John W. Gulliver Pierce Atwood LLP

CLEAN ENERGY REGULATOR INITIATIVE

25 March 2014

“Incentives to Attract Clean Energy Projects”

Incentives for Renewable Energy (RE) Growth

• Why is this important? • European Commission:

The RES Directive is based on the rationale that a positive framework for renewable energy development is necessary due to a number of market and regulatory failures or imperfections. These include non-internalisation of negative externalities of conventional energy forms, the presence of subsidies for other energy forms, imperfect market structures, regulatory barriers, the status of many renewable technologies as “infant industries” together with significant inertia of the system, and barriers related to information and public perception.*

* Commission Staff Working Paper SWD (2012) 149 Final; Impact Assessment accompanying the document Renewable energy: a major player in the European energy market; p. 12.

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New Investment in RE by Region, 2004-2012

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(Source: REN21, 2013 Renewables Global Status Report, 58-59)

Key Topics for Discussion

• Review of incentives utilized to encourage RE development in various countries

• Discussion of which have worked best to achieve policymakers’ desired results • Type • Amount • Location • Timing

• What has worked? What hasn’t? What can we learn?

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Principal Incentive Mechanisms

• Feed-In Tariffs (FITs) • Renewable Portfolio Standards (RPS)/

Tradable Certificates • Tax Credits • Loan Guarantees • Priority Dispatch, Priority Grid Access • Net Metering • Competitive Tender • Contracts for Differences • All of the above!

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FITs

• Establishes fixed price for all electricity generated by eligible RE facility and provided to grid

• Typically based on assumed cost of RE generation

• Most widely used tool – simple to administer

• Sometimes differentiated by RE type, size; sometimes single rate for all

• Mixed results

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The U.K. Experience

• FIT: • Commenced April 2010 • Applicable only to small-scale RE

• FIT-CfD Structure: • FIT insufficient, need to supplement to achieve targets • Creation of long-term “Contract for Differences” (CfD)

to encourage investment in RE • Generators receive “top-up” payment when agreed

contract strike price exceeds electricity market price • Long term revenue stability

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The German Experience • Global leader in renewable energy support and development • FITs key to success with 20-year term, differentiated by

project size and technology • Grid operators required to purchase RE output at FIT • FIT reset over time • Key role of public financing

• Critical role played by Kreditanstalt fur Wiederaufbau (kfW) • Provides additional support, analogous to U.S. investment tax

credits • Low-interest loans, up to 100% of project costs, to residential

households for PV installations, support for offshore wind projects, etc.

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The Turkish Experience

• Increased FITs included as part of 2010 law to provide more comprehensive RE support mechanism

• Prior FIT levels insufficient to achieve targets • Differentiated by type

• Wind and hydro: USD Cent 7.3/kWh • Solar and biomass: USD Cent 13.3/kWh • Geothermal: USD Cent 10.5/kWh

• Incentive tariffs apply for first ten years of commercial operation of plants commissioned by December 2015

• Subsequent FIT levels will be established by Cabinet of Ministers

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The California Experience

• FIT levels initially based on assumed cost of generation from a new fossil plant, not the cost of production for the renewable resource

• Insufficient to meet initial target of 20% • Reset targets and mechanisms • Tied FIT to other incentives, including

Renewable Auction Mechanism, creation of traded Renewable Energy Credits (RECs), and long term contracts

• New target of 33% by 2020 likely to be exceeded

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The Spanish Experience

• RE projects up to 100 MW chose either FIT with purchase obligation or market premium incentive without purchase obligation

• Massive over subscriptions, large “tariff deficit” • Incentive mechanisms for new projects

suspended January 2012 • Retroactive cuts to FITs and market premiums • FIT set too high, produced too much RE, too

expensive, too quickly • Drag on overall economy

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Spain: Annual Electricity Tariff Deficit, 2000-2012

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(Source: Comicion Nacional de Energia (CNE), “Nota Resumen Del Saldo De La Deuda Del Sistemas Electrico” 10/5/2013)

Successes, Setbacks and Lessons: Learned FIT Regimes

United Kingdom • Significance of RE CfD approach:

• Aggressive RE development not achievable without financial stability through long-term agreements with creditworthy counterparty

• FITs alone insufficient to procedure desired levels of generation • Better coordination and clarity of regulatory roles critical California • Due to misalignment between original FIT and cost of production

from RE, FIT program failed to attract desired investment levels • California adopted supplemental incentives, with greater revenue

certainty, longer term contracts

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Successes, Setbacks and Lessons: Learned FIT Regimes

Germany • Combine FIT with other financial support • FIT differentiated by RE type • Reset rates periodically • Overall German power rates declining – due to coal

Spain • FIT set too high • Achieved much more capacity than expected, and

faster: 3000 MW vs. 400 MW • Contributed to substantial tariff deficits

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Renewable Portfolio Standards (RPS)

• Incentive mechanism that mandates percentage of energy portfolio to come from RE

• How basic RPS works: • RECs (Green Certificates) issued to certified RE

generators for every unit of electricity produced • Both kWh and RES sold • Purchasers of RECs use them as evidence of regulatory

compliance

• Creates two income streams: • kWh sales • REC sales

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The U.K. Experience

• RPS equivalent (Renewable Obligation, RO) instituted in 2002 • Suppliers required to source increasing proportion of

electricity from RE sources • Operators of receive Renewable Obligation Certificates

(ROCs) – Tradable with other parties – Used by suppliers to demonstrate they have met their

obligations • If suppliers lack sufficient ROCs, must pay financial

penalty • Program administered by Office of Gas and Electricity

Markets – regulator

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The ROC Certificate Cycle

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The U.K. Experience

• Impending transition from ROCs to CfD as primary incentive mechanism to develop low-carbon electricity generation

• CfDs will be offered as parallel option alongside ROCs beginning in 2014

• Possible that CfDs will be only choice available by 2017, RO program closed to new entrants

• CfDs perceived to be more flexible, easier to administer than ROC system

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The U.S. Experience

• California • Most aggressive RPS program in U.S. • Requires utilities to obtain 33% of total

electricity supply from RE by 2020 • Target likely to be exceeded

• Massachusetts • Instituted in 1997; target 15% by 2020 • Statutory obligation imposed on both

regulated utilities and competitive suppliers • RPS in 29 states

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Renewable Portfolio Standard Policies

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Successes, Setbacks and Lessons: RPS/Certificate Regimes

California • Failure to achieve initial goals

• Lack of clear responsibilities between state agencies • Weak enforcement mechanisms for utilities’ failure to

reach goals

• Fixed shortcomings, expanded RPS • Stronger enforcement mechanisms,

clearer agency responsibilities

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Successes, Setbacks and Lessons: RPS/Certificate Regimes

Massachusetts • Desired targets under RPS initially unmet;

• Uncertain revenues from sale of RECs limited ability to finance • Regulatory risk – perception that legislature or government could

repeal program at anytime

• Solutions: • Massachusetts offered to purchase RECs under ten-year contracts • Green Communities Act: formal requirement that regulated

utilities purchase RE under long-term contract to meet RPS Lessons: • Enforceable procurement requirements, regulatory

certainty and long term contracts essential

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What is Priority Dispatch, Priority Grid Access

• Incentive mechanism whereby electricity from RE sources is given priority dispatch, priority access to grid, despite higher costs

• Frequently combined with other mechanisms, such as FIT

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Priority Dispatch: Selected Experiences

• Priority dispatch and access must be coupled with other mechanisms to assure financial stability (FIT, long term contract) • Numerous countries and regulatory regimes allow priority

dispatch/access, e.g., Germany, Spain, Greece, U.S., Albania • System operator must assure safe, adequate, reliable and

uninterrupted supply • RE can be intermittent and variable • Priority dispatch of intermittent and variable resources can

upset system stability • Balancing policy goals of RE vs. legitimate system stability

concerns

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Tax Credits

• National policymakers in U.S. prefer federal tax credits over FITS to encourage RE development

• Investment Tax Credits (ITC): Tax credit for qualified RE projects based on capital investment, up to 30% of investment

• Production Tax Credits (PTC): Per kWh tax credit for ten-year period for kWh generated and sold by qualified RE

• Additional Tax Mechanisms: Accelerated depreciation available under federal tax code, tax exempt bonds

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Tax Credits

• Proponents believe • Up front tax benefits facilitate RE finance • Subsidy up front places less risk on future contract

performance, since contracts based on market rates, not FITs

• Proponents of FITs respond • Incentives up front place risks on ratepayers/taxpayers

if plant fails or shuts down prior to contract termination • FIT, “pay as you go”, reduces these risks

• NB – so does PTC • But, PTC may not provide sufficient revenue, since

underlying tariff is usually market-based

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Successes, Setbacks and Lessons: Tax Incentives

• Tax mechanism typically do not require compulsory prices paid to RE generators

• To establish price certainty for investors and generators, further incentives required

• PTC, ITC, and related programs typically adopted for limited number of years

• RE projects in U.S. follow distinctive pattern • Closer to end of tax credits, fewer projects started • “See-saw” or “yo-yo” effect

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Competitive Tenders • Process that awards long term PPAs to qualified RE

projects in competitive tender • Different than FIT – instead of trying to “guesstimate”

target price to incentivize development, tender “tests the market”

• Tenders can be restricted by technology (e.g., only solar, only wind)

• Tenders can be allocated by geographic region or location, so as to reduce system costs, improve reliability

• Tenders have risks, too – despite financial stability, if bid price is too low, project won’t be built; if too high, stranded costs

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The Moroccan Experience

• Primarily single buyer system: government agency responsible for buying all RE from privately-owned distribution and selling to end-users

• Seeks development of RE sources, particularly solar energy

• Competitive Tender Procedure • Moroccan Agency for Solar Energy (MASEN) off-taker • Until RE prices fall, full purchase price in first phase of

bidding will not be passed through directly to consumers • Government absorbs difference • Morocco evolving sophisticated tender process as key part

of its effort to diversify from oil-fired generation

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MASEN-Identified Solar Power Sites in Morocco

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The Moroccan Experience

• Benefits of Government off-taker • Protects end users from higher cost of

generated renewable energy • Provides creditworthy counterparty for

contract • Increases revenue stability, project

financeability • But, can lead to sovereign debt problems

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Competitive Tenders for PPAs: An Assessment

• Create revenue stability, but • Experience shows that fixed price, long-term

power contracts persistently above market face enormous political pressure for rescission, revocation or renegotiation • USA • EU

• Tenders need to be conducted on periodic basis to reflect price changes

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Net Metering

• Incentive mechanism that allows customers to sell electricity to utilities generated by customer-owned distributed generation, such as PV

• kWh sold netted against kWh consumed • Typically for smaller systems • Payment (credit) at retail price per kWh • Price (credit) thus includes T&D

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The U.S. Experience

• California • Approximately 120,000 customer accounts registered

for net metering; • Program limited to customers who install solar, wind,

other RE < 1 MW • Massachusetts

• Mandatory for investor-owned utilities to offer net metering (voluntarily for municipal utilities)

• Individual customers, community groups (10+ residential customers), and governmental entities

• Widespread deployment • 43 U.S. states have adopted net metering

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Net Metering: Lessons Learned

• Provides simple and certain method by which customers paid for RE generation

• May cause cost shift from customers who own distributed RE generation to those who do not

• Retail price may be too high – includes T&D that customer is not necessarily displacing • Night and seasonal production variations • Standby demand costs

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Discussion

• Is one RE incentive system superior to others? • Probably not • No “one size fits all” approach to encouraging RE

development • Underperformance (or over performance) can

occur under any system • Important that policy makers and regulators:

• Carefully analyze markets and desired targets • Be flexible in responding to cost and price changes and

investment climate

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Discussion

• Recalibrate incentives periodically, but prospectively

• Retrospective change in rates very challenging to market development

• Benchmark and change programs as needed, but not too frequently

• “Goldilocks” • Policymakers can construct multiple kinds of

incentives (FIT, tax credit, carbon trade) that can be used simultaneously

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Parting Thoughts

• Stable, predictable legal and regulatory environment fundamental

• Well-defined roles for regulators and enforcement mechanisms for renewable energy are important

• Different technologies require different mechanisms

• Setting and subsequent evaluation of policy targets crucial to long-term success

• Incentive mechanisms that provide investors with long term revenue stability critical

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First Principles

“The Overriding Criterion: A legal and regulatory framework that is far, consistent, predictable where contracts and agreements are reasonably enforceable.” World Bank Energy and Mining Sector Board Discussion Paper 6, May 2003

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Many thanks to Leonardo ENERGY for sponsoring this webinar

Merrill’s Wharf 254 Commercial Street Portland, ME 04101 USA

John W. Gulliver jgulliver@pierceatwood.com

PH / +1.207.791.1296 CELL / +1.207.415.3400

/Preparers

Merrill’s Wharf 254 Commercial Street Portland, ME 04101 USA

Liam J. Paskvan lpaskvan@pierceatwood.com

PH / +1.207.791.1306