63214 ENERGY AND MINING SECTOR BOARD DISCUSSION PAPER PAPER NO.22 APRIL, 2011 Design and Performance of Policy Instruments to Promote the Development of Renewable Energy: Emerging Experience in Selected Developing Countries Gabriela Elizondo Azuela Luiz Augusto Barroso The World Bank, Washington, DC THE WORLD BANK GROUP The Energy and Mining Sector Board AUTHORS CONTACT INFORMATION Gabriela Elizondo Azuela is a senior energy specialist in To order additional copies of this discussion paper, the World Bank’s Energy Anchor Unit of the Sustainable please contact the Energy Help Desk: 202-473-0652, Energy Department (SEGEN). energyhelpdesk@worldbank.org Luiz Augusto Barroso is the technical director of Brazilian This paper is available online: www.worldbank.org/ consultant company PSR. energy/ DISCLAIMERS The material in this work is copyrighted. 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All rights reserved CONTENTS ACRONYMS AND ABBREVIATIONS ........................ v UNITS OF MEASURE ................................................. v FOREWORD .............................................................. vi ACKNOWLEDGMENTS............................................ vii 1. SCOPE AND COVERAGE OF THE STUDY .......... 1 2. SUMMARY OF KEY FINDINGS ........................... 1 3. BACKGROUND.................................................... 2 The Growing Importance of RE Development ...... 2 Use of RE Policy Tools to Support RE in Developed and Developing Countries ............ 3 Experience with the Use of RE Policy Mechanisms in Developed Countries .............. 4 Policy Choice and Trends in Developing Countries ......................................................... 5 4. EMERGING EXPERIENCE IN SELECTED DEVELOPING COUNTRIES ................................. 7 Objectives of the Review and Characterization of the Sample .................................................. 7 Emerging Experience with Designing and Implementing Price-Setting Policies ................. 8 Emerging Experience with Designing and Implementing Quantity-Setting Policies......... 12 Formal RE Targets ........................................... 12 Procurement Mechanisms ............................... 13 Experience with Auctions in Brazil ................... 14 Policy Interactions and Instrument Compatibility ................................................. 17 Investment Tax Credits and Feed-in Tariff Policies .............................................. 18 Firm Capacity Incentives and Obligations ....... 19 5. POLICY PERFORMANCE.................................... 21 Attainment of Targets ......................................... 21 Effectiveness of Policy Package in Sample Countries ....................................................... 22 Brazil and India .............................................. 22 Turkey and Sri Lanka ...................................... 24 Indonesia and Nicaragua ............................... 26 Alignment of Exhibited Trends in RE Deployment to Future Committed Targets..... 27 Economic Efficiency of RE Policy in Sample Countries ....................................................... 27 Costs and Impacts of RE Policy........................ 27 Economic Efficiency in Policy Design ............... 29 Sustainability of Incremental Cost Recovery Mechanisms ............................................... 30 6. POLICY TRENDS AND MARKET STRUCTURE .. 31 Market Structure and Types of Policy Instruments .................................................... 31 Market Structure and Types of Procurement Methods ......................................................... 31 Market Structure and Policy Performance ........... 31 Use of RE Policy Instruments in Different Market and System Structures ....................... 32 7. KEY FINDINGS .................................................. 33 Figure 9: Evolution of RE Capacity and Emerging Experience with Feed-in Tariff Share in Power System, Brazil ........... 23 Policies ........................................................... 33 Figure 10: Effectiveness as Average Annual Emerging Experience with Competitive Growth, India .................................... 23 Schemes ........................................................ 34 Figure 11: Evolution of RE Capacity and Emerging Trends on the Use of Price and Share in Power System, Turkey .......... 25 Quota-Based Mechanisms............................. 35 Figure 12: Evolution of RE Capacity and General Lessons of Experience ........................... 35 Share in Power System, Sri Lanka ..... 25 Final Remarks ..................................................... 36 Figure 13: Evolution of RE Capacity and Share in Power System, Indonesia .... 26 APPENDIX 1: TYPES OF RE POLICY Figure 14: Evolution of RE Capacity and MECHANISMS AND INCENTIVES ................... 37 Share in Power System, Nicaragua ... 27 APPENDIX 2: POLICY PACKAGE OF SAMPLE Figure 15: Evolution of AAG vis-à-vis AAG COUNTRIES AS OF LAST REFORM Required for Reaching Targets (2009–10) .......................................................... 38 for All RE ............................................ 28 APPENDIX 3: INSTRUMENT COMPARISON ........ 40 Figure 16: Estimated Cost and Impact of Meeting RE Target, Sri Lanka ........ 29 GLOSSARY .............................................................. 41 REFERENCES ........................................................... 43 TABLES DATA SOURCES ...................................................... 45 Table 1: RE Policy Instruments: Adoption and Policy Shifts................................... 6 BOXES Table 2: Policy Mix in Selected Countries Box 1: Feed-in Tariff Policy in Brazil ...................10 as of the Last Reform, 2010 ................ 9 FIGURES Table 3: FIT Design in Sample Countries Figure 1: Use of RE Policy Instruments................ 5 as of the Last Reform (2010) ............. 11 Figure 2: Mapping the Sample ........................... 7 Table 4: Compliance with RPO in India, Figure 3: Options for RE Procurement in 2009 .................................................. 12 Sample Countries .............................. 14 Table 5: Formal and Indicative Targets Figure 4: Capacity Factor vs. Winning in Sample Countries .......................... 13 Auctioned Prices for On-Shore Table 6: Final Bid in Brazil Auctions and Wind .................................................. 16 FITs for On-Shore Wind ..................... 15 Figure 5: Remuneration Level Efficiency Table 7: Efficiency Comparison: On-Shore Wind ................................. 16 PROINFA and Auctions ...................... 17 Figure 6: Evolution of Wind Capacity and Table 8: Subsidy Required for Meeting RE Aggregated CF, India ......................... 18 Targets, India and Sri Lanka ............. 28 Figure 7: Degree to which Official Targets Table 9: Incremental Cost Recovery on RE have been Attained ................. 21 Mechanisms ....................................... 29 Figure 8: Evolution of RE Capacity and Share in Power System, India ............ 22 ACRONYMS AND ABBREVIATIONS ANEEL Brazilian Electricity Regulatory Agency Agência Nacional de Energia Elétrica AAG Average annual growth BNDES Brazilian Development Bank O Banco Nacional de Desenvolvimento BRIC The countries of Brazil, Russia, India, and China, all of which are deemed to be at a similar stage of newly advanced economic development CDM Clean Development Mechanism Disco Distribution company EU ETS EU Emissions Trading System FEC Firm Energy Certificate FIT Feed-in tariff FITP Feed-in tariff policy GBI Generation-based incentive Genco Generation company IPP Independent power producer NAPCC National Action Plan on Climate Change (India) NFFO Non-Fossil Fuel Obligation (UK) OECD Organisation for Economic Co-operation and Development ONS National Power System Operator (Brazil) Operador Nacional do Sistema Elétrico PPA Power Purchase Agreement PROINFA Programme of Incentives for Alternative Electricity Sources (Brazil) Programa de Incentivo a Fontes Alternativas de Energia Elétrica PURPA Public Utility Policies Regulatory Act (United States) RD&D Research, Development and Demonstration RE Renewable energy REC Renewable Energy Certificate RPO Renewable purchase obligation RPS Renewable Portfolio Standard SHP Small hydropower SPPDF Special Purpose Debt Facility SPPA Standardized Power Purchase Agreement T&D Transmission and distribution TGC Tradable Green Certificate Transco Transmission company UNITS OF MEASURE GWh Gigawatt-hour MW Megawatt FOREWORD In the early 1990s, developing countries started to introduce different incentives to promote renewable energy investments, especially feed-in tariff policies. Today, more than 30 developing countries have introduced different types of price- or quantity-setting instruments to increase the share of renewable energy in their energy mix. There is an increasing interest among World Bank client countries to learn more about the experience with the design and performance of these policy instruments, especially lessons learned and the degree to which they are succeeding in creating sustainable renewable energy markets in developing countries. vi In response to these client needs, and given the wealth of experience that has emerged over the last few years, the Energy Anchor has started to analyze the effects and performance of renewable energy policies. To this end, this paper discusses the lessons on policy design, implementation, and performance emerging from the experience in six developing countries that introduced renewable energy policy tools before 2005. We hope that this paper serves to disseminate knowledge about some of the important issues and options confronting the implementation and adoption of renewable energy policies. It is also our hope that the analysis set out in this paper proves useful to World Bank Group staff, as well as the authorities and stakeholders of our client countries. Lucio Monari Manager, Energy Anchor Unit (SEGEN) Sustainable Energy Department ACKNOWLEDGMENTS The main report was produced by the Sustainable Energy Department, Energy Unit (SEGEN) and written by Gabriela Elizondo (SEGEN), with contributions by Luiz Augusto Barroso, Maria Shkaratan, and Federico Querio (consultants); Victor Loksha (ESMAP), and Ashaya Basnyat (SEGEN). The editing was conducted by Rebecca Kary. This paper has benefitted from valuable advice, suggestions and clarifications from peer reviewers, country focal points and World Bank colleagues, including: David Reinstein, Demetrios Papathanasiou, Kwawu Gaba, Leopoldo Montanez, Saamer Shukla, Fan Zhang, Xiaoping Wang, Migara Jayawardena, Abdulaziz Faghi, Beatriz Arizu, Luiz Maurer, Maria Vagliasindi and Venkata Ramana Putti. The analytical work has vii been developed under the guidance of Lucio Monari (SEGEN). The work was partially financed with resources granted by the Energy Sector Management Assistance Program (ESMAP). 1. SCOPE AND COVERAGE OF THE STUDY 2. SUMMARY OF KEY FINDINGS This paper summarizes the results of a recent review In the sample countries analyzed, different types of of the emerging experience with the design and policy instruments and incentives have been introduced implementation of policy instruments to promote the either sequentially or in parallel. The diversity of these development of renewable energy (RE) in a sample of policy packages and their effect on RE scale-up and six representative developing countries and transition market sustainability is the subject of the analysis economies (“developing countries”) (World Bank 2010). presented in this paper. The review suggests the following general lessons of experience. The review focused mainly on price- and quantity- setting policies, but it also covered fiscal and financial A tailor-made approach is necessary: Choice of policy incentives, as well as relevant market facilitation instruments, policy design, and complexity of the policy measures. The lessons learned were taken from the package (or regulatory regime) should be tailored to the rapidly growing literature and reports that analyze and actual conditions of the system in the type of market, discuss RE policy instruments in the context of different supply or demand volume, and nature and level of types of power market structures. risks, as well as institutional and administrative capacity. The analysis considered all types of grid-connected RE Policy sequencing is critical for policy effectiveness: 1 options except large hydropower: wind (on-shore and Policy sequencing, the existence of basic legal and off-shore), solar (photovoltaic and concentrated solar regulatory preconditions, as well as institutional and power), small hydropower (SHP) (with capacities below administrative efficiency, are crucial to the effectiveness 30 MW), biomass, bioelectricity (cogeneration), landfill of RE policy. For example, legal and regulatory gas, and geothermal.1 The six countries selected for the frameworks for grid connection and integration, review included Brazil, India, Indonesia, Nicaragua, Sri resource and land use and/or the allocation of Lanka, and Turkey. permits and rights must be in place before RE policy is introduced, and the process for granting permits should not create bottlenecks. Policies that successfully lead to the scale-up of renewable energy may not necessarily be efficient: Even if the policy mix succeeds in triggering investments that achieve RE capacity targets, its overall economic efficiency (cost per unit of benefits) may be poor. Policy interaction and compatibility need to be considered: The coexistence of policy instruments has the potential to result in complex interactions and unintended effects. Thus, policy makers need to assess the compatibility among policy and regulatory mechanisms or incentives—that is, their combined impact may result in inefficient outcomes. It is also vital that individual policies are coordinated with the wider set of conditions that impact the energy market in a specific setting. Policy and regulatory design is a dynamic process: Developing countries have tested different types of 1 The focus is on RE technologies that are not yet fully competitive and that, when compared to conventional sources, exhibit an incremental cost (that is, in the context of systems where externality pricing has not been introduced). instruments to support RE development (policy shifts) 3. BACKGROUND and many are now using both price and quantity setting instruments to support different segments of This section discusses the emerging trends and the RE market. In the sample countries, feed-in tariff general experience with the use of various policy policies (FITPs) have required successive adjustments tools to support RE deployment in the developed (the challenge has been attracting private investment and developing world. A general classification of while at the same time minimizing inframarginal rents). main policy instruments and incentives is provided in However, policy adjustments should be controlled Appendix 1 of this paper. through mechanisms—perhaps embedded in the policy design per se—that allow stakeholders to manage the The Growing Importance of RE Development risks in order to maintain a certain level of regulatory certainty (for example, programmed reviews, thresholds RE plays an important role in contributing to the on adjustments, and adjustments that affect only new transition toward low-carbon development growth projects). (to reduce greenhouse gas emissions), in enhancing technology diversification and hedging against fuel price RE policy performance (effectiveness/efficiency) volatility (to increase supply adequacy), in strengthening depends on a number of key factors: Even policies economic growth (to promote industrial development 2 with a sound design do not result in effective and and employment generation), and in facilitating access efficient development of RE if other critical aspects are to electricity (to promote rural development and reduce not considered in parallel, including the existence of a poverty). sustainable incremental cost recovery mechanism (paid through sustainable subsidy sources or a surcharge The global trends indicate a growing commitment to RE on consumer tariffs) and the existence of transmission development from developed and developing countries infrastructure capable for RE integration, as well as in both the introduction of specific policy levers clear rules on transmission access and connection. and investment flows. Although RE technologies still represent a tiny share of the world’s generation capacity mix (about 7 percent, excluding large hydropower), their share in total new capacity additions, considering all technologies, is gradually increasing (from 10 percent in 2004 to 36 percent in 2009). In 2009, investment in RE (excluding large hydropower) was comparable to that in fossil fuel-based generation capacity, at around , US$100 billion each (UNEP SEFI, and Bloomberg New Energy Finance 2010). In particular, the growth of RE capacity in developing countries has been remarkable, and associated services and equipment manufacturing industries have already started to boom. For instance, Brazil, China, and India today are among the top 10 countries in the world in the volume of new financing attracted for investments in sustainable energy (with a combined US$44.2 billion in 2009, representing 37 percent of global financial , investment in clean energy) (UNEP SEFI, and Bloomberg New Energy Finance 2010). In 2009 the RE industry in these three countries created almost 1 million jobs, and China alone became one of the largest suppliers of solar photovoltaics, batteries for electric vehicles, wind turbines, and solar hot water collectors (REN21 2010). Upper and lower middle-income countries are also instruments to promote RE. The first four countries to quickly progressing in the development of their RE introduce some type of preferential tariff or FIT were markets. For instance, developing countries in Asia India (from 1993), Sri Lanka (from 1997), and Brazil and Oceania, the Middle East and Africa, and South and Indonesia (from 2002) (REN21 2010). Quota America (excluding Brazil, China, and India) received mechanisms, however, have been less popular in the almost US$11 billion of new financial investment for developing world. For instance, a rigorous RPS—in both RE and energy efficiency in 2009 (9 percent of the which a quota or target is specified, a proportional , global total) (UNEP SEFI, and Bloomberg New Energy obligation is imposed on utilities or retail companies, Finance 2010). and the price is competitively determined by the market—has only been introduced as such by a few Today, more than 50 percent of the existing RE capacity countries, including Chile (from 2008), Poland (from in the world is operating in developing nations. In 2005), and Romania (from 2004).3 addition, about half the countries that have issued some type of RE promotion policy are now in the developing Although the use of competitive schemes or auctions world (REN21 2010). to deploy RE in the developing world is less common, some countries have or are now testing their Use of RE Policy Tools to Support RE in effectiveness (for example, Argentina, Brazil, China, Developed and Developing Countries Peru, Thailand, and Uruguay).4 Today, FITPs are being 3 implemented in about 49 countries around the world Developed and developing countries have accumulated and are often cited as the most effective policy for a long history with the implementation of different types attracting private investment in RE. Yet, many developed of policy tools to support RE development. and developing countries still use quota-based mechanisms, including RPSs and auctions (for example, The RE market is to a large extent a policy-driven Brazil, Chile, China, France, Poland, Sweden, the market. Developed countries have been designing and United Kingdom, and the United States). implementing diverse types of price- and quota-based mechanisms to promote RE development from the late A range of other supplementary measures is in use that 1970s. For instance, the United States implemented its directly stimulates investments in RE, including fiscal first FITP in 1978 (Public Utility Policies Regulatory Act, and financial incentives, and voluntary measures. These PURPA) and a quota mechanism known as Renewable have been adopted in parallel to price- and quantity- Portfolio Standard (RPS) from 1983 so that today 31 setting instruments in both developed and developing of 50 states have these obligations in place; in 1990 countries. Germany was the first European country to introduce a feed-in tariff (FIT), and since then many European A significant and growing category of policies that countries have experimented with either price- or indirectly promote the development of RE are known quota-based mechanisms (REN21 2010).2 The United as cap-and-trade programs. The cap- and-trade Kingdom, in particular, introduced competitive tenders mechanism sets a ceiling on the emissions of covered to fulfill specific RE quotas during the 1990s (the Non- entities, issues allowances or emission certificates, and Fossil Fuel Obligation, NFFO), but the scheme was promotes their trading to generate a market price for later substituted for a type of RPS mechanism with emissions. Emissions pricing can also be implemented tradable certificates (known as Renewables Obligation through a tax policy (for example, a carbon tax). Certificates, from 1998) (Butler and Neuhoff 2004). Cap-and-trade schemes are being implemented in many developed countries. In the United States the Developing countries also have a long history of Regional Greenhouse Gas Initiative operates across designing and implementing specific regulatory many states, and in the European Union the Emissions 2 It is important to note that although the PURPA’s tariff was based on avoided cost, the Act did not exclude the possibility of setting tariffs through competitive schemes. 3 In general, RPS policies use tradable and/or nontradable renewable energy certificates (RECs) to create a market of environmental attributes. The use of RECs has emerged as a market-based tool to facilitate compliance with the purchase obligations (quotas) mandated under the RPS. 4 Even though auctions do not represent a renewable energy policy per se, they are used as mechanisms to promote the development of RE on a competitive basis. Trading System (EU ETS) is active now in 30 European In general, developed countries have made successive nations. adjustments to their RE policies and associated regulatory instruments in response to unexpected A few developed countries have also been applying feedback effects (for example, effects on electricity or carbon taxes since the beginning of the 1990s gas prices), difficulties in their implementation, and/ (the Netherlands and Scandinavian countries), and or poor performance. Indeed, legal and regulatory others have only recently started to apply them frameworks for RE are constantly evolving. (Canadian Province of British Columbia). As of today, no developing country has formally implemented a Also, some developed countries have made important greenhouse gas cap-and-trade scheme or a carbon tax. policy shifts (that is, from price- to quantity-setting or vice versa). For instance, the United States made a Experience with the Use of RE Policy major policy shift from an early FITP (PURPA, introduced Mechanisms in Developed Countries in the late 1970s) to a quota mechanism with tradable RECs (RPS-REC scheme), which became widely used There is a large body of literature analyzing the in many states. Likewise, Italy went from an FITP experience of developed countries with the use of (established in 1992) to an RPS policy (from 1999). different types of policy and regulatory instruments to However, Italy has recently reintroduced an FIT for small 4 promote RE development. scale PV installations (from 2007) and for RE projects with capacities below 1 MW (from 2008). Similarly, The literature concentrates mainly on the experience many states in the United States are starting to consider in Europe and the United States. In particular, a long or experiment with FITs again, especially to support and ongoing debate throughout the literature has small scale RE (for example, California from 2006).6 focused on what policies are more effective and efficient in driving the sustainable least-cost development of In particular, the United Kingdom abandoned its RE markets. The debate has centered on the relative auction mechanism to promote the deployment of advantages and disadvantages between price- and mature RE technologies (NFFO) and moved to a quota quota-based mechanisms, focused mostly on FITs system, known as Renewables Obligation, in which (German and Spanish models), RPSs (United Kingdom, the government specifies the proportion of RE that Renewables Obligation Model; United States, Texan RPS must be supplied by distribution utilities as in the U.S. model), and auctions (United Kingdom, Non-Fossil Fuel RPS mechanism (that is, the obligation can be fulfilled Obligation model or NFFO). through either the utility’s own RE generation, the purchase of tradable certificates, or a fixed penalty). In In most recent analyses, a general consensus has 2010, the United Kingdom also introduced an FITP for emerged that FITs are more effective at lowering RE projects with capacities lower than 5 MW. investors’ risks than RPS or quota instruments (that is, when considering price, volume, and balancing The analysis of the recent literature thus shows that risks). However, some studies indicate that quota developed countries have not only made policy shifts to mechanisms (an RPS-REC scheme) can be relatively test the performance of different policy tools, but also less expensive than price-based mechanisms, that FITs are being offered in combination with either considering that FITPs typically offer high subsidy auctions or RPS-REC schemes to support less mature RE rates (to mature technologies in the case of technologies or small-scale RE projects. technology neutral FITs, and to less mature, expensive technologies in the case of technology specific FITs), In terms of policy performance, the IEA and OECD while RPS-REC systems encourage competition among (2008) found that high levels of policy effectiveness technologies (and therefore promote the most mature are linked to three factors coexisting at the same time: technologies).5 (a) a country’s level of policy ambition (for example, 5 FITP can however deliver the same results as an RPS/REC or tradable green certificate (TGC) schemes when offering uniform rates across all types of RE technologies (thereby eliminating special provisions for solar or other expensive technologies) (Fischer and Preonas 2010). 6 FIT policies are being experimented with in the United States, though at a smaller scale and less comprehensively than in a number of European countries. To date, several utilities in California, Florida, Oregon, Vermont, Washington, and Wisconsin have implemented different variations of FIT policies (Couture and Cory, 2009). level of targets), (b) the presence of a well designed segments of the RE market. For instance, Brazil moved incentive scheme, and (c) the capacity of the system for from an FITP (known as PROINFA and introduced in overcoming noneconomic barriers that may prevent the 2002) to the use of auctions (from 2007). Conversely, proper functioning of the market (such as administrative China moved from the use of auctions (on-shore wind) hurdles and obstacles to grid access). to an FITP in 2005 (which ultimately applied only to biomass-based generation). Most recently (May 2010), Policy Choice and Trends in Developing however, China launched an auction to deploy off- Countries shore wind-based capacity. The Philippines is also trying to implement a regime that includes both an RPS-REC As of today, about 31 developing countries have system (with a target for mature technologies) and an introduced some type of price- or quantity-setting FITP for less mature technologies (such as solar or instrument to increase the share of RE in the electricity tidal). In addition to its FITP and REC market, which generation capacity mix. Of these, at least 26 have support all types of RE technologies, at the end of 2010 , opted for an FITP and only a few have introduced an India also began to launch auctions to deploy solar RPS or use auctions to deploy RE (for example, Brazil, capacity. Chile, China, Poland, and Romania) (REN21 2010). Figure 1 shows the policy instrument of choice of Developing countries—especially emergent various developed and developing countries today and 5 economies—have also made important policy shifts, Table 1 illustrates the increasing adoption of RE policy and many are now also using both price- and quota- mechanisms by some of these countries as well as based instruments in parallel to support different policy shifts. Figure 1: Use of RE Policy Instruments Feed-in Tariff 20 European Countries Auction (Spain, Germany) RPS 28 developing countries (Turkey, Nicaragua, France Sri Lanka) China Brazil Peru Many UK Uruguay India European USA Thailand Countries Italy Argentina (Netherlands) Philippines Belgium Sweden Chile Poland TGC / REC Market Note: Almost all countries apply some type of fiscal or financial incentive in parallel to price or quota based mechanisms. Table 1: RE Policy Instruments: Adoption and Policy Shifts Year FITP RPS/REC Auction 1970s USA (PURPA) (1978) 1980s USA (first in Iowa) 1990s Germany (1990) Italy (1999) UK (NFFO) (1990) Italy (1992) Many European Countries India* (1993), Sri Lanka (1997) 2000–05 Brazil, Indonesia (2002) UK (RO) (2002) China (2003) Nicaragua (2004) Belgium, Austria, Japan, Sweden, Turkey, Ecuador, China (2005) Canada, Poland 2006–10 USA** (from 2006) Chile Romania, Brazil (2007) Argentina (2006) Philippines (2008) Peru (2008), Uruguay, Philippines, Kenya, South Africa (2008) Thailand + 11 developing countries China (2010) Italy (2007–2008) India (2010) UK (2010) 6 Today About 42 Countries 13–15 Countries 22 Countries Source: REN 21 (2010), Barroso and Maurer (2010). In bold: Countries that have shifted from one mechanism to another or that are using them in parallel. * Indian states introduced FITPs gradually in the period 1993 to 2008. ** Different USA states have started to introduce FITPs from 2006. 4. EMERGING EXPERIENCE IN SELECTED thus, the conclusions must be eventually confirmed DEVELOPING COUNTRIES through other more formal quantitative assessments (for example, statistical analyses or appropriate modeling to This section establishes the rationale for the need to more accurately assess causality between policies and investigate further the experience with the design and their impacts). The sample was chosen among the 12 performance of price and quantity-setting instruments in developing countries that introduced specific instruments the developing world and describes the characteristics of regulation to promote RE before 2005 (as indicated of the sample of countries subject to the review. by REN21 2010). Objectives of the Review and Characterization The selection of countries covers a broad spectrum of the Sample of economic and power sector sizes, as well as the degree of market liberalization, while at the same A growing body of analytical work is now reporting time exhibiting the common energy security problems on the experience of developing countries with the characteristic of electricity supply industries across the design and implementation of different types of RE developing world: fuel dependence and/or reduced or policies and regulations, especially on a country-by- negative reserve margins (that is, peak deficits). country basis. However, the general experience and the degree to which these policies are succeeding in In the sample countries, RE policy—or its adjustments— 7 creating sustainable domestic markets in the context has been streamlined primarily through legal of different power sector structures has been less frameworks associated with the reform and the analyzed. liberalization of their power sectors (Brazil, India, Turkey) or through legal provisions specifically addressing Thus, the review was set at identifying the main lessons security of supply concerns (Indonesia, Nicaragua, Sri learned, as well as best practice associated with Lanka, and Turkey), or both. Figure 2 maps the sample the design, implementation, and performance of RE in terms of the peak deficit that is exhibited today and policy tools through the experience in six developing the current power supply structure (that is, degree of countries. The work was limited to a desk review; market liberalization).7 Figure 2: Mapping the Sample +10% India Peak Deficit (%) Indonesia Turkey Brazil Sri Lanka Nicaragua –10% Monopoly +–IPP Single Purchaser Liberalized Market Dependence on Coal Dependence on Diesel Dependence on Natural Gas Note: Almost all countries apply some type of fiscal or financial incentive in parallel to price or quota based mechanisms. 7 From a vertically integrated monopoly (with or without IPP participation), to a single buyer (that is, as a national Genco, Transco, or Disco, or a combined national Genco-Transco or Transco-Disco and IPPs), to a structure with many Discos, Gencos, and a Transco as a single buyer (with third party access), to a power market of Gencos, Discos, large users, Transco, and an independent system operator. In Brazil, the model established after the enactment of Law 10.848 (2004) relies on a combination of competition and strong government planning with centralized procurement (auctions). In this sense, the Brazilian model can be considered a hybrid model, where the public and private sector coexist (and compete) in a contracts market, but where state-owned enterprises still dominate the market and the government still exercises considerable control. In the sample of countries chosen for the review, The design of FITPs typically involves three key all countries except for Brazil and Nicaragua are incentives: (a) a preferential tariff, (b) guaranteed committed to official targets for RE capacity additions purchase of the electricity produced for a specified in the system.8 Also, all countries in the sample offer period, and (c) guaranteed access to the grid. In some sort of price-based incentive (for example, general, FITPs impose a purchase obligation on national FITs, preferential tariff in standardized or small power or regional utilities (renewables purchase obligation, purchase agreements, reduction in transmission and RPO) and, in some countries, the obligation to distribution (T&D) charges, generation based incentives purchase or share the revenues associated with tradable or premiums), but none of them has committed to a environmental attributes (such as certified emission formal RPS. In particular, India has recently introduced reductions). FITPs may also offer additional incentives the use of RECs, but this market is not set to function in to entities purchasing RE supply, such as reduced cross- combination with an RPS, as in the developed countries subsidy surcharges or reduced wheeling charges. that have introduced them (United Kingdom, United States); rather, it will operate in combination with Experience with the design and implementation of FITPs state FITPs and other supplementary incentives. The in the sample countries can be summarized as follows. competitive route to RE procurement is being used at First, except for Indonesia, all countries in the sample present in Brazil and India (through auctions), and in have experimented with FITPs, and in all cases the tariffs 8 Indonesia, Sri Lanka and, Turkey through conventional per se have evolved from simple to more sophisticated bidding processes.9 Auctions in India however have formulations (the experience with the Brazilian FITP is only been recently launched to deploy solar based described in Box 1).10 generation (from December 2010). Finally, all countries in the sample offer some sort of fiscal or financial Also, all these countries have made successive incentive. Table 2 shows the composition of the policy adjustments to their FITs, either to increase their package applied today in the sample countries (a more performance (effectiveness and efficiency) or to adapt to detailed list of incentives is given in Appendix 2). new system or market conditions (in order to maintain the incentive for investments in RE). In the sample, the countries with the lower gross national income and smaller power sector in terms of In the former case, FITs have evolved from technology- installed generating capacity (Indonesia, Nicaragua, neutral flat tariffs (based on either levelized or avoided and Sri Lanka) are the countries with the less diverse costs) to technology-specific stepped tariffs (designed policy package. Emergent economies (BRIC countries) to lower inframarginal rents and the overall cost of and/or upper middle-income countries exhibit a rich FIT subsidies) and/or to tariffs with degression factors variety of mechanisms for increasing the use of RE. (designed to account for technology improvement, innovation, and learning). These adjustments are aligned Emerging Experience with Designing and to what has been identified by leading sources as best Implementing Price-Setting Policies practice with FIT design in Europe and other developed countries (that is, tariffs differentiated by technology, size, Price-setting policies reduce cost and pricing-related resource intensity, and degree of technological maturity barriers by establishing favorable price regimes for RE improve the overall economic efficiency of the policy).11 relative to other sources of power generation (World Bank 2008). This section focuses on FITPs, given their In systems that exhibit a high vulnerability to oil price importance and effectiveness in driving investments and fluctuations or fuel oil dependence, the FIT structure has scaling up RE. been adjusted to maintain the incentive for investments 8 In the past, however, Brazil did commit to a formal target on RE through its official program to stimulate RE development (PROINFA); this program has been cancelled. 9 Although competitive biddings and auctions do not represent RE policy instruments per se, they can be used as mechanisms to convey RE policy. For this reason, they are generally classified as incentives under “mandated market policies” (see World Bank 2008). 10 In Indonesia and Sri Lanka, a “preferential” tariff has been channeled through SPPAs. This arrangement has also included a guaranteed purchase for a multiyear period and a guaranteed access to the grid. In both countries, the “preferential tariff” was originally designed as a function of avoided costs of power generation (in 2008 Sri Lanka moved to a technology specific FIT, also provided through SPPAs); however in the case of Indonesia the tariff was set at a level below avoided costs. The arrangement was quite successful in Sri Lanka, but largely unsuccessful in Indonesia, as explained later in this paper. 11 See Couture and others 2010; Mercados—Energy Markets International 2009); and Klein and others 2008. Table 2: Policy Mix in Selected Countries as of the Last Reform, 2010 Policy Instrument IN BR TK INDO NI SRL Targets Formal/Official NCRE Targets Price Based Instruments Feed-in Policies and Premiums SPPA (fixed term and preferential price or FIT) Reduced T&D Costs Net Metering/Banking Carbon Market/CDM Transactions Quantity Based Instruments and Procurement Mechanisms Renewable Portfolio Standard (RPS) Competitive Bidding/Auction 9 Investment Cost Reduction/Financial Incentives Accelerated Depreciation Green Funds (e.g.; soft loans, grants) Capital Subsidy/Equity Participation Fiscal Incentives Tax Exemptions Grid Connection and Dispatch Prioritized Dispatch Other Measures Green Power/Retail Tariff R&D Funds/Subsidies Single Window Clearance Systems Exempted/Reduced Licensing Fees IN = India, SRL = Sri Lanka, BR = Brazil, INDO = Indonesia, NI = Nicaragua, CHI = China, TK = Turkey Note (1): Reduced transmission charges may include discounts on wheeling prices or connection costs. in RE (for example, FITs pegged to international oil fluctuations or spikes) or system instabilities (volatile prices, or shifts from avoided-cost tariffs to technology- spot prices) have lowered policy predictability, increased specific, levelized cost-based FITs when the avoided cost risks, and rendered the FITPs ineffectual. of power generation is expected to fall as a result of planned substitutions from expensive to cheaper fossil The analysis of successive policy adjustments and their fuels in the generation mix). effectiveness for the countries under consideration suggests that cost-based FITs (that is, not linked to In general, all sample countries applying FITPs have market fluctuations in fuel and electricity prices) are successively increased the level of FITs and adjusted the more effective at promoting RE market development periods of support. However, in some specific cases, than those linked to wholesale or fuel prices. Table 3 frequent FIT design adjustments, especially those that below shows the type of tariffs used to promote RE in are applied in response to unexpected shocks (fuel price the sample countries. Second, all countries applying FITPs offer guaranteed, Box 1: Feed-in Tariff Policy in Brazil nondiscriminatory access to the grid and impose a purchase obligation on utilities, retail providers, and PROINFA was the first step toward developing RE large consumers. This is also aligned with international on a larger scale in Brazil. However, the initial best practice. However, the actual compliance with design of the program imposed rules and specific constraints that created bottlenecks and affected the purchase obligations has been generally poor for two overall economic efficiency of RE deployment. reasons. On one hand, many Discos (especially those operating in India, Nicaragua, and Turkey) exhibit weak The first issue was the allocation of the targeted or unsustainable financial balances, and the purchase amount of 3,300 MW in equal shares of 1,100 obligation has became an additional burden, especially , MW to wind, SHP and biomass projects, despite their different costs (that is, the mechanism did not in cases where the FIT subsidy is not passed on to promote the least-cost expansion of RE capacity in consumer tariffs (or when the transfer is incomplete the system). or subject to government approvals) (this point is illustrated in Table 4 for the case of India). On the Project selection—within the technology specific quotas—was also not based on a least-cost other hand, the actual design of purchase obligations approach. Projects were selected based on the has—in some cases—lacked penalty mechanisms and dates that relevant environmental permits were realistic escalation schedules or has imposed ambitious 10 issued (that is, the older the permit, the closer the targets not aligned with lag times required for the project was in the merit order for contracting). construction of new plants. In particular, different states This process ended up creating a “black market” for environmental licenses. In fact, the issue across India are working toward strengthening the of permitting and licensing in Brazil became a design of RPOs. bottleneck to the introduction of new capacity in general, creating serious economic distortions, high Third, an important factor in determining the success transaction costs, and even court cases. of FITPs is the existence of a formal incremental cost In addition, the minimum national business recovery mechanism. This mechanism must be viable, participation rate (that is, equipment and services transparent, explicit, and sustainable in the long term. of national origin) of 60 percent required by The lack of a viable and sustainable funding source is PROINFA became a bottleneck to wind generation indeed a limiting factor to compliance with RPOs and development, given that Brazil had only one local wind manufacturer at the time. As a result, not ultimate RE deployment. all technologies could reach their quotas, and eventually some volumes of capacity had to be In systems where FIT subsidies are not passed through transferred from one technology to the other in to consumer tariffs, FITPs need to be tied to a realistic order to achieve the total target of 3,300 MW. strategy that outlines the short- and long-term options The deadlines for the initiation of commercial for the financing of incremental costs (for example, if operation of different plants were also postponed the funding source is the state budget, tranches to cover several times, and the lack of market confidence in FIT policies must be formally approved at the beginning the continuity of PROINFA was considered a “stop of the fiscal cycle). In India, for instance, fiscal transfers and go” situation. to cover FIT subsidies have been incomplete, and In addition, there is no evidence that PROINFA utilities have been expected to partially cover the was effective in its management of CDM revenues. subsidy with their own revenues. Under PROINFA, Eletrobras was responsible for managing carbon revenues to reduce program costs (and hence the “uplift” on consumer tariffs). In Sri Lanka, invoices from the Ceylon Electricity However, there is no information on whether Board to cover the incremental costs associated with projects were registered under the CDM or on the the existing five small hydropower (SHP) facilities use of carbon revenues to lower program costs and (which have been commissioned under the new FIT reduce consumer tariffs. system) are accumulating at the Sustainable Energy In general, PROINFA was criticized for failing Authority, which has been unable to pay them (Meier to provide economic signals for efficiency and 2010). technological improvement. Thus, without a sustainable mechanism for covering Source: Barroso 2010. incremental costs, the mobilization of financing for new Table 3: FIT Design in Sample Countries as of the Last Reform (2010) Fixed Price Purchase Tariff Country Obligation Stepped Tariff Degression Flat Tariff Premium Price Sample Countries Turkey X X1 Nicaragua X X2 India X X (wind, solar, SHP) X (wind) X7 Indonesia X X3 Sri Lanka X X4 X4 Some European Countries Denmark X5 X X (wind) France X X X (wind) Germany X X X (wind) 11 Italy X X X (PV) Spain X6 X X Source: Data on European countries comes from Klein and others 2008, data on the six sample countries come from a variety of sources (see main report, World Bank 2010). Notes: 1 The previous scheme (fixed FiT with upper and lower limits, in which RE generators could opt for the wholesale electricity price) was substituted for a flat fixed FiT (amendments to Renewable Energy law of December 2010). RE producers can also sell their energy in the “free market”. 2 Tariff level is a function of marginal costs and varies with oil prices 3 Tariff in SPPAs is fixed as 80–85 % of avoided cost of power generation (not a FIT in strict sense). 4 IPPs can choose between a flat and a three tier stepped tariff, stepped tariff applies to all RE eligible technologies. 5 Except for wind onshore. 6 Only in combination with fixed (stepped) tariff. 7 The Generation Based Incentives (GBI) recently introduced for solar and wind are a premium in practice. RE investments is implausible, even in the presence of subsidies on consumers or tax payers. This measure attractive FITs. The implementation of a transparent was not completely successful under PROINFA in Brazil mechanism to share the incremental costs associated (as described in Box 1), but it has proven successful in with RE policies (including grid integration and other countries (as long as the additionality criterion is balancing costs) has been identified as best practice met in the presence of an FITP).12 across the developed world. This has been achieved in Brazil, but remains a challenge for most of the countries Fourth, developing countries have learned that some in the review. requirements or preconditions embedded in the design of FITPs have the potential to constraint the actual use In particular, the FITPs of Brazil, India, and Sri Lanka of the incentive and development of RE. For example, have included rules that determine the allocation of the design of PROINFA established the requirement of a carbon revenues to explicitly reduce the impact of FIT minimum business participation rate (that is, 60 percent 12 A CDM project activity is considered additional if anthropogenic emissions of greenhouse gases by sources are reduced below those that would have occurred in the absence of the registered CDM project activity. Probing additionality in the presence of FITPs is therefore more challenging. For instance, in December 2009 the CDM Executive Board rejected 10 wind projects located in China for failing to prove that projects could not achieve financial closure even in the presence of existing FITPs (PCF 2010). In this case, the concern was focused on the FIT design (that is, determination of actual level of payments). The additionality criterion is also more difficult to justify when RE projects participate in REC markets. Table 4: Compliance with RPO in India, 2009 Targets Achievement Extent to which the target State (introduced from 2006) 2009 has been achieved (%) RPO Andhra Pradesh 5% (1% from wind) 4.52% (target on wind not met) 90 RPO Gujarat 2 2.10 105 RPO Haryana 3 0.01 ~0 RPO Karnataka 7 to 10 9.47 95–135 RPO Kerala 5 1.22 24 RPO Madhya Pradesh 10 0.11 1 RPO Maharashtra 5 3.17 63 RPO Rajasthan 6.5–6.75 7.49 111–115 RPO Punjab 1 1.8 180 RPO Tamil Nadu 10 NA NA 12 RPO Uttarakhand 5 1.32 26 RPO Chhattisgarh 10 3.77 38 RPO Himachal Pradesh 20 — — Source: World Bank 2009, ESMAP 2010, States’ Regulation on RPO (Maharashtra, Andhra Pradesh, Haryana). of services and equipment associated with RE projects of rights is also necessary to avoid bottlenecks in RE had to be produced or manufactured locally), which development. seriously constrained the development of wind-based capacity. In contrast, Turkey recently approved the use Emerging Experience with Designing and of premiums over the actual FIT to promote the use of Implementing Quantity-Setting Policies equipment manufactured locally (proposal approved on December 2010). Quota-based or quantity-setting mechanisms (also known as market share policies) mandate the Other typical constraints affecting the performance of introduction of a certain percentage or absolute FITPs—and ultimately RE deployment—are related to quantity of RE capacity or generation at unspecified bottlenecks in the administrative process for granting the prices (World Bank 2008). This section focuses on required licenses and permits. This has been especially the experience with the use of different procurement notable in Brazil and India, although both countries mechanisms in the sample countries, especially with the have made major efforts to improve the efficiency of use of auctions in Brazil. None of the sample countries administrative procedures. has implemented a formal RPS.13 Finally, one important lesson learned concerning the Formal RE Targets effectiveness of FITPs is that policy sequencing is crucial and that some key preconditions have to be met before Except for Brazil and Nicaragua, all other countries incentives to promote RE are introduced. The existence subject to the review are committed to formal targets on of specific legal and regulatory provisions addressing RE (see Table 5). The extent to which these targets are the issues of land use, resource use, and allocation attainable is discussed below. 13 With the recent introduction of auctions to deploy solar-based capacity, India now has the elements typical of an RPS (only for the case of solar initiatives): (a) targets and purchase obligations, (b) a REC market with solar-specific RECs, and (c) use of a competitive mechanism to determine the price. Yet, the purchase obligations are mandated under the FITP framework. Table 5: Formal and Indicative Targets in Sample Countries Issued Size of Target/Share Deadline Official Targets India 2008 1% annual increase, about 20% share (NAPCC) 2020 2009 54 GW, approx 12.7% share (13th Plan) 2022 2010 1 GW, solar capacity (National Solar Mission) 2013 Turkey 2009 30% 2023 Indonesia 2006 10% 2025 2008 4 GW geothermal capacity 2015 2008 9.5 GW geothermal capacity 2020 Sri Lanka 2006 10% 2015 European Union 2007 20% 2020 Indicative Expansion Plans 13 Brazil 2010 Add 10.7 GW, approx 19% share 2019 Nicaragua 2007 37% share 2014 Note: all targets exclude large hydroelectric capacity. Procurement Mechanisms Turkey has recently allowed the use of competitive bidding to procure wind-based generation when there As mentioned before, the competitive route to RE are multiple available projects in the same region. procurement is only being used at present in Brazil and The country also allows RE developers to sell in the India (through auctions) and in Indonesia and Sri Lanka wholesale energy market. Also India has recently through conventional bidding processes. However, introduced auctions to procure solar installations. none of the countries in the sample has committed to a formal RPS. In fact, the only developing country that The procurement of RE in Brazil is carried out had introduced a formal RPS before 2005 was Poland. through auctions, but developers are also allowed In 2008, both Chile and Romania implemented a type to sell directly through bilateral contracts in the free of RPS mechanism. unregulated market. In both, Brazil and Turkey selling in the wholesale market (especially through bilateral The procurement of RE in the sample countries varies contracts) has been a real possibility to RE developers. from direct contracting (cost-plus, fixed-fee contracts) In the case of Turkey, the spot market prices were well to competitive mechanisms (such as biddings, auctions, above the FIT in place until the formal approval of and transactions in the wholesale market). new technology-specific FITs in December 2010, and in Brazil, other incentives in place have leverage the In India, Indonesia, Nicaragua, Sri Lanka, and Turkey, feasibility of bilateral contracts between small-scale RE the bulk of RE capacity has been procured through developers (less than 30 MW) and large consumers cost-plus, fixed-fee contracts. In particular, Indonesia (that is, discounts on T&D tariffs). Both Indonesia and Sri Lanka have used Standardized Power Purchase and Sri Lanka now allow the use of competitive Agreements (SPPAs) to procure small-scale RE. In fact, the biddings for small-scale RE and geothermal initiatives, use of SPPAs in Sri Lanka has been notoriously successful respectively. for rapidly increasing SHP capacity. This has not been the case in Indonesia, however. Figure 3 illustrates the options for RE procurement in sample countries. Figure 3: Options for RE Procurement in Sample Countries Brazil Turkey Wholesale Market Spot/Contracts (market forces) Sri Lanka Competitive Bidding Auction (quota set) Brazil Turkey Indonesia India Sri Lanka Direct Single Source Contracting (price set) Nicaragua Turkey Indonesia India Monopoly +–IPP Single Purchaser Liberalized Market All NCRE Only in Wind Only Geothermal Only Solar Plants Higher than 10 MW 14 Experience with Auctions in Brazil of Brazil launched the first technology-specific auction to supply the regulated market where only RE could Brazil has launched two types of auctions to deploy participate, although participation in the auction RE: technology-specific auctions and reserve energy was unexpectedly low. This lack of interest has been auctions.14 attributed to the following factors: (a) RE developers have obtained higher prices in the free market because Technology- or project-specific auctions are carried of the attractiveness of the T&D discount (which is out within the framework of the regular auctions to offered only to RE of less than 30 MW); (b) it is often deploy new capacity and supply the regulated market. more difficult for RE to comply with the FEC coverage This type of auction has been used to support specific obligation, since intermittent generation faces a higher energy policy decisions or the introduction of special risk of penalization; and (c) the upper limit for the projects (such as large hydroelectric plants). In this remuneration level in the auction was set at a rate case, contracts have to be covered with Firm Energy lower than the FITs previously offered by PROINFA (de Certificates (FECs) to ensure that new generation is la Torre, Fajnzylber, and Nash 2008; IEA and OECD added to maintain minimum adequacy and reliability 2008; Barroso 2010). levels at the system level.15 Reserve energy auctions, by contrast, are carried out to directly increase the Indeed, one of the main challenges of auction system’s reserve margin. In this case, contracts do mechanisms is to attract sufficient bidders and ensure not have to be covered by FECs, and the auctioned that competition is established (for example, it is quantity is independent of the demand forecasts issued important to mitigate the barriers to entry for new players by Discos. and lower information asymmetries as much as possible). The experience with the use of auctions to deploy RE As of today, three “reserve energy” auctions for capacity in Brazil can be summarized as follows. First, RE have been launched (August 2008, December the procurement of RE through auctions has been so far 2009, and August 2010), awarding an aggregated more successful with reserve energy auctions than with , capacity of about 6.2 GW in SHP sugarcane bagasse technology specific auctions. In 2007 the Government cogeneration, and wind-based generation for delivery 14 The experience with auctions to deploy solar based capacity in India is too recent, and thus it is not analyzed in this review. 15 FECs (denominated in GWh/year) are issued by the Ministry of Mines and Energy (MME). The methodology for their calculation is fairly complex. In practice, FECs reflect the sustainable energy production of each generator when interconnected to the grid. For instance, to sign a contract of 100 “average MW,” a generator or trader must also acquire an equivalent amount of FECs (in GWh/year). The FEC of a plant is also the “maximum amount of energy that it can sell through contracts.” Any shortfall is penalized at a price that mirrors the cost of new energy. dates between 2008 and 2015, with contract terms historical records of hydrology or wind velocities as well ranging from 15 to 30 years. as grid access studies that demonstrates the feasibility of the connection point). In addition, the proper design Second, the auctioning of RE in Brazil has resulted so of project completion guarantees and penalties to far in low prices (in the lower bound, but not outside the avoid construction delays and underperformance range of international FITs), raising concerns as to the are crucial for ensuring deployment and operational extent to which auction winners will be able to construct efficiency. and profit from the plants (see Table 6). In particular, the low prices that resulted from the Although the auction system in Brazil includes a number reserve energy auctions to deploy wind-based of prerequisites and mitigation measures16 to avoid generation carried out in December 2009 and August speculative behavior among participants and lower the 2010 have raised the fear of no-implementation of risk of construction delays or no construction of facilities projects because of financial insolvency.17 at all (deployment risk), the actual enforcement and payment of project completion guarantees is an issue of The 2009 auction for wind-based generation did not concern (for example, potential lengthy court cases that result in a clear correlation between capacity factors may then discourage other investors). and prices, confirming to some extent the influence of strategic behavior in bidding results (that is, win the bid, 15 In general, to ensure that auction winners will deliver then adjust) (see Figure 4). However, this behavior may the awarded projects it is important to pre-qualify also be associated with the lack of a good record of bidders to discourage speculators or financially historical data on wind velocities. insolvent companies from participating and to include ad hoc mitigation measures and requirements (for When comparing Brazil’s auction prices for on-shore example, projects with granted environmental licenses wind with other countries, it can be observed that the and relevant permits, bids that include audited bid rounds have delivered prices in the lower bound, Table 6: Final Bid in Brazil Auctions and FITs for On-Shore Wind Data 2009–2010 (USD cents/kWh) Country Tariff Level Remuneration Period India FiT (CERC levelized tariff 2010–2011) 7.4–11.05 India (Maharashtra) 9.92 with annual escalations 6 India (Guajarat) 7.76, 25 years 25 Sri Lanka 20.5, 20 years 20 Turkey (proposed FiT) 11.1, 10 years 10 Nicaragua (Amayo plant) 8.6, 20 years 20 Germany 9.2, 20 years 20 France 8.2, 15 years 15 Brazil Auction December 2009 8, 20 years 20 Brazil Auction August 2010 7.5, 20 years 20 16 These include the requirement of granted environmental licenses prior to participation in auctions, deposit of bid bonds (equal to 1 percent of a reference investment, deposited before the auction and returned after the contract is signed), and project completion guarantees (10 percent of a reference investment value deposited after the contract is signed and released as the project completes construction), as well as the existence of grid access studies showing that a connection point is feasible and available. In addition, investors can be severely penalized for not delivering the project. In the case of wind power, new wind turbines must be used (machines could not have been used before for prototype testing) and a historical record of wind speed and direction for a period of at least 12 months issued by a third party is required. 17 On average, offered capacity factors reached 45 percent, and in a few cases even more than 50 percent. The effectiveness of the auction system to procure RE in Figure 4: Capacity Factor vs. Winning Auctioned Prices for On-Shore Wind Brazil will only be discovered with time; their potential to (Auction 2009) deliver least-cost RE capacity has already been proven. A comparison between the costs of PROINFA and the costs 55 of RE delivered through auctions is provided in Table 7, 50 showing that auctions are delivering a more economically Capacity Factor (%) efficient output than the previous FITP (PROINFA). 45 Third, the auctions for wind-based capacity additions 40 in Brazil have rapidly attracted the participation of 35 new equipment suppliers to the market. In addition to Wobben Wind Power, which has been present in 30 the market for many years (a subsidiary of German 25 company Enercon), IMPSA (Argentinean), Suzlon 7.0 7.2 7.4 7.6 7.8 8.0 8.2 8.4 (Indian), Vestas (Danish), Siemens (German), and GE UScents/kWh (United States) are now operating—or in the process of starting operations—in the country. Many private 16 developers have also emerged to participate in auctions (for example, in the auction launched in December but not outside the international range (as shown in 2009, 14 companies were awarded a portion of the Table 6). Yet the costs of debt and capital, as well as auctioned quota). the types and level of risks exhibited in a country like Brazil, are different to those exhibited in developed Fourth, environmental licensing issues are still creating countries. a bottleneck to the development of RE projects in Brazil. For instance, many projects have been severely delayed, A comparison of the remuneration levels using large cost overruns have been incurred, and some have common assumptions for a 30 MW wind-based plant even given up altogether, because of environmental again shows that the auctions in Brazil delivered impediments. Although there is a an established prices within the range of other countries (France, sequence of environmental licenses to be obtained Germany, Nicaragua, and Turkey), although well at each step of the project, with each license being below FITs provided in India and Sri Lanka (see more detailed than the preceding one, requirements Figure 5). sometimes change significantly from one license to Figure 5: Remuneration Level Efficiency On-Shore Wind 30 25 UScents/kWh 20 15 10 5 0 Turkey France Brazil Brazil Peru India Nicaragua Germany Brazil Sri Lanka (FiT) (FiT) Auction Auction Auction Guajarat (Amayo (FiT) PROINFA (FiT) August Dec February (FiT) Plant) 2010 2009 2010 Note: Annualized NPV of remuneration levels, under similar assumptions, not adjusted to inflation. Table 7: Efficiency Comparison: PROINFA and Auctions Technology-specific auction PROINFA (“reserve energy” auction) 2009 MW GWh/year USD/MWh MW GWh/year USD/MWh Wind 1423 3740 154 1800 6596 80 Small Hydro 1191 6260 96 — — Bioelectricity1 779 2661 77 2379 4800 84 Impact on costs Total capacity (MW)2 3,393 4,179 Total energy (GWh/year) 12,661 11,397 Average cost (USD/MWh) 109 80 Total cost (million USD/year)3 1,381 911 Net impact on tariffs (USD/MWh)4 3.8 1.6 Source: Barroso 2010. 17 Notes: 1 Values of April 2010, prices include taxes. 2 Installed capacity includes self-consumption. In the auction case, energy values correspond to the excess energy sold to the grid at the auction. More excess energy from the new plants is available to be sold to the free market of at future auctions. 3 Gross cost, i.e., total (fixed) cost paid by the consumers. 4 For the auction case, it is the net cost, i.e., includes estimates of yearly spot revenues collected by consumers. 5 Exchange rate: 1.85 USD/BRL. the next, and licenses are frequently challenged by perception of risks of public and private enterprises and public attorneys on various grounds, resulting in its effect on competition (such as different hurdle rates unpredictability and long-drawn-out lawsuits. or costs of capital). Finally, several other issues have generated strong Policy Interactions and Instrument debate among market participants and different Compatibility stakeholders. One area of concern is the role of the public sector as both auctioneer and power purchaser, A growing body of literature suggests that the which creates a conflict of interest. For instance, there compatibility among coexisting policy or regulatory has been frequent interference of the government in instruments and fiscal or financial incentives is critical to technical functions, such as dispatch, the selection the success of RE policy. In particular, many studies have of projects for capacity expansion, and even in the focused on the interaction among different RE policy decisions on what public enterprises can participate instruments, concluding that (a) some instruments are in auctions. Also, the type of technology and contract more effective when combined with other supporting volume can be discretionary (that is, the government schemes and (b) the effect of policy overlapping may has the prerogative to call an auction to contract a produce counterintuitive effects that create substantial given volume of energy even if it is not contemplated excess costs. in the demand forecasts prepared by Discos). In developed countries, the focus has been on the In fact, debate among auction participants has been effects of investment tax credits on operational efficiency strong concerning some of the technical parameters (in the absence of technology standards) and the included in the auction scheme (which may favor interactions between RE policies and emissions trading specific projects or technologies and, indirectly, systems, especially in European countries. Other studies specific companies). In addition, private participants have analyzed the effect of RE deployment on electricity have expressed concern with regards to the different and gas prices, especially in the context of liberalized markets.18 In the review, a few examples that illustrate of these two instruments has resulted in unintended the issue of policy interactions and compatibility were effects, both in the operational efficiency of wind identified. Two of these examples are briefly described installations and the costs of equipment. First, contrary below. to world market trends, technology improvements and economies of scale have not reduced the costs of the Investment Tax Credits and Feed-in Tariff Policies wind generation industry. In fact, the average costs of equipment increased from about US$880,000 to In 1994–95 India introduced accelerated depreciation US$1.3 million per MW between 2003 and 2008 to trigger investments in wind-based generation (ESMAP 2010; World Bank 2009). Second, wind- through adjustments to the Income Tax Act. The based installations in India have exhibited very low original incentive allowed 100 percent depreciation operational efficiencies (as shown in Figure 6).19 Third, within the first year on a written down value basis. the lack of harmonization among FITPs across different In 2002 the incentive was reduced to 80 percent States has driven investments to the regions where depreciation, also within the first year. To some extent, these policies are more attractive, and not necessarily however, the incentive attracted diversified profit-making to the locations with the highest wind or resource companies with high tax liabilities—as opposed to wind potential. developers—seeking to use accelerated depreciation 18 as a tax shield against profits on the entire company This suggests that the types of instruments chosen to balance sheet. At the same time, these companies had support RE and the policy mix per se have an effect not a marked preference for the use of turnkey project only on deployment but also on operational efficiency.20 packages sold by equipment vendors. In response, the Government of India has introduced Investors have profited from the use of accelerated generation-based incentives, which are designed to depreciation in addition to the FIT. The combination shift the incentive from installations to production and Figure 6: Evolution of Wind Capacity and Aggregated CF, India 12,000 20 19 10,000 18 Installed Capacity (MW) 17 Capacity Factor (%) 8,000 16 6,000 15 14 4,000 13 12 2,000 11 0 10 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Installed Capacity (MW) Capacity Factor (%) Source: EIA 2009; Ministry of Power India 2010. 18 The literature on “policy interactions” is rapidly evolving. See, for instance, Jensen and Skytte 2002; De Jonghe and others 2009; Blyth and others 2009; Fischer and Preonas 2010. 19 The lowering of this aggregated factor may also be attributed to dispatch dynamics and grid limitations. Thus, further investigation is necessary to differentiate between the impacts of policy and grid and dispatch constraints. 20 In the literature a few authors have emphasized that FITPs can have a negative effect on cost reductions, as they induce generators to choose high cost-sites and provide fewer incentives for cost cuts (Soderholm and Klaassen 2007). facilitate the entry of independent power producers (Bakovic 2010)). The “stand-by” plants can only recover (IPPs). These incentives have been offered since 2008 their investments if the spot price allows price spikes or for solar- and wind-based capacity additions in an if a capacity payment is offered. attempt to improve their technical and operational efficiency. In addition, the Government has also recently In some systems, the need for “firm energy” is introduced a REC market, mainly as an equalization addressed through an obligation. As discussed before, mechanism to improve the overall economic efficiency in Brazil all energy loads (regulated and unregulated of RE deployment. However, as of today the accelerated consumers) are required to cover 100 percent of depreciation incentive has not been phased out, and their energy needs with contracts; at the same time, it is being offered in parallel with generation-based all contracts have to be covered by FECs. The FEC incentives (in this case, a premium over the FIT). coverage requirement ensures that new generation is added on time to cover the growing future load. The dynamic resulting from this type of policy mix has Nicaragua, by contrast, offers capacity payments (a also been exhibited in other countries (for example, price premium) to generators capable of supplying firm investment tax credits for RE in California and for energy, but has imposed an obligation on all generators biofuels across the United States have also resulted in (including RE) to provide a capacity reserve equal to unintended effects) (Sawin 2004; de la Torre, Fajnzylber, 5 percent of installed capacity. and Nash 2008). 19 In general, however, firm energy incentives and Firm Capacity Incentives and Obligations obligations have not been designed to acknowledge the capacity of intermittent RE to also provide “firm energy Many power markets have developed financial services” (for example, RE can be dispatched in base- instruments or incentives to stimulate investment in new load when hydropower reservoirs are low or in between capacity and maintain an adequate reserve margin. biomass harvesting seasons). In fact, RE is generally These incentives, generally termed “reliability payments” excluded from the incentives (payments or premiums), or “firm capacity charges” have been offered either as but not from the obligations (as in Nicaragua). price premiums to technologies capable of delivering “firm energy”, or auctioned as incentives to achieve As they are designed, firm capacity instruments tend to prespecified levels of adequacy and reliability. reward or simply favor conventional technologies, but directly or indirectly undermine the financial viability In general, capacity payments compensate investors and competitiveness of intermittent sources of power for higher capital costs arising from regulatory risk supply, given their specific characteristics and the and the failure of market design to accommodate for greater uncertainty associated with their annual output long-term contracts with domestic consumer franchises delivery. The existence of firm capacity obligations also to allow hedging of investment decisions. Thus, these has the potential to affect the effectiveness of regulatory mechanisms compensate for market failures, rather than instruments or measures to promote RE development. In removing them (Neuhoff and Twomey in Grubb, Tooraj, Brazil for instance, RE developers have not participated and Pollit 2008). In hydropower-based systems, capacity in the so-called technology-specific auctions specifically payments are provided to help mitigate price spikes and aimed at deploying RE in part because of the FEC encourage investments in flexible and backup plants obligation. The use of “reserve energy auctions” to (that is, peaking generation receives capacity payments deploy RE, by contrast, has attracted more participation, to anticipate and receive a certain level of scarcity rents mostly because in this type of auction, FECs are not over time). required. However, the use of reserve energy auctions to deploy RE is limited. In a system where the price of RE The issue of firm capacity also arises when an important is discovered through auctions, the FEC obligation may volume of RE is expected to be deployed. As intermittent prove a limiting factor to the scale-up of RE. generation is added in a system, additional reserve capacity is necessary to maintain minimum levels of Thus, the existence of firm capacity payments and supply adequacy (for example, Germany, Portugal, and obligations may have two effects: (a) reduce the Spain require about 250–300 MW of additional reserve capacity of RE to compete on an equal footing with for every 1 GW of wind capacity added to the system thermal generation in some markets; and (b) undermine their financial viability as firm capacity and reserve “stand-by” plants and RE are priced to appropriately obligations impose a greater financial burden on RE, pay for the value of “firm energy services” needs to given their operational characteristics. be explored on a case-by-case basis (or at least until externality pricing is introduced). Already in Colombia, The introduction of FITs in systems that also offer firm an innovative mechanism is being explored by the capacity instruments need to consider this aspect regulator to allow intermittent RE to compete in “firm because it may change the way RE is priced. How energy” auctions (see Vergara and others 2010). 20 5. POLICY PERFORMANCE to feedback effects between design and implementation experience in the context of a dynamic system (that is, The performance of renewable energy policy depends a dynamic legal, institutional, economic, financial, and on a number of factors, including macroeconomic technical system). conditions, institutional structure and capacity, governance (regulatory quality, rule of law, control This section briefly discusses the effectiveness of policy of corruption, political stability, and government packages in the sample countries in terms of market effectiveness), fuels and electricity market dynamics, and growth.21 In this exercise, it is implicitly assumed that infrastructure capacity (for example, capacity of the grid policy design and implementation have a direct link with to evacuate intermittent generation). the intended outcome (that is, RE market growth).22 Thus, the review of the design and performance of RE Attainment of Targets policy cannot be decoupled from the analysis of the prevailing system and market conditions Indeed, the Except for Nicaragua, all countries in the sample have successive reforms of key regulatory incentives respond committed to targets on RE. Figure 7 depicts the degree 21 Figure 7: Degree to which Official Targets on RE have been Attained 2004–2009 All NCRE 2006–2025 2008–2009 2006–2025 Geothermal 2005–2025 2004–2010 Biomass 2002–2006 2002–2009 2007–2012 2002–2006 2002–2009 SHP 2005–2025 2002–2006 2002–2006 2007–2012 2002–2009 Wind 2002–2006 2002–2006 2007–2012 0% 25% 50% 75% Above 100% India Indonesia Sri Lanka Brazil Turkey Passed targets Target in progress 21 Trends in RE market growth are compared to the growth required for attaining official targets in the case of sample countries that have officially established them. 22 Clearly, it is necessary to control for a number of factors to more accurately assess causality between policies and their intended outcomes or empirical performance. In the absence of a formal impact evaluation or appropriate modeling of the system, attribution cannot be rigorously assessed. However, the simple analysis of market growth as a first step in the discussion of RE policy performance is thought to be appropriate in the context of a case-study approach. to which passed targets have been attained, as well as However, in 2004 the Government of Turkey set the degree to which new targets are being met. up a Special Purpose Debt Facility to promote RE development with the support of a World Bank loan. In particular, India has a very good record in achieving Under this initiative, the targets on RE were in fact targets, especially those offered in the 9th (1997–2001), surpassed by 2009. 10th (2002–06), and 11th (2007–12) five-year plans. Also, the target introduced in the Indian National Action Effectiveness of Policy Package in Sample Plan on Climate Change for increasing the share of RE Countries by 1 percent annually was met in its first year (2008– 09). Brazil, by contrast, did not meet the PROINFA This section briefly discusses the effectiveness of policy target offered in 2002 (an additional 1,100 MW for packages in the sample countries in terms of market each RE technology type, including wind, biomass, growth. , and SHP by 2006); however, the country managed to reach the target for wind in 2009 and has progressed Brazil and India substantially with biomass and SHP . Of the sample countries under review, Brazil and India At the other end of the spectrum, Indonesia could not have exhibited sustained RE market growth that started 22 attain the target on geothermal capacity offered in its soon after the introduction of an FITP (as depicted in Geothermal Road Map of 2004 (2,700 MW by 2010) Figures 8 and 9).23 India started introducing incentives to and targets offered in its National Energy Management promote the development of RE as early as 1993 when Blueprint of 2005 have also not progressed the newly created Ministry of New and Renewable Energy substantially. (MNRE, previously Department of Non-Conventional Energy Sources) issued tariff guidelines that offered a The new targets offered by Sri Lanka and Turkey are national preferential rate to all types of RE. Today, the fairly recent. Thus, it is too soon to report progress. Government of India offers a complex combination of Figure 8: Evolution of RE Capacity and Share in Power System, India State SHP GBIs 16,000 National 12 FiT Tariff Policy Policies 14,000 & State Biomass SERC 10 FiT Policies 12,000 Preferential Tariff SERC Regime 8 10,000 Electricity Preferential Act 2003 (SHP) Tariff (MW) 8,000 FiT Policy 6 (%) Regime (wind) 6,000 4 4,000 2 2,000 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Wind Grid Connected Solar PV Biomass Small-scale Hydro Sources: EIA 2009; Ministry of Power India 2010. Note: India introduced a REC market and the use of auctions from 2010. 23 The adjustments to PROINFA in Brazil included changes in the financing conditions offered by the BNDES to PROINFA projects. Figure 9: Evolution of RE Capacity and Share in Power System, Brazil 12,000 12 10,000 10 8,000 8 Reserve Adjustments Energy (MW) (%) 6,000 to PROINFA T&D Tariff Auctions 6 Tax and BNDES Discounts financing (Adjustments) Incentives 4,000 4 PROINFA incentives 2,000 2 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Wind Biomass Small-scale Hydro 23 Source: EPE 2009. Note: Data for the years 2009 and 2010 are “expected deployments” (actual data still not officially released). policy incentives that includes FITPs, fiscal and financial deployment of different types of RE capacity, especially incentives, generation-based incentives, and competitive on-shore wind (as seen in Figure 10 below). Yet, this mechanisms (for example, auctions to deploy solar-based sustained market growth has not been accompanied by capacity and a market of solar and nonsolar RECs from acceptable levels of operational efficiency—especially in 2010) (see matrix in Appendix 2). wind-based generation—partly because of unintended Brazil introduced an FITP (PROINFA) in 2002 for a relatively short period and moved to the use of Figure 10: Effectiveness as Average Annual auctions from 2007. The policy package to support RE Growth, India deployment in Brazil is less diverse and includes only discounts on T&D, fiscal and financial incentives, and 1400 the use of auctions to support the introduction of a 1200 Average Annual Growth predefined quota of RE (as shown in Appendix 2). 1000 Many factors have contributed to the sustained RE 800 market growth in both Brazil and India: (a) strong 600 government commitment (most notably in India); 400 (b) the creation of institutions exclusively focused on RE development at the central and state levels (India); 200 (c) the existence of a growing domestic equipment 0 manufacturing industry (in India, but also emerging in Wind SHP Biomass Solar Brazil); (d) a sustained effort toward attracting private 9th Plan 233 50.8 71.6 sector participation (Brazil, India); and (e) the existence of either a tight reserve margin or a large supply 10th Plan 1039 96.4 148.8 0.2 demand gap, which has signaled the need for new 11th Plan 1277 218 206.8 1.4 capacity investments, among others (Brazil, India). Source: Planning Commission 2001a,b; Ministry of New and Renewable Energy 2006. In India, the use of FITPs in combination with fiscal Note: Periods of the 9th, 10th, and 11th Plans are and financial incentives has effectively promoted the 1997–2001, 2002–06, and 2007–12, respectively. or perverse incentives driven by the policy mix per se, as Turkey and Sri Lanka explained before. Although on a more modest scale than in Brazil and In 2010 the Government of India introduced specific India, RE capacity has also gradually increased over the policy mechanisms to address this issue (generation- last decade in Turkey and Sri Lanka. based incentives, REC market), but their capacity to improve the overall operational and economic In Turkey, the sustained growth of on-shore wind efficiency of the RE market is yet to be seen. Thus, capacity additions are largely attributed to the the case of India suggests that the design of policy introduction of an FITP in 2005 (see Figure 11). The mechanisms and the composition of the policy mix policy package for the promotion of RE-based capacity can have a positive effect on market growth, but a in Turkey includes an FITP that offers technology-specific negative effect on efficiency and the overall costs of RE fixed FITs, green funds (which offer preferential loans deployment. under a Special Purpose Debt Facility), and reduced or exempted licensing and land use fees, as well as funds By contrast, the case of Brazil suggests that an emphasis to support RD&D activities.25 Turkey has also established on policy efficiency through the use of competitive an official target on RE—30 percent by 2023. auction mechanisms (in terms of low policy costs and 24 least-cost expansion), may not necessarily lead to a Many other contributing factors may explain the initial sustained RE deployment. In this case, the proper design takeoff of RE in Turkey: (a) the financing leverage of project completion guarantees, as well as penalties achieved under the Special Purpose Debt Facility, which to avoid construction delays and underperformance, triggered 620 MW of new privately owned additions are crucial for ensuring deployment and operational in RE capacity, especially in SHP (that is, equity-to- efficiency. The reserve energy auctions launched in 2008, debt ratio on the order of 2.6); (b) the demonstration 2009, and 2010 have already awarded a total of 6,199 and replication effect resulting from this facility, which MW of new least-cost RE capacity to be deployed before induced the emergence of new financing programs 2012. The effectiveness of the auction mechanism in for RE in local commercial banks and the additional terms of actual market growth is yet to be seen, although deployment of new SHP capacity; (c) the existence of a the construction of some of the first scheduled new RE strong regulatory agency; (d) the consistent effort toward plants is already delayed (ANEEL 2011). the establishment of a dynamic wholesale market and cost-reflective tariffs; and (e) the tight balance in supply Since the first successful auction for RE in Brazil was and demand in the system, which provides a strong carried out recently (August 2008), the deployment of signal for the need of new investments. RE before that date can only be partially attributed to the combination of other existing incentives, including However, to reach the committed targets and significantly the FITP (PROINFA), the reduced T&D tariff, tax scale up RE, Turkey will need to revise the effectiveness of incentives, and the preferential financing conditions the policy mix. For instance, it may be necessary to adjust offered by BNDES. Even though the PROINFA target the FIT levels—which are perhaps too low to attract was not reached by 2006 as originally established, private sector investments—and to ensure that the utilities adjustments to policy design and the introduction of or retail companies subject to the purchase obligation new incentives allowed Brazil to reach the quota of are able to guarantee the purchase.26 3,300 MW before the end of 2010.24 Investments in small-scale RE to supply the free or nonregulated In Sri Lanka, the sustained market growth of SHP can be market (lower than 30 MW) have also increased, mainly attributed to the introduction of SPPAs from 1998, which because of a discount—generally on the order of 50 offered a 15-year purchase guarantee and an attractive percent—on T&D charges offered by the government to tariff (based on avoided costs of power generation), as support RE development. well as to the provision of fiscal and financial incentives 24 For instance, the financing conditions offered by BNDES under PROINFA were adjusted after 2006, allowing higher debt-to-equity ratios, longer amortization periods, and lower interest rates. Also, from 2007, new tax incentives were introduced to promote RE development. 25 Other actions aimed at facilitating the introduction of RE include the release of a wind energy grid code. 26 One issue of concern in Turkey is that RE generators must approach retail companies in addition to Discos, given the low purchase obligations imposed on Discos (on the order of 4 percent). However, unlike Discos, most retail companies have no sizeable assets in their balance sheet to guarantee the purchase. (see Figure 12). In 2008, the Government of Sri Lanka committed to ambitious RE targets that will require the modified the scheme to the use of 20-year SPPAs based ramp-up of previous market growth trends. However, on technology-specific FITs (with the choice of stepped the new FIT levels are high—when compared to the , or flat FITs for on-shore wind, SHP and solid biomass). international range—and given the legal limitations to In particular, the Government of Sri Lanka has recently pass incremental costs on to consumer tariffs, the fiscal Figure 11: Evolution of RE Capacity and Share in Power System, Turkey 600 7 500 6 Geothermal 5 400 Law & Green Adjustments Concessional 4 (MW) to FiT (%) 300 Funds Incentives (SPDB) Feed-in 3 Licensing 200 Connection Tariff 25 Priority Policy 2 100 1 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Wind Geothermal Biomass Source: TEIAS 2009; Global Wind Energy Council 2009. Note: The graph excludes SHP to illustrate capacity additions of other types of RE. SHP accounted for 2,000 MW at the end of 2009 (including a net addition of 335 MW during the period 2002–09). The line representing the share of RE in the system includes SHP. Figure 12: Evolution of RE Capacity and Share in Power System, Sri Lanka SPPAs based on technology-specific FITs Competitive (RE Plants < 10 MW) 160 Bidding 6 Plants >10 MW 140 5 120 4 100 From 1998: SPPAs (MW) (%) 80 (based on 3 avoided cost, CDM 60 for RE plants < 10MW) 2 40 1 20 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Small-scale Hydro Wind Source: Central Bank of Sri Lanka 2010. sustainability of the scheme may prove a limiting factor sector; (b) lowering avoided costs of power generation, to RE deployment.27 especially in the islands that have switched from oil- to coal-based generation (and thus the existing policy is Indonesia and Nicaragua becoming even more ineffective); and (c) lack of clarity as to how the government will cover incremental costs By contrast, Indonesia has not been able to develop (there is a high off-take risk). its RE market consistently or sustainably (as shown in Figure 13). In this country, SPPAs were offered from In Nicaragua, the FITP has also been largely ineffective. 1993, but it was not until after 2002 that they actually Yet, the system is fairly small in terms of installed started to attract investments. This has been largely capacity (about 974 MW as of 2009) and thus, RE attributed to contextual factors (such as the effect of the capacity additions represent a high share of total Asian financial crisis and governance issues, among system’s capacity. others). Nicaragua introduced its first FITP in 2002 through In practice, the use of SPPAs based on tariffs levels Presidential Decree 279 to stimulate the addition of SHP below avoided costs of power generation has been and wind-based generation. However, the policy had no largely unsuccessful. Also, although competitive effect on either SHP or wind-based capacity additions. 26 biddings (with a tariff ceiling) have been recently With the enactment of the Renewable Energy Promotion allowed for geothermal capacity, the existing Law in 2005, the Government of Nicaragua then concessions have been so far negotiated directly. introduced a second FIT scheme (successively adjusted in 2007 and 2009). However, the scheme did not lead Three issues affect the scale-up of RE in Indonesia: to new investments in RE either (except perhaps for a 1 (a) high levels of regulatory uncertainty in the power MW SHP facility added in 2007) (see Figure 14).28 Figure 13: Evolution of RE Capacity and Share in Power System, Indonesia 2009: Competitive biddings allowed for Geothermal (with tariff ceiling) Reforms to Tax Incentives Ministerial introduced 1200 Ministerial 4.5 Decree on Decree Geothermal SPPA SPPA for RE 4.0 1000 Law 3.5 800 3.0 2.5 (MW) 600 (%) 2.0 400 1.5 1.0 200 0.5 0 0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 Geothermal Wind Small-scale Hydro Source: Ministry of Energy and Mineral Resources Indonesia 2008. 27 Today, the invoices from the Ceylon Electricity Board (CEB, the largest vertically integrated utility in the country) to cover the incremental cost of RE capacity introduced under the new FITP are accumulating at the Sustainable Energy Authority (SEA), which has no ability to pay. Incremental costs are estimated to reach US$116 million by 2015 (Meier 2010). 28 Neither was the introduction of a 40 MW wind-based generating plant in 2009 triggered by the FITP; rather, it was the result of a direct single-source contracting in which the negotiated price was set above the FIT established in the regulation. Figure 14: Evolution of RE Capacity and Share in Power System, Nicaragua Feed-in Tariff Policy 300 40 all NCRE & Tax Exemptions 35 250 Geothermal Law (Concessions) & Premium 30 200 over Spot Price to SHP and Wind 25 (MW) (%) 150 20 15 100 10 50 5 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Small-scale Hydro Biomass Geothermal Wind 27 Source: CEPAL 2009. The lack of investments in RE despite the existence of and 11th (2007–12) five-year plans. However, to reach an FITP—and other fiscal incentives—in Nicaragua its target on RE (54 GW by 2022), India will have to has been attributed to a number of factors: (a) a almost double its present AAG.29 This is even more generalized legal and regulatory uncertainty; (b) the acute in Indonesia, Sri Lanka, and Turkey, which will lack of a critical water rights law; (c) the existence of have to ramp up their efforts considerably if they are to legislation that converted geothermal resource-rich attain the targets they are committed to (increasing their areas into national parks; and (d) lack of clarity in the AAGs by 3-, 7-, and 12–fold, respectively). design of the FITP of 2002 (the pricing formula was not clearly defined in the regulation) (Mostert 2007, Economic Efficiency of RE Policy in Sample 2009). Countries In the sample countries, as indicated before, RE This section provides a general discussion of the costs policy—or its adjustments—has been streamlined and impacts of RE policy, the implications of policy primarily through legal frameworks associated with design on efficiency, and the sustainability of cost the reform and the liberalization of their power sectors recovery mechanisms. (Brazil, India, Turkey) or through legal provisions specifically addressing security of supply concerns Costs and Impacts of RE Policy (Indonesia, Nicaragua, Sri Lanka, and Turkey), or both. There is a general lack of analytical work that would Alignment of Exhibited Trends in RE provide estimates on the subsidy volume required to Deployment to Future Committed Targets reach the targets committed on RE across developing countries, and/or on the impact of RE supporting Figure 15 depicts the evolution of average annual policies on consumer tariffs or fiscal accounts. An growth (AAG, MW/year) for RE in the four sample indication of the subsidy volume required to cover countries that have a formal target on RE today. In the the incremental costs associated with RE additions in case of India, the country has experienced sustained relation to targets has been found for India and Sri growth through the 9th (1997–2001), 10th (2002–06), Lanka (as shown in Table 8). 29 The extent to which India will be able to maintain this sustained growth will be challenged by the existence of sites with good resource potential (in the case of wind) and the actual installation of solar-based projects. Figure 15: Evolution of AAG vis-à-vis AAG Required for Reaching Targets for All RE India Turkey 4,000 2,000 3,000 X 1.9 1,500 2,000 1,000 X7 1,000 500 0 0 2000 2005 2010 2015 2020 2025 2000 2005 2010 2015 2020 2025 Sri Lanka Indonesia 28 60 800 50 600 40 X3 30 400 X 12 20 200 10 0 0 1998 2003 2008 2013 2018 2005 2010 2015 2020 2025 2030 Evolution of Average Market Growth Average Market Growth required to reach target Note: Average annual growth (AAG) is in MW per year. Table 8: Subsidy Required for Meeting RE Targets, India and Sri Lanka Target Subsidy Required (incremental cost) Country Expansion Scenarios Volume Year Total Per Year India Scenario 1: 45 GW 2020 USD 68 Billion USD 6.8 Billion Diversified Mix (all types of NCRE) Scenario 2: 45 GW 2020 USD 12 Billion USD 1.2 Billion Only Wind and SHP (least cost) Sri Lanka Diversified Mix 366 MW 2015 USD 116 Million USD 23.2 Million , (SHP Wind, Biomass) 851 MW 2025 USD 258 Million USD 17.2 Million Sources: ESMAP 2010, Meier 2010. In the case of Sri Lanka, the FIT subsidy could have an negligible, given the size of the market (that is, 1.35 important impact on consumer tariffs if the incremental percent from PROINFA and 0.6 percent from auctioned costs were passed through to electricity tariffs, as shown RE capacity). in Figure 16. Economic Efficiency in Policy Design In Brazil, as shown earlier in Table 7, the total annual cost originating from RE generation triggered by both Although the scope of this review did not include an PROINFA and auctions is estimated at US$1.38 billion assessment of the economic efficiency associated with per year and US$911 million per year, respectively. the policy mix of sample countries, a few observations The impact on consumer tariffs today, however, is on efficiency were made during the course of the review. Figure 16: Estimated Cost and Impact of Meeting RE Target, Sri Lanka Incremental Costs of NCRE Target Impact of Meeting NCRE Target on Electricity Tariff 350 16 300 Rs / kWh 14 29 12 250 US$ Million 10 200 8 150 6 100 4 50 2 0 0 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2009 2014 2019 2024 2029 NCRE Scenario Tariff Thermal Fuel Cost Source: Meier, 2010 Table 9: Incremental Cost Recovery Mechanisms Incremental Cost Recovery IN BR TK INDO NI SRL Pass-Through to Consumer Tariff Equal Burden Sharing Differentiated Burden Sharing Fiscal Transfer & Other Fiscal Transfer (national/central or state level) Utility Revenue CDM Revenues Grants IN = India, SRL = Sri Lanka, BR = Brazil, INDO = Indonesia, NI = Nicaragua, CHI = China, TK = Turkey First, FITs designed to minimize producers’ inframarginal outcome (projects have been awarded based on lowest rents and the overall costs of FIT subsidies are only price, and the prices delivered are in the lower bound being used in India and Sri Lanka (that is, technology- when compared to international levels), although its specific stepped FITs and/or FITs with degression effectiveness in project completion rate is yet to be seen rates).30 In Sri Lanka, however, as shown earlier in (in general, there is a high deployment risk associated Figure 5, the initial value of FITs for on-shore wind has with auctions in RE). been set at very high levels (the remuneration level is one of the highest in the world). Sustainability of Incremental Cost Recovery Mechanisms In India on the other hand, despite the efforts in designing and introducing FITs that encourage economic Brazil, Nicaragua, and Turkey allow the pass-through efficiency, other factors seem to have significantly of incremental costs associated with RE generation to affected the overall economic efficiency of FITPs and consumer tariffs, while India, Indonesia, and Sri Lanka RE development (especially in wind): (a) the lack of transfer fiscal resources to utilities to cover these costs consistency across state FITPs seem to have driven (see Table 9). In the case of India, other contributing investments to the states with the most attractive policies, sources are carbon revenues (CDM proceedings should as opposed to the areas with the best resource potential be shared between the developers and the consumers 30 (thus, the expansion has not necessarily been least- for the case of solar initiatives) and utility revenues cost); and (b) the provision of accelerated depreciation, (which indeed are expected to partially cover the costs together with the FIT, has induced the installation of of FITPs). In Brazil, depending on the type of auction, wind-based plants with low operational efficiencies (as incremental costs are passed through to either regulated discussed previously). Thus, the actual design features users (technology specific auctions) or both regulated of the FITPs are not sufficient to ensure an economically and nonregulated consumers (reserve energy auctions) efficient expansion of RE generating capacity. as a fixed charge or uplift. Second, Brazil, India, Indonesia, Sri Lanka, and Turkey In Sri Lanka, the 2006 Energy Strategy proposed the use competitive mechanisms to procure RE development establishment of a fund to be supported through “an (as shown in Figure 3). In this case, competition is energy cess, grants received from donors, well wishers expected to induce the least-cost installation of RE (that and CDM revenues.” As of today, however, the fund has is, for one or all types of RE, depending on the policy not been established. and procurement rules). In practice, the success or failure of RE policy is In particular, the auction mechanism used in Brazil largely dependent on the sustainability of proposed to add RE capacity has already delivered an efficient mechanisms for the recovery of incremental costs. 30 In 2009, a new FITP that included technology-specific FITs with two-step degression rates, was proposed in Turkey. However, the proposal was rejected and instead the government approved technology-specific flat tariffs with characteristically low levels in December 2010 (as shown in Figure 5 before). 6. POLICY TRENDS AND MARKET STRUCTURE Brazil (wholesale market with strong government control), by contrast, is now using auctions to attract The section briefly discusses the links and compatibility investment in RE and has successfully promoted between market structure and types of policy competition among developers, since auctions have instruments, procurement methods, and policy attracted numerous companies and resulted in very performance. low prices. Most recently (December 2010), India introduced auctions to deploy solar based capacity. Market Structure and Types of Policy Instruments Both Indonesia and Sri Lanka (monopolies that allow IPP participation) are now promoting competitive The review did not find any relevant association between solicitations to attract RE (for geothermal capacity and the type of market structure and the type of RE policy plants higher than 10 MW, respectively). instruments being applied in the sample countries. Market Structure and Policy Performance However, there seems to be a distinction between large and medium-size countries (that is, gross The review did not find any relevant association national income and size of power sector) in the between the type of market structure and the diversity of instruments included in the policy package. performance of the policy mix in the sample countries. 31 For instance, Brazil, India, and Turkey are using a more diverse set of mechanisms to advance RE than The policy pathway to support RE seems to have been Indonesia, Nicaragua, and Sri Lanka (as shown in more effective in the higher-income countries (Brazil, Appendix 2). Also, BRIC countries Brazil and India India, and Turkey). This is also associated with other are applying the most complex types of instruments factors, such as investment climate, economic and (complex FIT design, REC market, and auctions). political stability, and governance issues. Market Structure and Types of Procurement As discussed before, low RE market growth was Methods exhibited in both Indonesia and Nicaragua for reasons related to policy or contract design in combination with Surprisingly, no links can be identified between the other external or contextual factors (such as regional type of market structure and the degree of competition financial crises, governance issues, or regulatory in the RE market. In Nicaragua and Turkey (markets uncertainty). in transition to full liberalization), as well as in India (single purchaser), the bulk of RE supply has been With regard to economic efficiency, the two countries contracted through direct single-source procurement. that have explicitly tried to attract least-cost RE In Nicaragua, however, although FITPs have been generation are Brazil (through auctions) and Turkey designed as a function of wholesale electricity price, (with a low FIT set at about wholesale market levels— they have been largely ineffective, considering the size subsequently substituted for technology-specific flat FITs of the market and its vulnerability to oil price shocks. with higher levels, but still in the lower bound when compared to those offered in the sample countries).31 In Turkey, RE developers are allowed to sell directly in the wholesale market, but there is a high price risk Both the Indian policy package and Brazil’s PROINFA associated with this possibility in the long term, and are believed to have delivered RE generation at very investors have not responded to the incentive (the high costs, either because of a high FIT (Brazil, as amendments of December 2010 to the Renewable shown in Figure 5 and Table 7) or because of a low Energy Law in Turkey introduced technology-specific, operational efficiency (India, as shown in Figure 6).32 In cost-based FITs). particular, the levels of the FITP issued in Sri Lanka in 31 Turkey recently (as of the end of 2010) introduced a new FIT regime, based on technology-specific fixed FITs whose level is in fact higher than the previous fixed technology-neutral FIT (that is, to increase the producer rent and hence the policy effectiveness). In the new amendments, however, RE firms are still allowed to participate in the free unregulated market. 32 Of course, RE capacity additions provide additional services related to enhanced security of supply, which need to be estimated and compared to a business-as- usual scenario to formally assess economic efficiency. 2007 are among the highest in the world for on-shore developed power markets with a large number of wind and SHP allowing producers a higher rent given buyers and sellers in sound financial standing are the level of other risks exhibited in the country. generally more conducive to competition; but even in systems where competition is modest and markets are Use of RE Policy Instruments in Different small, countries can benefit from the use of competitive Market and System Structures auction mechanisms (Maurer and Barroso 2010). However, effective auctions require a sophisticated The review suggests that FITPs can be very effective in level of regulatory and administrative capacity as attracting private investment for RE development in the well as a robust rule of law (for example, existence context of markets in transition where the institutional of independent regulators with the oversight capacity, structure and legal and regulatory frameworks are enforcement of contracts). evolving, and where players are still learning and gaining experience on competition practice and rules. In Nevertheless, auctions can be seen as a very good this case, the FIT provides the degree of price certainty mechanism for FIT-level determination (for example, necessary to counterbalance the other set of risks (such they help lower information asymmetries between the as regulatory uncertainty or off-take risk). For instance, government and RE suppliers right from the beginning). countries with no record of sound regulation face Indeed, auctions for long-term contracts may result in 32 greater lending constraints, and the FITP plays a critical the same Power Purchase Agreement (PPA) and risk role in increasing the debt-to-equity ratio.33 allocation as that provided in FITPs. However, FITP—which directly addresses price risks— In smaller vertically integrated power sectors, where can be unsuccessful when the other set of risks is too private sector participation in RE development is more high or when unusual external factors hit the sector difficult to attract and where there are no balancing or the economy (such as regional financial crises; markets, State-owned utilities have played an anchoring fuel price shocks that affect the financial health of the role in smoothing out some of the risks through take-on industry; and a track record of frequent or unpredictable contracts (for example, price volatility and intermittency regulatory changes, governance issues, such as risks are better addressed). This model has been corruption, and of course grid constraints). successful in some countries only when the PPAs are sustainable and the off-take risks are low. The literature suggests that an RPS or quota system can only be implemented effectively where the electricity The evidence in developed countries shows that market is more mature: institutions are experienced, the type, complexity, and sequencing of RE policy legal and regulatory frameworks and the process for are crucial for creating sustainable RE markets. For amending them are strong and predictable, competition instance, introducing simple technology neutral FITs— practices and rules have been established, and players although expensive—help pave the way for attracting are both experienced and financially strong (such as investors and lowering uncertainties in an initial stage in countries with large sophisticated utilities). In other or before a quota mechanism is introduced. The words, quota mechanisms are more appropriate for importance of policy sequencing is also reflected in the systems where price uncertainty can be accommodated, need to introduce legal and regulatory frameworks for given the low level of other types of risks. As discussed resource and land use, before RE policy is introduced. in this review, none of the sample countries has implemented an RPS. The review of the experience of sample developing countries shows that the design of policy instruments The use of auctions can also be more successful in aimed at creating sustainable RE markets is a dynamic systems where the markets are mature and relatively process, which requires frequent adjustments and the stable, where the rules are not evolving, and where introduction of complementary mechanisms to leverage there are a sufficient number of players and scope for the overall effectiveness of the policy mix. Clearly, market growth to achieve competition. For instance, along the way, regulators need to establish a solid track 33 The effectiveness of the FITP can be enhanced if combined with partial risk guarantees or other types of financial mechanism. record of decisions that consider and involve the various 7. KEY FINDINGS stakeholders participating in the market. Emerging Experience with Feed-in Tariff Appendix 3 of this paper provides a relative comparison Policies of most important price and quantity setting instruments. In the sample analyzed, all countries have implemented . some type of FITP The experience with the use of FITPs can be summarized as follows. FITPs can effectively promote the sustained deployment of RE capacity, especially when other key policy and regulatory instruments are also in place, including (a) clear rules on transmission connection and RE integration, (b) a sustainable incremental cost recovery mechanism, and (c) fiscal and financial incentives.34 FITPs have been particularly effective in India and Turkey, but largely ineffective in Indonesia and Nicaragua. In all cases, the design of FITPs has 33 required successive adjustments, either to improve policy performance (that is, lower inframarginal rents) or to adapt to new system or market conditions (for example, oil price fluctuations, decarbonization of generation mix, and market liberalization). However, policy adjustments should be controlled—perhaps through a mechanism embedded in the policy design per se—that allows stakeholders to manage the risks in order to maintain a certain level of regulatory certainty (for example, programmed reviews, thresholds on adjustments, and adjustments that affect only new projects). Also in the countries analyzed—except for the case of Indonesia—feed-in tariffs (FITs) have evolved from simple to more sophisticated formulations (for example, as information asymmetries between policy makers and RE producers diminish). However, compliance with the renewable purchase obligations (RPOs) imposed by FITPs has been poor in systems where off-takers exhibit weak or unsustainable financial balances or where schemes have lacked penalty mechanisms or realistic escalation schedules (that is, an RPO becomes an additional burden, especially in systems where incremental costs or the subsidy per se is not passed through to consumer tariffs or where the fiscal transfer is incomplete or unsustainable). Indeed, the effectiveness of FITPs seems to be strongly linked to the existence of fiscal and financial 34 Of course, RE policy effectiveness is also subject to the capacity of the grid to absorb renewables. incentives. This is particularly important for developing Emerging Experience with Competitive countries where uncertainties are higher and risks Schemes are more diverse. In particular, FITPs have been less effective when the FIT design is structured as a None of the sample countries analyzed has experience function of wholesale electricity markets or pegged with the implementation of Renewable Portfolio to oil prices, given that this type of preferential tariff Standards (RPSs) or with the use of Renewable Energy does not provide the minimum level of certainty on Certificates (RECs). The use of RPSs has actually been revenue flows required to attract private investment. less common in the developing world—with only Nevertheless, the lack of policy effectiveness is also Poland, Romania, and most recently Chile implementing linked to other factors, including overall investment this scheme. climate in the country and sector risks (off-take risks, regulatory uncertainty, governance issues), as well The review, however, provides an analysis of this as other external factors (such as global or regional type of regime because India recently introduced a financial crises). REC market (mainly as an equalization mechanism to improve the overall economic efficiency of RE Despite the relative success of FITPs in some of the deployment). With time, the use of RECs may become sample countries analyzed, the analysis suggests that more common, especially in systems where many Discos 34 effective FITPs have not necessarily led to efficient or retail companies operate and where the potential outcomes (that is, in overall costs and operational for RE scale-up is high and distributed across a large efficiency). Poor economic efficiency may be attributed geographic area. The review was, therefore, more to one or more of the following three factors: (a) use of focused on the experience with auctions for RE in Brazil a complex policy package that provides multiple sources and on the use of competitive mechanisms in other of incentives (expensive policy package); (b) a driving sample countries. policy mechanism that allows high producer rents (that is, poor FIT design); and (c) policy interactions The experience with auctions to deploy RE in Brazil can that introduce unintended economic distortions (such be summarized as follows: (a) auctions have been a as the use of FITPs in combination with accelerated useful tool for ensuring the economic efficiency of RE depreciation or tax breaks in the absence of technology deployment, although the resulting low prices have standards). Of course, grid access (connection) and the raised concerns as to the extent to which bid winners capacity of the system to absorb RE (integration) are will be able to construct and profit from the plants critical to the delivery of green electrons.35 (this has been the experience with RE auctions in other countries in the past, for example, the United Kingdom Expensive FITPs can have a direct impact on the poor and China); and (b) it is possible that these low prices when incremental costs are passed through to consumer may be the result of speculative behavior from bidders tariffs, especially when there is no differentiated burden (low correlation between capacity factors and offered sharing.36 The potential impact of FITP on poorest prices), although low prices may also be associated with consumers needs to be considered and properly the lack of a good record of historical data on resource assessed by policy markers when designing FITPs. In this potential (for example, wind velocities). review, information on the impact of FITPs on consumer tariffs was only found for the case of Sri Lanka. The auction design and process is complex, and requires a sophisticated level of regulatory and administrative Ultimately, an FITP can only be successful if—in capacity. For instance, the auctions in Brazil have combination with other policy levers—it leads to the included a number of prerequisites to avoid speculative deployment of RE capacity, as well as to the sustainable behavior and lower the risk of construction delays and efficient delivery of green electrons. or no construction of facilities at all, but the actual 35 This has been an issue of concern in the cases analyzed when the grid evacuation infrastructure is weak or when the regulations on connection and dispatch are not clear. 36 These incremental costs may include not only the cost associated with the production of RE, but also the cost associated with FITPs that promote the use of local equipment manufacturing. enforcement of project completion guarantees remains regulatory instruments to promote RE development. The an issue of concern (for example, potential court cases, leading reports concentrate mainly on the experience in which may then discourage future private investment). Europe and the United States. In particular, a long and ongoing debate throughout the literature focuses on The effectiveness of auctions can be affected by what policies are more effective and efficient in driving other external or sector issues (such as environmental the sustainable least-cost development of RE markets. licensing as a bottleneck to the development of projects, or the multiple roles of the public sector as a In most recent analyses, the general consensus planner, dispatcher, auctioneer, and power purchaser seems to be that FITPs are more effective at lowering introducing potential conflicts of interest). Nevertheless, investors’ risks than RPS or quota instruments (that is, auctions can also be seen as a very good mechanism when considering price, volume, and balancing risks). for FIT level determination (helps lower information However, some studies indicate that quota mechanisms asymmetries between policy makers and RE producers, (such as the RPS-REC scheme) can be relatively less right from the beginning). expensive than price-based mechanisms, considering that FITP typically offers high subsidy rates. As with FITPs, the provision of fiscal and financial incentives—as well as the existence of clear rules on The analysis of the recent literature shows that transmission connection and RE integration—is crucial developed countries have not only made policy shifts to 35 to the effectiveness of quota-based mechanisms. In test the performance of different policy tools, but also Brazil for instance, the Brazilian Development Bank that FITPs are being offered in combination with either (BNDES) provides very cheap financing with long auctions or RPS-REC schemes to support less mature amortization periods to RE-based projects, and the RE technologies or small-scale RE projects (hybrid regulator has designed innovative mechanisms on grid regimes). connection based on a cooperative planning approach. Developing countries—especially emergent In sum, auctions can deliver a very efficient outcome economies—have also made important policy shifts, but their effectiveness depends on a number of other and many are now also using both price- and quota- important preconditions. based instruments in parallel to support different segments of the RE market. As of November 2010, except for India and Nicaragua, all other countries encourage the use of competitive Future analysis should depart from the previous debate schemes (biddings, auctions) to procure a specific on the relative effectiveness of price- and quota-based segment of the RE market (Indonesia, Sri Lanka, and mechanisms (in practice, this depends very much on Turkey), but the use of competitive schemes has been country specific factors, institutional and administrative allowed only recently in these countries. Both India and capacity and the types and nature of risks) and focus Nicaragua use only direct contracting or cost-plus fixed more on the complementarities between different types FIT contracts for all types and scales of RE. of price- and quota-based instruments, as well as on the issue of policy interactions and their effects on Concerning RE targets, except for the case of India, the overall policy efficiency. analysis suggests a significant disconnection between committed quotas and historical trends, especially in General Lessons of Experience Indonesia, Sri Lanka, and Turkey (these countries would have to ramp up their RE deployment rate 3-, 7-, and The review suggests the following general lessons of 12-fold, respectively, in order to reach committed experience. targets). A tailor-made approach is necessary: Choice of policy Emerging Trends on the Use of Price and instruments, policy design, and complexity of the policy Quota-Based Mechanisms package (or regulatory regime) should be tailored to the actual conditions of the system in the type of market, There is a large body of literature analyzing the supply or demand volume, and nature and level of experience with the use of different types of policy and risks, as well as institutional and administrative capacity. Policy sequencing is critical for policy effectiveness: with a sound design do not result in effective and Policy sequencing, the existence of basic legal and efficient development of RE if other critical aspects are regulatory preconditions, as well as institutional and not considered in parallel, including the existence of administrative efficiency, are crucial to the effectiveness a sustainable incremental cost recovery mechanism of RE policy. For example, legal and regulatory (paid through sustainable subsidy sources or a frameworks for grid connection and integration, resource surcharge on consumer tariffs) and the existence of and land use and/or the allocation of permits and transmission infrastructure capable for RE integration, rights must be in place before RE policy is introduced, as well as clear rules on transmission access and and the process for granting permits should not create connection. bottlenecks. Final Remarks Policies that successfully lead to the scale-up of renewable energy may not necessarily be efficient: Ultimately, a low carbon development growth in Even if the policy mix succeeds in triggering investments the developing world depends on the availability that achieve RE capacity targets, its overall economic of resources to finance the solutions that exhibit efficiency (cost per unit of benefits) may be poor. incremental costs. 36 Policy interaction and compatibility need to be The volume of financing resources required and the considered: The coexistence of policy instruments sources are an issue of great concern. While green has the potential to result in complex interactions growth in the developing world is necessary to minimize and unintended effects. Thus, policy makers need to climate change impacts on a global level, other more assess the compatibility among policy and regulatory pressing developmental priorities compete for the use of mechanisms or incentives—that is, their combined budgetary resources, concessional finance and official impact may result in inefficient outcomes. It is also vital development assistance. that individual policies are coordinated with the wider set of conditions that impact the energy market in a The pass-through of incremental costs to consumer specific setting. tariffs is also an issue of concern, given the huge implications on affordability and potential impacts on Policy and regulatory design is a dynamic process: the poor. Moreover, the use of budgetary resources— Developing countries have tested different types of or the issuing of debt—to support RE development instruments to support RE development (policy shifts) displace other present and future competing priorities. and many are now using both price and quantity setting instruments to support different segments of For this reason, policies to support RE development the RE market. In the sample countries, feed-in tariff should be designed and introduced in combination policies (FITPs) have required successive adjustments with strategies that clearly identify sources of finance (the challenge has been attracting private investment and establish a sustainable incremental cost recovery while at the same time minimizing inframarginal rents). mechanism (for example, using concessional financial However, policy adjustments should be controlled flows from developed countries to leverage private through mechanisms—perhaps embedded in the policy financing, strengthening the performance of utilities design per se—that allow stakeholders to manage the and Discos, or allowing the partial pass-through risks in order to maintain a certain level of regulatory of incremental costs to consumer tariffs with a certainty (for example, programmed reviews, thresholds differentiated burden sharing that protects the poor). on adjustments, and adjustments that affect only new projects). Without question, policy makers will have to ensure that the design of different policy mechanisms and the policy RE policy performance (effectiveness/efficiency) mix per se deliver RE targets with the lowest possible depends on a number of key factors: Even policies incremental costs and volume of subsidies. APPENDIX 1: TYPES OF RE POLICY MECHANISMS AND INCENTIVES Classification Type of Instrument/Incentive I DIRECT Price Based Incentives Feed-in Policies (FITs or Premiums over Spot Price) Other Premiums: Generation Based Incentives (GBIs), Premiums for Use of Domestic Equipment or Services Reduced T&D Costs Quantity Based Incentives or Quota Targets on RE penetration Obligations Renewable Portfolio Standards (RPS) in combination with Renewable Energy Certificate or Credit (REC) markets (also known as Tradable Green Certificates, TGC markets) RE Policy (quota) through Competitive Procurement Mechanisms (competitive biddings, auctions) Fiscal and Financial Incentives Tax Credits/Incentives and Fiscal Exemptions (such as accelerated depreciation) 37 Grants/Capital Subsidies Preferential Loans and Loan Guarantees Carbon Financing (through CDM) R&D grants, loans or subsidies Voluntary Measures Green Tariffs Investment focused (shareholder/contribution programs) II INDIRECT Pricing of Environmental Externalities Carbon Tax Cap-and-Trade or Emissions Trading Schemes (ETS) Environmental Standards Performance Standards: penalize high emitting sources Voluntary Measures Voluntary agreements Source: Adapted from Menanteau, Finon, and Lam 2003; Klein and others 2008; World Bank 2010; Fischer and Preonas 2010. APPENDIX 2: POLICY PACKAGE OF SAMPLE COUNTRIES AS OF LAST REFORM (2009–10) Instruments Deployed (1990–10) IN BR TK INDO NI SRL Targets RE Targets Indicative Indicative Technology Specific Targets Price Based Instruments Feed-in Tariff/Premium Premium for Use of Domestic Equipment Generation Based Incentive (GBI) Reduced Transmission Cost (wheeling price and/or connection cost) Net Metering/Banking Carbon Market/CDM Transactions 38 Quantity Based Instruments and Procurement Mechanisms Renewable Portfolio Standard (RPS) REC Market Competitive Bidding/Auction Investment Cost Reduction/Financial Incentives Accelerated Depreciation Green Funds (e.g.; soft loans, grants) Capital Subsidy/Equity Participation 100% FDI Equipment Manufacturing Fiscal Incentives Value Added Tax Exemption (1) Income Tax Exemption /Reduction Property/Turn-Over Tax Exemption Import Duty/Customs Tax Exemption Excise Duty Exemption Entry Tax Exemption Electricity Duty Exemption Corporate Tax Exemption (10 years) Municipal Taxes Exemption Tax on Financial Operations Exemption Corporate Tax Credit on R&D Expenses Other Prioritized Dispatch Specific Connection Alternative for RE Grid Code to Facilitate RE Integration Instruments Deployed (1990–10) IN BR TK INDO NI SRL Voluntary Measures and Other Market facilitation Measured Green Power/Retail Tariff Voluntary Carbon Trading Reduced or Exempted Water Charges Biddings for the Use of Resources R&D Funds/Subsidies Single Window Clearance Systems/ Special Processing Environ Licensing Exempted/Reduced Licensing Fees Exempted/Reduced Land Use Fees IN = India, SRL = Sri Lanka, BR = Brazil, INDO = Indonesia, NI = Nicaragua, CHI = China, TK = Turkey 39 APPENDIX 3: INSTRUMENT COMPARISON Investment Risks Effectiveness/Efficiency Complexity Feed in Tariff Policy (FITP) Low price, volume and balancing risks Effectiveness in terms of In general complexity is low, but In spot market transactions, balancing market growth is high (subject depends on type of FIT (trade- risk may arise (this risk can be minimized to compliance with RPO) offs between simplicity and introducing a “per area” mechanism) Sophisticated FIT design can complexity) Designed to create stable investment reduce inframarginal rents Depending on design environment (although successive FITP Allows for strategic support of complexity, calibration design adjustments may decrease investors’ different types of RE may require a complex confidence) No incentive for cost administrative process Predictable revenue streams reductions (entire supply chain) Help increase debt financing Overall cost of FITP may be high (depends on FITP design and market conditions) RPS-REC Moderate to high price risk (value of REC Effectiveness in terms of REC market design and the depends on market dynamics) market growth depends on periodic setting or targets/ 40 Moderate to high volume risks (once targets actual compliance with quotas quotas may be complex are met, suppliers do not have an incentive to (market share) REC market requires high purchase RE generation) Market based instrument, institutional and administrative Balancing risk may be high (depends on fosters competition among capacity market rules and support mechanisms) RE suppliers (least-cost RE Less predictable revenue streams require introduced first) higher IRRs Favors mature technologies Participation in bids may entail high transaction costs More difficult to secure financing Competitive Procurement (Auctions, Biddings) Moderate to high price risk (depends on If competition is effectively Design of auction mechanism contract design, market rules) fostered, delivers low prices may be complex (depends on Stop-and-go nature creates uncertainty (entire supply chain) type of market and market Less predictable revenue streams require Allows for strategic support of conditions) higher IRRs different types of RE Requires high institutional and Awarded contracts provide predictable High deployment risk administrative capacity revenue streams (project delays or no Requires robust rule of law, Participation in bids may entail high implementation at all due enforcement of contracts transaction costs to difficulties in financial Regulatory stability is crucial More difficult to secure financing closure, administrative or (stable auction rules) licensing barriers, weak rule Requires proper design of of law or weak enforcement of project completion guarantees contracts or project completion and penalties for delays and guarantees) underperformance. GLOSSARY hour can be differentiated by technology type, project size, resource quality, and project location to reflect Accelerated depreciation. Refers to the accelerated actual project costs better. FITs are categorized as fixed amortization of fixed assets, such as plant and tariffs or premiums. Fixed FITs are paid to generators equipment (that is, faster recovery of capital costs and as guaranteed remuneration independent from the earlier tax advantages). For tax purposes, accelerated electricity market price (different types include stepped depreciation provides a way of deferring corporate tariffs, tariffs with degression rates, and flat tariffs). income taxes by reducing taxable income in current Premiums are paid to renewable energy generators on years, in exchange for increased taxable income top of the electricity market price; for this reason, they in future years. This is a valuable tax incentive that are considered a market-based support instrument. encourages businesses to purchase new assets. Feed-in tariff policy (FITP). An energy supply policy Additionality criterion. Applies to projects considered focused on supporting the development of renewable under the Clean Development Mechanism (CDM). energy projects by offering three key provisions: (a) A CDM project activity is additional if anthropogenic guaranteed access to the grid; (b) stable long-term emissions of greenhouse gases by sources are reduced purchase agreements or an arrangement that ensures below those that would have occurred in the absence a stable revenue stream for a prespecified period (for of the registered CDM project activity. The baseline for example, in multiple-buyer power markets, renewable 41 a CDM project activity is the scenario that reasonably energy suppliers are paid a preferential tariff or represents the anthropogenic emissions by sources of premium for a prespecified number of years from the greenhouse gases that would occur in the absence of market operator; in this case the market operator the proposed project activity (UNFCCC, 2008). imposes a surcharge on consumer tariffs to cover the incremental cost); and (c) payment levels, usually above Auction. A selection process designed to procure (or market price, based on the cost of renewable energy allocate) goods and services competitively, where the generation (that is, a feed-in tariff). FITPs also typically award is made to a prequalified bidder and is based on mandate a renewables purchase obligation (RPO) on a financial offer. In the most common type of auction, utilities or retail companies (for example, in the form of potential buyers bid for a product and the highest bid market share or minimum percent of electricity purchase price wins. In most cases involving electricity auctions, from RE suppliers). the sellers, such as generators, are the ones bidding their products, since they are interested in selling power Firm Energy Certificate (FEC). In the Brazilian contracts to large consumers or distribution companies, regulation, a FEC is a certificate (denominated in GWh/ with the bidding process designed in part to select the year) for the maximum amount of energy that a power lowest price. This is the so-called “reverse auction,” plant can sell annually through contracts. Any shortfall where the lowest offer is the winner (Maurer and is penalized at a price mirroring the cost of new energy Barroso, 2010). (Barroso, 2010). Capacity payment. A payment that compensate Clean Development Mechanism (CDM). A investors for higher capital costs arising from regulatory mechanism established by Article 12 of the Kyoto risk and the failure of market design to accommodate Protocol for project-based emissions reduction activities for long-term contracts with domestic consumer in developing countries. The CDM allows emissions franchises to allow hedging of investment decisions emission reduction (or emissions removal) projects (Grubb and others, 2008). In hydropower-based in developing countries to earn certified emissions systems, capacity payments are provided to help reductions (CERs), each equivalent to one tone of mitigate price spikes and encourage investments in carbon dioxide. These CERs can be traded and sold, flexible and backup plants (that is, peaking generation and used by industrialized countries to meet a part receives capacity payments to anticipate and receives a of their emissions reduction targets under the Kyoto certain level of scarcity rents over time). Protocol (UNFCCC, 2010). Feed-in tariff (FIT). A special tariff paid to renewable Generation-based incentive (GBI). A premium paid energy generators. The payment levels for each kilowatt- over the FIT or electricity price to shift the incentive from renewable energy installations (MW) to production purchase obligations under the RPS mechanism. The (GWh). By rewarding the actual generation, GBIs obligated entities under the standard (utilities, retail encourage the higher output efficiency of renewable suppliers) can either own generating capacity or buy energy plants. RECs. Suppliers can also exercise a “buy-out” option by paying a fixed penalty, which theoretically caps the price Price-setting policies. Price-setting policies reduce cost of credits. and pricing-related barriers by establishing favorable price regimes for renewable energy relative to other Renewable Portfolio Standard (RPS). A quota- sources of power generation. The most common price- based policy that mandates that electricity suppliers based policy is known as FITP (World Bank 2008). source a given proportion or share of their electricity from renewable energy. An RPS can be phased, with Quantity-setting policies. Quota-based or quantity- incrementally increasing targets, over a number of setting mechanisms (also known as market share years. Assuming there is sufficient capacity to meet policies) mandate the introduction of a certain the requirement, and assuming ideal operation of the percentage or absolute quantity of RE capacity or market, eligible renewable generating sources will generation at unspecified prices. The government sets “stack themselves” into a merit order of increasing cost a target and lets the market determine the price. The of generation. These sources then compete to supply 42 most common quota-based mechanisms for promoting renewable electricity to meet market demand, which RE deployment are the RPS and auctions (World Bank is determined by the policy target or quota. Typically, 2008). generators of eligible electricity receive a Renewable Energy Certificate or Credit (REC, also known as Renewable Energy Certificate (REC). Represents Tradable Green Certificates or TGCs), an official renewable and environmental attributes associated record certifying that a specified amount of renewable with energy production. For instance, a REC—for electricity has been generated (Grubb and others, California RPS purposes—is a certificate of proof, 2008). issued through the appropriate accounting system, that one unit of electricity was generated and delivered by Renewable purchase obligation (RPO). An obligation an eligible renewable energy source. A REC includes imposed on utilities or retail companies to source all renewable and environmental attributes associated a given proportion or share of their electricity from with the production of electricity from the eligible renewable energy. In this case, the RPO is a component energy resource, except for emissions reduction credits. of the FITP. RECs can be used not only as a unit of account for compliance purposes, but they can also be traded Standardized Power Purchase Agreement (SPPA). A separately from the energy produced. RECs are also legally binding standardized contractual agreement by known as Tradable Green Certificates (TGCs). which an entity, such as single buyer or a distribution company, undertakes to purchase the power generated REC market. A platform or legal framework for the by an independent or affiliated small-scale renewable trading of RECs. 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