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A Dummy’s Guide on RPS, RECs and ACP!

June 11, 2011

Source: translation-blog.trustedtranslations.comOriginally, this commentary was intended to profile Texas as a leader in renewable energy (wind power) but a slow adopter of solar energy. A major part of the article centered on Renewable Portfolio Standards (“RPS”), Renewable Energy Credits (“REC”) or in the case of Solar (“SREC”) and Alternative Compliance Payments (“ACP”), or in the case of Solar (“SACP”).

It was then decided a brief primer of these programs would provide a better understanding of how they interact to add or detract from the installed capacity of renewable energy. That original discussion titled “The Yellow Rose of Texas is Now Solar Energy,” will be released in several days.

In an over simplification of a rather complex political, financial, technical, environmental and regional model, the DNA of renewable energy lies in a delicate balance between RPS benchmarks and federal and state incentives. This is not intended to usurp the fact that the cost of renewable energy remains the key driver of installed capacity.

For higher price renewable energy to remain competitive, grants and tax incentives in combination with benchmarks, benefits and penalties are needed to go head-to-head with coal- and gas-fired plants. Since incentives are generally well know on the state and federal level, a look into the relationship of RPS, REC, SREC, ACP and SCAP is a welcome diversion.

Renewable Portfolio Standard (“RPS”)
What is an RPS? According to the National Renewable Energy Laboratory (“NREL”), “an RPS is a statutory requirement to achieve a renewable energy goal by a certain date. It is the tool of choice for many policy makers concerned about climate change and the role played by electric generation and requires electricity retailers to provide a minimum percentage or quantity of their electricity supplies from renewable energy sources. An RPS establishes a base level of demand but allows the market to determine which renewable energy resources will meet that demand. Historically, state legislatures and regulatory agencies have been the driving force behind RPS policy formulation, although some RPS polices have been adopted through citizen ballot initiatives. Initially proposed as a mechanism to support renewable energy development in competitively restructured electricity markets, the RPS model today serves additional policy aims such as fuel diversity and in-state economic development.”

The goal can take many forms (usually some percentage of retail electricity consumption or a specified amount of nameplate capacity), with varying degrees of specificity as to implementation rules. The essential features of a statute provide regulators with sufficient authority to set up the necessary administrative structures, assign requirements, and enforce compliance.”

“State-based RPS programs are shown in the following chart. No two states are the same standards. Wikipedia notes, each has been designed taking into account state-specific policy objectives (e.g. economic growth, diversity of energy supply, environmental concerns), local resource endowment, political considerations, and the capacity to expand renewable energy production. At the most basic level, this gives rise to differing RPS targets and years (e.g. Arizona’s 15% by 2025 and Colorado’s 20% by 2020). Other factors in program design include resource eligibility, in-state requirements, new build requirements, technology favoritism, lobbying by industry associations and non-profits, groups cost caps, program coverage (IOUs versus Cooperatives and Municipal utilities), cost recovery by utilities, penalties for non-compliance (ACP and SCAP), rules regarding REC creation and trading, and additional non-binding goals.

State Renewable Portfolio Standards

* States with RPS goals not mandatory requirements.

Source: Database of State Incentives for Renewable Energy (DSIRE), accessed March 2009, www.dsireusa.org

Renewable Energy Certificates (“REC” and “SREC”)
A Renewable Energy Certificate (“REC”) or Solar Renewable Energy Certificate (“SREC”) represents the property rights to the environmental, social, and other non-power qualities of renewable electricity generation. A REC or SREC, and its associated attributes and benefits, can be sold separately from the underlying physical electricity associated with a renewable-based generation source

The U.S. Environmental Protection Agency explains: “All grid-tied renewable-based electricity generators produce two distinct products:
• Physical electricity
• RECs

Renewable energy certificates and attributes creation

Source: greenpowermarkets:com

At the point of generation, both product components can be sold together or separately, as a bundled or unbundled product. In either case, the renewable generator feeds the physical electricity onto the electricity grid, where it mixes with electricity from other generation sources. Since electrons from all generation sources are indistinguishable, it is impossible to track the physical electrons from a specific point of generation to a specific point of use.”

“As renewable generators produce electricity, they create one REC for every 1000 kilowatt-hours (or 1 megawatt-hour) of electricity placed on the grid. If the physical electricity and the associated RECs are sold to separate buyers, the electricity is no longer considered “renewable” or “green.” The REC product is what conveys the attributes and benefits of the renewable electricity, not the electricity itself.”

Therefore, RECs are a market instrument created by separating the “attributes” (positive environmental, social, and other non-power qualities of renewable electricity generation) of renewable electricity generation from the physical electricity produced, thus making RECs a tradable commodity separate from the actual electrons (see below). One REC typically represents the attributes of 1 megawatt-hour (MWh) of renewable electricity generation.

RECs have many advantages. The use of RECs frees renewable energy sellers from the need to deliver the renewable electricity in real time to the ultimate users. Rather, the electricity, devoid of any attributes, is injected into the grid while the RECs are retained for other uses. The RECs provide an accurate, durable record of what was produced and a fungible commodity that can be traded among suppliers. A REC is spent or “retired” from circulation.

RECs also serve the role of laying claim to and accounting for the associated attributes of renewable-based generation. The REC and the associated underlying physical electricity take separate pathways to the point of end use (see diagram). As renewable generators produce electricity, they have a positive impact, reducing the need for fossil fuel-based generation sources to meet consumer demand. RECs embody these positive environmental impacts and convey these benefits to the REC owner.

The use of RECs can reduce the cost of RPS compliance by lowering transmission and distribution costs, while also providing access to a larger quantity of resource options. Finally, RECs provide compliance flexibility by facilitating market trading and increasing market liquidity. As a result, RECs have become the dominant mechanism of RPS compliance. However, the manner in which RECs are defined and treated in RPS policies varies by state and region.

“In a few cases, states have set non-binding goal or benchmark, which do not entail economic consequences. Therefore, it does not alter an economic actor’s rational decision-making calculus in a consistent and predictable manner. Secondly, a non-binding goal does not affect any predictable change in future renewable energy demand. A renewable energy developer faces similar investment risk regardless of whether the non-binding goal exists. A market-wide enforceable mandate creates both the need and the basis for systematic business planning, whereas non-binding goals do not.” http://lawlibrary.unm.edu/nrj/48/1/06_hurlbut_portfolio.pdf

Alternative Compliance Payments (“ACP” or “SACP”)
According to SREC Trade, “an Alternative Compliance Payment (“ACP”) or Solar Alternative Compliance Payment (“SACP”) is the amount that Load Serving Entities (LSEs), i.e. electricity suppliers, must pay per MWh of electricity that they are unable to generate themselves or buy rights to through REC or SREC purchases in order to meet the state’s RPS requirement. While the ACP or SACP is fixed in any given year, the price of REC or SRECs varies based on the market forces of supply and demand.”

The ACP and SACP programs provide LSEs an option for compliance with renewable energy portfolio standards (RPS), in instances of renewable energy certificate (REC) scarcity or unavailability, or in cases where the price is unexpectedly high due to the exertion of market power.

An LSE is better off buying RECs or SRECs as long as the price is less than the ACP or SCAP. However, LSEs incur costs in purchasing RECs, so the maximum price they are willing to pay is typically well below the ACP or SACP. For instance, if a utility calculates that the cost to purchase an SREC is $40, they may not be willing to pay more than $40 less than the SACP. At that price, they can save money by simply paying the SACP.

State-based ACP programs in place today are shown in the following chart from 2007. Consistent with RPS and RECs no two states are the same.

State Noncompliance Penalties

So what does this all mean? In 2008 the Energy Information Administration  (“EIA”) reported,
• Renewable capacity increased by 8,469 megawatts in 2008. This is an increase of 7.8 percent over the 2007 level. Most of this increase, 8,136 megawatts, or, 96 percent, came from new wind capacity.
• Renewable generation increased in 2008 by eight percent over its 2007 level.
• Texas continues to lead the Nation in installed wind capacity and generation. In 2008, Texas increased its wind capacity by 65 percent, reaching 7,427 megawatts, and its wind generation by 80 percent to 16,225 thousand megawatthours. With this significant increase, wind generation was responsible for four percent of total electricity generation in the State.

In one of the more recent studies, NREL reported on November 2009, that:
• States that have a renewable energy portfolio standard appear to be generating more clean wind energy the longer the RPS has been in effect.
• Non-hydro renewable electricity generation as a percent of total electricity generation increased 33.7 percent between 2001 and 2007, reaching a national total of 105 million megawatt-hours.
• California led the nation in terms of total non-hydroelectric renewable generation in 2007; Maine is No. 1 when also considering state population and gross state product.
• Washington led in total renewable generation in 2007 if conventional hydroelectric resources are included. Note: today conventional hydroelectric is not considered to be a renewable energy resource.
• South Dakota ranks first in overall growth in non-hydro renewable energy generation between 2001 and 2007.
• Geothermal electricity generation in the Lower 48 is concentrated in California, Nevada and Utah.
• Solar capacity is concentrated in the southwestern and northeastern states.
• Leading wind energy states are Texas, California, Iowa, Minnesota, and Washington. However, sparsely populated Wyoming leads in per-capita wind generation.

In closing, RPS programs create a mandate for LSEs to provide renewable energy; they create a lucrative captive market for renewable energy producers who are eligible in a particular state’s RPS program to issue RECs. The LSE weigh the relative price of the REC and the cost ACP to determine whether it is financially advantageous to purchase RECs (add capacity) or pay the ACP (defer additional capacity).

Various scenarios:
• If the RPS is not satisfied and the ACP is high, it is financially advantageous for the LSE to ensure increased capacity of renewable energy and purchase less expensive RECs.
• If the RPS is not satisfied and the ACP is low, RECs are relatively inexpensive and the LSE will either purchase RECs at the wholesale market price of electricity or pay the penalty, in either case the renewable energy provider has a very thin business proposition, which most likely is not bankable making the amount of added renewable energy capacity very low.
• If the RSP is satisfied, the ACP does not apply and the LSE has no immediate reason to purchase any RECs, which become valueless and drives down new renewable energy generation.
• If the ACP is low or non-existent, most LSE’s will pay wholesale market price for renewable energy, which without the aid of a high REC prices, makes it difficult if not impossible for a renewable energy provider to make a strong business case.

The kicker is both RSP and ACP are not standstill devices. In most cases RSP are legislated to increase over a 15-year period, while the ACP falls over the same period.

Curious to know your thoughts!

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3 Comments leave one →
  1. June 15, 2011 5:33 PM

    Thank you Barry. Very useful post! Especially, the analysis about the how the price of these instruments affect RE generation.

    Can you share your understanding of how RECs can be traded between states? For example, if I am generating in Colorado then can I sell in Nevada?

    Secondly, if the RECs are being generated with steam application (not electricity) do they fall in a different bucket?

  2. June 18, 2011 2:07 PM

    Colleges will play a huge role in our future energy endeavors as a country. It’s very important that our universities contine to train students for a greener future

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