For the first time, a regulated electric utility, Liberty Utilities (CalPeco Electric) LLC (“Liberty”), obtained all state and federal regulatory approvals to partner with a tax equity investor to acquire, own, and operate a utility-scale solar project. By using a tax equity partnership, Liberty expects to more efficiently take advantage of federal solar tax incentives and thereby decrease the cost of the solar energy for the benefit of its customers.
The Federal Energy Regulatory Commission (“FERC”) and the California Public Utilities Commission (“CPUC”) each issued a series of orders approving various transactions and ratemaking requests which enable Liberty to utilize a tax equity structure to offer utility-owned solar generation to its customers at a low price that is competitive with independent power producers. While there are important tax considerations relevant to each utility and the project that must be explored, the commercial arrangements and associated regulatory approvals Liberty obtained could serve as a blueprint for other electric utilities across the country to transition to utility-owned solar generation at lower costs for their customers.
Liberty is an investor-owned electric distribution utility that provides service to approximately 49,000 customers in and around the Lake Tahoe area of California. Liberty has obtained almost 100% of its power supply through a “full requirements” services agreement with a neighboring utility.
In 2015, Liberty determined that it could offer its customers a more diversified, cost-effective, and reliable supply portfolio by owning and operating its own solar generation facility. Areas in Northern Nevada offer excellent solar resources that could be readily delivered to Liberty. Moreover, the 30% investment tax credit (“30% ITC”) available for solar facilities could reduce Liberty’s cost of generating this energy for its customers. However, the Internal Revenue Code and IRS regulations require a public utility owning a solar generation facility to flow the 30% ITC benefits to its customers on a ratable basis over the useful life of the project, pursuant to the IRS “normalization” rules.
To enable Liberty to flow the benefit of the 30% ITC to its customers on an accelerated basis, Liberty partnered with a tax equity investor to purchase and own the solar generating facility. While independent power producers often use tax equity partnerships to build utility-scale solar and wind projects, regulated utilities have not traditionally used this partnership model.
RFP and Tax Equity Structure
Liberty identified potential solar projects through a request for proposals (“RFP”) process that solicited bids for developers to permit, construct, and interconnect solar photovoltaic power projects near Liberty’s service territory. Liberty ultimately agreed to purchase the 50 MW Luning Energy project (“Luning”), which was developed and initially owned by Invenergy Solar Development, LLC.
Prior to Liberty’s purchase of Luning, Liberty formed a partnership with a tax equity investor. In exchange for an allocation of almost all of the 30% ITC available to the project and a smaller allocation of the partnership’s income, the tax equity investor contributed to the partnership approximately 35% of the capital costs required to purchase the Luning project. As a result of the formation of the partnership and the tax equity investor’s capital contribution, Liberty’s cost to purchase the Luning project was reduced by 35%. Liberty will recover the reduced cost of the project through its retail ratebase.
The Luning project sells all of the facility’s energy and renewable attributes to Liberty pursuant to a power purchase agreement (“PPA”). However, the majority of the revenues (minus financing and operating expenses) flow right back to Liberty through the partnership. After the end of the 30% ITC recapture period, Liberty intends to acquire the tax equity investor’s interest in the partnership. Liberty will then own 100% of the project and its customers will continue to benefit from the renewable power it produces.
The Luning project began commercial operations in February 2017. When operating at full capacity, the project will produce enough power to satisfy almost all of the electric requirements of Liberty’s nearly 50,000 customers.
FERC Regulatory Requirements
The project’s tax equity financing was contingent on Liberty and Luning receiving all required state and federal regulatory approvals. With respect to FERC approvals under the Federal Power Act (“FPA”), the project needed five approvals: (1) market-based rate authorization under FPA section 205; (2); FPA section 203 prior approval for Liberty’s acquisition of the project; (3) Luning’s exempt wholesale generator filing; (4) notice of change in status of Luning (post-transaction); and (5) Luning’s request under FPA section 205 to undertake affiliate sales of power to Liberty pursuant to the PPA.
The affiliate sales filing represented a matter of first impression for the FERC. In the typical affiliate PPA transaction the FERC reviews under FPA section 205, the PPA’s $/MWh pricing is the rate the utility ultimately charges its customers for the generator’s power. However, in the tax equity partnership model approved for the Luning project, Liberty’s customers will not be charged for solar power according to the rate set forth in the Luning PPA. Rather, the cost of the Luning project is to be recovered from customers under traditional cost-of-service retail rates, just like any other utility-owned generation asset.
Luning’s affiliates sales filing for the Luning project had to adhere to the FERC’s rules against affiliate abuse established in Edgar (Boston Edison Co. Re: Edgar Electric Energy Co., 55 FERC ¶ 61,382 (1991) and clarified with respect to RFPs in Allegheny (Allegheny Energy Supply Co. 108 FERC ¶ 61,082 (2004)). Luning’s affiliate sales filing demonstrated that the competitive solicitation process conducted by Liberty for the Luning project met each of the Allegheny guidelines. The filing also supplied benchmark evidence showing that the PPA pricing was in line with similar PPAs in relevant markets. By delegated letter order, FERC approved Luning’s affiliate sales application (Letter Order issued in Docket No. ER17-299-000, January 31, 2017).
In addition to the FERC approvals, Liberty sought and received authorization from the CPUC to adjust its rates to recover the cost of its capital investment in the Luning project. The CPUC’s approval of the Luning transaction was the first time the CPUC has authorized a utility to partner with a third party investor to take advantage of the 30% ITC.
The CPUC issued its decision approving the Luning project in January 2016. (Decision 16-01-021). Subject to certain conditions, the decision approved a settlement agreement between Liberty and the Office of Ratepayer Advocates (“ORA”) with respect to Liberty’s purchase, ownership, and operation of the Luning project. The CPUC also approved of the commercial arrangements Liberty structured with the tax equity investor, the PPA and other related contracts, and several tariff mechanisms necessary to implement ratemaking treatment for the project.
With the 30% ITC currently in place until 2020 (and phased down, in steps, to 10% thereafter), regulated utilities and investors may have the opportunity to achieve this same type of “win-win” for both utility shareholders and customers. Under this framework, a utility could potentially diversify its energy portfolio while also adding a generation asset to its ratebase. The utility’s customers, in turn, could benefit from energy supply diversity while also receiving the benefit of a solar power supply at a lower cost. It is important to note, however, that there are unique tax and regulatory implications of this type of structure that would need to be assessed by any other utility considering a similar transaction.