Renewable Energy Support Mechanisms: Feed-In Tariffs and Auctions

Introduction/Background

Energy policies set the goals for a country’s energy future. They create stability in the market, increasing the confidence of investors and thereby allow for energy support to be realised. Therefore, policies play an important role in the future development of (renewable) energy technologies. Renewable energy technologies are widely seen as the future. They provide clean energy using non-finite resources, help mitigate climate change, increase countries’ energy independencies and can improve energy security. However, many renewable energy technologies are relatively new and not yet as established as ‘convention’ energy generation technologies which burn fossil fuels. By choosing to shift their support mechanisms away from fossil fuels and towards renewable energy technologies governments can help boost these technologies in their countries. For an overview of all of the different renewable energy support mechanisms and their strengths and weaknesses have a look at the article Comparison of various Policy Tools for Promoting Renewable Energies.

This article looks in detail at two of the main support mechanism, Feed-In Tariffs (FITs) and auctions. After a short definition and overview of each policy type the article examines how these policies can be implemented and looks at the effectiveness of each policy type at achieving certain objectives. Due to the complexity of renewable energy support mechanism it can often be difficult to judge which policy type might offer the most advantages for a given country. Especially for newly emerging and developing policies there are not yet that many case studies available which show the effects of a certain policy on the development of renewable energy technologies. Therefore, this article aims to provide a short guide on the benefits and disadvantages of FITs and auctions, based on a literature review and selected country examples.

 

Background

There are two main categories of regulatory generation focused renewable energy support mechanisms; Tariff-based Instruments and Quantity-based Instruments. Tariff-based instruments provide an economic incentive for generating electricity using renewable energy sources. Usually this takes the form of investment subsidies or payments for energy generated. The Feed-In Tariff (FIT) is an example of a tariff-based instrument. A FIT guarantees a fixed price for renewable energy which is fed in to the grid. (Barroso, et al., 2015a). On the other hand, Quantity-based instruments work by setting minimum targets for renewable energy in the energy mix and holding certain parties in the energy supply chain responsible for these targets. An example of a quantity-based instrument is a Renewable Purchase Obligation (RPO) which “imposes a minimum quota or a share of renewable energy production on electricity suppliers, and is often supplemented by a renewable energy market allowing for the trading of renewable energy certificates (RECs)“ (Barroso, et al., 2015a) (Wind Energy, The Facts, n.d.)

FIT are the most established renewable energy support mechanism. However, in recent years many countries have started to implement a blend of different policies, allowing them to profit from the benefits offered by a range of different policies. Such a mix of policies can be described as Hybrid Instruments. Hybrid instruments are support mechanisms which combine aspects from tariff and quantity-based instruments. Renewable energy Auctions (sometimes also called tenders) are an example of hybrid instruments. In auctions both the price and the quantity are determined through a price bidding process, before the project start. This allows auctions to provide a “stable revenue guarantee for the project developers (similar to the FIT mechanism), while at the same time ensuring that the renewable generation target will be met precisely (similar to an RPO).” (Barroso, et al., 2015a).

International Trends

The number of countries with at least one type of renewable energy target rose from 43 in 2005 to 164 in 2016. (Wuester, 2016) “By early 2012, 109 countries had some type of policy to support renewable power generation, up from 48 countries in 2005. More than half of these countries are developing countries or emerging economies.” (IRENA, 2012) The joint IEA/IREAN Country Policy Database for Global Renewable Energy currently stores information on 117 countries (status 2016).

Figure 1 and Figure 2 show the development of different support mechanisms since 2005. As can be seen in 2005, FITs used to be the most popular support mechanism by far, while only 6 countries at the time had implemented auctions. Even today the FIT remains the most common support mechanism, however, auctions have seen a very strong growth and where implemented in over 60 countries by early 2015. (Ferroukhi, et al., 2015)

Figure 1: Number of countries with renewable energy policies by type (Wuester, 2016)

Figure 2: Development of FIT and Auctions in the past years (Lucas, et al., 2013)

 

Feed-In Tariff

Definition

A Feed-In Tariff (FIT) provides renewable energy generators with a fixed price for the energy which they produce. The FIT is set for each technology individually and is paid for a fixed number of years. This increases the stability and allows for long-term planning, which encourages investment in to renewable energy projects. In some countries the FIT is funded through the electricity utility bills, which means that the costs are passed down to the consumers. However, in other countries, where an increase in consumer bills was deemed unacceptable government budgets have been set aside for the FIT. (Passey, et al., 2014)

 

Overview of Different FIT models

Gross FIT: The FIT is paid for all of the renewable energy which is being generated, independent of whether this energy is being exported to the grid or used on-site.

Net FIT: The FIT is only paid for the renewable energy which is being exported to the grid. Even though the FIT is not paid for generated electricity which is being used on site, this energy is offsetting the cost of bills which would normally have to be paid. Therefore, in order to determine whether the Gross FIT or the Net FIT model will be more profitable, the price of the FIT and of the grid retail price per unit of electricity has to be compared.

Net Metering: The current retail price is paid for all renewable energy which is being exported to the grid. Electricity used on site reduces the electricity bills, which would normally also have to be paid at the retail price. Therefore, this model effectively means that all renewable energy which is being generated gets paid the current retail price.

Net Billing: The payments for electricity generated and electricity consumed are netted out over a certain period of time. This can be applied using either the gross FIT or the net FIT model. (Passey, et al., 2014)

 

Advantages and Disadvantages

Advantages

Disadvantages

Simple policy model, however, can be customised to target specific technologies. Limits the risk for investors. Due to long term security FITs drives technological development. Facilitates the entry of new players in the market. Because the FIT is output based it provides an incentive to maximise productions. When funded by the consumers, the FIT imposes no burden on the public budget. Tariff structure can be adapted to impact on customer load patterns. Tariffs are linked to a fixed timeframe. Well established and successful policy method.

While the policy structure is simple, finding the best FIT level and digression mechanism for each country is difficult. With a fixed FIT, project do not need to respond to price signals from the market, resulting in bad market integration. The FIT only supports grid connected generation. FIT can be very costly for a country. Badly designed FIT can result in high utility costs for the consumers. When funded through a budget the stability of the FIT is linked to the budget reliability. There is less control over the installed quantity.

(Passey, et al., 2014)  (Laumanns, et al., 2015)

 

Links to other articles about FET

• Feed-In Tariffs (FIT)
• South Africa Renewable Energy Feed-In Tariff
• Powering the Green Economy: The Feed-In Tariff Handbook
• Feed-In Tariff (FIT) Tool – SADC RERA Mini-Grids
• Feed-In Policies
• Tariffs
• Actual Status of Feed-In Tariffs (FIT) Implementation World Wide
• Feed-In Tariffs Wind Energy

 

Auctions

 

Definition

Renewable energy auctions, sometimes also called ‘demand auctions’ or ‘procurement auctions’ are a type of support mechanism for renewable energy technologies. In most cases renewable energy auctions are opened by the government of a country. They will specify the capacity (kW) or the electricity generation (kWh) which is up for auction, as well as the generation technology and sometimes the generation location. Project developers can than submit a bid to the auction, outlining their project proposal and stating the price per unit of electricity at which they will be able to realise their project. The government then evaluates the different offers, ranking them based on their price and other criteria. The best candidates are then selected and the government signs a power purchasing agreement with the successful bidders. (Lucas, et al., 2013) Auctions are very flexible and can be organized in many different ways. In order for an auction to succeed it is important that it is adapted to the countries specific circumstances. These depend on the goals which the country wants to achieve through the auction.

 

Overview of Different Auction Models

Sealed Bid Auction: All bidders submit their proposal, containing the price and quantity of generation. The individual bidders are not able to see each other’s proposals. All of the submissions are then screened to confirm that they meet the outlined requirements. The bids are ranked from lowest to highest, according to their price and possibly other additional criterial. Then the best ranking projects are selected one by one, until the number of selected projects covers the volume of renewable energy generation which is being auctioned. (Lucas, et al., 2013)

Iterative Process/Descending Clock Auction: In this type of auction the auctioneer (in most cases the government) declares a price for a new renewable energy generation project. The bidders then come forward and announce what quantity of generation they are able to offer for this price. The price is then progressively lowered by the auctioneer, which results in lower generation quantities offered by the bidders. This process is continued until the generation quantity offered matches the volume of new renewable energy which the government wants to invest in. In this auction the bidders know each other’s offers and are therefore able to adapt their own offers based on the competition. (Lucas, et al., 2013)

Hybrid Type Auction: These auctions consist of a combination of different models to select the bidders. As an example, Brazil uses an auction which is divided into two phases. The first phase is a descending clock auction used to discover the price. The second phase consists of a sealed bid auctions which ensures that the bidders cannot collude on the price. (Lucas, et al., 2013)

Figure 3: Summary comparison of bidding procedures (Ferroukhi, et al., 2015)

 

Advantages and Disadvantages

Advantages

Disadvantages

Guaranteed purchase at fixed price. Guaranteed access to the grid. Long term guarantee leads to better financing options and potentially lower prices. High competition results in cost efficiency and reveals the true market price of different technologies. Limits can be set by the government for the capacity and the budget. Due to the fixed schedule, electricity generation from renewable energy technologies becomes more predictable. This makes future power planning easier. Bids can be selected according to specific criteria. This allows for multiple country policies (ex: environment, employment) to be considered.

When not scheduled regularly auctions can lead to discontinues (stop start) market development. Difficult for small/medium sized bidding companies due to the high transaction costs (project proposals need planning, feasibility study, risk assessments) and the risk of not getting a return on these investments in case they are not chosen. High administrative costs. High competition can lead to underbidding which results in low financial returns, contract failure or attempted post-auction price raises by successful bidders. If there is not enough competition offers might be too high. In open auctions there is a risk of collusive behaviour between bidders to drive up prices.

(Lucas, et al., 2013), (Laumanns, 2014)

Links to other articles about auctions

• Renewable Energy Tendering Schemes
• Competitive Tendering (Concessions, Auctions)
• Energy Auction in Brazil
• 
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• Bidding Strategies in Brazilian Electricity Auctions

 

Comparing FIT and Auctions

The main difference between FIT and auctions is the price discovery mechanism. ‘For FIT the price is fixed by the policy makers, however, in auctions the industry determines the price for the project through competitive bidding between the bidders.’ (Jacobs, 2015) If the country does not have much experience with setting prices for a certain renewable energy technology and there is not enough cost data available, then auctions are a useful way of discovering the true cost of the technology. However, for auctions to be successful they need to be competitive. This means that there needs to be enough interest amongst project developers in the country to invest in the technology. The auction should be oversubscribed, so that the generation capacity offered by all of the bidders is higher than the demand. In situations where these conditions cannot be met FIT are often a better option. Another point that should be considered is that auctions are open to everyone. If there is a special interest from the government’s point of view for the renewable energy generation to be focused on a certain sector (example farmers, private household, industry etc.) then FIT are often the better policy to target a certain type of production. (Jacobs, 2015) Usually auctions are better for large scale projects and established technologies. On the other hand, FIT are less risky from the project developers point of view, which is why they help support small scale projects as well as emerging technologies.

There is an increasing trend, world-wide, to move away from ridged support mechanisms models. As the energy market becomes more and more complex so do the energy policies in many countries. Hybrid support mechanisms are gaining in popularity. Often having two different types of support mechanisms ruining in parallel, or even combining elements from different policies into one can be advantageous. Therefore, FIT and Auctions can well be implemented in one country at the same time. In these cases, the conditions under which the two support mechanisms can be applied need to be well defined. For example, in many countries which have implemented both FIT and Auctions, the FIT are targeted towards small projects while the auctions are limited to large project developers. The country has to carefully choose and define the thresholds for the projects, deciding which project classify as small scale (Grau, 2014). However, there are also examples of countries which have implemented the policies in exactly the opposite way (example: Uganda: Auctions for small scale, Denmark: Auctions for emerging tech).

 

 

 

 

 

 

Table 1: Comparison of FIT and Auctions

Level	Category	FIT	Auctions
Government	Risk	Risk is shifted towards the government	Lower risk for government
	Cost	Can be very costly, however, if funded by consumers then there is no burden of the public budget.	Project costs are set far in advance, offering, more control and certainty over the final total cost. However, high transaction costs.
	Setting Target Groups	Easier to target the policy towards certain groups (ex: farmers, private households, industry).	Should be open to all. Difficult to target towards certain groups.
Project Developers	Risk	Lower risk for project developers	Risk is shifted towards project developers.
	Cost	Lower costs for project developers.	High planning and transaction costs due to pre-auction requisites.
	Small/New Project Developers	FITs make it easy for new companies to enter the market and allow small companies to be competitive.	Difficult for small/new companies due to high risk as well as large planning and transaction costs.
Innovation	Promoting New Technologies	Good at providing support for new technologies.	Suited for slightly more established technologies
Market Development	Discovering True Market Price	Especially in fast changing markets the FIT often does not reflect the true market price.	If designed well and there is enough competition, then actions are a good way of discovering the true market price
	Long-Term Stability	FITs offers very stable condition during their running time.	Offers very stable conditions for the phase of the projects, however, time gaps between auctions can lead to discontinuity and start stop market development.
	Adaptability	Changing/Adapting the policy is very complex	For each new auctions the terms can be adapted to reflect the present circumstances.
	Growth/Achieving RE Targets	Provides incentive for maximising generation.	More control over new installation capacity.

This table was put together based on information compiled from the following sources: (Wuester, 2016), (Passey, et al., 2014), (Laumanns, 2014), (Laumanns, et al., 2015), (Lucas, et al., 2013).