The Energy Futurist

Why America needs a feed-in tariff

Why America needs a feed-in tariff

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Energy futurist Chris Nelder argues for a national feed-in tariff, and predicts that Asia will blow the doors off the U.S. solar PV market.

The proven, most effective incentive for renewables is the feed-in tariff (FiT), yet it hasn’t caught on in the U.S. This week, I’ll attempt to explain why it hasn’t, and why we need one immediately.

FiTs have been responsible for a rapid deployment of wind and solar in over 40 countries, including most of Europe, and accounted for nearly all new solar PV systems there since 1997.

Simply, a FiT is a special fixed rate paid by utilities for renewably-generated power put onto the grid, under a contract set over a period of 15 to 25 years. FiTs are typically set at two to four times the regular grid power price, and paid for by a slightly higher standard grid power price. The strategy has met with opposition on occasion for being a regressive tax on residential customers who can’t afford to install solar PV, but the rate increases have been modest, and the programs have been very popular on the whole.

The German FIT, which began in April 2000, was the first major program of its kind in the world. It quickly captured half the world market for solar modules in five years. (When I was in the solar business in California in 2005, there were frequently periods when we simply couldn’t get modules, because everything was going to Germany. We often had to wait weeks for shipments of preferred models, and competition was fierce for locally available inventory.) Germany now has twice the solar PV capacity of the U.S., with around a quarter of our population and roughly half the insolation (available sunlight) of the Southwest. The program was so successful that it reached its target early and began accelerating the schedule to reduce it, dropping from $0.77/kWh in 2004 to $0.23/kWh for utility-scale projects in 2012.

Partially as a consequence of their FiT, Germany now has the second-highest grid power price in Europe at $0.37/kWh, a point that detractors like to emphasize. That compares to typical electricity prices in the U.S. of $0.06 to $0.13/kWh. Even so, the typical German utility bill is in the range of $100 to $275 a month, comparable to U.S. households.

Denmark, which has long had the most aggressive renewable incentives in the world, also pays the highest rates for electricity in Europe, at $0.41/kWh. Yet by all accounts the Danes are pleased with and proud of their transition effort, with over one-quarter of their electricity now generated from wind. “A green and more sustainable world does not evolve by itself," said newly-elected Prime Minister Helle Thorning-Schmidt at a conference in Copenhagen last month, while announcing a raised goal to generate 50 percent of the country’s power from renewables by 2020. (Oh, to have such leadership here!)

A fierce war of words has ensued in the UK over the government’s recent decision to halve the FiT for small rooftop solar projects installed after December 12 this year. The program has been a stunning success and resulted in a solar industry that grew from under 3,000 jobs to over 25,000 since its launch in April 2010. The decision to cut the FiT from $0.69/kWh to $0.34/kWh (where the average electricity price is $0.22/kWh) was made to stretch the program’s $1.4 billion budget, which is on track to be fully claimed within a few months. Industry representatives report that the new deadline is forcing thousands of projects to be cancelled, and will result in layoffs of more than half their current staff. Such boom-and-bust cycles in renewables are all too familiar to those who have observed the history of short-lived incentives in the U.S., and it’s unfortunate that the UK hasn’t learned from that history and designed a program with a much longer horizon.

Even so, the cost of FiTs have added far less to energy bills than the cost of fossil fuels. As Damian Carrington pointed out in the Guardian this week, high natural gas prices in the UK have added £170 to the average household’s annual energy expenditures, while all renewable subsidies have added only £20.

FiTs have encouraged equally rapid growth in other European countries, notably Spain, Italy, and France. Lax quality and budgetary controls in those countries have somewhat sullied the reputation of FiTs by incentivizing some poorly designed systems, but the problems have been in implementation and oversight, not the strategy itself.

When China unveiled its new unified national FiT in August, it completely changed the economics of solar and is resulting in a sudden explosion of installations. Set at a relatively low $0.18/kWh this year and dropping to $0.16/kWh in 2012, it has nevertheless made the business profitable where coal-fired generation costs about $0.05/kWh and the average industrial electricity price is $0.11/kWh. At the same time, the rapidly falling cost of China’s domestic solar module manufacturing has driven the installed system cost down to around $2.9/watt (which has to be the world’s lowest), on its way to $2/watt. The new tariff will allow systems to pay themselves off in seven years and throw off free cash for another two decades after that, according to the New York Times. The IRR over 25 years will be in the neighborhood of 10 percent, a substantially better yield than similarly low-risk assets. In the Gobi desert city of Golmud, capacity is expected to jump from 40 MW to over 300 MW in just six months. Solar market research company Solarbuzz reports that China will match US solar capacity with its installations in 2011.

The next major FiT will begin July 2012 in Japan. The initial rate for solar PV power will be a generous $0.50/kWh, which should take them a long way toward their objective of replacing their nuclear capacity. Their aim is to install 30 GW of renewable capacity within 10 years—equivalent to installing more than the entire grid-connected PV capacity of the U.S., every year for a decade.

Grid parity isn’t the objective

The rapid growth of the solar and wind industries due to FiTs has driven their costs down to the point where grid parity has already been reached in sunny and windy regions, and has put them on course to reach parity for most the world by 2018.

Trends in PV & Grid Residential Electricity Prices, U.S. Annual Averages
Source: Home Power

According to a new report from the IEA, wind has grown worldwide at an average rate of 27% per year, and solar PV at an average rate of 56%. Those growth rates are primarily the result of FiTs.

The ability of FiTs to produce rapid deployment of renewable capacity is critical for several reasons. First, as I explained last week, transitioning to renewables will require decades. Transition must begin before fossil fuels go into decline, and before market signals encourage it. Second, simply maintaining our existing power generation regime isn’t an option. Many of the existing power plants in the U.S. are aged and due for replacement, as shown in this EIA chart:

Over half of the nation’s generating capacity comes from plants that are at least 30 years old. Of the nation’s 104 nuclear power plants, contributing 20 percent of our electricity supply, half are over 30 years old, and all but two are at least 20 years old. They were initially granted operating licenses for 40 years, and 61 have already been granted 20-year extensions. Within 20 years, all but two will have reached their original expiration dates, and by 2050, all of them will reach their current expiration dates. But the life of a nuclear plant isn’t indefinite. Concrete becomes brittle, and other components wear out. Without additional extensions, all of the current U.S. nuclear capacity will need to be replaced within the next 40 years.

Nearly three-quarters of our coal-fired capacity, contributing 46 percent of our electricity supply, is at least 30 years old. Many of the plants are using outdated, inefficient technology. Some need to be retired immediately, and within 20 years nearly all of them will need to be replaced. The declining quality of domestic coal, which now has 20 percent less energy per kilogram than it did in 1949, will also exert a continuous upward pressure on its price.

The age of our power generation plants highlights why grid parity isn’t really the important metric. The cost of old legacy power generation plants has been fully recovered over decades, while the cost of new generation from renewables is fully priced in upon installation. One cannot simply compare the current cost of generation from an old coal plant ($0.04/kWh) or a nuclear plant ($0.02/kWh) to the cost of a renewable alternative. Instead, we must consider the cost of new generation. Per EIA, that cost for solar PV is now $4,755/kW, lower than coal-fired generation with carbon capture and sequestration (a fair basis for comparison to renewables, which emit no carbon) at $5,348/kW, and nuclear at $5,339/kW.

Since we must replace two-thirds of our power generation capacity within the next 40 years, why would we not choose renewables, which will have become significantly cheaper, while killing coal-plant emissions and the still-unsolved nuclear waste disposal problem at the same time?

Why FiTs are superior to other incentives

Given the obvious success of FiTs as a policy tool in Europe, one must wonder why the U.S. has not embraced them. Germany already tried all the incentives that we’re using in the U.S., such as aspirational targets like renewable portfolio standards (RPS), rebates, and low-interest loans, and eventually turned to FiTs because they proved to be far more effective, simple, low-cost, and efficient.

For example, compare a typical FiT with the main incentive program for residential rooftop PV in California, which leads the nation in solar electric generation.

If you install a solar PV system under a FiT program, you only get paid for its actual generation. If it doesn’t perform as expected, you don’t get paid, so the incentive encourages good design. Generating more than you consume becomes an advantage, which encourages consumers to reduce their consumption and install larger systems. The paperwork usually consists of a contract a few pages long. It’s simple, and generally uncorruptible.

By contrast, if you want to take advantage of the California Solar Initiative, you have to first get an energy audit of your home, which will guide you to install a smaller system. Then you have to find an installer, who will be required to vouch that a system of a certain size is needed, and supply documentation to prove what the output of the system will be, adding significant cost for the contractor. The installer then applies for the available rebates on your behalf, but the rebates can fall at any time depending on demand, and each period’s allocation can become fully subscribed before your application is approved, forcing you to accept a lower rebate for the following period. (Pennsylvania is experiencing this problem now.) Once your system is installed, it can be randomly inspected to prove that it performs as advertised. Then, after the system is approved and connected to the grid, you can claim the rebates and other incentives, requiring a load of additional paperwork. If you don’t use all the power you generate in a given year, you don’t get paid for it, which discourages conservation. In all, it’s a slow, bureaucratic nightmare compared to a FiT. (California did introduce a FiT in 2008, but at $0.096/kWh, it was too low to attract much interest.)

As a result of all that complexity and its inability to scale, Californians wound up paying incentives averaging around $0.34/kWh for solar PV last year, according to feed-in tariff expert Paul Gipe. If they had used a German FiT model instead, Gipe says, the cost would have been $0.24/kWh. (Those who are interested in the details of FiT rates are highly encouraged to explore Gipe’s work.)

The lack of a national FiT prompted states and a few cities to try creating their own equivalents. Unfortunately, they quickly ran afoul of regulation, because the Public Utility Regulatory Policies Act (PURPA) of 1978 forbids states from setting tariffs above the “avoided cost” of generation from other sources like conventional natural gas-fired plants. This led the states to adopt strategies like renewable energy credits, RPS policies, subsidies, and tax credits, which fall outside the Federal Energy Regulatory Commission’s (FERC) jurisdiction.

California then petitioned FERC to exempt systems under 20 MW from PURPA, paving the way for its state FiT. FERC issued a clarifying order which affirmed its jurisdiction over wholesale electric sales and continued to require rates to be set based on avoided costs, but opened the door to FiTs based on different ways to calculate those costs. Where that leaves FiTs today is unclear.

The absence of a FiT has spawned a renewables industry in the U.S. that’s clunky and inefficient, with incentives and standards (like equipment ratings and electrical codes) varying wildly from state to state. It has also given us a cottage industry of third-party financing strategies designed to capture the federal tax credits, which ultimately redirects a significant portion of the already-marginal profit to the financial industry instead of adding new capacity.

With the wind of Chinese and Japanese FiTs at their backs, along with the world’s lowest manufacturing costs, the stage is now set for Asia to absolutely blow the doors off the U.S. PV market, starting next year. While we have been building new manufacturing capacity in the U.S., it probably won’t be sufficient to dampen that giant sucking sound, and could result in another round of module shortages here. The U.S. grid-connected solar PV market doubled to 878 MW from 2009 to 2010, but that was dwarfed by the demand of the German and Italian FiTs. More than 17 GW of capacity was installed globally in 2010. If the U.S. were to install PV commensurate with its share of the global energy market as a whole, we’d have installed 3.87 GW; instead we installed about one quarter of that.

The economics are now clearly in favor of renewables, especially over a 20 year horizon. Retrospective studies have shown that over time  FiTs reduced the fully-considered costs of delivering power, and were the most cost-effective incentive strategy.

The only reason we wouldn’t follow the example of the rest of the world with an aggressive renewable FiT is because we, like the UK, are deeply beholden to the incumbent industries. Utilities, coal and natural gas producers, railroads, and pipeline companies make a great deal of money under the fossil fuel regime by shipping natural gas and coal to power stations, then shipping the electricity to consumers, then marking up that power for retail sale. Solar PV on sunny rooftops cuts all of that out of their businesses. It benefits them to bend federal regulations to their favor, drag their feet on installations, disperse a cloud of squid ink around climate change science, and throw up as many bureaucratic hurdles as possible.

This is, admittedly, a simplified analysis. There are actually twelve different FiTs in Germany alone. Different FiTs have different degrees of complexity, and grid power rate schedules can have many different tiers of pricing. I passed over other important factors, like grid capacity and interconnection issues, and focused on residential solar PV when utility-scale projects and other renewables like wind are equally affected by FiTs.

But what should be clear is that the hodgepodge of regional, state, and federal incentives in the U.S. has resulted in a far lower rate of deployment, at a higher cost, than what FiTs have produced. With a national FiT, the cost would be spread across all consumers and create sustained demand, instead of allowing it to collapse once or twice a year whenever state rebate funds run dry. If America wants to remain competitive in energy, we should try what has worked so well for Europe. FERC should do whatever is necessary to clear the way for a national FiT of around $0.30/kWh for at least 20 years and be done with it. We can’t afford to dink around with our regulations for several more years, kowtowing to vested fossil fuel interests, while the rest of the world pulls rapidly ahead in the race to energy transition.

Photo: (solarpanels-chinacom/Flickr)

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Chris Nelder

Columnist (Energy)

Chris Nelder is an energy analyst and consultant who has written about energy and investing for more than a decade. He is the author of two books on energy and investing, Profit from the Peak and Investing in Renewable Energy, and has appeared on BBC TV, Fox Business, CNN national radio, Australian Broadcasting Corp., CBS radio and France 24. He is based in California. Follow him on Twitter. Disclosure