight wind farm projects built in Texas during 2001, the power purchaser was also the purchaser of the RECs. Some of these offtakers retained all of the RECs, while others retained some of the RECs and sold the excess in the market or (in two cases) through multiyear REC supply agreements with third parties. It is unclear whether owners of future wind projects will sell RECs and electricity as an aggregated product. However, at least one project under development has entered into separate ten-year offtake agreements (with separate offtakers) for electricity and RECs respectively. Although the commercial terms of these agreements are not publicly available, the long-term firm price for the RECs is likely to be in the neighborhood of $4/ to 5/mWh. While certainly not representing a large percentage of the cash flow to be generated by the project, this revenue stream is being used to support the overall financing structure.

Going Forward

It is too early to tell whether the other states will follow Texas’ lead in establishing systems of tradable renewable energy credits. If a federal renewables mandate is enacted next year as part of a national energy plan, this may make states less likely to act on their own. Parties to long-term offtake agreements for all renewable energy projects — not just wind — would be well advised to allocate clearly REC ownership as between owner and offtaker, even if the project is in a state that does not currently have any form of RPS legislation. With the number of states with REC programs growing and the prospect for cross-state markets for RECs real, the project finance community should not ignore the potential value of RECs.

More broadly, developers and owners of wind projects should be on the look-out for innovative ways to monetize the environmental benefits and good will generated by these projects. For example, a developer of a wind farm in Texas has negotiated to sell naming rights for the wind farm to a third party that is hoping to benefit from its name being associated with an environmentally friendly project even though the party has no other connection to the project.