Overview and Evaluation of Renewable Energy Credits

17 Dec 2015

History of RECs

In 1983 riding on the wave of heightened environment awareness, Iowa became the first state to demand that a portion of the state’s electricity consumption come from renewable resources. This requirement was noticed and quickly replicated across the nation. In 1996, California Policy makers recommended that base-level requirements for the amount of renewable energy created be established. This recommendation, entitled the Renewable Portfolio Standard (RPS), went further than the original Iowa recommendation by mandating that a percentage (not a net amount) of the energy mix come from renewable resources. Despite being the first to propose statewide standards for renewable energy, California did not adapt the RPS initiative until 2003, after 11 other states had adopted the plan. Today, 34 states and Washington D.C. have RPS requirements ranging from a renewable energy base of 10% by the end of this year in Michigan, South Dakota and Wisconsin to one of 100% by 2040 in Hawaii.

The mounting federal pressure for the adoption of RPS mandates led many states to take on standards that they themselves could not meet due to a lack of natural resources within their borders. Some states, for example, have little access to wind energy, solar or hydro and therefore are unable to meet their standards through internal production. Furthermore, the standards are usually split evenly between municipal power plants, meaning that areas without access to natural resources are expected to contribute as much (percentage wise) as areas with myriad resources. It was this national lack of direct access to renewable sources of energy coupled with the adoption of Renewable Portfolio Standards that led to the conception of Renewable Energy Certificates.

Defining the REC

As stated, the idea of splitting renewable energy production electricity and the positive environmental externalities arose in the late 1990s with the introduction of the RPS system. An REC, therefore, represents only the environmental benefit that is derived from the use of renewable electricity and has no claim on the energy itself. Renewable Energy Certificates do not track CO2 or any metric other than overall measure of positive externalities as priced by the nine regional pseudo-governmental offices that track the certificates and the brokers who purchase the RECs for sale in private markets. The nine REC trackers are WREGIS, covering all states west of Colorado, ERCOT, covering Texas, NARR, covering most of the South, M-RETS, covering the Midwest, MIRECS, covering Michigan, NC-RETS, covering North Carolina, PJM GATS, covering New Jersey, Pennsylvania, the Virginias and often working with M-RETS, and finally NEPOOL-GIS, covering the North East.

Currently each tracking system individually decides what a renewable energy source is and therefore RECs can be produced many different resources including solar, wind, geothermal, hydro, biomass, hydrogen fuel cells, municipal solid waste, and even landfill and livestock methane. In order to begin producing RECs, renewable energy power plants in the aforementioned fields must register with their regional office and open an REC “bank account” where the certificates they generate are digitally stored. The regional office installs metering devices within the power plant so that the “bank account” is automatically credited one Renewable Energy Certificate per every megawatt hour of electricity produced. RECs are virtually marked with individual tracking numbers, the source of the energy (for example RECs coming from solar energy are marked as SRECs and those coming from wind energy are marked as WRECs), and their vintage (the year the REC was produced).

The separation of physical electricity from the benefits of renewable resources is crucial due to the technical restraints of our energy system. Energy storage technology and electricity grids are not developed enough to allow the small renewable plants to selectively send out green electricity on consumer demand, meaning that electricity has to be dumped into the grid regardless of whether renewable energy demand exists at that particular moment. Additionally once the electricity is fed into the grid, the electrons coming from renewable energy power plants are indistinguishable from those coming from the dirtiest coal power plants so the only viable solution for selling renewable energy to consumers is to track the positive externalities as a separate commodity and offer them on the free market.

As the RECs are being generated the renewable power plants can make an array of choices to capture their value. Larger scale producers will often enter pricing contracts with local municipal electric utilities that need to meet the Renewable Portfolio Standards and thereby fix a REC price for a period of time. Other producers might choose to bank their RECs until the end of the fiscal year in order to sell at higher prices when demand rises as a result municipal utilities rushing to balance their energy portfolios. Both of those are examples of producers operating within the compliance market—where municipal electric utilities are purchasing RECs to comply with their state’s RPS. Smaller renewable power plants don’t have the opportunity to enter the compliance market due to the decreased convenience for municipal utilities who would rather sign one contract with a single provider and get all the RECs they need. As a result of this, small renewable power plants tend to operate within voluntary markets, which are used by individuals and corporations for the sake of being “environmentally friendly” and minimizing any moral guilt they might have over climate change. These markets came about as a way for private corporations to help contribute to the price differential between costly clean energy and cheap dirty energy. Since municipal electric utilities must sell electricity at one price, renewable energy power plants sell their “electrons” for less than the production cost hoping to counteract the difference through RECs and government credits.

Despite changing ownership many times, RECs always remain within their regional tracking systems in order to allow for easy management. After having purchased an REC, the voluntary or compliance buyers are able to claim their positive externalities only once and therefore strategy is key. So long as spot market prices are lower than the fixed price of the REC purchasing agreement, a compliance buyer will bank the RECs purchased through the contract and buy and claim the cheaper RECs at spot prices. When spot prices are higher than the fixed price, the utility companies will claim the benefits from the RECs they had banked as a way to minimize the cost of adhering to the Renewable Portfolio Standard. Once an REC’s benefits have been claimed in either market, the REC is debited from the claimant’s account and the regional tracker retires the unique identification number in order to ensure that no double counting occurs.

Markets and Regulation

Due to the existence of multiple tracking systems across the United States, their differing standards of reporting and the prevalence of cashing in old Certificates, it is difficult to get accurate data for the size of the markets for Renewable Energy Certificates.

Compliance Markets and ACPs

The REC compliance market is complex by nature of it dealing with the protected filings of privately owned utility companies that adhere to the Renewable Portfolio Standards as well as the non-standardized reporting of regional tracking systems. This complexity makes it difficult to accurately estimate the size of the compliance REC market. With a total of 3,306 municipal electric utility companies across the United States of which roughly 35% are privately owned a loose calculation of REC market size would be as follows. The difference between the current renewable energy production capacity for each municipality and the Renewable Portfolio Standards would be calculated. The resulting net difference in renewable energy production per municipality is multiplied by the total electricity use in each municipality. This number is divided by 1MWh and then multiplied by the average price of RECs for that fiscal year. It is important to note the sign of the net percentage as this accounts for either an overproduction according to RPS Standards or a need to purchase RECs. The total sum of all the municipalities with RPS standards would then give a rough estimate for the size of the REC compliance market.

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While this estimate provides a precise number for the amount of RECs needed to fill the net RPS gap, the monetary value of the RECs is inaccurate since banking is prevalent.

In terms of Renewable Energy Certificate pricing each state within the compliance markets has different initial demand curves due to their different Renewable Portfolio Standards. Compliance prices, therefore, differ not only from one tracking region to the other, but also between the states within the same tracking regions. In Texas, the average REC compliance price across all accepted resources is $1.00, whereas in Rhode Island, that average is closer to $60.00. Prices also differ between the types of RECs due to specific state mandates on the renewable energy mix. Ohio which allows any renewable energy mix to meet its 25% Renewable Portfolio Standard has an average compliance Solar RECs value of $60.00, whereas in Washington DC, where 2.5% of the 22.5% RPS must be solar, the SREC price centers around $450.00. These average prices, however, do not present for the exact situation since they are attempts at spot pricing for the small amount of compliance REC work done outside of price fixing contracts, which tend to have cheaper value.

Additionally, most states have an Alternative Compliance Payment (ACP) exists which further complicates the economics and weakens the environmental value of Renewable Portfolio Standard compliance. ACPs exist and serve as the only state legislated price regulators for renewable energy. When a municipal electric utility is unable to purchase the amount of RECs needed to meet the tiered standards (standards that call for a percentage of electricity to come from a certain renewable resource), it can settle for paying a fee to cover the compliance gap. This fee is per REC and differs by energy type. In Washington DC, the ACP for the solar tier is $500.00/MWh, meaning that if the utility is unable to generate or purchase enough certificates to cover the 2.5% solar requirement, it must pay the government a per REC value of $500. The ACP backfires for two separate reasons: first, the ACP money does not go to the renewable energy power plants and ends up in state coffers, meaning that the power plants effectively sold their electricity at a loss and can’t do anything about it, and second, the price is fixed at $500.00, so if some of the solar energy producers in D.C. go out of business, the supply deficit would cause prices to spike above $500 (keeping in mind it only needs to go up by $50) and therefore, all SREC income is diverted from the remaining solar plants, and solar plants begin operating at a loss, leading more of them to shut down.

Overall, the compliance markets do a lot to fund Renewable resources due to the price premium induced by a stable demand curve. That being said, the system is extremely fragile due to existence of Alternative Compliance Payments and tiered Renewable Portfolio Standards.

Voluntary Markets and Brokers

Unlike the compliance markets, the voluntary market for RECs are much easier to track down since RECs are claimed and retired via public statements as opposed to privately turning them in to the RPS auditors. In 2014, 5.5 million entities (individuals and companies) purchased green energy through RECs. Since there is no inherent demand in the voluntary markets (consumers can choose not to purchase RECs if prices get too high), the price for voluntary market RECs trends around $1.20/ MWh, drastically cheaper than that of the compliance market. This allows companies like Intel to cheaply purchase 1.3 billion certificates in 2008 and be able to receive awards from the EPA and WWF for being leaders in green energy.

Voluntary REC markets have grown drastically since they were first developed in 2008 (when there were only 13,000 purchasing entities) due to a variety of options for purchasing RECS. Most large companies like Intel, Walmart, Cisco and Dell are able to reach out to medium scale renewable energy producers and purchase RECs at prices even cheaper than the $1.00/MWh through large contracts. On top of that, private brokers who deal in RECs have flooded the voluntary market. Since most small-scale power plants don’t produce enough RECs to make it worthwhile to seek out their own buyers, companies like Sterling Planet and SREC Trade can negotiate fixed prices with many producers and sell those at a premium on the open markets. Brokered RECs are mostly purchased by small companies that want to participate in the green movement and do their share to protect the environment but can’t afford large-scale contracts. Still, a third option for the voluntary purchase of RECs exists. This option, mostly directed towards homeowners, allows for electricity priced at a per kWh premium to be purchased from municipal electric utilities. The utility companies purchase the RECs through voluntary markets as opposed to compliance markets and upcharge their environmentally conscious clientele for whatever fraction of the REC they use (one full REC would account to about 700 hours of electricity use for a single household). This is called “bundled purchasing” since it gives an appearance of buying green electrons, when in reality that is not the case.

Despite the initial rapid growth of the total voluntary REC market since 2008, there has been a fairly large divestiture by both larger companies and residential users (dropping 20%) since 2014, while small businesses were the only group that grew, accounting for a 4% growth in 2014 after three years of 25% growth. This will be further discussed in the coming sections.

Tracking and Double Counting

A crucial piece of the REC equation is the existence of the nine pseudo-governmental tracking systems. These tracking systems mostly exist to minimize the effect of double counting in the relatively unregulated REC markets. Whereas the voluntary market has a lot more moving parts and is harder for the tracking systems to oversee, the compliance market operates simply due to the RPS being the only claim to REC benefits. Municipal utility companies need not publicize the fact that they are purchasing RECs since the reason for the purchase is RPS compliance, as such, positive externalities are not claimed in the public sphere until they have been handed in to RPS auditors at the end of every year. This means that compliance RECs will not be double counted since they are easily retired en masse. On the other hand, with voluntary markets, self-reporting is necessary since these companies claim their RECs through press releases. The tracking systems can’t keep track of Press Releases from 5.3 million consumers, and therefore a possibility of double counting exists. It is interesting to note that the renewable power plants that are producing this electricity cannot claim to be producing renewable energy by nature of the physical electrons being split from the positive environmental externalities of it’s source makes any statement of environmental benefice by the power plant instantly retire the relevant certificates.

Criticism and Downfall

There are many reasons why Renewable Energy Certificates are a great construct and there are many reasons why they are a terrible one. In order to understand the benefits and pitfalls of RECs it is important to repeat that they were created in order to address the cost differential between the production for clean energy and the market electricity rates. The prices of RECs are meant to exceed the differential and thereby not only cover costs, but also provide capital investment to generate new renewable energy power plants.

From a cost perspective, compliance markets serve the mission of RECs well in that the free-market prices are mostly fixed at levels that far exceed the cost of production and do provide extra capital for the pursuit of new plants. An issue, however is that most utilities have purchase contracts with large renewable energy power plants and therefore there is not much room for small startups to enter the compliance markets.

In terms of infrastructure, the compliance market has a couple of pitfalls. While originally created to help substitute a smart electric grid that could provide green energy across the nation regardless of availability or natural renewable resources, the creation of the regional tracking systems and state (as opposed to federal) Renewable Portfolio Standards diminish this impact. RECs were meant to be highly tradable across the USA at free market prices determined by the supply and demand at that moment as the public commodity exchanges do. The original goal was for a municipal electric utility in Virginia to be able to purchase excess solar from California to meet its Renewable Portfolio Standards, but since there is no national control system, this can’t occur (a national tracking system, Green-E, is being used more and more, but there is need for a national bank in order to centralize the market). The localized banking systems and state specific RPSs allow for different definitions of renewable resources making it hard to trade across states and regions. Trading across state lines when the definitions do match often incurs extra costs in order to incentivize the growth of renewable within state borders as opposed to just having them all come out of California. While this inter-state competition is beneficial by pushing more investment, it would be more impactful to have a single Federal RPS and outsource renewable energy production to areas with higher efficiency (CA, AZ). Although this would require higher capital costs in the creation of a more interconnected national electric grid, it would pay off by being more efficient as an overall system.

As for the voluntary markets, RECs don’t have much of an effect other than allowing companies to claim that they are reducing their emissions. With RECs, Johnson and Johnson reduced emissions by 17% since 1990. Without, emissions went up 25%. More and more, large companies are beginning to divest from RECs since there is no proof that they actually support the growth of renewable energy sectore. The artificially low prices of RECs and the brokerage structure make it so that an insignificant amount of the money spent actually ends up in the power plant’s hands. Due to the EPA’s support of the REC system, government agencies are also participating in the purchase of brokered RECs. The Sterling Planet brokerage consistently purchases RECs from Small County owned power plants at low prices and immediately turns them around for upwards of 200% markup to government agencies like NASA and the Air Force. At the end of the day, the small power plants receive checks that according to one Connecticut hydro-plant entrepreneur “are hardly worth the paper they’re written on”.

Companies like Nike, who were the largest REC consumers in 2008, have since cut purchases in half. Walmart has gone as far as releasing a company energy report stating that “while REC purchasing may allow [them] to more quickly say [they] are supplied by 100% renewable energy, it provides less certainty about the change [they’re] making in the world” and outlining new initiatives. While the minimal amount of money ending up in the renewable energy producer’s hands doesn’t do enough, the power plants do receive heavy government subsidies including around $20 in federal tax breaks and another $20 in accelerated capital depreciation per MWh.

In the coming years, it is foreseeable that the voluntary REC market will collapse due to its lack of efficacy in promoting real environmental and behavioral change. As large companies continue to divest from the voluntary markets, small companies and residential owners who do not have the money to conduct their own studies will continue to be duped by the dubious nature of the REC market and the EPA’s strong yet un-overseen partnership with the tracking systems. Looking forward, one can only hope that companies like Nike, Cisco, Intel, and Walmart will invest the money they pull out from RECs in the creation of new renewable energy plants that at least cover their own consumption and that they will be strong supporters of carbon offset programs that can measurably track our environmental progress. This paired with a more efficient federally mandated municipal RPS program, should be enough to push America to a point where capital flows more easily to and offers higher return from renewable resources like solar, wind and hydro.

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