August 2005

Still Energy Policy Still

by Roger Feldman  --   Bingham, Dana L.L.P.
(originally published by PMA OnLine Magazine: 2005/10/14)
 

The effect of the Energy Policy Act of 2005 (“Act”) on the electric power industry necessarily will come down to four basic questions:

1. Who will be the entities selling the power?

2. What will be the primary sources of fuel for the power they are selling?

3. Will the resulting shape of the market place allow sponsors of new technologies to achieve breakthroughs?

4. What does the future hold for the heirs to the merchant power tradition?

Here is one possible set of conclusions with respect to these questions and some principal items in the Act which prompt them.

1. The effects of the Electricity Title VII of the Act will be to provide favored positions in the industry to existing utilities and to large non-industry players, financial and otherwise, that are willing to accept the possibilities of growth in a regulated industry achieved through efficiency. Smaller firms dependent on statutory support through reliance on regulatory market openings and ability to capture utility financial credit through structured arrangements will be at a marked disadvantage. Public power and cooperatives should continue to thrive, although their interaction into the generally transmission
regulatory stream has been increased.

* The Public Utility Holding Company Act (PUHCA) has been repealed, although provisions for FERC and state regulatory access to books and records for ratemaking purposes and affiliate transactions and FERC assumption of certain holding company oversight responsibilities have been retained. Anticipated consequences are an increase in utility consolidation and equally importantly, entry of non-utility and foreign equity into the marketplace. (This activity still will be subject to FERC, DOJ and FTC review. The FPA merger acquisition review is confined and somewhat streamlined.)

* The amendment of the Public Utilities Regulatory Policy Act (PURPA) effectively limits future significance of this Act as a driver of future cogeneration outside the industrial sector. It also significantly limits the power purchase and backup power supply obligations of utilities except in “unhealthy competitive” markets — notably not where RTCs or ISOs are in place. Utility ownership limitations on QFs are lifted. Small power production is allowed to continue. That seems to be where the opportunity
(bolstered by State RPS—there is no comparable Federal provision)— appears to lie.

* The Act refocuses market creation on the liberalization of rights to own transmission (PUHCA repeal); creation of common reliability standards and the legal prospects — possibly wishful thinking , when the fine print is read — for the mandatory forging of new transmissions corridors by FERC.

2. The fuels of choice in the future will be driven not only by inherent cost of production economics (as handicapped by the applicable capital and operational requirements imposed by environmental law) but also by exploitation of the Act’s special incentives provided for two essentially competing complexes of technologies: “clean” coal and nuclear power on the one hand, and distributed “clean” technologies (generally of smaller scale) on the other. While the former bears greater near term technical challenges, reflected in the special targeted subsidies proposed, the latter frequently face the difficulties of achieving the scale via application of ongoing statutory subsidies to offset the fragmentary capital
requirements.

* Loan guarantees and investment tax credits are afforded to clean coal and nuclear facilities. Certainly the first few clean coal/coal projects will be in a strong position to be realized because of the direct grant, as well as the loan guarantee provisions: DOE may make grants of $200 million a year over the period 2006-2014 — generally up to 50% of the cost of projects. There are also a 20% tax credit for IGCC; a 15% tax credit for other projects that use advanced technologies for coal utilization and a
separate ITC for certain specified industrial gasification projects. Under Title II of the Act, coal project development utilization is clearly the big winner.

* Most important of the incentives for renewables (particularly wind) is the extension of the production tax
“PTC” credits — as much as 1.9 cents/ kilowatts per hour through 2007. The much sought after investment certainty for relying on these subsidies is thus provided. As a result of technical provisions, these benefits are, however, harder to monetize or otherwise utilize for foreign investors, smaller companies without tax bases and private equity funds than they are for large utilities and other integrated companies.

* The scope of PTC availability extends now to seven categories of renewables including wind and “closed loop ,” biomass i.e., energy farms. It runs for ten years (for certain of those resources). While solar, however, must be put in service by 2005 to receive the PTC it does received a one time 30% investment tax credit with respect to equipment put in service in 2006 and 2007. Overall it is estimated that 19% of the tax benefits will go to renewables, i.e., a smaller piece of the economic pie, spread over a larger number of projects.

3. In the resulting market environment created, while there are incentives for forecast longer term breakthroughs by newer technologies, e.g., fuel cells, hydrogen, biocellulose ethanol, the traditional gatekeepers (utilities and oil company/ refiners)will continue to occupy a central position in determining the outcome. Federally sponsored R&D contemplated by the Act, while potentially importantly in individual cases, seems unlikely to be the source of these breakthrough technology bets.

* With incentives programs heavily weighted toward coal-based technologies, the residuum of  incentives available for breakthroughs technological innovation is limited.

* In the grab bag category for eligible loan guarantees, in addition to a variety of gasification projects are these available under Title XVII as a sop to those concerned with innovations in climate control, e.g., “sequestration” of pollutant gases from power plants, use of hydrogen fuel cell technologies and efficient electrical and end use energy technologies. The Federal Government will guarantee up to 80% of project costs — loans cannot exceed the lesser of 30 years or 90% of the physical useful life of projects.

4. As the insignificance of the Act‘s impact on actual fuel prices becomes deafeningly evident and the marginal economic value of its boost for electric power industry consolidation, rationalization and innovation becomes more evident, attention will shift to national fuel displacement strategies (other than coal or LNG)— or unfortunately, to geopolitical solutions. In the interim, as in the last Oil Crisis, attention to energy efficiency solutions, lightly alluded to notably in Title I of the Act, will receive greater emphasis.

* As the other “home grown” (besides coal) fuel, ethanol is the initial beneficiary of this emerging recognition though receipt of major excise tax and minimum refiner blending purchase requirements written into the Act.

* Longer term and more directed towards large volume displacements of foreign oil; loan guarantees for cellulosic biomass plants and for DOE finance of four demonstration projects will become of greater importance.

* Operating subsidies are also provided for cellulosic biofuels, starting with a cents per gallon formulation which then shifts to a reverse auction system in 2008.

What strategies does this suggest for merchant power men? Leave combined cycle gas plants behind; find enterprising coal processors and venture with them; hook up with smart structurers of tax deals which utilize renewable credits or start focusing on liquid fuels development opportunities. What do we call it: still energy.

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.