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The Renewables Portfolio Standard:

How It Works and Why It's Needed

American Wind Energy Association

November 1997

What is the Renewables Portfolio Standard?

The Renewables Portfolio Standard (RPS) is a flexible,

market-driven policy that can ensure that the public benefits of wind,

solar, biomass, and geothermal energy continue to be recognized as

electricity markets become more competitive. The policy ensures

that a minimum amount of renewable energy is included in the

portfolio of electricity resources serving a state or country, and -- by

increasing the required amount over time -- the RPS can put the

electricity industry on a path toward increasing sustainability.

Because it is a market standard, the RPS relies almost entirely on the

private market for its implementation. Market implementation will

result in competition, efficiency and innovation that will deliver

renewable energy at the lowest possible cost.

How Would the RPS Work?

Renewable Energy Credits, or "RECs," are central to the RPS. A REC is a

tradable certificate of proof that one kWh of electricity has been generated by a

renewable-fueled source. RECs are denominated in kilowatt-hours (kWh) and are a

separate commodity from the power itself. The RPS requires all electricity generators (or

electricity retailers, depending on policy design) to demonstrate, through ownership of

RECs, that they have supported an amount of renewable energy generation equivalent to

some percentage of their total annual kWh sales. For example, if the RPS is set at 5%,

and a generator sells 100,000 kWhs in a given year, the generator would need to possess

5,000 RECs at the end of that year.

Investors and generators make all decisions about how to comply, including: the

type of renewable energy to acquire, which technologies to use, what renewable

developers to do business with, what price to pay, and which contract terms to agree to.

Generators decide for themselves whether to invest in renewable energy projects and

generate their own RECs, enter into long-term contracts to purchase RECs or renewable

power along with RECs, or simply to purchase RECs on the spot market. Only the bottom

line is enforced: possession of a sufficient number of RECs at the end of each year. The

REC system provides compliance flexibility and avoids the need to "track electrons."

Because the RPS applies equally to all generators, it is competitively-neutral.
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What Is The Government's Role Under the RPS?

Government involvement would be limited to certifying RECs, monitoring

compliance, and imposing penalties if necessary. The REC certification process would

apply to renewable producers who wish to certify their renewables output. Monitoring

compliance would require each generator to demonstrate ownership of a sufficient number

of RECs relative to electricity sales. For generators that are not in full compliance with the

RPS at the end of the year, the administrative agency would assess an automatic penalty

for each REC that the generator fails to produce as required.

The amount of the penalty should be several times what it would have cost to

purchase the RECs. A high penalty level makes the policy self-enforcing by avoiding the

need to resort to costly administrative and enforcement measures. It is modeled after the

federal SO2 allowance trading program, under which an automatic $2,000/ton penalty

(indexed to inflation) is imposed for each excess ton of SO2 produced. Because of the

high penalty associated with noncompliance, the EPA has not had to take any enforcement

actions -- it is far more economic for power plants to comply than not.

What Are the Efficiency Advantages of the RPS Approach?

First, the RPS avoids the administrative dissemination of funds by government

agencies, which can be bureaucratic and inefficient. In addition, government-administered

programs almost always impose artificial constraints of various types, which increases

costs.

Second, under the RPS, no renewable energy project is guaranteed a place in the

market. Unlike a one-time competition for funds, each project must continually compete

to keep its place in the market created by the standard. For example, existing projects and

technologies must compete with new ones, and project enhancements must compete with

greenfield projects.

Third, the certainty and stability of the renewables market created by a properlydesigned RPS will enable long-term contracts and financing for the renewable power

industry, which will, in turn, lower renewable power costs.

Fourth, least-cost compliance is encouraged through the flexibility provided to

generators who are subject to the standard: they can compare the cost of owning a

renewables facility to the cost of a REC/renewable power purchase package and to

secondary-market RECs. Those who are most efficient at generating renewable power

will end up producing it, and those who cannot efficiently produce it will purchase RECs

on the competitive market.

Finally, and perhaps most importantly, since large generation companies will be

looking to improve their competitive position in the market, they will have an interest in

driving down the cost of renewables to reduce their RPS compliance costs. They may do
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this by lending their own financial resources to a renewables project, by seeking out leastcost renewables applications, or by entering into long-term purchasing commitments. This

fosters a "competitive dynamic" that is not achieved with policies that involve direct

subsidies to renewable generators without involving the rest of the electric industry.

What Are the Key Design Details of an RPS?

As with any policy, getting the details right in the initial legislation is critical to the

policy's success. Three issues that are particularly important in designing the RPS are:

1. Defining "renewables." The definition must be limited to those resources and

technologies that are environmentally sound, that represent a small fraction of the current

resource base, and that need market support. Such a definition would include wind, solar,

biomass and geothermal resources.

2. Setting the level of the standard and its rate of increase over time. The level of

the standard must begin at, or very near, current levels of renewables (as defined) and rise

from that point.

3. Sunset date. The RPS should be "self-sunsetting" -- meaning that the RPS

policy sunsets when the price of RECs falls to zero, signifying that renewables are fully

competitive and integrated into the market. A self-sunset date indicates that the RPS is

intended to be a long-term policy.

For a lengthier discussion of these and other implementation issues, see AWEA's

"The Mechanics of a Renewables Portfolio Standard Applied at the State Level," and a

similar paper focused on a federal-level RPS, which can be found on AWEA's website

(www.econet.org/awea).

Why Is Renewable Energy Policy Necessary in Competitive Markets?

Even "perfectly competitive" markets have inherent imperfections that are

well-established in economic theory. The combination of the following market barriers

will serve as powerful hindrances to renewables:

 w Externalities: Fossil fuel generators pollute the air but do not have to pay for the

local, regional, and global damage caused by their emissions. Renewable energy

does not pollute but, in unregulated markets, will receive no credit for the damages

they prevent.

 w Public Goods: The price stability, environmental, and economic benefits of

renewable energy resources are ones that accrue to the public at large, not directly

to the purchasing consumer. This "free rider" phenomenon can be expected to

deter consumers from volunteering to pay a little more for renewables since their

purchase will benefit other, non-contributing consumers as much as it will them.
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Thus, while a "green market" of some size may develop, it is likely to be far

smaller than what is required to significantly diversify the nation's electricity supply

and than what might be expected given the strong public support that renewables

enjoy.

 w Transactions Costs: Under retail competition, there will be high transactions

costs associated with reaching consumers who are willing to pay for the public

benefits of renewables.

In addition, the market reality will be that -- absent the long-term contracts that

have supported virtually all existing renewable energy projects, but which will be very rare

in competitive markets -- investors will have very short investment horizons. In markets

that will be characterized by short-term energy sales and price volatility, investors will

prefer low-capital-cost technologies with short payback times. Financing for

capital-intensive renewable energy projects will be expensive and difficult to obtain, even

if they produce more cost-effective power over their lifetimes.

Without strong, long-term renewable energy policy, it is quite possible that the

amount of renewable energy serving the country could decline from current levels, rather

than increase as it should. The risk of such a possibility is too great to take, given the

importance of achieving a more diverse, economically and environmentally sound

electricity supply.

What is the Current Status of the RPS?

• The RPS Has Been Adopted by Legislatures or Regulators in Five States:

Adopted By Renewables Requirement Notes

Arizona Corporation

Commission

0.5%; takes effect in 1999, increasing to

1% in 2002

Solar only. Creates a 120-MW market

by 2002.

Maine Legislature 30%; takes effect in March 2000

Nevada Legislature 2/10ths of 1% rising to 1% by 2009.

Takes effect January 2001.

Half of the renewables must be derived

from solar resources.

Connecticut Legislature 0.5% takes effect in July 2000, increasing

to 1% by July 2002, 3% by 2006, and 6%

by July 2009

Increase must be supplied by solar, wind,

sustainable biomass, landfill gas, or fuel

cells.

Massachusetts

Legislature

Begins at existing levels as early as 2000;

grows by 1% in 2003 and 1/2% per year

thereafter to 2009.

Increased levels must be supplied by new

resources, including advanced biomass,

landfill gas, wind, solar, geothermal or

ocean technologies.

New Jersey Legislature 0.5% takes effect in 2001, increasing to

1% by 2006, then increases by .5% per

year to 4% by 2012

Two-tiered system: Class 1: solar, wind,

fuel cells, geothermal, ocean, landfill/

methane gas, and sustainably harvested

biomass. Class 2: hydro or resource

recovery facilities
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The RPS was Included in Four Major Federal Restructuring Bills during the 105th Congress:

Renewables Requirement*

Bill #, Author 2000 2001 2003 2005 2008 2010 2020 Notes

S. 237

Sen. Dale

Bumpers (DArk.)

 - - 5% 5% 9% 9% 12% Requirement rises to 12% in

2013. Large hydro eligible.

Applies to retailers.

S. 687

Sen. Jim

Jeffords (RVt.)

2.5% 3% 4% 5% 8% 10% 20% Increases 1/2% per year to

2005, then 1% per year to

2020. Hydro not eligible.

Applies to non-hydro

generators.

H.R. 1960

Rep. Ed

Markey (DMass.)

3% -- increases gradually -- 10% 3% requirement begins in

1998. DOE instructed to

increase req't gradually to

10%. Hydro not eligible.

Applies to generators.

H.R. 655

Rep. Dan

Schaefer (RColo.)

- 2% 2% 3% 3% 4% Hydro not eligible. Applies

to non-hydro generators.

Clinton

Legislation

- - - - - 5.5% - Energy Secretary determines

levels for 2005-2009. Hydro

not eleigable.

* Non-hydro renewables currently supply about 2% of the nation's power.

How Would a Federal RPS Relate to State RPS Requirements?

A "savings clause" in federal legislation would make it clear that the federal requirement is

a floor upon which states may build, not a ceiling. The Bumpers, Markey and Schaefer

bills each include such a clause.

For more information on the RPS, see AWEA's web page at http://www.awea.org/

or contact AWEA at (202) 383-2500.