Renewable Energy Act with feed-in tariffs
Perhaps no other legislation has been copied worldwide as much as Germany's Renewable Energy Act (EEG), making it a tremendous success story. The law specifies that renewables have priority on the grid and that investors in renewables must receive sufficient compensation to provide a return on their investment irrespective of electricity prices on the power exchange. The resulting high level of investment security and the lack of red tape are often cited as the main reasons why the EEG has brought down the cost of renewables so much. In contrast, quota systems do not provide investors with security or incentives to ensure that a wide range of renewables technologies are deployed so they can become less expensive.
In the early 1990s, Germany came up with a very simple policy to promote electricity from renewable energy sources, including wind power, solar energy, and small hydropower generators. In 2000, these feed-in tariffs were revised, expanded, and increased; every three to four years, they are reviewed and the law is amended. See the section on History for more information.
Owners of solar arrays and wind farms have guaranteed access to the grid. Grid operators are required by law to purchase renewable power, with the (intended) result being that conventional power plants have to be ramped down – in the process, renewable power directly offsets conventional power production.
While feed-in tariffs themselves have been widely copied outside of Germany in more than 50 countries, the central aspect of grid access is occasionally overlooked. Projects that would be profitable thanks to feed-in tariffs may then remain stuck in limbo for lack of a grid connection.
The situation is by no means perfect in Germany, either; any German project developer can probably complain about delays in the grid connections. But overall, most grid connections are fairly easy to get in a timely fashion, and project planners in other countries would probably love to have the grid access terms stipulated in Germany’s EEG.
The standard contract for feed-in tariffs that you sign with your utility is two pages long in Germany. In contrast, the United States has Power Purchase Agreements (PPAs), which can easily be 70 pages long and are individually negotiated between the seller and the buyer (say, a utility company). In Germany, feed-in tariffs are guaranteed for 20 years, which would be quite long for PPAs. And let’s not forget one important aspect – you will need a lawyer, if not a team of lawyers, to formulate a PPA, whereas the average German has no problem understanding the two-page contract for feed-in tariffs.
The feed-in tariffs themselves are quite simple to explain. Basically, you take the cost of a particular system, divide that figure by the number of kilowatt-hours the system can reasonably be expected to generate over its service life (generally 20 years), and you get the cost of that system per kilowatt-hour. Now, tack on whatever return on investment (ROI) you want to provide, and you have your feed-in tariff. In Germany, the target ROI is generally reported at around five to seven percent.
This approach allows distinctions to be made not only between technologies (such as solar, wind, and biomass), but also between system sizes. After all, a giant ground-mounted photovoltaic array on a brownfield will produce electricity that is cheaper than power from a large number of distributed solar rooftops on homes. By offering different feed-in tariffs for different system sizes, you ensure the economic viability of the various applications, thereby preventing windfall profits for large projects.
The EEG sets very ambitious targets. For instance, Germany plans to get at least 35 percent of its power from renewables by 2020, at least 50 percent by 2030, and at least 80 percent by 2050. This legal requirement to switch power generation almost entirely to renewable sources is one of the main pillars of Germany’s energy transition.
Criticism of feed-in tariffs
Critics of feed-in tariffs charge that the policy does not promote the least expensive type of renewable energy.
This outcome is not, however, unintended; it is what makes feed-in tariffs successful to begin with. Think about it – quota systems (such as Renewables Obligations in the UK and Renewable Energy Credits in the US) generally require utilities to generate or purchase a certain amount of their electricity from renewables (say, ten percent by 2020). The utility then looks for the cheapest source of renewable power, which is almost always wind power – and it is almost always large wind farms, not community projects with just a few turbines. But we will never bring down the price of photovoltaics by focusing on wind turbines.
Repeatedly, critics of feed-in tariffs have charged that the policy “picks winners,” but in fact quota systems always pick wind, whereas feed-in tariffs support all of the specified types of energy equally. The confusion is based on a misunderstanding. Up to now, conventional power sources have generally competed with each other. For instance, power companies leave their least expensive power plants online as much as possible and only switch to more expensive generators as demand increases. But if renewable power always has priority, then it does not compete with conventional power on price anyway. In addition, in quota systems, financing institutions add risk surcharges. Thus, financing costs are higher than in a feed-in tariff scheme, which provides long-term reliability for investors.
It would not be correct, however, to conclude that there is no competition with feed-in tariffs. For a given feed-in tariff, companies – from panel manufacturers to local installers – compete for customers. For instance, let’s say you want to put a solar array on your house. In Germany, you will get a couple of estimates from local installers, who will probably also give you a couple of options (such as monocrystalline or polycrystalline panels, or panels made in Germany or abroad). All of the companies you could buy from compete with each other.
Feed-in tariffs unleash the market
Not surprisingly, feed-in tariffs do not lead to unnecessarily high prices. In fact, Germany has the cheapest solar power in the world not because it has so much sunlight, but because of investment certainty and market maturity due to its feed-in tariff policy. Solar is so much cheaper in Germany than it is in sunny parts of the US, for instance, that the largest, most cost-efficient utility-scale solar power plants there still produce considerably more expensive power than small to midsize arrays in Germany.
Up until 2008, when the bottleneck in the supply of solar silicon finally worked itself out, critics of feed-in tariffs charged that Germany had been paying too much for photovoltaics with its feed-in tariffs, thereby keeping the cost up for the rest of the world, including developing countries in particular. But since prices began to plummet in 2008, we don’t hear that criticism anymore – because it wasn’t true in the first place.
Changes in German feed-in tariffs for PV did not bring about these lower prices; on the contrary, German politicians have been rushing to reduce solar feed-in tariffs to keep up with falling prices. Those who once claimed that German feed-in tariffs kept the price of solar up for the rest of the world should now explain why prices are down so much without being driven by cuts in German feed-in tariffs for PV.
The truth is that solar can get cheaper even if feed-in tariffs remain unchanged because there is still a competitive market. If you want to install a solar roof, you will pick one of the least expensive offers on the market.
Cost of the EEG
The EEG’s feed-in tariffs have scheduled reductions, usually annually, to ensure that the price for renewable power continues to drop. Unfortunately, the current market design has a flaw that actually makes the retail rate increase for consumers when renewables lower the wholesale rate for industry.
To maintain dynamic development for renewables on the market, the feed-in tariffs for newly installed systems decrease from year to year. The “degression rate” – stepped, scheduled tariff reductions – depends on the maturity of the different technologies. Hydropower tariffs go down one percent per year, wind 1.5 percent, and biomass two percent. For photovoltaics, the degression rate depends on the market volume in the preceding year.
The cost of these feed-in tariffs is passed on to power consumers. By 2012, this surcharge had raised the retail price by around 3.6 cents per kilowatt-hour – equivalent to roughly ten euros per month for the average German household; for 2013, the surcharge increased by 47% to 5.3 cents. These investments not only reduce energy imports, but also lower greenhouse gas emissions and the cost of resulting climate change.
But while renewable power has raised the retail rate in Germany, it has lowered wholesale prices. Solar power in particular is generated in the early afternoon at a time of peak consumption. Normally, even the most expensive generators are switched on during such hours (the technical term is “merit-order effect”), but less expensive solar power largely offsets this costly peak demand power in Germany now.
Some changes are needed
Ironically, lower wholesale rates have increased the EEG surcharge because of the way that surcharge is calculated – the price of wholesale power is reduced from the cost of renewable power, and the difference is passed on as the surcharge. Hence, as renewables make wholesale power cheaper, they also seem to make up an ever larger share of the power price, so consumers perceive renewable power as a cost driver – simply because of the calculation’s design.
In contrast, industry is benefiting tremendously from the current market design. Not only do they generally pay wholesale rates, not retail rates, but energy-intensive industry and the railway sector in particular are largely exempt from the EEG surcharge. In other words, German consumers and small businesses currently cover an inordinate share of the cost of green power.
Increasingly, the EEG surcharge is becoming an issue for social policy – how will the poor continue to pay their power bills? Proponents of renewables are increasingly calling for the exemption for energy-intensive industry to be done away with, as the sector already benefits from lower wholesale prices thanks to renewables and should gradually have to share a greater chunk of the burden. It has been estimated that the EEG surcharge would have come in at less than 2.5 cents per kilowatt-hour in 2012 (rather than nearly 3.6 cents) had energy-intensive industry been required to pay the full surcharge.