Stimulus VAR Support
by Roger Feldman --
Andrews Kurth, LLP
Can clean energy investments carry their important share of the Recovery & Reinvestment load? Here’s a contrarian answer: its up to the utility industry and its regulators.
In these bleak times the challenge to America is spending public money to fill the gap in investment and preserve jobs. Energy investment has been designated as one key to this goal. The tandem of the “Smart Grid” and renewables (slated to receive together many billions of dollars) is meant to be a centerpiece of the program to pump money into the economy. The new wires to be built are to conduct the clean new energy to supplant the use of greenhouse gas emitting fuels and also create “green jobs.” Complementing this thrust, energy efficiency savings are to be achieved through a diverse series of buildings and government grants programs which combine for a comparable aggregate amount. (Electric transportation and energy efficient manufacturing demonstration programs are miniscule by conparison.) But there’s a catch: the nature of the electricity business which is slated to absorb this shock therapy.
Energy policy proponents are accustomed to tie-ups in interregional energy resource, and energy processor internecine squabbles. It is the dirty linen of the business, and it is attested to in the final form of every Energy Bill. They just never thought all those issues would all have to be resolved to save the country. We hope it will.
But there are three major “matchup” factors which have to be taken into account in assessing the probability of energy repositioning representing a pillar of recovery. It is these three factors which make the involvement of the utility industry so important.
The renewable energy industry is one that has grown up based on tax credits and leverage, with the former making possible the latter. Its development is certainly made easier if there are mandatory purchase requirements as represented by Resource Portfolio Standards. The overriding problem, therefore, facing the industry is the shrinkage in both the number of financial lenders and the number of investors willing to provide equity for tax credits. The efficacy of the new provisions to provide Treasury direct grant funding in lieu of credits require implementation is critical to success. In any case, however, project development in remotely located areas remains a time consuming process that may fall outside the Stimulus penumbra.
Loan guarantees have proven to be a cumbersome tool for aggressive bank lending to date, particularly when they have been focused on commercializable innovation which can pay back the Government. They work best for the economy when there is someone other than the Federal Financing Bank to make the loans. Again the form and efficiency of the new “short form” program which the Stimulus gives to DoE to implement remains to be worked out. It, too, is conceived, however, as a relatively short term rather than a sustaining measure.
More fundamentally, loans--whether guaranteed or not--generally must proceed after pre-development and be based on firm offtake markets. The former is time consuming; the latter is frequently problematic, given the uncertainties as to power market prices (however much those future prices may be fueled by visions of cap-and-trade-driven price escalation).
Who still has the capital, the processing needs, and now entitlement to renewable tax credits? The utilities. If they opposed a Federal RPS designed to meet their power needs, do not contribute to removal of capital constraints, and are only modestly driven to seek to alter current regulation, this energy pillar of recovery is jeopardized.
This conclusion is exacerbated by the fact that renewables’ success in many cases will only be driven if there is a vast expansion of the “smart grid,” to which so many dollars have been allocated. There are several different connotations as to the meaning of a “smart grid”: the “smartest grid,” from a low cost power delivery/cost effectiveness standpoint, might wind up delivering fossil fuel power from remote locations--not quite what renewables’ sponsors probably had in mind. The smartest grid from a renewables standpoint would be one that reached to the far corner of renewables’ power sourcing and was also robust enough (e.g., sources of reactive power) that it could deal with fluctuations in the availability of unstored solar/wind power. The smartest grid from a consumer standpoint, on the other hand, should be flexible enough to accommodate the possibility of varying use to conform not only to renewable power characteristics’ variance, but to the requirements presented by the objective of energy efficiency. Certainly the renewable grid would be costly--$100 billion according to a recent study sponsored by several ISOs. Its efficiency smartness is only maximized when utility revenues and rates are decoupled so that utilities become a friend, not a foe, of required demand. Certainly this would be controversial. Why? A recent Wall Street Journal characterization says it all: “Less Demand, Same Great Revenue.”
Whatever grid is the smartest of them all, and however much support it may receive, it is clear from years of experience that its development will face many of the types of regulatory issues which grid development has in the past, exacerbated by the requirements of the types of long distance construction which the program may entail. To be anticipated, for example, are resistance from affected landowners, quarrels over who should pay for the grid, timing delays in getting permits, and continued assertion of individual state’s rights versus the assertion of national policy requirements by the Federal government.
It’s no wonder that various proposals of the Stimulus Bill had buried in them variations regulatory incentives: expenditure of funds by itself just doesn’t cure these problems. Probably the most dramatic that did succeed is the empowerment of certain Federal power agencies to exercise their eminent domain authority to build transmission wires. In part, that represents an effort to basically minimize the otherwise extended siting process. Not all measures with regulatory overtones were as successful. Pushback was experienced, for example, regarding programs linking efficiency incentives to the introduction of rate decoupling. None of the regulatory fixes to achieve a smart system directly addressed the underlying allocation of transmission costs problem: it remains a sore point for both utilities and renewable project sponsors.
Hovering over these issues is an environmental cloud: the uncertainty of to what extent power prices will be driven upward by cap and trade carbon regulation. To such an extent that renewables will be competitive in the future? This is likely to be particularly important, if tax incentives prove insufficient (as many believe they will) for investors to counterbalance the lower cost of conventional technology choices. Renewables then may be competitive in some cases only if the most stringent of caps (with resulting costs) are installed. Additionally, to the extent renewables have been “pulled” into the market by Resource Performance Standards, to the extent to which RECs are replaced by “unbundling” into carbon credits, this key regulatory incentive for renewables may be confused or even vitiated. Directly or indirectly, it is the interface of environmental regulation with utility reserve planning which will be at the heart of the matter.
Of course no one institution has the power to deal separately with all of the non-financial challenges which are presented to the implementation of the energy component of the Stimulus package. Perhaps, however, the institution least incented is that with the greatest investment in existing infrastructure, which definitely stands to have collateral costs from the new energy programs imposed on it by the Stimulus and related policies, but which does not stand to directly benefit from a significant portion of the Stimulus benefits. This appears to be the public utility industry.One of the better ways the issues which a private sponsor/Stimulus subsidized project likely will confront is to initiate now a review of how Federal policies could serve to constructively address the issues. While doing all it can to make the Stimulus program work, it certainly would appear that a conscious reaching out by Federal authorities to the stalwarts of the energy game, the utility industry, might be a productive undertaking, if energy is going to carry its significant portion of the recovery and reinvestment ball. Ratemaking, regulation, and the governmental programs specifically addressing issues like those affecting public utilities may be key to making the Stimulus work. To build more energy infrastructure in the renewables and energy efficiency space, the program must enlist the utility industry, not as a passive subject of change, but as a pragmatic advocate of Stimulus initiatives. At the very least the policy equivalent of VAR support is critical.
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.