Problem: Financing Constrains Renewable Energy Development
As renewable energy project developers know full well, financial
institutions demand certainty. Financial resources for traditional power
projects are conditioned on the existence of long-term power purchase
agreements (PPAs). But due to the cost of doing business renewable energy
project developers are asked to demonstrate long-term commitments for the
purchase of not only the electricity, but also the RECs.
Many project developers are finding a market for their electricity, but
power sold at market rates does not go far enough to recoup investment in
most renewable power projects. Banks are hoping that projects can improve
their bottom lines and achieve profitability faster by forward selling the
renewable energy credits, in many cases separately from the power itself.
However, long-term sales of RECs have been very difficult to execute.
Despite a number of state renewable portfolio standard (RPS) programs set
up to facilitate compliance trading in RECs - and a nascent wholesale
nation-wide voluntary REC market - forward sales of RECs rarely exceed
five years. This is short of the typical 10-year REC sale agreements most
banks require before financing a renewable energy project.
Solution: REC Forward Curve
State policy makers created RECs as a means to monetize the environmental
and fuel diversity benefits of renewable power. Sure, these projects
produce electricity, but they do so without many of the environmental
impacts of traditional fossil fuel generation. There are now more than 19
states and the District of Columbia that have created state legislation,
which require entities selling electricity in these states to have a
specific portion of their supply from renewable sources. In addition to
buying renewable power directly, companies in many states can also
purchase just the RECs to meet their RPS requirements.
These RECs are being traded in nascent markets that have yet to attain the
liquidity, efficiency, and transparency needed to develop investor
assurance. Most RPS programs have been implemented in states with
deregulated energy markets. Competitive energy suppliers in these markets
usually only have certainty in their load for a period of 1-3 years,
because of how load is auctioned in cycles. For this reason trades are
usually made for compliance with the current year's obligations - not for
long-term sales that extend several years.
Long-term trading is also hampered by regulatory policy in individual
states or regions that continues to be in flux. Several states continue to
fine-tune their RPS requirements, including the mechanics of trading
mechanisms in response to renewable energy supply and demand
considerations or other public policy goals. If regulation was more
certain and uniform across regions liquidity and price transparency would
improve, inviting the entrance of additional speculative capital to the
REC markets.
This market-generated view of future REC prices is called the forward
curve, and it is a common factor in all types of commodity trading from
energy and metals to soft commodities like coffee or sugar. Establishing a
forward curve would greatly increase the amount of renewable energy
facilities being built because developers could more easily obtain
financing.
Benefits of the Forward REC Curve
Banks and other financial institutions look for revenue streams for
extended periods of time to determine the economic feasibility of
projects. Knowing that a developer can sell his or her RECs for a 10-year
term allows these financial institutions to have the confidence they need
to lend a more substantial percentage of project costs.
In addition, creating a stable forward market allows market speculators to
enter into the marketplace. As speculators enter the marketplace, there
are more potential buyers and sellers of RECs at any given time, enhancing
liquidity. Once a marketplace becomes more liquid, participants become
more confident in both the viability of the market and price stability.
The price volatility of today's liquid and short-term REC markets has
scared off participants who feared they might have gotten caught on the
wrong side of a trade, unable to exit their positions.
How to Establish a Forward Curve
The key to creating a viable forward curve lies in transparency and
regulatory certainty. Foremost, there must be stable regulatory policy
underpinning REC markets. If the rules governing state RPS and REC trading
remain consistent, REC market players can make long-term decisions without
the risk of regulatory change.
In most state RPS, a premium is put on certain types of renewable
generation that provide the most environmental benefits, such as
photovoltaic solar, wind, landfill gas, and in some cases biomass
generation. These premium renewable sources are often labeled "Class 1" or
"Tier 1". States could provide additional clarity by creating uniform
market standards for Tier 1 or Class 1 generation. Standards for these
generation sources differ by region. Coordination of these standards will
allow the market to more easily trade specific tiers or classes of RECs
over broader geographic regions with consistent price expectations,
bolstering the forward market.
Market transparency must also be improved in order for a forward curve to
develop. Buyers and sellers in the REC market can more easily make long
term trading decisions if they are fully aware of supply conditions and
market prices. REC tracking systems that market participants can trust and
that effectively account for market supply are essential. Price
transparency is vital as well. Evolution Markets was the first to offer
daily updates on REC prices through its online evo.ID market data system.
This bulletin board is publicly available and the belief is that the
improved availability of accurate price information will give the market
confidence to engage in forward trading.
Lastly, a successful forward REC market will depend on the entrance of new
participants. These participants will need to be entities willing to take
on risk for substantial upside, either by bridging the gap between
wholesale term deals and retail sales to compliance buyers, or by serving
as credit-worthy counterparties themselves. Renewable energy project
development is poised to leap from a niche to mainstream market, but first
REC markets will need to align with the same forward structure currently
available in traditional energy markets such as fuel and power.
About the author...
Andrew Kolchins is a Director, Renewable Energy Markets for Evolution
Markets LLC. Working from Evolution Markets' White Plains headquarters,
Mr. Kolchins leads the company's brokerage services focused on
facilitating trades in the compliance driven state renewable energy
certificate (REC) markets in the Northeast and Texas, providing expert
brokerage service to renewable energy project developers, green power
marketers, traders, utilities, and end users. With extensive structured
transaction and energy markets expertise, Mr. Kolchins serves customers in
regional compliance REC markets. He will also seek to leverage
environmental credit markets to coordinate renewable energy project
finance, facilitating an overall increase in regional renewable energy
capacity. Mr. Kolchins joins Evolution Markets from Green Mountain Energy
where he built and managed the sales team for Sunshine Energy, a premium
program for Florida Power & Light (FPL) that allows residential customers
of FPL to purchase a cleaner form of electricity for the grid. Before
working with Green Mountain, he served for seven years as a broker of
natural gas swaps, options, and physical basis trades for a handful of
institutional brokerage firms. Mr. Kolchins also assisted in the
development and marketing of Bloomberg's online energy trading platform,
PowerMatch.
The information and views expressed in this article are those of the
author and not necessarily those of RenewableEnergyAccess.com or the
companies that advertise on its Web site and other publications.
