NYSERDA Tier 1 Restructuring Petition: More Than Meets the Eye

Unpacking the Implications of New York’s Proposal to Eliminate the Tier 1 Renewable Energy Standard Compliance Market for LSEs, Generators, and the Market

Written By: Po-Yu Yuen, Senior Consultant; Erin Smith, Principal Analyst; and Bob Grace, Managing Director & President

Publish Date: February 2, 2023

Estimated Reading Time: 12 minutes

A central feature of New York’s Clean Energy Standard (CES) adoption in 2016 was the creation of a Tier 1 Renewable Energy Standard (RES) obligation on load-serving entities (LSEs) that was consistent with Renewable Portfolio Standard market structures in adjacent states. The main motivations cited in the adopting Public Service Commission (PSC) Order for adopting the Tier 1 RES were to encourage efficiency, support voluntary hedging, help develop retail markets by encouraging load serving entities to develop innovative products, and be consistent with the approach taken in other states to allow developers to participate efficiently in multiple markets and enable regional arbitrage to reduce program costs.^[1]

Since its inception, the Tier 1 RES has been characterized by persistent REC supply shortage – even after multiple reductions to the Tier 1 target trajectory – due to material delays in the contracted large-scale renewable pipeline (a struggle shared by many states in the region). In addition, the Tier 1 RES has experienced limited regional arbitrage due to New York’s Tier 1 RES design features – such as a comparatively low Alternative Compliance Payment (ACP) price cap relative to surrounding markets – as well as changing conditions in adjacent markets. After consecutive years of market shortage and ratepayers bearing high ACP compliance costs as a result, New York has declared its intent to evolve from the model.

On November 9, the New York State Energy Research and Development Authority (NYSERDA) filed with the PSC a Petition proposing to transition away from the current Tier 1 RES compliance model. The central objective of the proposal is to reduce CES compliance costs and, by extension, costs to ratepayers. While the proposed reforms are likely to achieve these objectives, they would also create additional impacts on LSEs, market makers, developers and owners of renewable energy generation, and others that should be understood and potentially mitigated.

Below, we unpack key implications that stakeholders may want to raise before the February 6, 2023 comment deadline in the New York Public Service Commission’s State Administrative Procedures Act (SAPA) Notice for a proposed rulemaking on the Petition.^[2]

The Proposal

Under the present RES Tier 1 obligation, RES-obligated LSEs may comply with an annually increasing percentage of load annual Tier 1 requirement, set three years in advance, by either (i) acquiring from NYSERDA Tier 1 renewable energy credits (RECs) that NYSERDA has procured under long-term contract from large-scale renewable energy generators at prices based on NYSERDA’s actual costs, (ii) purchasing ‘market’ Tier 1 RECs from other generators or intermediaries, (iii) for investor-owned utilities, applying balances of Tier 1 RECs which they have procured from distributed renewables through VDER programs, or (iv) making ACPs to NYSERDA at a small premium to NYSERDA’s resale price.

In its Petition, NYSERDA proposed to transition away from the current target-based Tier 1 RES compliance model commencing in Compliance Year 2025. Thereafter, instead of requiring RES-obligated LSEs to actively comply as described above, under the proposed cost-allocation-based approach NYSERDA would directly allocate to LSEs NYSERDA-owned RECs in proportion to each LSE’s share of total state load, and require payment based on NYSERDA’s weighted average per-REC costs.  The proposed transition would align the Tier 1 compliance model with the approach currently used for the rest of the New York CES programs, including Tier 2, Tier 4, Zero Emission Credit (ZEC), and the Offshore Wind Standard.

Programmatic Changes

On its face, NYSERDA’s proposal would, commencing in 2025, absolve LSEs from any active RES Tier 1 compliance strategy, which will have several direct structural impacts:

• No More ACP. Without a pre-determined compliance obligation percentage, there would no longer be a need for ACPs that LSEs must pay and pass on to consumers in case of REC shortage conditions.
• No More REC Market Tied to Tier 1 Compliance. NYSERDA’s proposal would effectively eliminate the sale and purchase of ‘market’ (non-NYSERDA) RECs for compliance purposes, and narrow LSE compliance purchases from anybody but NYSERDA. With no market for Tier 1 RECs, the anchor for visible price formation for Tier 1 (new renewables) RECs will be eliminated.
• REC Resale Structure Transformed. With NYSERDA directly purchasing and allocating Tier 1 RECs to LSEs, there would no longer be a need for the current process of NYSERDA quarterly Tier 1 REC resale offers to LSEs. NYSERDA would, however, resell Tier 1 RECs twice a year (before and after RECs are minted) to voluntary buyers rather than LSEs. Note that under NYSERDA’s proposal, any Tier 1 REC sales to voluntary buyers would reduce the volume of Tier 1 RECs, and hence, cost allocated to LSEs.
• Uniform LSE Compliance Cost Approach. Under the new compliance approach, all LSEs will be subject to a uniform obligation payment (on a wholesale charge per MWh basis) instead of the current model, where LSEs may have different obligation payments depending on how they meet their compliance obligation percentages (e.g., sources of RECs purchased, volume of RECs purchased vs ACPs made, etc.).

Why the Change?

NYSERDA’s proposal is motivated by several reasons:  

• ACP Relief. As demonstrated in New York’s 2019, 2020, and 2021 Divergence Tests assessing potential Tier 1 oversupply or undersupply, the state’s renewable energy programs have fallen short in delivering sufficient Tier 1 RECs to keep pace with preestablished Tier 1 targets. Resultantly, LSEs have repeatedly needed to meet compliance via ACP payments and pass these costs along to ratepayers. By effectively eliminating the need for ACP, NYSERDA’s proposal would avoid putting customers on the hook for REC shortages that they had no role in creating. We note that the same objective could be achieved if the ACP mechanism was retained but if the payments were refunded directly to ratepayers, an approach that has been used by some RPS states, including Connecticut.
• Uneven Distribution of VDER Tier 1 RECs. Under the current VDER structure, Tier 1 VDER RECs are conveyed to the associated IOUs and cannot be traded. This structure has resulted in an uneven distribution of REC supply, where some IOUs have material surplus of Tier 1 VDER RECs (enough to potentially meet their entire compliance obligations through 2030) without a way of trading the surplus to other LSEs that are exposed to Tier 1 REC shortage. As a result, different IOUs and their ratepayers are exposed to differing costs of the same state-wide policy, and many IOUs may need to carry on their books costs incurred for which they may not be compensated for many years. In its Petition, NYSERDA proposed to purchase VDER Tier 1 RECs from each IOU and add them to the total volume of Tier 1 RECs to be allocated to LSEs, which would correct this uneven distribution issue that IOUs have been raising.
• Forecasting Supply and Demand for Compliance Target and ACP Setting. New York’s Tier 1 RES targets are set on a three-year rolling basis as a function of the projected volume of state-driven supply and load. The ACP is set ahead of each compliance year as a function of the projected cost of NYSERDA-acquired Tier 1 RECs. The usual development challenges have been exacerbated by a new set of uncertain development conditions – largely triggered by the pandemic and exacerbated by the Ukrainian war – making accurate forecasting challenging. Persistent delays and attrition in the development pipeline have triggered the need for NYSERDA and the Department of Public Service (DPS) to (sometimes retroactively) reduce preestablished Tier 1 compliance targets to limit ratepayers ACP exposure. Similarly, the 2022 ACP ($35) has been 55-80% higher than the 2022 quarterly Tier 1 REC resale prices for the first three quarters, which far exceeds the intended 10% adder to actual REC procurement costs. NYSERDA is proposing to remove one dimension of uncertainty by eliminating the need to make predictions.
• Efficiency Gains. By transitioning the Tier 1 obligation to a cost-allocation-based obligation, all the CES obligations would be consistent across all programs and enable both LSEs and NYSERDA to gain administrative efficiencies.
• Potential Ratepayer Cost Savings. Further, by proposing to offer a greater share of RECs to the voluntary market, if the market responded, NYSERDA may shift some of the compliance costs from all ratepayers to voluntary buyers.

Implications

While NYSERDA’s proposal offers several benefits, the Petition’s proposal as drafted would introduce a number of complications and large degree of uncertainty for key market participants that, if left unaddressed, could undermine the states’ climate and clean energy goals.

Retail Market Price Uncertainty

The cost-allocation-based approach could introduce a large degree of price uncertainty into the retail market. As the CES component of REC prices grows, the uncertainty would make it increasingly challenging for LSEs to forecast compliance costs and price retail products beyond a year or two absent detailed analysis. Effectively, NYSERDA’s proposal offers consumers a tradeoff between absorbing increasing annual rates from ACP exposure under the existing approach or grappling with annual rate shocks.

• Compliance Cost Predictability. Shifting from obligating LSEs to purchase Tier 1 RECs for a predetermined share of their annual load to allocating to LSEs the cost NYSERDA pays to procure Tier 1 RECs and VDER Tier 1 RECs would introduce significant volumetric as well as cost uncertainty for LSE compliance. Additionally, under NYSERDA’s index REC structure, there could be a material discrepancy between forecasted versus actual Tier 1 REC prices due to commodity price volatility. Further, the magnitude and trajectory of voluntary REC purchases is uncertain, further clouding insight into expected future compliance costs. Elimination of a fixed obligation target for the rapidly growing Tier I obligation, the petition would make a rapidly increasing percentage of retail generation service costs difficult to predict, making pricing of retail offerings increasingly challenging, and confound the ability for retail customers to lock in known costs for their energy budgets.

• Flexibility to Respond to Uncertainties. The elimination of alternative compliance options, such as banking or purchasing RECs from third parties, including entering into bilateral contracts, would further limit LSEs’ and customers’ ability to hedge against futures risks.

• Reconciliation. The cost-allocation-based approach includes a ‘reconciliation’ process that involves (i) LSEs making compliance payments throughout the compliance year based on estimated costs and forecasted statewide load, and (ii) truing up actual LSE compliance payments at the end of the compliance year based on actual costs and actual statewide load. SEA’s past research with LSEs on the reconciliation process for other CES tiers revealed that while NYSERDA would refund the discrepancy between forecasted and actual REC costs to LSEs, it could be frustrating for LSEs to have their capital be inaccessible until the compliance year settles. Given the expected scale of Tier 1 CES compliance, this challenge would likely be magnified under NYSERDA’s proposal.  

Merchant Market Eliminated

Eliminating LSEs’ need to purchase RECs from sources other than NYSERDA would effectively eliminate the merchant market for Tier 1 RECs, which would have a number of critical impacts:

• Higher Wall Around New York. NYSERDA’s proposal seeks to ensure that New York resources meet the state’s demand and that all Tier 1 RECs used for compliance are generated in New York. The proposal eliminates the ability for merchant Tier 1 renewables in New England, PJM, and Canada to respond to price signals and provide their surplus when New York supply is lagging the demand trajectory. One unintended consequence of this dynamic is that it introduces barriers to the deployment of renewable fuels in hard-to-decarbonize sectors. For instance, green hydrogen produced from renewable energy from within or outside of New York won’t respect state boundaries, even if the hydrogen’s end use isn’t ultimately in the power sector. The impact of NYSERDA’s proposal on these sectors is unclear.
• Risks Shifted to Large-Scale Renewable Generators. NYSERDA’s proposal introduces new uncertainties for in-state generators since, absent a merchant market tied to Tier 1 compliance, they will have no clear outlets in which to sell any uncontacted REC volumes before, during, and after their Tier 1 or OREC contracts with NYSERDA. Eliminating the merchant market would remove the ability for generators to sell test power prior to their contracts taking effect into a compliance market (a thin, illiquid and lower-priced outlet of sales to voluntary buyers would remain). The proposal would also prevent developers from selling their excess generation (e.g., above 120% of the Bid Quantity for Tier 1 contracts) or build a project larger than the contracted nameplate capacity to leverage economies of scale and to provide other hedge products in the market. We have observed large-scale renewable projects leveraging these types of arrangement in the northeastern U.S. Finally, eliminating the merchant compliance market further clouds the existing lack of clarity in REC revenues available to projects after their 20-year Tier 1 or 25-year OREC contracts with NYSERDA ends. The impacts of the increased uncertainty are twofold:
  • Impact on future bids. The potential loss of viable market outlets for RECs expected to be produced outside of Tier 1 contracts (e.g., test power, excess generation, post-contact generation) could result in higher bid prices due to developers making up for reflection of greater revenue risks.
  • Impact on existing NYSERDA Tier 1 contracts. NYSERDA’s proposal may eliminate revenue streams that developers with current Tier 1 or OREC contracts have already incorporated in their bid pricing. As a result, some existing contracted projects may not earn the same level of return as expected, potentially undermining their financeability and economic viability.
• Tier 4 Interactions with CPNY. The Clean Path New York (CPNY) project contracted with NYSERDA under Tier 4 is structured to maximize delivery of intermittent resources over a 1300 MW transmission line to spread the cost (on a $/MWh basis), by having a portfolio of 3,800 MW of upstate wind and solar generation capacity that is more than double the capacity of the line. Under this arrangement, there will inevitably be some hours when there will be too much contracted Tier 4 CPNY supply to be delivered to New York City. In these instances, NYSERDA would instead buy the excess supply that can’t be delivered as Tier 1 RECs – if they have Tier 1 contracts. While more than half of the projects identified as supplying energy and RECs as part of the CPNY project have secured Tier 1 contracts, many have not. Under current market rules, those non-contracted projects can sell their RECs to the Tier 1 merchant compliance market. However, if NYSERDA’s proposal is adopted and the Tier 1 merchant market is eliminated, those projects that can’t secure Tier 1 contracts by the time the CPNY line is energized would be exposed to much greater revenue risk. The number of projects without Tier 1 contracts by the time CPNY is energized may shrink – as the project sponsors have stated their intent to pursue Tier 1 contracts for all projects in the generation portfolio – but in a competitive procurement, success is uncertain.

Voluntary Market Additionality

It is unclear whether a vibrant voluntary market will grow around the prospect of purchasing what NYSERDA has purchased – and would sell to LSEs for RES Tier I compliance in the absence of voluntary purchases – in contrast to the motivation to purchase incremental supply that not have existed  in the absence of NYSERDA’s purchase decision. This creates a question of whether NYSERDA’s proposal really creates the additionality that some users seek to maximize achievement of clean energy and climate goals.

Self-Hedging

By eliminating RECs purchases from any entity but NYSERDA, the proposal eliminates the opportunity for LSEs or other end users to self-hedge, such as entering into bilateral REC contracts with generators on their own. NYSERDA noted in its Petition that LSEs have not, to date, procured significant quantities of merchant Tier 1 RECS outside of NYSERDA’s REC procurements, concluding that the impact on market participants’ actual hedging behavior could be minimal. However, eliminating the merchant market outright would eliminate any opportunity for self-hedging, especially as Tier 1 compliance volume grows.  As noted above, the centralization of compliance purchases and the introduction of Tier 1 target uncertainty introduces a barrier to end users or their suppliers fixing their electricity prices through competitive retail supply.   

Key Takeaways

New York is proposing to bring all its CES tiers in sync by ditching its Tier 1 RES compliance market. In the current environment of supply lagging targets, and with the compelling argument for saving ratepayers money by eliminating their exposure to the ACP, NYSERDA appears committed to this path, and as the DPS staff concurs with the approach, there is a good chance this proposal will go forward. While NYSERDA’s proposed load-share compliance approach could contribute to the achievement of the stated objectives that it lays out, the proposed transition away from the existing market-based approach could also lead to other indirect market outcomes – some identified by NYSERDA in the petition – and some potential unintended consequences that we have discussed above. We remind readers of the impending February 6 comment deadline to contemplate and raise these issues for NYSERDA to potentially address in a refined proposal. It is unclear whether all the side effects can be mitigated, or even should, but by highlighting the above issues for discussion, we hope to stimulate discussions and empower stakeholders to go forward with their eyes wide open.

References

New York Public Service Commission. 2022. “PROPOSED RULE MAKING – Clean Energy Standard Tier 1 Load Serving Entity Obligations.” New York State Register. New York Department of State, December 7. https://dos.ny.gov/system/files/documents/2022/12/120722.pdf.

New York State Energy Research and Development Authority. 2022. “Petition Regarding Modification of the Clean Energy Standard to Transition from a Defined Percentage Obligation to a Load Share Obligation.” November 9. https://documents.dps.ny.gov/public/Common/ViewDoc.aspx?DocRefId=%7b2034271D-4BB1-4F5C-9D8A-D4C0BA257E6C%7d.

Order Adopting a Clean Energy Standard. 2016. Case 15-E-302 – Proceeding on Motion of the Commission to Implement a Large-Scale RenewableProgram and a Clean Energy Standard (New York State Public Service Commission, August 1). http://documents.dps.ny.gov/public/Common/ViewDoc.aspx?DocRefId=%7b1A8C4DCA-E2CC-449C-AA0D-7F9C3125F8A5%7d.

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[1] (Order Adopting a Clean Energy Standard 2016, pp. 93-94)

[2] (New York Public Service Commission 2022, pp. 37-39)