Policy Support Mechanisms for Renewables

By Zaheer A Shaikh

The high investment cost of renewable energy technology means it is clearly beyond the budgets of most governments to directly inject money in to renewables in order to fast track a competitive industry. This means the option of subsidy and direct financial rewards to the renewable energy generators would put a strain on government’s expenditure. In a monopoly market it is easier for the government to intervene in the market to promote renewables as the monopoly generator then would be compensated. However this becomes difficult in a completely liberalised market.

At the retail end of the competition, the suppliers compete to capture more consumers on narrow margins of the price. And given the high investment cost of the renewable energy projects, the cost of per unit generated will be more to cover this. This puts renewables on a disadvantageous position. This problem can be overcome by incorporating these obligations in legislation. This means governments have a critical role as their use of legislation and market dynamics may lead to private sector investment in to renewable power projects. The following content will discuss some of the schemes which are used in various degrees to promote and increase the share of  renewable energy.

Feed In Tariffs:

Feed in Tariff (FiT) scheme is a popular renewable energy support scheme and is used in many of the European countries. FITs typically offer a guaranteed purchase for electricity generated from renewable energy sources and may also involve long term purchase agreements. This means that the generators will be guaranteed of return on their investments to cover their costs incurred. The premium paid on the price ensures encouragement for future investments. The price is typically set by the government and the quantity is to the market. This mechanism works by focusing on the supply side of the market.

In some cases the electricity produced is purchased by the network operator / distributor and the additional cost for the renewables is passed to the suppliers, which then they pass on to the consumers. In this the power purchasing is fixed for a specific period of time. Another variation in this mechanism is fixed premium mechanism mostly used in Denmark and Spain. In this system, fixed premium or environmental bonus is set by the government and usually paid above the normal or spot electricity price to renewables energy generators (Cameroon, 2007). The certainty about the revenues helps the renewable energy generators to raise their project finances with ease as this certainty is important for the financial institutions. As pointed out earlier majority of the great innovations in modern life have largely been assisted in some way by governments. Therefore the ultimate goal with this market based approach of FiT mechanism is to encourage innovation which will drive down the overall technology costs. Carefully balancing too much government spending, the premiums paid needs to be adequate so that the developers of the renewables are motivated to invest and innovate more.

Green Certificates:

In this mechanism renewables are sold at conventional power market prices. The governments in this case for covering the additional cost of renewable energy generation, oblige the consumers (also generators in some countries) to purchase a certain number of green certificates from the renewable energy generators. The number of certificates required to purchase depends on the percentage or quota of the total electricity consumption (or generation). It is a very good market based mechanism in which the consumers and the generators try to purchase these certificates at a cheaper rate. This leads to a competition amongst the renewable energy generators. Simply put more the supply of renewables lower the prices. In this system the non compliance penalties are imposed, therefore at the end of the period the parties who fail to produce the required number of certificates are charged this penalty. This penalty then sets the price cap. The consumers (or generators) get a choice with regard to price.

For long term high cost technologies this mechanism is not very useful. This can be explained by the fact that some of the renewable energy technologies are expensive compared to others. And since this is a market based mechanism the cheaper renewable technology would out-compete the more expensive ones. This is again a detriment for the development of all other technologies.

Tendering:

This process of incentivising the renewable energy generation is not very popular. Like the way in other tenders, the government sets tenders for the supply of renewable electricity. The lowest bidder gets the contract and then is required to provide the stipulated amount of electricity from renewable source. The problem with this mechanism is that the already developed and mature technologies can bid at low cost- putting the untested but promising technologies at disadvantage. The lowest bidder after some time may not find the project profitable and this risk may lead to non completion of the project (Cameroon, 2007).

Renewables Obligation Certificates:

The Renewable Obligation (RO) is a market based renewables support mechanism. Launched in the year 2002, this aims to achieve 30% of electricity from renewable sources by the year 2020 in United Kingdom. This ambitious scheme is already lagging behind the targets and there is a debate about its possible target achievement. Notwithstanding RO is one of the effective market based mechanisms to support the renewables. In this system the suppliers are required to purchase electricity from the renewable energy generators. The quantity of electricity for every year is decided by the regulator. The supplier at the end of the year produces the certificates as an evidence of their use of renewable energy in their total supplies. The failure to produce these certificates results in a penalty (the buyout price) which is a fixed price per MWh shortfall and is adjusted in line with Retail Price Index each year.

RO support mechanism was conceptualised by learning from mistakes of NFFO (Non Fossil – Fuel Obligation). However after 8 years of its formation now it is suspected that it might not achieve its targets. The no technology banding means the cheapest renewable energy technology will be picked, also the renewable energy generators do not try to increase their production beyond the target meaning not realising full generation capacity.

Support for Renewables in a Liberalised Market:

As discussed earlier, the cost of renewable technology makes it difficult to survive on its own in a liberalised market. If a government wants to achieve its objective of promotion of renewable energy generation, the liberalised market most usually acts as a barrier; therefore the renewable energy generators need support mechanisms. The philosophy behind liberalisation is to encourage competition and to remove legal barriers. The competition will then promote the most efficient technologies which will help to bring down the prices. Now the market forces will promote the cheapest technology such as coal fired power generators. And the higher cost renewable energy generators will not be able to compete with these cheaper technologies.To overcome this difficulty the EU agreed on a broader policy in which it was agreed that the renewable technologies will be kept out of competition up to some extent[1]. The member states were then required to put this support for renewable in their legislation. England passed the Renewable Obligation Order 2002 giving special protection to the renewable energy generation[2]. This was crucial as this order led a market based approach to encourage the use of renewable generation technologies without compromising the flavour of the competition. 

As the governments in the EU are trying to increase the percentage of renewable energy in total energy mix through various laws, the question remains about the duration for such support. As repeatedly we have seen that the more promising but high cost technologies are being left out. The typical nature of short term contract in this system means the generators are not certain about the payments as they keep changing, thus affecting the revenue flow. Again then the support to renewables in the form of long term contracts goes against the spirit of fair competition.  However further market intervention by the government in terms of allowing long term contracts for this smaller segment of overall electricity market will give positive results. Compared to FiT mechanism the RO support mechanism is less interventionist and more market based. Therefore support for renewable energy generator is a real balancing act for the governments.

The Future of Renewables:

Despite all efforts the successive targets for increase in renewable energy generation are under achieved. There is no immediate remedy to replace the current fossil fuel based technology to the cleaner renewable technology. Increased support or further reforming the markets will only lead to more intervention in a liberalised market structure. Therefore a policy to increase and promote technology banding is needed, where all the technologies would be provided the appropriate support. This will help in competition between the different technologies to drive down the cost. Similarly the sourcing of components from the local markets will also help to push down the cost. Clearly the future of renewable energy is the one where it will compete with other fossil fuels. The ultimate target of integration of all the electricity looks illusionary however if achieved would help further reducing the cost with fair competition and greater efficiencies.

Taking It home

To promote and sustain share of renewable energy in total energy mix has always been tricky. Supporting the projects which are not yet proved commercial and at the same time keeping the final electricity cost reasonable has been difficult without market intervention. The objective of all these activities is that the high cost of renewable energy at some point will go down. Furthermore managing this in a liberalised market is more problematic. Increased efficiency and lower costs are the outcome of a successful market. And we have discussed that if we allow these high cost technologies to compete with established technologies, a market for them will never develop. However help in the form of regulation can help these technologies to establish themselves. Also this regulation will help to address the issue of long term contracts. To avoid the price uncertainty and for steady flow of revenues the developers of the renewables projects need assured contracts.

To make the renewable technology more competitive the sourcing and procurement of components can help to drive down the cost of the project. The initial cost of investment in the case of renewable energy is high therefore the combination of assured purchase, localising the procurement and long term contracts can help to recover investments quite early. Then again no fuel requirement means the renewable energy source is a good option in the long once its initial investments are recovered.

NUTSHELL:

This article is a continuation of the discussion of Renewable Energy by Zaheer. In this article, Zaheer has discussed in the above paragraphs- various support mechanisms to guarantee the share of renewable energy. He argues that though the FiT mechanism is a very effective support mechanism its critics argue that it fails to achieve the cost efficiency.  Another criticism is that the FiT mechanism requires more intervention. He also explains that, similarly, the Green Certificate mechanism tends to promote the cheapest renewable technology which then again puts the high cost long term project at disadvantage. To Zaheer, RO mechanism even though it is not very cost effective is a good support mechanism; the reason being that it offers the rapid deployment of resources and if further included with technology banding can deliver the expected targets. For him, this is the one market based system in which the design of the system has an influence on its outcomes, therefore the new design can include increase duration of support to the renewables, and periodic review of the targets. Finally, Zaheer concludes his analysis by positing that Renewable energy has a greater potential to form as a major source of energy, but it will need time and help to be competitive in longer run.  Great Article. For more information on this article and to view Zaheer's professional profile and his other articles, click here.-->

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[1]  Directive 2001/77/EC On producing the electricity from the renewable sources

[2]  Renewable Obligation Order 2002