This article appears in the August 1, 2011 edition of Power Finance & Risk.

The Obama Administration has set an ambitious goal for clean energy – 80% of U.S. energy should be produced by clean energy resources by 2035. But Congress has not passed comprehensive energy legislation, and two federal incentives that are important to developing renewable energy projects are set to expire in the near future. Renewable energy projects must commence construction by the end of this year to be eligible for the American Recovery and Reinvestment Act’s 30% Treasury cash grants in lieu of investment tax credits, and the Department of Energy’s 1705 loan guarantee program for commercial renewable energy projects expires at the end of September. The DOE and developers are moving quickly to meet these two deadlines.  

Congress has been focused on resolving federal budget and debt-limit issues, and the prospects for near-term, on-time extension of either of these two programs are becoming increasingly dim. Industry participants are waiting to see how the potential expiration of these incentives affects the debt and tax-equity markets for renewable energy projects.

As industry experience shows, growth in renewable energy benefits from predictability of tax credits and other incentives: uncertainty discourages investment and impedes growth in the sector. Recent reports suggest that at least some utilities are finding it increasingly difficult to justify the costs of new technologies, such as carbon capture and storage, without incentives that improve the economics of those investments.

A federal renewable or clean energy standard (CES) is one such approach that has recently gained some traction. Although several prior legislative proposals have included renewable energy resources, a CES that credits fossil fuel with carbon capture, natural gas and nuclear facilities will likely receive broader support from energy industry participants.

To date, 31 states and the District of Columbia have adopted various renewable portfolio standards with some form of renewable energy credits for renewable generation. Proposed federal CES policies would award clean energy credits on a per-megawatt basis (CECs), and require utilities to source increasing percentages of their generation portfolio from renewable or clean generation sources over a period of years with interim benchmarks. Under most proposals, these credits may be stripped from the underlying electricity and sold and traded separately.  

Evidence suggests that some in Congress are willing to consider moving toward federal clean energy legislation. For example, Senators Jeff Bingaman (D) and Lisa Murkowski (R), chair and ranking member of the Senate’s Committee on Energy and Natural Resources, respectively, recently received a robust response to a white paper calling for comments on a national clean energy standard. The most encouraging sign for supporters is that clean energy standards have garnered some bi-partisan attention from Congressmen and Senators such as Edward Markey (D), Henry Waxman (D), Richard Lugar (R), Lindsey Graham (R), and Bingaman (D) and others over the last few years.

Congress would need to balance several competing concerns in designing CES legislation. CES legislation also would need to adequately encourage investments in clean energy projects and technology as well as potential cost and rate impacts. In a 2007 report, the Energy Information Administration predicted that U.S. utilities would spend an incremental $7.8 billion complying with a clean energy standard that targeted 25% of generation from clean energy resources (including new nuclear and coal plants with carbon capture and storage technology (CCS)) by 2025. Other estimates suggest the costs could be much higher. A Congressional Budget Office report released in late July concluded that a federal CES would likely increase energy prices (depending on region) but would reduce overall carbon emissions.  

Technologies and Credits

One of the most fundamental policy decisions for a CES is choosing the technologies that will receive credit and how those credits should be applied. According to the Energy Information Administration, as of March 2011 the United States received about 44.7% of our electric energy from coal facilities, 20.6% from natural gas, 20.5% from nuclear, 8.2% from conventional hydropower and 4.1% from other renewable resources.

President Obama’s proposed clean energy standard is broader than many existing state renewable portfolio standards. It includes nuclear power, “efficient” combined-cycle natural gas plants and fossil fuel plants that employ CCS technologies.  

The separate clean energy proposals of Senators Lugar and Graham are also similarly broad and include coal facilities equipped with CCS technologies and new nuclear plants. Senator Graham’s plan also credits fossil fuel generation retired in the near term. But these proposals have higher compliance targets than past renewable-only proposals. Utilities that have already begun to invest in the development of these types of generation, however, will benefit from a broader definition.  

Other Congressional proposals have hewed more closely to the standards used in most states, which generally credit only traditional renewable energy resources. For example, Senator Bingaman’s proposal gives credit to wind, solar, geothermal, qualified incremental hydropower, marine and hydrokinetic energy, ocean energy, biomass, landfill gas, and coal-mined methane and qualified waste-to-energy technologies. The Senator’s proposal also excludes, among others, hydropower, new nuclear facilities and coal plants with CCS technology from the total amount of energy used for compliance purposes, which effectively gives partial credit for those additional technologies.  

Although not included in any recent federal proposals, some states (like North Carolina and New Jersey) have also used carve-outs that set separate targets for certain generation resources like solar. Because the outside compliance periods for most proposals expire from 2030 to 2050, Congress will also need to consider a process to identify and assimilate new clean technologies.

Credit allocations will matter most to load serving entities with existing generation portfolios that are more heavily weighted to resources that don’t ultimately qualify for clean energy credits. And some have argued that small utilities and utilities in regions without abundant renewable resources should be excluded from CES compliance requirements. Without a functioning, efficient market for clean energy credits, small utilities may have more difficulty complying because of scale problems associated with owned-generation. Likewise, utilities without ready access to renewable generation may be overly dependent on purchased CECs, especially if the policy does not credit non-renewable clean technologies.

Most of the current proposals would exempt utilities that sold less than 4 million megawatt hours of electricity during the prior year but don’t contain any meaningful geographic limitation. Any size exemption, such as this one, will reduce the headline, nominal effective clean energy targets because those utilities will not be required to comply.

Implementation and Market Design

Although outside target dates in CES proposals vary (e.g., 80% CES by 2035 in President Obama’s proposal), scaling and timing of interim targets are subject to more debate. Previous legislative proposals provide for interim targets that vary from two to ten years apart. For example, Senator Lugar’s bill would require utilities to comply with his broadbased diversified energy standard with targets of 15% in 2015, 20% in 2020, 25% in 2025, 30% in 2030 and 50% in 2050 and beyond. By way of comparison, Senator Bingaman’s more narrow renewable electricity standard would target 6% by 2014, 9% by 2017, 12% by 2019 and 15% from 2021-2039.  

All current proposals scale linearly, although targets could be designed to include an interim “ramp-up period” for the first several years of the program. A ramp-up period would encourage the construction of long-lead time generation like nuclear and fossil fuels with CCS technology and would also benefit utilities from regions with lower relative access to clean energy resources.

Depending on the timing of interim targets, some linear models may have the effect of encouraging near-term construction of natural gas-fired capacity (if credited) and traditional renewables while clean energy projects with longer lead times are still in development. And a robust system that allows utilities to bank unused CECs for later use or borrow CECs from future compliance periods could provide additional flexibility both to utilities in regions with less abundant clean energy resources and to those developing long-lead time or larger-scale projects.  

Integrating a federal CES with the state RPS programs is also a key concern. State governments may prefer to retain control over their own state renewable standards, but federal preemption would avoid a patchwork of conflicting standards. Renewable energy supporters, however, argue that the CES should be a “floor” and not a ceiling for states wishing to impose higher renewable or clean energy goals.

It should be possible to design a CES that complements existing state programs and is not too burdensome for affected utilities. Each of four recent CES proposals make clear that state programs would not be preempted. This approach generally treats state renewable energy credits as completely distinct from CECs. To ensure fair treatment of utilities subject to state standards, a federal program may provide state renewable energy credits to purchasers with existing contracts with equivalent CECs (unless the contracts stated otherwise) and could credit state alternative compliance payments towards compliance with the federal standard.  

Most industry participants also agree that policies that encourage a functioning, liquid market for CECs are an essential part of any clean energy standard. To this end, CECs could be centrally certificated and credited to clearly establish ownership and to avoid any double counting. Preventing double counting ensures that voluntary purchases of CECs are meaningful and reduces potential for litigation for claims of multiple owners. Trades in CECs could also be centrally cleared on one of the existing exchanges.

To protect ratepayers, most federal proposals include alternative compliance payments (ACPs), priced from $25.00 to $50.00 per megawatt-hour, that allow utilities to pay set amounts in lieu of acquiring CECs. Alternative compliance payments would act to establish a ceiling price for CECs in times of market disruption.

But an ACP’s value can also greatly affect the development of clean technologies and ultimate costs of complying with the program. If the ACP is too low, utilities would prefer to pay the alternative compliance payment instead of purchasing CECs or developing clean owned-generation. Although based on extensive assumptions, National Renewable Energy Laboratory modeling suggests that CECs might predominately trade in the $31-$63 range for a program that targeted 25% of generation from renewable energy resources by 2030 with linear interim benchmarks.

Policy-makers considering a clean energy standard have been and will be confronted with a many difficult policy decisions that will have important and varied effects on our national energy policy and on energy industry participants, from climate change, to resource diversity, to new clean energy technologies, to cost. Designing a CES that accounts for these issues and that receives broad industry and bi-partisan support will require an inclusive approach that seeks to achieve clean-energy goals while mitigating costs and rate impacts.