Challenges and Opportunities for QFs, Part I of III
by Laurel W. Glassman
Much has been written, mainly in the doom-and-gloom genre, about the future of the qualifying facility industry after passage of the Energy Policy Act in August 2005.
It’s true that post-EPAct, the QF industry faces a number of challenges, yet there remain significant-and unique-benefits and opportunities for QFs. Of course, these benefits may depend upon the size of a particular QF, its location, configuration, regulatory status, and other factors, but a QF may still reap significant rate advantages while avoiding most of the regulatory requirements of the Federal Power Act, the Public Utility Holding Company Act of 2005 (PUHCA 2005), and state utility laws.
Contrary to rumors of the demise of the QF industry, it’s likely that the industry will continue to grow. In this first of a three-part series, we begin to explore the regulatory changes that are impacting the QF industry.
A QF’s Original Advantages
After the passage of the Public Utility Regulatory Policies Act of 1978 (PURPA), certain types of cogeneration facilities and small power production facilities could achieve QF status if they met federally mandated standards with respect to ownership and technical operating characteristics.
QF status under PURPA provided a collection of new advantages. QFs were entitled (with some narrow exceptions)to be interconnected to an electric utility of their choosing. They were afforded a guaranteed wholesale market for their power. (Specifically, they could require the electric utility with which they were directly interconnected to purchase their power, referred to as the “PURPA Put.”) They were entitled to receive payment for their power at a rate equal to the incremental cost to the purchasing utility of alternative electric energy. This rate, referred to as the “avoided cost rate,” was defined as “the cost to the electric utility of the energy which, but for the purchase from the cogenerator or small power producer, such utility would generate or purchase from another source.”
QFs were guaranteed the right to be provided with backup, maintenance, and supplementary power by electric utilities, and all cogeneration QFs and many types of small power QFs were entitled to exemption from most of the provisions of the Federal Power Act (FPA). As a result, these QFs could, for example, sell their power at wholesale, issue securities, and dispose of their assets with very limited oversight by the Federal Energy Regulatory Commission; in addition, they were not subject to a variety of onerous FERC filing and reporting requirements. QFs were exempt from state laws and regulations affecting the rates of electric utilities and the financial and organizational regulation of electric utilities.
In addition to this package of benefits-unavailable to any other type of electric generating facilities subject to FERC regulation-QFs provided a substantial benefit to their upstream owners: they were exempt from regulation under the Public Utility Holding Company Act of 1935 (PUHCA 1935) as “holding companies.” (The exemption was available to companies that were “holding companies” solely with respect to QFs, exempt wholesale generators, and/or foreign utility companies and was not available to companies that owned QFs and other types of non-QF electric utility companies.)
PURPA was designed to encourage the development of QFs because of their highly efficient use of fuel or their use of “alternative” fuels. Cogeneration QFs produce two forms of useful energy more efficiently than facilities that do not employ a cogeneration process; and small power QFs use non-fossil fuels (e.g., waste, wind, hydropower and geothermal energy) as the primary energy source.
The package of incentives provided by PURPA was, in fact, extraordinarily successful in encouraging such development. Today, there are many thousands of QF projects. QFs represent approximately 5 percent (in terms of generating nameplate capacity) of the total generation market in the U.S.
Changes to PURPA
EPAct represents the first major revision to PURPA in nearly 30 years. It embodies Congress’s recognition of the maturation of the QF industry, the presence of competitive markets in certain areas of the U.S., and of the need to tighten the technical requirements for cogeneration QFs in order to ensure that the benefits of the cogeneration process would be more fully realized.
In this regard, EPAct makes the following key changes to PURPA:
- Elimination of the “PURPA Put” in four large markets where FERC found that QFs have nondiscriminatory access to markets found to meet certain standards of competitiveness
- Elimination of the guaranteed right to obtain electric energy from utilities where FERC has found that competing retail electric suppliers are willing and able to sell and deliver electric energy to QFs
- Imposition of more stringent technical operating requirements on “new” cogeneration QFs in certain circumstances
- Elimination of the utility ownership restrictions on QFs.
In addition to these key changes, FERC, in implementing EPAct, has chosen to eliminate the exemption most QFs had previously enjoyed from the rate provisions of the FPA (other than QFs selling under state-approved contracts). Consequently, most QFs will now be required to submit rate schedules to FERC with respect to new wholesale power sales contracts and will not be permitted to commence wholesale sales until those rate schedules have been accepted for filing (other than “PURPA Put” sales under certain state regulatory programs).
In addition, QFs are now subject to regulation with respect to rules governing market transparency, false statements and market manipulation.
Unfortunately, the new PURPA regulations fail to address several key questions. Does an existing QF contract that is subsequently amended become a “new” contract that loses the protections from FERC rate review? What is the status of contracts that were not executed on the date of enactment of EPAct but were pending approval before the appropriate state regulatory authority on that date? Such pending contracts were specifically protected under Section 1253(a) of EPAct as “existing” contracts.
Right to “PURPA Put” Substantially Reduced
EPAct provides that electric utilities will no longer be required to enter into new contracts-contracts executed on or after the date of enactment of EPAct, Aug. 8, 2005-for the purchase of electric energy from QFs if FERC makes a finding that QFs have nondiscriminatory access to “independently administered, auction-based day ahead and real-time wholesale markets for the sale of electric energy . . . and wholesale markets for long-term sales of capacity and electric energy . . . .” or “transmission and interconnection services that are provided by a Commission-approved regional transmission entity and administered pursuant to an open access transmission tariff that affords nondiscriminatory treatment to all customers and . . . competitive wholesale markets that provide a meaningful opportunity to sell capacity, including long-term and short-term sales, and electric energy, including long-term, short-term and real-time sales, to buyers other than the utility to which the qualifying facility is interconnected.”
There is a third scenario under EPAct in which “PURPA Put” rights could not be exercised, involving “wholesale markets for the sale of capacity and electric energy that are, at a minimum, of comparable competitive quality” as the other two types of markets.
On Nov. 1, 2006, FERC issued a final rule finding that four independent regional transmission organizations (RTOs)-the Midwest Independent Transmission System Operator Inc. (MISO), PJM Interconnection LLC, ISO New England Inc.(ISO-NE), and New York Independent System Operator Inc. (NYISO)-satisfy the “independently administered” wholesale market standard with respect to QFs larger than 20 MW.
Interestingly FERC gave limited consideration to whether there is actually a “market” in these RTOs for the often unique types of energy and capacity that QFs have to offer. For example, some cogeneration QFs may be able to offer energy and capacity only at certain times, depending on the electricity and steam needs of their industrial hosts. Similarly, small power QFs using biomass as the primary energy source tend to have fluctuating power outputs due to the fluctuating amount of BTUs in that type of fuel. For QFs that, for example, do not have access to the market because of operational characteristics or transmission constraints, they must make a filing with FERC seeking to rebut the presumption of nondiscriminatory market access.
As a consequence of the final rule, all QFs larger than 20 MW seeking to sell power under new contracts, if such QFs are located within the footprint of these RTOs-approximately three-quarters of the land area of the continental U.S.-would be barred from exercising the “PURPA Put.” A QF does have the right, however, to present evidence that a particular market is not truly competitive, and if FERC agrees, the “PURPA Put” right would be restored for that QF.
Notably, FERC did not find that California Independent System Operator Corporation (CAISO) and Southwest Power Pool Inc. (SPP) meet the EPAct standards of competitiveness, on the grounds that they each lack a day-ahead market. Although FERC noted that utilities within CAISO and SPP could file an application seeking relief from the mandatory purchase obligation, no utility has done so yet.
In addition, FERC has not found that any other area outside of MISO, PJM, ISO-NE and NYISO has a sufficiently competitive market. As a consequence, the “PURPA Put” likely will continue to be available in some areas with the largest and fastest-growing need for power, such as Florida, Texas and California, as well as in the Pacific Northwest and other areas in the South and Southeast. These are areas that merit particular consideration by project developers, notwithstanding the difficulties faced in the past by QFs attempting to secure power purchase contracts with some of the larger utilities in these areas.
Moreover, FERC has created an exemption from the elimination of the “PURPA Put” for QFs with a capacity of 20 MW or less. Thus, there could well be significant opportunities for new small QF renewable projects throughout the U.S.
Finally, even QFs located in MISO, PJM, ISO-NE and NYISO should keep in mind that they may still have significant opportunities to market their power without the benefit of the “PURPA Put” if they are able to offer that power at competitive prices.
[Editor’s note: The second part of this article will be published in the March/April issue.]
Laurel Glassman practices in the energy, infrastructure and project finance group at White & Case, LLP, resident in the firm’s Washington, D.C., office. She has more than 30 years of experience representing clients before the Federal Energy Regulatory Commission, and has also represented clients before state public utility commissions and in federal courts. She routinely provides advice on complex qualifying facility issues, and has published extensively on developments in the qualifying facilities sector.