The mechanisms that countries around the world have used to get wind energy on to the grid and pay for it are changing as governments look for ways to lower costs and better align additions of new capacity with market signals.
"Where we're moving globally is away from the feed-in tariff and towards competitive auctions," says Amy Grace, head of wind at Bloomberg New Energy Finance (BNEF). "Brazil was really the first to start that, and it has been very successful. They've been able to build a tremendous amount of wind, and relatively cheaply. They do have great wind resources, but the auctions have played a strong part in bringing costs down. South Africa followed, and Europe has been watching."
According to Global Trends in Renewable Energy 2015, a report issued by the United Nations Environment Programme in March, the number of countries implementing auction programmes to procure renewables shot up from 10 in 2009 to 44 in 2013. That number is expected to grow further, given guidelines issued last year by the European Commission calling for the gradual introduction of competitive bidding processes for allocating public support to renewables.
"It is time for renewables to join the market," says Joaquin Almunia, the commission's vice-president in charge of competition policy. "The new guidelines provide a framework for designing more efficient public-support measures that reflect market conditions."
Industry incubation
The shift is a significant one for the wind industry. By far the most common mechanism for encouraging renewable-energy development globally has been feed-in tariffs (FIT), first introduced by Germany in 1990 and utilised in some form by dozens of jurisdictions since. The mechanism essentially creates an obligation to buy wind energy at prices that are mandated by government and, while these above-market payments have been integral to incubating the industry over the past two decades, they also have drawbacks.
"The feed-in tariff has been great for getting a lot of capacity installed quickly, but it has been a disastrous policy for a lot of countries from the perspective of cost," says Grace.
The 2009 financial crisis set the stage for this evolving landscape, with southern European countries like Spain and Italy backing off on support for renewables in an effort to rein in burgeoning budget deficits. Concern about the impact of rising levels of low marginal-cost generators on wholesale market price signals has prompted a search for new ways to integrate wind energy into markets. And when it comes to the FIT design itself, the mechanism is not always able to react quickly to the falling cost of wind energy, bottlenecks in transmission, or sluggish growth in electricity demand.
Governments are increasingly seeing the move to market-based support for renewable energy as a way past these challenges. In a competitive auction process, bidders offering to accept the lowest tariffs per megawatt hour are selected to build the capacity. Prices reflect the latest technology costs, and governments have control over the volume of energy they buy, making it easier to respond to changes in market conditions and align power purchases with infrastructure build out.
Competitive auctions are starting to displace other traditional support mechanisms as well. The UK, for example, is transitioning away from its renewables obligation support scheme - which requires electricity retailers to include a rising proportion of renewable energy in their electricity portfolios through the purchase of green certificates - towards a system under which all types of low-carbon producers have to compete against each other for contracts guaranteeing a set price for their electricity.
The so-called contract for difference, or CfD, mechanism is tied directly to the underlying wholesale power market. The auction sets a "strike price" for output from the project based on the developer's bid. When market prices fall below that level, the producer receives a top-up payment from the government, and when the wholesale price rises above it, the generator pays the difference back to the government. The idea is to provide generators with a more stable revenue stream and, at the same time, minimise what consumers have to pay to support renewable energy when electricity prices are high. The first CfD auction, completed in February, also managed to tap into ongoing cost reductions for wind energy. The 27 winning projects, which include 15 onshore wind farms and two offshore projects, will share subsidies of about £315 million (€430 million) a year by 2021, which the government estimates is about £110 million a year less than they would have been without competition.
Dangerously low
Competitive market mechanisms are not without potential pitfalls. The results of Brazil's recent A3 auction prompted warnings that the low average contract price of BRL 181.14/MWh ($50.40/MWh) could hurt the profitability of projects. And in the UK, the average strike price for offshore in the CfD auction was an unexpectedly low £117/MWh, raising questions in some quarters about whether the projects could ultimately be built.
Bidding too low in order to win a contract is the danger in competitive auction systems, says Grace. "With all auctions the risk is that young developers in the heat of the moment bid prices so low that they actually can't deliver on those prices. So you may have this lost capacity," she says.
There are strategies for mitigating that risk. Brazil, Grace notes, factors the likelihood of project attrition into the amount of capacity it sets out to procure. In Ontario, Canada, the province is currently reviewing bids in its first competitive renewable-energy procurement since scrapping its FIT programme for large-scale projects last year. It put developers through a rigorous prequalification process that included demonstrating they had successfully completed at least one complex infrastructure project worth more than C$200 million (US$150 million).
The process can also pile significant risk on to developers. "In many of these countries you are not just bidding theoretical capacity, you are bidding capacity that has its grid connections, permits and things like that already in place," says Grace. "You can't enter the auction until you have all that secured. So there is a lot of money going out even before a developer has any guarantee it will get money from the project. It puts a lot of stress on the developers."
Because of this need for significant capital outlay, well-capitalised large players have a strategic advantage under competitive procurement systems. That has raised concerns in Germany, where some worry the country's planned move to an auction system in 2017 will see citizens who want to invest in small, local wind farms cut out of the equation.
There is room for policy trade-offs in the competitive model, however, with jurisdictions ranging from Brazil to Quebec developing rules around desired outcomes, such as local jobs, local manufacturing or even local ownership. "Each country is slightly different in how they structure it," Grace says.
Although the move to competitive procurement is accelerating, it is by no means universal. China remains firmly tied to the FIT model, despite the challenges it has encountered. The decision to cut FITs for wind projects starting next year, for example, has prompted a wind rush by developers that is going to put more pressure on an already overloaded grid and is likely to increase the amount of unconnected wind power capacity to 22.2GW by the end of this year, according to Feng Zhao, a renewable-energy specialist at consultancy FTI Intelligence.
Whether there will be more tariff cuts in an effort to manage the installation boom and get a handle on rising costs to consumers, remains to be seen, but Zhao does expect that China will eventually follow European countries in the switch to competitive bidding. "I think the auction is the best way for the policymakers to get the total amount of renewable energy additions under control. That's what we saw in Brazil and South Africa," he says.
Climate policy
With momentum building toward the COP21 UN climate summit in Paris this December, climate action seems likely to play a role in the design of least-cost market structures for wind energy over the long term. The US industry, anticipating the eventual end of its main support mechanism, the $0.023/kWh production tax credit, is looking to proposed new carbon regulations to provide a long-term footing for the industry. In its June position paper on market reform, the European Wind Energy Association called for reforms to the EU's emissions trading system to create longer-term investment signals for abatement options like wind. China is also working on its own national carbon trading scheme.
"We will see how it works there, and it will absolutely provide a reference to the rest of the world," says Zhao. "I personally expect that it will have an impact on wind and renewables in general."
PAYING FOR WIND — THE MOST COMMON POLICY SUPPORT AND MARKET MECHANISMS AT A GLANCE
Feed-in tariffs (FIT)
An obligation on electric utilities to buy wind energy at fixed power purchase prices set by government. The mechanism has proven very effective for bringing large amounts of new wind energy online quickly by providing stable long-term revenues that facilitate access to financing.
FITs can be slow to respond to changing market conditions, and the unpredictability of market uptake means it can be difficult to control overall policy costs. China, Japan, Germany and Denmark are among dozens of countries that have employed FIT systems.
Tax credits
A mechanism used mainly in the US that provides either an investment tax credit (ITC), based on total project cost, or a production tax credit (PTC), paid for each kilowatt hour of electricity produced for ten years. The credit reduces the cost of wind for buyers, but is accessible only to investors with large tax bills. This can limit the pool of potential investors and increase project financing cost. US developers also face significant uncertainty over whether the credits, which generally expire every year or two, will be renewed.
Green certificates
Governments place an obligation on electricity retailers to source an increasing proportion of their supply from renewable sources. Wind generators receive a green certificate for each unit of electricity produced, then sell them to retailers who use the certificates to show compliance. The wind-generated electricity is sold on into the wholesale market.
Oversupply of credits in one market drives down costs, as does the falling costs of wind-energy production. A drawback for developers is that they are exposed to the volatility of both electricity and green certificate prices. Markets using this mechanism include Norway, Sweden, and, until 2016, the UK.
Auctions
Competitive bidding for governmentor utility-sponsored contracts drives down purchase prices, which are locked-in over the long term and free from retroactive policy changes. The cost of participating can be high, giving large market players a strategic advantage. They can be structured in various ways to suit the local market, and are becoming more common.
Contracts for difference (CfD)
Recently introduced in the UK, this mechanism uses auction bids from developers to set a "strike price" for output from an individual project.
When market prices fall below that strike price, the producer receives a top-up payment from the government, and when the wholesale price rises above it, the generator pays back the difference to the government. CfDs provide generators with a stable revenue stream while minimising subsidy costs to consumers.
Power purchase agreements (PPA)
Long-term agreements to sell the wind energy through PPAs lock-in revenue for the wind generator, easing access to financing and fixing the costs for the utility, protecting against future fuel and carbon price increases.
The PPA lays out which costs and risk are borne by the power provider and which by the utility, all of which need to be factored into the price. PPAs are standard in most North American markets.
Hedging
A hedge is a financial agreement designed to smooth out price volatility in wholesale power markets and deliver stable cash flow to a project when PPAs are not available, allowing developers to access project financing.
Hedges are often for shorter terms than PPAs and usually do not cover the full output of the facility, leaving the project exposed to significant market risk. But this can also be an opportunity to earn higher returns as market prices rise.
Wholesale power markets
Competitive power markets provide an opportunity for wind producers to sell their output, but without a hedge or some form of stable revenue stream, it exposes projects to short-term price volatility and makes financing extremely difficult and expensive.
A growing penetration of renewables can also have a price-depressing effect, which can negatively affect revenues.
Selling direct to power user
An emerging market, particularly in the US, where commercial consumers agree contracts directly with wind generators for renewable energy. The drivers vary, and include locking-in stable prices and meeting internal carbon goals. Market structures and tariffs that facilitate these types of deals are key.
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