The concept is simple enough: apply a monetary value to the collective environmental and social benefits from the electrical power generated at renewable energy facilities, and sell them. Yet, over the past four years, renewable energy credits (RECs) have had little impact on energy production and financing. Now, the market for RECs is just about as hot a topic as global warming.

Social, political, and economic forces are finally converging to create the ideal market for RECs (also known as tradable renewable energy credits, TRCs, or green tags). Will 2005 be the year that distributed renewable energy producers cash in on RECs? Many industry leaders say yes. After all, greenhouse gas is a worldwide concern. And one REC generally represents 1 megawatt-hour of renewable, carbon dioxide—free electricity, displacing 1 megawatt-hour of electricity from carbon-laden fossil fuel. It's a benefit with universal appeal, and a cost-effective solution for energy producers and consumers under government mandate to reduce carbon dioxide emissions.

"The good news is this is a huge market about to go global," says Peter Fusaro, chairman and founder of Global Change Associates Inc., an international energy and environmental consulting firm. Research from the World Bank echoes Fusaro's predictions. A review of the global carbon market found that the volume exchanged on the carbon market has more than doubled since 2002, with more than 70 million tons of carbon dioxide traded as of November 2003.

Fusaro has touted the benefits of RECs as a consultant, and, since 2002, as organizer of Global Change's Annual GreenTrading Summit. Buying RECs can help firms reduce corporate greenhouse gas emissions, achieve renewable energy goals, boost stakeholder relations, and identify products and brands as environmentally conscious. Compared to traditional green products, they're also a bargain. An energy producer can sell RECs independent of their associated electricity and buyers can thus get lower cost, wider selection of suppliers, simplified transactions, and easy access to renewable energy projects.

And distributed energy developers should take note: as we'll see later, RECs can be sold before a power facility is built, thus helping finance the construction.

Such benefits drew more than 150 buyers, sellers, and traders to Global Change's 2004 Summit. Among the attendees were representatives of companies such as Shell Oil, DuPont, and Dreyfus. According to Fusaro, these are early adopters that recognize the convergence of greenhouse gas, renewables, and "negawatts" (load curtailment) markets. What's driving these markets? Financial liabilities, shareholder pressure, litigation threats, and the inevitable development of a regulatory regime.

Fusaro predicts that these forces will create a $3 trillion commodity market over the next 20 years. That may sound like a large number for a market where RECs have previously been valued low—from $0.50 per ton to $17 per ton of displaced carbon dioxide. However, demand is growing, and values are rising. Case in point: Connecticut's new renewable portfolio standard (RPS).

Connecticut's legislature strengthened the state's RPS in mid-2003. As a result, offer prices for Connecticut RPS–eligible RECs skyrocketed from $1 per megawatt-hour to $40 per megawatt-hour. Connecticut belongs to the New England Power Pool (NEPOOL), along with Massachusetts, Maine, New Hampshire, Rhode Island, and Vermont. The new RPS requires Connecticut power producers to purchase and retire a higher quantity of NEPOOL certificates from eligible resources such as wind, methane, fuel cells, solar photovoltaics, and some hydropower and biomass.

According to Anna Giovinetto, an analyst and broker with Evolution Markets, an REC broker, Connecticut's actions spurred a demand that could exceed supply by more than 50%. It means that distributed energy producers using renewable energy such as fuel cells are in a great position. "In the Northeast, REC prices are the highest of anywhere in the country," notes Giovinetto. "At $40 to $45 a megawatt-hour, a decent-sized fuel cell producing a few thousand megawatt-hours per year could end up with $40,000 to $50,000 of revenue."

While Connecticut's RPS shows how quickly state laws can boost REC prices, it also illustrates how a lack of standards can impede generators from receiving those prices. The NEPOOL members use a system that should make it easy to buy and sell RECs. All must report their electricity generation to NEPOOL's Generation Information System, an online platform that logs "certificates" for each member's megawatt-hours of electricity. The certificates can be transferred between participants' accounts online, allowing for instant compliance with Connecticut's RPS, theoretically, even from renewable energy pools outside of NEPOOL, such as New York. However, there's a catch.

Connecticut demands that imported electricity be delivered in "real time," with hourly matching. For a wind generator that agrees to such a schedule, a change in the weather could be a financial disaster—forcing the generator to cover a shortfall by purchasing spot market energy. As recent events in California have demonstrated, the spot market can be less than forgiving.

The Connecticut program is a compliance market, and those utilities that cannot buy enough RECs to cover their requirements will pay a non-compliance penalty of $0.055 per kilowatt-hour for up to 1% of their power sold. According to Evolution Markets' latest study, 14 states have compliance programs for renewable energy, but only five (Texas, New Jersey, Massachusetts, Connecticut, and Maine) recognize REC trading as a compliance mechanism. Nonetheless, there are other ways for distributed energy producers to market their RECs.

There's a flip side to the compliance market; not surprisingly, it's known as the voluntary market. One venue serving this market is the Chicago Climate Exchange (CCX), which operates a voluntary pilot greenhouse gas trading program for emissions sources and offset projects in North America and offset projects in Brazil. Michael Walsh, senior vice president of CCX, attended Global Change's GreenTrading Summit, and offered an impressive roster of major US companies proactively responding to the environmental concerns of their customers.

The Exchange counts 45 US corporations as members, including Ford, DuPont, Dow Corning, Motorola, Amtrak, and others. The firms use the Exchange's program of standards and structure to trade emissions reduction credits. Typical efforts to reduce emissions target a 1998–2001 baseline at a rate of 1%, 2%, 3%, and 4% per year. Although the requirements are voluntary, members make a legally binding commitment.

Fusaro expects to see more involvement from investors and financial institutions in CCX. "Wall Street has been buying power stations over the last year and many big financial institutions have a carbon footprint," says Fusaro. "So they'll be much more conversant in trading emissions credits."

Having a carbon footprint also leaves investors open to a growing number of liabilities. According to Paul Hilton, portfolio manager for socially responsible investing at The Dreyfus Fund, investors are concerned with the liabilities of climate change, including extreme weather events and subsequent insurance costs, damage to corporate assets, costs from existing and potential environmental regulations, emissions abatement costs, and potential environmental litigation fees plus their associated settlement costs.

Obviously, there are many business and social benefits for corporate buyers of RECs. But one that has yet to be considered is the potential for REC sales to function as a project finance mechanism. Fusaro would like to see a market system where developers gain access to a stream of emissions credits for 30 to 40 years (the project's lifetime), which they could bring to financial institutions to gain upfront funding.

Such a system is already in place in the US, serving a different segment of the emissions trading market. In 1995, the EPA introduced a program to auction and trade sulfur dioxide credits. In 1999, nitrogen oxide (NOx) credits were added. Under the program, utilities must meet mandated targets. Fusaro says the program has succeeded far beyond its architect's intentions, with more than 1 million trades per year. Over 810 utility plants have participated.

Federal mandates get the credit for establishing the sulfur dioxide and NOx markets, says Fusaro. But he doesn't see a firm date for the same involvement for carbon dioxide and REC trading. And that could continue to stall emissions credit funding for distributed energy projects using renewables. However, one company, NativeEnergy, has decided not to wait for action from the Feds or mandatory markets. Instead, it has forged ahead by selling the total lifetime RECs for two distributed energy projects (wind and biogas), far in advance of construction. The results bode well for future development.

NativeEnergy launched in 2001 with a mission to help develop domestic renewable energy resources favoring Native American projects. The company joined forces with the South Dakota–based Rosebud Sioux Tribe, to help them build the first large-scale Native American–owned and –operated wind turbine.

The first phase began with a single, 750-kilowatt wind turbine, capable of generating electricity when wind speeds exceed 8 miles per hour. It reaches its maximum 750-kilowatt rating at 31 miles per hour. The site's average wind speed is estimated to be 17.9 miles per hour at 155 feet above ground, and the initial turbine is expected to produce about 2,400,000 kilowatt-hours of clean electricity each year, enough to supply about 200 homes. Phase 2 will expand the project to a 10-megawatt wind farm.

"Our model is very different," explains Tom Stoddard, NativeEnergy's vice president and general counsel. "You buy from a wind farm that has not been built. What you're buying is essentially a share of the renewable energy credits that the project will generate over its lifetime. By aggregating purchasers of all those lifetime shares of RECs we are able to bring that project a lump-sum when it reaches commercial operations that represents the value of all the renewable energy credits that it will ever generate."

The company also has a program to support farm methane and biomass projects in Pennsylvania. Partners include the Pennsylvania Departments of Agriculture and Environmental Protection, and financing from the West Penn Power, Metropolitan Edison Company, and Pennelec Sustainable Energy Funds.

Rather than sell the RECs directly, NativeEnergy repackages the credits in a user-friendly marketing approach called Windbuilders. The system appeals to both commercial and private customers by offering two ways to make a purchase. They can use the SafeClimate Carbon Footprint Calculator to determine their own carbon footprint from energy use and car and air travel, and offset it for just $10 per ton.

The second choice offers yearly subscriptions linked to carbon offsetting credits in quantities of 1, 6, 8, or 12 tons. NativeEnergy's customer list reads like a who's who of environmentally conscious companies and organizations: Ben & Jerry's, Timberland, Clif Bar, a host of small colleges, and even pop music artists the Dave Matthews Band.

Drawing from both commercial and private customers has paid off well. "For the Rosebud Sioux project we were able to cover about 25% of the costs of the turbine," says Stoddard. The percentage is considerable in light of the fact that Indian reservations can't benefit from wind tax credits due to their tax-free status.

Word has spread about NativeEnergy's success, and Stoddard says he gets calls from developers of wind and solar projects on a regular basis. New projects are in early planning, and the company also offers services such as green energy supply procurement, green pricing programs, green tag and power purchase agreements, and green energy marketing and sales programs.

In fact, there are many companies offering such services (see sidebar), and Peter Fusaro predicts that thanks to growing state mandates, these companies, and power generators offering RECs, could see much more business in 2005. Although federal standards for carbon dioxide aren't likely in the near future, government agencies such as the EPA are helping drive the market.

In mid-2004, the EPA entered into agreements to purchase a total of 7.7 million kilowatt-hours of renewable energy RECs annually for three laboratories in Minnesota, Michigan, and Nevada. The RECs will represent wind facilities located in Dodge Center, MN, and California's San Gorgonio Pass. The Michigan laboratory's RECs will come from a landfill gas generating facility in Lenox, MI. The EPA now purchases a total of about 122.5 million kilowatt-hours of green power annually, equivalent to 44% of the electricity consumed at all EPA facilities nationwide. The Department of Defense is also a major player in REC purchases.

Fusaro also sees an impact on REC demand from hedge funds on global energy commodities trading. "The next wave of energy trading has now begun with hedge funds entering the energy markets," says Fusaro. "Their importance cannot be understated as both liquidity providers and price influencing factors."

Importantly, large financial institutions are finding an increasing need to manage the financial risk of owning generation assets. Most large oil and gas companies are following suit, and creating profit and loss statements for carbon liabilities. All told, the social, political, and economic forces seem to be converging rapidly toward 2005. If so, distributed energy producers using renewables may finally cash in on RECs.

Ed Ritchie is a writer specializing in energy, transportation, and communication technologies.

DE - November/December 2004