Federal Renewable Electric Standard Presents Challenges

By Ed Feo, Milbank Tweed Hadley & McCloy LLP

Twenty-nine states and the District of Columbia have renewable portfolio standards (RPSs), and six other states have set elective renewable energy generation goals.

Northeastern, Midwestern and Western states have been the principal RPS adopters; Southeastern states have not followed the same path. Mandatory RPSs first were implemented in the 1990s to compel regulated utilities to diversify their energy supply sources with renewable energy. The effect has been a significant build out of renewables in the past decade, especially wind energy projects, which now aggregate more than 35,000 MW in installed capacity.

Congress has considered a federal RPS during the past six years. In bills last year, RPS was re-named renewable electric standard (RES). For this article, however, RPS will be used for state and federal programs.

The Senate passed versions of a federal RPS in the 107th, 108th and 109th Congress. The House passed a 2009 energy bill with a federal RPS, but that, too, failed to get enacted into law. Legislation considered during this year’s Congress likely will include a federal RPS again. To some congressional observers, this is a federal standard’s do-or-die year.

Given the breadth of state RPS programs, is there a need for a federal RPS? If there is, which generation resources will benefit? What other consequences will result from a federal mandate?

State RPS programs are subject to at least three criticisms a federal standard can address:

  1. Not all states participate. States with RPS programs are diversifying supply, cleaning up their carbon footprints and incurring the cost. Non-RPS neighboring states continue to enjoy relatively larger carbon footprints and are not incurring the clean-technology conversion cost. If energy diversity, security and climate change are national objectives, then a federal law is required to promote a fair allocation of clean-technology conversion cost and benefit.
  2. State programs are disparate in their approaches to approved technologies, the inclusion of energy efficiency and distributed generation, and the penalty schemes for noncompliance. Virtually all state programs include wind, but some do not include solar, geothermal, landfill gas and other technologies. This diversity creates unnecessary barriers to renewable energy adoption, as well as inefficiency and related increased costs.
  3. State programs will go only so far in promoting renewables. State RPS programs will result in an additional 50 GW of installed wind energy capacity, according to a 2008 U.S. Department of Energy study, “20% Wind Energy by 2030.” Other studies show that state programs will result in wind energy growth through 2015 or so, then will tail off to 2020; solar will continue through that period to have modest growth; and other renewable energy technologies such as geothermal and biomass will have marginal increases in installed capacity. State programs are insufficient to penetrate renewables beyond 10 percent of the generation base.

A federal RPS potentially could drive more efficient and greater investment in a broader range of renewable energy resources. That potential might not be realized in a law passed, depending on how some issues are resolved.

One issue is the level of a federal mandate. The proposals in bills introduced in 2009 ranged from 15 to 25 percent. A 15 percent threshold (especially with carve outs discussed further in this article) will not add materially to the level of renewable energy capacity achieved under state RPS programs. Most states with RPS programs have standards of 20 percent or greater.

Another issue is the definition of qualified technologies and practices meeting a federal mandate. Proposed federal legislation includes most major technologies, but whether municipal solid waste generation should be permitted is debated. More important is whether distributed generation should be encouraged with a greater weighting or whether energy efficiency can be counted to displace new generation (as in the Waxman-Markey bill). The inclusion of energy efficiency in particular significantly impacts the amount of new installed renewables, given that efficiency projects tend to be more economic. Under the Waxman-Markey bill, up to 40 percent of the RPS could be met with efficiency gains. New renewable energy projects would be deferred or never built. While the need to promote energy efficiency exists, an efficiency carve out might delay for another generation the generation fleet’s clean-energy conversion.

A federal RPS also might impact resource diversity. In the absence of set asides or other incentives for newer technologies, a federal RPS will tend to promote wind energy over most other sources because of cost. Wind is among the cheapest renewable energy sources, only surpassed by co-firing with biomass and small hydro up-rate projects. Geothermal can compete with wind depending on the cost of developing the geothermal resource. The track record of state RPS programs, likely to be repeated in a federal program, is that as much as 75 percent of new installations will be wind energy projects. This is terrific for the wind industry, but it might not be preferred in creating supply diversity.

A third issue with a federal RPS is the level of the alternative compliance payment (ACP), the price a utility pays for failing to meet its mandate. The challenge in setting the ACP is to achieve a sufficient incentive to meet the mandate. If the ACP is too low, then obligated utilities may pay the ACP in lieu of complying with the mandate. Whether to comply or pay might depend on a utility’s economic circumstances and the market.

Outside of a federal mandate, adopting carbon legislation might affect renewables implementation nationally. A carbon tax or cap and trade might make fossil fuel sources more expensive and drive renewable energy purchases in excess of any mandate, concludes a Black & Veatch analysis performed in connection with the DOE wind study. A carbon program’s effect will depend on the regulated resources, timing of implementation, system of allocating or auctioning compliance credits, allocation of proceeds from sale of compliance credits, and other factors. A carbon system potentially benefits renewables generally without favoring any particular technology. As with an undifferentiated federal RPS, wind projects are more likely to benefit, given their relatively low cost.

Several challenges would result from a meaningful federal RPS.

First, any significant expansion of the renewable energy generation base must include a major build out of transmission. Renewable resources generally are not where excess transmission exists. Experience in Texas and California highlights that transmission constraints will impede renewable energy deployment, even with mandates. The DOE wind study concludes that 12,000 miles of new transmission lines are needed to accommodate a 20 percent wind penetration by 2030 at a $60 billion capital cost.

An aggressive federal mandate might aggravate equipment supply chain constraints. The wind industry saw constraint-driven price impacts in 2006-07 as turbine orders exceeded vendors’ abilities to source the parts necessary to build turbines. The wind supply chain improves as suppliers invest in expanded capacity and new companies enter key component markets, but a mandated energy-purchase regime can push the supply chain to its limits, and prices for parts understandably increase. In an unregulated market, price increases result in reduced demand. In a mandated purchase market, the demand remains notwithstanding price increases. A federal RPS might not take effect for years, so the industry might have time to scale up to meet demand, but forecasting the interplay of mandated demand and supply response is difficult.

Another consequence of a federal mandate, even in states such as California with significant mandates, will be the need for firming capacity if the RPS program does not differentiate firm from nonfirm energy. As noted, wind is the dominant renewable resource, but it is intermittent with an energy-delivery profile typically not coincident with load and difficult to forecast. Forecasting is improving, and geographic diversity achieved through a massive transmission network can mitigate intermittency’s impact. But these energy sources most likely will continue to have a low capacity value.

To make intermittent renewables work well for a purchasing utility, there must be sources for firming the energy, either through dedicated resources such as gas-fired projects or energy storage. This means there is another cost to increased renewables (at least those that are intermittent), as well as an opportunity for firming technology developers. A federal RPS could mitigate this additional investment by favoring renewable technologies that provide for firm energy, at least up to the cost of the competitive nonfirm energy with the cost of firming added in.

Finally, a federal RPS likely will present political and economic conflicts. Renewable resources are not equally distributed nationally. The middle is rich in wind, the Southwest is rich in solar, the West is dominant in geothermal resources and the East and Southeast have more biomass density.

This resource allocation might suggest some basis for trading among regions based on respective resource advantages, but the cost differentials of renewable technologies, aggravated by transmission constraints, mean that some regions likely will be net energy exporters and others will be net importers.

A federal mandate will overcome the disparate allocation of renewable energy use currently effected by the checkerboard state RPS programs have achieved. It also will mean that regions rich in the cheaper resource will gain economically, and those that are resource-poor (or at least poor in the less expensive resource) will lose economically. This potential economic outcome remains a federal program’s principal impediment.

A federal RPS can promote a national approach to renewables deployment and converting the generation fleet from fossil fuel to cleaner technologies. Issues must be addressed for a federal RPS to work. One outcome, in the absence of a structure designed to promote diverse supply sources, will be wind energy’s continued dominance as the choice renewable energy.

Any federal RPS assessment should consider the investment in transmission and firming technologies necessary to make the investment in wind and other intermittent technologies functional and valuable. Adoption of a federal RPS hinges on legislators’ dealing with the potential economic effects on the resource-rich vs. the resource-poor.

Author

Ed Feo is a partner in the international law firm Milbank, Tweed, Hadley & McCloy LLP. He co-chairs the firm’s project finance and energy practice. Feo represents sponsors and investors in the energy and infrastructure industries and specializes in renewable energy projects. Reach him at efeo@milbank.com.

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