Renewable Energy Credit – Supply and Demand
The “spot” market price for New Jersey SRECs has dropped dramatically over the last several months, from over $600 back in May 2011 to almost $200 currently! What is going on?
Before we can answer the question as to why SREC prices have crashed, it is critical that we define our terms correctly. It is important to understand the New Jersey SRECs are quoted and valued depending on the specific “Energy Year” in which they are created. Energy Years in NJ consist of the 12 month period beginning on June 1 and running until May 31 of the following year; we are currently in Energy Year 2012. SRECs created in 2012 cannot be used to satisfy the Renewable Portfolio Standard (“RPS” – please see prior BLOG for more information on that) obligations of earlier Energy Years, although they can be “banked” and used to offset future Energy Years (a 2012 SREC could be used to offset 2013 or even 2014 RPS obligations).
The point is that comparing spot SREC prices between different Energy Years is a bit of an “apples-to-oranges” exercise. Having said all of that, even on an “apples-to-apples” basis, there is no question that the price of New Jersey’s current 2012 SRECs and future SRECs (i.e. multi-year SREC “strips”) has been declining precipitously. So the question remains, why?
The simple answer is “Supply & Demand”.
As we discussed in one of our prior blogs on SRECs, the demand side of the SREC equation is very easy to get your head around; it is set legislatively and there are explicit SREC targets that must be achieved each and every year through 2026 per NJ’s Renewable Portfolio Standard (“RPS”) requirement.
Supply is the wild card here, and huge increases in SREC supply have been the primary driver behind the dramatic declines in the SREC market. In the chart above, the “New Solar kW Required” reflects the incremental new solar system capacity that is needed each year to satisfy the RPS requirement. For Energy Year 2012, the state needs about 113MW of total new solar, or about 9.4MW of new solar per month. The actual rate of solar installations in the state has been significantly higher in recent months, with over 40MW installed in the month of June alone!
In fact, according to SREC Trade blog (an excellent source of SREC information in our opinion) the 2012 Energy Year SREC requirement has already been met.
SREC Pricing Equilibrium
Having said all of that, it is important to understand that New Jersey SREC prices are driven by real underlying market forces, and that SREC Supply and Demand will ultimately reach an equilibrium point that results in sufficient new solar installations in order to satisfy the increasing RPS requirements. Said another way, there is an SREC “feedback loop”, and in order for new solar systems to be developed and ultimately installed, SREC prices must be at a level that provides prospective solar system owners with an adequate Return On Invested Capital (ROIC) .
As a leading developer of solar projects for businesses in New Jersey, we see this scenario play out every day. Most businesses have numerous potential projects in which they can invest their limited capital. Assessing a solar project is fundamentally an exercise of capital budgeting in which prospective owners compare the anticipated after-tax cash flow return of a solar project relative to that project’s implicit risks (and then owners compare this risk/return opportunity to all other available investment opportunities).
Volatile SREC prices present a challenge to this fundamental economic analysis because the uncertainty reduces the predictability of what is often the largest potential cash flow source of a New Jersey solar project. As a result, we advise our corporate solar clients to seek long-term SREC contracts that provide long-term pricing visibility and cash flow certainty.
For more information on long-term SREC contracts and solar system project economics for your business, please contact us at EnterSolar.