In recent years, the Ontario Power Authority's ("OPA") Feed-in Tariff ("FIT") program has driven the market for new renewable generation in Ontario. While there continues to be a pipeline of FIT projects to be completed in 2015, FIT will increasingly become a niche program for smaller solar projects this year and may fade away in years to come. Developers of larger projects will have to look to the Large Renewal Procurement that is now being run by the newly amalgamated Independent Electricity System Operator ("IESO"). The IESO (as successor to the OPA) is also exploring ideas for a new capacity auction that may significantly change Ontario's approach to generation procurement starting in 2017. In both the short and long-term, conservation and storage will become increasingly relevant alternatives to generation.

This bulletin discusses these emerging developments in more detail. A companion bulletin takes stock of the changes in the regulatory and policy framework of the sector. Together, these bulletins provide a clearer picture of where the industry is headed in 2015. Project proponents, equity players, lenders and other stakeholders involved in small and large renewable energy projects will benefit from this summary of the new rules, their impact on winning, developing and profiting from new renewable projects, and the range of opportunities available.

Procurement and Supply Mix Management: Continuing a Narrowing FIT Program

The OPA capped off 2014 by awarding another 332 FIT 3 contracts representing 100 MW of generation in December of last year. In 2015, the FIT procurement target will be about 200 MW and the microFIT procurement target will be 50 MW, showing significant activity in the FIT space will continue this year.

However, that opportunity looks much different than it did in the early days of FIT. The OPA narrowed the FIT program substantially in 2014 when it moved the procurement of large projects (generally over 500 kW) to the Large Renewal Procurement ("LRP") process as directed by the Minister of Energy last March. The IESO recently conducted a consultation regarding additional proposed "enhancements" to the FIT and microFIT programs. The enhancements, if implemented, will introduce an element of price competition, will continue to transform FIT into a niche program for smaller solar projects, and will deal with some pain points under the existing rules. The proposed enhancements include:

  • Allowing proponents to bid below the published FIT prices to gain priority points for their applications. This incentive to lower prices may be amplified by the removal of priority points for community and aboriginal participation and for system benefits.
  • Removing fuel types (other than solar) from the program on the basis that the 500 kW project limit makes little sense for non-solar projects. Solar, which represented the overwhelming majority of FIT 3 applications, will remain the star of the program, but the fate of wind, waterpower, biomass, and biogas are all less certain.
  • Making the 2014 pilot for unconstructed rooftop solar a permanent feature of FIT.
  • Updating land use rules by adding exemptions for projects endorsed by a municipality, making that level of consultation even more important, and attempting to harmonize the rules with the 2014 Provincial Policy Statement on land use planning.
  • Replacing the time stamp that is used to break ties between applications with a random draw, in part to avoid a crush of applications when a FIT procurement window opens.

For FIT proponents, the proposed enhancements will mean another new set of rules to consider in an even more competitive battle for contracts when the FIT 4 window opens. Many of the proponents who will be chasing new FIT 4 contracts will also still need to devote significant time and attention to financing and building projects under their existing FIT contracts. Lenders and equity providers who want to stay involved in the FIT market will probably be most interested in proponents who need money for a portfolio of projects. More forward-looking players may begin assessing their post-FIT options, as there is no guarantee the program will continue much beyond the next couple of years.

Pushing for Further Growth Through the LRP

The province has committed to putting 20,000 megawatts of renewable energy online by 2025. This target includes having 10,700 MW of wind, solar and bioenergy online by 2021. About 9,500 MW is online or has been announced. About another 250 MW will be taken up by FIT and microFIT, leaving another approximately 950 MW of wind, solar and bioenergy to be procured outside of FIT in the coming years. That procurement will occur under the new LRP program.

The LRP replaces FIT for large projects after that program was cancelled in May of 2013 (discussed in this previous Davis LLP bulletin). The LRP will likely be run in two (or possibly three) phases.

In the first phase, which is currently under development, the IESO expects to procure:

  • 300 MW of wind,
  • 140 MW of solar,
  • 75 MW of hydro, and
  • 50 MW to bioenergy.

In the second phase, the IESO will procure:

  • 300 MW of wind,
  • 140 MW of solar,
  • 50 MW of bioenergy and
  • 45 MW of hydroelectricity.

Any shortfall that remains after the first two phases will be procured in a third phase.

The OPA has pre-qualified 42 developers to participate in the first phase of the LRP. As the procurement targets for LRP I are relatively modest, competition will likely be intense. This will result in bid prices that squeeze margins for developers. Under these realities, developers and their lenders will have to revisit carefully the financial models that they may have become comfortable with under FIT.

The OPA has published a draft form of request for proposal (the "LRP I RFP"), the LRP I contract and related prescribed forms. Its comment period on these documents closed in late December and these comments were discussed in webinars hosted by the IESO in late January. Finalized versions are expected in early 2015. The current draft LRP I RFP contemplates that bids will be due June 1, 2015 (although this may change as the program is finalized.

A review of the current drafts is beyond the scope of this bulletin. However, some common themes emerge when comparing the draft documents against the existing FIT regime. First, there is ever-increasing emphasis on community consultation, including during the pre-application phase of development. Three measures of community engagement are mandatory requirements and it also weighs heavily in the rated criteria component of proposal assessment. However, the government has not unwound the changes it made to the Planning Act under FIT to return siting approval power to municipalities. Second, other application criteria and mandatory assessment criteria under the RFP are increasingly demanding, meaning that proponents will have to undertake (and fund) more pre-development activity to participate in the RFP. A third theme is the shift of risk to proponents in the draft contract. For example, it includes an ongoing right of the IESO to terminate for convenience, caps the compensation that generators can receive when they are dispatched off, and excludes Renewable Energy Approval appeals from the scope of force majeure events.

In light of the foregoing, proponents and their equity investors and lenders must revisit all that they learned under FIT before participating in the LRP. New rules, new economics and new competitive pressures will likely mean that only the most sophisticated, well-funded and prepared proponents will succeed under the LRP I RFP.

Considering Capacity Auctions as a New Procurement Approach

After experiencing supply shortages a decade ago, Ontario has largely taken a centralized, long-term approach to matching electricity supply with demand. This approach is reflected in the predominance of market mechanisms like the OPA's 20-year power purchase agreements (e.g., under FIT) and the Ontario Energy Board's regulation of rates for nuclear and hydro generators. However, uncertainty in demand forecasts, the widespread integration of renewables, an increased emphasis on conservation, and the need to refurbish much of the nuclear fleet are all introducing more volatility into the demand and supply projections of the IESO. To ensure that it has the means to manage that volatility, and to help reign in the increasing cost of electricity, the IESO is beginning to explore capacity auctions as a more dynamic tool for procuring generation to fill supply gaps that may be much less than 20 years in duration.

Already used in several US jurisdictions, capacity auctions would represent a markedly different approach in Ontario to procurement than either the FIT or the LRP. They would likely require proponents to compete to make capacity available for relatively short periods (one, three or five years). Unlike the FIT or LRP, they would likely be technology neutral, allowing for example solar and gas fired-generation to compete to fill the same slice of capacity. Capacity auctions would not necessarily favour greenfield development, but may instead provide opportunities for generators who can increase the input of existing facilities.

Capacity auctions may give a particular advantage to Ontario's Non-Utility Generators, who have had ample opportunity to recover the initial capital cost of building their facilities and may be able to squeeze extra operational life out of their facilities at a substantially lower cost than newly-built generation. (Tellingly, the IESO was directed in December to suspend contract renewal negotiations pending the analysis of contracting options). Renewable generators may also be given an opportunity to amp up their production, either by expanding facilities or retrofitting them with higher output solar modules or turbines.

The IESO is running a stakeholder engagement process on the capacity auction design. A "Draft High Level Design" was presented in December and comments on the design were open until January 30, 2015.

Investing in "Conservation First" Framework

A major component of implementing Ontario's Long-Term Energy Plan is the Minister's Conservation First framework. This six year conservation plan builds on conservation and demand management programs previously offered by the OPA and aims to reduce electricity consumption by seven terawatt-hours by 2020. To do so, local distribution companies will receive funding from the IESO to develop and deliver incentive programs for electricity consumers who wish to boost conservation. Industrial, commercial and residential consumers will be able to access these incentive programs to help pay for energy efficiency upgrades.

The LDCs are in the process of signing their energy conservation agreements with the IESO (the form of which was published on October 31, 2014), finalizing their conservation and demand management plans, and developing their incentive programs (which may include programs based on province-wide rules developed by the OPA). Roll out of these incentive programs will start this year and will replace programs offered under the prior conservation framework.

Electricity consumers who are looking for opportunities to improve energy efficiency and boost conservation should contact their LDC regarding the details of the new incentive programs. Those who have unfinished projects under the existing 2011-2014 saveONenergy programs should ensure they understand the transition rules for the new program to ensure uninterrupted funding.

Adding Energy Storage to the Supply Mix

Energy storage is also an area of potential growth, as Ontario came close to meeting its target of procuring 50 MW of energy storage by the end of 2014. The IESO secured 34 MW of energy storage on July 25, 2014, and the OPA launched its procurement of the remaining 16 MW in September 2014. The deadline for qualification submissions was November 28, 2014, and qualified applicants were expected to be notified in January 2015, but this list of successful applicants had not been released as of the date of this bulletin. Energy storage looks to be an area of future opportunity as the Ontario government continues to push for innovations that will smooth the generating load in Ontario.

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