Feed-in Tariffs Wind Energy

Overview

A Renewable Energy Feed-in Tariff (REFIT) is a policy mechanism designed to support and accelerate investment in renewable energy technologies. This is achieved by offering long-term contracts to renewable energy producers, typically based on the cost of generation of each different technology. Technologies like wind power are awarded a lower per-kWh price, while technologies like solar PV and tidal power are currently offered a higher price, reflecting their higher costs.

In addition, feed-in tariffs often include "tariff degression", a mechanism according to which the price (or tariff) ratchets down over time. This is done in order to track and encourage technological cost reductions. The goal of feed-in tariffs is ultimately to offer cost-based compensation to renewable energy producers, providing the price certainty and long-term contracts that help finance renewable energy investments. The outline of the article is geared to an scientific analysis of feed-in tariff remuneration models by Couture and Gagnon (2010) and to a policy maker's guide to feed-in tariff design published by the US National Renewable Energy laboratory (2010).

Market-dependent and Market-independent REFIT Models

The design of a REFIT is an importment basement for the overall effectivenes of the development and integration of renewable energies into an energy system of a country. The payment levels must be high enough to give a return on investment, by this means encouraging investors to develop new projects. For this reason reliability of the REFIT over project lifetime is an important variable as well: If the REFIT-policy allows changes of the payment during project lifetime, this will cause additional risk for potential investors.

On the other hand too high payments rise costs of renewable energy supply and the additional costs have to be covered either by increased electricity prices (costs for renewable energy supply are passed through to consumers) or by government subsidies (passing-through the costs to the tax-payer).
The main difference in REFIT-design concerns the connection to the electricity market. The most common market-dependent REFITs are known as premium price models. These models require the operators of renewables to sell their electricity on the market, while incentives for investment is set by premium payments tied to the market price. The 'tightness' of this connection varies significantly with the different designs of market-dependent REFITs.

The most common market-independent REFITs are fixed-price models: A determined payment (€/MWh) is paid for a period of time, which is often geared to the specific technology lifetime. Normally these modells are accompanied by a purchase guarantee for the electricity generated by a RE-project.

The design of an appropriate REFIT within a jurisdiction is usually a combination of great number of options. As this article provides a rough description about REFIT designs commonly used today, it should be stated, that the design options described here can be combined in several different ways according to the policy goals and specific conditions within a country.

Market-dependent Feed-in Tariffs

Percentage of the Retail Price Model

In this type of REFIT-Design the operator is paid a percentage of the retail price for the electricity delivered to the grid. As an example Germany offered a payment of 90% of the retail price for wind and solar application smaller than 5 MW under its feed-in law of 1990. In this way payments were directly connected to the spot market price. These types of models have been used in early renewable energy policies and are not used very often today.

• Advantages: When models of this type have been implemented, the coupling of the tariffs to the retail price was regarded as an appropriate measure to remove some discretionarity from the REFIT, because premiums are not set by government agencies directly. The retail price itself is often seen as an 'objective referent' of the value of electricity, which should be the guiding value for the renewables tariff either. In general REFITs related to the retail price are easier to implement in comparison to fixed feed-in tariffs, because only the percentage has to be set without regard to different technology costs.
  An important advantages of the model is its sensitivity to market demand. The coupling to the retail price sets an incentive to supply electricity when demand is highest.

• Disadvantages: As tariffs are not adjusted to the substantial variations in technology costs, resulting payments for generated electricity have been of inadequate renewable resources other than wind. Coupling of REFIT to the retail prices poses additional risk on investments, because financial benefits of projects can not be calculated accurately in advance.
  Additionally it has been observed, that the percentage of retail price model frequently lead to windfall profits in the past.

Premium Price Model

A constant premium for electricity generated by renewable energy projects is offered above the average retail price. The idea of this model is to support integration of renewable energy projects into the market while at the same time higher investment costs are covered and an incentive for investment is set.

• Advantages: The payments can be adjusted to the different technology costs of renewable energies. In this way different policy goals like supporting a specific technology or diversifying the implemented portfolio in a country can be pursued. From the perspective of a project operator the premium price model causes more return with high prices and vice versa.
• Disadvantages: A higher risk of too high or too low premium level is often mentioned as a disadvantage of the premium price model. This can cause negative effects on market growth, and investor security similarily to the effects of the 'percentage of retail price model': The premium price model can not be regarded as an exactly definable base for investment calculation.
  Analyses have shown that on average, premium price policies cause higher costs per kWh than fixed-price policies. Generally the implementation of a premium price model imposes the risk of high policy costs due to increasing market prices.

Variable Premium Price Model

The described disadvantages of premium price models have been adressed by some jurisdictions through implementing regulations concerning the price premium: Spain introduced a cap and a floor for the price paid to the operators of renewable energy projects to avoid rapidly increasing policy costs. If the market price decreases below a certain minimum, premium is increased to ensure an adequate return for renewable energy projects. In turn the premium decreases with rising market prices and is finally off-set, in case the market price reaches the determined cap.
In general the determination of certain upper and lower limits provides higher security for investment calculation. Thus risk perceived by potential investors is decreased.

Market-independent Feed-in Tariffs

Spot Market Gap Model

The spot market gap model operates basically similar to the explained variable premium price model with determined cap and floor: As long as the market price does not reach a certain limit set by the policy, the gap is 'filled' by additional payments to the renewable operator. If the market price rises, the FIT premium declines and is offset in case the set limit is reached.

• Advantages: The important difference according to the variable premium model is the guaranteed payment per energy unit provided by this policy. While the variable premium model only fixed a certain limit of variations in payment, the spot market gap model determines a price, which can be used for financial assessments of renewable energy projects.
• Disadvantages: In some countries the premium, which is paid to fill the price gap, is financed through governmental subsidies. This strategy makes the model dependend to a policy budget, which could be exhausted and thus poses a certain risk on the investment in the renewable energy project. On the other hand, covering the difference by government subsidy means that electricity rates will not be influenced.
  An additional disadvantage results from the transaction costs of marketing the power of a project to the electricity market. Especially for smaller project operator (communities, homeowner or farmers) it could be a burden to pose offers for the electricity to be sold and to observe the market continuously: On the first hand the spot market gap model increases the compatibility to existing electricity markets, but on the other hand it cause a significant additional work-load for project operators.

Fixed Price Model

Fixed price REFITs today are the most frequently used tariff models. As the name 'fixed price model' describes, the implementation of these models contains the determination of a fixed payment for electricity for a fixed period of time (often the lifetime of the related technology is used). The payment is not influenced by other variables like market prices, fuel prices or inflation. As the fixed price is not adjusted to inflation, the real value of the payments decreases during the project lifetime.

To avoid the risk of not covering the costs of a project appropriately, the payments are set to a higher value for photovoltaics compared to wind projects. In Germany the missing adjustment of inflation is replaced by a higher initial payment during the first project years and diminishing payments in the later years of a project.

The guaranteed payments for the contracted time period form a very reliable base for calculation of expected profits. Even if no adjustment of inflation is applied, the fixed prices creates a stable and reliable environment for investment.

Fixed Price Model with Full or Partial Inflation Adjustment

The fixed price model can be adjusted to several parameters.

Common adjustments applied in international jurisdictions are:

• predetermined tariff degression: this strategy has been explained according to the German form of the fixed price model
• responsive tariff degression: this term means an adjustment of the tariff degression dependent on market growth. This model has been implemented recently for German photovoltaic projects.
• annual inflation adjustment
  The adjustment to inflation can be applied in several ways. In some jurisdictions the whole rate of payment is adjusted by a pre-established formula. In other countries only certain a portion of the tariff price is raised according to inflation. The range of different strategies also contains full adjustments, with only a number of basis points excluded. Additionally the period of adjustment can be set (e.g. annually, quaterly).
  If the influence of inflation is balanced by higher payments at the end of a project, a high level of remuneration is secured near the end of a project’s life, when the depts of the project usually are paid. As a result a larger part of the revenue generates profits for the operator. For the appraisal of a project such a strategy is attractive even for risk averse investors, because the payments over project lifetime are guaranteed and the risk caused by inflation can be avoided.
• front-end loading: This REFIT-design contains higher payments in the first years of a project and lower payments in the later years. The higher payments help operators to repay loans and equity investors during the first years. Additional reasons for the implementation of this strategy are the promotion of a greater site flexibility and thus the promotion of a greater dispersion of project sites have general benefits for the energy system.

References

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