Can a Feed-In Tariff Help Increase Renewable Energy Capacity?

By Alexander Morse

It’s no secret that the Earth’s climate is getting warmer. 2020 tied 2016 as the hottest year on record, and the 10 hottest years on record have all occurred in the last 15 years. One of the biggest culprits in the rising average global temperature are greenhouse gases, like carbon dioxide (CO2) and methane (CH4), whose emissions trap heat in the atmosphere. The resulting average global temperature rise does more to affect the Earth than just result in warmer days in some places (and colder ones in others); it impacts the habitability of areas for humans and wildlife alike, and leads to catastrophic weather events (see, for example, last week’s devastating cold snap in Texas and southern and central US). In recent years, we have seen wildfires raging through California and Australia and increases in the frequency and severity of storms.

The destruction of habitats across the United States associated with these kinds of extreme events cost approximately $91 billion in 2018 alone in emergency response and restoration. To successfully reduce greenhouse gas emissions and limit the damage of climate change will take a massive overhaul of our current energy infrastructure if we are to achieve net zero emissions by the middle of this century. The United States is among the world’s leaders in CO2 and CH4 pollution, underscoring the significant challenge that the transformation to renewable energy will require.

To transition to a system powered by renewable energy will necessitate significant political investment, financial capital, and public buy-in. The United States, however, does not currently have a comprehensive federal climate policy to invest in renewables or reduce CO2 emissions. This may change as President Biden announced the appointment of Gina McCarthy, former Environmental Protection Agency administrator and current head of the Natural Resources Defense Council, as White House climate coordinator and John Kerry, former secretary of state, as special presidential envoy for climate on the National Security Council. The creation of these new positions, and other recent appointments, signal that climate will be a priority under this administration. Biden’s climate plans have thus far included strengthening the goals of the Obama-era Clean Power Plan, effectively reversed by President Trump, to achieve 100 percent ‘clean energy’ by 2035; reinstating a number of environmental rules aimed at curbing greenhouse gas emissions; and rejoining the Paris Climate Accord. And since Democrats now control both the House and Senate, the administration will have greater influence over climate policy.

In response to rollbacks in federal environmental policies over the past four years, several states have been leading the charge to address the climate crisis, effectively serving as policy laboratories. Some states have developed approaches to invest in renewable technology and mitigate their carbon footprint. A previous piece by the Rockefeller Institute examined the benefits and challenges of the renewable portfolio standard as one policy option to address these issues. That type of policy requires electric utilities to supply a specific amount or share of renewable electricity by a certain year—a quantity-based mechanism.

This piece will examine another policy option that is popular in Europe, but less common in the United States: the feed-in tariff (FIT). FIT is a price-based mechanism designed to incentivize rapid investment and deployment of renewable energy infrastructure by establishing long-term contracts with renewable energy project developers. This post will explore the intended goals of the policy, how existing laws in the United States can affect its use, and review the different policy design options.

What is a Feed-In Tariff?

A feed-in tariff is a policy tool that encourages the development of new renewable energy infrastructure through financial incentives paid by the utilities directly to the power producer. Construction of renewable energy infrastructure requires high levels of capital investment up front. However, electricity prices fluctuate, creating uncertainty about the revenue streams the investment will generate over the long-term. The high levels of uncertainty make for a less attractive opportunity for investors.

FIT programs establish a long-term and price-fixed contract (in which prices are often set higher than prevailing electricity prices) with a guaranteed flow of income and positive return on investment. Because the contracts significantly reduce uncertainty, project developers (power producers) have a greater incentive to fund renewable energy projects. FIT policies are typically targeted towards smaller renewable projects, including distributed generation in the commercial and residential sector. Distributed generation refers to technologies that produce electricity close to where it will be used, for example, solar panels affixed to the roof of a house.


The primary goal of an FIT is to rapidly deploy renewable energy projects by establishing a stable return on investment. In addition to minimizing uncertainty, the contracts allow project developers to finance new infrastructure at more affordable financing rates, lowering the costs of project investment. The policy is also intended to help reduce the cost of renewable energy technologies in the long term through market growth, learning, and innovation. The FIT’s approach has been designed to achieve broader climate goals, including diversifying energy infrastructure, securing the uninterrupted flow of electricity, reducing reliance on fossil fuels, and lowering the carbon footprint, alongside providing for economic development.

How a Feed-In Tariff Works

Electricity markets can be volatile, unpredictable, and can vary by region, introducing risk for potential project developers. Wholesale electricity prices in the Northeast were approximately 15 to 30 percent lower in 2019 compared to the previous year due to falling natural gas prices. Meanwhile, record-high electricity demand in Texas caused electricity prices to spike in 2019, representing a 13 percent average price increase over the year before.

An FIT program seeks to remove or limit uncertainty through two key design principles:

  1. Purchase Obligation: Electric utilities must provide grid access to renewable energy power producers and purchase all available renewable energy generated by the producer;
  2. Price Setting: Policymakers set a determined purchase price per unit of renewable energy electricity for an extended period of time (typically 15-25 years)

These two principles help establish confidence in renewable energy markets and increase a project developer’s chances of securing project financing to build and deploy renewable energy projects.

The purchase obligation is fundamental to the success of the FIT because it ensures project developers will have their renewable energy project’s electricity delivered to the grid. Price setting is key because, in addition to the above-market return for each kilowatt hour of generated electricity, it provides a clear and transparent framework that allows each stakeholder to understand all of the costs and revenues involved in a project, from planning and construction to operation.

There are two general forms of price setting: “fixed-price model,” which provides predetermined price to power producers and is independent of the prevailing market price of electricity, and a “feed-in premium,” which adjusts the tariff payment based on real-time electricity prices. A variation of the feed-in premium is the “spot-market gap model,” which caps payouts to developers at a predetermined amount. Table 1 lists the models and describes the payment incentive and purpose.

Table 1. List of FIT Payment Models

 

One of the major challenges of setting prices in long-term contracts is forecasting the future costs of renewable technologies. Over time, as technological advances in renewable energy improve efficiencies and new projects are implemented, costs per kWh should fall. As such, in later years, the government may want to avoid paying the same rate for more cost-effective technologies. An FIT that does not account for technological advancements and improved efficiencies may end up overpaying for renewable electricity for a period of time. Additionally, a great disparity between (higher) FIT payments and (lower) development costs could result in a of flood of project developers entering into contracts. A 2012 study analyzing Ontario, Canada’s FIT policy saw that FIT payments for solar almost doubled between 2006 and 2009, meanwhile prices for solar fell 25 percent the following year. The price offered through the FIT was revised downward in 2010 and again in 2012. In 2009, just prior to the initial downward adjustment, the Ontario Power Authority received 13,600 applications (85 percent of total FIT applications) for ground-mounted solar, which alerted policymakers that project developers were capturing returns greater than the program had intended.

To guard against any significant gaps in cost and pricing, and incentivize technological advancement, FIT designs can utilize tariff degressions, which reduce the FIT payments for new projects over time. Tariff degression policies can have a fixed reduction over time or decline based on the amount of overall capacity that is installed through the program. Each new renewable energy project that enters into an FIT will receive a smaller relative payment.

Renewable energy advocates support FIT policies, in part, because the policy can be highly effective and cost efficient if designed with the right incentives and mechanisms in place. Policymakers could set payments based on the type of desired technology and size of the project to spur development in areas of need; a well-designed policy can align technological development in geographically prime areas (solar panels where the sun shines or wind farms by coastal areas). Degression mechanisms can help further control costs and drive them down over time. FITs can also be revisited under times of significant financial constraint and unexpected economic challenges.

Who Funds the Feed-In Tariff?

Since the utility is obligated to purchase the electricity from the power producer under an FIT, the utility generally bears the cost of the policy. However, without a tax credit or additional revenue stream to help offset the added costs, utilities are likely to fold the program costs into higher electricity bills for customers—effectively passing on the incremental costs. While integrating the program’s costs into electricity bills ensures constant revenue for program funding, it does raise concerns for customers, especially low-income customers that would be more negatively impacted by higher electricity bills.

Policymakers could also introduce a new tax or reallocate existing funds to pay for the policy and design a tax that does not disproportionately affect low-income residents. While this approach will not result in higher electricity bills, it does run the risk of being tied to budget uncertainty. Political leadership often changes and with it policy priorities. For example, the COVID-19 pandemic has put tremendous strain on state and local government budgets. Sudden changes in fiscal outlooks or political appetite could jeopardize program funding.

Do Feed-In Tariffs Work?

Several countries have successfully implemented FITs to increase and accelerate the installation and increased capacity of renewable energy. FITs are versatile and can be applied to various renewable energy technologies such as wind and solar, and they can differentiate by project size. Policymakers can take advantage of the versatility and customize FITs to achieve the intended outcome in a given context: newly installed renewable energy capacity.

Germany added almost 52 gigawatts of renewable electricity to the grid since 2000. Germany first introduced an FIT program in 1991, then passed its landmark legislation, the Erneuerbare-Energien-Gesetz (Renewable Energy Sources Act, or, EEG) that built upon the 1991 law. The new law increased payments to above the price of electricity and introduced a staggered tariff degression scheme to help contain costs over time. The results were striking. In 2000, the share of renewables in Germany’s electricity mix was about 6 percent. That increased to 46 percent by 2020—a 667 percent increase.

The United Kingdom also saw a dramatic influx in renewable energy projects after passing an FIT in 2010. Within five years, the UK had installed over 682,500 separate renewable energy projects under the FIT program—achieving almost 88 percent of its 2020 goal (780,000 installations) and representing approximately 13.5 percent of the UK’s total renewable electricity capacity.

Japan has also had success with FITs. After the 2011 Fukishimia nuclear disaster, in which 4.7 gigawatts of energy was displaced, the country originally turned to coal and natural gas to generate electricity. This pivot presented two problems: increased CO2 and CH4 emissions, and, a reliance on coal imports—increasing energy costs and risking energy security. To address these concerns, FITs were implemented and dramatically increased renewable electricity generation; between 2012 and 2020, Japan more than tripled its renewable energy capacity, from 20,600 MW to 72,944 MW.

The results were striking. In 2000, the share of renewables in Germany’s electricity mix was about 6 percent. That increased to 46 percent by 2020—a 667 percent increase.

However, despite the success of these FIT programs, the policy and economic environment can present unforeseen challenges. It’s impossible to know what the electricity landscape and market will look like in the future. Establishing a predetermined price for electricity so many years into the future could lead to inefficiencies. Prices set too high risks spending unnecessary taxpayer dollars which could erode public support for the policy, and prices set too low will not attract developers.

And although policymakers can adjust the FIT, there can be issues with timing and efficiency. Several European countries actually saw a boom in photovoltaic development as upfront costs fell in 2008 and project developers lined up to take advantage of the FITs guaranteed return on investment. Germany, France, Spain, and others eventually imposed budget cuts and program changes. Despite the restructuring, FITs still presented an opportunity to earn a profit above the market rate, encouraging project developers to pursue new renewables projects. However, 15 investors filed a lawsuit against Spain for changing the terms of the FIT. In 2019, the Spanish government offered subsidies to the energy companies that agreed to drop their lawsuit.

Federalism an Issue in the United States

The FIT is less commonly used in the United States and one reason is because FITs must adhere to existing federal laws, limiting the potential scope of the policy. In 2007, California passed legislation that authorized the California Public Utilities Commission to design and implement an FIT policy. Shortly after, California utilities argued to the Federal Energy Regulatory Commission (FERC) that the new state FIT policy violated two federal laws: The Federal Power Act of 1935 and the Public Utility Regulatory Policies Act of 1978.

The Federal Power Act stipulates that states cannot mandate the price of wholesale electricity and that FERC has sole discretion over wholesale electricity in interstate commerce—a federal domain. Wholesale electricity is the sale of electricity from a generator to a utility. As noted above, one of the principles of the FIT is the purchase obligation and, as such, federal price setting authority can constrain the ability of states to implement FIT policies.

The other federal energy law cited by FERC, the Public Utility Regulatory Policies Act (PURPA), was passed to help diversify energy systems and allow states and local governments to require utilities purchase electricity from smaller energy facilities (similar to the FIT’s purchase obligation), called “qualifying facilities” (QF). A QF is exempt from the Federal Power Act price regulation, which allows state and local policymakers to regulate the price. However, under PURPA, the price cannot exceed the utilities’ avoided costs or the costs a utility would incur to either build or purchase electricity from a different power producer using any available fuel source. Because of this statute, FIT design parameters can be constrained and provide inadequate incentives to develop new renewable capacity.

California’s FIT ultimately satisfied the requirements outlined by the FERC decision.[1] But while other state and municipal governments could pursue their own policies, FITs have yet to gain a bigger foothold in the United States.

Table 2 displays a nonexhaustive list of state, municipal, and utility-initiated FITs in the United States, according to the Database of State Incentives for Renewable Energy (DSIRE). Since there is no standard FIT definition and various incentive policies can be employed to spark growth in renewable development, tracking policies across the US remains challenging.

Table 2. Brief List of Feed-in Tariffs in the United States

SOURCE: Database of State Incentives for Renewable Energy (DSIRE).

FERC has the authority to revise rules with regard to PURPA (i.e., allow prices to exceed the avoided cost of alternative electricity generation and increase the scope of the QF definition) and empower states to develop autonomous renewable energy systems. However, the makeup of political leadership has significant influence on the types of rule changes and reforms. In July 2020, for example, FERC, then controlled by Republicans, voted to reform PURPA guidelines, which effectively weakened the assurances and protections for QFs.

Clean energy advocates rebuked the new rule, stating it would limit renewable energy development. The new FERC Chairman, Richard Glick, a Biden appointee, was the lone “no” vote, saying at the time, “I have a hard time seeing how [the reforms] encourages [qualifying facilities]. I think it actually discourages QF development.” It is to be determined if Chairman Glick will move to reverse the July decision or implement other new rules that give more discretion to states to promote renewable energy development.

What’s Next for Feed-In Tariffs?

It is undetermined if FITs have a robust future in US policy. Currently, there are regulatory challenges to state level implementation of FITs. Elements of FERC’s authority over and rules pertaining to the energy sector along with existing laws make it difficult for states to more independently determine and enforce energy policy for renewables. As described earlier, the Federal Power Act and PURPA can limit state level FIT policies. If the FIT is to be more broadly utilized by states, existing federal laws and the role of FERC may need to be amended to allow states broader jurisdiction and flexibility with respect to renewables.

Policymakers will also have to be responsive to the current economic landscape and the impact of the COVID-19 pandemic. Municipal and state governments will have to make budget cuts and reallocate funding to maintain operations and provide essential services throughout the pandemic and beyond. As the US recovers and looks to ramp up the transition to renewable energy, it will be important to consider how renewable energy policies can align with and enhance economic recovery. The American Recovery and Reinvestment Act of 2009 invested $90 billion in clean energy investments in an effort to promote emerging low-carbon technologies and job creation. The White House Council of Economic Advisors estimated the Recovery Act created approximately 900,000 jobs and helped spur more than 100,000 renewable energy projects throughout the country, while simultaneously reducing costs for new green technologies, including wind and solar.

President Biden has indicated that both economic recovery and climate change will be major components of his administration. We will, however, have to wait to see what particular effects the administration’s priorities will have on funding and policies with respect to renewables.

Despite the fact that renewable energy technology has made significant advancements and it is generally at least cost-competitive with—or even less expensive than—fossil fuels in most places, more renewables are needed to effectively combat climate change. Upfront capital costs for renewable technologies remain a barrier for project developers and price uncertainty can make investors weary of potential returns. An FIT policy can alleviate many of those concerns with its guaranteed, above-market payment structure and purchase obligation, encouraging developers to pursue more renewable energy projects.

Policymakers can strategically employ tailored FIT models to help complement other climate policies and achieve broader energy and climate goals, such as energy diversification, support for emerging technologies, and related policies like the renewable portfolio standard, which is employed in some form by 30 states and Washington, DC.

Ultimately, it will not be one climate policy tool, but a comprehensive collection of many that will help the United States commit to a future that is powered by renewable energy. The Rockefeller Institute will continue to identify and analyze different policies, both enacted or not yet used, to provide an understanding and framework for policymakers and the public.

ABOUT THE AUTHOR

Alexander Morse is policy analyst and special assistant to Communications at the Rockefeller Institute of Government


[1] “California feed-in tariffs petition,” Federal Energy Regulatory Agency (FERC), docket no. EL10-64, issuance no. 20100715-3055, filed July 15, 2010, https://elibrary.ferc.gov/eLibrary/search.

 

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