23 Oct 12 Eddie's Blog Global

Subsidies! What’s in the best interest of the consumer?

Energy subsidies always court controversy. The anti-renewables lobby never misses an opportunity to point at the $66 billion spent on renewable energy subsidies globally in 2010. In this blog I will look at the bigger picture and examine two very different types of support mechanisms for renewables and give you my view on which is in the best interest of the consumer.

All forms of energy are subsidised. Some are subsidised directly, ie. in a visible manner like diesel fuel for power generation in Saudi Arabia. Some are subsidised indirectly, like shale gas in the USA. The fact that shale gas exploration does not have to carry out any environmental impact assessment means it is subsidised by comparison with any form of energy that is extracted on the earth’s surface. This includes wind, solar, coal, biomass, and hydro. The profits made from shale gas are also protected by allowing a depletion charge to be made against them. This amounts to 15% of the well resource per annum.

According to the International Energy Agency (IEA) fossil fuel subsidies in 2010 were at least six times larger than renewable energy subsidies.

Global government spending on programmes that directly lowered the cost of consuming or producing oil, natural gas, or coal totaled $409 billion in 2010, a number expected to swell to $630 billion this year, the IEA says.

Wind energy is almost always subsidised. The subsidies range from tax breaks in the USA, to obligation and penalty systems as in the UK Renewable Obligation Certificates (ROCs), to the German fixed price feed in systems (FITs). One exception was the wind power built by Airtricity in Ireland, which by and large was done without subsidy.

Which is the most appropriate subsidy for wind?

If we follow the principle that consumers of a service ought to pay for it then tax based systems are inappropriate. Using tax based subsidies, the general taxpayer reduces the price for a particular service. The price is reduced artificially and consumption is encouraged.

The most notable schemes where the customer pays are the ROCs and the FITs. Both work.

Under the UK ROC scheme the reward to the wind farm owner includes at least two elements: the price for electricity, and the obligation fine. The wind farm owner is therefore partially paid according to the prevailing price for electricity. This price is dominated by the prevailing fossil fuel price. So in a way the wind farm owner is being asked to take fossil fuel price risk. Over the past 40 years this has been alarmingly volatile. There are in principle five things wrong with this arrangement

1. A wind farm owner cannot mitigate fossil fuel price risk. The fundamental philosophy of project management is that risks are allocated to the balance sheet that can manage them. A utility, with its portfolio of generators, including nuclear, gas, and coal can effectively mitigate fossil risk by having wind as part of that portfolio.

2. The customer pays a higher price for electricity because of this mis-allocation of risk. I estimate that the customer pays 15% more for wind energy because of an inappropriate ROC support scheme in the UK.

3. Any reward scheme should seek to pay for actual costs plus allowed profits, not costs which arise external to the project. The ROC support includes a reward component coming from the price of fossil fuels. The costs of building a wind plant are almost completely fixed. The fuel is free. The capital cost is everything.

4. There is a necessary over-rewarding of projects using ROCs.

5. Banks see a variable price for electricity produced from a wind farm, and so they lend less and at a higher interest rate.

The Feed In Tariff system meets the following criteria

· It is fixed. It reflects the cost reality of building a wind plant. No fuel cost, all capital.

· The customer pays for, and takes the benefit from a fixed price for a component of generation. The customer pays less than for ROC because

o Fossil fuel risk is mitigated, by the fixed price paid for wind

o When the wind blows the demand for and price of fossils reduce.

· Banks see a fixed price for all electricity produced. They therefore lend more money (and debt is always the cheapest component of financing a project) at a lesser interest rate. In this way less equity capital can be deployed (very expensive) and more wind plant can be built for the same quantum of equity.

The exact same argument applies to solar, it’s fuel cost being free and the price being only capital.

At no point in the above have we mentioned a carbon tax as a support for renewables. A carbon tax adds cost to the consumer. It is therefore attacked by all consumers, particularly influential ones like cement companies, utilities, and all energy intensive heavy and light industries. We have seen almost 8 years of carbon taxes in the EU (the ETS system). It has not met the goals set for it initially. As far as I can see there has been no new renewable built because of the EUETS. It is too indirect. It can never be seen as a substitute for targeted measures described above. We will deal with carbon taxes in a later blog.