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Which support systems work best?

By Dave Elliott

Renewable energy technologies have required subsidies to help them get established in markets dominated by sometimes cheaper but also often well-supported conventional energy sources – fossil and nuclear also enjoy subsidies. Essentially the renewable subsidies seek to reflect their environmental benefits – something that conventional markets do not internalise. However there are various ways in which subsidies can be applied and some work better than others. The simplest approach, usually for relatively undeveloped technologies, is straightforward grants, for example for demonstration projects, or in a weaker version for more advanced projects, grants offered as repayable loans or, even softer, for near-market projects, loan guarantees. There is usually a competitive element to access to these grants or loans, but they all offer above market-level support. At the other extreme, for more developed technologies, competitive contract auctions are usually arranged to be nearer market-level, while green certificate trading systems create a competitive market incentive.

In terms of building capacity, the most successful approach so far however seems to have been Feed In Tariffs (FiTs) – guaranteed price systems offering above market prices, usually degressed down in stages annually to reflect technical and/or market development. Across the EU they have led to rapid expansion of renewable capacity, wind power especially, and they have been adopted in many places elsewhere. However, in some cases, for example with PV solar, which started out being expensive, this approach initially led to high cost pass-through to consumers, so that, with PV costs also falling rapidly, in part due to the success of the FiTs, FiT levels have been cut back dramatically. In theory the annual price degression mechanism, based on projected cost reductions, should have avoided the need for that, but in the case of PV, the cost reduction was much more significant and rapid than expected.

A US National Renewable Energy Labs (NREL) report, reviewing all the approaches argues that the initial approach, including FiTs, ‘was developed when the cost of renewable energy technologies was significantly higher than both conventional electricity prices and utilities’ avoided generation costs. As renewable technology costs continue to fall and conventional fuel prices continue to rise, these policies are being adapted to these new power sector economics. In Germany, for example, the levelized cost of solar energy is now significantly below the retail price of electricity. In other regions such as in the Caribbean and the Pacific Islands, renewable electricity sources are increasingly competitive at the wholesale level as well, undercutting the avoided cost of generation from diesel or heavy fuel oil’. It goes on: ‘partly in response to these changing cost dynamics, policymakers in certain jurisdictions are beginning to introduce policies that do not fit neatly into the “traditional” policy categories.’ And it looks at some examples, including some which combine FiTs and auctions, depending on the project scale, and premium market approaches, as being developed in Germany and recommended by the EU as a replacement for fixed price FiTs across the EU from 2017 onwards.

Auctions in theory encourage price competition. However, the NREL report notes, they also ‘tend to favour large players that are able to afford the associated administrative and transaction costs’. So some of its conclusions are what you might expect: ‘the case of France demonstrates that retaining a FIT for smaller project sizes can help drive significant investment in projects typically owned by individual citizens or residents.’ And, in France, it found that ‘the move to auctions resulted in higher per kWh payments for generators, rather than lower prices’. That was certainly the experience with the NFFO auction system in the UK and also its certificate trading replacement, the Renewables Obligation, with the result being that UK consumers were charged more per kW and per kWh than they were elsewhere under FiTs. Oddly though, neither of these UK schemes, or the UK’s new CfD contract auction system, are covered or mentioned in the NREL report. It does however look in detail at Germany and its FiT-based EEG support system. It says ‘after incentivizing on-site consumption for a few years, Germany has now reversed course, and has started to require these prosumers to share in the costs of the EEG surcharge. This dynamic highlights the challenges that policymakers face in the years ahead in controlling the rate of uptake of customer-sited solar PV in an environment of decreasing PV costs, and rising retail rates. Germany’s decision to require PV prosumers to share in the costs of the EEG surcharge is merely the beginning, as more jurisdictions around the world design new ways either to slow the pace of growth in this market segment, or to require prosumers to contribute more to cover fixed electricity system’.

The NREL report sees this as an example of the breakdown of the traditional policy definitions and the rise of hybrid policy designs. It is certainly true that changes are underway, with renewables getting cheaper, and consumer take-up of them reshaping markets. In theory, as prices fall and renewables become competitive, subsidies should be withdrawn, but that is only reasonable if the subsidies for other options are also cut, and that so far is not always the case. Subsidies for fossil fuels remain and, indeed, globally are in total much larger than those for renewables. According to the IEA, governments pumped over $0.5 trillion into subsidies for oil, gas and coal in 2012, 6 times more than for renewables, and this imbalance has continued. Nuclear power is also heavily subsidised in most countries, sometimes much more so than renewables. For example, if it eventually goes ahead, in addition to the £10 bn investment loan guarantee, the UK Hinkley project will get index-linked support for 35 years under the CfD system, where renewables are only being offered 15 year CfDs, and unlike the renewables, the £24 bn Hinkley project was not subject to a competitive contract auction process.

Some say we should aim for a proper level playing field, with no subsidies for anything, just simple market competition, but the reality is that, for a variety of often conflicting reasons, each set of options gets special treatment and it will be hard to wean most of them off this support. If the aim is to promote renewables as the best long-term supply-side response to climate change, then, if the rival options continue to be subsidized, maybe subsidies for renewables will have to stay for a while, especially for some of the less developed ones. NREL report: http://www.nrel.gov/docs/fy15osti/63149.pdf.

* In the UK, where support for large solar farms is already being cut, in line with their election manifesto proposals, the new Tory government is also to block access to the Renewables Obligation for new onshore wind generating projects from April 2016, although DECC says ‘5.2 GW of onshore wind capacity could be eligible for grace periods which the Government is minded to offer to projects that already have planning consent, a grid connection offer and acceptance, as well as evidence of land rights’. So although around 7 GW of projects may be halted, it’s not a dead stop. https://www.gov.uk/government/news/changes-to-onshore-wind-subsidies-protect-investment-and-get-the-best-deal-for-bill-payers   However it was claimed that on-shore wind was now mature, so that RO subsidies, along possibly with new CfD support, will be retargeted elsewhere: http://www.publications.parliament.uk/pa/cm201516/cmhansrd/cm150622/debtext/150622-0001.htm#1506227000002

However, in addition to selective cuts like this, in a move to reduce support from all types of renewables, the Climate Change Levy rules are being changed. It was initially set up to penalise companies that used fossil-derived energy, thus promoting the use of renewable energy, but now renewables will loose their CCL exemption. That will hit all projects hard, including off-shore wind, with the renewables sector losing around £3.9 billion over the next five years. https://www.gov.uk/government/publications/summer-budget-2015/summer-budget-2015

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