Regulation to Foster Bulk Electricity Generation from Renewable Energy

Overview

This article represents the status of discussion in the year 2002.

Feed-In Tariffs vs. Renewable Set-asides

Feed-in tariffs require the grid-operator respectively the default electricity supplier to purchase electricity form renewable energy (RE) generators at fixed premium prices. Note that a minimum price standard does not only regulate the price but also grid access and power purchase. With RE set-asides, electricity supplier (sometimes alternatively electricity customers or electricity generators) are obliged to cover a certain share of their electricity supply (respective electricity demand or generation) with RE. The obliged parties comply with the obligation by presenting tradable 'green certificates' certifying the generation of a certain amount of electricity. Thus these certificates have an economic value generating an extra income to RE electricity producers. In the order of their generation costs, RE electricity will be generated until the targeted amount is reached.

There is long and ongoing discussion both on the theoretical level as well as in practical politics whether feed-in tariffs or RE set-asides are the best suitable mean to foster the market dissemination. Neoclassical economic theory predicts, that both systems lead to an optimal and efficient solution. In a feed-in tariff the price is fixed and the amount of generated RE electricity is adapted. An individual generator will produce until his marginal costs equals the regulated price. With set-asides, the total amount of RE electricity is fixed and the price is flexible. In order of their generation costs, RE electricity will be generated until the targeted amount is reached.

Albeit we have seen a considerable influence of theoretical arguments on the practical political discussion and decisions, an assessment of the success respectively the failure of certain instruments in reality is naturally of much bigger importance for the choice of an effective policy. Countries with feed-in tariffs (e.g. Denmark until 2000, France since 2001, Germany and Spain) have seen the largest growth of RE electricity. This applies particularly to wind power. At the same time, a viable RE manufacturing industry has been established in these countries. For reasons of organizing political support and creating local acceptance it has been proven successful to spread ownership among many, preferable also local people. Although it is not appropriate to attribute the success in RE deployment solely to the influence of a single policy instrument it gets clear that a well designed feed-In tariff together with supplementing policies like simplified building permission procedures is an effective mean to support the deployment of RE electricity. Still, a proper design of a specific support instrument is even more crucial than the type of instrument.

RE set-asides have been widely discussed recently and have been introduced in Australia, Belgium (only the Flemish part), Italy, Sweden and the United Kingdom. Such mechanism is promising in theory since it allows for the least expensive renewable energy technology to be implemented first and equalizes marginal costs of all obligated parties at the same time. However, practical experience has been limited and rather mixed. Larger generators are more ready to take over the risk of selling electricity and certificates under uncertain conditions. Instead of a wide range of different RE technologies only the presently very most cost effective technology will be supported. Long-term contracts rather than spot markets will govern transactions between RE generators and the obliged parties undermining competition. The different design of the national renewable portfolio standards hinder rather than enable the free trade of certificates between different countries.

In bidding schemes RE capacity is periodically publicly tendered and power purchase contracts are awarded to the winning bids. Bidding schemes may be regarded as a special form of set-asides. Actual, obliged parties in RE set-asides have issued public call for tenders (refer e.g. Langniss, Wiser 2002). England and Wales introduced a bidding scheme called Non-Fossil-Fuel obligation in 1990. In five rounds between 1990 and 1998, developers of RE plants could bid in different technology slots (e.g. wind power, waste to power, hydro power). The winners with the lowest bided generation costs were awarded with a 15 year power purchase agreement. The bid prices sank between 45 % (hydro power) and 70 % (wind power) between the first and the last round. Yet, due to different conditions in the procedure and the awarded power purchase agreements as well, the bids are not directly comparable to each other. More over, up to now (September 2002) none large wind project of the last bid round in 1998 has been commissioned at the low average bid price of 0.045 €/kWh. Supposedly, these expected prices are economically not feasible. Albeit the UK has the largest wind power potential in Europe, the NFFO failed to foster wind and other RES-E in the expected way due to design weaknesses of the NFFO itself but also a lack of appropriate building permission procedures and was therefore abandoned.

Considering the large investments needed to establish RE in the energy system it will be crucial to be a magnet for private capital. Long-term stability of income is a pre-condition to attract investors in long-term investments like RE power plants. Thus long-term power purchase agreements either directly issued or guaranteed by a Feed-In-regulation are a suitable mean. The long term stability allows also access to low-interest credits. In contrast, set-aside regimes create uncertain income streams both for electricity and certificates leading to high costs for capital.

A general regulation will thereby create more reliable conditions for investors than the present case-by-case approach. This is of special importance if one not only wants to attract investment in RE electricity generation but also target on creating a viable industry basis to manufacture RE plants. For the latter, the long-term perspective for a demand for RE power plants is a essential pre-condition. Moreover, a certain minimum size of the market for different technologies needs to be created to make investment in RE manufacturing feasible. Taking the case of wind power, it has been proven that the most viable manufacturing industry can be found in these countries which have established a Feed-In-type of regulation4 whereas countries with tender systems5 or quotas6 failed to establish a comparable manufacturing industry. Considering the significance of SA for entire Southern Africa, a South African RE manufacturing industry can gain a large importance for the entire region. Practice has proven that Feed-In regulation create far better conditions for small and medium size enterprises as operators. Thus, they give better grounds for economic development and black empowerment. In contrast, quotas tend to support larger enterprises.

Although economic support lasts to be the major driver for market dissemination of RE appropriate framework conditions like a fair access to electricity and gas grids, adapted building codes, good access to capital or a vivid research environment are of high importance playing the role of 'hygienic factors' which need to be addressed for a successful market development.

The Need for Regulation

According to neoclassical economics the state should only intervene in markets if markets fail to provide a beneficial good otherwise. This is especially true for so called public goods which are beneficial for many but for which individuals will not pay for. There are different public benefits which are attributed to RE making it reasonable to the state to support them via a regulation.

RE have usually a lower environmental impact then conventional energy carriers. They do not emit poisonous gases - as fossil power plans usually do - nor do they release CO₂ . Environmental benefits from the use of RE arise therefore on the local, regional and global level. RE plants do not produce poisonous waste either - like nuclear power plants do. Based on scientific calculations of the EXTERNE project the European Commission is assuming external costs of electricity generation of 5 cents€/kWh electricity (EC 2001). Using RE is also more labour intensive then fossil fuels thus jobs are created by the deployment of RE. Jobs are created with manufacturing of the plants, but also with erection and maintenance. Since RE are applied locally and dispersedly the jobs are created in remote areas leading to some economic development desperately needed in these areas. As far as foreign energy sources are displaced the use of the domestic RE also saves on foreign currency.

Unfortunately, these public benefits are not appreciated by markets today. Thus, RE technologies are still not economically competitive with conventional energy carriers in many applications. Thus, a cost gap between RE and conventional energy carriers still exists. This is especially true for the case of South Africa where inexpensive and abundant domestic coal reserves exist. But the use of this reserves is combined with high external costs. Thus, public regulation needs to correct this miss-control of the energy markets.

However, such kind of regulation is not meant as a permanent subsidisation of RE. Instead, dissemination of RE is targeted on bringing down generation costs of RE. Thereby, the head start of conventional energy carriers which has led to a technological lock-up will be compensated to a certain extent. At the same time, other national or international policies like emission trade or air regulation will consider the external costs of conventional energy use thus increasing the generation costs of such technologies. Thus, a regulation to foster RE electricity generation should be regarded as a temporary mean until the cost gap is balanced due to lower generation costs and an appropriate recognition of the external costs of conventional energy supply. In other words, such a regulation acknowledge the external benefits of RE.

Beyond the general reasoning for a policy supporting RE the choice of Feed-In-Regulation must be justified against alternative means of support. As noted earlier we will not replicate the long and ongoing debate on the best support mechanism. Still, we believe that the knowledge of specific benefits of a Feed-In regulation will enhance the chance that a proposal for such kind of regulation will survive in the political decision process.

Considering the large investments needed to establish RE in the energy system it will be crucial to be a magnet for private capital. Long-term stability of income is a pre-condition to attract investors in long-term investments like RE power plants. Thus long-term power purchase agreements either directly issued or guaranteed by a Feed-In-regulation are a suitable mean. The loan term stability allows also access to low-interest credits. In contrast, set-aside regimes create uncertain income streams both for electricity and certificates leading to high costs for capital. A general regulation will thereby create more reliable conditions for investors than the present case-by-case approach. This is of special importance if one not only wants to attract investment in RE electricity generation but also target on creating a viable industry basis to manufacture RE plants. For the latter, the long-term perspective for a demand for RE power plants is a essential pre-condition. Moreover, a certain minimum size of the market for different technologies needs to be created to make investment in RE manufacturing feasible. Taking the case of wind power,
it has been proven that the most viable manufacturing industry can be found in these countries which have established a Feed-In-type of regulation (Denmark, Germany, Spain) whereas countries with tender systems (UK) or quotas (Netherlands, Italy, UK) failed to establish a comparable manufacturing industry.
Considering the significance of SA for entire Southern Africa, a South African RE manufacturing industry can gain a large importance for the entire region. Practise has proven that Feed-In regulation create far better conditions for small and medium size
enterprises as operators. Thus, they give better grounds for economic development and black empowerment. In contrast, quotas tend to support larger enterprises.

A Simple Scenario on Renewable Energy in the Electricity Sector

In the following, we will give with some rough calculation an indication, which extent the financial burden may be originated from the support of bulk RE electricity generation. This calculation is based on some very simple assumptions. We would be very glad to tune this scenario with some more accurate input data in the future.

We assume different realization rates of the potentials according to the different costs of the technologies (the lower the costs the higher the realization rate) and short term feasibility both in technical and organizational sense. 80 % of the potential biomass residues are used as well as 80% of the wind power potential. The potential hydro power is assumed to be exploited only half due to the more lengthy realization. Five solar thermal power plants each of 100 MW are assessed to be feasible to be commissioned by 2012. Since the scenario describes exclusively grid connected power generation PV is not considered. In sum, such a RE generation port-folio would contribute to 14.6% of the present electricity supply which translates to 26.6 TWh. Please note, that this amount is much more as the target stated in the August version of the White Paper and relates much more to targets expressed in earlier versions of the White Paper. Additional costs amounts to € 380 million/yr by 2012. This translates to an increase of the present average electricity sales price of 0.0021 EUR/kWh sold or a relative price increase of 12% over ten years.

There are certain short falls of this scenario approach. First, due to a lack of transparent generation and transmission costs we relate the RE generation costs to the entire average electricity price. No growth of the electricity demand is considered. No cost reductions due to e.g. technical progress with RE technologies is considered. We have not calculated mitigated external costs either. This scenario may still give an indication of the order of magnitude of costs.

Who Should be Obliged to Purchase the Electricity?

The first question to be answered when designing a Feed-In regulation is who should be obliged to purchase the electricity from RE power plants.

If one assume a fully liberalised and disintegrated electricity market:

• power generators
• transportation grid-operators
• distribution grid-operators
• electricity suppliers or
• electricity consumers
• an independent (state) agency

could be potentially obliged.

Principles to be considered with the choice are:

1. there should be exactly one but only one obliged party for any RE plant. Otherwise it might lead to confusion if several different entities are obliged with a certain power plant. More over, obliged parties might shift off their obligation to each other.
2. the parties to be obliged should be able to market the RE electricity. At least they should be able to forward it to entities that are able to do so.
3. the additional financial burden from the purchase of RE power should be distributed equally since it is a national target to deploy RE electricity. For instance, the additional costs electricity consumers are charged in a region with a lot of obliged RE electricity purchase should be not higher than in areas with only a few RE power plants.
4. the obliged purchase of power should not lead to a distortion of competition. This has to be considered only if the parties who finally bear the burden are in competition to each other.
5. It must be feasible to enforce the obligation.

The first two principles point very much to the sectors of the electricity industry which are monopolies. Then in any region only exactly one grid-operator exists to whom the RE generator may address. In an regulated environment that are the integrated electricity suppliers. In a liberalised market it is the grid usually which remains a regulated monopoly. An important and desirable side-effect of obliging the grid-operator is that the access to the grid is regulated simultaneously. Thus, access to the grid (often rated as the highest hurdle for independent RE generators) will be solved at the same time. It is sometimes argued that obliging the grid-operator to purchase electricity would counteract against a clear distinction between generation, distribution and trade, as it is seen as an indispensable condition for liberalising electricity markets. According to this argument, grid-operators should have the exclusive task to transport and distribute electricity from the generation to the consumption but they should not own or market power. In practise however, a grid-operator needs to purchase and marketed electricity also in a entirely liberalised market to balance generation and demand in the electricity system. Thus, the marketing of the RE electricity would not require additional skills which are located with the grid-operators anyway. The grid-operator might even use some of the RE power to balance the system.

With one national operator running a grid all over the country a surcharge on the grid-fees may be imposed on any electricity to be transported through the grid. By this, the financial burden will be distributed equally among all customers. Certain customer groups like electricity intensive industry (for reasons of international competition) or low-income households (for reasons of affordability) might be excepted from this surcharge. However, since electricity prices in SA are already among the lowest world-wide and the specific financial burden is very low it seems reasonable to abstain from such exemptions as far as possible.

In case of several different grid-operating companies operating in different regions one has to establish a balancing mechanism to keep the burden equal for all customers all over the country. This is not only desirable according to the third principle but also because commercial customers in competition might be effected differently in different grid-areas otherwise. A possible option for a balancing system would be to include the additional costs of the RE in the surcharge to be raised for the purpose of the planned National Electrification Fund anyway.

Alternatively to imposing an obligation, the state itself might purchase and marketed the RE electricity. Either an own state agency is established for this purpose or this task is handed over via a public request for proposals to a private entity. The costs could be covered via a grid-charge. Such an approach would have the advantage that the purchase of RE electricity did not interfere with any other business of the purchasing party. RE generators would clearly know to whom to address to. However, such an attempt would require additional regulations on grid-access which would be included with an obligation of grid-operators automatically. Moreover, it would contradict against privatisation of the power sector since the state would need to play a more active role on the market.

The German Way:

According to the old German Electricity Feed-In Law it was the utility who had the exclusive right to serve in the area where the RE power plant was erected that was obliged to purchase the RE electricity. This led to a situation where utilities and their customers in northern Germany with the majority of wind power installations under the Law had to pay a considerable higher share of the costs than the southern companies and their customers. This problem was addressed by introducing amount caps: If the RE electricity fed-in exceeded 10 % of the total sales of the utility, the obligation for the specific utility to purchase the RE electricity would end. However, this solution threaten the further deployment of wind energy in certain areas and addressed the unbalanced burden insufficiently.

The Renewable Energy Act of 2000 solves this problem in a different way by requiring electricity supplier to have the same share of RET-electricity in its fuel mix (Thus a kind of ex-post quota). Thus, not only the costs but also the benefits in form of the generated electricity are shared equally among all electricity suppliers, thus electricity customers. Through this design there is no need to calculate the "real" value of the electricity fed in. On the other hand the physical distribution of the RET- electricity among all suppliers causes additional costs.

Which entities should be favoured?

In a liberalised market any market player should be eligible to receive the premium tariffs according to the regulation. This means that established utilities as well as Independent Power Producers (IPP) can operate a RE plant which receives the premium remuneration. However, in practise electricity markets are not so much liberalised as text books assumes. Thus, an exclusion of established utilities may be considered under certain aspects.

Regulations to foster RE electricity were specifically successful in these countries where new players in form of IPP could be established. IPPs focusing on RE create usually strong support for public policies to foster RE since their core business is effected by any changes in the regulation. If ownership on these IPPs is spread among the population15 such support translates also in votes thus raising the importance of such lobbying in the view of the politicians. Supporting new generators also enhance competition, once electricity markets are liberalised. Established utilities want often to exploit their existing generation capacity as much as possible thus having not too much interest in establishing new technologies. Another problem with the eligibility of utilities occurs when these utilities are still vertically integrated thus operating also the grid. The grid operating subsidiary of the utility could refuse grid-connection of a RE-IPP thus preparing ground for an own RE power plant of the utility's generation branch. Moreover, an internal business is created, if the generation branch of the utility is paid by the grid-operating branch. Such an internal business would require additional monitoring to avoid fraud. Due to the decentralised, small character of many RE technologies, namely wind and PV, IPPs ran as small entities are sometimes better suited to implement RE than large utilities16.

On the other, there exist large economies of scale with certain RE technologies. This is especially true for solar thermal power plants and biomass plants. Also large wind power plants can realise some economies of scale. Large companies are well suited to raised the necessary capital for such projects and manage their operation. Regarding the large total capital required to deploy RE one should not exclude entities which have the capital sources to invest in RE. There is also a political aspect: Excluding certain parties may intensify resistance against a regulation from those who are excluded.

The German Way:

According to the old German Electricity Feed-In Law utilities could only receive premium remuneration for power plants outside the utility's own supplying area. Thus they could erect RE plants in areas served by other utilities. In practise, no such case occurred thus the entire wind power deployment was driven by IPPs in Germany. The exclusion of utilities was felt justified because among others utilities could invest in RE and recover additional costs due to such investments through the electricity tariffs anyway. Since deregulation led to an end of exclusive rights to serve the Renewable Energy Act from 2000 allows now also utilities to run RE power plants and receive a premium tariff in any place.

7. Which RE Technologies Should be Favoured? Generally, any technology using RE to generate electricity should be supported. All available RE sources need to be exploited to reach a higher share of RE on the total energy supply. Also from the perspective of technology policy it is reasonable not to restrict development on too few technologies. RE technologies for bulk electricity generation which have good prospects in terms of potential and possible application are wind power, solar thermal power plants, biomass and some small hydro power plants. For on-grid bulk electricity generation, will be economical reasonable in a few niche applications on the short and medium run. Deviations from the general rule may be considered for different reasons:

Certain RE technologies are already mature and economical viable thus they do not need any extra public support. This applies e.g. for large hydropower plants.

Due to restrictions in budget, regulators might wish to focus the limited financial means to only some, most promising technologies.

Likewise, certain technologies might be realised economically only in large installations. Then, the absolute burden from these installations might be rather high albeit the specific costs are rather low. Even though a certain share of RE-electricity would be achieved quite inexpensive this way, a few installations would not lead to a general establishment of RE technologies in South Africa.

Certain technologies might be already supported by other national and international means therefore they might not need additional support by a regulation. However, these others means are only an alternative to a regulation if they have the same reliability and long-term horizon as a regulation which is proposed here. This has to be considered especially regarding international funding.

Certain technologies might be also sponsored for other reasons than deployment of RE. This applies especially for waste to power schemes which are built to solve waste deposition at a first place. If legal requirements for building such schemes already exist, there is no need to sponsor it additionally with an RE regulation.

The German Way:

According to the old German Electricity Feed-In Law, only power plants smaller than 5 MW were eligible for premium remuneration. By this, especially large hydropower plants were excluded. Wind power farms were not rated at their total capacity but plant by plant so that also wind power farms larger than 5 MW received the extra remuneration. The Renewable Energy Act of 2000 has created some more different categories. Limits of size are set for each technology). The remuneration level is further differentiated according to the plant size for some technologies.

What principles to set the remuneration level should be applied?

An appropriate level of remuneration is very crucial for the success of a Feed-In regulation. If the remuneration levels are set too low, than no or only insufficient deployment of RE will take place. If on the other hand the levels are set too high, more financial means than original targeted will be allocated to RE electricity generation. Yet, the latter situation is neither 'inefficient' nor is it an 'excess-subsidisation'. It only means that more RE electricity will be generated at the specific price then originally implicitly targeted. In the SEPCO project we have not the means to determine an appropriate remuneration level. The level of remuneration will be decided in politics since there are value judgements involved. Still, such a decision can follow certain principles on scientific grounds. Principles to be considered are:

• One can orientate the remuneration on the generation costs of the different technologies.
• The remuneration is set following the prices of electricity.
• The remuneration is fixed according the avoided cost of conventional electricity generation considering thereby also the external costs of conventional electricity generation.

With putting the RE generation costs into focus one remunerates according what RE generators need to survive. Thereby, one can assess the real costs of each plant applying for premium tariffs. This would ensure that not more than necessary is paid. However, in practise it is difficult and time consuming to determine exactly the generation costs as the general practise of regulating the electricity supply industry shows. Moreover, such a case-by-case approach would undermine the certainty so important for investors. Thus, the remuneration should orientate itself on the general costs of the power plants. Thereby, it is feasible to distinguish by different RE technologies so that power plants using less expensive technologies will get a lower remuneration than more expensive ones. Usually, one distinguish between solar thermal power, wind power hydro power, biomass and PV. If the generation cost of a certain technologies varies over a large range a further distinction is indicated. This distinction should follow the factor determining the cost differences. For example, if there exist large economies of scale with a certain technology the remuneration can be differentiated according to the size of the power plants. As another example, generation costs of wind power plans vary largely with the average wind speed at the specific site thus an orientation of the remuneration of wind power plants on the wind speed is appropriate. The general costs of generation can be determined with calculating typical, standard applications of RE technologies under typical South African conditions17. Experiences from realised projects should be considered, too. With more and more RE applications in SA, cost determination will ease more and more in the future.

Against that a remuneration oriented on the prices18 of electricity follow a totally different concept. Here, it puts much more in focus what is affordable compared to the electricity prices or the generation costs of conventional power plants. The burden of the parties obliged to purchase the RE electricity should be reasonable. Thus, political opposition from those who will be obliged can be limited. On the other hand, a remuneration determined this way might be insufficient to drive a RE development. Or it will come to a remuneration exceeding by far the cost of generation. Consequently, the costs of typical RE generation have to be calculated anyway to give an indication whether the remuneration levels are sufficient or not.

We have stressed earlier that a Feed-In-regulation should be regarded as a mean to consider the external benefits of electricity generation from RE. So it is rationale to orientate the level of remuneration on the avoided external costs plus the avoided market costs of conventional electricity generation. As with taking the prices of conventional electricity production as a guidance this concept confines the remuneration to some justified level. However, it fails to ascertain what level of remuneration is needed to see a certain deployment of RE generation. Thus, this concept may serve as a justification for the remuneration rather than for determination19.

The level of remuneration is not the only factor influencing the income of the entities parties favoured by the regulation. Also the duration/term in which the premium tariffs are guaranteed has an influence. The shorter this term is the higher has to be the remuneration to have the same income effect to the generator. Principally, the term of guaranteed payments should be as long as the usual economical life-time of a certain RE technology thereby lowering the absolute level of remuneration. At the same time, a strong incentive is provided to operate conscientiously the RE power plant over its entire lifetime. To raise certainty with investors, the term of remuneration should be fixed in the regulation.

The German Way:

The old German Electricity Feed-In Law followed the principle of affordability. The remuneration level were adapted each year according to the average specific revenues (= mean electricity prices) of all electricity suppliers in the preceding year. Wind and solar power plants received 90 % of this value, small hydro power and biomass plants 75 respectively 80 % and large hydro power and biomass plants 65 % (refer Table 3).

(a) Percentage of specific mean annually revenues

In the first years of the existence of the Law this led to increasing remuneration, in later years to a decreasing remuneration due to fallen electricity price as a consequence of the electricity market liberalisation. It was felt that these fluctuating remuneration levels do not create a sufficient certainty for investors in RE power plants over the investment's life-time. Therefore, the succeeding Renewable Energy Act introduced cost based tariffs. A RE installation will get the same specific remuneration over a period of 20 years. In each year, the remuneration for new plants are reduced by a certain factor to give incentives for cost reductions. Additionally, a board consisting of the Electricity Supply Industry, power generators, public administration and researchers are periodically reviewing the remuneration.

The Electricity Feed-In Law awarded the same remuneration to all wind power plants regardless of their site. Since generation costs differ largely dependent on the local wind speed at the site, the remuneration for wind power plants according to the Renewable Energy Act is adapted to the specific site conditions. The higher the capacity factor of a certain plant the shorter the period the plant will receive the high premium prices.

References

• EC 2001 European Commission: Community guidelines on State aid for environmental protection. Official Journal C037, 0003-0015
• Espey, S (2001):Renewables portfolio standard: a mean for trade with electricity from renewable energy sources? Energy Policy 29 (2001) p 557-566.
• FIRE 1999 Langniss, O (ed) Financing Renewable Energy Systems. Kiel 1999
• Hveplund, F (2001) Renewable Energy Governance Systems. A comparison of the ‘political price-/amount market’ model with the ‘political quota-/certifcate price market’ system. Aalborg 2001
• Langniß, Ole: A Regulation to Foster Bulk Electricity Generation from Renewable Energies in South Africa (Author), Lund University, 2001
• Langniss, O.; Wiser, R. (2002): The Texan Renewable Portfolio Standard. An Early Assessment. Energy Policy. Forthcoming.
• SESSA 2002 Sustainable Energy Society of Southern Africa. Programme
• White Paper on the Promotion of Renewable Energy and Clean Energy Development. Part 1 – Promotion of Renewable Energy. August 2002.