Feed-in tariffs: too much of a good thing? Rates for renewables: lessons learned from the European experience while a U.S. Cooperative finds another way.

• Author: Barclay, Richard A.
• Position: Report

Twenty-nine states have renewable portfolio standards (RPS) that mandate production quotas for renewable energy, and across the United States, the renewable energy policy debate has shifted from whether mandatory renewable portfolio standards are a good idea to other policies that encourage more renewable energy production. One model to which U.S. policymakers are looking utilizes European-style "feed-in tariffs." But what are "feed-in tariffs?" Are they a good idea? Or do we have a better model to follow in our quest for energy independence?

What Are Feed-In Tariffs?

Almost all European countries have adopted feed-in tariffs (FITs), where they are often described as a "stunning success." (1) According to some commentators, feed-in tariffs look very promising, but according to the New York Times, "[t]he party is about to end. " (2)

Feed-in tariffs are a policy mechanism designed to encourage renewable energy development. Guaranteed minimum prices are established by government and paid by utilities for a guaranteed minimum number of years to independent generators of electricity from renewable energy sources (RES). (i) They are not net metering, where the generator uses the renewable energy source to provide its own electricity and only sells surplus back to the grid, nor are they Community-Based Energy Development (C-BED) programs, which encourage a consortium of local entities, such as farmers, small businesses, local government, etc., to develop a small commercial size RES, and where utilities typically are required to purchase the power under a special tariff design rather than specific rates that guarantee the viability of the project. "Successful" feed-in tariffs typically have the following characteristics: (3)

* Utilities are required to purchase all power under a specified "standard-offer contract," which usually lasts 20 years. The rate per kilowatt hour (kWh) is fixed and guaranteed for the contract period.

* The rate schedules decline each year by some percentage, called "tariff degression." This is to reflect assumed increases in each RES' technological efficiency and reward early entrants. So, generators who contract in year one get higher rates than those who contract in year two, and so on.

* Rates are different for different types of renewable energy reflecting the underlying costs. That is, rates for wind are generally lower than for solar photovoltaic (PV). (See Table l)

* There are different rates for RES located in different geographic locations, and/or "on the ground" versus "located on a building." (See Table 1)

* Larger capacity sources have lower rates than smaller ones, reflecting a need for larger incentives for smaller facilities to be financially viable. (See Table 1)

Why Enact Feed-In Tariffs?

Feed-in tariffs are intended to dramatically increase the amount of electricity produced from renewable energy and create green jobs.

Advocates argue that FITs provide the following benefits: (4)

1. Stability:

   1. Guaranteed prices covering the costs plus a reasonable profit reduces risk in renewable energy investments.

   2. Not revising rates frequently makes them predictable.

2. Simplicity:

   1. A standard-offer contract is short and reduces transaction costs.

   2. There is "no need negotiating with utilities, partnering with tax-credit hungry investors, or uncertainties about [continuance of tax incentives]." (5)

3. Fairness: "it removes the barriers to participation," allowing people "with little or no tax liability or non-taxable entities" to own renewable energy projects. (6)

   European FITs can be as low as four, and as high as thirteen, (7) times higher than regular prices. They are intended to encourage RES development with diseconomies of size and in locations that are not economical. Advocates acknowledge they do not lead to "minimization of generation costs." (8) They justify this as "level[ing] the playing field," (9) reducing "cost inequities," (10) and "market democratization." (11)

   What appears to underlie FIT advocacy, however, is the mindset that it is bad to allow utilities to dominate renewable energy markets. It is good for government to set prices high enough to ensure that small uneconomically viable projects will be built. It is good for everyone to own renewable energy sources if they want to, with little financial risk.

   As a result of this mindset, feed-in tariffs arguably constitute "political control of the markets" (12) that differs significantly from traditional rate-making. A traditional rate case sets rates that are an approximation of competitive market prices designed by an experienced impartial commission. (13) Rates are determined after the true costs of generation are known, while FITs are determined before they are known.

   There are two basic approaches to determining FITs: (1) basing them on the avoided cost to utilities of getting electricity from traditional sources, or (2) paying RES generators based upon their cost of generation plus a profit ("cost-plus-return"). (14)

   Some of the early European models used the avoided cost approach, but found it did not provide a big enough incentive to promote all renewable energy sources. As a result, European-style FITs use the cost-plus-profit model. Avoided cost programs are not considered generous enough by most FIT advocates.

   Setting the rates should involve accurately evaluating a very complex set of variables and their interactions for different technologies, applications, sizes, regions and resource intensities over 20 years. Best practices in utility ratemaking establishes that:

   Detailed analysis is required to properly set the payment level at the outset. The payment level must ensure revenues will be adequate to cover project costs. If the FIT payments are set too low, then little new [renewable energy] development will result. And if set too high, the FIT may provide unwarranted profits to developers. To achieve the right balance across a wide range of technologies and project sizes, many levels of differentiation are used. However, if the FIT policy is too complex with too many bonuses, exemptions, and qualifications, it may hinder program implementation. And as costs change and markets shift due to technological innovation and increasing market maturity, the FIT policy needs periodic revision to reflect evolving costs and market conditions. (15) Even if cost studies are done, often the final FITs are established after negotiations among 'stakeholders'--which seldom include ratepayers. If the rates are set too high, the consequences last for 20 years.

   Here in the United States, the Public Utility Regulatory Policies Act of 1978 (PURPA) (ii) led to the development of non-traditional and renewable energy generation--the so-called "PURPA machines"--that were, in many cases, poorly performing generation that could survive only because of heavy subsidies at the expense of customers. (16) Advocates of FITs sometimes refer to them as "PURPA on steroids." (17)

   In Europe, feed-in tariffs have stimulated significant levels of biomass and wind energy production. They have stimulated very little solar energy production. Advocates claim that they are stable, simple and fair. In addition, they claim that feed-in tariffs have produced lots of new green jobs. But, a close look suggests this may not be accurate.

   Are They Stable?

   Germany and Spain have been the two most frequently cited examples of successful feed-in tariffs. Yet rather than stability, both countries have experienced increasingly frequent changes to the tariffs, the categories to which they apply and collapsing markets.

   Germany created the Electric Feed Law in 1991. It proved to be generally ineffective, with the exception of wind energy. (18) Major changes were enacted in the Renewable Energy Law (EEG) in 2000, and significant changes were again made in 2004. There have been two changes since, and one proposed. Yet, as noted by The Economist,

   ... the country that pioneered [FITs] seems unable to agree on a formula for them that is generous enough to spur investment without being so lavish that it overburdens consumers. (19) A megawatt (MW) cap on the total capacity that can be installed is often recommended in order to mitigate the total subsidy costs, and/or be a hedge in case the FITs are too high. This might be seen as a tacit admission that the impacts of FITs are unpredictable. Caps can also create an economic bubble that is devastating when it collapses. (20)

   Feed-in tariffs in Spain can be as high as 10 times the cost of coal production. (21)

   These...