If It's Built, Will They Come? Analyzing Issues in Renewable Energy Transmission Contributed by: Robert Freedman and Patricia Hammes, Shearman & Sterling, LLP In the wake of a credit crisis induced retrenchment, the United States renewable energy market is once again surging forward, driven by both political and market forces to expand “green” energy production. As the issue of limited capital is moderated through a recovering financing market and the availability of various government incentives, in particular those incentives included in the 2009 American Recovery and Reinvestment Act,1 other issues that had been trumped by the lack of funding have now moved to the front of investment considerations. Chief among these issues is transmission. As lenders and equity investors seek renewable project investment opportunities, they are increasingly challenged by an energy grid that has not kept pace with the political and market push for such projects. These challenges are causing investors to dig deeper in their diligence efforts and ultimately could hamper renewable energy investment until adequate solutions are found. The Transmission Deficit and the Role of Curtailment Each type of power generation has unique characteristics that affect its interaction with a transmission system. Unlike fossil fuel projects, wind and solar projects are intermittent resources, dependent on uncontrollable weather and inherently limited in the ability to control and predict generation amounts. A transmission system incorporating extensive renewable resources may not be capable of tolerating the wide deviations in generation resulting from those resources, and therefore may resort to curtailment when renewable input is high. “Transmission curtailment” can generally be described as a reduction in transmission service in response to a transmission capacity shortage brought about by integrity issues on the transmission system. Curtailment generally occurs when inputs to the grid become too high to be balanced with outputs, and energy must be turned away. The National Renewable Energy Laboratory conducted a case study on wind energy curtailment in October 2009, and concluded that wind curtailment occurs for two primary reasons.2 First, curtailment is caused by congestion. Transmission providers schedule their availability to transmit power in advance. If a wind generator has only reserved a certain amount of capacity on the system, and then their generation exceeds that amount, there is no guarantee that the transmission provider will be able to accommodate the excess capacity without endangering the stability of the grid, even if there is a willing buyer on the other end of the transmission line. Congestion problems are exacerbated by the frequent remoteness of wind generators from their ultimate demand locale and consequent reliance on several lines or systems to deliver power to its intended recipient. The ________________
© 2010 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 3, No. 11 edition of the Bloomberg Law Reports—Sustainable Energy. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P. The discussions set forth in this report are for informational purposes only. They do not take into account the qualifications, exceptions and other considerations that may be relevant to particular situations. These discussions should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Any tax information contained in this report is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. The opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities do not take responsibility for the content contained in this report and do not make any representation or warranty as to its completeness or accuracy. second reason for wind curtailment is high levels of wind generation occurring at times of low demand. Because of operational requirements, nuclear and large coal plants are generally viewed as "must run" facilities because they cannot be started and stopped easily. Therefore, at times there may only be demand for the amount of power already being supplied by these types of facilities, leading to curtailment of other facilities. The frequency and severity of curtailment could vary from system to system. The continental U.S. is divided into eight North American Electric Reliability Corporation (NERC) regions, regional authorities which are in turn responsible for one or more regional transmission organizations and independent system operators (RTOs/ISOs) within their borders. The Electric Reliability Council of Texas (ERCOT), the Texas ISO, curtailed between 500 MW and 1000 MW of wind energy daily between December 2008 and July 2009. Xcel Energy curtailed 23,000 megawatt‐hours (MWh) of wind generation in 2008 at the direction of the Midwest Independent Transmission System Operator.3 Interconnection: Where to Begin It is not surprising that curtailment has been an important issue as incentives to develop renewable energy continue to be provided by states and the Federal government, including state‐mandated renewable portfolio standards requiring utilities to purchase power from renewable resources. In understanding how to address curtailment, however, it is useful to understand one of its roots: a project’s interconnection. In the initial stages of development, a renewable energy developer will look for a site which obviously has an abundance of wind, sun or other renewable resource, but will also consider adequacy of transmission and any barriers to interconnection. The basis of interconnection will be the interconnection agreement. Electricity transmission from an independent power generator to a transmission system in the United States is often governed by the standard Large Generator Interconnection Agreement (LGIA).4 The LGIA offers two different levels of service to the generator. Energy Resource Interconnection Service (ERIS) allows the generator to connect its facility to the transmission system, but only provides a right to the transmission system on an “as‐available” basis. This form of service allows transmission access when it is available, leaving no access if the capacity of the system is exhausted by other generators with a higher level of rights. In contrast, Network Resource Interconnection Service (NRIS) provides the generator with the ability to integrate into the transmission system with the highest level of rights available, rights at least equal to every other generator on the system. If there is a transmission shortage that could lead to curtailment, the ERIS customers could be dropped before the NRIS customers are affected. Both ERIS and NRIS may require the construction of upgrades to the network necessary to safely transmit the facility’s power. Once these network upgrades are completed, a generator with NRIS would be eligible to be designated as a network resource and obtain Network Integration Transmission Service (NITS), or if it is merely using that particular system to transmit its power somewhere else, it can obtain firm point to point transmission5. Both NITS service and firm point to point transmission permit a generator to enjoy rights to access that are at least equal to every other generator using the grid, but they are not a complete guard against curtailment.6 Additionally, in some cases the NRIS upgrades can take far longer to complete than the actual project itself, so a project may find itself forced into ERIS service for a period of years until the upgrades can be completed. The scope, cost and timing differences are factors historically resulting in most independent wind power projects obtaining ERIS service. However, as debt and equity investors learn the lessons from the renewable energy build‐out and apply increased scrutiny to a project’s contractual arrangements, © 2010 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 3, No. 11 edition of the Bloomberg Law Reports—Sustainable Energy. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P. NRIS service requirement. may increasingly become a Allocation of Curtailment Risk: From Merchant Power to Contracts Two approaches to an investor’s diligence of curtailment risk involve an independent curtailment study and a review of the contractual allocation of risk between a power purchaser and the generator. The curtailment study will generally include an analysis of the existing and future queue of interconnection requests on the transmission grid that would serve the project, and the likelihood for curtailment that may arise. The curtailment study will also provide an analysis relating to the cost of curtailment, taking into account factors specific to the project and the particular transmission system and/or region which it is intended to serve. The tenor of debt investments in renewable assets have in many cases become increasingly longer and an equity investor may have a long period of time expected for its return on investment. In some cases the length of the investment is beyond what can be accurately predicted by a curtailment study; one may be able to review the existing and expected projects in the queue and the barriers to entry over a certain period, but that time period may not be 15‐plus years, which is the investment period for some transactions. Regarding the contractual analysis, this is a part of the diligence process which is now the object of increased focus after a period of merchant power build‐out when projects received investor funds without the benefit of a long term power purchase agreement. While solid contracts with investment grade counterparties were historically an investor requirement, during a period in the mid 2000’s a combination of easy credit, tax incentives and attractive commodity prices prompted some investors to focus on optimizing renewable assets rather than seeking the stability of a contract. During this time, a number of wind facilities in particular were constructed with the intent to sell power into a regional power market, or to a counterparty in a derivative transaction with the counterparty intending to optimize the asset. In these arrangements, if a project is paid only for power actually transmitted through the system and delivered to the end user, that project is directly responsible for the risk of being curtailed. If a project is party to a power purchase agreement (PPA), however, that curtailment risk can be shared between the parties. Since much of the recent renewable generation built in the U.S. has been wind, it is most illustrative to focus on wind PPAs. Wind PPAs are typically energy‐only contracts, meaning the generator is paid for power produced and not the generator's capacity. Contrast this to a fossil fuel PPA where a project is often paid a capacity payment, as compensation for being available, and an energy payment, as compensation for actually delivering power. The capacity payment is intended to cover a project’s fixed costs, including debt service, and is typically dependent on the project’s ability to deliver power, not the power actually delivered, so therefore transmission constraints may likely not be a risk. Given this difference in PPAs, it is particularly important to fully understand a wind project’s obligation with respect to power delivery, including the delivery point and the buyer’s obligation to receive power at the delivery point. A project which is obligated to deliver power beyond its own point of interconnection is allocated the risk of transmission availability. However, even a project delivering to its point of interconnection may also be allocated transmission risk if, for example, a purchaser’s obligation is conditioned on its ability to receive such power, or its obligation to purchase is excused by force majeure where force majeure includes transmission system congestion issues. Additionally, a power purchaser may require the ability to “economically curtail” a project, © 2010 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 3, No. 11 edition of the Bloomberg Law Reports—Sustainable Energy. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P. essentially permitting a power purchaser to reject power produced. In addition to the important effect on the payments to a project, another consideration is the effect curtailment has on any output guarantees contained in a PPA. When entering into a PPA, the purchaser may require a guarantee that a certain amount of power will be delivered over an agreed period of time. Curtailed energy which is not carved out of an output guarantee can lead to a project default or, in some cases, termination of an agreement. Robert Freedman and Patricia Hammes are Partners in the Project Development & Finance Group of Shearman & Sterling, LLP and co‐founders of that firm’s Sustainable Development Group. David Dubrovsky and Colin Keefe are Associates of Shearman & Sterling, LLP. 1 H.R. 1, 111th Cong. § 1103 (2009). 2 Nat'l Renewable Energy Laboratory, S. Fink et al., Wind Energy Curtailment Case Studies May 2008 ‐ May 2009 (Oct. 2009), at 1, available at http://www.nrel.gov/docs/fy10osti/46716.pdf. 3 Id. at 6. 4 Federal Energy Regulatory Commission (FERC), Standardization of Generator One of the current mitigants of curtailment risk is the selection of NRIS service. If NRIS service is not feasible or if there is a delay in the completion of the necessary upgrades, there are also other structural options for mitigating the risk. From a debt perspective, the simplest option is to keep project leverage to a level that can be serviced in a down‐side curtailment case. Another option is to establish additional project reserves to compensate for those periods of curtailment that result in lost revenue. Interconnection Agreements and Procedures (July 24, 2003), available at http://www.ferc.gov/whats‐new/comm‐meet/072303/E‐1.pdf. 5 FERC, Standard Large Generator Interconnection Procedures (June 2005), at 13, available at http://www.ferc.gov/industries/electric/indus‐act/gi/stnd‐gen/2003‐C‐
LGIP.doc; FERC, Rehearing Order Pro Forma Open Access Transmission Tariff (June 2008), at 45, available at http://www.ferc.gov/industries/electric/indus‐act/oatt‐
reform/order‐890‐B/pro‐forma‐open‐access.doc. 6 Id. Looking Forward Some potential solutions to the curtailment issue continue to be considered. One such solution is energy storage where power is stored at times of low demand, and then recovered at times of high demand. However, the market is still working out how the high costs of storage projects will be best allocated. Additionally, proposals are being discussed in some regions to alter the cost allocation of transmission upgrades, incentivizing the construction of longer transmission lines. The construction of new lines, though, is a time consuming process. Until viable solutions are found and have time to take effect, investors need to work with the available tools such as the distinction in interconnection service, the allocation of risk in PPAs, and the structuring of protections through lower project leverage or the creation of reserves. © 2010 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 3, No. 11 edition of the Bloomberg Law Reports—Sustainable Energy. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P.