Daniel Englander

Are Feed-In Tariffs Rational? April 14, 2008 at 11:51 AM

All three presidential candidates back some mix of carbon regulation and renewable energy market stimulation. The detailed proposals that have emerged, however, can charitably be called incoherent. Hillary Clinton, as SunEdison’s Jigar Shah noted recently, has commented approvingly on the success of Germany’s feed-in tariff in spurring job creation and building a renewables market. So, taking this thought to its illogical extreme, let’s imagine Hillary wins in November and starts pushing for a national feed-in tariff. This possible reality begs the question, ‘are feed-in tariffs rational?’

Feed-in tariffs are designed to push renewables into electricity markets. A feed-in tariff generates consumer demand for installed systems by setting the renewable energy price at some level above the market rate. Instead of reducing upfront capital costs for the consumer, a feed-in tariff shortens the payback period on an installed system. The tariffs are typically set on a declining price schedule that reflects the effect of economies of scale on renewable technologies. Rates are locked in over the lifetime of a system from its installation date – typically 20 to 30 years. This both promotes certainty and reduces risk.

Utilities are obligated to buy excess power generated from these systems at the above market rate. However, since feed-in tariffs are revenue-neutral by design, utilities are allowed to spread the marginal cost of the subsidy over their customer base. Thus, some individuals receive income from having installed systems, while others are charged a nominal monthly fee for the privilege of using green electricity.

Let’s take a closer look at that declining schedule. Germany’s feed-in tariff will contribute to a 107.33 percent increase in installed PV capacity from 1.05 GW in 2006 to 2.177 in 2010, according to Prometheus Institute President Travis Bradford’s base case projection. During that period, the average module price will decline 46.05 percent from €2.41 per watt to €1.30 per watt. The feed-in tariff for ground mounted PV systems is set to decline 23.5 percent from €0.40/kWh to €0.306/kWh, while the tariff for rooftop systems less than 30 kW will drop only 18.53 percent, from €0.518/kWh to €0.422/kWh. Averages prices are declining at a rate faster than the scheduled 1.5 percent tariff reduction. While the relationship is not expected to be one-to-one, this growing differential may have some long-term negative effects.

Subsidies create market distortions by artificially manipulating price signals. The first year of Germany’s feed-in tariff sent a large number of PV producers into the market, all angling to fill the growing demand for PV. The entry rush constrained polysilicon supply, sending up market prices and appearing to prove out the feed-in tariff’s necessity. Two things happened in response to this – research and development funds were diverted to thin film PV and a host of new polysilicon producers started building factories in a bid to satisfy the global feedstock demand. Thin film PV is a low cost, low efficiency substitute for silicon-based PV, and the supply crunch provided an opportunity for this technology to gain a market foothold where one would have not existed otherwise.

The nail in the feed-in tariff’s coffin is the coming expansion of polysilicon supply. Consumers will respond to dropping technology prices and comparatively high tariff rates by installing more capacity. That installed capacity expands and the price paid for that capacity declines while the German government pays increasingly higher subsidies is perverse. Perhaps even more odd is the privileging of PV over other, more appropriate forms of renewable energy, like wind power. Germany’s open expanses are more wind-whipped than sun-drenched.

Last fall the German government made noise about recalculating the scheduled tariff decrease, sending equity researchers into fits, and forcing them to revise their demand models downwards. In other words, seven years after the program started, PV capacity may still largely be responsive to the tariff price signals. This is not a good for sign for what many had hoped would be an independently moving market in a few years’ time. This also contravenes the certainty and risk-reduction that long-term policies aim to establish. Other problems may also surface, like the lack of interconnection standards or ongoing utility payment and ratemaking schemes that have yet to be fully resolved. Of course, Germany only has four major utility companies that will need to deal with these problems. The U.S. has more than 3,000.

A U.S. policy aimed at increasing renewables capacity that also establishes a sustainable market with clear price signals may require taking an opposite approach. Instead of pushing renewables onto the market, pulling them through an RPS-based quota system will build a strong, technology-agnostic renewables base backed by renewable energy certificate trading. This gets at the low-hanging fruit first, giving time for high-priced technologies like PV to reach market competitive prices without market distortion. In the mean time, we’ll maintain our watch for the killer amp.

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