By Lynn Hargis

Congress is expected to make significant changes in the Public Utility Regulatory Policies Act — called “PURPA”— this fall.

The changes should not affect power projects with existing contracts to supply electricity to regulated utilities, but they could affect projects whose power purchase agreements are amended in the future. The changes could also affect the resale market for distressed power plants.

PURPA is a 1978 law that created the independent power industry in the United States by requiring regulated electric utilities to buy electricity from two types of power plants. In so doing, it assured entrepreneurs who wanted to build power plants that they would have a purchaser for the output from their projects. The two types of power plants that are favored under PURPA are “qualifying cogeneration facilities,” or power plants that produce two useful forms of energy from a single fuel, and smaller power plants that use renewable fuels. An example of a cogeneration facility is a power plant that burns coal under a boiler to make steam. The steam is used to run a steam turbine to generate electricity for sale and then reused to heat an adjacent factory.

Utilities are required to buy the output from such power plants — called “QFs” for qualifying facilities — at the avoided cost the utility would have to pay to generate or purchase the electricity itself.

Congress is expected to make two main changes in PURPA this fall.

First, it is expected to repeal the obligation that PURPA imposes on utilities to buy output from QF power plants, but the repeal would require future action by the Federal Energy Regulatory Commission before it takes effect. Second, Congress is expected to let regulated utilities own 100% of QFs. Regulated electric utilities are limited today to owning no more than 50% of a QF. Utility ownership was restricted in the past because Congress feared that utilities would engage in self-dealing. Repeal of the 50% limit on utility ownership would create an additional class of potential buyers for the QF projects that are currently on the market.

The changes are expected to be included in a national energy bill that is now working its way through Congress. The House passed the energy bill with such PURPA revision provisions in April. The Senate is expected to do the same in June. The revision provisions in these bills are complicated, and there are differences between the two houses that will have to be worked out in a “conference committee.”  The effort to reconcile the two repeal provisions, as well as other differences between the House and Senate bills, is expected to take until the fall.

Background

PURPA led to the creation of independent power companies in the United States. Once such a company signed a long-term contract to sell electricity to a utility at fixed rates, it could then finance its power plant. A bank would be prepared to lend against the expected revenue stream from electricity sales.

However, the fact that utilities had to buy from QF power plants was not the only benefit from PURPA. Another hugely important benefit was that the statute exempted QF power plants from most federal and state utility regulation. In particular, QFs are exempted from the Public Utility Holding Company Act, or “PUHCA,” and, as a consequence, companies owning QFs can have power plants all over the country without regard to the geographical limitations on utility systems and their owners imposed by PUHCA.

The unexpected success of QFs led regulated utilities to complain to Congress about the 50% ownership restriction for utilities. As a consequence, in 1992, Congress created another type of independent power plant — called an “exempt wholesale generator,” or “EWG” — that utilities could own without any percentage limit on ownership. At about the same time, the Federal Energy Regulatory Commission, which has jurisdiction over the rates at which electricity can be sold at wholesale across state lines within the United States, started allowing anyone proposing to sell electricity in the interstate wholesale electricity market to do so at whatever rate he can negotiate with the purchaser. Most EWGs have orders allowing the electricity from their power plants to be sold at such market-based rates. This made QFs less important: the practical result has been that virtually all new independent power plants built in the US since 1992 have been EWGs. EWGs enjoy the same exemption as QFs from regulation under PUHCA. Also since 1992, a number of states have allowed existing plants owned by regulated utilities that are part of their rate bases to become EWGs, which has led to significant erosion in state control over electricity generation, as California learned to its dismay when it tried to regain control over its dysfunctional market in 2001. Since state commissions are required by the supremacy clause of the US constitution to allow their local utilities to pass through FERC-approved wholesale prices in retail rates with only minor and difficult-to-prove exceptions, states lost significant control over electric generation starting in 1992.

Because QFs can only charge “avoided costs,” which are at very low levels in many parts of the county, few QFs have been built since the mid-1990’s.

Effects of PURPA Revisions

The proposed revisions to PURPA raise obvious questions about how existing QF projects will be affected. Many such projects still have contracts to supply electricity to utilities. The proposals also raise questions about the future makeup of the independent power industry.

Both the House and Senate bills would remove the current 50% limit on utility ownership of QF power plants, thereby opening up opportunities for utilities or their subsidiaries to own and control such power plants. This will also make it easier for private equity funds and other investor groups that may have utilities as part of their membership to own qualifying facilities without having to worry about exceeding the 50% limit if their membership changes.

Care should be taken to ensure that an existing power purchase agreement with an electric utility does not, by its terms, prevent ownership by a utility or create a default if utility ownership exceeds 50%. Many existing QF contracts with utilities contain such default or restrictive provisions. It might make sense to amend some of these contracts in light of the changed statutory requirements.

There will still be QFs. Utilities would not be required to buy the output from such plants, but the label will still confer a benefit in terms of avoiding utility regulation. The advantage that QFs have over EWGs is they are not subject even to modest regulation under the Federal Power Act. This can be important in today’s market where many power plants are up for sale. Section 203 of the Federal Power Act requires approval from the Federal Energy Regulatory Commission of mergers or “changes in control,” including upstream changes in control, over companies that own power plants, including EWGs — but not QFs.

Thus, financial institutions that are pondering whether to take active ownership of power plants whose owners have defaulted on loans, and private equity funds that are in the market to buy generating plants, and that in either case do not want to subject their parent companies to any form of utility regulation, however “lightened,” may prefer owning QFs to owning EWGs since EWGs are “public utilities” for purpose of regulation under the Federal Power Act. With QFs, such financial or other companies will not have to fear that their parent companies may require FERC approval before merging or selling their own assets if FERC finds such transactions to constitute a “change in control” of the downstream EWG.

Both the House and Senate bills would repeal the obligation by utilities to buy output from QF power plants. In the Senate bill, the obligation would disappear once the Federal Energy Regulatory Commission finds that QFs have access to “an independently administered, auction-based day ahead and real time wholesale market for the sale of electric energy.”  The determination would be made on a regional basis. Thus, FERC might find there is a well-developed enough wholesale market to drop the purchase obligation in one part of the country but not in another.

The Senate is focusing on the wrong thing, since an independent power company probably cannot finance the construction of a power plant on the basis of energy costs alone, not to mention changing energy costs, but must have a long-term contract that includes capacity costs. The House recognized this problem by adding that QFs must also have access to “long-term wholesale markets for the sale of capacity and electric energy” and by adding other potential criteria. The House bill also provides for the reinstatement of the obligation to purchase for individual QFs if a QF files an application with FERC, and FERC finds that the conditions justifying repeal of the obligation to purchase no longer exist. This will provide some protection for the owners of QFs if they are shut out of long-term wholesale contract markets.

Existing QF contracts would not be affected by the changes in PURPA — unless the contracts are amended in the future. Both bills include language that states that nothing in these revisions to PURPA affects the rights or remedies of any party under any contract or obligation “in effect or pending approval on” (the House bill) or “entered into or imposed before” (the Senate bill) “enactment of this subsection ... including the right to recover costs of purchasing electric energy or capacity” (both bills).

Both bills are silent about the effect of future contract amendments. However, when a federal statute is amended, existing contracts are usually brought under the new rules if the contract is amended after the enactment date in a manner that is considered significant. The thought is that if the parties are going to rewrite their deal, then they ought to do so with the new rules in mind.

Another benefit that independent power companies have enjoyed under PURPA is that utilities must sell them “backup” power — for example, to restart their plants after the plants are shut down for maintenance. The Senate bill would remove the obligation of an electric utility to sell electricity to a QF if competing retail electric suppliers are “able” to provide electric energy to the QF. I pointed out in a Newswire article last year that being “able” was insufficient, since utilities had, prior to PURPA, been “able” but unwilling to sell electricity to QFs at non-discriminatory prices. The House bill picks up the “willing” part (“willing and able”), but it fails to provide for non-discriminatory pricing. A QF owner requiring electricity to run its plant may not have much bargaining power in the retail market.

The FERC rules implementing PURPA require that a qualifying cogeneration facility must supply at least 5% of its total energy output in the form of “useful” thermal energy. The House bill, but not the Senate bill, would require FERC to issue a new rule revising the operating and efficiency standards for QFs to ensure that the thermal energy output is “used in a productive and beneficial manner,” used “predominantly for commercial or industrial processes and not for sale to an electric utility,” and ensures “progress in the development of efficient electric energy generating technology.” Although it appears that the rule was intended to apply only prospectively to new QFs, the way it is currently written in the House bill would make it apply to any existing QF that has not filed a notice of self-certification or an application for FERC certification. While most QFs have made one or the other filing, such a filing is not actually required by the statute or any FERC rule, and some QFs may not have one, or at least, not have up-to-date filings.

Finally, both the House and Senate bills would codify the holding in Freehold Cogeneration Associates, LP v. BRC of NJ, 44 F.3d 1178 (1995) that, once a state commission has approved a QF contract as consistent with PURPA and prudent, the state must allow recovery of the QF contract price in the purchasing utility’s retail rates. In the Senate bill, the section applies only to legally enforceable obligations entered into or imposed under this section “before the date of enactment of this subsection,” thereby leaving out future QF contracts. The House bill applies to all such obligations imposed under the section.