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Insights

May 28, 2019

INSIGHT: Renewables’ Next Frontier: Regional Transmission Orgs

By Steven Shparber

Bloomberg Environment

Reproduced with permission. Published May 28, 2019. Copyright 2019 The Bureau of National Affairs, Inc. 800- 372-1033. For further use, please visit http://www.bna.com/copyright-permission-request/

Renewable resources, particularly wind and solar, have experienced tremendous growth in the U.S.

Spurred by a combination of improved technological performance, declining costs, increased consumer demand, federal tax credits, and state policies, wind and solar resources are poised to account for more than 10% of all electricity generated in the U.S.

While this growth has been impressive, several factors could change the way such projects will be financed.

Federal tax credits are expected to be phased out, and states and utilities are pushing back against how the Public Utility Regulatory Policies Act of 1978 (PURPA), which has traditionally driven renewable development in “regulated” markets, is implemented.

For renewable energy to achieve its full potential in the U.S., new market rules, operational protocols, and financing structures are needed.

Many of these issues will be impacted either directly or indirectly by developments at Regional Transmission Organizations (RTOs). These entities, overseen by the Federal Energy Regulatory Commission (FERC), administer “deregulated” wholesale power markets and operate and plan the bulk power system for about two-thirds of customers in North America.

Put succinctly, RTOs are crucial to the continued growth of renewables. 

Renewables’ Traditional Place in RTOs
RTOs have not traditionally been a focus of renewables’ interests because most early investment was driven by state policies supporting renewable energy and long-term power purchase agreements (PPAs) at relatively high energy market prices. Debt providers were assured reasonably safe returns based on contracted revenue streams via these long-term PPAs.

While renewable energy has been regarded by many as an innovative and disruptive technology, most financing structures to date have been relatively straightforward.

Meanwhile, most RTO rules were originally designed and adopted in the 1990s and early 2000s, and were rooted in grid operation protocols from earlier decades when the grid was dominated by large, slow-moving fossil-fired and nuclear power plants. Given the lower penetration of renewables in most RTOs, their impact on RTOs was minimal.

Changing Tides
In recent years, several developments have begun to change this paradigm.

Low electricity demand, combined with a surplus of cheap natural gas, have generally lowered energy market prices across the country, and accordingly, have lowered renewable PPA prices and investor margins. Moreover, higher renewable penetration means a new generation of faster, zero-marginal cost, variable resources are operating now compared to when RTO rules were originally established.

High renewable penetration in RTOs could significantly disrupt the way these grid operators run the bulk power system and the way wholesale energy market prices are formed.

This will create associated challenges and opportunities for market participants and consumers. Further, increased renewable demand from large corporations such as Microsoft, Amazon, and Facebook has led to the widespread proliferation of “corporate PPAs,” which are typically entered into via deregulated wholesale markets administered by RTOs.

The Importance of RTOs Moving Forward
The foregoing factors, among others, are increasing the renewable industry’s focus on RTOs. Future investment in renewable projects will be driven by factors other than tax equity or favorable PURPA contracts in regulated markets. As a result, the underlying projects’ value will be increasingly linked to wholesale power market revenues that renewables are able to access.

Given that RTOs are responsible for planning and operating the bulk power system and interconnection processes, and administrating wholesale power markets, they will have a vital role in creating market revenues and opportunities, or lack thereof, for renewable energy projects.

However, because RTO market rules and operations were not designed with widespread renewable penetration in mind, most RTO rules do not fully value renewable energy resource capabilities.

For example, most lack proper incentives for services from flexible, fast responding resources such as wind, solar and batteries. This discounts the fact that these resources can respond more rapidly to grid disruptions relative to slower-moving resources (although recent actions by FERC and PJM, the nation’s largest RTO, represent improvements on this front).

A report authored last year by the Wind Solar Alliance outlines many of these challenges in detail, and makes several recommendations for how technology-neutral RTO market, planning and operational changes can create fairer opportunities for renewables in RTOs.

Moving forward, in order to have a meaningful impact on financing new projects and achieving state policy objectives, not only do new rules need to be developed in RTOs, but project developers and investors will need to get comfortable underwriting these new potential revenues and managing risks associated with renewable projects operating in RTOs.

Achieving this goal will require a greater degree of market and regulatory sophistication than in the past, and a deeper understanding of RTO rules and market trends, along with some creativity in structuring risks, has the potential to unlock new revenue streams for renewable projects, greater investor returns and ultimately the construction of more renewable projects.

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