The Energy Law Advisor

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Carmel Douglas
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1 The Energy Law Advisor Security Interests in Renewable Energy Credits (Part I) By: Howard M. Steinberg and Reade Ryan Instute for Energy Law The Center for American and International Law 5201 Democracy Drive Plano, Texas USA (fax)

2 Security Interests in Renewable Energy Credits (Part I) By: Howard M. Steinberg and Reade Ryan Initiatives to protect the environment have led to both legal and voluntary measures to reduce atmospheric pollution. Governments, institutions, organizations, corporations, and consumers worldwide are involved in promoting so-called clean energy. Many of these legal requirements and voluntary programs involve the purchase of energy directly from a generator using renewable fuel, the purchase of a renewable energy generator s renewable attribute 1 (such attribute is often referred to as a renewable energy credit ), or the purchase of a renewable energy attribute attributable to the reduction in polluting emissions (such attribute is often referred to as an emissions reduction credit ) that arises from the use of a fuel source that is less atmospherically harmful than the emissions of an existing or theoretical proxy energy generation source. 2 Emissions of oxides of nitrogen, sulfur, carbon, particulate matter, soot and mercury, among others, are regulated in many jurisdictions. These desirable attributes are generally represented by a certificate (in the case of renewable energy generation) or by a credit (in the case of a reduction of polluting emissions). In either case, the physical certificate or notional credit is only evidence of the attribute associated with the renewable energy generated or the production method of the renewable energy generation facility that is being transferred, and the certificate or credit itself is not the real object of what is being transferred. The certificate or credit is used for commercial convenience in connection with an attempt to represent the characteristic purporting to be sold, because without the occurrence of the underlying renewable energy generation or polluting emissions reduction, the certificate or credit itself is of no value. Historical vs. Future Transactions Transactions involving certificates or credits can be categorized into two types. First are historical transactions whereby the buyer purchases renewable energy attributes associated with renewable energy that has already been generated. Second are so-called future or forward transactions in which the buyer desires to purchase renewable energy attributes that will be associated with renewable energy to be generated during some specified period in the future. Often, buyers specify in what period (often referred to as vintage ) they desire the renewable energy or attributes to be generated. Thus a typical contract may specify that, for example, the buyer desires x certificates or credits generated in year 1 of the contract and y certificates or credits generated in year 2 of the contract and so on. The authors are respectively partner of, and of counsel to, Shearman & Sterling LLP.

3 Historical Transactions Historical purchases present no particular legal challenge and can be memorialized in a single purchase agreement or perhaps even a bill of sale. In a historical transaction perhaps the only critical terms (aside from the price and vintages required) would be a representation and warranty that the seller is transferring title to the attribute (and also the certificate, if any) free and clear of any liens or encumbrances and a determination by the buyer that the seller is creditworthy enough to support its obligations if the seller breaches this representation and warranty. Performance Risk in Future Transactions Future or forward transactions are more complex. Since what is being sold has not yet been created, the buyer runs the risk that it may never receive what it has purchased. Aside from the risk that the generating facility itself might be damaged or destroyed, there is a risk that the seller may not perform its contractual obligations either because the seller has found a more attractive sale price or because it has successfully sought to terminate its contractual obligations under a state insolvency law or the U.S. Bankruptcy Code (11 U.S.C. 101 et seq.) (the Bankruptcy Code ). In either case, the buyer will be left solely to pursue its remedy of monetary damages and is unlikely to be awarded the remedy of specific performance by a court or an arbitrator in order to obtain the right to the actual renewable energy attribute. Courts generally will not grant specific performance if there is an adequate remedy at law through the payment of monetary compensation by the breaching party. Except in cases of real estate and personal services contracts, it is very difficult to prevail on a claim for specific performance. The authors believe that it is unlikely that a court or arbitrator would characterize the contract to purchase a renewable energy attribute as a contract involving real estate or personal services. Credit Exposure In order to cover the buyer s risk that the seller may fail to perform, purchase contracts for future renewable energy credits and emissions reduction credits often contain provisions that calculate (generally weekly or monthly) the aggregate amount of the buyer s expected losses if the seller fails to continue its performance under the contract (this aggregate amount of losses is often referred to as credit exposure ). Posting Margin If the credit exposure becomes too great (that is, such credit increases above agreed thresholds), the contract will usually require the seller to post collateral in favor of the buyer (usually in the form of cash collateral or, in lieu of cash collateral, a letter of credit from a bank). This is often referred to as margin or margining in the financial derivatives industry. It should be noted

4 that a letter of credit may be preferable to cash collateral for margin because under the Bankruptcy Code a bankrupt seller may be entitled, if so authorized by the bankruptcy court after notice and a hearing, to use the cash collateral that has been posted by it to the buyer even if the secured party (in this case the buyer of the renewable energy credit or the emissions reduction credit) has properly perfected (discussed below) its security interest in the cash collateral. (See 11 U.S.C. 363 (c)(2)). On the other hand, a letter of credit is an obligation of the bank that issued the letter credit to the beneficiary buyer and not an obligation of the bankrupt seller. (See U.C.C (d)). Thus, the seller of the credit will have no ability to prevent a draw by the buyer on the bank s letter of credit. 3 In cases of letters of credit, the buyer need only make sure it is comfortable with the bank s credit standing and the procedure specified in the letter of credit. Many contracts provide that if the buyer s credit exposure to the seller is too great or if the seller fails to post any additional required margin or otherwise breaches its contract with the buyer, the buyer may cover its losses by terminating the contract with the seller and entering into a new replacement contract under which the buyer would purchase replacement renewable energy credits or emissions reduction credits from the seller based on market prices (the loss of the buyer in this case being usually referred to as the so-called market to market loss) and make the seller pay for the buyer s costs to cover the loss of the benefit of its bargain from the original seller. Forward Contracts Bankruptcy Code 556 permits a termination of the contract providing for a future or forward transaction if the contract is a forward contract (within the definition of the Bankruptcy Code), even if the merchant (within the definition of the Bankruptcy Code) has sought the protection of the automatic stay under the Bankruptcy Code. The automatic stay under Bankruptcy Code 362 serves to block all actions against a bankrupt debtor (including terminating a contract with the debtor under the contract s provisions) until the bankruptcy court has ruled upon the contract termination, which can take time and involve risk to the counterparty that the market may change during that period and thereby compound its losses. However, the authors believe that a contract providing for a future or forward transaction for the purchase of future credits is a forward contract within the meaning of Bankruptcy Code 556, thereby allowing the buyer to terminate its contract with the seller. Specific Generation Facilities In the case of a transaction for the purchase of future renewable energy credits or emissions reduction credits, the buyer is often relying upon a specific facility to generate the credits that it wishes to buy. In some cases, it may not be difficult for the buyer to buy replacement certificates in the market if its seller defaults. In some cases, however, it may be very difficult to purchase replacement renewable energy credits or emissions reduction credits, especially

5 in regions that do not have ample renewable power generators with available renewable attributes. Marketers in the Middle The issues discussed above become even more complex when the purchase of a future renewable energy credit or future emissions reduction credit is arranged between a buyer and a seller by or through marketers or marketing agents who may be aggregating sales on behalf of different generation facility owners. Therefore, a buyer should understand that it may not even be buying the future credit from the generator of the credit and the buyer might thus have no privity of contract (that is, no contractual relationship) with the entity owning the generating source of the credit. This will increase the risk to the buyer because in this case the buyer must rely upon the performance of two parties, the generator and the marketer. In cases such as this, in which the buyer is depending upon the performance of a specific facility or facilities, an approach similar to that known in the insurance industry as a cut through could be employed to allow the buyer to receive a written acknowledgment from the generator of the credit. This cut through acknowledgement would provide that if the marketer doesn t honor its obligation for any reason, then the buyer may rely on the generator of the credit to perform the marketer s obligation under the contract to deliver the future credit.

6 1 2 Organizations such as Green e exist to audit facilities and certify that these generation facilities operate as required to produce the credit in question. The following are typical definitions used in this area: Environmental Attributes means any and all credits, benefits, emissions reductions, offsets, and allowances, howsoever entitled, attributable to the generation from a renewable energy facility, and its avoided emission of pollutants. Environmental Attributes include but are not limited to renewable energy credits, as well as: (1) any avoided emission of pollutants to the air, soil or water such as sulfur oxides (SOx), nitrogen oxides (NOx), carbon monoxide (CO) and other pollutants; (2) any avoided emissions of carbon dioxide (CO2), methane (CH4), nitrous oxide, hydrofluorocarbons, perfluorocarbons, sulfur hexafluoride and other greenhouse gases (GHGs) that have been determined by the United Nations Intergovernmental Panel on Climate Change, or otherwise by law, to contribute to the actual or potential threat of altering the Earth s climate by trapping heat in the atmosphere; and (3) the reporting rights to these avoided emissions, such as Product Reporting Rights. Product Reporting Rights are the right of an REC purchaser to report the ownership of accumulated RECs in compliance with federal or state law, if applicable, and to a federal or state agency or any other party at the REC purchaser s discretion, and include without limitation those Product Reporting Rights accruing under Section 1605(b) of The Energy Policy Act of 1992, 42 U.S.C (b) and any present or future federal, state, or local law, regulation or bill, and international or foreign emissions trading program. RECs are accumulated on a megawatt-hour basis and one REC represents the Environmental Attributes associated with one (1) megawatt hour of energy. Environmental Attributes do not include (i) any energy, capacity, reliability or other power attributes from a renewable energy facility, (ii) production tax credits associated with the construction or operation of a renewable energy facility and other financial incentives in the form of credits, reductions, or allowances associated with a renewable energy facility that are applicable to a state or federal income taxation obligation, (iii) fuel-related subsidies or tipping fees that may be paid to accept certain fuels, or local subsidies received by the generator for the destruction of particular pre-existing pollutants or the promotion of local environmental benefits, or (iv) emission reduction credits encumbered or used by a renewable energy facility for compliance with local, state, or federal operating and/or air quality permits. If a renewable energy facility is a biomass or biogas facility and Seller receives any tradable Environmental Attributes based on the greenhouse gas reduction benefits or other emission offsets attributed to its fuel usage, it shall provide buyer with sufficient Environmental Attributes to ensure that there are zero net emissions associated with the production of electricity from a renewable energy facility. Renewable Energy Certificate or REC means a tradable certificate, credit, allowance, green tag, or other transferable document conferring ownership, howsoever entitled, created by an applicable program or certification authority indicating proof of at least one megawatt-hour of generation from a renewable energy source by a renewable energy facility. Owning an REC means the right to claim title to all the Environmental Attributes attributable to the generation of electric energy from a Renewable Energy Facility and includes all of the Environmental Attributes associated with the generation of electricity. The Environmental Attributes may be disaggregated and retained or sold separately. An REC is separate from the energy produced and may be separately transferred or conveyed. RECs are measured in one megawatt-hour increments. 3 In re Guy C. Long, Inc., 74 B.R. 939 (Bankr. E.D. Pa. 1987); In re Page, 18 B.R. 713 (D.D.C. 1982); In re Originala Petroleum Corp., 39 B.R (Bankr. N.D. Tex. 1984).

Portland General Electric Company Sheet No SCHEDULE 201 QUALIFYING FACILITY 10 MW or LESS AVOIDED COST POWER PURCHASE INFORMATION

Portland General Electric Company Sheet No. 201-1 PURPOSE SCHEDULE 201 QUALIFYING FACILITY 10 MW or LESS AVOIDED COST POWER PURCHASE INFORMATION To provide information about Standard Avoided Costs and