A Solar Renewable Energy Credit, often referred to as an SREC, represents the renewable component of 1 megawatt hour of power production generated from a solar photovoltaic system.
The Solar Renewable Energy Credit (SREC) Program
Gabe Phillips | GP Renewables & Trading
Can you elaborate a bit on what SRECS are, generally, and how / why they differ from state to state?
A Solar Renewable Energy Credit, often referred to as an SREC, represents the renewable component of 1 megawatt hour of power production generated from a solar photovoltaic system. The advent of state-level laws called Renewable Portfolio Standards (RPS) have enabled these renewable components to be sold separately from, or together with, the physical electricity from the system.
As intangible commodities, SRECs are a market-based, policy tool created to increase the financial viability of Solar PV. They do this by providing solar an additional revenue stream to what is available to other forms of electricity generation.
Since SRECs are created, defined, and regulated by each state’s RPS, their characteristics can differ from state to state.
New Jersey has been one of the fastest growing solar markets, fostering what many call a “gold rush” mentality, how did this come about?
The Garden State’s solar capacity is the second highest in the nation with over 1000 Megawatts of installed solar generation, behind only California. At the time they were introduced, the incredibly high value of SRECs was heavily driven by aggressive state and local policy measures and penalty prices intended to spur solar development. On top of that, banks and other investors provided financing for new projects predicated upon expected future SREC revenues at those same high prices. Early on in the SREC program, investment decisions in NJ solar seemed easy to make.
Generally, there were two key factors making investments in NJ solar seem easy:
- The 1603 tax grant, which was a check from the US treasury department for 30% of the total cost of the installation, expiring at the end of 2011. This was relatively simple to take advantage of and any investor could utilize it.
- SREC demand exceeded supply during the program’s infancy fostering a high-price environment. The price eventually increased enough so that SRECs traded on the spot market at close to the “ceiling” price – an amount predetermined by the state through a compliance penalty mechanism – while long term futures contracts were trading at relative bargains at a discount to the spot price, they were still trading a t levels that made solar projects easily financeable. These SREC prices were assumed by many participating in solar investments to remain unchanged for the duration of the solar investment; an assumption supported by many of the aggressive installation companies throughout the state that were also unaware of where the futures market was trading and prudent commodity risk management practices.
These significant assumptions led many installers and unsophisticated investors to ignore the need for hedging their investments with SREC futures contracts. Across NJ’s solar investment market this misinformation was dispersed without proper disclosure as speculative solar investors honed in on dollar signs while ignoring risks. The “gold rush” ensued.
The volatility of the New Jersey solar market has been discussed with frequency, why is the Garden State’s market so different from other states?
There are a few reasons the NJ SREC market has been viewed as more volatile than the markets in other states. Some states have done little to change their RPS rules (like Pennsylvania) since inception and some states have made legislative programs that take years to play out (like Massachusetts).
For one, NJ has its own internally generated volatility, partly caused by the hyperactive nature of NJ solar legislative activity. There are constantly new laws proposed, rejected, passed, implemented, and altered which reflect the powerful competing lobbies and zealous legislators in the state. Examples of these proposed law changes include: changing compliance obligations for retail suppliers (the entities that are legally obligated to buy SRECs); adding incentives for projects sited in specific locations such as closed landfills; imposing penalties for projects located in areas such as farmland; stringent metering requirements; and procedural changes that only favor residential sized projects.
Additionally in NJ, due to the complexity of the laws and the large number of SREC stakeholders, regulatory interpretation is often times false and disseminated quickly. This, in turn, leads to drastic market moves and corrections causing a constant push and pull in the market due to potential impact on SREC values.
The diversity of participants in NJ has allowed for a market environment in which there are a range of opinions being communicated through pricing and reflected in trading strategies at all times. In NJ, SRECs can typically be bought or sold in large volumes for durations ranging from 1 to 5 years at prices very close to recent transactions. This market pricing generally holds, until major legislation is proposed. While it seems to be more volatile, the relative liquidity compared to the other solar markets discussed and increased price discovery allows the NJ SREC market to function much more effectively as a hedging tool for market participants than in MA or PA for example.
Where were SRECS trading when the New Jersey solar market was created and where have they traded since on a spot forward basis?
In 2009, the spot market traded close to $700. In 2011, they were trading at around $600 in the spot market and just over $400 for 3-5 year strips. They traded as low as $75/SREC on a spot basis in the summer of 2012 while 3-5 year contracts were trading around $100/SREC. Now, NJ SRECs are trading around $130 for 2013 spot SRECs and $135 or so for 3-5 year contracts.
What can New Jersey-based owners of existing projects do now to rectify their situations?
A number of system owners have either found themselves upside-down on their solar PV investments in NJ, or have found themselves in over their heads managing time consuming, complex activities for generating SREC revenues to help recoup their solar investment.
There are two possible options:
- Small- to medium-sized system owners can consider selling the system itself to an interested and qualified third party purchaser. A qualified purchaser would be a party who can not only package and sell the electricity generated by the system back to its original owner in a Power Purchase Agreement (PPA), but one who can also generate additional value from the SRECs that are created in association with the electricity production. For an existing system owner to reap benefits in this way, the third party purchaser would acquire the system from the owner and then sell back the power generated through a PPA.
- Another alternative, similar in appearance for the existing system owner, would be to sell the system to a purchaser able to structure a lease for the generating equipment as a way of financing or refinancing the initial investment of the initial owner.
These solutions allow the current owners to recoup an upfront payment on the costly investments made when the system was installed by providing a lump-sum payment at the time of system sale along with a discounted power price into the 10 to 15 to 20 year horizon. Each situation is unique and options for system owners can be tailored and are dependent on the third party stepping in. In certain cases, arrangements for SREC revenues can be built into an agreement, whereby both the initial owner and the third party acquirer can share in upside from that party’s ability to generate additional revenue from the SRECs when compared to the initial owner alone. At GP Renewables, for example, we evaluate system purchases on a case by case basis, tailoring the final agreement based on the company we’re working with and its specific situation.
How is the New Jersey solar market indicative of what could happen in other markets? And should this matter to owners of existing projects in other states?
What has occurred in the NJ SREC market is absolutely indicative of what could, and has, happened in other markets. At the beginning of each SREC program, they were grossly undersupplied and SRECs traded at levels close to the compliance penalty. Subsequently, as building activity picked up, the market dropped and the average solar investor had done nothing to hedge their risk. Now, these investors are holding something that was predicated on a set of factors (high SREC prices) that turned out to be false, the risk of which could have been mitigated if any hedging had been done.
The key differentiator in NJ, is that what has happened there is actually indicative of what could and should happen in other markets if additional elements to the market design were not added that negatively impacted the SREC market’s ability to reach an equilibrium at a level that sophisticated solar investors can use to finance projects. In markets such as MA, where a floor mechanism was put into place in conjunction with an auction meant to make it easier for unsophisticated participants to invest in solar, liquid markets can never develop making it difficult for participants to actually hedge their SREC risk and make sound investment decisions. In markets such as PA, where SRECs from any state in the PJM footprint were allowed to qualify without any regard for other potential subsidies they were receiving, the SREC market is bound to crash and create no additional value for new projects going forward.
NJ has not added additional constraints for the market itself and the market has settled at equilibrium levels that were indicative of the value needed to make projects financially viable.
Is there a better solution going forward?
In order to allow both unsophisticated homeowners and more sophisticated investors to invest in solar, a hybrid mechanism needs to be utilized. The unsophisticated investor, the homeowner, needs some way to subsidize an investment in solar and the simplest is a state grant of some kind which doesn’t require that homeowner to navigate SREC market risk.
For larger projects or commercially owned projects, which hypothetically would be built by more sophisticated investors, market places for RECs and SRECs must be created and regulated with proper oversight while reducing complex and burdensome regulatory interventions, much like the NJ SREC market is today (aside from the hyperactive legislation in the state causing short term market volatility).
How do you see the solar industry evolving over the next 5 to 10 years in the US?
The future of the solar industry is difficult to predict because of its close ties to policy drivers. Any changes to renewable policies at the federal, state or local level will have a major impact on the market’s evolution.
In the mid-term it’s foreseeable that a number of incentives, such as investment tax credits and bonus depreciation, will be phased out. What is likely to continue, however, is decreased costs associated with solar such as procurement, installation, operations and maintenance and insurance. Lower associated costs will move solar power closer to grid parity, eventually causing less reliance on policy mechanisms like SRECs and tax credits.
As for the bigger picture – as solar approaches grid parity, the technology will be more widespread across the United States. In the near term, distributed (on-site) solar will become pervasive on residential and commercial levels and over the longer-term this will scale to the utility level. As this development progresses, the market evolution will require more sophisticated investors and more economically sound projects to draw interest of qualified participants with less reliance on incentive programs.
Gabe Phillips, CEO, GP Renewables & Trading
After working for more than five years at premier energy trading firm Sempra Energy Trading, in mid-2010 Gabe left to start GP Renewables & Trading in order to better serve the community of participants in all corners of the energy markets. GP Renewables & Trading is a multifaceted energy services company that combines energy management consulting, project development, and commodity risk and operations management to provide a full array of services to clients in the North American wholesale, retail, renewable power and natural gas industries.
At Sempra, Gabe traded a portfolio of financial and physical power and natural gas positions spanning every ISO territory in the continental United States. He held several positions at Sempra before his final position as a trader on the East Coast Term Power Desk, including responsibilities in areas such as Business Analysis, Credit & Collateral Management, Power Scheduling and Real Time Trading.
Gabe holds a B.S. in Engineering Mechanics with a concentration in Robotics from the Johns Hopkins University Whiting School of Engineering.
The content & opinions in this article are the author’s and do not necessarily represent the views of AltEnergyMag
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