FIT for purpose? Feed-in tariffs set to work alongside ROCs

A recent Law Now identified that the Energy Act 2008 (the “Act”) includes specific provisions for the introduction of a feed-in tariff system (“FIT”) for renewable energies, making it possible for micro-generators (including single site operators, community developments, affordable housing schemes and farmers) to benefit from generating small-scale low-carbon energy. Under the new provisions micro-generators will be permitted to set up schemes of up to a maximum of 5MW. In this update we explore the implications of FITs in more detail, for those less familiar with this mechanism.

What are FITs?

FITs are mechanisms providing financial incentives to encourage small scale low carbon generation of electricity fed into the grid. These are supported by requirements for distribution licence holders to source a percentage of electricity generated in this way. The premium rates at which national and electricity utilities are obliged to buy electricity from small scale renewable generators are set by the government. FITs have already proven very effective in furthering wind power deployment in countries like Germany and Spain and have been adopted in over 40 countries and regions.

The ability to introduce FITs

The original wording in the Energy Bill provided that within one year the SoS “shall make regulations…for the purpose of introducing a renewable energy tariff for a specified fixed period to specified producers of renewable energy.” It was envisaged that these regulations would cover tariff levels and conditions including the amount of the FIT by technology, size and class; details of eligible organisations; funding; administration; and more importantly, the right of “specified producers of renewable energy to have their production conveyed into a distribution system as a priority.”

In contrast the Act merely grants the Secretary of State the necessary powers to introduce FITs. The final text provides that the government may modify conditions under certain licences under sections 6(1) (c) or (d) of the Electricity Act 1989 (which deal with distribution and supply licences) and exercise powers to establish or make arrangements for a FIT or a scheme of financial incentives to encourage small-scale low-carbon generation. The Secretary of State must consult the holder of any licence being modified, the Gas and Electricity Market Authority and other appropriate persons. 40 days after presenting the proposed modifications approval must be obtained from Parliament. If approval is not granted, no further action may be taken but revised provisions may later be circulated for approval. Further detail on proposed regulations covering the operation of FITs is awaited.

5 megawatt threshold

The productive capacity of electrical generators operated by utility companies is often measured in MW. The threshold of 5MW has been set as a cap on the size of any one renewable energy technology installed by a small-scale low carbon generator. Any renewable technology which produces up to and including 5MW of electricity will be eligible for the tariff. It is generally thought that if micro-generators sell 2MW of renewable electricity to the grid, it is sufficient to power a community of more than 1,000 people. 5MW, therefore, is a substantial figure.

Eligible technologies and energy sources

Technologies and energy sources eligible to participate in the scheme are: biomass, biofuels, fuel cells, photovoltaics, water (including waves and tides), wind, solar power, geothermal sources and combined heat and power systems with an electrical capacity of 50 kilowatts or less. The list may be modified in order to take account of emerging technologies.

Current system

The UK, US and Japan have thus far utilised a quota model to promote renewables instead of setting a price for renewable energy. In the UK, this quota system is known as the Renewables Obligation (RO), which came into force in April 2002. It places an obligation on UK electricity suppliers to source an increasing proportion of their electricity from renewable sources. Electricity suppliers meet their renewable energy obligations by presenting sufficient Renewables Obligation Certificates (“ROCs”). Where suppliers do not have sufficient ROCs to meet their obligations, they must pay an equivalent amount into a fund, the proceeds of which are paid back on a pro-rata basis to those suppliers that have presented adequate ROCs. This is known as the “buy-out price” – fixed at £33.24/MWh for 2006/07 which rises with inflation each year. The RO in UK started at 3% in 2002 and is increased each year. The target for 2008/9 is 9.1% rising to 15.4% in 2015.

Empirical studies have shown that quota systems produce less renewable energy deployment and at a much higher cost, than FITs. One of the main criticisms of the quota system is the fact that there is often a lack of support across all technologies, as quota systems tend to result in only the cheapest technologies being invested in first. Also, the greater investment risk inherent in quota systems in general acts to restrict the size of investor that can participate. While this is not an issue for large utility companies, householders cannot make cost-effective investments in residential photovoltaics (PV) without further incentives. More importantly, it has been suggested that should the current scheme of ROCs remain as it is, then UK will only achieve 5% (instead of 15%) of renewables by 2020. At present, less than 2% of energy is produced by renewables. It is envisaged that FITs will complement- not replace - the RO.

Success of FITs in other countries

The task of FITs is to transform macro social economics into the micro incentives that will mobilize the renewable energy technologies. It is crucially important to get the policy right, and feed-in legislation has been proved to be the most effective policy for this purpose. This is essentially a ‘pricing law’, where the rates paid to producers of electricity from renewable sources are set in law, and calculated to provide sufficient profitability for the investment. Countries like Germany, Spain and Denmark have demonstrated the possible outcomes of well-designed FITs. Denmark now generates 20% of its electricity from wind power. Spain also has a very effective FIT, which has helped to make them one of the world’s top renewables manufacturers. They have set themselves a target of producing 30% of their electricity from renewables by 2010, and are presently at 16.2%.

Germany has transformed from having no real renewables market to becoming a world leader in renewable energy capacity, technology, manufacture and policy, with a new, multibillion-euro industry and over 214,000 new jobs – within 15 years of implementing a feed-in law. The German FIT model (Erneuerbare-Energien-Gesetz, or EEG) provides renewable generators with a technology specific fixed premium per unit for a fixed period of time. More expensive options such as PVs receive a higher premium than cheaper options such as wind power. Each year the premium given to new developments is reduced to reflect technological improvements. Payments to existing developments are fixed and protected and are assured for 20 years. According to the Federal Environment Ministry, the use of renewables prevented the emission of 83 million tonnes of CO2 in 2005. In 2006 the share of total electricity consumption in Germany from renewables rose to 11.8 %, and German renewables companies had a combined turnover of €21.6 billion.

Reasons for introducing FITs in UK

It is anticipated that FITs will not only benefit UK micro-generators but also single site operators, community developments, affordable housing schemes, schools and farmers, who are unlikely to want to trade in the ROCs market with large energy companies. Other benefits of FITs include the following:

• A fixed price provides investors with greater security of income
• Differentiation by technology allows countries to target support according to the technological maturity of each technology and adjust support as technologies improve
• FITs are simpler in operation than ROC type schemes
• FITs encourage steady growth of small- and medium-scale producers
• Low transaction costs
• Ease of financing
• Ease of entry

Drawbacks of FITs

If FITs are not managed properly and tariff levels/time periods/technology preferences are not set appropriately, FITs can prove to be ineffective. In addition, if tariffs are not adjusted over time, consumers may pay unnecessarily high prices for renewable power. This can be addressed through monitoring, however.

Conclusion

At present the RO is designed to assist large-scale projects leaving a small-scale electricity generation gap. It is expected that the RO and, the new FIT, will work in parallel with generators helping them choose the most appropriate support scheme according to their needs whilst encouraging investment in alternative energy sources and technology which will be a key ingredient in meeting Climate Change Act reductions in CO2 emissions and achieving an appropriate energy mix to deliver the UK’s share of the EU target of 20% of energy from renewable sources by 2020.