Renewable energy developers, financiers and utilities breathed a collective sigh of relief last week when the Commodity Futures Trading Commission issued its long-awaited final rule on a crucial exemption from the Dodd Frank Act.
The Dodd Frank Act was enacted in 2010 after the financial crisis to restrict the trading of derivatives, a $700 trillion industry which was blamed for triggering the 2008 crisis.
Industry commenters were concerned that the CFTC might determine that environmental commodities such as Renewable Energy Credits (RECs), emissions allowances and carbon offsets might be classed as swaps.
Developers and traders would have been required to post collateral on an exchange, potentially in the region of 5%-25%. Liquidity for project development earned through RECs trading would have been severely limited.
The CFTC issued its delayed final ruling last week and said that trading in forward contracts for environmental commodities would not be defined as swaps in the same way as other non-financial commodities such as derivatives.
“An environmental commodity, such as an emission allowance, [can] be physically delivered and consumed, eg, by emitting the amount of pollutant specified in the allowance,” said the CFTC rule.
A Collective Sigh of Relief
“We haven’t seen a market response pertaining to actual trading but certainly market participants have breathed a sigh of collective relief,” said Andrew Kolchins, managing director of renewable energy markets, at Evolution Markets.
“It was really unknown whether Dodd Frank would include environmental markets in the definition of a swap. We’re very thankful that things worked out. If it hadn’t, it would have been quite disastrous for the markets.
“At stake was the continued growth of liquidity of REC market place and other environmental commodities. The markets have been working and growing in confidence at great rates and great levels and this would have set us back a year or two.
“From a worst-case scenario it would have been a complete shutdown. Ultimately solutions would be created and figure it out but you would have had a six month period in which people weren’t sure how to transact and do business.”
Under the 1603 cash grant programme demand for financing for thousands of small-scale projects became clear. Kolchins said that many small developers and owners would have struggled to comply with the requirement to post collateral.
“You have a tremendous amount of participants in the renewables markets, but a large part of the participants would be ‘naturals’, ie the owner of the renewable energy credits. How would a homeowner provide collaterol to sell the renewable energy credits – someone has a 10kw solar system on their rooftop – would they have had to comply with these regulations?
“For a 250kw facility on a commercial and industrial facility, they have limited credit and their cash flows are tied to the sale of electricity or RECs. They more often than not don’t have the additional cash to post a margin.”
Wind spot prices for compliance RECs varied from $2.75 in Texas to $55 in New England, while voluntary RECs were trading as low as $0.75c, he said.
“There’s been a tremendous amount of market fluctuation activity over the last 12 months. There’s been a tremendous amount of activity in the solar markets in the ‘solar carve’ out markets. More recently the price volatility has been to the down side.”
The collapse of PV panel prices, the proliferation of project development and low natural gas prices had all contributed to downward pressure on prices, he said.
New Jersey has passed legislation to support the price of solar RECs (SRECs) and is waiting to be signed into law by Governor Chris Christie.
Steve Mickelsen, counsel at 3Degrees which had advocated for the exemption for environmental commodities from the swap definition, said: “Parties throughout our industry from developers to end users, such as utilities and corporate America, are breathing a sigh of relief.
“This is the outcome that we had hoped for so the industry is very happy. The CFTC relied heavily on our industry’s comments in deciding that environmental commodities are eligible for contract exclusion from the definition of swaps in the Dodd Frank Act. This means that parties who are trading in forward contracts in RECs and other environmental commodities do not have to comply with all of the swaps-related obligations like reporting, margin [posting collateral],
Kolchins said that the expiration of the PTC was now the greatest threat facing the industry.
“Uncertainty around the revenue from the PTC creates ambiguity and uncertainty. That’s the biggest threat to the developers business right now.
“Low natural gas pricing does not make life any easier. Low natural gas pricing means low power pricing and low REC pricing.”
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