A significant key to financing a renewable energy project is an offtake agreement. If a developer starts explaining to lenders the concept of “bidding zero” into the wholesale market and being a “price taker” resource, the lenders will go into shutdown mode pretty quickly (that’s especially true in New England today, where the market clearing price is linked to natural gas prices which are at a seven year low). In these tight credit markets, lenders want to see a steady and predictable revenue stream coming into the project from a creditworthy counterparty.
So what is a project developer to do? ARRA-related incentives and state programs only go so far, and they simply aren’t geared toward providing long-term stable revenue streams. Developers need someone willing in this economy to sign up for a 10-20 year contract to take renewable (and variable) resource at a rate that may not be attractive today, let alone just a few years from now. Any takers . . . ? Anyone . . . ?
As we’ve noted previously, to address this issue, states have returned to a familiar idea: require the state’s utilities to enter into long-term contracts with the developers. After all, the utilities are serving load either as a vertically integrated utility or, if the state has restructured its electric industry, then the utility likely has a standard offer or default service that it provides to consumers. A fine idea, conceptually. But let’s remember where we’ve been recently and try to avoid going back there.
Do PURPA, state mini-PURPAs and the avoided cost debacle ring any bells? Back in the late 70’s, while the US was in the throes of an earlier energy crisis, vertically integrated utilities were perceived as building too much big, fossil-fired generation. In response, the Public Utility Regulatory Policies Act of 1978 (PURPA) and the state PURP-ettes were enacted to require local utilities to enter into offtake deals with small QF generators. (A concise history of the creation and implementation of PURPA can be found here (pdf).) The term for those contracts? Well, the project developers demanded 10-20 year terms because that’s what bankers needed to finance the projects (sound familiar?). The contract price? By law, it was tied to the utility’s long-term “avoided costs,” or the cost to the utility to generate or procure that same energy which the utility “avoided” by purchasing instead from the small generator. Brilliant. Policy makers achieve the goal of developing small, distributed non-fossil generation resources and consumers would pay the same price they would have paid for fossil-fuel generated power!
Long story short: the predictions made in the early 80’s as to what a utility’s avoided costs would be in the 1990’s and beyond turned out to be overstated. And not by just a little. By a lot. PURPA contract prices that were five to six times the then-existing market wholesale price were not unheard of. Consumers overpaid.
Trying to predict anything twenty years into the future is a daunting task. The complexity and dynamic nature of the US energy industry provokes sleepless nights in even the most accomplished energy forecaster. So, the fact that the PURPA avoided cost predictions were proved wrong by reality isn’t a knock against the forecasters. It does, however, serve as a reminder that we need to think long and hard before going back down the road of requiring utilities to enter into long-term PPAs to provide a buyer that the market is not self-supplying.
If states are going to head down this path again, here are a few suggestions to help ensure that long-term PPAs are successful for all concerned:
So what is a project developer to do? ARRA-related incentives and state programs only go so far, and they simply aren’t geared toward providing long-term stable revenue streams. Developers need someone willing in this economy to sign up for a 10-20 year contract to take renewable (and variable) resource at a rate that may not be attractive today, let alone just a few years from now. Any takers . . . ? Anyone . . . ?
As we’ve noted previously, to address this issue, states have returned to a familiar idea: require the state’s utilities to enter into long-term contracts with the developers. After all, the utilities are serving load either as a vertically integrated utility or, if the state has restructured its electric industry, then the utility likely has a standard offer or default service that it provides to consumers. A fine idea, conceptually. But let’s remember where we’ve been recently and try to avoid going back there.
Do PURPA, state mini-PURPAs and the avoided cost debacle ring any bells? Back in the late 70’s, while the US was in the throes of an earlier energy crisis, vertically integrated utilities were perceived as building too much big, fossil-fired generation. In response, the Public Utility Regulatory Policies Act of 1978 (PURPA) and the state PURP-ettes were enacted to require local utilities to enter into offtake deals with small QF generators. (A concise history of the creation and implementation of PURPA can be found here (pdf).) The term for those contracts? Well, the project developers demanded 10-20 year terms because that’s what bankers needed to finance the projects (sound familiar?). The contract price? By law, it was tied to the utility’s long-term “avoided costs,” or the cost to the utility to generate or procure that same energy which the utility “avoided” by purchasing instead from the small generator. Brilliant. Policy makers achieve the goal of developing small, distributed non-fossil generation resources and consumers would pay the same price they would have paid for fossil-fuel generated power!
Long story short: the predictions made in the early 80’s as to what a utility’s avoided costs would be in the 1990’s and beyond turned out to be overstated. And not by just a little. By a lot. PURPA contract prices that were five to six times the then-existing market wholesale price were not unheard of. Consumers overpaid.
Trying to predict anything twenty years into the future is a daunting task. The complexity and dynamic nature of the US energy industry provokes sleepless nights in even the most accomplished energy forecaster. So, the fact that the PURPA avoided cost predictions were proved wrong by reality isn’t a knock against the forecasters. It does, however, serve as a reminder that we need to think long and hard before going back down the road of requiring utilities to enter into long-term PPAs to provide a buyer that the market is not self-supplying.
If states are going to head down this path again, here are a few suggestions to help ensure that long-term PPAs are successful for all concerned:
- Avoid avoided costs. Period.
- Drive project efficiency. Use competitive processes such as auctions to wring efficiencies from project developers. Use industry published development costs to ensure bidders are being realistic.
- Procure in stages. Don’t purchase all of your long-term capacity needs in your first auction. Rather, take advantage of the likelihood that renewable industries will become more efficient as technologies and methodologies mature over time.
- Consider innovative deal structures. For example, a contract for differences may allow the developer to satisfy its lender’s need to finance against a predictable income stream, but consumers benefit when wholesale markets exceed the strike price.
- To thine own self (and thine constituents) be true: Consumers are smarter than politicians often give credit. Consumers know they will be paying more in the “short” term for long-term environmental benefits and the development of diverse and secure renewable resources. Be up front about the objectives, the costs and ensure fairness to all stakeholders.
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