Environmental Sustainability plays an increasingly crucial role in today’s energy markets. Innovation, regulation and competition are also evolving and playing a larger role as climate change is confronted. The Clean Power Plan was unveiled in August 2015 to reduce the nation’s carbon footprint from power plants. Innovative companies have launched a number of cutting-edge technologies like the Tesla’s scalable residential battery and Bloom Energy’s on-site fuel cells.
In addition, some states are setting Renewable Portfolio Standards (RPS) for power suppliers, which in turn apply to all power end-users.
RPS is currently a state-by-state-controlled mandate that calls for all load-serving entities supplying power to source a certain percentage of their total statewide load from qualified renewable resources. Percentages vary in each New England state in the deregulated electricity market. In Rhode Island, for example, power suppliers must purchase 10% of their state-supplied power in 2016 from these qualified renewable resources. Types of renewables that qualify (wind, solar, biomass, hydro) also differ by state. In Connecticut, certain classes of renewable energy have been established and those classes are combined each year to identify the total renewable energy required.
Each state decides which resources qualify to fulfill the demands by distributing renewable energy certificates (RECs). Because of the way the wholesale market is structured, New England suppliers can’t typically differentiate between the fuel types used for generation when buying electricity in the open market. So, to meet the RPS requirements, RECs are attributed to qualified generation sources. RECs can be resold and purchased in a secondary market to allow suppliers to fulfill their RPS commitments. Purchasing RECs allows suppliers to support financial incentives for renewable assets to be ready and online to produce power while fulfilling their RPS mandate.
If a supplier cannot fulfill the RECs “proof of purchase” by the end of the year, an Alternative Compliance Payment (ACP) rate is charged. This can serve as a ceiling for REC prices in the secondary market. Most REC prices trade below the ACP rate, so there is generally incentive for suppliers to buy them (and expend transaction costs and resources). The management of the load served and the cost of RPS compliance must be counted and built-in to supplier prices.
Although these costs are not billed from the Independent System Operator (ISO) to the supplier (like most ancillary charges), the costs are very real and substantial. The portfolio management team must precisely track each state’s compliance rates and REC prices in the secondary market to forecast all RPS costs incurred. These inputs are included as part of the model when pricing power supply contracts. They can vary day-to-day due to state legislative actions and the price movements in the REC market.
We have seen a rise in RPS costs in the supplier cost breakout over the past three years. States ratchet up incentives for renewable generation and in turn increase compliance percentages. Massachusetts announced an expanded solar program, SREC II, to continue support of solar photovoltaic installations, which means suppliers need to source solar-specific, resource-size specific RECs to balance their portfolio. The chart below shows that Massachusetts power zones have the highest costs and rates of increase since 2013.
REC supply also plays a large role in costs. Under the current market constructs, basic supply-and-demand fundamentals result in higher prices if the renewable generation lags, or lower prices if RECs are abundant. With that in mind, the RPS market has and will be largely driven by regulatory action. This “market in a vacuum” is not a free, open competitive market. States try to balance out the supply and demand of RECs based on compliance percentage and their larger sustainability goals.
In late June, the Massachusetts state senate passed a renewable energy bill. The bill calls for contracted long-term purchase agreements by utilities for wind and hydro generation. The bill also seeks to increase the yearly incremental compliance rate from 1% to 2% through 2030. The passing of this bill could have a large impact on RPS costs for retail customers in two major ways. First, if utilities contract for long-term power purchase agreements outside of the wholesale market, they would also likely own the RECs to fulfill their own supplied load (default/last resort service). Fewer RECs in the secondary market could mean higher costs for competitive suppliers. Second, an increase in required renewable compliance rates could mean more REC purchases for suppliers to balance the renewable portfolio, which may result in higher costs included in supplier rates.
In late June, the Rhode Island Public Utilities Commission passed a bill in which they lengthened the target timeline and increased their RPS compliance percentages. The mandate that was in place stated 14.5% of total supplies through 2020 needed to be renewable power. The new bill requires 38.5% for 2036.
This bill should not have any short-term effects for power supply contracts up through 2019 for Rhode Island accounts. It does mean though, any contract terms priced for 2020 and beyond will see an increase due to higher RPS costs. This is a signal to suppliers and retail customers that RPS is here to stay and will play a large role in the cost rollup in supplier rates.
As social pressures continue for environmentally responsible action, this market could be volatile as the regulatory terrain in passing these bills remains polarizing and REC supply could be challenged by out-of-market supply agreements. Customers may be able to get some budget certainty in RPS costs by fixing RPS in supply contracts. Customers with RPS locked-in may not be subject to volatile REC pricing or compliance percentage changes (barring extreme legislative changes to the structure of the RPS, which could trigger change in law).
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