Lessons for the US from Germany’s Renewable Subsidies Experience

on July 24, 2014 at 2:03 PM

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Another axe has fallen in Europe over renewable energy subsidies. Just last month, Italy announced that it will cut its feed-in tariffs (FIT) for certain renewable energy plants – not only for future plants, but also for existing plants with valid FIT guarantees. German lawmakers also recently approved an extensive revision of the country’s renewable energy subsidies for future investments, and Spanish lawmakers are setting new energy rates for green energy producers – an indication that renewable subsidies there are winding down.

But how harmful could subsidies for renewables be to have led to this kind of drastic reversal? When not properly planned for, subsidies for renewable energy sources can lead to severe market distortions with material market consequences. U.S. policymakers and electricity stakeholders in America should quickly and carefully consider the lessons learned from Germany and elsewhere in Europe, with respect to what the growth of renewable energy as part of a broader energy strategy might look like in the future. This will ensure that consumers and businesses in the U.S. do not have to suffer from the same consequences.

As a recent study we authored assesses, Germany is the country that experienced the most profound energy-policy repercussions. Excessive subsidies for renewable energy sources in Germany have harmed many stakeholders involved, from consumers to renewable companies to utilities.

First, as our research shows, German consumers have experienced a significant increase in their electricity bills as a result of these subsidies, as the subsidies are not paid out by the state but are added to consumer prices. In fact, electricity prices for residential consumers have more than doubled from $.18/kilowatt hour (kWh) (€0.14/kWh) in 2000 to more than $0.38/kWh (€0.29/kWh) in 2013. €0.05/kWh of this is directly attributable to the growth of renewables. This is compared to household electricity prices in the U.S., which average $0.13/kWh (€0.10/kWh).

Second, the way these subsidies have impacted wholesale electricity markets could potentially have an adverse effect on electricity price volatility in Germany. This is because renewables have zero variable cost of production (although they have high levelized costs), so they are taking precedence in wholesale markets over thermal plants. Not surprisingly, wholesale electricity prices have fallen dramatically from €90-95/megawatt hour (MWh) in 2008 to €37/MWh in 2013, to which renewables considerably contributed. In the short run, the subsidies hurt the conventional power producers via an unsustainably low wholesale power price. This has tightened margins for utilities that have built and financed thermal plants.

The overwhelming increase in the capacity of renewable energy does not lead to a similar reduction in the amount of conventional power plant capacity. This is because wind and solar are intermittent resources, so flexible power plant capacity is needed for times when the wind doesn’t blow or the sun doesn’t shine.  But because of decreasing capacity factors of thermal power plants, the cost per unit of power produced is rising, and in the long run will increase the price of conventionally-produced power. In other words this stopgap role of the conventional plants will come at a premium. This means that in the long run the price of conventionally-produced power will not only return to the (higher) levels from before the advent of renewables, but will rise even higher. Conventional generation plants are losing efficiency as they face the need to ramp up or power down in conjunction with the ebbs and flows of renewable sources.

Finally, policymakers in Germany also did not consider the significant costs of the additional transmission infrastructure needed to bring more renewables online. Over the next ten years, the country will have to spend some $52 billion (€40 billion) to build out the transmission grids that are needed to connect with offshore and onshore wind projects, all for a country that has some 80 million residents and is roughly the size of Montana. While conventional power plants were typically built close to areas of high demand, renewable plants are built where the natural resources, including wind, sun, and biomass, can be found.

Taking all of this into account, it’s hardly a surprise that Germany and other countries in Europe are reconsidering their subsidization-scheme of renewable energy sources. As the United States moves towards integrating more renewables, steps must be taken to ensure that electric grid reliability, consumers’ electricity bills, and the broader economy are not harmed. America should take advantage of the opportunity it has to bring renewables online in a sustainable way that helps consumers and businesses and also furthers the country’s environmental goals.

Felix ab Egg and Hans Poser are Managing Directors at Finadvice, a European company that advises utility and renewable companies on investment decisions, valuations and economic calculations.

Read additional Breaking Energy analysis of this issue here.