This week, the Massachusetts Department of Energy Resources will run its first Solar Renewable Energy Credit (SREC) auction under thesolarcarve-out. 

It might not clear, and everything will be okay.

The Solar Credit Clearinghouse Auction (SCCA) is happening for the first time this year because even though 2012 was the third year of the solar carve-out, it was the first year in which SREC supply exceeded SREC demand. Under-supply and high SREC prices in 2010 and 2011 attracted investment that tipped the 2012 SREC vintage into oversupply, and guaranteed oversupply in 2013 as well.

By rule, any 2012 SRECs not used for 2012 compliance will expire and lose all value unless they are deposited in the SCCA account in the month after compliance is closed, and before the auction is run. The 2012 minimum standard was 81,559 SRECs, and 119,247 SRECs were actually minted -- 37,688 more than were needed. That’s close to the 38,866 SRECs that ended up in the SCCA account by the time it closed last month.

Next, the Department of Energy Resources (DOER) announces the minimum standard -- that is, the demand level -- for 2014.  It’s important to note that the DOER has no discretion over the 2014 minimum standard; it is calculated according to a formula set forth in the regulation, 225 CMR 14.00. The reason that the DOER has to wait until July 2013 to announce the 2014 minimum standard is that the formula for calculating it includes, as its final term, the number of 2012 SRECs deposited in the SCCA account. 

Specifically, whatever the formula says 2014 demand would be, the actual 2014 minimum standard gets increased by 38,866. This is actually pretty intuitive, if you remember that every design element that makes this program unique among SREC programs is there to foster supply-demand balance. The SRECs deposited in the SCCA account represent over-supply -- they are extra SRECs in need of a home.  By including the SCCA term in the formula for calculating new demand, the formula is simply saying, “Okay, there is an oversupply of 38,866 SRECs; if we want to get back to supply/demand balance, let’s increase demand by those 38,866 SRECs, and presto change-o, we’re back to balance.”

Now that the formula has sent an unambiguous signal to the market -- “Hey, market: you’re gonna need these SRECs” -- it's time to run the auction. 

The SCCA is in fact a nested series of three rounds of a fixed-price auction, that price being $300, or, from the seller’s perspective, $285, because there is a $15 administrative fee. In each round, if there are fewer bids than there are SRECs in the auction, the round is scrubbed and the process begins again. But by rule, the pot gets sweetened between each round. In the first round of the SCCA, the SRECs get two years of extended life -- they can be used for compliance in 2013 or 2014. If buyers don’t like what they are seeing enough to pay $285 for every available SREC, then we try again with round two, but this time those same SRECs get another year of extended life; they can also be used in 2015.

If the second round doesn’t clear, the DOER plays hardball. The pot-sweetener before the third and final round of the SCCA is that the 2014 minimum standard gets increased a second time by the number of SRECs deposited in the SCCA account. So for 2014, that’s another increase of 38,866 SRECs to the 2014 minimum standard. 

In our analysis, this, along with the 400 megawatt cap on supply, is the linchpin of the program’s design. Taken along with the various other program rules as defined in 225 CMR 14.00, the conclusion is robust and powerful: an uncleared 2012 auction inevitably leads to undersupply by 2015 at the latest. In other words, this occurs within the three-year extended life of an uncleared 2012 SCCA SREC.

Of course, that doesn’t guarantee a cleared auction, for a couple of reasons.

One, $300 is by many measures a pretty steep price to pay in the summer of 2013 for an SREC that could very well not find a willing buyer at a good price until the spring of 2016. Today’s market price for a 2012 SREC is just a bit above $200. 

Two, it’s not obvious what a “good price” will be for that SREC. On the one hand, we have consistently observed in all SREC markets that the clearing price in an under-supplied market has been just a bit below the alternative compliance payment, which in this case would mean a price in the high $400s selling into an under-supplied 2015 SREC market. But on the other hand, the data set is not terribly large, and our shared history with SREC markets is not long, so it’s fair for investors to be cautious and conservative. 

And three, this is a policy-created market, which means that it is exposed to political and regulatory risk, which is nobody’s favorite type of risk. Two to three years may be a long time to be exposed to it.

So this auction may well not clear.  And in fact, the third reason in the paragraph above is the reason we decided to write this note.

If the SCCA doesn’t clear, we may hear a number of calls for policy intervention, claiming that because the auction didn’t clear, the program is not working as it was designed to work. But that’s not accurate. In fact, the most innovative and effective element of the DOER’s brainchild is exactly its resilience in the wake of an uncleared auction. The program is designed to provide stability whether the SCCA clears or not.

We would not have seen the investment and building boom that we saw in 2012 if this weren’t the case. So far, the solar carve-out program has stimulated over half a billion dollars of new investment in the Commonwealth -- an incredible success story for the Patrick administration and the Green Communities Act. 

Does anyone think that investors injected half a billion dollars into our state’s economy with one hand while keeping their fingers crossed on the other that the SCCA would clear? Quite the contrary; I’m sure that no less than 90 percent of the time spent by credit committees evaluating these investments was dedicated to this simple question: “What happens if the auction doesn’t clear?” (By the way, if you have half a billion dollars and aren’t in the habit of asking that kind of question, I have a bridge I’d like to sell you.)

Now, that said, I would argue that there are two kinds of SREC sellers in Massachusetts. The first -- the group that owns the vast majority of all MA SRECs -- are investors like the ones I just described. Some are energy companies, some are purely financial investors, and others are independent local investors who saw a good opportunity to earn a return by putting their money into something positive. But as a group, these are sophisticated professionals who are totally capable of evaluating the opportunities and risks to a potential investment.

Massachusetts has both a right and an obligation with respect to these investors. The right is that the ratepayers and taxpayers of Massachusetts don’t have to bear the financial risk of this investment; if it turns out that investing in SREC-generating solar in MA in 2012 was a bad bet, a money-loser, that’s not their problem. Public officials tried to design the program so that it offered an attractive but not-too-attractive return, with minimal risk. If you then invested, Massachusetts hopes you will make a little money, not a lot of money. But whether you lose your shirt or do quite well, that’s the idea of a market-based incentive program.

The flip side of that is the obligation: in order to encourage a strong, low-risk, attractive investment climate in this kind of market-based program, policymakers have to refrain from changing the program rules unless it is so clearly necessary that all or almost all stakeholders agree. An un-cleared auction this summer would be a crossroads for the solar carve-out; good public policy in this case calls for forbearance. If those un-cleared SRECs end up back in investors’ hands -- with a new lease on life -- no doubt some will call for some policy intervention to prop up prices, and others will be content to bide their time in the expectation of a seller’s market within a few years. Either way, the rules are the rules.

But that’s just one group of SREC sellers. The problem with this argument is that group two is in a different situation altogether. Group two are homeowners. Though Borrego only works at the commercial and utility scale, I have some direct experience with group two because it includes some friends who, knowing I work in solar, have come to me for advice about going solar at the residential scale in Massachusetts. Actually, "advice" is the wrong word; "translation" is more accurate. These are savvy, sophisticated people, but it’s easy to see that group two is totally different from group one; they have no way to evaluate the future value of a Massachusetts SREC other than to listen to what other people tell them.

When the solar carve-out was being implemented in 2009 and 2010, many stakeholders took to referring to the SCCA as a “floor,” which understandably conjures a strong impression of something through which one cannot fall. To a first approximation, the SCCA was designed to clear, and I know that it is possible to pinpoint this or that statement from someone at the DOER or the Massachusetts CEC that could have been interpreted by a homeowner that they would always be able to sell their SRECs for $285, especially when relayed by a solar installer making a sale. 

We may have a problem here. If the SCCA doesn’t clear, it may be a good idea to explore potential policy interventions that provide $285 per SREC, or something close to it, in relatively short order, to small system owners who hold the SREC position on their systems themselves.

Beyond that, though, let’s allow this well-designed program to run its course.

For the moment, though the market is tough, there is no macro-problem: SREC prices are low, solar is getting built, and business is good for local solar companies and national investors alike, which is a great recipe for job creation. If the auction doesn’t clear, we will likely see a quick drop in prices and fresh calls for a change in the regulation. But overreaction would be a mistake, especially given the trauma that the Massachusetts solar community just went through in June, with the quick filling of the 400 MW qualification queue. 

The program design is sound and resilient, and in its present form will almost surely deliver 400 MW of solar more efficiently -- for fewer subsidy dollars -- than any of the other Northeast SREC markets.

A market-based incentive delivery mechanism is just that: a market. Like all markets, this one will go through good times and not-so-good times, and will achieve its objectives by leveraging the value of competitive pressure, which of course can be painful for market participants. But overall, if we take the long view and exercise restraint, this one is going to continue to work out well.

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Dan Berwick is Borrego Solar’s Vice President of Business Development, based out of the New England regional headquarters. Dan’s primary focus is on shaping Borrego Solar’s unique business strategies and product offerings around the country, with a particular emphasis on the opportunities created by policy and regulation.