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Comment on “Comparing the feed-in tariff incentives for renewable electricity in Ontario and Germany” by Mabee, Mannion, and Carpenter
Energy Policy 44 (2012) 485–486
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Comment on ‘‘Comparing the feed-in tariff incentives for renewable electricity in Ontario and Germany’’ by Mabee, Mannion, and Carpenter Matthias Weitzel n Kiel Institute for the World Economy, Hindenburgufer 66, 24105 Kiel, Germany
a r t i c l e i n f o
abstract
Article history: Received 23 January 2012 Accepted 4 February 2012 Available online 28 February 2012
In a recent article Mabee et al. [2012, Energy Policy 40 (1), 480–489] describe the German legislation to promote renewable electricity generation (Erneuerbare-Energien-Gesetz). The erroneous assumption that an annual degression of feed-in tariffs for any given power generating facility are stipulated in the law leads to a wrong calculation of net present values of the revenue stream. Reduction of feed-in tariff rates only holds for new additions. There is however one exception in offshore wind energy where the operator can opt for a degression. The implications of the newly introduced option are discussed in this comment. & 2012 Elsevier Ltd. All rights reserved.
Keywords: Feed-in tariffs Renewable electricity Price degression
1. Degression in German feed-in tariffs In German legislation regarding the promotion of renewable electricity (Erneuerbare-Energien-Gesetz, EEG) an annual degression of feed-in tariff (FIT) rates is stipulated. The degression rates range from 1% to 2% per annum for most generation technologies and up to 9% for solar to reflect declined generation costs.1 Depending on capacity additions, degression for solar can be substantially higher, up to 35.4% within one year.2 In their article, Mabee et al. (2012, MMC hereafter) misinterpret the degression in German FITs, assuming to hold for each individual power generation facility. However, instead of being applicable for given facilities, the degression only is applicable for new additions. Once a facility is installed and registered, a fixed rate is paid for a set duration. For a given facility, there is hence neither an indexation to inflation as in Ontario, nor is there a degression as suggested by MMC. The degression is meant to account for the technological progress which leads to lower generation costs. In its function it is therefore similar to the review and revise mechanism in Ontario.
n
Tel.: þ49 431 8814 580; fax: þ 49 431 8814 500. E-mail address: [email protected] 1 Offshore wind and geothermal energy have degression rates of 7% and 5%, respectively, but only starting in 2018 (Germany, 2012). 2 The regular degression for solar energy takes place on January 1 and is set to 9%. Depending on the capacity additions in the 12 months prior to the past October, this rate can be increased by up to 15 percentage points. Additionally, depending on capacity additions between past October and past May, FIT are cut up to 15% on July 1 (Germany, 2011). 0301-4215/$ - see front matter & 2012 Elsevier Ltd. All rights reserved. doi:10.1016/j.enpol.2012.02.015
However, there is one exception in German rates where FITs are lowered for a given power generation facility over time. Since the beginning of 2012, offshore wind energy operators can opt for a degression scheme, in which the FIT for a given wind energy facility is higher at the beginning and then reduced. Since this yields a similar phenomenon as described by MMC, it might be useful to look at the effect of FIT degression of individual facilities in more detail.
2. Implications of feed-in tariff degression for individual power generation facilities From the investor’s perspective the net present value (NPV) of the revenue stream is determining whether the investment into a specific generation facility is profitable. MMC only calculate the NPV from the FIT revenue stream and abstract from other forms of income or operating cost. Since the tariff for a given facility in Germany is not decreased over time, MMC understate the NPV compared to the actual fixed rate. The NPV can however also be changed by keeping the total payments constant (see KPMG, 2010 for examples in the offshore wind sector). If a higher tariff for a given power generation facility is paid earlier and the rate is subsequently reduced, a larger share of revenues is discounted less. Hence, the NPV is increased as the average discounting is reduced. Also from a cash-flow perspective this might be important for the investor. If the capital is tied up for a shorter period, additional investments can be carried out earlier or debt can be serviced earlier. It is (implicitly) argued that this payment model is beneficial for the investor by increasing the return of the project, but at the same time keeping overall FIT
486
M. Weitzel / Energy Policy 44 (2012) 485–486
as the loss of the consumers could outweigh the higher gain of the investor. There is hence a trade-off between fostering investment in renewable electricity and the cost borne by the ratepayer.
3. Conclusion
Fig. 1. Absolute (A) and discounted (B) FIT rates for offshore wind in Germany. The base tariff rate of 3.5 cents is used here after 12 or 15 years, respectively. In reality, the electricity would then be sold outside the EEG at higher market prices (Germany, 2011; KPMG, 2010), this would not change the outcome of the example.
payments constant for society (KPMG, 2010). Fig. 1 gives a simple example for the situation as would be applicable for German offshore wind. The FIT for offshore wind generation is set to 15 cents per kWh for a duration of 12 years. In addition, this duration is extended depending on water depth and distance to coast, in this example for 3 years. In the most recent revision of the German EEG, offshore wind operators can now opt for a model with higher FITs of 19 cents but for only 8 years, the extension is equal to the regular FIT at a rate of 15 cents per kWh (Germany, 2011, Section 31 Abs. 3). The total (undiscounted) payment (A) would be smaller in the degression case, as the area below the dotted line (degressed) is smaller than continuous line. The opposite holds when the FIT rates are discounted (B) using an 8% discount rate as in MMC, the degression option increases the NPV because the initial higher rates are worth more to the investor than burden of the reduced rates later. Shifting a part of the tariff revenue to an earlier stage however comes at a cost, because a larger share has to be paid earlier and the NPV of the total payments rises. In Germany, FITs are paid for by the ratepayers, mostly firms and private consumers. If the discount rate of the ratepayer were equal to the discount rate applied by the investor, this is a pure wealth transfer. Firms should have similar rates as the investors since they orient at market interest rates. Empirical evidence shows that private consumer’s discount rates can be quite high and might even exceed discount rates that investors apply (Frederick et al., 2002). Therefore, it is not clear whether a FIT schedule with degression is welfare improving
Correcting the NPV calculation of MMC, the NPVs for Germany would still be lower than for Ontario. This does not necessarily need to imply that FITs are set too generous in Ontario, it could also be the result of differences in the cost for renewable electricity generation technologies (including the cost for installation, differences in the tax system and the time cost of registering the project), differences in resource endowment (MMC assume this to be equal in Germany and Ontario), or differences in perceived risk. The latter includes inflation risk, which is reduced in Ontario by indexing the FIT rates to changes in the consumer price index. Consequently the NPV an investor requires in Ontario should ceteris paribus be lower than in Germany, as the investment would be less risky in terms of inflation risk. This is however not observed in the data. A degression as discussed in this comment on the other hand does not change the risk compared to a fixed rate. To keep the investor’s NPV constant, a higher initial FIT rate would be necessary. In general, the NPV from the FIT revenue can be increased from the investor’s perspective by introducing a FIT degression keeping the total (undiscounted) payments unchanged. In the case of offshore wind energy in Germany such a degression option aims at improving the NPV for investors and hence increase the number of offshore wind installations which currently lag behind expectations. On the other hand, this increases the NPV of the cost borne by the ratepayer. Whether the increase of the positive NPV for the investor or the negative NPV of the ratepayer dominates a welfare comparison depends on their magnitude of their respective discount rates.
References Frederick, S., Loewenstein, G., O’Donoghue, T., 2002. Time discounting and time preference: a critical review. Journal of Economic Literature 40 (2), 351–401. ¨ den Vorrang Erneuerbarer Energien (ErneuerbareGermany, 2011. Gesetz fur ¨ Energien-Gesetz—EEG). zuletzt geandert durch Artikel 2 G. v. 22.12.2011. /http://www.gesetze-im-internet.de/bundesrecht/eeg_2009/gesamt.pdfS. KPMG, 2010. Offshore Wind in Europe: 2010 Market Report. KPMG, Berlin, Frankfurt. Mabee, W., Mannion, J., Carpenter, T., 2012. Comparing the feed-in tariff incentives for renewable electricity in Ontario and Germany. Energy Policy 40 (1), 480–489.
Contents lists available at SciVerse ScienceDirect
Energy Policy journal homepage: www.elsevier.com/locate/enpol
Forum
Comment on ‘‘Comparing the feed-in tariff incentives for renewable electricity in Ontario and Germany’’ by Mabee, Mannion, and Carpenter Matthias Weitzel n Kiel Institute for the World Economy, Hindenburgufer 66, 24105 Kiel, Germany
a r t i c l e i n f o
abstract
Article history: Received 23 January 2012 Accepted 4 February 2012 Available online 28 February 2012
In a recent article Mabee et al. [2012, Energy Policy 40 (1), 480–489] describe the German legislation to promote renewable electricity generation (Erneuerbare-Energien-Gesetz). The erroneous assumption that an annual degression of feed-in tariffs for any given power generating facility are stipulated in the law leads to a wrong calculation of net present values of the revenue stream. Reduction of feed-in tariff rates only holds for new additions. There is however one exception in offshore wind energy where the operator can opt for a degression. The implications of the newly introduced option are discussed in this comment. & 2012 Elsevier Ltd. All rights reserved.
Keywords: Feed-in tariffs Renewable electricity Price degression
1. Degression in German feed-in tariffs In German legislation regarding the promotion of renewable electricity (Erneuerbare-Energien-Gesetz, EEG) an annual degression of feed-in tariff (FIT) rates is stipulated. The degression rates range from 1% to 2% per annum for most generation technologies and up to 9% for solar to reflect declined generation costs.1 Depending on capacity additions, degression for solar can be substantially higher, up to 35.4% within one year.2 In their article, Mabee et al. (2012, MMC hereafter) misinterpret the degression in German FITs, assuming to hold for each individual power generation facility. However, instead of being applicable for given facilities, the degression only is applicable for new additions. Once a facility is installed and registered, a fixed rate is paid for a set duration. For a given facility, there is hence neither an indexation to inflation as in Ontario, nor is there a degression as suggested by MMC. The degression is meant to account for the technological progress which leads to lower generation costs. In its function it is therefore similar to the review and revise mechanism in Ontario.
n
Tel.: þ49 431 8814 580; fax: þ 49 431 8814 500. E-mail address: [email protected] 1 Offshore wind and geothermal energy have degression rates of 7% and 5%, respectively, but only starting in 2018 (Germany, 2012). 2 The regular degression for solar energy takes place on January 1 and is set to 9%. Depending on the capacity additions in the 12 months prior to the past October, this rate can be increased by up to 15 percentage points. Additionally, depending on capacity additions between past October and past May, FIT are cut up to 15% on July 1 (Germany, 2011). 0301-4215/$ - see front matter & 2012 Elsevier Ltd. All rights reserved. doi:10.1016/j.enpol.2012.02.015
However, there is one exception in German rates where FITs are lowered for a given power generation facility over time. Since the beginning of 2012, offshore wind energy operators can opt for a degression scheme, in which the FIT for a given wind energy facility is higher at the beginning and then reduced. Since this yields a similar phenomenon as described by MMC, it might be useful to look at the effect of FIT degression of individual facilities in more detail.
2. Implications of feed-in tariff degression for individual power generation facilities From the investor’s perspective the net present value (NPV) of the revenue stream is determining whether the investment into a specific generation facility is profitable. MMC only calculate the NPV from the FIT revenue stream and abstract from other forms of income or operating cost. Since the tariff for a given facility in Germany is not decreased over time, MMC understate the NPV compared to the actual fixed rate. The NPV can however also be changed by keeping the total payments constant (see KPMG, 2010 for examples in the offshore wind sector). If a higher tariff for a given power generation facility is paid earlier and the rate is subsequently reduced, a larger share of revenues is discounted less. Hence, the NPV is increased as the average discounting is reduced. Also from a cash-flow perspective this might be important for the investor. If the capital is tied up for a shorter period, additional investments can be carried out earlier or debt can be serviced earlier. It is (implicitly) argued that this payment model is beneficial for the investor by increasing the return of the project, but at the same time keeping overall FIT
486
M. Weitzel / Energy Policy 44 (2012) 485–486
as the loss of the consumers could outweigh the higher gain of the investor. There is hence a trade-off between fostering investment in renewable electricity and the cost borne by the ratepayer.
3. Conclusion
Fig. 1. Absolute (A) and discounted (B) FIT rates for offshore wind in Germany. The base tariff rate of 3.5 cents is used here after 12 or 15 years, respectively. In reality, the electricity would then be sold outside the EEG at higher market prices (Germany, 2011; KPMG, 2010), this would not change the outcome of the example.
payments constant for society (KPMG, 2010). Fig. 1 gives a simple example for the situation as would be applicable for German offshore wind. The FIT for offshore wind generation is set to 15 cents per kWh for a duration of 12 years. In addition, this duration is extended depending on water depth and distance to coast, in this example for 3 years. In the most recent revision of the German EEG, offshore wind operators can now opt for a model with higher FITs of 19 cents but for only 8 years, the extension is equal to the regular FIT at a rate of 15 cents per kWh (Germany, 2011, Section 31 Abs. 3). The total (undiscounted) payment (A) would be smaller in the degression case, as the area below the dotted line (degressed) is smaller than continuous line. The opposite holds when the FIT rates are discounted (B) using an 8% discount rate as in MMC, the degression option increases the NPV because the initial higher rates are worth more to the investor than burden of the reduced rates later. Shifting a part of the tariff revenue to an earlier stage however comes at a cost, because a larger share has to be paid earlier and the NPV of the total payments rises. In Germany, FITs are paid for by the ratepayers, mostly firms and private consumers. If the discount rate of the ratepayer were equal to the discount rate applied by the investor, this is a pure wealth transfer. Firms should have similar rates as the investors since they orient at market interest rates. Empirical evidence shows that private consumer’s discount rates can be quite high and might even exceed discount rates that investors apply (Frederick et al., 2002). Therefore, it is not clear whether a FIT schedule with degression is welfare improving
Correcting the NPV calculation of MMC, the NPVs for Germany would still be lower than for Ontario. This does not necessarily need to imply that FITs are set too generous in Ontario, it could also be the result of differences in the cost for renewable electricity generation technologies (including the cost for installation, differences in the tax system and the time cost of registering the project), differences in resource endowment (MMC assume this to be equal in Germany and Ontario), or differences in perceived risk. The latter includes inflation risk, which is reduced in Ontario by indexing the FIT rates to changes in the consumer price index. Consequently the NPV an investor requires in Ontario should ceteris paribus be lower than in Germany, as the investment would be less risky in terms of inflation risk. This is however not observed in the data. A degression as discussed in this comment on the other hand does not change the risk compared to a fixed rate. To keep the investor’s NPV constant, a higher initial FIT rate would be necessary. In general, the NPV from the FIT revenue can be increased from the investor’s perspective by introducing a FIT degression keeping the total (undiscounted) payments unchanged. In the case of offshore wind energy in Germany such a degression option aims at improving the NPV for investors and hence increase the number of offshore wind installations which currently lag behind expectations. On the other hand, this increases the NPV of the cost borne by the ratepayer. Whether the increase of the positive NPV for the investor or the negative NPV of the ratepayer dominates a welfare comparison depends on their magnitude of their respective discount rates.
References Frederick, S., Loewenstein, G., O’Donoghue, T., 2002. Time discounting and time preference: a critical review. Journal of Economic Literature 40 (2), 351–401. ¨ den Vorrang Erneuerbarer Energien (ErneuerbareGermany, 2011. Gesetz fur ¨ Energien-Gesetz—EEG). zuletzt geandert durch Artikel 2 G. v. 22.12.2011. /http://www.gesetze-im-internet.de/bundesrecht/eeg_2009/gesamt.pdfS. KPMG, 2010. Offshore Wind in Europe: 2010 Market Report. KPMG, Berlin, Frankfurt. Mabee, W., Mannion, J., Carpenter, T., 2012. Comparing the feed-in tariff incentives for renewable electricity in Ontario and Germany. Energy Policy 40 (1), 480–489.