Pennsylvania’s solar energy boom has gone bust. Reports describe local solar developers as scrambling to find healthier solar markets elsewhere. Several nearby states — we will focus in this article on Massachusetts and Connecticut — are frequently mentioned as “sunnier” climes for solar. Experience shows that where there is hype in the solar energy market, economic activity usually follows. Unfortunately, if current trends continue, there will likely be not only less clean energy for Pennsylvania, but also fewer solar jobs for Pennsylvanians.

The Pennsylvania solar industry is a victim of its own success. The combination of solar policies and incentives in the commonwealth led to unprecedented, rapid growth for a couple of years through 2011. But the policies did not include mechanisms to modulate that growth so that supply and demand could be balanced over time. What resulted is a market that experienced a striking oversupply.

Solar RECs in Pennsylvania

A solar renewable energy credit, more commonly known as an SREC, represents a quantity of electricity — in technical terms, one megawatt hour (MW/h) — generated by a solar system. (In Pennsylvania, the term is Solar Alternative Energy Credit, or SAEC; because SREC is more commonly used in the industry, it will be used throughout this article.)

Pennsylvania’s SREC program is part of the commonwealth’s Alternative Energy Portfolio Standard (AEPS) requiring electric utilities to generate a percentage of their electricity from alternative energy sources. The standard mandates utilities to pay a cash penalty after the end of each year if they do not comply with solar energy generation targets set by the commonwealth. Compliance can be demonstrated through direct generation of solar energy or through the purchase of third-party-generated SRECs.

Generally speaking, SRECs have become an important component of solar project economics in many states. The sale of SRECs generated from a project can serve as a significant revenue stream for projects and has often played a vital role in developers’ abilities to secure necessary project financing.

Overgrowth of an Industry

Not too long ago, in the summer of 2010, SREC prices in Pennsylvania topped $300/MWh. Responding to this price, as well as enhanced federal tax incentives that have since decreased, solar project developers built unprecedented levels of solar energy projects in the commonwealth through much of 2011. Fast-forward to 2012 when SREC prices in Pennsylvania have now bottomed out around $20/MWh and the faltering of the industry in the commonwealth has accelerated.

The problem facing Pennsylvania stems largely from an overbuild of solar development, resulting in a glut of SRECs. One expert we spoke with estimates available SRECs will represent more than three times the amount of SRECs utilities need to meet this year’s AEPS requirement.

The same expert noted that Pennsylvania’s solar market saw strong growth in 2011 despite the fact that SREC oversupply had already occurred. Development did not begin to cool down until SREC values on the spot market dropped below $50/MWh. Remarkably, the slowdown did not really start until six months after clear signs of SREC oversupply took shape. As a result, when the bubble burst, it had grown very large indeed.

We should also note that there were some additional factors in play in Pennsylvania. Pennsylvania’s AEPS, which permits SRECs from many neighboring states, makes it far less likely that Pennsylvania will ever experience an undersupply of SRECs. This unusual open-border policy encourages solar development in other nearby states and leads to further sources of oversupply. In addition, the Pennsylvania SREC system is relatively complicated in comparison to other states. For example, the penalty to be paid for not generating enough solar energy and not purchasing enough SRECs to make up the difference is not determined until after the end of each applicable compliance year, creating a challenge for advance planning by utility companies.

House Bill 1580: Legislative Fix?

In October 2011, Pennsylvania Representative Chris Ross, R-Chester, introduced House Bill 1580 in an attempt to prop up the Pennsylvania solar industry. Among other technical fixes, the bill would accelerate the solar energy requirements for Pennsylvania’s utilities for 2013, 2014 and 2015 in an attempt to raise demand to meet the current oversupply. Reports indicate that the bill has run into stiff opposition from large conventional power producers and large energy customers and that passage seems unlikely in the near term, despite compromise attempts by Ross.

However, HB 1580 would likely not prevent the overbuild scenario that Pennsylvania currently faces. The Pennsylvania solar market is grossly oversupplied, and the increase in the SREC requirement can serve to relieve the glut only in the short term. Solar experts we spoke to suggested that passage of HB 1580 would result in a brief rise in SREC prices, followed by a fall once oversupply occurs again.

New Jersey

A discussion of solar oversupply should include at least a brief mention of neighboring New Jersey. The Garden State, for similar reasons, is also experiencing trouble in what once appeared to be a market where the sky was the limit. Although New Jersey solar project build has continued to be strong into 2012, New Jersey SREC prices on the spot market have plummeted from highs of the mid-$600s in 2011 to the mid-$100s this year. Many foresee a rapid decline in the New Jersey solar industry, similar to that in Pennsylvania.

Recently passed solar legislation in New Jersey (S1925/A2966, which passed the New Jersey legislature and is pending Governor Chris Christie’s signature) attempts several fixes, and most prominently accelerates the state’s solar energy requirement for several years. However, there is concern that, should development continue at the recent high levels in New Jersey, a significant oversupply scenario would continue to occur. Most importantly, the bill’s critics argue that the legislation lacks a mechanism to modulate growth and keep supply and demand in balance over time.

Looking North: Massachusetts and Connecticut

Two New England states, Massachusetts and Connecticut, have relatively recently developed policies designed to combat SREC volatility and unchecked solar development. The Massachusetts SREC program, in particular, has received a significant amount of attention from the solar industry. Massachusetts evaluates how much to increase solar requirements on a yearly basis through a complex formula that takes into account a variety of factors, including previous years’ SREC production. In addition, the Massachusetts SREC program has attempted, through an annual auction mechanism, to set a floor for SREC prices ($300 minus a $15 commission), which in theory could give investors confidence in future revenue streams as they evaluate their financing alternatives.

It should be noted that finding that right mix of incentives is highly challenging. Although the Massachusetts solar program has seen a level of success, analysts are concerned about oversupply there as well, due to lower solar requirements in previous years. There have also been rumblings within the industry that the Massachusetts floor is not a true floor given that sales pursuant to the auction mechanism are not guaranteed, and SREC sales completed outside of the auction could result in prices below the floor.

Connecticut’s new renewable energy programs are also receiving attention from the solar industry. Connecticut’s program, approved by the state’s Public Utilities Regulatory Authority in April 2012, creates two related REC programs — low-emissions renewable energy credits (known as LRECs) and zero-emissions renewable energy credits (known as ZRECs).

Under the ZREC/LREC programs, the state’s two largest utilities — Connecticut Light & Power (CL&P) and United Illuminating (UI) — will issue competitive solicitations for 15-year REC contracts over the next six years. It is intended that CL&P and UI will procure approximately $1 billion in RECs under these programs.

ZREC projects can be sized up to one megawatt and must not produce any emissions; LREC projects, on the other hand, cannot be larger than two megawatts and must come from sources that produce low emissions. Initially, ZRECs will be capped at $350/MWh and LRECs will top out at $200/MWh. Experts believe that solar projects will compose a large portion of ZREC projects and fuel cell technology will be a major source of LREC projects.

The long-term REC contracts with CL&P and UI may well enable long-term REC price certainty and therefore long-term REC purchase contracts — something lacking in Pennsylvania. In addition, competitive REC solicitations at capped REC prices will work toward avoiding an oversupplied REC market through carefully planned REC solicitations. The intended result is a solar market free of the type of unchecked solar development experienced in Pennsylvania and New Jersey, where solar developers flooded the market with projects as SREC prices skyrocketed.

Breaking the Cycle

As of press time, Pennsylvania’s HB 1580 has stalled, and any hope of its passage will have to wait until the next legislative session in the fall. In the interim, the commonwealth’s policymakers should seriously consider the Massachusetts and Connecticut programs designed to modulate the solar energy market in those states and address the threat of oversupply. While accelerating Pennsylvania’s solar requirements would potentially resurrect solar development, it would likely do so only temporarily. Growth in solar development (and therefore SRECs generated) would likely eventually outpace SREC demand and the industry would find itself growing at unsustainable levels once again. New policies are needed to break the cycle. •

Neil A. Cooper is a partner of Royer Cooper Cohen Braunfeld in Conshohocken, Pa. He focuses his practice primarily on business and corporate law matters, effectively serving as outside general counsel to many of his clients, including in the solar energy industry. He can be reached at ncooper@rccblaw.com.

Sean S. Litz is an associate of the firm in Conshohocken, Pa. He focuses his practice in the areas of clean technology, energy and transactional law. He can be reached at slitz@rccblaw.com.