Policies And Market Uncertainty: Exploring The Impact On Renewables Adoption

There is a wide international consensus on the need to limit global warming. This is evident from the 195 countries who have adopted a binding agreement on global climate change in December 2015, known as the Paris Agreement. Governments have to implement a wide set of policy tools to curb emissions and also to mitigate the consequences of climate change. Among these policies, the promotion of renewable technologies is the most popular one to decarbonize the energy mix and the economy. Now, a key question is, what is the best policy to promote renewable energy?

Energy transition cannot be implemented by the public sector alone. The involvement of the private sector is a necessary condition for a shift from solely a fossil fuel based economy to a balanced diversified economy. However, private investors are not charities or non-profits, meaning they require a return on investment. For private investors, renewable energy is not different from any other economic sector. Investment in renewable energy occurs only if there is an attractive balance between yield and risk. On the other hand, and despite the significant decrease in costs, private sector renewable projects typically require public support to get started.

It is the public objective to make renewable projects attractive for private investors in order to accelerate the transition towards a decarbonized energy mix. In theory, the objective is clear and simple. In practice, it is often a struggle for governments to create and execute an efficient renewable policy. The reason is that governments try to achieve multiple objectives simultaneously and, on many occasions, these objectives compete with each other. In layman’s terms, the policy must be “good, pretty and cheap.” In policymakers’ terms, the optimal policy must achieve “a maximum penetration of renewable technology, at the fastest speed possible, and with no cost at all for the taxpayers.” This is considered the Holy Trinity of renewable policy, but policy is not religion, and achieving this trifecta is not possible.

There are several instruments that governments can use to promote renewable deployment and accelerate the decarbonization of the energy mix. Three very popular policy tools implemented around the world include:

  1. The feed-in tariff, which is a fixed price for the electricity produced using renewable sources.
  2. The feed-in premium, which is, a premium on top of the market price of electricity for the electricity from renewables.
  3. The investment credit or investment subsidy, which is an upfront payment to reduce the initial cost of the investment.

A recent study explores how these policy instruments perform under different market conditions, taking into account the impact of electricity price volatility and uncertainty of those investments. The results show that, in reality, there is no ‘‘best policy instrument.’’ In other words, the Holy Trinity is not achievable. The reason is that since there are trade-offs among the different policy instruments. The best policy depends on the government’s objectives. Prioritizing between the total deployment of renewables, speed of adoption and cost of policies. There are two key takeaways from the study.

First, an initial investment subsidy is the most attractive policy instrument, since it is the cheapest tool under realistic market conditions. This result is due to the capital-intensive nature of renewable technologies. Investors have to make a strong financial effort in the first moment, while the revenues expand over a period of 20 or 25 years. However, this policy has been less attractive to utilize because it requires a large upfront payment. This is something politically difficult to implement, given the current public budget situation of most developed economies.

Second, if the objective is to accelerate the deployment of renewables in a short period of time, with no regard to costs, then a feed-in tariff is the preferred option. Given the continued effects of climate change, this would be the most adequate policy tool. Unfortunately, this tool, although extremely popular in Western Europe, is being strongly criticized because it is expensive. Many European countries financed renewable adoption using this tool and, as a result, there was a substantial increase in electricity bills. This backfired on the popularity of climate change initiatives.

These findings are described in the open access article entitled Economic policy instruments and market uncertainty: Exploring the impact on renewables adoption, recently published in the journal Renewable and Sustainable Energy Reviews. This work was conducted by Jorge Blazquez, Nora Nezamuddin, and Tamim Zamrik at KAPSARC, an energy economics and policy research center in Riyadh, Saudi Arabia.