Ontario's Feed-In Tariff

Deck: 

Can a European-style renewable model work in the Americas?

Fortnightly Magazine - October 2009

The Province of Ontario, Canada is the first jurisdiction in North America to implement a European style feed-in tariff (FIT). It also was the first jurisdiction in North America to have a comprehensive standard-offer program for electricity supply from renewables.

The renewable energy standard offer program (RESOP) was the subject of a Fortnightly article published in December 2008.1 At that time, the program had been suspended and was under review because, although more generation was offered than had been anticipated,2 several problems had emerged. Some problems came from the sheer size of the response: Distribution utilities couldn’t cope with the volume of connection applications and T&D systems couldn’t absorb the new generation. A related problem was that developers had no financial commitment so they could treat contracts as a free option, hoarding connection queue positions while not progressing on project development. This is a significant issue given that the attractiveness of standard-offer rates varies with changes in foreign exchange rates because a high proportion of project costs are likely to be denominated in foreign currencies, which have varied by over 20 percent in the last 12 months. Finally, the vast majority of contracts were held by commercial developers, so community groups that had advocated for the development of a standard offer or feed-in tariff couldn’t, in many instances, secure the connection they needed for contract award.

During the RESOP review, a new Ontario energy minister travelled to Germany, Denmark and Spain and was impressed with the success of those countries’ FIT programs. They built a large amount of renewable generation, attracted companies to manufacture the generation equipment and positioned these companies to become technology leaders. The German government reports more than 214,000 people are employed in the country’s renewable energy sector, with the FIT a major contributor to this level of economic activity.3

As a result of the minister’s interest, the province of Ontario formed a committee composed of government electricity sector agencies4 to design a FIT and address many of the barriers to renewable project development that became apparent under the RESOP.

FIT vs. Standard Offer

While in some ways quite new, the government’s enabling legislation, the Green Energy and Green Economy Act (GEGEA), returns to a previous practice of using the electricity supply industry as a tool of economic development. The government stated its objectives in the preamble to the GEGEA: “The government of Ontario is committed to fostering the growth of renewable energy projects, which use cleaner sources of energy, and to removing barriers to and promoting opportunities for renewable energy projects and to promoting a green economy.”5

In addition to its energy policy directions, the GEGEA advances other policy objectives, such as promoting industrial development in the production of equipment for renewable energy, to replacing lost activity in the automotive sector and assisting in development of aboriginal and community groups.

The FIT is to be a key instrument to accomplish these goals. The GEGEA allows the minister to set minimum Ontario content requirements and to direct the Ontario Power Authority (OPA) to find ways, including funding programs, to facilitate participation by aboriginal and community groups in development of new renewable energy facilities or transmission or distribution. FIT implementation is carried out by OPA, which is the electricity planning and procurement agency for Ontario. The OPA performs all procurement under both the previous standard-offer program and the proposed FIT.

The difference between FIT programs and standard-offer programs is the basis for pricing the electricity from renewables. Standard-offer programs rely on value-based pricing (e.g., avoided costs or prices established by a request for proposal or auction process regarding the value of renewable generation); FIT programs use cost-based pricing. In the Ontario standard-offer program all forms of renewable generation (except solar photovoltaic) received the same price of $110 per MWh.

The price in FIT programs is based on the cost of the renewable generation being procured and is calculated to allow a typical facility to recover its cost plus a “reasonable” rate of return. Since cost varies with the kind of renewable generation and project size, prices in FIT programs typically are differentiated according to the kind of renewable generation offered (for example, wind vs. solar) and in many instances the size of the project. The key is to identify generation types and sizes with different cost structures and determine the cost (and therefore FIT price) for a typical installation. A second element of many FIT programs is a long-term schedule of prices that specifies how these prices will change over time. This provides equipment manufacturers with the certainty needed to make investment decisions essential to realizing the economic development benefits offered by a FIT.

By using cost-based pricing, the expectation is that a FIT will attract a more diverse range of technologies than a similar standard-offer program and will help Ontario achieve its economic development goals.

The OPA enunciated four goals for the Ontario FIT program: increase capacity of renewable energy supply to ensure adequate generation and reduce emissions; simplify the method to procure and develop generation; create new green industries through new investment and job creation; and provide incentives for investment in renewable energy technologies.6

Among these priorities, OPA gives economic-development goals almost equal importance with the electricity supply and environmental goals. The FIT design and the GEGEA sought to promote these goals and address the identified failings of the RESOP.

Ontario FIT Design

In addition to avoiding the problems of the past, the design of the FIT had to address the challenges unique to the FIT itself. The main such challenge is getting the various prices right. Too low a price won’t increase renewable energy supply; too high a price can attract more renewable generation than the system needs or can afford. Spain’s experience is a case in point. With a high FIT rate, in one year Spain committed to $26.4 billion in payments for solar power, forcing a change in the program. Spain had no cap and no adjustment for the FIT rate as photovoltaic costs declined (see “Spain’s Solar Market Crash Offers a Cautionary Tale About Feed-in Tariffs,” New York Times, Aug. 18, 2009). The balance on pricing must be maintained for all of the forms and sizes of generation to be included in the FIT program.

To balance the risks associated with setting such a price, the costs and operating performance of renewable resour-ces must be well understood and subject to limited variation. For example, for technologies where there is limited construction or operating experience, establishing a reasonable FIT rate is challeng- ing. The renewables to be evaluated were chosen based on the known resources in Ontario and on the kinds of generation that were offered to the RESOP program. The chosen technologies were on-shore wind, off-shore wind, several sizes of ground and roof-mounted solar PV, waterpower, biomass, biogas and landfill gas. All the technologies included plants of more than one size except for on- and off-shore wind. The prices were based on an analysis of cost for each renewable resource with the best available public information. The analysis used a discounted cash-flow model. Financial assumptions included a debt-to-equity ratio of 70 to 30 and an after-tax return on equity of 11 percent.

Projects that had a previous contract with the OPA, including RESOP contracts, aren’t eligible to participate in the FIT. This prevents developers from abandoning contracted RESOP projects in order to receive the higher prices offered by the FIT.

Consistent with the objectives of the GEGEA, community-based and aboriginal groups receive higher prices for their projects. The premiums compensate for these groups’ higher costs due to such factors as their likely higher borrowing costs and their need to borrow for the equity portion of their investment; their need for more extensive consultation within their own groups and consequently longer lead times; and their different financing structures, including an inability to take advantage of favorable tax treatments.

Unlike the practice in many European FITs, the Ontario prices do not decline over time. However, FIT pricing will be reviewed every two years and adjusted based on the market response and changes in technology costs (see Figures 1 and 2).

Program Rules

The FIT rules address the lack of a financial commitment by RESOP developers. The FIT has a non-refundable application fee of $500 per MW, plus application security requirements totaling $20,000 per MW of solar PV, $10,000 per MW for other technologies, and $5,000 per MW for projects proposed by aboriginal or community groups. This security is forfeit if the proponent accepts a FIT contract and doesn’t build the facility, unless excused by force majeure.

At the time of signing the FIT contract, the applicant must post additional security totaling half the amount of the application security. This security is returned to the applicant after the commercial operation date.

Contract terms (except for water power) are 20 years. Given the longer life of hydroelectric facilities, water power contracts are for 40 years.

To avoid the problem of developers indefinitely holding queue positions, failure to meet a milestone completion date for operation carries the penalty of a reduced period for collecting contracted prices.

A major problem for most FIT programs, and in general for development of generation from renewables, is access to the distribution or transmission grid. Grid access was a major issue for RESOP. The GEGEA addressed these difficulties by stating that T&D providers must connect renewable projects that request it. Any needed large upgrades will be paid for by all electricity consumers in Ontario, not just those of the particular transmitter or distributor.

This requirement could lead to connections that clearly aren’t economic, such as building many kilometers of connecting line for a 10 MW project. As part of the FIT design, therefore, the OPA has devised a process to determine whether a required upgrade is economic or not.

Projects that can connect immediately can move through contract and connection stages directly. Projects that can’t be connected immediately are subject to an economic connection test with others in the same area. This test is intended to determine whether it’s economic to expand transmission or distribution facilities to accommodate FIT program applicants. If transmission expansion for a project is economic, it’s placed in a queue called the FIT production line. However, the first time the project is included in an economic connection test as a resource in the FIT production line, 10 percent of its applica- tion security is placed at risk; another 5 percent is placed at risk with each subsequent economic connection test. This process makes implementation of projects in the queue more certain so the OPA can include them in its integrated system plan. Also they’re used by T&D planners to establish the need for grid upgrades.

Projects that fail the economic connection test are placed in the FIT reserve. Projects are checked every six months for potential inclusion given changing conditions of access. Proponents can withdraw from the FIT reserve and get back the entire application security.

The Ontario content requirements haven’t yet been published, even in draft form. They could affect the design or equipment choice for some projects. Probably the government will start with less stringent requirements and gradually tighten them as provincial resources develop.

FIT in the United States

In May 2009, the Vermont legislature implemented the country’s first state-wide set of feed-in tariffs.7 The program explicitly seeks to encourage the “rapid development” of renewable energy projects. It will cover renewable energy systems with capacity up to 2.2 MW, sets a cap of 50 MW, and allows contracts for power purchases of 10 to 20 years.8

The bill sets interim prices at 12 cents/kWh for methane derived from landfills or agriculture, 20 cents/kWh for wind power less than 15 kW, and 30 cents/kWh for solar power. Additionally, systems greater than 15 kW using wind, hydro, or biomass energy will receive prices equal to average residential rates (about 12.3 cents/kWh).

The Vermont Public Service Board was directed to review and amend these interim prices if they don’t “constitute a reasonable approximation of the price that would be paid” based on the technology’s cost, available tax credits and other incentives, and return on equity no less than that received by a Vermont investor-owned retail electric service provider.

In March 2009, Gainesville Regional Utilities (GRU), the state’s fifth-largest municipal electric utility, implemented the first solar feed-in tariff in the United States. For 2009 and 2010, GRU purchases excess solar power generated by customers at a fixed rate of 32 cents/kWh for 20 years. For contracts entered after 2010, the rate gradually decreases from 30 cents in 2011 to 23 cents in 2016. The program sets a soft annual cap of 4 MW. The purchase rate was set to provide a 5-percent return on large-scale investments.

The Gainesville program has been oversubscribed. In February, a month before the program launched, GRU announced it had reached its targeted 4 MW-cap for 2009. By early March, it already had sold out contracts for 2010 and now has received enough applications to fulfill all contracts through 2014.

Ontario’s experience with RESOP and Gainesville’s experience with its solar program illustrates the difficulty of accurately establishing prices that provide sufficient, but not excessive, returns to incent renewable-project development at a level that reasonably can be incorporated into the grid. Given the relatively low return target, it’s possible that Gainesville’s response level was significantly influenced by customers valuing the environmental attributes of solar power. Ontario’s RESOP experience also illustrates the dangers of having programs without sufficient financial commitments. For such programs, consider- ation needs to be given to strategies for addressing the integration of the renewable generation into the system. Ontario’s approach of considering connection and reinforcement costs as part of the selection of viable projects holds promise.

FITs are not necessarily appropriate for all jurisdictions. The stability provided by the FIT was needed to allow Ontario to compete with the United States for the jobs from renewable energy-technology manufacturers. The various renewable portfolio standards implemented by 29 states plus Washington, D.C., create demand for over 70,000 MW of renewable energy by 2020, and the American Recovery and Reinvestment Act of 2009 allows renewable project developers to convert the production tax credit to an investment tax credit or grant covering up to 30 percent of the project’s qualifying costs. Transportation costs for wind turbines and other logistical considerations make locating these manufacturing facilities close to the ultimate market desirable, so this demand represents a strong draw for manufactures. The stability offered by FIT was essential given the smaller size of the Ontario market relative to the United States.

 

Endnotes:

1. Forrest Small and Mitchell Rothman, “Ontario’s Standard Offer,” Public Utilities Fortnightly, December 2008.

2. The Ontario Power Authority’s (OPA) informal expectation was 1,000 MW of capacity over 10 years. As of the first quarter of 2009, the OPA had 1,412 MW under contract in the RESOP program, but only 107 MW in service. Of the contract totals, about 52 percent is for wind capacity and 38 percent for solar PV. Of the in-service capacity, almost 2/3 is wind and under 2 percent solar PV.

3. German Federal Ministry of Economics and Technology, Renewable Energies in Germany – A Success Story.

4. Led by the OPA, it included the Independent System Operator, the Ontario Energy Board, Hydro One (the transmission utility) and the Ministry of Energy and Infrastructure. Power Advisory LLC acted as a consultant to the OPA for the committee and the subsequent multi-stakeholder process.

5. Queen’s Printer, Bill 150, Preamble, pg. 4.

6. Ontario Power Authority, Feed-in Tariff Home page.

7. The legislation calls it a standard offer, but the rates are cost-based and differentiated by technology, so it is more appropriately a feed-in tariff.

8. Contracts for solar power may span 10 to 25 years.