Foley & Lardner LLP: Energy Industry Updates for March 2011

Foley & Lardner LLP: Energy Industry Updates for March 2011

Foley & Lardner LLP  

By Foley & Lardner LLP

An Uncertain Future for the DOE Loan Guarantee Program

As discussions heat up over how to reduce the deficit in the current fiscal year, many eyes are on the loan guarantee program administered by the U.S. Department of Energy (DOE). A recent proposal from the House of Representatives essentially would cut $2 billion of the current $2.5 billion loan guarantee appropriations because, to date, only $500 million in loan guarantee funds have been obligated to specific projects.

The DOE loan guarantee program was created as part of the Energy Policy Act of 2005. Sections 1703 and 1705 of the American Recovery and Reinvestment Act of 2009 (ARRA) provided for loan guarantees, and ARRA appropriated $6 billion to the DOE loan guarantee program. That initial $6 billion appropriation was later reduced to $2.5 billion — Congress reallocated $2 billion to the “cash for clunkers” program and $1.5 billion to state aid.

DOE estimates that the $2.5 billion loan guarantee program can guarantee up to $71 billion in loans. The loan guarantee program leverages federal dollars by allowing the DOE to guarantee the debt of privately owned clean energy developers and manufacturing companies instead of providing grants or tax subsidies. Section 1703 loan guarantees are available to encourage commercial use of new or significantly improved energy-related technologies, while loan guarantees issued under Section 1705 cover renewable energy and electric power transmission projects. In essence, the loan guarantee program covers the credit subsidy cost for loan guarantees for renewable energy, advanced biofuels, and upgrades to the nation's transmission system.

To date, 10 loan guarantees have been issued, and there are an additional 10 "conditional commitments." However, funds set aside for conditional commitments technically have not been “obligated” and may fall victim to proposed cuts of the loan guarantee program. Apart from talks of budget cuts, DOE's loan guarantee program has recently come under fire for insufficient due diligence and record keeping, as covered in a report by the Inspector General published on March 3, 2011. Nonetheless, proponents of the loan guarantee program posit that the program provides an essential financing tool for bringing emerging technologies to market scale. Regardless of the outcome of the negotiations for the current fiscal year, President Obama's budget proposal for 2012 allocates $200 million in funding to the loan guarantee program, a marked decrease.

New Jersey Program Aims to Promote Development of New Baseload Generation

Three new natural gas generation facilities appear likely to be constructed in New Jersey as a direct result of a new state law. The Long-Term Capacity Agreement Pilot Program (LCAPP), signed into law by New Jersey Governor Chris Christie on January 28, 2011 aims to spur new baseload and mid-merit capacity in the state in hopes of reducing ratepayer costs.

Proponents of the LCAPP law have pointed to auction clearing prices for capacity in New Jersey being as high as nine times the same price in other parts of PJM's territory as a driving force for its adoption. While related controversies at FERC have arisen over capacity prices and rules, in New Jersey, the LCAPP program offers developers of approved projects a guaranteed capacity price for a period of up to 15 years, limited by law to 2,000 megawatts of new generation.

The projects benefitting from the law have now been identified. Pursuant to the LCAPP law and a February 10, 2011 order of the New Jersey Board of Public Utilities, the process involved the state's four public electric utilities retaining an agent to evaluate and recommend proposals. On March 21, 2011, that agent released its final report recommending that the utilities enter into Standard Offer Capacity Agreements with three projects (from 34 original submissions), guaranteeing the developers of those projects a set price for the maximum term of 15 years. All three of the projects selected by the agent are combined cycle natural gas facilities located in Northeastern New Jersey and are expected to generate between 625 megawatts and 665 megawatts. Each is expected to begin operating in 2015 or 2016. The Board of Public Utilities approved of the agent's recommendations on March 29, 2011, and the utilities will now begin the process of signing contracts with the selected generators.

FERC Demand Response Order: LMP Payments for Usage Reductions

In a divided opinion, FERC recently issued its long-awaited order on demand response compensation in organized markets. The order allows demand response resources in wholesale energy markets administered by RTOs/ISOs to be compensated based on locational marginal pricing (LMP) in certain situations.

Specifically, demand response resources can qualify for LMP-based compensation if they clear security-constrained dispatch and satisfy a net-benefits test. The rule requires RTOs/ISOs to pay demand response resources the LMP as long as the dispatch of the demand response resources results in overall cost savings.

That is, demand response resources are generally compensated like generation, but only when the demand response resources are economical to dispatch. FERC found that this distinction from generation was necessary because of the “billing unit effect.” The billing unit effect occurs when the dispatch of a demand response resource reduces load more than the LMP of energy; the net effect is that the reduced consumer load could result in higher costs overall if the load drops faster than the price. In short, under FERC's rule, demand response resources would not be paid the LMP when utilizing demand response resources would not provide a net benefit to the market.

Market participants heavily debated the new rule during the past year, with generators expressing concern over losing revenue (and thus incentive to develop additional generation). Demand response providers generally support the new rule, but believe that the net-benefits requirement should not have been imposed because it does not treat demand response comparably to generation.

FERC Commissioner Moeller dissented from FERC's opinion. He argued two major points: first, that certain customers could receive a “double payment.” This would occur when a customer could reduce energy use and (i) save money by not paying for the unused energy, and (ii ) receive the full LMP for its energy by acting as a demand response resource. Second, Commissioner Moeller pointed out that FERC's original goal was to treat demand response resources comparably to generation, yet generation did not have to undergo a net-benefits test before receiving compensation.

Each RTO/ISO must make a compliance filing by July 2011 to demonstrate how it will implement the new rule, including the methodology it will use to calculate the net benefits of dispatching demand response resources. Demand response aggregators will be watching the rules for this new market opportunity closely.

Authors and Editors

Ronald N. Carroll
Washington, D.C.

Thomas McCann Mullooly
Milwaukee, Wisconsin

Jeffery R. Atkin
Los Angeles, California

Andrea J. Chambers
Washington, D.C.

William D. DuFour III
Los Angeles, California

John T. Dunlap
Milwaukee, Wisconsin

Trevor D. Stiles
Milwaukee, Wisconsin

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