Energy
Tarifs for renewables

A cheaper tariff for saving the world

Burgess COMMENTARY

Peter Burgess

A cheaper tariff for saving the world

Workers install a solar panel in Jiuquan, Gansu province, July 14, 2013. China aims to more than quadruple solar power generating capacity to 35 gigawatts by 2015 in an apparent bid to ease a massive glut in the domestic solar panel industry. Picture taken July 14, 2013. REUTERS/Stringer (CHINA - Tags: BUSINESS ENERGY) CHINA OUT. NO COMMERCIAL OR EDITORIAL SALES IN CHINA - RTX11P0O©Reuters

Feed-in tariffs have become a victim of their success, with governments having to pay out far more than they expected. Payments to solar projects are a particular problem because the cost of equipment plummeted unexpectedly thanks to a massive surge in capacity in China

All around the world, governments that embarked on programmes to support the growth of renewable energy are trying to get to grips with the unforeseen costs of these schemes.

One of the most popular methods of support has been the feed-in tariff, a minimum payment for each unit of renewable electricity generated. In some cases this includes an extra payment for exporting that electricity to the grid. FiTs have been successful in many countries, particularly in Europe, in introducing new technologies to the market and expanding the amount of renewable energy capacity in the energy mix.

However, many countries became victims of their FiTs’ success. While the tariffs are designed to regress year on year to reflect the benefits of the learning curve and greater economies of scale as the sector grows, many governments found themselves paying out far more than they expected to, just as they were least able to do so as a result of the financial crisis. Payments to solar projects presented a particular problem because the cost of equipment plummeted unexpectedly thanks to a massive surge in capacity in China. This meant that FiT payments were earning bumper rates of return in an environment of extremely low interest rates – and investors piled into the space.

Outside Europe, many governments have shied away from FiTs, preferring reverse auctioning of renewable capacity, in which the lowest bidder wins. Recently, Policy Exchange, the UK think-tank, published “Going, Going, Gone: The role of auctions and competition in renewable electricity support”, a report calling for the government to bring forward plans to introduce auctions for mature technologies. The UK government has announced it will do this for onshore wind and solar projects.

“The cost-effectiveness of support schemes in reducing greenhouse gases has been an issue over the past few years,” says Simon Moore, environment and energy research fellow at Policy Exchange, who wrote the report. “Auctioning allows you to move money towards companies or technologies that provide low-carbon electricity at the least cost.”

The report says that prices for onshore wind in Brazil have dropped to world-record lows since auctioning was introduced. Last year the cost of onshore wind was as low as £27 per MWh compared with £95 per MWh in the UK. While this was partly due to very high wind capacity in Brazil and cheap turbines, “if the UK can achieve even a fraction of that result, it would allow much greater decarbonisation for the available budget”, Mr Moore says.

South Africa has also used auctioning, having introduced and then abandoned an FiT system. “Initial outcomes are encouraging: there has been much market interest, and subsequent bidding rounds have seen prices fall,” says Professor Anton Eberhard, who leads the management programme in infrastructure reform at the University of Cape Town’s business school. Other countries with auctioning systems include Italy and the Netherlands, while Poland is considering the idea. Many observers believe auctioning is the future of renewable-energy support.

“FiTs are excellent if you want loads of people to come in early,” says Munir Hassan, head of the clean energy practice at CMS, the law firm. But because they are open-access schemes, where anyone building an eligible project can claim the payment, the government has very little control over costs.

“As renewable energy becomes an ever bigger proportion of the energy mix, the costs become substantial to consumers,” says Ronald Dorlas, director of structured finance for power and renewable energy at ING Commercial Banking. “That has led governments to move to control the costs of support.”

Auctioning looks likely to become more common because “it gives governments good price transparency and allows them to have very direct control over the investment landscape”, says Mr Hassan. Shai Hill, head of European renewables research at Macquarie, the investment bank, adds that “without doubt, it will lead to lower prices. Most markets will shift towards some form of reverse auctioning for utility-scale renewables over the next five years.”

It will therefore also reduce returns for investors, he says. “The returns will be lower, but so be it. They will still be adequate. When Brazil started auctioning, a lot of people squealed but there are still plenty of wind farmers prepared to build stuff at 40 per cent lower levels of return than two years ago.”

Not everyone is so sanguine. “As an investor, it is easiest to get your head around an offtake pricing regime where you know what the electricity price is and your expected cash flows for the next 10-20 years,” says Erich Becker, Partner at Zouk Capital.

“The more uncertainty you introduce, the more expensive the cost of capital will be.”

There is also a danger that during the transition to an auctioning system projects agreed under the previous system will struggle to attract capital, says Alessandro Reitelli, chief financial officer and interim chief operating officer of Greentech Energy Systems, a mid-cap developer with projects in Denmark, Italy, Germany, Spain and Poland. “We are expecting this transition in Poland but it will not be introduced until 2016 at the earliest, so it is very uncertain,” he says.

“Players like us, with projects that are ready to build and looking for finance, are playing with our scenarios and talking to banks. Frankly, it is difficult to understand and to develop projects for the next two to three years. If you want to introduce auctions, please clarify the transition,” he continues.

This is a particular danger for the UK, says Mr Hassan, where “there is a very significant programme of development going through the consenting process. In the past, when you won consent, you were automatically entitled to renewable obligation certificates. Now the government can decide whether it goes ahead or not at a stage when developers have already spent a lot of money. That is quite a harsh position for the government to have taken and there may be a recognition later that support needs to be offered earlier in the process.”

Mr Reitelli also warns that prices should not be squeezed too much in the auction, otherwise it creates an oligopoly. “If you leave the market to two to three players, there is a risk that you will never reach the efficiency that you want.”

Not everyone is convinced of the benefits the change will bring. “It is a sensible thing to do, and it will deliver capacity at a somewhat cheaper rate, but I suspect it will not be that much cheaper,” says Peter Atherton, head of utilities research at Liberum Capital. “The other problem is that this all screams ‘central planning’. The government will be deciding what gets built and where, using what technology.”

Jonathan Gaventa, programme leader at E3G, the consultancy, adds that “the relative difference between auctions and FiTs is much smaller than the difference between leaving a system alone and constantly meddling with it. The first rule is ‘don’t keep changing the system’. One of the biggest costs is the cost of capital, so the stability and dependability of the structure is probably as important as the relative merits of each system.”

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