If a government decides to consider feed-in tariffs (FITs) as a tool to promote distributed generation via renewable energy, what are the regulatory steps that should be taken to these implement rules?
[Response by Julie Taylor with the assistance of Sanford Berg, drawing on the June 2010 NARUC Report. We give a special thanks to Thembani Bukula for his update on the South African experience.] June 2013.
A feed-in tariff (FIT) encourages new renewable energy development by creating a long-term financial incentive to customers who generate renewable electricity, and offering a standardized and streamlined process to do so, easing the entry for new systems. Unlike a net metering mechanism, revenue for the investor is not dependent on the actual retail price, but on the terms and conditions of the FIT contract with the utility. Under a feed-in tariff, a utility is contractually obligated to connect the renewable energy generator to the grid and pay that generator for electricity at a fixed or pre-determined rate for the life of the FIT contract, typically 10-20 years. The goal of a FIT is to create a robust market for renewable energy to lower technology costs and increase development of such resources for the duration of the program, and potentially pave the way for future growth. The design of FITs can vary considerably in how rates are calculated, eligibility of different technologies, project scales and resource sizes, and the contract terms. If a feed-in tariff is passed as law by the legislative body, the regulatory agency (or public utility commission) may have the responsibility to design, implement, and monitor the FIT program, given potential impacts on rate-payers.
According to Stiftung (2012), the most important issues faced by policy-makers and those implementing policy careful definition and implementation for the following:
- Eligible technologies;
- Eligible plants;
- Financing mechanisms;
- Tariff calculation methodology;
- Purchase obligations;
- Priority grid access;
- Cost-sharing methodology for grid connection;
- Effective administrative procedures;
- Setting targets; and
- Progress reports
The basic lesson emerging from international experience is “keep it simple at the start”.
Note that other mechanisms can be utilized in conjunction with FIT: an international sponsor could provide a portion of the payment to the generator, a multinational organization could provide risk insurance against political risks, or the national government could provide a portion of the payment going to the generator. In addition, A Deutsche Bank Report on FIT Programs (p. 8) underscored the importance of capacity-building in addressing the non-financial barriers to renewable energy (and distributed generation) in the developing world. The Report identified five areas for technical assistance:
- Advanced feed-in tariff policy design, including initial rate setting and ongoing review
- Grid capacity and expansion cost analysis, resource assessments, project feasibility studies, and integrated energy planning processes for governments and government agencies,
- Grid management and renewable energy integration strategies for utilizes,
- Financial due diligence and risk mitigation strategies for local financiers, and
- Renewable energy project development, system construction, and operation and maintenance services for local private sector players.
The specific steps for implementing FiTs include (i) resolution of the five issues identified in the Deutsche Bank Report and (ii) public consultations through public hearings and workshops (so stakeholders have an opportunity to present their views and introduce relevant studies)..
Readers interested in project level issues are encouraged to review GET FiT Program: Global Energy Transfer Feed-in Tariffs for Developing Countries (2010), DB Climate Change Advisors (Deutsche Bank Group). Programs in South Africa, Thailand, and Tanzania are evaluated in terms of key design features.
The remaining of this FAQ focuses on two main regulatory issues: payment methodology and FIT program design.
Payment methodology: What should payments be based on?
Those designing a FIT would want the payments made to renewable generator participants to be high enough to attract investor interest without resulting in windfall profits and undue burden to the ratepayers. But in achieving this balance, what components should be included? What should participants be getting paid for? Two primary methodologies are used for determining payment structure: cost-based paymentand value-based payment.
Table: Methodologies for Determining Payment Structure
Cost-Based (Project Cost + Profit) Value-Based (Avoided External Cost)
|Payment design||Includes the cost of renewable energy project, plus a return to investors as typically determined by program administrator.||Builds upon market-based products to include a premium based on the value of renewable generation to society.|
|Market interaction||The FIT payment is set and independent of fluctuating market conditions. Certain cost-based FIT payment structures are paid based on market price, with a premium administratively determined payment with floor and ceiling.||As the price of energy and electricity shifts, the total FIT payment shifts along with it.|
|Sale of FIT power||After entering into FIT contract, utility or program operator compensates FIT generator for electricity.||After entering into FIT contract, generators compete with each other to sell power.|
|States/utilities using structure||Vermont, Oregon||California, Sacramento Municipal Utility District|
|Benefits||1. Higher investment security may lead to lower capital costs and diverse investors.2. Payment stability consistent with the cost characteristics of the technologies.||1. Ability to expressly incorporate external benefits, including avoided T&D and environmental costs.2. Lower payment levels lead to lower ratepayer impact.|
|Challenges||1. Determining the right payment levels to avoid overpayment or failure to attract willing investors.||1. Investor profit and ROI uncertainty.2. Technology-neutral program may not encourage diverse renewable energy portfolio.3. Administration of payment may be time-consuming and complicated.4. Additional costs of dealing with intermittent supply—in terms of system support.|
FIT Program Design: What program elements achieve policy goals?
In addition to determining the payment methodology, the structure of the REFIT program design must be explored. The key takeaway when considering a REFIT is that the appropriate REFIT design depends on the policy being pursued by the State. Policymakers should have a clear sense of what they would like to accomplish prior to the design phase. Regulators should have input regarding the design of the Program. Nine elements to consider are outlined below.
I. Contract Length: typically, 10 to 20 years to create a stable policy environment, reducing investor risk;
II. Interconnection Rules: apply model interconnection standards, procedures, and agreements (possibly including a ‘must take’ feature, even when lower cost resources are available). Cost sharing for grid connection and reinforcement can have a significant impact on incentives to develop RE.
III. Program and Project Cap: If the policy goal also includes project diversity and local development and ownership, a project size limit by resource type may be setto ensure the program is not flooded by a few large projects or a limited set of technologies. Caps reduce the cost impacts for ratepayers.
IV. Tariff Revision: A step-down schedule can be part of the contract, reducing payments per kWh, which encourages efficient operations and lower subsidies over time. A fixed price reduces risk to the producer. Alternatively, the price can be linked the actual market price of electricity via some premium. The premium FiT payment can be fixed (as a predetermined adder) or variable. For the Spanish and Dutch premium-FiT models, if the market price becomes greater than the guaranteed payment, the premium is eliminated—so the premium is essentially variable (Cory, Couture, and Kreycik, 2009).
V. Payment Differentiation by Technology: Under a cost-based model, the price paid to a project will depend on the technology that is utilized, as the development and operation & maintenance costs can vary significantly depending on the method of generation. Differential payments also mean that technologies that are currently relatively high cost are introduced, which is problematic for developing countries since it conflicts with the objective of affordability. Payments could be related to avoided cost or to the actual production costs of the specific technology.
VI Payment Differentiation by Scale: Since larger plants tend to have lower average costs than smaller plants, payments can distinguish between investments that might be made by private households (such as a rooftop installation) and larger investments made by industrial or commercial buildings. Of course, setting up pass-fail qualifying standards also can result in artificially separated ownership arrangements just to qualify for support programs (as has occurred with wind farms in Brazil).
VII. Bonus Payments: To accomplish specific policy goals, bonus payments may be offered on top of base feed-in tariff rates for certain categories. Bonus payments can have an influence on power producer behavior and promote efficiencies and policy prioritiessuch as using locally sourced materials or close to load projects; however they may add additional complexities in program administration.
VIII. Grid System Stability: Decision-makers need to assess the ability of the distribution system to accommodate new distributed resources as well as the capacity of existing interconnection codes and standards. Particular nodes in the distribution system may require significant upgrades to accommodate distributed generation. It is important to ensure that utilities, while being required to interconnect FIT resources, are allowed to require adequate interconnection equipment and acquire firming resources to protect system reliability and stability.
IX. Progress Reports: Future adjustments can be based on technical studies about existing REFiT arrangements. Transparency in policy development requires periodic analyses of institutional and incentive arrangements.
The Case of Spain: In 2007, Spain introduced a new FIT program, with a 400 MW cap and payments of up to 44 euro cents for solar photovoltaic (PV). The program was meant to encourage new projects – particularly PV – over a three year span until 2010 but investors interested in the high payment levels quickly flooded the program within six months. To accommodate the investors, the Spanish government increased the cap to 1,200 MW, but reduced the FIT payment by thirty percent to contain the cost impact from the new projects. Many solar developers were unable to continue with their projects, resulting in a global market distortion with unfulfilled projects and a backlog of unsold PV panels that would be a large factor in lowering the global price for PV panels by 40 percent in 2009. Pros and cons of this program are numerous: 3 GW of solar capacity was installed in less than eighteen months and Spain gained valuable knowledge of systems integration, however, the program resulted in high debt, poorly designed solar installations, and a global PV market disruption.
The takeaway: When designing a FIT program setting the initial payment level correctly is vital to provide economic certainty for developers and industry; Four lessons emerge from the Spanish case: i) FIT policies need to be capped; ii) caps need to be established in phases; iii) initial levels need to err on the conservative (low) side; iv) FIT policies in the initial phase need to be clear about the rules to be applied for recalculation of the tariff levels (adjustment mechanisms).
The Case of South Africa: In 2009, the National Energy Regulator of South Africa (NERSA) determined that REFiTs would be implemented for wind, solar PV, concentrating solar power and biomass, leading to $20 million being spent by developers between 2009 and 2010 to identify sites and develop commercial relationships. Standardized PPAs for the different technologies weredeveloped, with inflationary escalations on the operating expenditures only. The Integrated Resources Plan for 2010-2030 projected about 800 MW of these renewables per year. Then there was a change in policy direction, in response to a second NERSA Consultation Paper (both are in the references). The capital cost of solar PVs (more than 90% of project costs) had decreased by more than 40% since the initiative had begun, and experiences in Spain, India, and Germany supported the need for a new direction. Developers and contractors objected to the changes, while debt and equity providers accepted the long term outcomes associated with the new process. NERSA adopted a Hybrid REFIT program, with the revised REFIT as the maximum price in a bidding process. Job creation, local manufacturing and economic development were given a 30% weight in selecting the winners, and the price given a 70% weight. NERSA concluded that the more transparent decision process provided “some” investor comfort, despite the change in policy direction—the shift to bidding. South Africa is now on course to meet (or exceed) the 2013 target of 10,000 GWh from RE.
The takeaway: A Hybrid REFIT with bidding can reduce the cost of expanding renewables as a source of electricity.
Other Cases from Africa: The Stiftung (2012) study summarizes the experiences of seven REFiT pioneers (Algeria, Kenya, Mauritius, Rwanda, South Africa, Tanzania, and Uganda) and six REFiT newcomers (Botswana, Egypt, Ethiopia, Ghana, Namibia, and Nigeria). The study presents experience with technology and size-specific tariffs, duration of tariffs, purchase obligations, grid access, cost-sharing arrangements for grid connection, administrative procedures (and capacity), targets, and progress reports. Many countries in this region are characterized by unreliable or unaffordable generation. So Stiftung concludes that success with renewable energy could be a significant boost for national economies.
Concluding Observation: FITs have been shown to be effective mechanisms to attract investments in renewables and to achieve Renewable Portfolio targets. However, the rate impacts need to be considered if the mechanism is to be used in large scale. As always, decision-makers should consider whether alternative programs could achieve the same policy objectives at lower cost. For example, instead of a technology-specific “fixed price,” additional renewable generation could be acquired via an bidding process—as in South Africa. In addition, redirecting fossil fuel subsidies into renewables would have the dual advantage of increasing the price of a substitute and reducing the cost of renewables to consumers—moving market participants up the learning curve more rapidly.
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