REP Round 2: Indexed-REC, Benchmark-REC or Something Else?

We will know shortly which renewable power projects were successful in Alberta’s REP Round 1 procurement for 400 MW of new renewable power. REP stands for the Renewable Electricity Program.  This program, administered by the Alberta Electric System Operator (AESO), is intended to encourage the development of 5000 MW of new renewable electricity generation capacity in Alberta between now and 2030.  REP Round 1 is therefore the first of what are expected to be many competitions, or Rounds of REP, for new renewable power projects.  In fact the AESO is expected to kick-off REP Round 2 at the same time or shortly after it announces the winners of REP Round 1.

The AESO has been clear to stakeholders that the terms and conditions applicable to REP Round 1 will not necessarily apply to REP Round 2.  So AlbertaPowerMarket.com is anxious to see what, if any, changes the AESO will make for REP Round 2.

Possible changes for REP Round 2 include the introduction of socio-economic factors (e.g. aboriginal and rural partnerships/involvement, municipal support) in the selection process, the introduction of longer in-service dates to reflect the fact that some renewable projects (e.g. hydro) take longer to construct, and a move away from the principle of technology-neutrality (lowest price wins independent of the type of project) to encourage the development of a mix of wind, solar and other types of renewable projects in Alberta.

The Canadian Solar Industries Association (CanSIA) is also asking the Province to reconsider its use of an Indexed-REC if the Province is going to maintain the principle of technology-neutrality in REP Round 2, i.e. not provide solar projects with a designated slice, or carve out, of the renewable generation capacity to be procured in REP Round 2.  CanSIA pointed out in a recent letter to the Alberta Minister of Energy, found here, that the Indexed-REC mechanism used in REP Round 1 does not recognize the relative value that the competing projects in a procurement provide to the Province. This CanSIA letter relies on a November 16, 2017 report titled “Assessing Alberta’s Renewable Electricity Program (REP): Solar Electricity, the “Indexed-REC” & Cost to the Carbon Levy” that was prepared by Blake Shaffer, a PhD candidate at the University of Calgary (Shaffer Report).

To understand CanSIA’s position one must first understand how the Indexed-REC works in REP Round 1. A successful proponent in REP Round 1 will be awarded a 20 year contract called a Renewable Electricity Support Agreement (RESA) with the AESO.  The RESA essentially locks in the price that the successful proponent will receive for all of the electricity generated by its new project over the 20 years. That price is called the “strike price”, and the winners of REP Round 1 will have bid the lowest strike price. It is important to note that under the RESA the AESO is only purchasing the renewable attributes of the electricity generated by the project, and not the actual electricity.  Accordingly, the successful proponent will, like all generators, sell the electricity it generates over the 20 years in Alberta’s energy market at hourly power pool prices. However, the RESA provides that if the power pool price received for that electricity from time to time is less than the strike price then the proponent will receive a top-up payment from the AESO equal to that difference (strike price minus pool price).  On the flip side, the RESA also provides that if the power pool price received by the successful proponent for that electricity from time to time is more than the strike price then the proponent will pay the AESO the difference (pool price minus strike price).  This is generally referred to as an Indexed-REC by stakeholders.

The problem with this Indexed-REC approach used by the AESO in REP Round 1 is that it selects the proponent who bid the lowest strike price without any assessment of the pool prices that its project will likely receive from the energy market for its electricity.  Hourly pool prices fluctuate in Alberta depending on the time of the day (higher in the daytime during so-called peak periods when more electricity is being consumed) and on the season (higher in summer according to the Shaffer Report). The criticism is that, if the AESO is going to pay or receive money depending upon the pool prices that a project will receive in the energy market, then the time (both hour of the day and the season) when a project is likely to generate its electricity should also be factored into the AESO’s selection decision.  It should not simply be the project that bid the lowest strike price because this may actually result in the AESO having to pay more money (higher top-up payments) to that project in respect of its generated electricity than it would actually pay to a project that bid a higher strike price.

This flaw in the Indexed-REC approach is compounded by the fact that in Alberta the best wind resource is in Southern Alberta.  Accordingly, this is where the bulk of the existing wind farms are located. It is also where most people think the winning project(s) in REP Round 1 will be located because those wind farms will have the highest capacity factors.  The problem is that this concentration of wind farms all come on line and generate electricity at the same time when the wind begins to blow in Southern Alberta.  This concentrated supply coming on at the same time depresses the pool prices that these projects receive from the energy market. Throw in the fact that the wind often blows in the evenings, when pool prices are lower, and it is not surprising that Alberta wind farms capture lower pool prices in the energy market than other forms of generation. AlbertaPowerMarket.com has previously explained why this phenomenon, called the “Alberta Wind Discount”, occurs here.  Importantly, for this discussion, any winning wind farms in REP Round 1 will be insulated from the Alberta Wind Discount because of the use of the Indexed-REC mechanism in the RESA.  Those wind farms just need to generate as much electricity as they can because the AESO bears the pool price risk, including the adverse effects of the Alberta Wind Discount.

CanSIA’s position is that the Indexed-REC mechanism used in REP Round 1 prejudices the utility-scale solar projects proposed by CanSIA’s members because those solar projects receive no credit for the fact that they generate electricity during the day, and more in the summer months, when pool prices in Alberta are higher.  Economists would say that in Alberta the generation profile for solar projects is positively correlated with power pool prices, while the generation profile for wind farms is negatively correlated with power pool prices, but none of this matters under the Indexed-REC approach.  For example, the Shaffer Report concludes, using 2013 to 2016 market data, that a solar project which bid a $90/MWh strike price in REP Round 1 would result in the same aggregate cost to the AESO as a wind project that bid a $50/MWh strike price in REP Round 1.  Of course, under the Indexed-REC mechanism, where the winner is chosen solely based on the lowest strike price bid by a proponent, the solar project would not win because it would have to bid a strike price that was lower than the strike price bid by the wind project. Schaffer therefore recommends that the AESO rank projects based on the highest net benefit based on both value (reflected by the pool price) and strike price – not just strike price.

One problem with trying to include pool price, and not just strike price, in the selection process is that this would require the AESO to model and forecast the relative pool prices that each project is likely to earn for its electricity over the 20 year term of the RESA.  That model would be complex, and involve the AESO forecasting for 20 years the likely hourly distribution of pool prices, and the likely timing (hour of day and season) for the generation for each competing project based on wind patterns, water flows and solar irradiance.  That model would be controversial, and open to criticism and legal challenge by an unsuccessful project proponent.  These factors do not exist when the AESO simply picks the competing renewable project with the lowest strike price.

One way that the pool prices likely to be earned by the competing projects could be reflected in the selection process is for the AESO to change from the Indexed-REC to the “adder” approach that was recommended in the 2015 Climate Leadership Report. Instead of bidding a strike price for an Indexed-REC, proponents would bid a fixed amount ($/MWh) that they need, in addition to the power pool prices they expected to earn in the energy market, to support their renewable projects.  That approach, whereby proponents assume all of the power pool risk in exchange for receiving a fixed top-up payment from the AESO for each MWh they generate, was rejected by the Province for REP Round 1, because it would result in unacceptable higher bid prices for many reasons.

Another alternative to the Indexed-REC is described in the Shaffer Report as a “Benchmark-REC”. According to Shaffer, it is similar to the Indexed-REC in that proponents continue to bid a strike price into the procurement.  However, the payment to be made by the AESO to the successful proponent or by the successful proponent to the AESO is not based on the difference between the strike price and the actual pool price received from time to time in the energy market by the proponent for its project’s renewable electricity.  Instead, the true-up is to a weighted average pool price that is received in the energy market at that time by a benchmark set of facilities.  That punishes generation facilities that earn pool prices in the energy market for their electricity that are less than the weighted average pool prices earned by the benchmark of facilities.  The benchmark might be a mix of different types of generation facilities, or be technology specific, e.g. a basket of geographically dispersed wind farms.  As Shaffer notes, the Benchmark-REC first mitigates general pool price risk for project proponents, like the Indexed-REC does, but the Benchmark-REC then incents generators to “beat the benchmark” by generating in hours (time of day and season) with higher pool prices.

A final alternative may be to run a procurement that has specific locational requirements.  For example, a requirement that some of the procured capacity come from wind farms located outside of Southern Alberta.  This would be supported by the fact that existing wind farms outside of that area (e.g. around Red Deer) capture a higher power pool price than those concentrated in Southern Alberta (e.g. around Pincher Creek).  Encouraging such geographic diversification might also help, in the long run, to maintain social acceptance of wind farms, and reduce the intermittency of the generation from this source by tapping into different wind patterns.

CanSIA is correct to point out to the Alberta Minister of Energy that there are alternatives to the Indexed-REC approach used in REP Round 1, especially given that it adversely affects CanSIA’s members.  That said, the Renewable Electricity Program is in its infancy here in Alberta. By all accounts, REP Round 1 has been a competitive success with about 4000 MWs of qualified projects competing for the 400 MW to be awarded in the procurement.  The buzz in the market is that winning strike prices will be in the low $50 range, and we even heard someone suggest at a recent industry conference that we might see a high $40 strike price come out of REP Round 1.  That will be a good news story for the Government of Alberta.  The Province has also promised some consistency, at least in the timing and size of the procurements.  Therefore our prediction is that the AESO will stay the course and we will see the Indexed-REC used again in REP Round 2.  But one never knows so, like others, AlbertaPowerMarket.com is anxious to see what, if any, changes the AESO will make for REP Round 2, including whether we will see an Indexed-REC, Benchmark-REC or something else in REP Round 2.

Kent Howie and Peter Bryan

Kent and Peter both practice in the Electricity Markets Group at the Calgary, Alberta office of the national law firm Borden Ladner Gervais LLP. The views expressed in this article are the personal views of the authors, and not the views of Borden Ladner Gervais LLP.

 

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