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Correcting a market failure: fast tracking renewable energy with the wondrous feed-in tariff.

BENJAMIN K. SOVACOOL explores the justification behind Feed-in Tariffs (FITs) in promoting development and use of renewable energy and their advantages over other mechanisms. Everyone wins with Feed-in-Tariffs and every Kilowatt hour of energy from renewable resources saves lives, reduces greenhouse gas emissions, enhances human health, and improves social stability.

Politicians and real estate moguls often fondly refer to "win-win" situations. Yet most important policy decisions involve winners and losers; benefits that accrue to one group often come at the expense of another. Occasionally, factors align like the stars and policy makers are faced with a true "win-win" situation. A relatively new mechanism to promote renewable energy, called a feed-in tariff, is one of these rare opportunities.

Like other policy mechanisms intended to stimulate renewable energy, such as tendering systems and power purchase agreements, feed-in tariffs (FITs) set a fixed price for electric utility purchases of renewable power. But a FIT is different, paying renewable energy producers a premium rate over the existing, market rate for each unit of electricity, or kilowatt-hour, fed into the grid. FITs usually require power companies to purchase all electricity from eligible producers in their service area at this premium rate over a long time period (usually 15 to 20 years). They also mandate electric utilities to connect all possible FIT power providers to the grid, and often force the utilities themselves to pay the interconnection and grid expansion costs. These costs are then distributed among all electricity consumers. Regulators generally differentiate FITs by location, technology, and time to reflect differing production costs.

When designed and implemented properly, FITs can bring great advantages to electricity consumers, electric utilities, politicians, and society at large. Consumers wishing to generate their own power receive FIT payments and benefit from additional revenue and improved reliability of energy supply, which spillover and help all consumers by lowering electricity prices. Electric utilities benefit from displaced fuel costs and decreased volatility of fuel and electricity prices. Politicians benefit because FITs often jump-start a robust manufacturing sector for renewable electricity technologies, bringing with them tax revenue and high-paying jobs that stay within the community, and society benefits from reduced greenhouse gas emissions and greater diversification of the electricity sector.

Three justifications for FITs

FITs are designed to correct at least three major failures in the existing market for electricity: 1) electricity prices do not reflect the true costs of generating power; 2) energy subsidies have created an unfair market advantage for conventional fuels and technologies; and 3) renewable energy is a "common good" so is subject to a "free rider" problem, enabling society at large to benefit from people's investments without paying for them.

Mismatched electricity prices Firstly, there is a severe mismatch between the current market electricity price and its full social cost. In almost every country, the cost of combusting coal to generate electricity does not include the money needed to clean up acid rain and toxic pollution, or care for people with asthma and other respiratory problems, nor does it replenish water supplies, or reclaim land. Nuclear energy costs often exclude the money needed to construct and maintain permanent waste storage sites, and costs of limiting the liability for a catastrophic accident which forces taxpayers as a whole to carry the costs of plant decommissioning. The electricity costs of natural gas do not include damage to the earth's climate from flaring and venting methane, nor the environmental damage costs associated with natural gas pipeline transmission and storage.

The most significant benefit of renewable power supply is its ability to generate electricity with fewer of these negative costs than every other power source. While renewable power systems have their own associated set of environmental and social impacts, these are far less damaging than those for fossil-fuel and nuclear units. Renewable power stations, for example, do not meltdown, rely on hazardous and combustible fuels, or depend on a fuel cycle of mining or milling that must beat, drill, or leech fuels from the earth. When roughly quantified and put into monetary terms, the negative externalities for coal power plants are 74 times greater than those for wind farms, and from nuclear power plants negative impacts are 12 times greater than solar PV systems. (1) A FIT is intended to partly correct this market failure by promoting renewable power, as every single kWh from renewable resources saves lives, enhances human health, improves social stability, and minimizes environmental degradation.

Huge subsidies for dirty energy Secondly, existing energy subsidies continue to heavily favour conventional resources, despite increasing public concern about climate change and the recent growth in the renewable energy industry. Funding for renewable energy as a whole peaked in 1980 at $2.1 billion, then dropped to $750 million in countries of the Organization for Economic Cooperation and Development. Nuclear energy on the other hand received close to 70 percent of all energy related research expenditures from 1974 to 2006 followed by coal, oil, and gas. (2) Put another way, from 1974 to 2002 nuclear power received $138 billion in subsidies from OECD countries and fossil fuels an additional $37 billion, but solar photovoltaics received $6.3 billion and wind energy a miserly $2.9 billion (See Figure 1). (3)

In many industrialized countries, especially the United States, coal producers still receive a percentage depletion allowance for mining operations, deductions for mining exploration and development costs, special capital gains treatment for coal and iron ore, a special deduction for mine reclamation and closing, research subsidies, and black-lung disease benefits paid for by national governments (black-lung disease, or coal worker's pneumoconiosis, is caused by long-term exposure to coal dust and causes fibrosis, necrosis, and lung failure). Oil and gas producers still receive a similar depletion allowance, bonuses for enhanced oil recovery, tax reductions for drilling and development costs, fuel production credits, and research subsidies. (4) Nuclear energy operators and manufacturers benefit from massive loan guarantees, research funds, public insurance and compensation against construction delays, tax breaks for decommissioning, tax credits for operation, and government-funded off-site security and nuclear waste storage.

So a policy mechanism like a FIT is absolutely essential to counter the momentum for conventional technologies shaped by decades of these subsidies.

The public goods problem The third factor is that renewable energy is subject to a "free rider" or "public goods" problem. Private goods, such as apples and i-pods can be owned by individuals. A long history defines the property rights associated with private goods, and individuals also can be excluded from owning them. Public goods by contrast, are "non-excludable" and "non-rivalrous." Exclusion from consuming public goods is not easily possible, and consumption of public goods by additional parties does not reduce the quantity of the goods available to others. The classic example of a public good is national defense: whether you pay taxes or not, you are still "defended," and no matter how secure you are others can enjoy the same security at no extra cost.

Public goods give rise to the problem of "free riders," people who benefit from the actions of others without shouldering their fair share of the cost. A free rider is the person who refuses to pay for a park even though she uses it, as she believes others will maintain it, or refuses to be inoculated against smallpox, as everyone else is inoculated, the smallpox risk to them is less than the risk of harm from inoculation. Economic theory claims rational individuals will optimize their use of free public goods (or commons) until this good no longer has any value. In other words, people will ride for free unless forced by country or conscience to do otherwise. Markets, the thinking goes, provide optimal, efficient allocation of private goods but not public goods. Improved health, cleaner air, and enhanced economic strength, created by renewable energy technologies are also public goods yet these benefits are not efficiently allocated by existing electricity markets. FITs are needed to partially correct this market failure.

Advantages over other mechanisms

A FIT is not the only tool available to public policymakers wanting to correct the market failure associated with renewable energy. Policies, ranging from research subsidies and tax credits to government procurement and mandates, can be used. These policies have merits but FITs have many advantages. In contrast to the inherent price risk involved with tendering systems (setting the price too low) and mandates and renewable portfolio standards (leaving the price to the market), FITs guarantee a stable investment stream for project developers, as the profitability of projects is virtually guaranteed. Unlike investment tax credits or research subsidies, a FIT is performance based, paying providers only if they actually generate electricity, not if they merely invest in a technology. They cost governments nothing, as the expense of the tariff and running a FIT program are paid for by consumers, not taxpayers. FIT suppliers also get paid immediately, rather than having to wait for the sale of credits or to get reimbursed by tax credits. FITs also tend to put pressure on equipment producers for lower prices and on developers for the best available locations, enhancing competition among manufacturers for lower equipment prices. (5)

While FITs have much to offer, they are not without risks. A trial and error process is usually needed to find the right price. When prices are set too low, the instrument is unable to spur development of renewables. When set too high, it can offer windfall gains to producers at consumers' expense and an efficiency loss for the economy. (6) A fixed price for each kWh also ignores the differentiation of electricity markets when designed without variation, and thereby is likely to diverge from economic efficiency, as electricity prices differ by season, daytime, and reliability of supply. (7) Providers may also have little incentive with FIT systems to drive costs down by improving their operation or efficiency, as their income is guaranteed. (8) Many regulators have conveniently designed around this issue, lowering the tariff each year in the process known as degression. When assessed equally the benefits of FITs overwhelmingly outweigh their costs.

Experience in Germany shows FITs are the best way to encourage expansion of renewable power. Use of the tariffs in Germany increased renewable energy consumption from 6.3 percent in 2000 to 14.2 percent in 2007, an increase of over 200 percent in eight years. According to FIT experts Miguel Mendonca and David Jacobs, over 50 countries, states and provinces have implemented some sort of FIT. Table 1 lists them at the end of 2008. When designed properly FITs can benefit consumers, utilities, politicians, and society simultaneously.

Benefits environment and all of society

Despite the extra initial cost to consumers to cover the expense of the tariff, FIT policies end up benefiting consumers in the long-run by depressing electricity prices after their first few years of operation. The German Federal Ministry of Environment has calculated that while their FIT cost consumers $3.2 billion in higher electricity rates in 2007 (adding an average of 3 [euro] per month to the typical residential electricity bill), it saved them $5 billion in depressed fossil fuel costs and wholesale prices. In Spain, where a similar national FIT saw deployment of 26.7 TWh of wind energy in 2007, the policy cost consumers about $1 billion but depressed the market prices of fossil fuels by 0.6 [euro]cents/kWh, saving utilities (and thus consumers) $1.7 billion in avoided costs (for a net savings of more than 640 million [euro]). The FIT also lowered the average delivered cost of wind energy to 3.8 [euro]cents]/kWh, and if Spanish policymakers achieve their goal of 20,000 MW of wind by 2010, they expect the FIT to produce a net savings of 2.3 billion [euro] per year. (9)

Consumers and electric utilities also benefit from improved energy security. Disruptions and interruptions in supply due to accidents, severe weather, and bottlenecks can prevent fuels such as natural gas, coal, and uranium from being adequately and cost-effectively distributed to conventional power plants. Such depletable fuels are also prone to rapid price escalations as well as significant price volatility, and exposed to sudden fluctuations in currency rates. Between 1995 and 2005 natural gas prices rose by an average of 15 percent yearly; between 2001 and 2006 coal prices rose by 7 percent yearly; and between 2001 and 2006 uranium prices rose by more than 600 percent. Renewable fuels promoted by FITs, in contrast, are free for the taking, widely available, and non-depletable. They are less prone to speculation, do not need to be transported (with some exceptions), and insulate the power sector from dependence on foreign suppliers.

For electric utilities transmitting and distributing power, FITs promote distributed renewable power generators that can improve grid reliability, lessen the need to build expensive transmission infrastructure, reduce congestion, offer important ancillary services, and improve energy security through geographic diversification. By encouraging distributed solar, biomass, and small-scale wind units, FITs create effective alternatives to constructing new transmission and distribution lines, transformers, local taps, feeders, and switchgears, especially in congested areas or regions where permitting new transmission networks is difficult. Distributed renewable systems can provide utilities with a variety of important ancillary services as well, including system control, reactive power supply, and spinning reserves. Because of their smaller size, renewable generators have lower outage rates, decreasing the need for reserve margins. Indeed, researchers at the University of Albany, New York and the National Renewable Energy Laboratory concluded that dispersed solar PV resources are so valuable they could have prevented the $6 billion blackout affecting 40 million people spread across Canada and the United States in 2003. (10)

Because FITs create consistency and predictability for renewable energy financiers, investors, manufacturers, and producers, they bolster domestic renewable energy industries creating hundreds of thousands of new, high-paying jobs, a huge political asset. Economists in Germany have credited their FIT with creating at least 157,000 jobs in renewable energy manufacturing and installation. QCells, based in Wolfen, Germany, overtook Sharp to become the world's largest manufacturer of PV cells in 2008 precisely because of the German FIT, which encouraged their solar industry to grow by a factor of 4 from 2000 to 2006. Enercon, the leading German wind energy manufacturer, expects employment in the domestic renewables industry to increase to 710,000 by 2030, matching the number of jobs offered by the German automobile industry. Correspondingly, the FIT in Spain has created 188,682 new jobs, enabling the country to become the third largest wind turbine manufacturer.


Finally, for both politicians and their constituents, FITs promote more stable local economic growth and minimize environmental degradation. Renewable power sources prompted by FITs involve a highly skilled workforce and modernize the local industry base. Using renewable energy makes local businesses less dependent on imports from other regions, frees up capital for investments outside the energy sector, and serves as an important financial hedge against future energy price spikes. Investments in conventional fossil-fuel and nuclear power plants send money out of the economy whereas investments in renewable power keep money in the economy. About 50 cents for every dollar expended on conventional electricity leaves many economies (and in some areas 80 to 95% of the cost of energy leaves local economies), whereas every dollar invested in renewable electricity can produce $1.40 of gross economic gain. (11)

Importantly, by rapidly incentivizing renewable power plants, FITs reduce more greenhouse gas emissions. When carbon dioxide equivalent emissions from the entire lifecycle are taken into consideration, wind farms, hydroelectric power stations, solar photovoltaics and solar thermal power plants, bioelectric facilities, and geothermal units, all emit the equivalent of between a mean of 5.1 and 59.6 grams of carbon dioxide per kWh. The next closest source, nuclear power, emits a mean of 124 grams of carbon dioxide per kWh, and clean coal and carbon capture and storage systems emit a mean of 439 grams of carbon dioxide per kWh. Conventional fossil-fueled units are even worse and emit between 443 and 1,005 grams per kWh. This means renewable energy technologies are 2 to 24 times more effective on a per kWh basis at mitigating climate change risks. (12) (See Figure 2).


Experience to date suggests FITs offers policymakers the best single tool available to rapidly promote renewable energy. FITs are therefore a vital strategy for promoting a more efficient, medium scale, decentralized electricity system, independent of government funding, operating with minimal degradation of ecological services, resilient to disruptions and price volatility and highly beneficial to all income groups. Thoughtful entrepreneurs, regulators, and citizens in the next decades have much to gain by investing in FITs and the development of renewable power technologies they bring. It's time to take advantage of the potential where everybody truly wins. Now is the time to utilize FITs to craft more coherent national energy policies that protect not only the interests of politicians and energy companies, but also the environment, consumers and society as a whole.


(1) See "Putting it All Together" section of Benjamin K. Sovacool, Dirty Energy Dilemma: What's Blocking Clean Power in the United States (Westport: Praegar, 2008), pp. 113-121.

(2) International Energy Agency, Deploying Renewables: Principles for Effective Policies (Paris: OECD, 2008).

(3) International Energy Agency, Renewable Energy RD&D Priorities: Insights from IEA Technology Programs (Paris: OECD Publishing, 2004), p. 54.

(4) Mark Z. Jacobson and Gilbert M. Masters, "Letters and Responses: The Real Cost of Wind Energy," Science 294 (5544) (November 2, 2001), pp. 1000-1003.

(5) See Volkmar Lauber, "REFIT and RPS: Options for a Harmonized Community Framework," Energy Policy 32 (2004), pp. 1405-1414; Wilson H. Rickerson et al., "If the Shoe FITs: Using Feed-in Tariffs to Meet U.S. Renewable Electricity Targets," Electricity Journal 20(4) (May, 2007), pp. 73-86.

(6) Marc Ringel, "Fostering the Use of Renewable Energies in the European Union: The Race Between Feed-in Tariffs and Green Certificates," Renewable Energy 31 (2006), pp. 1-17.

(7) Marc Ringel, "Fostering the Use of Renewable Energies in the European Union: The Race Between Feed-in Tariffs and Green Certificates," Renewable Energy 31 (2006), pp. 1-17; Mirjam Harmelink, Monique Voogt, and Clemens Cremer, "Analyzing the Effectiveness of Renewable Energy Supporting Policies in the European Union," Energy Policy 34 (2006), pp. 346-347.

(8) Philippe Menanteau, Dominique Finon, Marie-Laure Lamy, "Prices versus Quantities: Choosing Policies for Promoting the Development of Renewable Energy," Energy Policy 31 (2003), pp. 799-812.

(9) See Benjamin K. Sovacool, "The Importance of Comprehensiveness in Renewable Electricity and Energy Efficiency Policy," Energy Policy 37(4) (April, 2009), pp. 1529-1541.

(10) See Richard Perez, Marek Kmiecik, Tom Hoff, John G. Williams, Christy Herig, Steve Letendre, and Robert M. Margolis, Availability of Dispersed Photovoltaic Resource During the August 14th 2003 Northeast Power Outage (Albany, NY: University of Albany, 2007).

(11) These figures come from two studies in California and Arizona. See Black and Veatch, Economic, Energy, and Environmental Benefits of Concentrating Solar Power in California (Los Angeles: Black and Veatch, April 2006); Arizona Department of Commerce Energy Office, Energy Dollar Flow Analysis for the State of Arizona (Phoenix: State of Arizona, 2004).

(12) Mark Z. Jacobson, "Review of Solutions to Global Warming, Air Pollution, and Energy Security," Energy & Environmental Science 2 (2009), pp. 148-173.

Join climate action at 350

350 Aotearoa is part of the international movement ( to unite the world on solutions to climate change. Our mission is to inspire action in New Zealand communities with a sense of unity, urgency and possibility in the face of the climate crisis.

350 Aotearoa was launched on 6 December 2008 at the 350 Climate Action Festival at Waitangi Park in Wellington. founder and renowned author Bill McKibben's recent tour of New Zealand has seen the support base grow exponentially. 350 Aotearoa is now co-ordinating action groups in over 10 regions across Aotearoa. E: ; ph 021 607 488

* 350 Aotearoa invites all New Zealanders to join the International Day of Climate Action. Everyone can get involved and bring their creativity to planning positive, fun, engaging actions to show their support for a 350 world where carbon dioxide in the atmosphere is no more than 350 ppm.

* Early July 2009 we launched our website, which shows how to get involved for the great 350 action for 24 October and to get it noticed by politicians and the media.

* All over New Zealand plans are being hatched for creative actions to make the number 350 visible to everyone on October 24. There'll be 350 surfers in Dunedin and 350 people planting trees in Raglan. In September 2009, in the lead-up to the big day, there'll be a 350 km long walk on the West Coast from Karamea to Franz Josef. The walkers will stop at the three main centres and hold fun activities along the way.

* So have a think what your community action might be. What can you do to make your voice the loudest or most effective?


Benjamin K. Sovacool is research Fellow in the Energy Governance program at the Centre on Asia and Globalisation,, Lee Kuan yew School of public policy, National University of Singapore. He is Adjunct Assistant professor in the Government and International Affairs Program at Virginia Polytechnic Institute and has worked in advisory and research capacities at Oak ridge National Laboratory, the New York State Energy research and Development Authority and the US Dept of energy's Climate Change technology programme. He is author of the book The Dirty Energy Dilemma: What's Blocking Clean Power in the United States, published in 2008. See book review section.
Table 1: FITs Worldwide (end of 2008)

Africa: Algeria, Kenya, Mauritius
Americas: Argentina, Brazil, Canada*, Costa Rica, Ecuador,
Nicaragua, United States *
Asia: India *, Indonesia, Japan *, Korea (South), Pakistan, Philippines,
Sri Lanka, Thailand
Middle East: Israel, Turkey
Australasia: Australia *
Europe: Austria, Croatia, Cyprus, Czech Republic, Denmark, Estonia,
   France, Germany, Greece, Hungary, Ireland, Italy, Latvia,
   Lithuania, Luxembourg, Macedonia, Malta, Netherlands, Portugal,
   Slovak Republic, Slovenia, Spain, Switzerland, Ukraine

* Federations or countries with FITs in jurisdictions below the
national level are asterisked.

Figure 1: Energy research Subsidies in OECD Countries, 1974-2002

Nuclear Fission                    47.3%
Fossil Fuels                       12.7%
Nuclear Fusion                     10.5%
Others                             10.0%
Energy Efficiency                   8.1%
Storage                             3.4%
Geothermal                          1.4%
Biomass                             1.2%
Wind                                1.0%
Ocean                               0.3%
Hydro                               0.1%
Solar                               4.1%
Renwable Energy                     8.0%

Source: International Energy Agency, Renewable Energy RD&D Priorities:
Insights from IEA Technology Programs (Paris: OECD
Publishing, 2004), p. 54.

Note: Table made from pie chart.
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Author:Sovacool, Benjamin K.
Publication:Pacific Ecologist
Article Type:Essay
Geographic Code:1USA
Date:Jan 1, 2009
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