State Action Under the Clean Power Plan 

As detailed in previous editions of The Climate Report, the Obama administration announced in August 2015 its final Clean Power Plan, under which the Environmental Protection Agency ("EPA") will require reductions of carbon dioxide ("CO") emissions from existing fossil fuel power plants to 68 percent of their 2005 levels by 2030. Ultimately, while the Clean Power Plan sets targeted emission reduction levels for the states, each state must determine for itself how to meet its goal by developing a State Implementation Plan ("SIP"). This SIP must demonstrate how the power plants within the state's borders will meet the standard set by EPA; initial plans are due September 6, 2016, and final plans must then be delivered to EPA within two years. 

And while it is still early, it is evident that some states will face more difficulty in complying than others, and that they are likely to employ a wide variety of strategies in order to hit their targets. 

Staying the Course. For some states, compliance with the EPA targets may prove as easy as staying the course. In Washington and California, existing state-level CO2reduction policies mean that the state's power plants will already emit less COin 2020 than will be required by 2030. In Washington, the state's last operational coal-fired power plant is scheduled to shut down one of its boilers in 2020 and the other in 2025. In California, a demanding renewable portfolio standard and an economy-wide cap-and-trade program will allow the state to comply easily by 2030. Other states in this category include New Hampshire, Oregon, Delaware, and Maine.

Nascent Regional Efforts. For most states, however, determining how to meet Clean Power Plan goals will be a long process. Among the most discussed methods are a variety of multistate strategies, which expert analysts believe would make compliance cheaper and more efficient by enlarging the "market" for such reductions. These generally take one of two forms: under the first, states would aggregate their COreduction goals across a region and comply as a group, while under the second, they would trade emissions credits or allowances among themselves.

Such strategies could take hold between states served by the same regional transmission organization, because they share a transmission grid and wholesale electricity markets. For example, reports indicate that most of the states served by the PJM Interconnection (which includes all or parts of Delaware, Maryland, New Jersey, Ohio, Pennsylvania, Virginia, West Virginia, the District of Columbia, and several other states) are holding initial discussions into how they might coordinate their compliance efforts. The Southwest Power Pool (which serves all or parts of Nebraska, Kansas, Oklahoma, New Mexico, Texas, Missouri, Arkansas, Louisiana, and several other states) held a meeting last month to introduce itself to state environmental regulators tasked with developing SIPs and pitch regional compliance as a cheaper option. Another group, comprising environmental and energy regulators in states served by the Midcontinent Independent System Operator (including all or parts of Minnesota, Wisconsin, Michigan, Iowa, and parts of Illinois, Indiana, Missouri, Arkansas, Louisiana, Mississippi, and several other states), has held a series of meetings on collaboration and even filed joint comments to EPA's proposed plan late last year.

One specific option available for states in the northeast is to leverage the existing Regional Greenhouse Gas Initiative ("RGGI") to achieve compliance. RGGI is market-based regulatory program whose members include New York, Maryland, Delaware, and the New England states and that has already capped and begun reducing COemissions from the region's power sector. Pennsylvania's governor is in favor of his state joining RGGI, and many advocates are pushing the same for Virginia, New Jersey, and others.

Accelerating the Coal-to-Gas Trend. Many analysts believe that states will lean heavily on coal plant retirements and coal-to-natural gas conversions to meet their goals. In Michigan and Minnesota, for example, utilities have already announced that they will shutter coal-fired units earlier than they had anticipated, replacing the capacity with some combination of natural gas and renewable generation. But the possibility is not without its detractors: Environmentalists have long argued that upstream methane emissions in the production and transportation of natural gas reduce or cancel out any reduction in CO2emissions that come from switching from coal to natural gas. Natural gas infrastructure, too, could pose a problem in regions like New England, where transportation supply constraints cannot be solved quickly.

Lawsuits, Holdouts, and the Federal Implementation Plan. While numerous lawsuits have already been filed against the Clean Power Plan, many expect that the most significant legal action will occur only after it has been published in the Federal Register, which is expected in late October. Unsurprisingly, many of the states expected to file or join such lawsuits also face the most daunting compliance challenges. Political leaders in states dependent on coal generation, such as Montana, Wyoming, and Utah, have bemoaned the aggressive targets set for them by EPA. Even still, states such as Arkansas, Colorado, and South Carolina are poised to employ a two-track strategy of suing while developing a compliance plan.

Other states have announced that they will not comply with the Clean Power Plan at all, including Indiana, Louisiana, Wisconsin, Oklahoma, and Texas. This does not mean, however, that their power plants will not reduce COemissions. While EPA has announced that it will not sanction states by withholding a portion of their federal highway funding, EPA will impose a Federal Implementation Plan ("FIP") in lieu of a SIP. EPA released a model FIP the same day as the Clean Power Plan, and once finalized, it would become the basis for a compliance plan for states without a SIP, either because the state did not produce one or because EPA rejected its proposed SIP. And so, should the Clean Power Plan survive the series of legal challenges facing it, power plants will reduce CO2emissions one way or another. We will find out over the next several years how states decide to comply.

As Yieldcos Face Uncertainty, Renewable Energy Firms Assess Their Options 

In recent months, dramatic share price declines across the yieldco sector have generated extensive commentary on the future viability of yieldcos as a means of financingrenewable energy projects. While analysts have adopted divergent viewpoints, a number of alternatives to the prevalent yieldco model may constitute more promising avenues for future project development if yieldcos continue to struggle. In particular, companies may look to third-party sales or move projects to warehouse funds, and potential changes to the Internal Revenue Code could ultimately facilitate the use of master limited partnerships ("MLPs") as an alternative to yieldcos.

Renewable energy firms form yieldcos to hold operating power generation assets, which generate stable cash flows that the companies then use to develop additional projects in addition to providing investors with generous returns. The success that yieldcos have enjoyed since 2013 has created high demand for contracted assets, driving up prices and forcing yieldcos to consider acquisition of riskier projects. Faced with the attendant risk of lower returns, many investors have retreated from the yieldco market, forcing renewable energy firms to consider new ways of raising capital. The companies maintain that the overall market for renewable projects remains strong, and observers have suggested that new categories of investors, such as pension funds, may take the place of hedge funds and others that have departed.

While the future of yieldcos in their current form remains to be seen, renewable energy companies are also revisiting their strategies moving forward. New yieldcos are hesitant to proceed with IPOs in the face of the current uncertainty, and a number of publicly traded yieldcos have already stopped issuing equity for new project acquisitions, at least for the present. In addition, one company has announced that it will discontinue dropdowns of assets into its yieldco for the time being. The company will instead market its projects to third parties or move them into warehouse funds.

Warehouse funds, which have sometimes been called "private yieldcos," are a new variation on a financial structure that MLPs have used to acquire assets. The funds serve as vehicles for companies to hold projects outside yieldcos, providing liquidity while allowing companies more flexibility in timing the eventual dropdown of the project assets. However, the introduction of warehouse funds to hold projects that companies would otherwise drop into yieldcos has raised new concerns. The need for warehouses reflects yieldcos' inability to acquire the warehoused projects at the best possible prices, and companies forego significant profits by electing to warehouse projects instead of selling them to third parties. Still, at least some renewable energy firms appear confident that the options offered by warehouse funds justify the drawbacks.

It is also possible that, given the opportunity, renewable energy firms will choose to shift away from the yieldco structure in favor of MLPs. While traditional oil and gas assets are commonly held in MLPs, the Internal Revenue Code currently does not grant renewables the same favorable tax treatment. The MLP Parity Act (S.1656, H.R. 2883), a bill that was reintroduced this summer after failing to pass in a previous session of Congress, would amend the Internal Revenue Code's definition of "qualifying income," set forth at 26 U.S.C. § 7704(d)(1)(E), to include renewables among the types of assets that may be held in MLPs. Identical versions of the bill are currently before the Senate Finance Committee and the House Ways and Means Committee. Should the MLP Parity Act become law, and should certain passive activity loss rules change, it could spark a rush toward renewables by acquisition-starved MLPs while also offering renewable energy firms a promising alternative to their current options. That outcome of course will also be a function of whether the pipeline of contracted renewable projects is sufficiently large enough to accommodate any new demand.