In an effort to encourage the production of clean, renewable energy, some states have adopted or are considering policies that require utilities to purchase renewable energy from independent, non-utility producers. One such example are feed-in tariffs which provide a long-term guaranteed level of income for electricity produced by small-scale renewable energy producers by requiring utilities to purchase wholesale electricity under a fixed-price contract.

The FERC Ruling

Last month, the Federal Energy Regulatory Commission (“FERC”) issued its first ruling addressing the federal government’s role in state feed-in tariff policies. The policy in question required utilities to offer to purchase electricity from 20 MW or less producers under a 10 year, fixed-price contract. The price was set by the California Public Utilities Commission.

Two federal laws are implicated by state feed-in tariffs and both preempt certain state action. First, the Federal Power Act of 1935 (“FPA”) generally prohibits states from setting wholesale electricity prices. Second, the Public Utility Regulatory Policies Act of 1978 (“PURPA”) requires states to set wholesale prices for “qualifying facilities” (generally producers no larger than 80 MW) but preempts prices that exceed the utility’s “avoided cost.”

FERC ruled that California’s activity was preempted by FPA because the state set a wholesale price when it required utilities to purchase wholesale electricity. FERC was apparently not swayed by the fact that the feed-in tariff only required utilities to offer to purchase electricity but did not require a producer to accept.

A rehearing or appeal is expected.

States Need to Get Creative

While PURPA still allows states to set feed-in tariffs in certain circumstances, its application is limited. First, PURPA limits the production size and technology used by “qualified facilities.” Second, the price under PURPA may not exceed the utility’s “avoided cost,” which is usually lower than the producer’s cost. Third, under certain circumstances, utilities can request an exemption from a state’s PURPA feed-in tariff purchase obligation.

Despite these limitations, states are left with a few options. First, states can set feed-in tariffs at the utility’s avoided cost and otherwise comply with PURPA. Second, states could comply with PURPA and offer producers a kicker, such as tax benefits or renewable energy credits, to offset the difference between the utility’s “avoided cost” and the producer’s cost. Third, states can establish stricter renewable portfolio standards (“RPS”) for utilities, thereby driving demand, while at the same time complying with FPA by not setting a wholesale electricity price. Establishing more aggressive RPS is one alternative. Another alternative is for states, who have the power to order utilities to purchase wholesale electricity from certain producers, to target specific renewable producers by distinguishing based on output capacity and/or the technology used to generate the electricity. For example, rather than require utilities to purchase electricity from facilities producing less than 80 MW (only one category), a state could require a utility to solicit multiple categories of producers (perhaps between 1 MW and 10 MW, 10 MW and 20 MW and 20 MW and above). More narrow categories may protect smaller producers from price competition with larger producers. States can also establish mandates on what type of renewable energy source (hydro-electric vs. solar) or technology (existing vs. new) qualifies for its RPS.

Given the limitations of FPA and PURPA, states may need to consider tax benefits and renewable energy credits, as well as stricter RPS requirements. Many utilities are experiencing noticeable customer demand for renewable energy, thereby encouraging the utilities to purchase renewable energy at prices in excess of their “avoided cost.” States should evaluate policies which further encourage and support market demand for renewable energy. Regardless of the approach, states will need to get a little more creative in their efforts to encourage small producers of renewable energy.

Other Federal Activity

States may find further guidance in the recently issued report from the National Renewable Energy Laboratory entitled “A Policymaker’s Guide to Feed-in Tariff Policy Design.” This report is the longest, most detailed governmental agency report on feed-in tariffs. It looks beyond U.S. policymaking and outlines best practices worldwide. Further, it addresses many of the myths surrounding feed-in tariffs and concludes that feed-in tariffs are one of the most effective methods of encouraging certain renewable energy sources, specifically solar-generated electricity.

Earlier in August, Senator Kerry introduced the Clean Energy Leadership Technology Act of 2010. This bill abandons the cap-and-trade and federal RPS proposals and, instead, focuses on incentives and funding for renewable energy producers and users. The Senate appears set to take up this bill later in the fall, prior to mid-term elections.