Incentive Schemes for Renewable Energy

The success of renewable energy in the electricity sector in individual states differs greatly. This is more a result of policy context than natural potential.This raises a few questions. 1. What instruments do governments use? 2. What has proved to be the most efficient and effective way of support? And finally, we look at what governments really do and what that could mean for investors.

the tree of incentives

Production-based Incentives

Production-based incentives provide an award that is proporitonal to the actual energy generated.

There are 3 main systems:

  • Minimum Feed-in Tariff: The generator is guaranteed a minimum tariff per kWh for a specified period.
  • Production Tax Credit: Mostly in the U.S. , the generator receives a tax credit. It can therefore only be used by investors with sufficient tax capacity.
  • Quota System: awards the generator with certificates that can be sold into a market. No price guarantee. An alternative to this is an exemption from a charge levied on electricity if generated from renewable sources. E.g. climate change levy in the UK

All of those systems come with a number of parameters, such as

  • Technology Differentiation: Where the tariff pays the same amount for all technologies, some will be benefit from a quasi free-loading effect, whilst others won't pass the hurdle rate. This happened in the UK before the introduction of banding.
  • Inflation Adjustment: Some tariffs (e.g. in the U.S.) are increased annually by inflation.
  • Degression: Some governments have strict mechanisms and measures that govern the reduction in feed-in tariffs. Mostly dependant on the size of new installation during the year.
  • Own use: What tariff do householders get for electrcity used in-house vs fed into the grid.
  • Off-take guarantee: Some countries have imposed annual caps on total installation that can qualify (e.g. Spain).
  • Income Tax Treatment: Do householders have to pay income tax on the revenue from sold electricity?

Investment-based Incentives

Investment-based incentives provide awards for the initial investment, regardless of how much electrcity is generated.

  • Investment Tax Credits: provide individual investors with the opportunity to offset the investment against their own personal income tax.
  • VAT exemption: Allow householders not to have to pay VAT on equipment for small generators.
  • Accelerated Depreciation: In some countries, renewable energy plants can be depreciated for tax purposes in a few years that can be offset against profits elsewhere in the company.
  • Interest-free loans: Some governmental agenices like the Carbon Trust in the UK provide interest-free loans for the purchase of renewable energy equipment.
  • Loan Guarantees: To de-risk the investment in renewable assets in emerging markets, export agencies or the European Investment Bank may provide certain guarantees regarding the exchange rate or the loan up to a limit.

Robust Legal Framework

Although not a direct monetary incentive, a robust legal framework has to be in place to attract investors. This includes

  • Streamlined Planning Process: Has the country implemented a "one-stop-agency" approach or do developers have to submit applications to any number of authorities and interested parties?
  • Spatial Planning Process: Do local authorities prioritise land-use for renewable energy? If so, applications will much more likely be approved, as the land had been pre-vetted. This reduces time for approval and development costs.
  • Building Regulation: What are the requirements and approval processes for renewable energy installations in new / old buildings? Also, do building regulations mandate the use of renewable energy, as is the case in some states in Germany, thus forcing investors rather than just attracting - though the result is the same.

The Art of Setting Incentives

What is the most effective and efficient way for the market introduction of renewables? A stable, feed in tariff regime that is sustained over many years. Beyond market introduction, competitive procurement has yielded the lowest tariffs but not all of the lowest bidders are able to implement their projects.

One of the challenges with setting the feed-in tariff at the right level is finding the right moment of reducing the tariff at the right time. Ideally, a feed-in tariff tracks the costs, which have come down dramatically over the past decade. They are however very much a political instrument and do therefore not necessarily follow rational logic. For instance, feed-in tariffs in 2008 in sunny Spain and not-so-sunny Germany were nearly the same, while Greece paid almost 20 cents more per kWh.

Tax credits

Production tax credits in the U.S. are only beneficial to profitable companies, only available for 10 years, and only issued in chunks, i.e. not always available.

Investment Incentives

As with production tax credits, most investment incentives are either tax credits (only available to some) or they do not significantly lower the high capital costs. More importantly, unlike feed-in tariffs, they do not address the uncertainties of the revenue streams.

Legal Framework

Even with the best feed-in tariff on the planet, the introduction of renewables won't be a success without a robust legal framework. The approval and planning processes must be transparent and streamlined. The responsibilities of grid or utility companies must be clearly defined. Despite favourable feed-in tariffs in Greece, there is no significant installed PV capacity - mainly because of bureacracy.

Eco- Taxes & Exemptions

Rather than incentivising investors, governments can (and do) also use the instrument of taxation. There are many examples such as the Eco-Tax or the Climate Change Levy in the UK where the consumption of fuels or electricity is taxed, some of which is promised to be channelled into renewable energy projects, although most of the income is consumed in other departments of the administration. While such taxes may discourage the use of energy, they do not alter the economics of renewable energy plants, and therefore will have only a very narrow effect on investment decisions regarding renewable energy.

However, where levy exemptions for use of renewables are granted (in the UK), the exemption works like a certificate that can be traded for money. See above for effectiveness. Seems bureaucratic and not available to all.


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