B – Renewable Energy Act with feed-in tariffs and auctions
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 Chapter 4 – History of the Energiewende). The last major revision is being undertaken in 2016 to continue the switch from feed-in tariffs to auctions.
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 unusually long for PPAs. And let us not overlook 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 around five to seven percent (although the levels vary in practice).
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 40 to 45 percent of its power from renewables by 2025, and at least 80 percent of its power from renewables by 2050. This legal requirement to switch power generation almost entirely to renewable sources is one of the main pillars of Germany’s Energiewende.
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 only 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 arrays are 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 do not 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. For wind and PV, there is now also a “growth corridor” with a target of 2.5 gigawatts per year. If that level is surpassed, the scheduled reduction are stepped up. 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. Green electricity is sold on the power exchange, and the difference between feed-in tariffs paid to producers and the revenue from the power exchange is passed on as the renewable energy surcharge.
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 0.4 percent, PV 0.5 per month, and biomass 0.5 percent per quarter. For biomass, photovoltaics, and wind, the regression rate depends on the market volume in the preceding year. If the PV market falls below one gigawatt per year, rates will even increase.
The cost of these feed-in tariffs is passed on to power consumers. By 2016, this surcharge had raised the retail price by around 6.4 cents per kilowatt-hour – equivalent to roughly a quarter of the retail power price (not including the monthly hookup fee). 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 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 made wholesale power cheaper, they also seemed to make up an ever larger share of the power price, so consumers perceived renewable power as a cost driver – simply because of the calculation’s design.
In contrast, energy-intensive industry is benefiting tremendously from this trend. 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 retail consumers and small businesses currently cover an inordinate share of the cost of green power.
Increasingly, however, 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 around 4 cents per kilowatt-hour in 2015 (rather than nearly 6.1 cents) had energy-intensive industry been required to pay the full surcharge.
By 2017, Germany is to phase out feed-in tariffs for systems larger than 100 kilowatts and switch to auctions, in which the buyer receives bids from sellers. In 2016, the government continues to finalize the details for a transition from feed-in tariffs to auctions. The fourth round of pilot auctions for ground-mounted PV produced a price of 7.4 cents, which is competitive with the scheduled reduction for feed-in tariffs. The government is therefore happy with the progress.
During the summer of 2016, the German government is working to implement further changes to its EEG to take effect on January 1, 2017. The effect could be to slow down the growth of renewables – ironically, just after signing the international climate agreement. What may these changes entail for each energy source?
Solar, which is already expected to fall short of the annual target of 1.5 megawatts for the second year in a row, will probably slow down further. Now, arrays larger than 750 kW will no longer be eligible for feed-in tariffs and instead have to be auctioned. Below that level, solar will increasingly offset power purchases from the grid, but the governments wants to rein in this potentially strong market as well. If more than 20 MWh of solar power is consumed directly, the electricity tax of 2.05 cents per kWh is payable for the entire amount of electricity in addition to roughly 2 cents for the renewable surcharge. Solar power from new arrays may only cost nine cents, but the German government is adding four cents to systems of this size. Mainly, very large commercial roofs are affected.
Biomass, which also fell short of the 100 megawatt annual target last year with only around 71 megawatts built, will receive an annual limit of 150 megawatts for the next three years, followed by 200 megawatts per year. The question remains whether those targets will be reached at all, as with solar.
Arguably, the biggest battle took place in the wind sector. Here the compromise reached has a gross limit of 2.8 gigawatts. Because Germany installed 3.2 gigawatts in 2002, there is therefore likely to be a net reduction of 0.4 gigawatts when those systems reach the end of their 20-year eligibility for feed-in tariffs and come up for repowering. This reduction only applies to onshore wind, which is the cheapest source of new electricity in Germany; there are separate targets for offshore wind (6.5 gigawatts by 2020 and 15 gigawatts by 2030).
There has been widespread dismay over this outcome. The overwhelming consensus is that the German government is slowing down the Energiewende and pushing back citizen energy. The policy switch from feed-in tariffs to auctions is widely expected to produce numerous losing bids; small cooperatives that cannot pass losses across multiple projects are likely to refrain from participating to begin with. Any onshore wind project larger than one megawatt must now be auctioned.