Feed-in Tariff Cost Containment: A Summary of Three Primary Policy Mechanisms

By Bethany Speer, U.S. National Renewable Energy Laboratory
October 2011

Feed-in tariffs are the most widely used renewable energy policy worldwide, beating out renewable portfolio standards and other quota systems, according to the REN 21 Renewables 2011 Global Status Report.

Feed-in tariffs are the most widely used renewable energy policy worldwide, beating out renewable portfolio standards and other quota systems, according to the REN 21 Renewables 2011 Global Status Report. Feed-in tariffs (FITs) provide guaranteed access to the grid and known long-term payments based on the cost of energy (often for 15 to 20 years) [1]. For these reasons, FITs are an effective policy for incentivizing investments in a variety of renewable electricity (and heat) systems. But because FITs are a powerful policy for attracting renewable energy development, they can sometimes result in the overheating of markets and higher than anticipated program costs. With the appropriate design mechanisms, policymakers can reign in expenditures on FITs as well as avoid overpayment to project owners.

Three primary mechanisms can be used to limit the overall cost of a FIT program: caps, payment-level adjustments, and auction-based designs [1]. Here, the Solutions Center examines these options and provides examples of each in use. With any of the cost containment options, potential implications should be studied prior to the policy being put in place so that unintended consequences are avoided (e.g., sudden and significant changes to the FIT can have significant impacts on the renewable energy market).

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Discussion Questions

Are you aware of other policy mechanisms that help contain FIT program costs? Has your country implemented FITs with cost containment mechanisms, and have they been effective?

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Cost-containment Mechanisms—Caps

Caps limit the exposure of ratepayers, taxpayers, or other supporters to an over-procurement of renewable energy, usually by limiting the total program expenditures. Policymakers may cap:

  • Capacity: Total megawatts (MW) installed or maximum project size
  • Program cost: Total allowable program cost
  • Energy production: Total share of renewable electricity produced.

Caps can be applied to a whole renewable energy program or to specific technologies. Programs promoting specific technologies usually target the more expensive ones. Caps can be determined on an annual or long-term basis (e.g., 10 or 20 years).

Case Study: Spain

From 1998 until 2008, Spain used an uncapped solar photovoltaic (PV) FIT [2]. As markets began to overheat during 2007 and 2008, Spain’s policymakers passed new legislation (RD 1578/2008) implementing a 500-MW annual capacity cap for 2009 and 2010 and a 400-MW annual cap for 2011 and 2012. Spain also imposed a cap on project size of 10 MW for ground-mounted systems and 2 MW for rooftop PV [3].

Cost-containment Mechanisms—Payment-Level Adjustments

Payment-level adjustments can be used to control incremental and total policy costs and provide market signals about future payment levels. These market signals can encourage innovations that result in further technology cost reductions. The most common payment-level adjustments include:

  • Pre-determined annual degression rates
  • Degression rates based on annual installed capacityy
  • Volumetric adjustments to payment levels based on steps (i.e., a specific cost/kWh price is provided until a MW target is met, after which the price is lowered until the next MW target is met, and so on) or a sliding scale (i.e., the price is continually adjusted as capacity is installed)
  • Real-time adjustments, up or down, based on capacity installed during a given period of time, usually less than a year. The amount of the subsequent FIT payment level adjustment will depend on how quickly the capacity cap is met or not met.
Case Study: Germany

Germany uses two types of payment-level adjustments: predetermined degression (for wind, biogas, biomass, and others) and responsive degression (for solar PV). In its Renewable Energy Sources Act of 2000, Germany first included specific annual degression rates, by technology, for FIT payment levels. Germany assigned the most significant reductions to solar PV because of the declining cost of the technology. Payment levels for all technologies, except for solar PV, continue to be ratcheted down over time on a pre-determined basis. Degression rates for PV are adjusted annually from a base degression rate depending on capacity installed. Higher installed capacity in any given year leads to greater payment reductions in the following year.

Cost-containment Mechanisms—Auction-based Designs

Auctions and competitive bidding systems are technically an alternative policy to FITs. Unlike FITs, auctions and competitive bidding systems do not provide developers or their investors access to a reliable, long-term revenue stream. But auctions and bidding can be applied in conjunction with FITs in a variety of ways, such as helping to set payment levels.

Case Study: China

In 2008, China began using an annual competitive bidding process to set regional competitive benchmark electricity prices; energy contracts set at these benchmarks are effectively FITs. Through this single-round, sealed-bid process, China solicits prices from manufacturers and developers to set regional renewable energy contract prices [6]. This approach works particularly well for China because the growing wind and solar manufacturing industry and rapidly changing technology prices make utilizing a standard FIT difficult. For example, if a FIT were set, and then technology prices rapidly declined without an adjustment to the payment level, excessive overpayments could occur. However, some of the bids received during initial auctions were too low, which resulted in economically unviable projects that necessitated retroactive adjustments to the power purchase prices [77, 8]. While competitive bidding is still being used, China is also offering a standard national FIT for solar PV projects that do not participate in the bidding process [6, 9].

Table 1. Strengths and Weaknesses of Cost Containment Mechanisms

The following table outlines the key strengths and weakness of FIT caps, payment level adjustment mechanisms, and auction-based systems.

Strengths Weaknesses
Caps
  • Provide a predictable limit on program costs
  • Result in developer uncertainty regarding ability to access the FIT payments
  • Could limit the ability of a market to achieve economies of scale
Payment-level adjustments
  • Allow a response to prevailing cost trends
  • Enable payments levels to be aligned with market realities
  • Provide valuable information about future price levels
  • Help prevent overpayment and markets from getting overheated
  • Cannot alone contain policy costs
Auction-based designs
  • Allow the setting of electricity contracts that track market prices; this is especially useful in dynamic markets with many manufacturers
  • Could result in unviable projects and contracts that may need posthumous adjustment if developers underbid contract prices

Closing Thoughts

FITs can be a powerful policy tool to encourage investments in renewable energy. However, left unchecked, FIT program costs may exceed anticipated budgets. Fortunately, with caps, payment-level adjustments, and auctions, policymakers can help control costs while meeting policy objectives. Policymakers should consider the goals for the FIT program and market realities to determine which cost containment option or options can best address their policy needs. Implementation of cost containment mechanisms should be studied carefully before being applied so that likely impacts are known and unintended consequences are avoided.

Learn More

This blog is based on Innovative Feed-In Tariff Designs that Limit Policy Costs, a technical report prepared by the U.S. Department of Energy’s National Renewable Energy Laboratory.

For a general introduction to FITs, see A Policymaker’s Guide to Feed-in Tariff Policy Design).

Sources

[1] Mendonça, M.; Jacobs, D.; Sovacool, B. (2009). Powering the Green Economy: The Feed-in Tariff Handbook. London: Earthscan.

[2] de la Hoz., J.; Boix, O.; Martin, H.; Martins, B.; Graells, M. (2010). “Promotion of Grid-connected Photovoltaic Systems in Spain: Performance Analysis of the Period 1998-2008.” Renewable and Sustainable Energy Reviews (14); pp. 2547–2563.

[3] Spain. (2008). “Royal Decree 1578/2008.” Official State Journal No. 234, September 26, 2008. http://www.boe.es/aeboe/consultas/bases_datos/doc.php?coleccion=iberlex&.... Accessed December 2, 2010.

[4] David, A.K.; Wen, F. (2002). “Strategic Bidding in Competitive Electricity Markets: A Literature Survey.” IEEE Xplore.

[5] Tierney, S.; Schatski, T. (July 2008). “Competitive Procurement of Retail Electricity Supply: Recent Trends in State Policies and Utility Practices.” Boston, MA: Analysis Group.

[6] Martinot E. (2010). "Renewable Power for China: Past, Present and Future". Frontiers of Energy and Power Engineering in China.

[7]M Chan, Y. (27 July 2009). “China Sets Feed-in Tariff for Wind Power Plants.” Business Green in Hong Kong. http://www.businessgreen.com/business-green/news/2246766/china-sets-feed-tariff-wind. Accessed July 8, 2010.

[8] Han, J.; Mol, P.J.A.; Lu, Y.; Zhang, L. (2009). “Onshore Wind Power Development in China: Challenges Behind a Successful Story.” Energy Policy (37:8); pp. 2941–2951.

[9] Bloomberg New Energy Finance (BNEF). (8 July 2010). “Guodian Inks Deal to Build 50-megawatt Solar Thermal Plant.” Energy Watch.