ASSESSMENT OF POWER PURCHASE AGREEMENT BETWEEN DELMARVA POWER AND BLUEWATER WIND DELAWARE LLC

Transcription

1 BEFORE THE PUBLIC SERVICE COMMISSION OF THE STATE OF DELAWARE IN THE MATTER OF INTEGRATED RESOURCE PLANNING FOR THE PROVISION OF STANDARD OFFER SERVICE BY DELMARVA POWER & LIGHT COMPANY UNDER 26 DEL C. 1007(c) & (d): REVIEW AND APPROVAL OF THE REQUEST FOR PROPOSALS FOR THE CONSTRUCTION OF NEW GENERATION RESOURCES UNDER 26 DEL. C. 1007(d) (OPENED JULY 25, 2006) PSC DOCKET NO ASSESSMENT OF POWER PURCHASE AGREEMENT BETWEEN DELMARVA POWER AND BLUEWATER WIND DELAWARE LLC PREPARED FOR: Delaware Public Service Commission Delaware Office of Management and Budget Delaware Energy Office Delaware Controller General PREPARED BY THE CONSULTING TEAM OF: New Energy Opportunities, Inc. La Capra Associates, Inc. Merrimack Energy Group, Inc. McCauley Lyman LLC December 13,

2 Table of Contents I. INTRODUCTION... 1 A. BACKGROUND... 1 B. THE BLUEWATER/DELMARVA PPA... 2 C. MATTERS ADDRESSED IN THIS REPORT... 3 II. ECONOMIC ANALYSIS... 4 A. METHODOLOGY AND PRESENTATION... 4 B. OVERALL RATEPAYER IMPACT OF REVISED BLUEWATER PROPOSAL... 5 C. INITIAL AND YEAR-BY-YEAR CUSTOMER IMPACT... 7 D. IMPLICATIONS OF SPREADING THE IMPACT OVER A LARGER CUSTOMER BASE... 8 E. SENSITIVITY ANALYSES AND ECONOMIC RISKS III. POLICY ISSUES IV. ASSESSMENT OF PPA TERMS AND CONDITIONS V. CONCLUSIONS Appendices Appendix A Load Data Appendix B Rate Impact Appendix C Delmarva REC Purchases Compared to RPS Requirements

3 I. Introduction A. Background On November 1, 2006, Delmarva Power & Light Company ( Delmarva or DP&L ) issued a Request for Proposals ( RFP ) for the purchase of power under long-term contracts from new generation resources to be built within the State of Delaware for the purpose of supplying standard offer service ( SOS ), as required under the Electric Utility Retail Customer Supply Act of 2006 ( EURCSA or the Act ). Following the submission and evaluation of the bids, the state agencies authorized by the Act the Delaware Public Service Commission ( Commission ), the Energy Office, the Office of Management and Budget, and the Controller General ( State Agencies ) directed Delmarva to negotiate a power purchase agreement ( PPA ) with Bluewater Delaware Wind LLC ( Bluewater ) for approximately MW of energy and associated capacity from its proposed offshore wind project and for backup power from a natural gas-fired facility to be built by either of the two other bidders, NRG Energy, Inc. ( NRG ) or Conectiv Energy Supply, Inc. ( Conectiv or CESI ). 1 Delmarva was directed to conduct three separate negotiations in parallel with oversight from an independent mediator. On September 14, 2007, Delmarva submitted term sheets for a PPA with Bluewater and PPAs for backup power from NRG and Conectiv. Following two separate modifications by Bluewater of its term sheet pricing proposal (first, a modification of its price escalator provision based on construction-related commodities and currency exchange rates, and then an elimination of this provision), the State Agencies adopted the Commission staff s procedural proposal to reach closure in this proceeding. 2 Key elements are: Authorizing the mediator, Professor Lawrence A. Hamermesh, to act as an arbitrator to resolve all outstanding PPA issues between Delmarva and Bluewater; Directing that a Bluewater/Delmarva PPA be submitted by December 10, 2007 that resolves all outstanding issues; Directing the Commission staff ( Staff ) to solicit an expert analysis on (a) the merits of the Bluewater proposal based on a common set of metrics and (b) the implications of execution of a non-bypassable charge against Delmarva s entire customer base; Meeting of the State Agencies on December 18, 2007 to consider the Bluewater/Delmarva PPA. 1 Findings, Opinion and Order No. 7199, PSC Docket No (May 22, 2007). 2 Findings, Opinion and Order No. 7328, PSC Docket No (Dec. 4, 2007). Page 1

4 On December 10, 2007, a completed Delmarva/Bluewater PPA acceptable to Bluewater was concluded and filed with the State Agencies. 3 On December 13, 2007, Professor Hamermesh issued a report on his resolution of disputed issues in the PPA negotiations. This assessment of the merits of the resulting PPA and the implications of allocating costs to a larger customer base than residential and small commercial and industrial ( RSCI ) SOS customers is submitted by New Energy Opportunities, Inc. and its subcontractors, the consulting team previously hired by the State Agencies to assist in overseeing the RFP and in evaluating the bids (the Independent Consultant or IC ). 4 B. The Bluewater/Delmarva PPA In the course of the PPA negotiations, there were a number of changes to the transaction embodied in the Bluewater/Delmarva Term Sheet of September 14, They fell into three general categories: Changes to elements of the business transaction Resolution of issues in dispute in the Term Sheet Resolution of additional issues associated with converting the Term Sheet into a PPA. Delmarva proposed two important changes: Moving the delivery point from Bethany Beach to Indian River Delmarva would build an interconnection line between the two points at Bluewater s expense Delmarva would be responsible for network upgrade costs associated with the Bluewater project Delmarva would be willing to purchase a greater amount of Renewable Energy Credits ( RECs ) than the 175,000 maximum amount per year set forth in the Term Sheet; price proposals were sought based on three different REC purchase scenarios. In addition, Delmarva proposed that Bluewater, rather than Delmarva, be responsible for providing capacity that clears PJM s Reliability Pricing Model ( RPM ) capacity market. These modifications provided for a more favorable delivery point on the Delmarva transmission system and reduced the risk to Delmarva associated with clearing capacity in the RPM capacity auctions. 3 See Proposed Purchase Power Agreement Between DP&L and BWW (December 10, 2007), 4 The IC also provided technical assistance to Professor Hamermesh with respect to the Delmarva/Bluewater PPA negotiations. Page 2

5 Based on these changes, Bluewater revised its pricing offer, which varied with the number of RECs to be purchased by Delmarva. Delmarva selected the following pricing/rec option: REC amount: one REC for each MWh (estimated 1.1 million/year) Pricing: Energy: $98.93/MWh (formerly, $105.90/MWh) Capacity: $70.23/kW-year (formerly, $65.23/kW-year) RECs: $19.75 (same as previously) All of these prices are for 2007 and increase annually by 2.5%. The Guaranteed Initial Delivery Date is June 1, The term of the PPA is 25 years following commercial operation of the Project. On a net basis, Bluewater reduced energy and capacity prices by approximately 5 percent from the Term Sheet proposal without the commodity price escalators (taking into consideration the transmission upgrade costs associated with the new proposal) while maintaining REC prices at the same level. Professor Hamermesh crafted resolutions to address three issues that were in dispute: Terms and conditions associated with Delmarva s right to terminate the PPA in the event Delmarva s auditing firm determines that it must consolidate Bluewater on its financial statements under Financial Accounting Standards Board Interpretation No. 46 ( FIN 46 ) (Section 12.4); Impact on Bluewater s contract rights and obligations if Delmarva or an affiliate litigates matters pertaining to the PPA or the Project (Section 13.4); and Delmarva s right to consent to a change in control in Bluewater (Section 14.5(a)). Resolution of these issues, and other issues that arose in the PPA negotiations, are addressed in Professor Hamermesh s report. As reflected in Professor Hamermesh s report, Delmarva has stated that it does not agree on a number of key terms, including price, contract size (maximum purchase obligation of 300 MWh per hour from a 450 MW project), and delivery term. C. Matters Addressed in This Report In this report, we present our economic evaluation of the proposed PPA with and without consideration of the Conectiv and NRG backup proposals in terms of the projected rate impact on RSCI customers. 5 In addition, we consider the rate impact if the costs and 5 Although NRG has indicated a willingness to change its proposal, we evaluated the proposal embodied in its term sheet with Delmarva. If the State Agencies reach a favorable conclusion with regard to the Bluewater/Delmarva PPA, there will be a further opportunity to consider changes to NRG s proposal. Page 3

6 benefits of the Bluewater PPA are allocated to (a) all Delmarva distribution customers in Delaware or (b) all Delaware distribution customers, regardless of whether they are Delmarva customers. In connection with these potential cost allocation approaches, we address the regulatory and practical implications associated with these potential approaches. In addition, to our reference case analyses, we also explore the economic impacts associated with the following scenarios: Natural gas market prices are substantially higher or lower than projected; REC market prices are substantially higher or lower than projected; and Federal Greenhouse Gas regulation is either (a) not enacted or is no more stringent than the Regional Greenhouse Gas Initiative ( RGGI ) or (b) more stringent than expected or otherwise results in higher compliance costs than projected. We also present several combination scenarios (high gas/high carbon and low gas/low carbon) and address other scenarios explored in previous reports (such as high/low capacity prices and higher Bluewater output than projected). Then, we address several big picture policy issues in connection with the Bluewater proposal, including: The benefits and risks associated with the Bluewater proposal as a hedge against market price risks; Climate change and the Bluewater proposal; and The relative costs, risks and benefits associated with the Bluewater PPA compared to the potential purchase of energy and/or RECs from out-of-state onshore wind projects. Finally, we address some of the key commercial terms and conditions of the Bluewater PPA, including security, critical milestones, and FIN 46. II. Economic Analysis A. Methodology and Presentation Our methodology for determining the rate impact on customers is to compare the cost of the Bluewater proposal, with and without the backup power proposals, to market rates for 300 MW of energy and unforced capacity ( UCAP ) and comparable quantities of RECs. 6 We then divide the annual above-market or below-market dollars by projected 6 See Assessment of Term Sheets for Proposed Power Sales to Delmarva Power (pp , attached as Exhibit A to PSC Staff Report of the Term Sheets for Proposed Power Sales dated October 29, 2007). Page 4

7 load of the customer class (in MWh) responsible for the costs and benefits associated with the contract(s). The annual $/MWh amount, which is in nominal dollars, is converted to $/MWh in 2007$ based on a projected 2.5% inflation rate. Then, a single real (2007$) levelized $/MWh above-market or below-market figure is calculated to determine the ratepayer impact over the entire term of the Bluewater PPA. 7 Because the typical Delmarva residential customer uses approximately 1,000 kwh per month one MWh the $/MWh figure is equal to a monthly bill for a typical residential customer. In addition to the IC, several other consultants submitted their economic analysis of the term sheet proposals ICF and Pace for Delmarva and ESAI for Bluewater but their analyses were not presented on the same basis as the IC. 8 The State Agencies directed that any further analyses be on an apples to apples basis. Subsequently, we have worked with Delmarva and Bluewater (through their consultants) to arrive at a common set of metrics for presentation of economic impacts: Impact on customers over the term of the PPA: in real levelized $/MWh (2007$) using a 2.5% inflation rate and a 6.3% real discount rate Year-by-year rate impacts: (a) stated in today s dollars (real 2007$) and (b) stated in nominal dollars Customer impacts are presented in terms of today s dollars to provide a better sense of the value of future net costs. Year-by-year impacts are also provided in nominal dollars for the reference case scenario to provide decisionmakers with information on the dollars to be paid in the future (with the value that future dollars may have after inflation). In determining customer impacts, we have agreed to use updated projections for RSCI SOS load, as well as projections for Delmarva s Delaware distribution load, and all Delaware distribution load. These load projections assume a level of Demand Side Management (as had the RSCI SOS load projections previously used). The updated load projections are somewhat higher than the ones we previously used (which has the effect of slightly reducing customer impacts). 9 B. Overall Ratepayer Impact of Revised Bluewater Proposal As shown below, when the Bluewater PPA proposal is compared to prior proposals, the PPA economics are better than the Term Sheet proposal even without the commodity 7 In making this calculation, a 6.3% real discount rate is used to calculate the net present value of the rate impacts over the entire term of the PPA back to the beginning of assumed power purchases (January 2014); a single mortgage-style payment using the same 6.3% rate is then calculated over the entire term of the PPA based on the NPV of the above-market or below-market amount. The discount rate is the same rate that has been used in all of the bid evaluations conducted by the IC and in the original bid evaluations. In the original bid evaluations, customer impacts were presented in 2005$. The net present value calculations we previously presented used a nominal discount rate of 8.96% (based on a real discount rate of 6.3% and a 2.5% inflation rate). 8 We note that in some instances, we were not explicit in our assumptions, which made the task difficult for other consultants and participants in this proceeding. 9 The load projections are set forth in Appendix A of this report. Page 5

8 price escalators and are roughly comparable to Bluewater s original proposal with a larger energy cap (400 MW from a 600 MW facility instead of 300 MW from a 450 MW facility). Table 1: Comparison to Previous Bluewater Proposals Old BW (2006) New BW-Nov New BW-Dec 2007(No Adj) 2007 Contracted Annual Energy (GWh) 1,588 1,106 1,106 Percentage of 2014 SOS Load 42% 29% 29% Annual Avg. REC Purchases (GWh) ,106 Real Levelized SOS Cost Impact with 25% Risk Factor for Imputed Debt ($/MWh) $6.26 $8.06 $6.46 As shown above, the overall impact to RSCI SOS customers is projected to be $6.46/MWh in real levelized 2007$, assuming the REC price proposed is reflective of market prices. In a subsequent section, we will discuss the impact on rates if market REC prices are higher or lower than this assumption. Because our analysis shows that the Conectiv proposal would add economic value, the impact to RSCI SOS customers would be reduced to $5.15/MWh in real levelized 2007$ (the NRG proposal would have negative value which would increase the impact to over $7/MWh). However, if the costs and benefits of the Bluewater PPA, with and without a backup PPA, are allocated against a larger set of customers, the cost impact is reduced. As shown below, if allocated against Delmarva distribution customers, the impact is reduced by nearly 50 percent--$3.37/mwh for Delmarva Delaware distribution customers for Bluewater only and $2.69/MWh for the Bluewater/CESI combination. If allocated against all electricity purchasers in Delaware the impact would be further reduced to $2.24/MWh for Bluewater only and $1.78/MWh for the Bluewater/CESI combination. Table 2: Revised Bluewater Proposal with Backup PPAs and Different Load Impacts SOS Load Impact (2007$/MWh) Delmarva Load Impact (2007$/MWh) Delaware State Load Impact (2007$/MWh) BW ONLY $6.46 $3.37 $2.28 BW+NRG $7.35 $3.83 $2.60 BW+CESI $5.15 $2.69 $1.83 Hence, the revised Bluewater proposal when coupled with the potential for allocating the net costs against a larger customer base presents an opportunity to reduce the impact over the term of the PPA to approximately $2-$3/MWh in 2007$. Page 6

9 C. Initial and Year-By-Year Customer Impact While in our reference case the impacts on customers appear relatively modest, the impacts in the initial years when Bluewater is projected to come on line are much higher. As shown in the graph below and the table in Appendix B, the impact in real 2007$ is in the range of $13-$14/MWh equivalent to $13-$14/month for a typical residential customer using 1,000 kwh/month for 2014, the first year, declining to approximately $10.50/MWh in 2017, $2-4/MWh in 2025, and then breaking even and turning positive later in the contract term. If PPA costs are allocated against all Delmarva Delaware distribution customers, the initial year impact is approximately $7/MWh ($7/month) in 2017, reducing to $5.50/MWh in 2017, approximately $1-2/MWh in 2025, and then breaking even and turning positive (the impacts are lower if costs are allocated to all Delaware electrical load). 2007$/MWh $20.00 $15.00 $10.00 $5.00 $0.00 ($5.00) Rate Impact for BW and BW+CESI (2007$) for Different Loads Impact on SOS Load BW Impact on SOS Load BW+CESI Impact on Delmarva Load BW Impact on Delmarva Load BW+CESI Impact on Delaware State Load BW Impact on Delaware State Load BW+CESI ($10.00) In nominal dollars (the future value of dollars rather than dollars with today s value), the impact is somewhat higher--$16/mwh in 2014, declining to approximately $14/MWh in 2017, and $3-6/MWh in 2025 before eventually turning positive (as shown in the graph below and the table in Appendix C). If PPA costs are allocated against all of Delmarva s Delaware distribution customers, the initial year impact is approximately $8.00- $8.50/MWh, declining to approximately $7/MWh in 2017, $2-$3/MWh in 2025 before eventually turning positive. Page 7

10 Rate Impact for BW and BW+CESI (Nominal$) for Different Loads Nominal$/MWh $20.00 $15.00 $10.00 $5.00 $0.00 ($5.00) Impact on SOS Load BW Impact on SOS Load BW+CESI Impact on Delmarva Load BW Impact on Delmarva Load BW+CESI Impact on Delaware State Load BW Impact on Delaware State Load BW+CESI ($10.00) Hence, based on our forecast of energy, capacity and REC prices, the rate impacts during the first several years of service in today s dollars will be approximately double the real levelized cost impact over the entire 25 years of the Bluewater PPA. Over time, the impact is reduced until it breaks even and turns positive about half-way or more through the contract term. D. Implications of Spreading the Impact Over a Larger Customer Base In Order No. 7328, the State Agencies directed an evaluation of the implications of directing a non-bypassable charge against all of Delmarva s distribution customers in the state ( 62). In addition, the IC has been requested to evaluate the implications of allocating the PPA costs against all Delaware electricity consumers, regardless of whether they are Delmarva customers. Section 1010(c) of EURCSA (House Bill 6) provides a mechanism that the Commission could utilize to impose a non-bypassable charge payable by all of Delmarva s distribution customers: After hearing and a determination that it is in the public interest, the Commission is authorized to restrict retail competition and/or add a nonbypassable charge to protect the customers of the electric distribution company receiving standard offer service. The General Assembly recognizes that electric distribution companies are now required to provide standard offer service to many customers who may not have the opportunity to choose their own electric supplier. Consequently, it is Page 8

11 necessary to protect these customers from substantial migration away from standard offer service, whereupon they may be forced to share too great a share of the cost of the fixed assets that are necessary to service them as required by the Electric Utility Retail Customer Supply Act of Del. C. 1010(c). Earlier in this proceeding, we viewed this section as a mechanism that the Commission could utilize to respond to impending or actual migration of customers away from standard offer service due to sales of power under a PPA at prices that are high relative to the then-current market price. However, the statutory section does not appear to limit the Commission from applying a nonbypassable charge to all of Delmarva s distribution customers in the state in connection with a PPA entered into pursuant to EURCSA before electric power sales are even commenced under a PPA, especially where it is forecasted that substantial increases in SOS costs are likely to result with the threat of migration resulting in even larger SOS cost impacts. There are two potential approaches that could be taken if the State Agencies (a) are inclined to order Delmarva to enter into the PPA with Bluewater and (b) favor assessing the net costs of the PPA to Delmarva s Delaware distribution customers. The State Agencies could approve the PPA, with the understanding that the Commission would institute a separate proceeding to consider instituting a nonbypassable charge based on the net above-market costs associated with the Bluewater PPA (including any backup PPA). However, regulatory approval of the PPA would not be conditioned on a subsequent Commission order directing a nonbypassable charge regarding PPA costs. A second approach is that the regulatory approval provided by the State Agencies would be conditioned on the Commission issuing an order under Section 1010(c) of EURCSA to direct a nonbypassable charge to Delmarva s Delaware distribution customers. Under the statute, a proceeding would need to be instituted, hearings would need to be held, and the Commission would need to find that the resulting cost allocation is in the public interest to protect the customers of the electric distribution customers receiving standard offer service. This has several implications. If the approval of the State Agencies is conditioned on a subsequent approval by the Commission, it would appear that under the Bluewater PPA, Regulatory Approval would not be received until the Commission authorizes Delmarva to recover its costs through its rates through the nonbypassable charge. Under Section 2.3 of the Bluewater PPA, either party has the right to terminate the PPA if Regulatory Approval is not obtained within one year of the Execution Date. This would create some uncertainty from Bluewater s perspective but more certainty from the State Agencies s perspective if this cost allocation approach is critical to their decision. It would appear that if the Commissioners in voting for this approach expressed strong support for commencing and concluding the necessary proceeding expeditiously that the risk would be (or should be) a manageable one for Bluewater. Allocating the net costs of the Bluewater PPA against all Delaware customers, including customers of the Delaware Electric Cooperative and the various Delaware municipal electric utilities, would, at a minimum, require approval of the Delaware Legislature. There are or may be a variety of legal and practical issues associated with implementation of any such mandate. Conditioning approval on enactment of any such legislation presents numerous uncertainties and risks. On the other hand, enactment of legislation Page 9

12 that would allocate Bluewater PPA costs to a wider set of customers would help in reducing the cost impacts to Delmarva customers. It could help achieve the objectives of further reducing the impact on SOS customers. A constructive approach consistent with providing a solid approval for Bluewater to proceed could involve (a) regulatory approval not conditioned on subsequent legislation but (b) a separate initiative to provide a legislative basis for additional cost sharing; provided, that if legal or other implementation problems prevent the wider cost sharing that the fallback cost allocation approach directed by the Commission would prevail. E. Sensitivity Analyses and Economic Risks The economic analysis presented in Section II.C is based on the reference case energy, capacity and REC market price assumptions that were also used in our October 29, 2007 assessment of the Bluewater, Conectiv and NRG term sheet proposals. 10 In this section, we explore alternative scenarios and resulting ratepayer impacts. Natural Gas Prices In a scenario where natural gas prices are projected to be 30% higher than the reference case based on the ICF forecast, the Bluewater PPA proposal comes close to breaking even in real $2007/MWh and with the Conectiv backup is slightly positive. 10 Assessment of Term Sheets for Proposed Power Sales to Delmarva Power ( Term Sheet Assessment ), attached as Exhibit A to PSC Staff Report of the Term Sheets for Proposed Power Sales to Delmarva Power (Oct. 29, 2007). The key scenarios and sensitivities are described at pp and pp The only change in our analysis (aside from using different load projections) was to use the high oil forecast for the combined Bluewater/CESI case. This affected the SOS ratepayer impact by less than $.05/MWh (real levelized 2007$). As in our prior analysis, the projected real levelized market price for a 300 MW block of energy and UCAP is $88.55/MWh (2007$). When the projected amount of RECs to be purchased by Delmarva is included, the projected real levelized market price for a 300 MW block of energy and UCAP and 1.1 million RECs/year is $96.86/MWh (2007$). Page 10

13 $16.00 Gas Price Sensitivity - Real Levelized Impact on SOS Load 2007$/MWh $12.00 $8.00 $4.00 BW ONLY BW+NRG BW+CESI $0.00 ($4.00) Reference High Gas Low Gas Sensitivities However, in the initial years, even with the high natural gas forecast, the ratepayer impacts for SOS customers are still significant in the $9/MWh range. Spread over all Delmarva distribution customers, the impact would diminish by approximately 50 percent. The ratepayer impact declines in subsequent years until it is projected to turn positive in the timeframe. Gas Price Sensitivity - Rate Impact (2007$) $20.00 $15.00 $10.00 $ $/MWh $0.00 ($5.00) ($10.00) ($15.00) ($20.00) Low Gas BW Reference BW High Gas BW Low Gas BW+CESI Reference BW+CESI High Gas BW+CESI Page 11

14 If natural gas prices follow the Low Gas trajectory based on the Energy Information Administration s Annual Energy Outlook 2007 Reference case rate impacts would be substantially higher than shown in our reference case throughout the 25-year term of the Bluewater PPA. Carbon Regulation If the Federal Government does not enact greenhouse gas control legislation or if it does, it is no more stringent than those under the Regional Greenhouse Gas Initiative ( RGGI ), the real levelized cost to SOS customers increases to $8-9/MWh levelized (2007$). In a case where controls are more stringent than projected, the impact is reduced to the $2-4/MWh range over the term of the PPA. While using the reference carbon case is reasonable over the term of the PPA, there is a substantial risk that the commencement of a federal regulatory scheme will be delayed beyond our projected start date for the Bluewater project $16.00 Carbon Price Sensitivity - Real Levelized Impact on SOS Load 2007$/MWh $12.00 $8.00 $4.00 BW ONLY BW+NRG BW+CESI $0.00 ($4.00) Reference Low Carbon High Carbon Sensitivities Page 12

15 Carbon Price Sensitivity - Rate Impact (2007$) $20.00 $15.00 $10.00 $ $/MWh $0.00 ($5.00) ($10.00) ($15.00) ($20.00) Low Carbon BW Reference BW High Carbon BW Low Carbon BW+CESI Reference BW+CESI High Carbon BW+CESI REC Prices In the past year since bids were submitted in response to Delmarva s RFP, REC market prices for 5-10 year contracts in the Mid-Atlantic region have increased from the low teens to the upper teens, based on discussions with market participants (although the market is admittedly thin and illiquid). Bluewater s proposed REC prices are somewhat above the current market. However, given current trends and the potential impact that Bluewater could have in terms of dampening REC market prices, our conclusion is that Bluewater s REC pricing approximates market prices during the time period of the sale. 11 If one assumes that REC prices are approximately $10 higher or lower than Bluewater s price of $19.75 in 2007$, the impact on SOS rate payers will be approximately $2.50/MWH higher or lower than the reference case forecast of $5-6.50/MWh. 11 See Term Sheet Assessment at 24. Page 13

16 $16.00 REC Price Sensitivity - Real Levelized Impact on SOS Load 2007$/MWh $12.00 $8.00 $4.00 BW ONLY BW+NRG BW+CESI $0.00 ($4.00) Reference Low REC Price ($10) High REC Price ($30) Sensitivities REC Price Sensitivity - Rate Impact (2007$) $20.00 $15.00 $10.00 $ $/MWh $ ($5.00) Low REC Price ($10) BW Low REC Price ($10) BW+CESI ($10.00) Reference BW Reference BW+CESI ($15.00) High REC Price ($30) BW High REC Price ($30) BW+CESI ($20.00) We note that Delmarva has agreed to purchase a quantity of RECs that is substantially above the RFP requirement associated with RSCI RPS load and is even above the RPS requirements for Delmarva s Delaware distribution customers in the early years of the Page 14

17 contract. 12 While Delmarva can always sell excess RECs back into the market (which may be used for retail suppliers to meet RPS requirements in Delaware or in other PJM states), Delmarva would be taking on a REC quantity risk that exceeds its customer requirements. In the context of the overall transaction, we do not find this unduly concerning. Combined Scenarios We also ran scenarios that combined high natural gas prices and high carbon prices the High Fuel scenario and low natural gas prices and low carbon prices (assuming that federal carbon control regulation is not enacted) the Low Fuel Scenario. These scenarios, unsurprisingly, produced substantially more favorable and unfavorable customer impacts for the Bluewater proposal with and without backups. In fact, in the High Fuel scenario, Bluewater alone and each of the backup cases produced small net benefits over the 25-year contract term, with initial 2007$ SOS customer impacts of approximately $7/MWh. $16.00 Fuel and Carbon Price Sensitivity - Real Levelized Impact on SOS Load 2007$/MWh $12.00 $8.00 $4.00 BW ONLY BW+NRG BW+CESI $0.00 ($4.00) Reference High Fuel Low Fuel Sensitivities 12 The projected RPS requirement associated with RSCI SOS load and Delmarva s distribution load and a comparison to projected REC purchases is provided in Appendix C. The distribution load RPS requirement does not take into consideration that under the Delaware RPS industrial customers with peak loads greater than 1.5 MW may seek an exemption from RPS requirements. Page 15

18 Fuel and Carbon Price Sensitivity - Rate Impact (2007$) $20.00 $15.00 $10.00 $ $/MWh $- $(5.00) $(10.00) $(15.00) $(20.00) Low Fuel BW Low Fuel BW+CESI Reference BW Reference BW+CESI High Fuel BW High Fuel BW+CESI Other Variables In our assessment of the term sheets, we also explored the impact of higher and lower capacity prices than projected, 10% higher Bluewater output than projected, and a lower rate of increase in market energy prices due to a flat rather than increasing system heat rate over time. In these analyses, results were within $1-2/MWh in real levelized 2007$ of the reference case, and we expect that the results would not change significantly with the revised Bluewater proposal. 13 III. Policy Issues The State Agencies are faced with some key policy questions in determining whether to approve the Bluewater PPA and to direct Delmarva to execute the contract. One key issue ratepayer equity and cost allocation has been previously addressed in this report. Other big picture issues are addressed here. 13 As indicated in the Term Sheet Assessment (p.24) and our initial Bid Evaluation Report issued on February 21, 2007 (pp ), imputed debt costs associated with Bluewater s proposal are less than $1/MWh when applied to SOS customers, using S&P s proxy combustion turbine methodology for wind projects and a 25% risk factor. In light of the large size and high prices associated with Bluewater s project, it is possible that the rating agencies would employ a different approach to calculate imputed debt which could result in a larger rate impact. On the other hand, the result of adding equity to capital structure is higher distribution rates which would be incurred by all Delmarva customers. Page 16

19 Price Stability Through Long-Term PPAs; Opportunity Costs One of the objectives of EURCSA (House Bill 6) was to foster long-term price stability for SOS customers. The RFP process for long-term power contracts from new generation to be built in Delaware was a vehicle to help achieve that objective. While high priced, the Bluewater PPA has a predictable price although as an intermittent resource the quantity is not entirely predictable. A backup power contract may be of further assistance in providing predictability of price and quantity. A key question is how effective is the Bluewater project and PPA in providing price stability for SOS customers or even Delmarva distribution customers. Wind energy projects generally are quite effective in hedging long-term energy market price risk. While output is variable on an hourly and daily basis, it is quite predictable over the long term. However, a key issue is the level of development risk (i.e., the degree of uncertainty as to whether the project will go into operation) and the timeframe before one knows that the project will be successfully financed and constructed. While the lead time for onshore wind projects can be relatively short from the date of contracting a PPA (six months to three years) and development risks are low to moderate, the lead time for offshore wind projects is longer (four to eight years) and development risk is higher. For example, the permitting regime for offshore wind projects is not in place at this time. The Bluewater PPA requires Bluewater to provide millions of dollars in security in support of liquidated damages for a delay or failure in achieving commercial operation and other project milestones (this and other elements of the Bluewater PPA are addressed in the following section). However, Delmarva s entry into a PPA with Bluewater on behalf of its SOS customers has a significant opportunity cost. Because the size of the contract is so large relative to the SOS load and it will likely be several years before it is known whether Bluewater will be successful in developing, financing and building the project, Delmarva will likely be precluded from taking some other action (such as entering into other PPAs) that could hedge market prices over the next few years. If market prices rise sharply over the next 2-3 years and the ultimate success of the Bluewater project is unknown, it will probably be imprudent for Delmarva to overhedge its customers energy price risk by entering into another sizeable PPA. This is an inherent risk associated with the Bluewater proposal. However, this risk is mitigated by the liquidated damages and security provisions in the PPA. Climate Change Our economic analysis effectively monetizes the projected cost of reduction of carbon dioxide emissions, an accepted way of addressing the external costs associated with electric power generation. Because a wind project will have no carbon dioxide emissions, this analysis forecasts increased energy market prices without adding any associated cost to a wind project. Hence, these external costs are incorporated into the economic evaluation. Carbon dioxide emissions, which contribute to climate change, are a major societal cause for concern. Climate change is perhaps, the greatest environmental challenge we will face in this century. Approving the Bluewater PPA would pave the way for development Page 17

20 of what would be one of the largest carbon-free electric generating resources in North America. This would undoubtedly be a major step both in itself and as an example of what can be done to address climate change. This cannot be quantified. However, what one can address quantitatively is whether Bluewater is the most cost-effective way to add renewable resources to the mix on a risk-adjusted basis. Cost-Effectiveness and Risk Compared to Onshore Wind Prices quoted in the market for onshore wind projects in Pennsylvania and surrounding states range in the mid $70s/MWh to $90/MWh for bundled energy, RECs, and capacity (if any). When one adds basis to Delaware (the difference between the locational value of energy at the project and Delaware), pricing comparable to Bluewater s bundled price of approximately $125/MWh increases to the $80-$95/MWh range. Moreover, escalation for onshore wind varies between flat pricing and annual escalators similar to Bluewater s. 14 Based on our prior analysis, the above-market costs to ratepayers associated with buying energy and RECs from a regional onshore wind project are likely to be relatively low. 15 Onshore wind can be produced less expensively because siting, permitting, developing, and constructing onshore wind projects is easier, takes less time, is less costly and imposes less technological, construction, and execution risk. This presents less risk to the power purchaser and reduced opportunity costs due to the shorter development and construction lead times. However, Delaware has little in the way of onshore wind potential due to its geography and wind resource. A key question is whether the benefit of adding a large, new landmark offshore wind resource off Delaware s coast is worth the additional cost, lead time, and uncertainty compared to a purchase from an out-of-state wind project. It is our view that, ultimately, the onshore regional wind resource will be substantially developed with developers focusing on less attractive sites with less productive wind resources resulting in higher PPA costs and that there will be a move to developing offshore resources in a manner similar to what is now happening in Europe. The question is whether now is the time for Bluewater and the PPA that it hopes to enter into with Delmarva with its associated pricing, benefits and risks. IV. Assessment of PPA Terms and Conditions In our prior report, we evaluated the terms and conditions of the Bluewater/Delmarva Term Sheet for substantial compliance with the RFP terms and conditions and for 14 See Term Sheet Assessment at See Interim Report on Delmarva Power IRP in Relation to RFP (April 4, 2007) at While we have not updated the economic analysis, the result should be substantially similar since increased wind project construction costs leading to higher prices for energy and RECs are offset, at least to a significant degree, by increased REC market prices. Page 18

21 commercial reasonableness where the terms differed substantially. 16 We also addressed issues which were in dispute. In this section, we conduct a similar review. Schedule, Liquidated Damages and Security The PPA provisions on critical milestones, development period security, operational period security, and delay damages are generally consistent with those in the Term Sheet. As we stated in our prior report, modifications of the RFP standard terms appear to be commensurate with the phased nature of the project and the lengthy time to develop and build the project. The Guaranteed Initial Delivery Date is June 1, 2014, one year later than was set forth in the RFP. Bluewater has an additional 18 months to achieve Commercial Operation, but is subject to delay damages (unless excused due to Force Majeure conditions). The PPA provides Bluewater with more leeway in performance than provided for under the standard terms in the RFP but is subject to significantly higher liquidated damages for delay and a higher termination fee. 17 Development period security is $12 million and operational period security is $24 million, which is equal to what the RFP standard terms required for a purchase of all the energy and capacity from a 300 MW wind project. In light of the 300 MW energy cap, our opinion is that the amount of security is acceptable. We also note that under the PPA Delmarva has a right to a lien on the project that will be subordinated to the lien of the project s senior lenders. This will supplement the security held by Delmarva during the project s operational period. Disputed Issues: FIN 46 There were three sets of issues that Delmarva and Bluewater set forth as disputed in the Term Sheet. Two of those issues appeals by Delmarva or an affiliate and Delmarva s right to consent to a change of control in Bluewater were resolved by Professor Hamermesh in a manner consistent with the suggested solutions in our Term Sheet Assessment report. Resolution of the FIN 46 termination issue the contract provision whereby Delmarva would have the right to terminate the PPA if its auditors determined that Bluewater s assets and liabilities must be consolidated on Delmarva s balance sheet under FIN 46 (a FIN 46 Determination ) required considerable additional thought and crafting. Professor Hamermesh s resolution involves an independent review of a FIN 46 Determination by an independent evaluator, who would inquire into the basis for the determination and seek a remedy that would preferably avoid consolidation, avoid termination, and minimize adverse impacts to the parties and Delmarva ratepayers. 18 If the parties could not agree on a remedy, the matter would be resolved by the Commission. In the absence of a suitable remedy, the Commission could authorize 16 Term Sheet Assessment at See Term Sheet Assessment at Resolution and Commentary on Disputed Issues in the Delmarva/Bluewater Power Purchase Agreement (Dec. 13, 2007) at 3-5. Page 19

22 Delmarva to terminate the PPA to avoid consolidation under FIN 46 without liabililty to Delmarva and its ratepayers. This approach is similar to the process the IC worked out with Delmarva regarding bid evaluation and was reflected in the terms of the RFP. If Delmarva determines that a proposal would trigger consolidation on its books under FIN No. 46, it will provide a written justification to the Independent Consultant and the State Agencies so such a determination may be adequately reviewed. As part of the review process, Delmarva, the State Agencies and the bidder shall explore whether the structure of the proposed generation entity or power purchase agreement can be modified to prevent consolidation under FIN 46 on Delmarva s books as an alternative to disqualification. 19 As Professor Hamermesh noted in his opinion, neither Delmarva nor Bluewater believes that under the current accounting rules FIN 46 would require Delmarva to consolidate Bluewater s assets and liabilities on Delmarva s books. In fact, we are unaware of any PPA for a wind project where this is an issue. 20 Moreover, if a problem did arise, almost certainly in the case of amended accounting rules, there are a variety of tools that could be employed to prevent consolidation, including modifications to the terms of the PPA, such as a reduction of the quantity of energy sold to Delmarva, and changes to the structure of Bluewater, which may include the infusion of additional equity. Section 12.4 of the PPA, as crafted by Professor Hamermesh, provides a procedural vehicle to explore solutions to the problem in a manner that would provide some comfort to investors planning to invest over $1.5 billion in a project while providing Delmarva, with the Commission s authorization, the right to terminate if no adequate solution is found (similar to disqualification if a bid could not be restructured to avoid a FIN 46 Determination). 21 In the process of converting the Term Sheet to a PPA other issues arose that the parties could not resolve and were resolved by Professor Hamermesh (e.g., risk associated with negative LMP and minimum guarantees of contract capacity). These matters, in our view, do not have major commercial implications in terms of acceptability of the PPA. Overall Assessment The PPA as a whole is a reasonable commercial document in terms of its risk allocation between Bluewater and Delmarva. There are underlying risks associated with Bluewater s ability to develop and build the project with its uncertain permitting regime, long lead times, and technological, economic and financial challenges. However, the PPA (a) reasonably mitigates the risks to Delmarva and its ratepayers of Bluewater s 19 RFP Instructions to Bidders at Nor are we aware of any executed PPA where the buyer has a FIN 46 termination right. 21 We note that a FIN 46 termination right was first proposed by Delmarva the day before a hearing held on October 31, 2007 to consider a few remaining issues on RFP design, which was one day before the RFP was required to be issued under EURCSA. Had there been more time to consider this matter after input from interested participants with the same degree of thoughtfulness applied to other issues, it is likely that a result similar to the one developed by Professor Hamermesh would have been reached earlier. Page 20

23 non-performance or delayed performance through liquidated damages and security while (b) doing so in a commercially reasonably manner that would enable Bluewater to make the considerable investments required in reliance on the PPA. V. Conclusions The revised Bluewater proposal provides a significant price reduction which decreases the real levelized impact on SOS customers from $8/MWh (without the commodity price escalators) in real levelized 2007$ to approximately $6.50/MWh ($5/MWh with the CESI project as a backup). This overall impact is reduced by nearly 50 percent if costs are allocated against all of Delmarva s Delaware distribution customers and is further reduced if costs are allocated against all Delaware electricity consumers. However, the rate impact in the first two years of operation of the project projected for are expected to be in the $12-14/MWh range in 2007$ for residential and small commercial and industrial SOS customers. Again, the impact is roughly half if the costs are allocated against all of Delmarva s Delaware distribution customers. Since we prepared our last report on October 29, 2007, there have been several favorable developments with regard to the Bluewater project: Elimination of the one-way commodity and currency price escalator provisions that we previously found objectionable; Reduction of the base energy price; Completion of a PPA with Delmarva, with certain disputed matters resolved by Professor Hamermesh, with generally acceptable commercial terms and conditions. At the same time, the costs based on our projections are still above market prices, purchases from less costly out-of-state wind projects with shorter lead times are a potential alternative, and there is an early year burden on ratepayers. The decision whether or not to go forward with the Bluewater PPA is an important policy decision for Delaware s future. Page 21

24 Appendix A: Load Data Revised Load (GWh) Net of DSM Delmarva SOS Load 3,793 3,805 3,852 3,868 3,886 3,903 Delmarva State Load 7,272 7,314 7,412 7,455 7,502 7,547 Delaware State Load 10,713 10,802 10,965 11,052 11,146 11, Delmarva SOS Load 3,920 3,968 4,019 4,085 4,123 4,161 Delmarva State Load 7,594 7,697 7,807 7,923 8,012 8,098 Delaware State Load 11,344 11,515 11,697 11,889 12,043 12, Delmarva SOS Load 4,232 4,304 4,377 4,452 4,527 4,605 Delmarva State Load 8,228 8,359 8,491 8,625 8,760 8,898 Delaware State Load 12,395 12,598 12,803 13,010 13,220 13, Delmarva SOS Load 4,695 4,787 4,881 4,978 5,076 5,176 5,278 Delmarva State Load 9,074 9,256 9,439 9,628 9,819 10,015 10,214 Delaware State Load 13,698 13,969 14,244 14,527 14,813 15,106 15,403 Page 22

25 Appendix B: Rate Impact Annual Rate Impact on Different Loads (2007$) Impact on SOS BW $13.10 $11.77 $10.97 $10.55 $8.91 $8.51 Load BW+CESI $13.84 $12.25 $11.27 $10.71 $8.66 $8.02 Impact on BW $6.85 $6.15 $5.72 $5.50 $4.63 $4.42 Delmarva Load BW+CESI $7.24 $6.40 $5.88 $5.58 $4.51 $4.17 Impact on BW $4.67 $4.18 $3.88 $3.72 $3.13 $2.98 Delaware State BW+CESI $4.93 $4.35 $3.99 $3.78 $3.05 $2.81 Load Impact on SOS BW $8.10 $7.53 $6.97 $5.24 $4.72 $4.19 Load BW+CESI $7.36 $6.55 $5.75 $3.62 $2.87 $2.11 Impact on BW $4.20 $3.90 $3.61 $2.72 $2.45 $2.17 Delmarva Load BW+CESI $3.82 $3.39 $2.98 $1.89 $1.50 $1.10 Impact on BW $2.82 $2.62 $2.42 $1.83 $1.64 $1.46 Delaware State BW+CESI $2.57 $2.28 $2.00 $1.27 $1.01 $0.74 Load Impact on SOS BW $3.75 $3.32 $2.43 $2.03 $1.71 $1.41 Load BW+CESI $1.47 $0.85 ($0.31) ($0.89) ($1.32) ($1.73) Impact on BW $1.95 $1.73 $1.27 $1.06 $0.90 $0.75 Delmarva Load BW+CESI $0.77 $0.45 ($0.14) ($0.44) ($0.66) ($0.88) Impact on BW $1.30 $1.16 $0.85 $0.72 $0.61 $0.51 Delaware State Load BW+CESI $0.53 $0.31 ($0.08) ($0.28) ($0.43) ($0.57) Impact on SOS BW $1.11 $0.82 $0.54 $0.26 ($0.01) ($0.27) ($0.52) Load BW+CESI ($2.12) ($2.50) ($2.87) ($3.22) ($3.56) ($3.89) ($4.21) Impact on BW $0.59 $0.44 $0.29 $0.15 $0.01 ($0.12) ($0.26) Delmarva Load BW+CESI ($1.08) ($1.28) ($1.47) ($1.65) ($1.83) ($2.00) ($2.16) Impact on BW $0.40 $0.30 $0.21 $0.11 $0.02 ($0.07) ($0.16) Delaware State Load BW+CESI ($0.71) ($0.84) ($0.96) ($1.08) ($1.20) ($1.31) ($1.42) Page 23