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ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon Markets Group has practiced law related to the finance of environmental and energy projects and companies for 40 years.  In particular, he has analyzed and executed a wide variety and substantial value of project financings.  He chairs the American Bar Association’s Committee on Carbon Trading and Finance, serves on the Board of the American Council for Renewable Energy, and has been a senior official in the Federal Energy Administration.  He is a graduate of Brown University, Yale Law School and Harvard Business School.















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Washington Viewpoint by Roger Feldman


When Barbie Met RECs

by Roger Feldman  --   Andrews Kurth, LLP
(originally published by PMA OnLine Magazine: 2008/01/05)


Barbie has gone virtual -- from vinyl idol to computer-based avatar for on-line purchase by her worshipers of a whole new world of goods.  Now you can go on line and shop for what Barbie likes to wear -- shop with virtual dollars that you bought with real ones.  So, too, can green energy buyers.

Can legal draftsmen follow the suit of the computer-based consumer culture into the energy/environment “space,” without developing policy schizophrenia?   That is the issue which the pursuit of RECs “monetization” through development of a Master Energy Certificate Purchase and Sale Agreement (the “Master Agreement”) presents today.

To apprehend this issue, it is first necessary to understand the process the humble RECs Scriveners went through, what the resulting contract is, and what the ensuing policy issues may be, as the use of RECs flows into the larger fermenting energy/environment commerce stream and policy world.

Grasping and evaluating the “Master Renewable Energy Certificate Purchase and Sale Agreement” leads one to pass through the stages of human intellectual growth:

(1)  basic absorption of operative facts;
(2)  the leap of faith into abstraction;
(3)  the harvest of the benefits (through commerce) of a regime of faith-imposed order on unruly reality;
(4)  the development of existential doubts about the faith and angst over the outcomes of the ordering.

I.                   The Facts

Renewable Portfolio Standards (RPS) have been enacted in 23 states and have surrogate regimes  in several more.  Essentially, each state’s RPS requires utilities to obtain specified percentages, or absolute amounts of production, of new power from renewables (even specified types of renewables) by specified dates.  Failure to do so generally results in fines or penalties.

The “Renewable Energy Credits” arising from renewable power production are not allocated among parties and are not given values but, since they can be used by utilities to meet statutory requirements, they are subject to value through trade.  There are also voluntary (non-state-compliance) programs creating analogous “green tags” for renewables, based on private certification.  Their purchase and retirement by third parties yields non-monetary psychic or PR benefits.  These Green Tags are also susceptible of being part of a market.  Definitions of RECs differ and compliance regimes differ.  This reflects the ongoing reality that enacting states and other certifiers have several overlapping but different goals of reducing dependence on foreign energy supplies, reducing utilization of polluting energy sources (notably carbon), and providing economic assistance to certain local resources based within their borders.

For any of these reasons it is desirable for Renewable Energy Certificates to be readily tradable and have their values identifiable, so that the resulting cash flow can strengthen project feasibility.  It is readily perceived that standardization of the terms of trade which overcomes the current balkanization of markets is desirable.  That premise, implicit in the Interstate Commerce Clause, has already been tangibly demonstrated in the “cap and trade” SOX and NOX trading markets.  These motivations led to the development of a “Master Agreement” which is intended to enable the process of REC sales to move from a cumbersome bilateral process to one where increasingly trading -- and the development of derivative valuations based on trading -- can be realized.  In the absence of a royal Rex or a regal Webmaster managing the virtual universe, innovation -- born of legal scholastic ingenuity -- is required.

II.                The Leap of Faith into Abstractions

The leap of faith involved in a commercial contract for the purchase and sale of a material commodity is limited;  it relates mostly to the transparency of the process.  With an adequate set of commercial rules, if a REC were a bundle of firewood, a Phoenician could trade it, as long as the weights and measures, the rights of the parties, the bookkeeping and, only slightly more sophisticated, the credit and collateral of the parties and the means for dispute resolution are clear.  This store is not virtual;  Barbie can shop there.

But there is a leap of faith when the physical product being sold, “power,” is said to possess an “unbundled,” separate, and tradable attribute.  Specifically that its “green-ness” (as legally defined) may be pulled from the power bundle of sticks and bought and sold separately.

Once the feasibility of such unbundling is deemed possible, it is only a further intellectual leap to treat a REC to being further splinter-able into its green attributes;  voluntarily at first, based on the scientific word of verifers, and then even legally, if a binding legal compass is adopted to trade single attributes of the REC as well.  Most notably, the carbon reduction value of a REC can, in principle, be unbundled and separately traded. 

In our electronic age, where people can postulate such virtual avatars and trade in parallel computer reality universes, it’s not a large step to ascribe reality to digits on a screen.  Barbie’s accessories can be bought and sold, why not credits for energy production or carbon diminution?  This no longer seems the leap of theology it once may have been.  But there remains a need for a rulebook as to how the system shall unbundle RECs from power, and enable them to trade.  That is the grail which the Master Agreement quest by the RECs Scriveners has been all about.

Review of the Master Agreement, therefore, immediately focuses on the Product definition, and then to confirmation of trades, allocation of risk, treatment of default and enforcement mechanisms which it offers.  However, whether the noble Master Agreement construct will have practical meaning depends on whether merchants will use it to trade their newly created products on exchanges established to trade the virtual rights.  The path to a better mousetrap must be trodden down through frequent use.

III.             From Faith To Commerce:  “Monetization”

The key to the journey from faith in a concept to value in the marketplace is the concept of “monetization”:  in this case, the ability to easily capitalize as a tangible revenue stream the fact that power is derived from a green source (or, better even a green source which reduces global warming) if a regimen for trades is designed for that purpose.  To an economist, this “monetization” is the internalization of previously external costs -- to a banker, it is the ability to realize a firm cash flow stream from a deal -- to a broker this is the basis for reward for facilitation -- and to a lawyer, it is the scaffolding of a commercial temple in which either future financing security interests may be created and/or disputes with respect to them may arise.

If it works as a monetization device, the Master Agreement provides the predicate to move from multiple bilateral green credit transactions to the trading market wherein the value of electrons being green can be formally recognized as, for example:

  • collateral for loans whose future value rests on the firmness of the obligation, price, terms and customer credit worthiness reflected in the Agreement;

  •  potential implicit equity value from future cost free revenue sources which can be anticipated in assessing IRR compliance;

  • auctions by states with a view to assuring a flow for green power within their respective borders to jurisdictional utilities (and ideally beyond those borders to embrace national markets)

  • auctions by load serving entities seeking least cost solutions to their RECs compliance problems (or analogous arrangements in the voluntary spheres)

  • auctions by green power vendors to maximize the future value of resource streams.

The greater the standardization, the larger the market scale, the longer term the obligations can be, the more revenue, the more projects . . .

IV.              Existential Doubts and Angst

We’re not there yet.  First, because the essential simplicity of the Master Agreement remains to be divined generally beneath the diverse complexity of the types of different types of Certificate trades it purports to make possible and the flexibility in doing so.  In addition existential angst has begun to hover over the effort at the policy level.  Each is now a topic of consideration by the ongoing successor Clean Trades Working Group to the original ABA-EMA-ACORE effort.

At the functional level, while all of the benefits of trading standardization mentioned above are now conceptually within reach under a functioning Master Agreement, reality seems to fall short.  What the Master Agreement offers today is at best a framework for a simultaneous translation device for a willing buyer and seller who check the same product boxes and willingly check the same transactional description boxes.  Complexity is added to this by the fact that the Master Agreement addresses the Voluntary as well as the Compliance market.  In the Master Agreement’s Exhibit P, a range of potential reimbursable attributes and verification devices are addressed, as possibilities.  This may only be a seeming (and possibly even a transient) complexity.  However, absent a single Rex in the form of a Federal program, Master Agreement proponents must winnow down this giant “portable” phone to a more palm-sized device which even Barbie could use to call home.

But even as the contractual menu shrinks and the market presses toward standard definitions of RECs and their attributes, there remains a larger question -- a source of existential angst:  is the path toward easily-traded, unbundled, unitary RECs related to green power the path of the future or merely a diversion from the “true” path to the trading a smaller unbundled carbon credits which represent a single more purely attributable environmental “essence of RECs”?  Are RECs the “right thing” to be traded?  RECs fulfill a compliance need;  but what if that need is superseded by the further division of the REC into its environmental attributes?  Falls then the shadow:  is facilitation of the sale of RECs not legally stripped of environmental benefits, in fact simply an impediment to the monetization of the “true” carbon market, dedicated to green house gas reduction?

There are many possible answers.  One possibility that must be considered is that a Master Agreement which evolves out of the current RECs Master Agreement to serve the carbon market must be satisfied  with the lesser objective of facilitating bilateral trade and not aspire to move further, until such time as greater Product definition can be obtained.  It is an issue with which the Clean Trades Working Group is now struggling. 

Even a larger existential question is raised:  is the goal of carbon trading and GHG control better served by abandoning the unitary universal REC trading ideal as an anachronism -- even if that means sacrifice of one of the few unifying supports for development of all renewables as an asset class?

Put as an old fashioned public policy matter:  can the preservation of “optionality” via a Master Agreement supporting the notion of a unified trading floor work against either the desire for optimum development of green power technologies or the emergence of an optimum carbon reduction environment?  In particular, it may be that RPS-linked RECs may not be the most efficient way to promote carbon reduction, which can be better done by promoting energy efficiency or even non-renewable energy generation technologies.  Perhaps in fact, focus on carbon reduction is best not done by bypassing RECs monetization altogether.  Providing “optionality” to trade unified RECs or their attributes may be short term good business, but it may be long term bad policy.

It is an existential question the Clean Trades Working Group currently is also addressing.  However, its resolution cries out for the guidance of a (still hypothetical) King James, and the devil, of course, is in the details.

Time magazine literally recently counseled green-sensitive Barbies to “wear green eye shadow.”  Like Barbie we live in a material world, and always will.  But now we can live in a virtual world as well, to facilitate new kinds of trading markets.  While the two can be reconciled in computer entries, they may not be as easily reconcilable in terms of the policies which they respectively encourage.

These are the issues with which lawyers, traders, and policy makers from the Clean Trades Working Group implicitly grapple as they seek to both refine and expand the Master Agreement for Renewable Energy trading.

When Barbie meets RECs, will they become hopelessly lost in the seductive Optionality Woods?  Can’t wait to see the movie.

ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon Markets Group has practiced law related to the finance of environmental and energy projects and companies for 40 years.  In particular, he has analyzed and executed a wide variety and substantial value of project financings.  He chairs the American Bar Association’s Committee on Carbon Trading and Finance, serves on the Board of the American Council for Renewable Energy, and has been a senior official in the Federal Energy Administration.  He is a graduate of Brown University, Yale Law School and Harvard Business School.


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