Federal Law and Regulations


Today's grid interconnected renewable energy systems owe their regulatory existence to an act passed in 1978 called the Public Utility Regulatory Policies Act or PURPA. But PURPA itself is now under attack and my be overturned. The following summary is from a longer article written for the Department of Energy by Micahel Zucchet.

Renewable Resource Electricity in the Changing Regulatory Environment

by Michael J. Zucchet

The current form of the renewable energy industry in the United States was spawned during the 1970s, when oil embargoes, rising energy prices, and increased pollution concerns raised questions about the Nation's continued dependence on fossil fuels. As world oil prices increased by 300 percent in 1974, alternative energy sources became a national priority. To spur renewable energy development, the Federal Government provided investment tax credits and research and development funds that topped out at $718.5 million in 1980. Taking advantage of these incentive packages, private industry responded by pioneering new renewable technologies and applications. Consumer interest in alternative energy sources provided the political support for the Federal incentive programs and laid a strong foundation for an industry that grew rapidly.

While these economic and environmental forces lifted renewable energy off the ground, Federal regulation built the industry. The single most important factor in the development of a commercial renewable energy market was the passage of the Public Utility Regulatory Policies Act (PURPA) in 1978. Among other things, PURPA encouraged the development of small-scale electric power plants, especially those fueled by renewable resources. The renewables industry responded to such incentives by growing rapidly, gaining experience, improving technologies and reliability, and lowering costs.

New and proposed regulatory reforms during the 1990s, and especially in 1995, have adversely affected the near-term outlook for renewable electric technologies. Potentially critical regulatory and legislative changes have been proposed in two areas: 1) changes related to PURPA, including the possible repeal of sections of the Act, and 2) changes related to the restructuring and deregulation of electricity generation. While some recent State and regional initiatives continue to provide incentives for renewable energy development, the Federal changes have the potential to severely affect the entire renewable energy industry.


In enacting PURPA, President Jimmy Carter and the U.S. Congress sought to decrease the Nation's dependence on foreign oil and increase domestic energy conservation and efficiency. To achieve those ends, PURPA encouraged the development of cogenerators and small power producers by eliminating certain barriers that had prevented their entry into a market controlled by public utilities. PURPA defined a class of independent generators as "qualifying facilities" (QFs) and mandated that utilities purchase power from QFs at the utility's full avoided cost. In other words, PURPA required utilities to pay QFs what they would otherwise spend to generate or procure power. The Federal Energy Regulatory Commission (FERC), responsible for the oversight of PURPA implementation, left it to the States and their utility commissions to determine the utilities' avoided costs.

PURPA mandated that utilities interconnect with QFs and buy whatever amount of QF capacity and energy was offered. It also simplified contracts, streamlined the power sales process, increased financial certainty for creditors and equity sponsors, and generally eliminated several procedural and planning problems that had made entry into the electricity market prohibitive for most of the smaller energy producers. These PURPA provisions provided a substantial boost to nonutility power producers. They also enabled nonutility renewable electricity production to grow into the 1990s, while utility production of renewable electricity declined slightly.

The renewables industry used its newfound market niche to improve technologies, increase efficiency, and decrease costs. Thanks primarily to PURPA, renewable and nonrenewable QFs now comprise large amounts of new and existing generating capacity in certain markets. For example, one-third of the California Edison Company's generating capacity is QF capacity, a substantial fraction of which is renewable energy.

By the mid-1980s, some States (most notably, California) had mandated that QFs receive long-run avoided cost rates that today substantially exceed current market prices. These rates were based on expectations of sharply rising oil and natural gas prices, as well as the expectation of future increases in the demand for electricity and construction of new generating capacity. From the perspective of the QFs, these above current avoided cost rates (6 cents per kilowatthour or higher) and long terms (often 10 years) were essential to establish the QF power market.

By the late 1980s and early 1990s, however, oil prices had stabilized, natural gas prices had declined, and excess generating capacity in most regions of the country, especially the Southwest and the Northeast, allowed utilities to buy capacity and energy at much lower prices than had been forecast a decade earlier. The utilities' actual avoided costs dropped lower than in the mid-1980s and were considerably lower than the levels required by the long-term contracts imposed by State commissions. Utilities in California, New York, Maine, and other proactive States were especially affected by long-term QF contracts above current avoided cost.

While some State public utility commissions (California and Wisconsin, for example) still favor long-term contracts and incentive rates, other commissions and almost all affected utilities have complained about above-market energy costs and higher rates. Many utilities contend that PURPA has caused dramatic hikes in retail electric rates, and that new regulatory action must be taken to correct past misjudgments. FERC has recently addressed some of these issues in the form of case decisions that could have a profound impact on the future of renewable energy.

FERC Decisions Involving PURPA

FERC oversees several aspects of the utility industry in the United States. Among its functions are the regulation of wholesale and interstate utility power and ransmission transactions and the oversight of PURPA and any rates, terms, or conditions set by State public utility commissions under PURPA. While the States set and mandate the avoided-cost rates paid to QFs, the process used by each State to set these rates is subject to review by FERC.

In response to several cases involving utilities appealing to overturn mandated QF rates, FERC has made rulings that may change the way QF power is purchased and will affect the ability of State commissions to dictate the resource energy mix of their future capacity. In separate cases involving Connecticut Light & Power Company and two California utilities (Southern California Edison Company and San Diego Gas & Electric Company), FERC refused to allow the State to set rates above the current avoided cost of capacity and energy. The most significant of these cases for renewables was the California case, where FERC disapproved the Biennial Resource Plan Update (BRPU) of the California Public Utilities Commission (CPUC). BRPU structured a bidding process where only QFs bid against one another for new capacity, and it required renewable ■set-asides,■ forcing utilities to purchase a certain percentage of energy from renewable sources. FERC disallowed the plan, ruling that BRPU forced utilities to pay above avoided costs by excluding some potential generation sources from the bidding for the QF segment of the bid. Citing Section 210(b) of PURPA, FERC ruled that the States must include all alternative sources of capacity and energy in their calculations of avoided cost.

While the utilities involved in the cases were satisfied, independent power producers and the CPUC were stunned. CPUC, which has been a leader in the evolution of electric markets, claimed that the FERC order was irreconcilable with California's progressive State energy policy. CPUC further asserted that the FERC rulings limited the ability of States to initiate set-asides or other resource planning activities, which is not a proper role for FERC, according to CPUC. The FERC rulings regarding QF treatment under PURPA are especially critical given the terms of many QF contracts. The majority of QFs in California and, to a much lesser extent, in other States, are now facing an avoided cost ■cliff,■ as 10-year contracts written at rates in the 6-9 cents per kilowatthour range in the mid-1980s expire over the next few years. With current avoided costs in the 3-4 cent range, rolling over the contracts at today's rates would create financial problems for QFs.

Although FERC has since reaffirmed its California decision rejecting QF rates above avoided cost, it has also asserted that States can favor specific energy sources as long as such action does not result in rates above avoided cost. For example, FERC said that States may influence costs incurred by utilities through taxes or tax credits on generation produced by a particular fuel. What FERC explicitly disallowed was the addition of ■externality adders■ in avoided-cost calculations. Since renewable energy production is environmentally benign relative to most fossil fuel energy technologies, some States have included these adders in their avoided-cost calculations to level the playing field between renewables and fossil fuels. FERC ruled, however, that policies that constitute environmental externality adders that result in rates above avoided cost would not be acceptable.

In short, if a State wishes to encourage renewable generation, FERC has indicated that it may do so through the tax code (or some other broad policy measure), but it may not use a rate-setting mechanism that results in a rate that is above avoided cost. CPUC has responded to this directive by considering a proposal mandating that utilities that sell at retail in the State obtain 12 percent of their energy from renewable resources. This approach is designed to support renewables and circumvent the FERC orders rejecting QF rates above avoided cost.

In other cases brought before FERC, the Commission has repeatedly rejected utilities' requests to abrogate existing QF contracts. In unrelated cases involving Niagara Mohawk Power Corporation and New York State Electric and Gas Corporation, FERC reaffirmed its unwillingness to cancel existing QF contracts simply because avoided-cost rates have changed and the deals have gone sour in changing electricity markets. FERC ruled that it will not disturb existing above-avoided-cost QF contracts if they were not challenged at the time they were signed.

In rejecting these petitions, FERC made several key findings. First, it affirmed that PURPA regulations permit QF rates to remain in effect even if avoided cost rates decline over time. Second, it affirmed the policy of relying on States to do the factual determination of avoided cost. And finally, the Commission plainly stated its disposition not to disturb executed contracts.

While the positions of most utilities and QFs are quite evident (and opposite), State public utility commissions and residential and industrial energy consumers are not necessarily decided on the issue of favorable QF treatment. Most State commissions are in favor of the States' ability to control their own energy planning, although not all have endorsed the idea of above-avoided-cost QF contracts as a means to their planning ends. The Nevada Public Service Commission, for example, recently disallowed the rates set for a geothermal development because they were deemed too far above avoided cost to be reasonable, even though the QF and the utility both supported the rates. Many con- sumers, especially large industrial consumers, do not necessarily favor or oppose renewables but want to ensure both that power purchases are competitive and that utilities cannot exert monopoly power over QFs and independent power producers. On the other hand, some smaller consumers, especially residential consumers, have shown a willingness to pay for environmentally benign electricity.

Proposal to Repeal PURPA

On June 6, 1995, the Energy Production and Regulation Subcommittee of the Senate Energy and Natural Resources Committee, chaired by Senator Don Nickles (R-OK), held a hearing on S. 708, The Electric Utility Ratepayer Act, which would repeal Section 210 of PURPA. Section 210 mandates the purchase of power from QFs at avoided- cost rates.

Proponents of PURPA repeal assert, among other claims, that increased competition in the electricity generation industry makes PURPA unnecessary, and that mandating power purchases from QFs is actually quelling real competition. Many critics of the proposal for repeal argue that while changes are clearly needed in some areas of PURPA, repealing Section 210 would be premature because of continued utility monopoly power over transmission. They add that repeal should not take place until the transmission grid is open to all wholesale buyers and sellers of electricity.

While interests on each side of the debate argue the merits and faults of PURPA, the renewables industry waits in a state of anxious uncertainty. PURPA repeal could seriously hamper renewable energy development, potentially eroding what little market share renewables currently enjoy. One-quarter of all existing QFs are renewables, and without PURPA, much of this renewable capacity likely would not exist. PURPA has provided renewables with the opportunity to compete in an electricity market that was previously dominated by large-scale energy producers. The larger producers were the only ones who could undertake the complicated process of bidding for new capacity, arranging transmission, and securing financing without the guarantees provided by PURPA. PURPA lifted several of those procedural and planning burdens and moved QFs to the head of the energy pack. Repealing PURPA could mean a return to the situation where smaller power producers, including renewables, would have a difficult time penetrating the electricity market.