Renewables roll-out needs price guarantees
Power generation from renewable sources such as wind turbines, solar cells and biomass plays a small but important part in satisfying total electricity demand around the world, and is growing at an exponential rate thanks to generous public subsidies and government support.
Renewable sources have increased their share of worldwide generation from just 0.4 percent in 1980 and 1.1 percent to 2.3 percent in 2006. In its “World Energy Outlook 2008″, The International Energy Agency (IEA) projects their share will double to 4.9 percent by 2015, and then almost double again to 8.7 percent by 2030. Click here for PDF.
Policymakers are relying heavily on renewable generation to meet projected growth in the electricity demand over the next 20 years while limiting growth in the emission of greenhouse gases.
Unlike reserves of oil and gas, which may be exhausted within the next 70 years, renewables will remain a source of power indefinitely. Much the same could be said of coal, but renewables do not contribute to increased carbon dioxin concentrations in the atmosphere.
But with renewable sources still costing more per kilowatt hour than conventional power from nuclear or fossil fuel plants burning gas and coal, renewables have not yet reached “grid parity” with other power producers and are struggling to penetrate the power market.
Market penetration depends on subsidies, price support and quota schemes mandating power suppliers buy a minimum share of their electricity from renewable. But widespread variations between countries and even within them suggest uptake is sensitive to the form in which support is offered. In particular, guaranteed prices for renewable producers have been more effective than quota systems in encouraging widespread development of wind and solar power.
Since all OECD governments are committed to increasing the share of renewables in total output, it makes sense to rank policy effectiveness in terms of market share rather than absolute watt hours generated.
On this measure, penetration ranges from 25 percent in Iceland, 20 percent in Denmark and 9 percent in both Germany and Spain, to 1.6 percent in the United Kingdom, 1.3 percent in Sweden and 0.6 percent in Japan.
In absolute terms, the United States is the world’s largest producer of renewable energy with 72,000 gigwatt hours (GWh) last year. Only Germany (60,000 GWh) and Spain (27,000 GWh) are comparable. But it is also by far the world’s largest producer and consumer of non-renewable power (more than 3.7 million GWh). The share of renewable generation in the total was actually rather small (just 1.7 percent) and puts it in the middle of the international spectrum.
Some country-to-country variability can be explained as the result of past policy choices and natural resource endowments. Iceland’s high share is based on its abundant geothermal resources. France’s low one the fact nuclear plants provide three quarters of the country’s total power output, leaving little demand for renewables or power from any other source.
But historic policies and natural resources cannot explain why Denmark, Germany and Spain generate six times more renewable power (proportionately) than the United Kingdom, the United States and Sweden.
PRICE GUARANTEES OR QUOTAS
The main factor determining policy success is the structure of the program. Price-support systems (used in Denmark, Germany and Spain) have been more effective than quota-based systems (used in the United Kingdom, Sweden and parts of the United States):
(1) Price-based feed-in-tariffs (FITs) guarantee renewable power producers the right to sell electricity into the grid at a fixed rate set by law, or in some variants at a premium over the peak market price or some average of the prices in a previous period:
* FITs guarantee priority access to the network (grid managers must buy power offered by renewable producers first at the agreed price, even when competing conventional generators offer power more cheaply).
* The grid pays a premium for renewable power (allowing renewable generators to recover the higher costs associated with their generation).
* In the most successful schemes this price is reasonably predictable (it is either fixed in cents per kilowatt or linked to an annual average) to make it easier for renewable producers to obtain project financing.
(2) In contrast, renewable obligation certificates (ROCs) and renewable portfolio standards (RPS) are quota systems. They require power sellers to buy a minimum number of megawatt hours (MWh) or a minimum percentage of total sales from renewable sources. Power sellers receive credits for every MW of renewable power they buy and must acquire a set number of credits by the end of the compliance period, buy surplus credits from others, or pay a financial penalty.
Quotas have been adopted by the United Kingdom, Sweden and most state-level governments in the United States that have set renewable targets. Favored by economists as the most efficient way to produce a given volume of renewable energy, since they encourage lowest-cost options to be developed first, they are seen as “market friendly”, technology neutral, and more compatible with integrating renewable output into the wider power system. In theory, the target volume of renewable power is guaranteed because tradable creditable prices will rise until enough renewable generation is incentivised.
Because quota systems do not guarantee a price for the power being sold to the grid, prices remain highly variable, determined by supply and demand in the wider power market, which can make it hard to obtain project financing.
Uncertainty can prove fatal to projects involving with high upfront capital costs (such as solar and offshore wind farms), long payback times (7-10 years), or where developers are small technology-driven companies relying on bank-based lending rather than established power utilities which can finance projects on their balance sheets. Quota systems have not tended to encourage innovation.
In contrast, price-based FITs have proved extremely successful in encouraging widespread installation of wind turbines (Denmark and Germany) and solar cells (Germany and Spain). Because they guarantee prices and revenues for an extended period, up to 20 years in some cases, loan finance is readily available, even for projects on a fairly small scale. In Germany and Spain, banks will provide loans for solar cells at household level.
TILTING THE PLAYING FIELD
The most common objection is that FITs may not be efficient because they do not promote the sequential uptake of lowest-cost options first. Most FITs are designed so higher-cost forms of renewable generation receive higher guaranteed prices to encourage the uptake of a diverse range of technologies. But there is a risk that power consumers can be forced to pay high prices for extended periods even if the generation cost eventually declines.
Most FITs have some flexibility built into them. While prices for existing producers of renewable energy are guaranteed for the lifetime of the FIT, the terms on which new FITs are offered to new projects can be adjusted periodically in response to changes in uptake rates and costs. In Germany, increases in uptake and cost reductions result in “degression” — a cut in the guaranteed price offered to new producers once certain target levels are met (previous guaranteed tariffs are not altered).
The objection remains that FITs involve the government picking winners rather than allowing technologies to emerge through market-based competition. But the need to recover high upfront capital costs over long timescales in volatile power markets means that large-scale renewable power generation may not be consistent with private financing unless some form of price support is forthcoming.
If policymakers want to encourage it, with all the associated costs, recent experience suggests feed in tariffs and price guarantees will prove far more effective than the quota systems favored so far in the United States and United Kingdom.