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CHAPTER 4: PRICES AND SUPPORT MECHANISMS

Introduction: Types of RES-E Support Mechanisms

When clustering the different types of support mechanisms available to electricity from renewable energy sources (RES-E), a fundamental distinction can be made between direct and indirect policy instruments. Direct policy measures aim to stimulate the installation of RES-E technologies immediately, whereas indirect instruments focus on improving long-term framework conditions. Besides regulatory instruments, voluntary approaches for the promotion of RES-E technologies also exist, mainly based on consumers’ willingness to pay premium rates for green electricity. Further important classification criteria are whether policy instruments address price or quantity, and whether they support investments or generation.

Table 4.1 provides a classification of the existing promotional strategies for renewables; it is followed by an explanation of the terminology used.

Table 4.1: Types of RES-E Support Mechanisms.

		DIRECT		INDIRECT
	Price-driven		Quantity-driven
REGULATORY
Investment focused	-Investment incentives -Tax credits -Low interest /Soft loans		-Tendering system for investment grant	- Environmental taxes -Simplification of authorisation procedures
Generation based	-(Fixed) Feed-in tariffs - Fixed premium system		- Tendering system for long-term contracts - Tradable Green Certificate system	-Connection charges, balancing costs
VOLUNTARY
Investment focused	-Shareholder programmes -Contribution programmes			- Voluntary agreements
Generation based	- Green tariffs

Source: Ragwitz et al. (2007)

REGULATORY PRICE-DRIVEN STRATEGIES

Generators of RES-E receive financial support in terms of a subsidy per kW of capacity installed, or a payment per kWh produced and sold. The major strategies are:

• Investment-focused strategies: financial support is given by investment subsidies, soft loans or tax credits (usually per unit of generating capacity); and
  
• Generation-based strategies: financial support is a fixed regulated feed-in tariff (FIT) or a fixed premium (in addition to the electricity price) that a governmental institution, utility or supplier is legally obligated to pay for renewable electricity from eligible generators.

The difference between fixed FITs and premiums is as follows: for fixed FITs, the total feed-in price is fixed; for premium systems, the amount to be added to the electricity price is fixed. For the renewable plant owner, the total price received per kWh, in the premium scheme (electricity price plus the premium), is less predictable than under a feed-in tariff, since this depends on a volatile electricity price.

In principle, a mechanism based on a fixed premium/environmental bonus that reflects the external costs of conventional power generation could establish fair trade, fair competition and a level playing-field between RES and conventional power sources in a competitive electricity market. From a market development perspective, the advantage of such a scheme is that it allows renewables to penetrate the market quickly if their production costs drop below the electricity price plus premium. If the premium is set at the ‘right’ level (theoretically at a level equal to the external costs of conventional power), it allows renewables to compete with conventional sources without the need for governments to set 'artificial' quotas. Together with taxing conventional power sources in accordance with their environmental impact, well-designed fixed premium systems are theoretically the most effective way of internalising external costs.

In practice, however, basing the mechanism on the environmental benefits of renewables is challenging. Ambitious studies, such as the European Commission’s ExternE project, which investigates the external costs of power generation, have been conducted in both Europe and America; these suggest that establishing exact costs is a complex matter. In reality, fixed premiums for wind power and other renewable energy technologies, such as the Spanish model, are based on estimated production costs and are fixed based on the electricity price, rather than on the environmental benefits of RES.

REGULATORY QUANTITY-DRIVEN STRATEGIES

The desired level of RES generation or market penetration – a quota or a Renewable Portfolio Standard – is defined by governments. The most important points are:

• Tendering or bidding systems: calls for tender are launched for defined amounts of capacity. Competition between bidders results in contract winners that receive a guaranteed tariff for a specified period of time.
• Tradable certificate systems: these systems are better known in Europe as Tradeable Green Certificate (TCG) systems and in the US and Japan as renewable portfolio standards (RPS). In such systems, the generators (producers), wholesalers, distribution companies or retailers (depending on who is involved in the electricity supply chain) are obliged to supply or purchase a certain percentage of electricity from RES. At the date of settlement, they have to submit the required number of certificates to demonstrate compliance. Those involved may obtain certificates:
  • From their own renewable electricity generation;
  • By purchasing renewable electricity and associated certificates from another generator; and/or
  • By purchasing certificates without purchasing the actual power from a generator or broker, that is to say purchasing certificates that have been traded independently of the power itself.

The price of the certificates is determined, in principle, according to the market for these certificates (for example, NordPool).

VOLUNTARY APPROACHES

This type of strategy is mainly based on the willingness of consumers to pay premium rates for renewable energy, due to concerns over global warming, for example. There are two main categories:

• Investment focused: the most important are shareholder programmes, donation projects and ethical input; and
  
• Generation based: green electricity tariffs, with and without labelling.

INDIRECT STRATEGIES

Aside from strategies which directly address the promotion of one (or more) specific renewable electricity technologies, there are other strategies that may have an indirect impact on the dissemination of renewables. The most important are:

• Eco taxes on electricity produced with non-renewable sources;
• Taxes/permits on CO₂ emissions; and
• The removal of subsidies previously given to fossil and nuclear generation.

There are two options for the promotion of renewable electricity via energy or environmental taxes:

1. Exemption from taxes (such as energy and sulphur taxes); and
   
2. If there is no exemption for RES, taxes can be (partially or wholly) refunded.

Both measures make RES more competitive in the market and are applicable for both established and new plants.

Indirect strategies also include the institutional promotion of the deployment of RES plants, such as site planning and easy connection to the grid, and the operational conditions of feeding electricity into the system. Firstly, siting and planning requirements can reduce the potential opposition to RES-E plants if they address issues of concern, such as noise and visual or environmental impacts. Laws can be used, for example, to set aside specific locations for development and/or omit areas that are particularly open to environmental damage or injury to birds.

Secondly, complementary measures also concern the standardisation of economic and technical connection conditions. Interconnection requirements are often unnecessarily onerous and inconsistent and can lead to high transaction costs for project developers, particularly if they need to hire technical and legal experts. Safety requirements are essential, particularly in the case of interconnection in weak parts of the grid. However, unclear criteria on interconnections can potentially lead to higher prices for access to the grid and use of transmission lines, or even unreasonable rejections of transmission access. Therefore, it is recommended that authorities clarify the safety requirements and the rules on the burden of additional expenses.

Finally, rules must be established governing the responsibility for physical balancing associated with some technologies’ variable production, in particular for wind power.

 

COMPARISON OF PRICE-DRIVEN VERSUS QUANTITY-DRIVEN INSTRUMENTS

In the following section, an assessment of direct promotional strategies is carried out by focusing on the comparison between price-driven (for example FITs, investment incentives and tax credits) and quantity-driven (for example Tradable Green Certificate (TGC)-based quotas and tendering systems) strategies. The different instruments can be described as follows:

• Feed-in tariffs (FITs) are generation-based, price-driven incentives. The price per unit of electricity that a utility, supplier or grid operator is legally obliged to pay for electricity from RES-E producers is determined by this system. Thus a federal (or provincial) government regulates the tariff rate. It usually takes the form of either a fixed price to be paid for RES-E production, or an additional premium on top of the electricity market price paid to RES-E producers. Besides the level of the tariff, its guaranteed duration represents an important parameter for an appraisal of the actual financial incentive. FITs allow technology-specific promotion, as well as an acknowledgement of future cost reductions by applying dynamic decreasing tariffs.
• Quota obligations based on Tradable Green Certificates (TGCs) are generation-based, quantity-driven instruments. The government defines targets for RES-E deployment and requires a particular party in the electricity supply chain (for example, the generator, wholesaler or consumer) to fulfil certain obligations. Once defined, a parallel market for renewable energy certificates is established and their price is set following demand and supply conditions (forced by the obligation). Hence for RES-E producers, financial support may arise from selling certificates, in addition to the revenues from selling electricity on the power market. Technology-specific promotion in TGC systems is also possible in principle. However, market separation for different technologies would lead to much smaller and less liquid markets. One solution could be to weight certificates from different technologies, but the key dilemma is how to find weights that are correct or at least widely accepted as fair.
• Tendering systems are quantity-driven mechanisms. Financial support can either be investment-focused or generation-based. In the first case, a fixed amount of capacity to be installed is announced and contracts are given following a predefined bidding process, which offers winners a set of favourable investment conditions, including investment grants per kW installed. The generation-based tendering systems work in a similar way; but instead of providing up-front support, they offer support in the form of a ‘bid price’ per kWh for a guaranteed duration.
• Investment incentives are price-driven instruments that establish an incentive for the development of RES-E projects as a percentage of total costs, or as a predefined amount of money per kW installed. The level of these incentives is usually technology-specific.
• Production tax incentives are also price-driven, generation-based mechanisms that work through payment exemptions from the electricity taxes applied to all producers. Hence, this type of instrument differs from premium feed-in tariffs only in terms of the cash flow for RES-E producers; it represents a negative cost instead of additional revenue.