Feed Laws

Feed-in Tariffs--The Economic Case

November 8, 2011
Paul Gipe

Feed-in Tariffs Best to Deal with Climate Change Says IPCC Working Group III Renewables


The 135-page report by the Intergovernmental Panel on Climate Change , especially Chapter 11 on Policy, Financing and Implementation, makes it clear that the overwhelming weight of academic studies conclude that feed-in tariffs--or fixed-price mechanisms--perform better at delivering renewable energy quickly and equitably than quota systems, such as Renewable Portfolio Standards in the US or the Renewable Obligation in Britain. This is not the unsurprising conclusion from a surprising source: the IPCC's Working Group III on Renewables.

Below are selected excerpts illustrating the theme that runs through the report.

Page 5

Several studies have concluded that some feed-in tariffs have been effective and efficient at promoting RE electricity, mainly due to the combination of long-term fixed price or premium payments, network connections, and guaranteed purchase of all RE electricity generated. Quota policies can be effective and efficient if designed to reduce risk; for example, with long-term contracts.

Page 53

Although they have not succeeded in every country that has enacted them, price-driven policies have resulted in rapid renewable electric capacity growth and strong domestic industries in several countries--most notably Germany (See Box 11.6) and Spain (See Box 11.8) but more recently in China and other countries as well--and have spread rapidly across Europe and around the world (REN21, 2006, 2009b; Mendonça, 2007; Rickerson et al., 2007; Girardet and Mendonca, 2009). (See Boxes 11.7, 11.11 and 11.12.)

The success of FIT policies depends on the details. The most effective and efficient policies have included most or all of the following elements (Sawin, 2004; Mendonça, 2007; Klein et al., 2008a; Couture, 2009):

  • Utility purchase obligation;
  • Priority access and dispatch;
  • Tariffs based on cost of generation and differentiated by technology type and project size, with carefully calculated starting values;
  • Regular long-term design evaluations and short-term payment level adjustments, with incremental adjustments built into law in order to reflect changes in technologies and the marketplace, to encourage innovation and technological change, and to control costs;
  • Tariffs for all potential generators, including utilities;
  • Tariffs guaranteed for a long enough time period to ensure adequate rate of return;
  • Integration of costs into the rate base and shared equally across country or region;
  • Clear connection standards and procedures to allocate costs for transmission and distribution;
  • Streamlined administrative and application processes; and
  • Attention to preferred exempted groups, for example, major users on competitiveness grounds or low-income and other vulnerable customers.

Page 55

The IEA argues that the key for countries like Germany, Spain and Denmark has been high investment security coupled with low administrative and regulatory barriers (IEA, 2008c). The IPCC's Fourth Assessment Report, in comparing quantity-based mechanisms and FITs, noted that: "In theory, this difference should not exist as bidding prices that are set at the same level as feed-in tariffs should logically give rise to comparable capacities being installed. The discrepancy can be explained by the higher certainty of current feed-in tariff schemes and the stronger incentive effect of guaranteed prices." (Sims et al., 2007). Likewise, Stern (2007) concluded that "feed-in mechanisms achieve larger [RE] deployment at lower cost. Central to this is the assurance of longterm price guarantees [that come with FITs]…. Uncertainty discourages investment and increases the cost of capital as the risks associated with the uncertain rewards require greater rewards.". Bürer and Wüstenhagen (2009) found that, because FITs effectively reduce risk, venture capital and private equity investors perceive FITs to be the most effective policy to stimulate investment in RE technologies (Bürer and Wüstenhagen, 2009).

Page 55 . . .

FITs have encouraged both technological (Huber et al., 2004) and geographic diversity (Sawin, 2004), and have been found to be more suitable for promoting projects of varying sizes (Mitchell and Connor, 2004; van Alphen et al., 2008). . . . A number of studies have concluded that FITs have consistently delivered new supply, from a variety of technologies, more effectively and at lower cost than alternative mechanisms, including quotas, although they have not succeeded in every country that has enacted them (Ragwitz et al., 2005; Stern, 2007; de Jager and Rathmann, 2008).

Page 56

Recent studies (Resch et al., 2009; de Jager et al., 2010) of quota systems in Europe found that Italy, the UK, Poland and Belgium had experienced high producer profits resulting from high investment risks and low growth rates. Other studies have reached similar conclusions (D. Fouquet et al., 2005; New Energy Finance Limited, 2007; Jacobsson et al., 2009; Verbruggen and Lauber, 2009). Such profits primarily benefit incumbent actors and relatively mature, low-cost technologies, and can be costly for consumers (Jacobsson et al., 2009). The exception among European countries using a quota obligation is Sweden, which has experienced a high rate of RE growth coupled with relatively low producer profits. This was because quota systems tend to favour least-cost RE and Sweden has an abundance of biomass.

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With respect to competitiveness, another element of efficiency, a 2008 analysis found that market competition (number of players) was stronger among wind turbine producers and constructors under the German FIT than under the quota scheme used in the UK (Butler and Neuhoff, 2008). Except in the case of Spain, where the premium option attracts mostly incumbent power generators, FITs have been more successful at bringing new players into the market (Verbruggen and Lauber, 2009). FITs encourage competition among manufacturers rather than investors (Held et al., 2007). FITs have been found to encourage development of domestic manufacturing industries, which leads to a large number of companies and thereby creates competition (Sawin, 2004). FITs shift competition from electricity price to equipment price, which some analysts have argued is more appropriate competition for capital-intensive RE technologies (Wagner, 1999; Hvelplund, 2001).

Verbruggen and Lauber (2009) demonstrate that well-designed FITs provide dynamic incentives to reduce long-run marginal costs of a variety of RE technologies because investment money is assigned to investors accordingly; more efficient producers obtain greater rents by lowering costs, and the FIT payment rates are regularly adjusted to avoid excessive rents.

. . . At the same time, detailed analysis of which companies gain from quota systems suggest that it is primarily incumbent actors that continue to benefit from the new market (Girardet and Mendonca, 2009; Jacobsson et al., 2009; Verbruggen and Lauber, 2009). The transaction and administrative costs of a TGC system are higher than with FIT, making participation of small-scale new entrants cumbersome, and therefore limited (C. Mitchell et al., 2006). In contrast, FITs tend to favour ease of entry, local ownership and control of RE systems (Sawin, 2004; Lipp, 2007; Farrell, 2009), and thus can result in wider public support for RE (Damborg and Krohn, 1998; Sawin, 2001, 2004; Hvelplund, 2006; Mendonça et al., 2009). Such ease of entry has also proved a powerful means for unleashing capital towards the deployment of RE projects (Couture et al., 2010).

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FITs generally have lower administrative costs than quota policies (Haas et al., 2011) and are considered easier to implement (van der Linden et al., 2005), though tariff setting can be challenging, particularly if there are very dynamic cost developments (as with PV in recent years).

Quotas, particularly those operating with tradable certificates, appear to be more complex because of the need to set both penalty prices and quantities. Transaction costs are also generally higher for such quota systems. Complexities also arise from the need for trading platforms under quotas with tradable certificates, and tendering schemes require administrative capacity to deal with the bidding process (Sawin, 2004; de Jager et al., 2010).

. . . In summary, a number of historical studies, including those carried out for the European Commission, have concluded that well-designed and well-implemented FITs are the most efficient (defined as comparison of total support received and generation cost) and effective (ability to deliver increase in the share of RE electricity consumed) support policies for promoting RE electricity (Ragwitz et al, 2005; de Jager et al, 2010; Sawin, 2004; European Commission, 2005; Stern, 2007; Mendonça, 2007; Ernst & Young, 2008; Klein et al., 2008b; Couture and Gagnon, 2009; Held et al, 2010; Ragwitz et al, 2011).

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