(Jan. 14, 2011) Aldyen Donnelly offers a closer look at why Spain’s renewable energy policy should not be repeated in Ontario and other Canadian provinces.

As I have suggested in the past, I think that all Canadian energy policy influencers and decision-makers might wish to study and learn Spain’s renewable industry development history. It is one of great successes and equally great failures.

It is very important to differentiate between legally-binding renewable energy mandates (called Renewable Portfolio Standards, “RPSs” or Renewable Energy Standards, “RESs”, depending on the jurisdictions) and Feed-In Tariffs (“FITs”). These are distinctly different measures that can operate separately or together.

Since about 2002, much of the literature published by academics and the environmental community has used the term FIT to describe RPSs and RESs, which is a significant error.

Background

Japan was the first nation in the world to regulate low impact renewable energy mandates, which were first introduced there in 1971.  Spain was the first European nation to introduce a legally-binding RES, in 1985.  Spain did not add an FIT to its renewable energy policy package until around 2000.

I would argue that the data clearly shows that Spain’s RES was well-designed and very successful from 1985 through 1999.  By 1999, Spain had the largest per capita low impact renewable energy market penetration in the world, with the lowest relative retail electricity price impact   By comparison, Germany introduced a FIT, with new renewable power supply price guarantees that were significantly higher than the renewable price premiums that were being realized in Spain, in 1991.

Note that 80+% of renewable power capacity costs are fixed capital costs, so Spain’s lower wage rates do not explain the renewable power price differentials between Spain and Germany. Germany did not promulgate its national RES until roughly 2000.

As will be the case with every nation, after 10 – 15 years of enforcing the legally binding RES, Spain had achieved about as much incremental low impact renewable energy market penetration as could be achieved anywhere with an RES alone. Texas is close to reaching this platform at this time.

Around 2000 Spain introduced an unique FIT, the goal of which was to spur on more investment in low impact (“LI”) renewables given that the RES-alone plateau had been reached.  This unique Spanish FIT was highly efficient in many ways that no other FIT was, and in 2006 Spain still had the highest per capita market penetration of LI renewables notwithstanding the apparent explosions of LI renewable investment in Germany, Denmark and Texas.

But by 2006, Spain appeared to have reached another LI renewable investment plateau.

In that year, under great pressure from industry lobbies, Spain retired its original, unique FIT regulations and replaced them with a new FIT that almost exactly mirrored the German FIT.  This was a surprising and illogical move—in my opinion.  From 2000 through 2006, Spain’s FIT out-performed Germany’s in both rate of new investment in renewable power supply terms, as well as impact on retail power price terms.  There was no logical, fact-based argument, therefore, for switching from the Spanish FIT model to the German model when Spain hit the second LI renewable energy investment plateau.

Within 2 years, both Germany and Spain started retroactively reneging on the price guarantees to which they had contractually committed since 2006.  Some reporters argue that they were compelled to do so in response to the global financial crisis.

I argue quite differently.

The German-style FIT operating in both Germany and Spain created unsustainable construction bubbles that contributed to their national financial crises.  Overly generous FITs are simply mechanisms for providing near free financing for uncompetitive energy projects.  The FIT is nothing more than an elegant way to borrow money from future rate payers.

Excessively high guaranteed FIT prices combine (1) excessively high power supply costs with (2) excessively high costs of capital.  Many of the renewable energy projects that have been developed under FITs are constructed by private entities who have put absolutely no capital at risk.

The overly generous FIT transfers all investment risk to the rate base/tax base and does not act as a magnet to risk-oriented capital.  It displaces risk-oriented capital by transferring all risk from the private investors to the rate base.  Once the risk transfer occurs, private investors enter the market who are not, in many ways, suitable entrants to competitive energy markets.

Significant rates of business failure are inevitable if/when power rates paid to this project developers decline to anywhere near competitive levels, at any time.

So, in many ways, the excessive and unsustainable price premiums offered in the German-style FIT has much the same effect as mortgage loans that offer no interest in the early part of the mortgage term with the promise that the rates will be adjusted to market rates in the later part of the term.  The projects never had the capacity to continue operating if the prices paid dropped as per the FIT schedule, and the FIT schedule was never sustainable, so it was inevitable that governments or market participants would intervene to renege on the rates guaranteed in the market schedule.

It is well understood that Spain’s recovery from the global recession is more uncertain than it is for others.  It is well-known that this is in large part due to a pre-global recession Spanish domestic construction bubble. Nations (including Germany) that were more dependent on exports for GDP growth are having an easier time recovering from the recession than nations that depended more heavily on domestic construction booms and growth in public sector jobs for pre-recession GDP growth.

What is rarely discussed is the significant contribution that the German-style FIT made to domestic construction bubbles.  The renewable energy construction boom relied entirely on government maintenance of artificially inflated power prices in perpetuity, and a significant share of the domestic residential construction boom relied on construction worker wage inflation.

When the global recession hit, Germany was quick to reverse FIT price commitments.  This had a devastating effect on the rate of expansion of Germany’s renewable energy industry.  Large numbers of independently developed projects are now owned by the nation’s two largest, established utilities, which utilities have picked up the renewable assets at large discounts to their actual cost.  The original developers have written down significant capital investment.

German energy prices will remain very high (over CAD$0.35/kWh) for a long time as a result of the FIT policies.  But at least they will stabilize.

The German situation is not a disaster because of the role that traditional (as opposed to renewable/green) exports play in Germany’s economy as well as the fact that Germany’s pre-recession tax-payer funded-to-goods-producing jobs ratio was 0.93:1.

By comparison, in the pre-recession case: (1) exports contributed proportionately much less to Spain’s GDP, (3) renewable energy/green tech and service exports held a larger share of total Spanish exports than they did for Germany, (3) Spain’s tax-payer funded-to-goods-producing jobs ratio was over 1.45:1.

Since renewable energy/green tech exports depended so heavily on subsidies (in both the countries of origin and the receiving country), pre-recession trade levels were not sustainable post-recession.  Post-recession, any nation whose pre-recession domestic construction bubble had been more tied to green energy subsidies and employment in the public sector would have a much more difficult time recovering than a nation whose domestic construction bubble derived only from cheap credit and had no links to energy policy.

In other words, the German FIT model has proved disastrous in both Germany and Spain, but the disaster was much larger for Spain because growth in the unsustainable FIT subsidies for renewable energy played a much larger role in national pre-recession GDP growth than it ever did in Germany.

Note that at this time, as part of its economic recovery plan,

Key Lessons

Lesson #1:

Almost all nations reveal histories in which investment trends in LI renewables reach plateaus.  Too often, when an RI investment plateau is reached, national/state governments ask: what new subsidies can we introduce to maintain historical rates of growth of investment in LI renewables?

Instead they should be asking: to date, have we developed a LI renewable energy sector that has any shot at sustainability if/after we wean it off subsidies?  Is it really rational to increase subsidies to attract more/new domestic competition for the existing market participants whose business models are unsustainable without perpetual subsidies at current levels?

The Danish renewable power industry probably is our best indicator of what can go wrong when we build a whole industry off of long-term public subsidies.  While Denmark does not have an FIT, that nation built special tariffs into domestic power to finance the development of an export-oriented wind power industry.

By 2000, Danish residential rate-payers paid over CAD$0.06/kWh which revenues were directly distributed to Danish wind turbine and parts manufacturers to subsidize the development of the Danish wind technology exports.

In 2002, Denmark’s natural governing party lost the national election to a right-of-centre coalition that promised to cap the subsidy for Danish wind technology manufacturers at 2000 levels.  The new government kept that commitment and was re-elected in 2006.

But Danish wind technology exports peaked in 2000.  Those exports caved over the 2003 through 2006 period.

The value of gross Danish wind technology exports has increased over the 2007 through 2010 period.  But this year, after 4 years of growth the gross value of Danish wind tech exports will still be less than 2/5 of the nominal 2000 value.

More important is the difference between net and gross export market value.  In 2000, most of the blades that were installed in Danish wind farms or exported with other turbine parts from Denmark to export markets were manufactured in Denmark.  Today, however, almost all of the blades and other key components that are integrated in new Danish wind farm developments as well as in packages of Danish wind technology exports are manufactured elsewhere and imported into Denmark.

So the net value (GNP contribution, as opposed to GDP contribution) of Danish wind technology exports today is a small fraction of what it was in 2000.

The Danish story has nothing to do with the global recession.  It teaches a key lesson:

Lesson #2

A new industry that is born from and nourished with large government subsidies does not necessarily ever grow into an industry that has the capacity to survive in competitive global markets.

Lesson #3

Renewable Energy Standards (RESs), properly designed, can prove out as efficient and effective government mechanisms to attract risk-oriented investment in LI renewable energy.  The RES creates demand, still leaving it to risk-oriented investors to compete to deliver new products and services to meet that demand on price and innovation.

Feed In Tariffs (FITs)—which require government to set prices and select technologies, are inefficient and rarely sustainable LI renewable energy incentives.  Badly designed, they prove to be absolute LI renewable market destroyers.

No nation/state, to date, has designed a sustainable FIT when they promulgated the FIT before regulating an RES.  Only a small fraction of the FITs introduced after an RES is promulgated will enhance–as opposed to destroy–emerging LI renewable markets.

Never introduce a FIT in the absence of the cover of an RES regulation.

Both Ontario and BC are making the mistake of barrelling ahead with FITs while resisting advice to introduce legally binding RESs.  By comparison, Nova Scotia regulated an RES in 2007 and does not have an FIT.  At the end of the first quarter of 2001 Nova Scotia will have in full operation 50% of the long-term renewable energy target for 2015 associated with Ontario’s first FIT contract round.

Nova Scotia, with 1/14th the population of Ontario, will achieve 50% of Ontario’s longer-term supply objective in place 4 years faster and at a significantly lower retail electricity price impact.  The difference is the policy package, not market structure or the targets.

Lesson #4

If government insists on implementing an FIT, governments should lean towards the pre-2006 Spanish FIT model and avoid the German FIT model, which was introduced in Spain in late 2006, which FIT change was the beginning of the end for Spain’s LI renewable industry).

Here is a copy of a useful comparison of the German and pre-2007 Spanish FITs.  The author of this study makes the common error of attributing all investment into LI renewables to the FIT and failing to identify and differentiate between the two separate policies that have been in replaced in both countries since 2000—the RES and the FIT.

By failing to identify both policies and attempting to determine how much investment truly derives from the RES, as opposed to the FIT, the author over-credits the FIT.  For this reason, a number of conclusions in this very pro-FIT biased article are misleading/not based on fact.

However, I think the summary comparison of the two different FIT models is very useful and should be considered by any Canadian legislators who are considering implementing any form of FIT (against my best advice).  Please, if you are going to do it, adopt the pre-2006 Spanish version, not the German/pst-2006/Ontario government versions of the FIT.

Read more of Aldyen’s blog postings here.