Cutting the Renewables Subsidy Umbilical Cord

The phasing out of subsidies for renewables makes good market sense but the process requires a smooth transition plan.
Published: Mon 14 Sep 2015

Some renewable sources are beginning to reach a scale and level of maturity that is enabling them to compete with more commensurable sources, making them market ready.To avoid severe market distortions, there should be a gradual phase out of renewable energy subsidies.

Tackling market distortions

The European Commission has announced guidelines that are aimed at gradually phasing out renewable energy subsidies that currently bolster the European Union’s (EU’s) €48-billion-a-year clean energy industry.

This move has been made in response to an investigation into Germany’s renewable energy subsidies which have seen a remarkable growth in the country’s renewable but has also been the cause of severe market distortions.

The new Energy and Environmental State Aid Guidelines suggest a gradual introduction of competitive bidding processes for allocating public support.

In 2015 and 2016, a pilot phase will be launched to test competitive bidding procedures in a small share of new renewable power capacity. Small installations (less than 6MW for wind power and 1MW for other renewables such as solar or biomass) will be initially exempted, but tender processes will be obligatory for all new installations as of 2017.

South Africa’s Independent Power Producer (IPP) programme is doing exactly this-it is less about subsidies but more about off-taker guarantees.

The guidelines also call for the gradual replacement of feed-in tariffs with more market-based types of aids such as feed-in premiums. The premiums will not apply when prices on the market are negative, which means generators will have no incentive to generate electricity under negative prices. Small installations will still benefit from a special programme, however, and the rules do not affect installations that are already in place.

Significantly, the rules also seek to alleviate the “very high burden” of charges levied for the funding of renewables for energy-intensive companies.The rules also back cross-border energy infrastructure in support of a single European energy market, and they permit aid to secure adequate generation when there is a real risk of a reliability lapse. That means aid for so-called “capacity mechanisms” is possible if a state shows that adequate capacity cannot be delivered without state intervention.

When renewables are market-ready

The UK government has been developing guidelines to remove solar and wind from accessing the country’s Renewable Obligation financial support subsidy.  

The Renewable Energy Association (REA), the largest renewable energy trade association in the UK, in conjunction with leading advisory firm KPMG, released its UK Solar Beyond Subsidy: The Transition report, which indicates that solar PV’s popularity and increased deployment will enable it to become the first renewable technology to achieve “grid parity”.

The reason for this is because technology costs have dropped tremendously over the past 10 years. As a result, solar could reach grid parity in the next five years, according to the report.The cost to generation ratio is certainly tipping the balance and with Chinese-manufactured technology becoming more and more competitively priced, it certainly looks as if we are reaching that point at a rapid rate.

While the report is focused on solar, it still may hold relevance for other renewable sources that will see ongoing development, despite varying technology costs.

Small-scale solar still need support

Despite solar’s growing competitiveness with traditional power generation, the report points out that there is still a need for support especially for small and medium enterprises that still need to grow and reach grid parity themselves.

The report also points to the fact that strong government backing will ensure the smooth transition from subsidy to business as usual.  

Three main recommendations are made by the report’s authors:

  • Create a national energy strategy, incorporating energy storage alongside solar and giving a coherent grid overview.

  • Review FiTs and ensure these are set at a level that allows acceptable returns and that digressions are clearly set out.

  • Review alternative ways to support the solar industry, including for example the tax regime and net metering to allow a smooth transition away from subsidies.

The report points out that the phasing out of subsidies for PV will require a transition plan” to avoid the technology falling off the “cliff edge.” A five year transition plan is recommended for the UK instead of the immediate cessation currently under consultation. The authors of the report propose the following policy options:

  • A combination of net metering and enhanced building regulations in the residential sector. This would help to create demand for PV on both new build and retrofit houses.

  • An improved tax regime for non-domestic properties taking into account business rates, capital gains allowance and corporation tax alongside clear rules on required EPC ratings for leased properties would help drive growth in this sector.

  • A strategy to transition and integrate PV into energy markets and distributed energy systems.

Onshore wind needs a phased approach

Broadly similar conclusions on a phased approach for onshore wind in the UK are reached in another new report from the Policy Exchange. Earlier this year the government announced its intention to cut subsidies for new onshore wind one year earlier than planned. [Engerati-UK Onshore Windfarm Subsidies Take A Cut] In the report it is argued that with the use of larger turbines in high wind speed areas of the country, predominantly Scotland, the cost of onshore wind could continue to fall to a level (£60/MWh) that would put it in the same league as a new gas plant and significantly cheaper than offshore wind, biomass or even nuclear by 2020.

In order to achieve these cost reductions, the paper says that new onshore wind projects should be allowed to continue to take part in the government’s Contract for Difference (CfD) auction mechanism - an issue that the government has yet to decide upon. Currently public support for onshore wind is significantly higher in Scotland than in England and in the first CfD round, 10 of the 15 projects were located in Scotland, accounting for 73% of the total capacity, with the remainder in Wales (24%), and England (3%). By capping and reducing the amount paid to new and repowered onshore wind projects, they can effectively become ‘subsidy free’ by 2020, the report states.

It is clear that to avoid market distortions, subsidisation of renewables will have to be cut eventually but the process has to be a gradual one to avoid investor uncertainty and a reduction in development. If this is done, unsubsidised renewables will stand a strong chance in the energy sector.

Further reading

European Union-Guidelines on State aid for environmental protection and energy 2014-2020 [pdf]

KPMG- UK Solar Beyond Subsidy: The Transition [pdf]

Energy Exchange: Powering Up. The future of onshore wind in the UK