The New Massachusetts SREC Market
Solar developers, tax equity investors and lenders are trying to figure out what value to assign to renewable energy credits that solar projects receive in Massachusetts for generating electricity. The state is in the final stages of implementing its new SREC II program. Three experts talked about the new program during a webinar that Chadbourne hosted in late March. The following is an edited transcript.
The panelists are Michael Judge, associate manager of the Massachusetts Department of Energy Resources renewable portfolio standards programs, Noah Pollak, a lawyer with Chadbourne in Washington, and Alex Anich, director of research at Karbone Inc. The moderator is Todd Alexander with Chadbourne in New York.
MR. ANICH: It helps to have an understanding first of how prices for solar renewable energy credits have moved in the past in Massachusetts and also to understand the binary nature of markets with fixed targets under renewable portfolio standards.
Most markets have tended to trade initially as undersupplied markets. In an undersupplied market, prices gravitate toward the alternative compliance payment, or the amount a utility must pay as a penalty if it fails to turn in enough renewable energy credits to meet the RPS target. In Massachusetts, credits traded initially well above $300 a MWh and right up to $500 a MWh, which is the alternative compliance payment, because there were not enough SRECs available in the market. Buyers either had to buy SRECs, bidding up the price, or pay the alternative compliance payment, called the SACP. Obviously, the SREC price will not go above the SACP since buyers will pay the SACP rather than buy more expensive SRECs.
Like many markets, Massachusetts went from a period of undersupply to a period of oversupply as more and more solar projects were built in the state. Prices dropped rapidly and eventually fell below $285 a MWh, which was supposed to be a floor of sorts under a clearinghouse price support mechanism. The solar credit clearinghouse price support mechanism in Massachusetts is unique. Where other markets also went from periods of undersupply to periods of oversupply, SRECs in Massachusetts — notwithstanding the fall in prices — managed to maintain a premium above the value in other markets.
The New Jersey market is similar to Massachusetts in that it has free market entry. Developers can build projects with few limitations, and there is a relatively smooth approval process. However, Massachusetts SRECs maintained a $100 a MWh price premium over New Jersey SRECs when each market moved into oversupply.
Pennsylvania is distinct from these other two markets in that SRECs can be sold in that market from projects in other states within the PJM grid. That meant that when other markets moved into oversupply, the Pennsylvania market was flooded with SRECs from neighboring states. This caused SREC prices in Pennsylvania to drop below $50 a MWh. There was a very large price premium for Massachusetts SRECs compared to Pennsylvania SRECs.
As we look ahead to the new Massachusetts SREC II program, the key challenges that the program faces are price stability and maintaining the SREC prices in the range of something called the solar credit clearinghouse auction price support value. The solar credit clearinghouse auction price support value will start at $300. The Massachusetts SREC price support mechanism functions based on supply and demand, so it does not guarantee a minimum floor price. If the market is oversupplied, then prices could fall below the solar credit clearinghouse auction price support value. Therefore, the first challenge facing the SREC II market is to limit the oversupply. The SREC I market went into oversupply because of rapid development of a number of large solar projects in the commercial sector.
We are looking at two potential scenarios for the SREC II market. In an undersupplied market, we expect the prices to track above the solar credit clearinghouse auction price support value, but below the alternative compliance payment. If the market is oversupplied, then prices could fall below the solar credit clearinghouse auction price support value. These markets tend over time to become oversupplied.
Another challenge facing the Massachusetts SREC II market is the net metering cap. This is the amount of capacity that can be signed up to supply electricity to the grid through net metering. The current net metering cap is 663.4 megawatts, and there are already 672 megawatts of projects that effectively received a statement of qualification and have the potential to get built. Therefore, the Massachusetts legislature is considering two bills to increase the net metering cap. Net metering essentially allows projects to sell power at retail rates and is essential for establishing a strong SREC II market.
How the Program Works
MR. JUDGE: Let me give a quick overview of how the renewable portfolio standard programs work in Massachusetts.
We have three classes within the renewable portfolio standard programs. Class I, which has been in effect since 2003, is for new renewables. Class II includes both new renewables and waste-to-energy facilities. Finally, we have the alternative portfolio standard for combined heat and power facilities and other generating systems.
Within class I is a subclass that we call the solar carve out, which is a specific target for the amount of solar electricity utilities are required to supply each year. It is a carve out from the larger class I obligation. We are in the process of implementing a new carve out from class I, which will be the solar carve out II program. When everything has been fully implemented, utilities will have an overall class I target for 2014 of 9% renewable energy, which includes the two separate carve outs for SREC I resources and SREC II resources.
Solar has received special treatment in Massachusetts since 2010 when the solar carve out program was first implemented. New solar construction was a little slow at first, but then really picked up in 2011, and a lot was built last spring and summer. Unlike other states, Massachusetts has an adjustable RPS target — called a minimum standard — that is supposed to keep SREC supply and demand in reasonable balance and prevent prolonged periods of oversupply or undersupply that have been issues in other SREC markets.
Often when an SREC market is created, the targets are set by statute many years in advance. When the market moves into an oversupply, the regulators administering those programs have no ability to make adjustments. In Massachusetts, our regulations include a formula that adjusts demand based on market oversupply. We also have a forward alternative compliance payment schedule. This allows market participants to see the alternative compliance payment up to 10 years in advance.
We also have a solar credit clearinghouse auction account that provides a soft floor price. It is not necessarily a hard or guaranteed floor price. It helps maintain pricing in the market, and I think you can make a strong argument that, because of it, pricing in Massachusetts has been more stable than in some other SREC markets that have experienced oversupplies.
So here is an update on the market. In May and June 2013, we received about 800 megawatts of applications for about 200 megawatts of remaining capacity in the solar set aside program. Given the wide variety of projects that were in front of us, some of which had made serious investments and had serious sunk costs, and others that were not at as an advanced stage of development, we announced our intention to issue emergency regulations that were filed on June 28 and extended eligibility to projects that had met certain development milestones. Namely, any project over 100 kilowatts could qualify if it had signed an interconnection agreement with the local utility by June 7, 2013. Those projects were given through December 31 to be completed. If they were not completed by that date, then they had to demonstrate that 50% or more of their construction costs had been incurred.
We have now passed the deadline. Some projects dropped out. The majority of projects remain in the program. As of right now, we have about 675 megawatts qualified, of which about 420 megawatts are operating. So we still have a little over another 250 megawatts that are not operating, but they have until June 30 to interconnect.
We are also still qualifying projects under 100 kilowatts until the SREC II program goes into effect. Any such project that is interconnected and submits an application to us by the time the SREC II regulations go into effect will be eligible under SREC I. Otherwise, no new projects will qualify for SREC I as of the effective date of SREC II.
If any project over 100 kilowatts is currently qualified under SREC I, it cannot be qualified for SREC II until it has withdrawn its statement of qualification under SREC I and then reapplies under SREC II. No project can be qualified for both programs.
Differences Between SREC I and II
There are a few key differences between the SREC I and SREC II programs. SREC II is a much larger program. The program cap will ultimately be 1,600 megawatts minus the final SREC I cap. For example, if the SREC I final cap is 600 megawatts, then there will be 1,000 megawatts of capacity available under SREC II.
There are no more opt-in terms. The opt-in term is the number of quarters a project has the right to deposit SRECs into the clearinghouse auction account. Instead, all projects receive SREC IIs for 40 quarters from either the quarter in which they qualify or the following quarter. Also, both the alternative compliance payment and auction price have declining forward schedules. In SREC I, we had a declining alternative compliance payment schedule, but a fixed auction price for the duration of the program. In SREC II, that auction price begins to decline in the fourth year of the program. Perhaps the biggest change between SREC I and SREC II, is the introduction of “SREC factors.” SREC factors offer different incentive levels to different types of projects. These were added to meet certain public policy goals as well as to differentiate the incentives based on differing economic needs of different sectors. Finally, the compliance formula has changed because, instead of growing a market from scratch, we are now trying to maintain steady, stable market growth. We are not trying to grow a market from essentially zero to 10 megawatts a year to 150 megawatts a year. We are trying to maintain it at about a 150-megawatt or so range per year.
The alternative compliance payment rate begins at $375 a MWh, which is substantially lower than the $523 rate that is currently in the SREC I program. So there has been a significant reduction in the alternative compliance payment rate, which will provide significant cost savings for ratepayers, but also less upside to project developers. The auction price stays at the same price level for the first three years as it is under SREC I, and then begins to decline.
With the introduction of the “SREC factors,” the amount of marketable SREC IIs produced by a project will be a function of whether the project is in market sector A, B, C or “managed growth.” Projects in market sector A receive an SREC factor of 1.0x. Projects in market sectors B and C receive SREC factors of 0.9x and 0.8x, respectively. Projects in the “managed growth” sector receive an SREC factor of 0.7x.
Market sector A includes projects of up to 25 kilowatts in size, solar canopies located on parking structures or pedestrian walkways, emergency power generation units that provide power to critical infrastructure in the event of an emergency or power outage, community-shared solar generation units, and units that provide power or metering credits for low-to-moderate income housing.
Units mounted on buildings and ground-mounted units that are larger than 25 kilowatts, but less than 650 kilowatts, and that use 67% of their output on site are all in market sector B. If these units use less than two thirds of their output on site, then they fall within market sector C. Market sector C also includes projects located on landfills and brownfields.
Finally, the managed growth sector is anything that does not qualify in one of the other sectors. Therefore, managed growth is primarily comprised of projects larger than 650 kilowatts that are virtually net metered and are not located on a landfill or brownfield. These are the very large-scale developments that make up most of the megawatts that were installed under SREC I. By giving these projects a lower SREC factor, we are trying to limit the rate at which those projects come into the market.
We revised the SREC II regulations in January. We held a public hearing and collected comments in late January. An updated draft of the regulations, based on review of those comments, was filed with the legislature on February 11. We received comments from the legislature in mid-March. We are now reviewing the comments and making final revisions. We expect to file the final regulations with the Secretary of State on April 11, and we expect it to go into effect on April 25.
I should mention a couple other things quickly. In addition to the SREC II program, we have an alternative compliance payment-funded support program for direct ownership of solar systems from homeowners. We are setting aside $30 million of alternative compliance payment funds to support direct ownership of residential solar. We see that it can be hard to get loans for homeowners who want to buy solar systems, and we are looking into designing a program. We are still in the early stages, but have done some outreach and selected a consultant. The goal of the program would be to encourage banks and other financial institutions to provide loans directly to homeowners. The state would offer credit enhancement, probably either by buying down interest rates or establishing a loan loss reserve. The final design has not been settled.
There is a lot going on with net metering in Massachusetts. We are aware that many projects depend on net metering credits along with the SREC revenue. The Massachusetts market is not uniform in the availability of net-metering credits from one utility territory to the next. Some utility territories have more capacity available. Others have less. It is a function of how great the load is in each utility territory. Any change in the net-metering caps or aspects of the program must be made by the legislature. There are currently two bills under consideration by the legislature. It is unclear what direction the legislature will take ultimately, but there is a lot of dialogue taking place among the interested parties.
Finally, I want to highlight how successful some of the programs have been here in Massachusetts.
The governor’s goal of 250 megawatts of solar capacity by 2017 was met four years early in 2013. A new goal was set of 1,600 megawatts by 2020. Solar is widespread throughout the state: 348 of the 351 cities and towns have at least one solar installation, and more than 130 municipalities are hosting a project on town facilities or town land. Last year, more solar was installed than in all prior years combined. That is the fourth or fifth year in a row in which this has happened in Massachusetts. We are ranked very well nationally: we were fourth in solar capacity installed in 2013. We are sixth in total cumulative installed capacity. We are third in commercial installations. We are fifth in residential. We are fourth in total solar jobs, and sixth in per capita jobs.
MR. POLLAK: Let me focus on distributed solar projects briefly.
Massachusetts SRECs are only awarded to solar projects that are smaller than six megawatts and, thus, by definition most SRECs go to distributed solar facilities. Cash flow from distributed solar projects in Massachusetts comes from two sources. First, the solar company receives payments from homeowners, commercial and utility customers. These payments may be under a power contract, lease of the solar equipment or net metering credit purchase agreement. Second, the solar company receives SRECs that can be sold in the market.
It may be possible to make a forward sale of the SRECs. Investors and lenders will take the contracted SREC revenue into account in a financing of a solar project, but the allocation of regulatory risks, the creditworthiness of the SREC buyer and any credit support behind a purchase obligation will affect the value they assign. Alternatively, project owners may choose to play the spot market and rely on the stability that the solar clearinghouse auction is designed to provide. However, it is unclear how well the clearinghouse price support mechanism will function to keep prices at or above the target price and what credit, if any, tax equity investors and lenders will assign to contracted revenue when deciding how much to invest or lend.
A key difference between SREC I and SREC II is the weighting of SRECs through the “SREC factors.” This mechanism is an effort by the Massachusetts regulators to promote smaller solar installations and to achieve other public policy goals by giving those projects a higher SREC factor. Thus, for example, projects under 25 kilowatts receive one SREC for every 1 MWh of output. Brownfield and landfill units have a 0.8 SREC factor. This means that brownfield and landfill units receive 0.8 SRECs for each 1 MWh of output. The large projects are in the “managed growth” category have a 0.7 SREC factor and receive 0.7 SRECs for each 1 MWh of output.
Another difference between the SREC I and SREC II programs is in the process for qualifying under the programs. Under SREC I, you needed an authorization to interconnect in order to obtain a statement of qualification. Under SREC II, a statement of qualification can be received merely upon submission of an executed interconnection agreement and demonstration that you have the real estate rights and governmental approvals to move forward with the project.
MR. ALEXANDER: Let’s turn to audience questions. Mike Judge, why is the state giving the most encouragement to small solar installations rather than utility-scale projects?
Why Only Small Projects?
MR. JUDGE: We would rather see development take place on rooftops, landfills, brownfields and parking lots before other types of open space.
The intent of the original program was to encourage distributed generation. It did not have to be solar. Distributed generation tends to mean smaller projects that are on the customer side of the meter. So the program was aligned initially with the net metering rules, and it still is aligned in many respects with those rules.
You can build up to six megawatts per parcel of land. There is no intention to allow projects larger than that to qualify unless you can find multiple parcels of lands that are next to one another. Furthermore, virtual net metering rules in Massachusetts prohibit projects, unless they are under a so-called public cap, from being larger than two megawatts, and the rules actually discourage projects from being larger than one megawatt. It is possible to build larger projects; you just may be doing it without SRECs or net metering.
MR. ALEXANDER: Given that SREC prices can fall below the compliance auction price, can you explain how this functions as floor? How can a tax equity investor or lender get comfortable with the potential revenue from SREC sales given such a mechanism?
MR. JUDGE: There is no floor in a sense of a guaranteed minimum price, but the auction mechanism helps. For every SREC that gets deposited into the auction, the demand for the following year is increased by one MWh. For every round that does not clear, if you go to the third round of the auction, say, then the amount of demand that is added as a result of the auction doubles. So this coming year, under SREC I, there will be about a 100,000 MWh oversupply in the market. If 100,000 SRECs are deposited into the auction, the demand for 2015 — the next compliance year for which we are calculating the demand — would be increased by 100,000 MWh. If that auction doesn’t clear and it goes to the third round, demand is increased by 200,000 MWh.
The auction functions through a series of carrots and sticks. The carrot is the SRECs are available and eligible to be used in multiple years. The stick is if a retail supplier does not buy in the early rounds, then it will face a potentially much higher compliance obligation and demand in future years and will probably end up paying higher prices. The auction has been designed to accelerate demand for SRECs. The auction is an opportunity for retail suppliers to hedge against future demand increases and future price increases.
MR. ALEXANDER: Noah Pollak, from your experience working with investors and lenders on these projects, are they willing to take future SREC revenues into account? What do they view as the biggest risk to try to mitigate?
MR. POLLAK: They will invest or lend against contracted revenue. Otherwise, they are left trying to understand how the floor mechanism will work going forward.
MR. ALEXANDER: Are they giving much credit to uncontracted SRECs?
MR. POLLAK: It is a negotiation.
MR. ALEXANDER: Alex Anich, when developers come to you looking for help getting value for their SRECs, are you able to find them long-term contracts or what other types of strategies do you offer them?
MR. ANICH: We have had a huge interest from third parties who are looking to get 10-year deals, not only in the SREC I program but also in SREC II. The SREC price in a 10-year deal is a discounted price because the buyer is being asked to take price volatility risk. The longer the period he is asked to assume this risk, the higher the discount. We are also seeing a 20% discount in SREC II prices compared to SREC I prices under 10-year contracts. The reason is the SREC II rules are still going through a rulemaking process.
MR. ALEXANDER: I know from having worked on a bunch of projects in New Jersey that the discount for longer term contracts is steep. Anybody who is going to contract for SRECs for more than a year or two in advance demands a very steep discount.
MR. ANICH: We cannot really talk about a set market price or anything along those lines yet in Massachusetts. New Jersey functions through an auction for retail electricity supply that runs on three-year cycles. Most of the liquidity there is bounded by that three-year cycle, and the retailers only have to hedge their compliance for SRECs for three years.
Massachusetts is very different. Massachusetts has a 10-year opt-in term and other factors that create a different term structure of liquidity for the bid side for SRECs.
MR. ALEXANDER: Mike Judge, if the SREC factors are adjusted in the future, would the adjustments apply to all projects, including retroactively to projects that are already in operation? Or would they only apply to the incremental capacity installed after the change in SREC factors?
MR. JUDGE: They would only apply prospectively. If there were an incremental capacity addition, the new factors would apply to the addition. The regulations say we will review the SREC factors no later than March 2016. Any changes to the SREC factors that come from that review would be implemented starting in 2017.
MR. ALEXANDER: Do solar canopy installations of any size fit into market sector A?
MR. JUDGE: Yes, as long as 75% of the modules being used are on a parking surface or pedestrian walkway. The installation could be up to six megawatts.
MR. ALEXANDER: What happens to the residual percentage of the SREC where your SREC factor is less than one?
MR. JUDGE: Let’s say you are managed growth and you get a 0.7 factor, so you receive SREC IIs for 70% of your output. The other 30% would result in creation of certificates at NEPOOL that would be automatically retired. The NEPOOL certificate can’t be used by anyone. They are accounted for the purpose of tracking solar generation, but they have no RPS eligibility associated with them, they are automatically retired in the NEPOOL GIS trading system.
MR. ALEXANDER: Can you address how the net metering caps are calculated by utility territory?
MR. JUDGE: Net metering is a statewide program, but it is implemented by the investor-owned utilities, and each utility has a cap. The overall state cap is just over 660 megawatts — about 330 for private and 330 for public — but the amount that is available in any particular utility’s service territory is different. National Grid and NSTAR have similar amounts of capacity available in their service territories. Western Massachusetts Electric has much less capacity because it has a smaller electric load. So there is a lot less space available under the net metering caps in the Western Massachusetts Electric territory, even though there is a lot more space to develop projects in the western part of the state.
The public caps have been reached in terms of applications received and approved in the National Grid service territory and Western Massachusetts Electric service territory. There still is space in NSTAR’s service territory.
So there are different amounts of capacity available in each utility territory and that information is available on the Mass ACA website at www.massaca.org. Even within utility service territories, the net metering rate varies depending on the type of meter that you are connecting to. If you are connecting to an industrial meter, you get the net metering credit for the industrial rate in that utility service territory. If you are connecting to a residential meter, you get the residential rate. There is also a small commercial rate. The variation in net metering credits across utilities is due to different rates in different utility service territories.
MR. ALEXANDER: Will the state consider allowing older projects that are pre-2012 into the SREC II program?
MR. JUDGE: The cutoff date in the most recent version of the regulations is January 1, 2013. So, no, we do not have any intention to allow older projects that were either eligible to participate in the SREC I program or receive substantial rebates or grants prior to the SREC II program being in effect to qualify. However, those projects would remain eligible to quality for general class 1 certificates.
MR. ALEXANDER: Can projects that interconnected before April 25 apply under SREC II if they do not apply under SREC I?
MR. JUDGE: Yes. The cutoff date for SREC II is January 1, 2013. Any project that came on line January 1, 2013 or later that did not qualify under SREC I and meets the other program eligibility criteria would be eligible to participate in SREC II. We do not expect a lot of that. We expect most such projects to come on line and apply for SREC I.