Regulatory Options for Feed-in Tariffs

Feed-in tariffs (FITs) have been used by European countries to foster the growth of renewable generation resources, notably solar. These tariffs generally require electric distribution companies to purchase power produced by a specified class of generators at above-market rates. The object of the tariffs is to encourage development of the favored generation resources by ensuring the existence of a profitable market for their power production.

Some U.S. states have shown an interest in using FITs to create an incentive for the construction of desirable generating resources. However, under the Federal Power Act, the federal government has exclusive jurisdiction to regulate the prices for power sold by most generators to a distribution utility for its resale to retail customers. Tension exists between the federal government’s authority to regulate rates for wholesale power sales and the states’ desire to use FITs as an incentive for developing favored generation resources.

Using PURPA as a Basis for Feed-In Tariffs

A recent case before the Federal Energy Regulatory Commission (FERC) highlighted this tension and provided guidance about one way to relieve it. The case involved a FIT requirement for utilities to purchase power from certain cogeneration facilities at incentive rates set by the California Public Utilities Commission (CPUC). The CPUC asked FERC for a declaration that this program was not preempted by federal law. The CPUC argued that it was not setting a price for wholesale power sales but was only requiring its jurisdictional utilities to offer to purchase power from cogenerators at the price set by the CPUC.

In an order issued July 15, 2010, FERC held that the CPUC was effectively setting the price at which electricity was sold by the preferred generators. FERC concluded that the California program was impermissible as it constituted wholesale price-setting, which is solely within FERC’s jurisdiction. However, FERC stated that the CPUC program might pass muster if it were set up in compliance with the Public Utility Regulatory Policies Act (PURPA). This statute requires utilities to purchase power from “qualifying facilities” (QFs) at state-established rates that are no higher than the utilities’ “avoided costs.”

It had been unclear whether different “avoided costs” could be established for purchases of power from different resources, and whether the avoided cost limitation would defeat the purpose of the incentive rates states wished to set in FITs. FERC issued a clarifying order on October 21, 2010, in which it emphasizes that states have wide latitude in establishing the level of avoided costs under PURPA and that a “multi-tiered avoided cost rate structure” is acceptable. FERC reasoned that where a state requires a utility to procure a certain percentage of energy from generators with certain characteristics, those types of generators “constitute the sources that are relevant to the determination of the utility’s avoided cost for that procurement requirement.”

FERC also clarified that the state may include in its avoided cost calculation the costs of transmission upgrades that would be avoided by the utility by purchasing power from closer resources. These clarifications have the effect of allowing states to set higher incentive rates for QFs, thus giving states more leeway with respect to FITs that otherwise satisfy PURPA. Additionally, FERC noted that a state is free to establish a basis for providing additional compensation to favored resources through mechanisms that are outside of the avoided cost rate, such as the creation of renewable energy credits that the generator can sell and that the utility must purchase.

Limitations of PURPA FITs

Using PURPA as a basis for FITs has some limitations:

• The encouraged resources must be cogeneration, renewable, biomass, waste, or geothermal resources that meet FERC’s definition of a QF.
• The state must be able to demonstrate some relationship between the established rate and the costs a utility would avoid by purchasing electricity from that class of resources.
• This PURPA-type FIT may only be used where utilities remain under a legal obligation to purchase electricity from QFs. That obligation has been lifted for some utilities based on a determination by FERC that the QFs in their area have access to competitive markets to sell their power.

Another Possible FIT Model

There may be other non-PURPA methods for states to avoid concerns over federal preemption of FIT programs. For example, a state could potentially require its jurisdictional utilities to purchase a specified amount of power from a governmental entity established for the purpose of encouraging the favored generation resources, at rates set by that entity. That entity would then offer to purchase electricity from the favored resources at prices sufficient to encourage development of such resources.

FERC does not have jurisdiction under the Federal Power Act over power sales by governmental entities that may be established by the states. FERC has in fact acknowledged that a state requirement that regulated electric utilities purchase electricity from a state-owned corporation at specified rates would not be preempted by FERC’s authority over wholesale power sales.

Although it may be debated from a policy perspective whether feed-in tariffs are the right way to foster desirable generation resources, if a state chooses to use such a mechanism, it must structure its program to avoid the pitfalls of federal preemption.

— Brian R. Gish ([email protected]) is of counsel and James K. Mitchell ([email protected]) is a partner in Davis Wright Tremaine’s Energy Practice Group.