Canada: The Continuous Evolution Of Ontario’s Electricity Sector – New FIT Rules; New Clean Energy Task Force; New Electricity Sector Review

In the last 30 days, much has happened in Ontario's electricity sector. On March 22, 2012, the Ontario Government released the results of its review ("FIT Review") of the Ontario Feed-in Tariff program ("FIT Program"). The FIT Review set out numerous recommendations for changes to the FIT Program. On April 5, 2012, the Minister of Energy issued a direction ("Minister's Direction") to the Ontario Power Authority ("OPA") to continue the FIT Program (and microFIT) in a manner consistent with policies set out in the Minister's Direction. The next day, the OPA complied by issuing drafts of the new FIT Program rules ("FIT 2.0 Rules") and contract ("FIT 2.0 Contract").¹ In case that was not enough, on April 12, 2012 the Ontario Government launched its clean energy economic development strategy and on April 13, 2012 announced the appointment of a committee to review the province's electricity sector. The OPA has requested comments on the draft FIT 2.0 Rules and Contract by April 27, 2012 and has stated that it expects to issue the finalized versions by May 7, 2012.²

The government is clearly affirming that it wishes the FIT Program to continue. But the changes proposed to the FIT 2.0 Rules and Contract may pose significant challenges to project developers and financing parties.

(I) Ontario Power Authority Releases FIT 2.0 Rules and Contract Following Two-Year Review

The FIT 2.0 Rules and Contract contain numerous amendments that developers and potential investors and participants should consider carefully. As a whole, a developer can expect greater challenges to obtain a FIT 2.0 Contract under the new rules. The new rules contemplate procurement limits, application windows and priority ranking based on the significant involvement of groups not historically in the business of generating electricity – community, Aboriginal and public sector groups.

With the release of the draft FIT 2.0 Rules and Contract, all those active (or who want to be active) in the renewable energy space in Ontario are reviewing and strategizing on two fronts: (1) How can I best play by the new rules? and (2) What rules need to change for me to play? Another fundamental question is – how many more MW's are available to be awarded under the FIT Program? some industry observers suggest that there is less than 1,000 MW available unless the government increases its current target for renewables of 10,700 MW by 2015. The Minister's Direction states that the OPA shall allocate, of the available capacity, a minimum of 100 MW for projects with 50% or more community and aboriginal equity participation and a minimum of 50 MW for hydroelectric projects.

How Different are the New Rules?

From above the clouds, it might be tempting to characterize the draft FIT 2.0 Rules and Contract as "tweaks" but you really only have to zoom to the trees to see some fundamental changes.

• Controlled Scope – Procurement Limits; Application Windows

Unlike the initial open-endedness of the FIT Program, the issuance of contracts will now be subject to periodic procurement limits set by the OPA in its discretion.

In addition, the OPA intends to announce application periods during which applications may be submitted. The OPA may also determine the type of FIT Project that may be the subject of an application submitted during a particular application period. It is also clear that applicants will be competing with each other and will be ranked based on points, time stamp and then availability of grid capacity.

While specific procurement limits and the timing of the first application period have not yet been determined, we can anticipate early calls for 50 MW of microFIT and 200 MW of small FIT projects (less than 500 kw) as a result of the Minister's Direction. And of available capacity, particular focus will be placed on projects (small and large FIT) with greater than or equal to 50% community and Aboriginal equity participation and hydroelectric projects.

• Project Eligibility

A number of changes have been made to eligibility requirements, some of which affect specific renewable fuels. For example, groundmount PV projects may not be located on property that include Class 1, 2 or 3 lands, or organic and specialty crop lands. Ground-mount solar PV projects may also not be located on or adjacent to residential lands nor on commercial and industrial property if it is the primary use of such property. Solar projects cannot exceed 10 MW and cannot utilize inverters and panels which have manufacturer's capacity ratings which exceed 120% of the proposed contract capacity. Waterpower projects continue to be limited to a maximum of 50 MW. Incremental and behind-the-meter projects are no longer allowed. There are also specific provisions for co-locating projects and limitations on developers submitting similar projects during the same application period.

In addition, a proposed project will need to be located within a certain distance from the facility's contemplated connection point. The FIT 2.0 Rules do not yet specify this connection distance, which will be the subject of special consultations.

Large FIT projects are more likely to be affected by an unduly short connection distance. While it is not clear what special consultations will be conducted beyond the FIT 2.0 Rules comment process, interested stakeholders should ensure their views are received by the OPA.

• Application Requirements

Small FIT projects (capacity allocation exempt) must now submit application security. In addition, an applicant must provide representations and warranties which attest to an awareness of certain project requirements, such as environmental permitting and particular FIT Program rules, and which confirm that certain preparatory actions have been completed in respect of the project, such as obtaining all access rights and independent engineer reports. The effect is to place a greater degree of responsibility as well as additional costs on the applicant to ensure the viability of its proposed project.

• Pricing

The draft FIT 2.0 Rules introduce a new price schedule which, as expected, reduces the prices paid for wind and solar. The pricing for other technologies remains unchanged. Price adders for Aboriginal and community projects have been maintained where the economic interest of Aboriginal and community participants exceeds 15% (formerly the minimum was 10%). The draft FIT 2.0 Rules have also changed key definitions and provisions relating to Aboriginal and community projects which will require careful review when structuring such projects.

The Minister's Direction also stipulates that price schedules and inflation escalators will be reviewed and updated annually in November to take effect as of January 1.

In a significant departure from the existing FIT Program, an applicant offered a FIT 2.0 Contract will be offered the pricing in effect when the contract offer is made, not the price in effect when the application was filed.

• Domestic Content

The FIT 2.0 Contract maintains domestic content requirements, set at 50% for wind and 60% for solar facilities.

• Assignment; Change of Control

Any assignment of an application, or change of control of an applicant, is not permitted. Any violation of these prohibitions will allow the OPA to terminate the application and retain the application security.

• Priority Points System

Under the new proposed FIT 2.0 Rules, a new priority points system will be used to rank applications with the time stamp now acting as tie breaker. An application may only proceed if the proposed project can receive at least one point. The new system clearly assigns priority to projects that have a community, Aboriginal or municipal, education or health ("MUSH" sector) component, whether as a direct participant in the project or as supporting entity.

Of the seven categories of points set out in the priority points table below, only two categories do not require some type of community, Aboriginal or MUSH sector involvement.

One point may be awarded for the category of "system benefit", which in actuality is a point for fuel type and unavailable to wind and solar projects. Two points may be awarded for "project readiness" which is narrowly defined in relation to access rights, but as most serious applicants should be able to meet this requirement, it is unlikely that an applicant will gain significant competitive advantage through this category.

The rules do not permit a project to obtain more than one type of participation project points but do permit certain combinations of project and non-project type points under certain circumstances.

The points that may be awarded for Aboriginal participation or support require additional clarity. For example, to obtain points related to an Aboriginal Support Resolution, the proponent will need resolutions from one or more Corresponding Aboriginal Community as designated by the Ministry of Environment. Project proponents will want to see the designation of Subject Lands and Corresponding Aboriginal Community confirmed as quickly as possible by the Ministry in connection with a proposed application. Developers may wish to recommend that this designated list be determined based on proximity to a proposed project and be limited in scope. In addition, the current wording of the draft FIT 2.0 Rules may be interpreted to require every Aboriginal community potentially affected by a project to provide support before the Aboriginal support points may be awarded.

• Connection Matters

The Economic Connection Test ("ECT") will no longer be part of the FIT 2.0 Rules (and the existing ECT list will be terminated) but connection availability continues to be, as expected, a critical factor. Applications will first be ranked in accordance with the priority points system describe above. Applications will then be assessed, in order of rank, as to whether there is available transmission and/or distribution capacity based on a transmission availability test ("TAT") or distribution availability test ("DAT") as applicable.

The FIT 2.0 Rules urge applicants to consult with the applicable transmitter or distributor prior to submitting an application but the OPA reserves its discretion to determine whether an application can pass the TAT or DAT.

• Transition

Applications that were submitted prior to April 5, 2012 will be subject to the new FIT 2.0 Rules and pricing, and not the FIT Rules in effect when the application was submitted. An applicant may resubmit a pre-existing application during an application period and will be able to maintain its original time stamp. A resubmitted application need not contain the same information as was contained in the pre-existing application subject to the requirements that (i) the project be located on the same site, and (ii) the applicant must be the same person except that a change in ownership is permitted for the purpose of qualifying the project as a participation project. If a pre-existing application is not resubmitted during the first application period for the applicable project size, the pre-existing application will automatically be terminated.

The OPA is also offering those who hold existing FIT Contracts the opportunity to terminate those contracts and receive back the application security without being subjected to any penalty.

And the FIT 2.0 Contract?

A number of substantive changes have been made in the form of proposed FIT 2.0 Contract. We note a few of the significant amendments.

• Termination for Convenience

The FIT 2.0 Contract provides the OPA with the right to terminate the contract for convenience after issuance of a Notice to Proceed. The supplier would receive sunk costs and the net present value of future reasonably anticipated profits from operation during the term of the contract, but not following. If the parties do not agree on the amount payable by the OPA in damages, then the FIT 2.0 Contract provides for mandatory, binding arbitration from which there are limited rights of appeal.

It remains at the sole discretion of the OPA to terminate the contract prior to Notice to proceed with limited liability to pay for pre-construction development costs. In addition, there is a new concept of a "Stop Work Direction" which allows the OPA to direct a Supplier to permanently cease the development and construction of a facility. It is not clear whether the OPA could invoke this remedy without terminating the contract and making the compensatory payments described above.

Clearly this provision detracts from the stability that a long term power purchase agreement is typically expected to provide. Developers, investors and lenders will wish to influence the OPA to remove this new clause.

• Liquidated Damages

New provisions impose liquidated damages for each day that the milestone commercial operation date ("COD") has been missed. The new FIT 2.0 Contract no longer contains the provisions that previously permitted a supplier to extend the end of the term to 20 years after the actual COD in the event of a missed milestone COD for which liquidated damages have been paid.

• Pricing and Curtailment

The provisions that deal with payment of compensation when certain projects have been curtailed have been deleted. A note to draft states that a provision will be inserted in conjunction with developments in the SE-91 Renewable Integration Initiative of the Independent Electricity System Operator.

• Supplier Representations

The representations to be provided by a supplier have been expanded with increased limitation on the ability to invoke a claim of force majeure.

• Events of Default

The FIT 2.0 Contract contains new events of default that relate particularly to priority project categories. It will be an event of default if a project was awarded priority points for having an education or health host, and the host ceases to qualify as such education or health host at any time prior to the tenth anniversary of COD.

It will also be an event of default if a participation project (one comprising community, Aboriginal, education or health investment), other than a rooftop solar project, no longer qualifies as such participation project at any time during the term. For a participation project that is a rooftop solar project, it will be an event of default if, at any time prior to the fifth anniversary of COD, the participation level decreases to below 15%.

It may be reasonable for a supplier to lose the benefit of any price adder obtained for a participation project as a result of certain priority points. However, termination of the contract for default in such a case is arguably an unduly harsh consequence since such occurrences are likely to be outside the developer's control.

Next Steps

The FIT 2.0 Rules and FIT 2.0 Contract have been posted on the OPA's web site for review and comment. The comment period closes on April 27, 2012. Final versions of the documents are expected to be available by May 7, 2012.

(II) Ontario Government Launches Clean Energy Economic Development Strategy

On April 12, 2012, the Ontario Government launched its Clean Energy Economic Development Strategy, which continues the government's platform of a green energy economy. The new strategy is intended to leverage the province's clean energy experience to become a global leader in key areas of the energy sector. Priority areas include:

• Maintaining progress in solar and wind energy by supporting companies that are looking to export their Ontario-made products and services to the world;
• Leveraging global leadership in smart meters and the smart grid, including grid automation, data management and consumer engagement in energy usage; and
• Exploring the potential of energy storage.

In carrying out this strategy, the Government intends to:

• Establish the Ontario Clean Energy Task Force to help broaden Ontario's energy focus by facilitating collaboration within Ontario's clean energy industry to identify export markets, marketing opportunities and approaches to demonstrate Ontario's advanced clean energy systems;
• Lead cleantech trade missions to support domestic manufacturers by showcasing Ontario's clean energy solutions in key markets world-wide including Asia, the Middle East and the United States; and
• Deliver on the province's Smart Grid Fund and other targeted investments to spur innovation in priority areas.

(III) Ontario Government Launches Clean Energy Economic Development Strategy

On April 13, 2012, the Ontario Government announced its plans to conduct a comprehensive review of the province's electricity sector. The review will explore options to improve efficiencies, including local distribution sector ("LDC") consolidation. Following on the 2012 Budget statements, the Government will also undertake independent benchmarking of the Province's electricity agencies.

The Government will establish an Ontario Distribution Sector Panel to be led by Murray Elston. The panel will consult with municipalities, LDCs and the Electricity Distributors Association, as well as other energy experts to review potential savings associated with consolidation, benefits for ratepayers, operational efficiencies and potential risks. The panel is to report to the Minister of Energy within one year.

Footnotes

1. Any capitalized term in this bulletin, not otherwise defined, has the meaning given to it in the FIT 2.0 Rules or FIT 2.0 Contract.

2 The OPA has also issued draft new rules and a draft new contract for the microFIT program which are not discussed in this bulletin.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.