By James Scarrow

The number of states with programs to promote the development of renewable energy continues to grow, creating both new opportunities and complexities in the US power market.

Background

At last count, 18 US states had adopted renewable portfolio standards – called RPS – requiring electric utilities to supply a specified minimum percentage of their electricity from renewable fuels, such as wind, biomass and small-scale hydropower. At least three other states are debating whether to impose similar requirements.

Although each state RPS program is unique, each program addresses six core issues. They are what qualifies as a renewable, the goal, frequently expressed as a percentage of the state’s total retail load, a phase-in schedule, the manner in which electricity retailers are allocated responsibility for achieving the goal, whether a utility that does not want to generate electricity from renewable fuels can satisfy its obligations by purchasing “renewable energy credits” from other, renewable generators, and the penalties for non-compliance and alternative methods for achieving compliance, such as making payments to a state’s renewable energy trust fund.

Some states have tiered RPS programs in which certain types of renewable resources are valued more than others, or in which the program has specific goals for certain types of renewable resources, such as solar energy.

Of the 18 states with some form of RPS program, six adopted their programs within the past year. The six are New York, Maryland, Hawaii, Rhode Island, New Mexico and Colorado. In addition, the Pennsylvania legislature passed a bill in November that strengthens an existing RPS program in that state. The bill would require that 18% of the state’s energy come from alternative resources by 2020. Governor Rendell was expected to sign the bill as the NewsWire went to press.

The Union of Concerned Scientists estimates that existing RPS standards will result in approximately 22,000 megawatts of new renewable energy being developed by 2017.

Renewable Energy Credits

Renewable energy credits – called RECs – are a mechanism that can be used in some states to comply with the RPS requirements, and they are potentially an additional source of financing for independent generators in such states.

Eleven states currently use, or are intending to phase in, REC trading programs. Under these programs, a generator of renewable electricity earns one credit for each megawatt hour of electricity that is generated. RECs can then be bought, sold or accumulated and used to achieve compliance in that same year or to meet future year compliance requirements. The rules for earning and transferring RECs vary from state to state, but the building blocks of a REC program are certification and distribution of the RECs by the administering authority to generators, a tracking system and a sunset date at which time the REC expires unless used.

Through state REC programs, the renewable attributes of energy are unbundled from the electricity commodity. This has several important implications. First, because RECs are credits rather than physical commodities, the transfer of a REC from a seller to a buyer does not occur over transmission lines but rather as an accounting entry. Second, renewable electricity generators can have two separate revenue streams in theory – one from the sale of commodity electricity and one from the sale of RECs – allowing generators to seek the maximum sales price for each individual stream. (In practice, various states have proceedings underway to decide who owns the RECs in cases where the electricity is sold by an independent generator to a utility. Utilities argue the RECs convey with the electricity.) Third, the market forces can be harnessed to help ensure that a state’s RPS goals will be achieved in an economically efficient manner.

In order to ensure that an individual REC is not used more than once to meet RPS compliance requirements, it is necessary to have an REC tracking system. REC tracking systems give unique identification numbers to each unit of renewable energy generated, which allows the RECs to be tracked from generator to subsequent owners until the REC is used by a utility for compliance. There are three REC tracking systems currently in operation – one in Texas, one for the states in the New England power pool, and one in Wisconsin. Several other tracking systems are in the developmental stage.

The volume of REC purchases has been on the rise as states ratchet up the amount of electricity that must come from renewables. In 2003, there was more than a four-fold increase in REC sales as compared to 2004. The rising demand for RECs (primarily as a result of RPS programs) has kept REC prices higher than some had originally anticipated.

The price of RECs in the various state REC markets is a function of supply and demand. In Massachusetts, where the state has a relatively narrow definition of what qualifies as a renewable, there is currently a shortage of RECs. As a result, REC prices in Massachusetts are now bumping up against the program’s alternative compliance payment price of $50 per megawatt – that is, the payment a utility can make into the state’s renewable energy trust fund as an alternative method of achieving compliance. Other states with REC programs have seen rising or steady REC prices over recent months.

While owners of renewable energy facilities generally benefit from high REC prices, high prices can be a double-edged sword. Under REC purchase agreements and under general principles of contract law, a REC seller may be liable to a REC purchaser for the costs of obtaining replacement RECs at market prices if the seller is not able to provide the REC from the intended source. Depending on the market price of RECs, the cost of providing replacement RECs could be significant.

REC Ownership

Disputes have arisen over whether utilities that purchase electricity through long-term contracts are entitled to the RECs associated with that electricity where the power purchase contract is otherwise silent on the issue.

Under PURPA (the acronym for the Public Utility Regulatory Policies Act), utilities are required to buy power from two types of independent power plants at the “avoided cost” the utility would have to pay to generate the electricity itself. Most power purchase agreements between utilities and independent power producers were entered before enactment of state RPS programs and, therefore, do not address the question whether the purchaser is entitled to any RECs associated with the electricity being sold.

In 2003, several independent power producers sought an order from the Federal Energy Regulatory Commission declaring that avoided-cost power sales agreements entered pursuant to PURPA do not inherently convey to the purchasing utilities any RECs. By order dated October 1, 2003, FERC ruled that RECs do not automatically convey to the utility and that the question whether RECs convey is a state-law issue. Even though FERC bounced the issue to the states, it emphasized – to the disappointment of electric utilities – that avoided cost rates in power purchase agreements under PURPA are only intended to compensate independent generators for electric capacity and energy and not for environmental or other attributes. In this regard, FERC noted that the avoided cost paid by a utility under a PURPA contract does not depend on whether the generating facility is a fossil-fuel-fired plant or a renewable energy generating facility. The logic of FERC’s decision suggests that REC ownership should remain with the independent generator unless the RECs are expressly conveyed. Nevertheless, it remains unclear how individual states will decide the issue.

In Maine, the Public Utilities Commission determined that utilities purchasing power from independent generators also get the RECs in cases where the power purchase agreement is silent on the matter. Utilities that cannot obtain clear title to RECs from independent generators under contract can achieve RPS compliance by submitting evidence of contractual entitlement to the electric power from renewable power plants. As a consequence, certain RECs will, in effect, be double counted towards the achievement of Maine’s RPS goal.

The New Jersey Board of Public Utilities has not yet determined whether wholesale power contracts automatically transfer REC ownership, but it ruled that for the initial two years of the state RPS program, utilities would be credited as if REC ownership were conveyed with electricity under power sales agreements. In August 2004, the New Jersey Board of Public Utilities invited public comment on the question of REC ownership. As would be expected, utilities and ratepayer advocates have taken the position that RECs should belong to the utility, and that any other result would be a windfall to independent generators. Independent generators claim the utilities would receive a windfall if they have their way.

According to Anna Giovinetto, director of renewable energy markets for Evolution Markets LLC, because of the cloud of uncertainty surrounding the question of REC ownership, many RECs that might otherwise be available to be bought and sold are not on the market. This has contributed to REC shortages in states such as Massachusetts. It may be many years before the REC ownership issues are resolved in the states with REC programs.

Source of Finance

REC purchase agreements hold out the possibility of providing a second potential revenue stream for renewable energy projects. However, to date, creditworthy REC purchasers have been reluctant to enter into REC purchase agreements for terms longer than five years. As a result, the revenue streams from REC sales have generally not been able to support long-term financings, which can have 10- to 15-year terms.

One of the reasons that long-term REC purchase agreements have been rare is because of the way electricity markets have been restructured. In New Jersey, for example, electricity distribution companies bid out their basic generation services through an auction process. Through this process, the winning bidder will provide generation services – including compliance with New Jersey RPS requirements – for a specified portion of the overall load and typically for a period not exceeding three years. Because the winning bidders provide those services for a relatively short period, they are unlikely to enter into long-term REC purchase agreements.

A number of states have taken steps to facilitate long-term REC purchase agreements the revenues from which can support project financing. Such steps range from requiring utilities to enter into long-term REC purchase agreements to direct purchases of RECs by state entities. In the recently-adopted Colorado RPS, utilities are required to enter into 20-year contracts for the purchase of renewable energy. The California RPS program requires investor-owned utilities to solicit bids for 10-year contracts for renewables, while utilities in Connecticut have until 2007 to enter into longer than 10-year contracts totaling at least 100 megawatts with projects supported by the state’s Renewable Energy Investment Fund.

Massachusetts takes a different approach to fostering long-term REC purchase agreements. The Massachusetts Technology Collaborative, known as the MTC, enters into long-term REC purchase agreements with selected renewable projects. (The MTC receives funds to purchase RECs from that state’s systems benefits charge established as part of the Massachusetts electricity restructuring law.) These agreements either provide for the direct purchase of RECs by MTC or give the seller the option to sell RECs to MTC at a specified price on a future date. The first set of such support contracts was entered by MTC in 2003. The MTC hopes to sell its positions in REC purchase agreements and, at current prices, will probably be able to do so at a profit.

In New York, the New York Public Utility Commission issued an order on September 24, 2004 adopting an RPS goal that renewable electricity must amount to 25% of the state’s electricity supply by 2013. The New York RPS program will be funded by delivery charges to be imposed on electric utility customers beginning in the fourth quarter of 2005. These charges will be used by the administering body, the New York State Energy Research and Development Authority (or NYSERDA), to enter into direct long-term purchase agreements for renewable energy. Unlike in Massachusetts where the MTC enters long-term REC purchases as part of a market-based RPS program, in New York, NYSERDA will be the central purchaser of renewable energy and there will be no REC program. The staff of the New York Public Utility Commission is still working on the implementation plan for the New York RPS program. It is expected to be released for public comment in the first half of 2005.

Time will tell which approach to encouraging long-term REC purchase agreements is most effective.

Cross-Boundary Transactions

There is currently an interstate market for RECs among the six states that comprise the New England power pool, or NEPOOL – Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island and Vermont. Of these six states, four – Connecticut, Maine, Massachusetts and Rhode Island – have RPS programs that allow utilities to satisfy their RPS requirements by purchasing RECs from generators anywhere within NEPOOL, including generators located in New Hampshire and Vermont, which do not have RPS programs. The buying and selling of RECs within NEPOOL is administered by the NEPOOL generation information system.

RECs from one NEPOOL state can be only be used to satisfy the RPS requirements in another NEPOOL state if the characteristics of the REC satisfy the requirements of the particular state RPS program where the REC will be used. This can result in a variety of complicated compliance scenarios because each state’s RPS has its own particular eligibility requirements. For example, projects in Connecticut may not qualify as a renewable under the Connecticut RPS program but they might meet the Massachusetts requirements. Conversely, a project in Massachusetts might qualify as a renewable resource in Connecticut, but not Massachusetts.

As RPS programs continue to spread and existing REC markets mature,the complexities can be expected to multiply.