Are SRECs the Future of U.S. Solar Policy?

SRECs are tradable credits that represent one megawatt-hour of solar electricity. In states like Delaware, Massachusetts, Maryland, New Jersey, Ohio and Pennsylvania, energy suppliers are required to accumulate a certain number of SRECs to meet a mandated generation target. Power providers can generate the credits themselves by investing directly in projects, or purchase the credits from project owners, brokers or aggregators.

The value of credits is based upon supply and demand: If there's a shortage of solar electricity in a given state, SREC prices will be high, thus stimulating more development. If there's an oversupply of solar, SREC prices will drop. Prices are capped by a penalty that power providers pay if they can't meet their targets.

Theoretically, the “free” market (some dispute calling it a free market because the parameters are so closely monitored by regulatory agencies) will find the right incentive price for solar electricity far more efficiently than policymakers or regulators.

The policy is the opposite of a FIT, which requires utilities to sign long-term contracts for renewable electricity at a premium price, usually determined by a legislature. Except in a few cases with FITs, both types of programs are funded by ratepayers.

The two policies are often compared side-by-side because they represent different ends of the philosophical (and perhaps ideological) spectrum over how best to incentivize solar.

The idea for an SREC-only market was born in New Jersey in 2004-2005, when the state started running out of money for rebates. Due to continued problems funding the popular program, the state has phased out rebates for all but a limited number of residential projects. During the transition, the state looked at both FITs and SRECs, but eventually decided that SRECs were a more suitable way to create a market.

In an effort to build a solar industry without being budget dependent while also appealing to politicians who are more inclined to support a free-market approach, numerous states have followed New Jersey's lead. In the last few years, six states and the District of Columbia have implemented comprehensive SREC programs for financing solar.

Because these programs are still so new, their effectiveness over the long term is unclear. Some installers – many of whom are advocates of FITs – believe the programs create too much volatility and favor larger commercial and industrial-scale project developers.

All the major emerging SREC markets are in deregulated states. Under deregulation, energy suppliers are short-term players in the market. Thus, they have been unwilling to sign contracts for longer than five years in states like New Jersey and Maryland. (In Maryland's case, there is a requirement that SREC generators bid for 15-year contracts, but energy suppliers have been more willing to pay the penalty than enter into such long agreements). Thus, a number of installers have found it difficult to finance projects with a 30-year lifetime based upon contracts for five years or less.

At the same time, large project developers who may be generating thousands of SRECs each year are able to negotiate contracts directly with energy suppliers, securing far more favorable terms and pricing than smaller players. Some are worried that this could limit diversity in the market.

To address this problem, a slew of new businesses have emerged to help residential and small commercial project owners register, track and sell their SRECs to energy suppliers. Financing and aggregation companies like Sol Systems, SRECTrade and Flett Exchange have seen business explode as SREC markets have expanded.

There's been a steady drumbeat of concerns over the complexity and effectiveness of floating SRECs over the years. But they are only now being tested as the markets mature.

New Jersey is the only state with enough experience to gauge success. After a couple years of missing solar targets during the program transition, the industry is finally catching up – driven by the high prices of SRECs due to limited supply. The average market price for an SREC has been about $570, or $0.57 per kilowatt-hour. That's well above the cost of generating solar electricity.

The high SREC prices have driven a flurry of new development in the state. However, if the industry overshoots its targets for 2011 and there's an oversupply of SRECs in the market, prices could drop substantially and hurt the financial viability of projects. Some are worried that it could put some installers out of business.

A number of fixes to these issues have been proposed: Some want to see required long-term contracts to provide security; some are hoping to create a hybrid structure where FITs target the smaller end of the market and SRECs are used for large projects; and a few people are even proposing that states with SREC markets start from scratch and implement pure-play FITs. (The likelihood of that is very slim).

While SRECs are certainly gaining traction and will likely be an important part of American solar policy, it may be another year or two before we know how effective they are. Depending on how these emerging markets perform, there may be a lot more experimentation ahead.

For more detail on how SREC markets are functioning, take a listen to this week's podcast linked above. We'll talk to aggregators and project developers about how to use SRECs to finance projects. We'll also talk to BusinessWeek reporter Ben Elgin about why the REC markets aren't responsible for bringing new renewable energy online.