SNL Energy: How are RECs being valued when it comes to financing projects?
Stern: Right now, they're not being given a lot of consideration. The markets are nascent and investors aren't familiar with them. For the most part, renewable projects are financed with PPAs [power purchase agreements] that have RECs bundled with power. However, I think that there may be a movement toward considering them. I know of at least one project where RECs have been considered. The Massachusetts Technology Collaborative is selling put options on long-term RECs which helps project financing.
Do you think RECs will eventually become more valued for financing projects?
I think as the markets develop and as investors begin to get some understanding of RECs - what they are, how they behave, and they have insights as to why they go up and down and what the long-term outlooks are going to be - they will be willing to rely on them for financing.
In addition to investors getting a better understanding of the REC markets, do you think part of it will be getting regulators to build a consensus on how RECs are defined and traded?
Certainly, the developers and investors will need to have confidence in them. I think regulators could help by having consistency in their regulations, both in terms of time - not changing rules from one year to the next too much - and also in terms of ending inconsistency across states. Right now we have rather a hodge-podge of RECs markets across the country.
There's been a lot of discussion about forming a regional REC trading system that would interconnect or streamline them. What are the challenges and benefits associated with that setup?
The challenges relate to just developing a system and reaching an agreement with all the stakeholders how that system would be structured. As I said, there are many different REC markets across the country and these, of course, are driven by renewable portfolio standards in terms of the compliance markets as opposed to the voluntary markets.
The RPSs [renewable portfolio standards] and REC markets are all different. They have different definitions of renewables, different requirements in terms of geographies and different rules about how they can be traded. So it's a big political issue in reaching an agreement on these issues. In terms of the benefits, having such a market would be likely to be beneficial to renewables in general because it would allow renewables to be developed in areas where they make more sense, from the resource potential perspective. In other words, if you had a national system, you could potentially put your wind turbines in the windiest places rather than the state RPS required, and that would be a lot more economically efficient.
How would a national RPS do that?
If you had a national standard that required the nation to have a certain amount of energy generated by renewables and that all utilities, all the buyers of electricities had to provide a certain amount of the load by renewables and if that standard did not specify that the renewable resource had to be located in anywhere particular, then it would likely be located in the best sites. So you'd get the most out of your wind turbine or your biomass generator from an economic point of view.
Your outlook on a national RPS is somewhat optimistic, right?
I think it's quite possible that we'll see one in the next few years. It was in the Senate Energy Policy bill, both this year and in 2003, and both years it was cut in the joint committee. So it's a matter of politics at the federal level but the fact that it's got as far as the Senate I think indicates that it could happen.
As far as a national compliance REC trading market is concerned, what is your outlook on that?
A federal REC trading system was also in the Senate Energy Policy bill. Again, it was cut in the joint committee. So I think if we were to see a federal RPS we … might see a federal REC trading system. There are regional systems that are in place right now: the
New England generating system, Texas has one, PJM is working on one as is the WECC [Western Electricity Coordinating Council]. So I think that as these markets develop they will increase customer confidence in the market. It also increases the understanding and comfort of policymakers and I think all of that will help renewables.
Given the fact that these markets are in their infancy, tell me how PA Consulting Group came up with its long-term REC pricing forecast model.
We do a great deal of modeling of markets. We model the electricity markets throughout the United States and Europe and other countries. We have a detailed model of the U.S. power market that considers individual power plant units on an hourly basis. We also model emission allowances. So we have a good understanding of how to model markets and prices related to markets.
The REC model grew out of our power markets model and is based on a long-run economic equilibrium perspective. The basic concept is that RECs are a means for owners of renewables to recover the additional revenues that they need in order to be reasonably profitable and that this is in addition to what they would earn from power markets and from tax credits, accelerated depreciation or any other types of revenues. We project a demand for renewables — which is primarily driven by a renewable portfolio standard — and then we look at what's likely to meet that demand. We determine the marginal generating unit — the last unit that would be added in a particular REC market in order to meet the demand. We model what we expect a marginal unit would earn in the power markets. We then calculate REC prices as the additional revenue that the marginal unit needs to earn after considering power revenues, PTCs, accelerated depreciation, and the unit's annualized costs.
Who will be your clients for this model?
We are seeing interest from some of the investment banks that are looking at investing in renewable projects. There would be an interest on behalf of developers who want to attract investment. Also, I think, in terms of determining the best sites for renewables you want to see not just where it's windy but what are the revenues from this plant going to be. That requires looking at power prices and REC prices, as well as transmission constraints. If you want to sell a wind plant or if you want to get the value of your wind plant for some reason, it is important to know what the RECs are worth in order to get that type of valuation. We have done that for some wind contracts.
Can you talk about some of the challenges involved with doing this long-term forecasting? How could you, for example, anticipate what happened with the Connecticut REC market?
In the near term, there's always the potential for that to happen. Certainly, we saw this in the power markets in recent years because of overdevelopment of supply. One explanation I have for the crash of the Connecticut market is the excess of supply happening in the marketplace. … Another possible explanation for what's going on in Connecticut - and I'd say that I haven't studied it closely - is we have seen an increase in gas prices recently, and when gas prices go up, so renewable power needs to earn less money from RECs because they're making more money in the power markets since gas prices directly affect power prices.
Anything else you wanted to comment on, Frank?
We're taking a long-term view of RECs for the purpose of giving an understanding to investors and developers and what the long-term value is. There certainly can be fluctuations around equilibrium and we would expect to see that but I think there are some long-term fundamentals that are important to understand and can really help to add value to your project if you do understand them.
Frank Stern is a managing consultant in PA Consulting Group's global energy practice. He has 16 years' experience in a variety of areas in the electricity and natural gas industries.
