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Designing Effective Incentives for Wind Power Development

G M Pillai

Founder Director GeneralWorld Institute of Sustainable Energy (WISE),

PUNE, INDIAEmail: gmpillai@wisein.org

Website: www.wisein.org

Presentation for

‘Quantum Leap in Wind Power in Asia’

Asian Development Bank, Manila, 20-21 June 2011

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PRESENTATION PLAN Global wind power review

Cost structure - LCOE comparison

Development barriers

Support incentives and mechanisms

Global experiences and their evaluation (EU & USA)

Support incentives in India: A brief case study

Conclusion

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GLOBAL WIND POWER REVIEW

Current global installed capacity is 197 GW. Global market to add 262 GW by 2015,

reaching cumulative capacity of 459 GW by 2015.

Global annual market to grow from 38.3 GW (2010) to 62.5 GW (2015).

Asian annual market to grow from 21.5 GW (2010) to 28 GW (2015) – GWEC projection.

Asia’s market share in global wind power presently > 55% (2010).

About 1/3 cumulative global installed capacity (end 2010) is in Asia: Asia set to overtake Europe by 2012.

3000 MW offshore wind worldwide, mostly in EU.

China has an offshore target of 15,100 MW by 2015. Installation in progress.

India has no targets. THE DISCUSSION HERE IS ON ONSHORE

WIND ONLY.

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LCOE: Levelised cost of energy (LCOE) represents the sum of all costs over the lifetime of a given project, discounted to the present time, and levelised based on annual energy production. Does not account for any residual cost or benefits incurred beyond the assumed project life.

Country LCOE (Euro/MWh)

LCOE ($/MWh)

Switzerland 120 167

The Netherlands 94 131

Germany 85 118

Spain 83 115

Sweden 67 93

United States 65 91

Denmark 61 85

CHINA 61 84

INDIA 61 85

(Source: IEA Wind Task 26, March 2011; India: WISE Estimates; China: Media reports)

• Assumptions for LCOE differ from market to market.

• Developed country wind markets have better wind resources, higher capacity factors, lower interest rates for debt, and longer (13-20 years) loan tenure.

• Developing markets in Asia like India and China have lower /moderate wind resources, low capacity factors as compared to developed markets, relatively much higher interest rates and lower loan tenure.

• However, the advantage is much lower capital costs (20%-25% lower) in Asia.

COST STRUCTURE-LCOE: COMPARISON BY COUNTRY

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DEVELOPMENT BARRIERS FOR WIND POWER

Lack of level-playing field due to large public subsidies for competing fossil and nuclear fuels.

Future fuel price risk and supply risk not considered for conventional power plants and hence tariff

determination skewed in their favour.

Environmental externalities: Not factored into conventional electricity pricing.

High initial capital costs, transaction costs, longer payback periods.

Unfavorable power pricing rules: ‘Locational’ value of wind power plants is not captured in pricing.

Other barriers include: Legal, regulatory, access to credit, high interest rates, etc.

HENCE WIND POWER NEEDS INCENTIVE SUPPORT MECHANISMS

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SUPPORT INCENTIVES AND MECHANISMS

Incentives can be designed for:- Technology upgradation, adoption, R&D.- Product commercialization.

- Manufacturing scale-up. - Lowering energy prices.

- Market development.- Rewarding environmental benefits.

Incentives can be effected through:

- Policy/regulatory intervention.- Creating a legal framework (Renewable

Energy Law, Feed-in Law, etc.) - Voluntary green marketing systems

DESIGN AND GROUPING Support incentives/mechanisms can be

grouped as: Fixed Prices: The government or regulator

decides the electricity tariff to be paid to the producer (feed-in tariff) and lets the market determine the quantity.

Fiscal and Financial Incentives: Like tax holidays, tax offsets, performance-oriented incentives, etc.

Quotas: The government or regulator decides the quantum of renewable electricity and leaves it to the market to determine the prices (RPS or RPO).

Tendering systems or competitive bidding. Green Marketing: Regulated or voluntary

systems where markets determine the prices and quantity for electricity systems. (eg: Tradable Certificates).

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FIT Determination Methodologies

1 . Cost-plus methodology: Tariff is determined considering the levellised cost of generation plus guaranteed return typically set by the regulators and policy makers. Most countries including India have chosen this FIT methodology.

2. Premium-price FIT Methodology: Tariff is determined by adding a premium over the spot market electricity price. Premium is usually designed to approximate avoided externalities of RE generation. Followed in EU countries .

3. FIT based on value of RE generation to society or utility : value to society = value of electricity + climate change mitigation + health impacts + energy security + other externalities . Whereas value to utility = avoided cost of generation. eg. Sri Lanka.

4. Competitive bidding: Tariff is discovered via tendering. Practiced in some cases in India and China.

Design Options

• Eligible technologies

• Eligible plants

• Tariff calculation methodology

• Technology-specific tariffs

• Size-specific tariffs

• Duration of tariff period

• Financing mechanisms

• Purchase obligation

FIT DESIGN OPTIONS AND METHODOLOGIES FIT considered the most effective incentive; hence some details

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Mechanism Advantages Disadvantages

Feed-In Tariffs • Provides attractive and stable returns to developers.• Suppliers receive payments immediately.• Puts pressure on lower equipment prices.• More consistent than unclear RPS.

• Little incentive may exist to drive electricity rates down or to innovate.• Initially inflates the cost of electricity until significant amounts of renewable

energy are deployed.

Tax Credits • Wide in scope.• Socializes the costs of renewable energy.

• Can be insufficient to attract new investment.• Significant budget must be available with the government.• Producers must have significant tax appetites.• Exclusionary to IPPs, individuals and small firms.

Renewable Portfolio Standard (RPS) /Renewable Purchase Obligation (RPO)

• Diversifies investment risk.• Creates continuous pressure for lower electricity

prices.• Minimizes government intervention. • Provides flexibility when coupled with a renewable

energy certificate credit market.

• Will not initially support higher cost renewable energy.• Does not support off-grid systems. • Renewable energy certificate credit prices will fluctuate and diminish in price.• Not effective without penal provisions.

Tendering System • Government can control level of renewable penetration.• Provides an incentive to keep costs low.• Distributes savings onto consumers.

• Fixed price distorts the market; does not allow indexing.• Reduces investor margins and can hurt R & D.• Tends to hurt domestic manufacturing as investors seek least cost international

suppliers.

Green Marketing (Voluntary Green Power Programs)

• Allows consumers in areas without plentiful renewable resources to support them.

• Does not impose the cost of renewable energy on those who do not wish to pay for it.

• Voluntary nature means no guarantee that new projects get built.• Does not uniformly promote renewable energy projects. • Inflated cost of renewable energy may create little incentive to improve efficiency

among providers.

PROS AND CONS OF SOME GLOBAL SUPPORT MECHANISMS

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GLOBAL EXPERIENCE IN INCENTIVES Feed-in tariffs have been the mainstay of European wind power development. Whereas the quota system and tax credits have worked well in the United States. Some countries/provinces have adopted a combination of both the above incentive mechanisms.*

By early 2010, more than 78 countries, states, provinces, enacted feed-in tariff. Most of the major wind power markets have feed-in tariff for wind power.

By end 2009, about 50 countries, states, provinces, have established RPS/RPO

Criteria for assessing the success of the support instrument: Effectiveness: Leading to a substantial increase in the deployment of capacities within certain

time period, in relation to the potential. Economic Efficiency: Absolute support level as compared to the actual generation cost and

the trends in support over time.

One major study assessing the success of the support instruments was done recently in Europe viz. RE-Shaping (2011).

*(Source: Renewables 2010, Global Status Report, REN21)

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MAIN RE SUPPORT INSTRUMENTS IN THE EU-27

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In most of the EU-27 countries, feed-in tariff is the popular and accepted support mechanism.

Quota/tradable green energy certificate is the second best instrument adopted in EU.

Few countries tried tendering mechanisms, and over the period, shifted to quotas/feed-in tariffs.

Most of the countries offer tax incentives/investment grants.

1)

EVOLUTION OF RE SUPPORT INSTRUMENTS IN EU (1997-2012)

(Source: RE-shaping 2011)

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EU INCENTIVES: EVALUATION - 1 • Countries with highest

average effectiveness index during last seven years—

Germany, Spain, Portugal and Ireland—apply feed-in tariff for onshore wind power.

• Upward reasonable average policy effectiveness observed in 2009 in Belgium, Estonia, Hungary, Italy, Sweden and the UK.

• In France, effectiveness of the policy is improving. Despite favorable feed-in tariff, barriers persist with permission procedures and opposition from anti-wind lobby.

(Source: RE-Shaping, 2011)

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EU INCENTIVES: EVALUATION - 2

(Source: RE-Shaping, 2011)

• Absolute market size and share of exploited potential is in medium range for Portugal, Denmark, and Ireland. Wind electricity contributes more than 10% in these countries.

• Germany has largest onshore wind market and has developed 57% of its onshore potential; contribution to the electricity sector is just 6%.

• Spain scores high on all sub-indicators.

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EU INCENTIVES: EVALUATION - 2

(Source: RE-Shaping, 2011)

• All EU member states appear to provide sufficiently high support level for onshore wind electricity.

• In Austria and Luxembourg, the support is just enough to cover lower limit of electricity generation.

• Countries having quota system with tradable green certificates such as Belgium, Italy, Poland, Romania, and the UK, offer the support level which exceeds the average level of cost of generation. Overall, FITs have been most successful in

Europe.

EU INCENTIVES: EVALUATION - 3

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Main support mechanisms in the USA are RPS and Federal Tax Incentives.

FITs in various stages of development.

Renewable Portfolio Standard (RPS)

29 states have RPS.

RPS mandates utilities to purchase a certain percentage of their electricity from renewable sources.

Supports utility scale renewable power generation.

USA: SUPPORT INCENTIVES - 1

29 States have RPS

(8 states have goals)

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USA : SUPPORT INCENTIVES -2 Federal Tax Incentives

Tax breaks for businesses, utilities, and governments, under the American Recovery and Reinvestment Act 2009.

Corporate Tax Credits: Production Tax Credit (PTC).

Performance-based Incentive: Renewable Energy Production Incentive (REPI).

1. Production Tax Credit (PTC): A tax credit for utility-scale wind power generation by commercial and industrial sectors. $21 per MWh or 2.2 cents/kWh for first 10 years of operation (in operation till 31

December 2012).

2. Renewable Energy Production Incentive (REPI): A performance-based incentive complementing the PTC (but mutually exclusive) for renewable electricity generation for local/state/tribal governments, municipal utilities, electric cooperatives, etc. $21 per MWh or 2.2 cents/kWh for first 10 years of operation (subject to availability of

annual appropriations in each federal fiscal year).

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• Even though feed-in tariff has not been a prominent instrument for RE promotion, fixed-price incentives for renewable energy have been around in the US since the 1970s.

• The Federal Public Utility Regulatory Policies Act (PURPA), 1978, was the first major legislation to offer a fixed payment to small-scale renewable power producers.

• The state of California implemented PURPA through standard offer contracts, which helped in the addition of 1200 MW of wind capacity between 1984 and 1991.

• However, the FIT movement did not gather momentum in the US for a long time.

• Even though RPS is the predominant instrument in the US, both RPS and FIT can be structured to work together—they can in fact do so synergistically.

• Many states have subsequently experimented with FIT for solar power.

• It is reported that, of late, discussions for comprehensive FIT programs at the legislative or regulatory level were taking place in about 18 states of the US.

FIT EXPERIENCE IN THE USA

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INDIA: SUPPORT INCENTIVES - 1 Power: A Concurrent Subject Power is a concurrent subject wherein both the central government and state governments are empowered to enact

policies and regulations. India established the institution of Electricity Regulators in 1998, with a Central Regulator and State-level Regulators in

each state. The Regulators are autonomous and legally empowered. Hence the policy and regulatory environment in India is a mix of Federal Government policies, Central Electricity

Regulator’s guidelines, directives of State Electricity Regulators and policy prescriptions of State Governments.

Regulatory Support The Central Electricity Regulatory Commission (CERC) has issued RE tariff guidelines in September 2010. The CERC

suggested wind power tariff ranging from INR. 3.55/kWh to INR. 5.33 kWh, on the basis of zoning. State-specific feed-in tariffs (INR 3.39-5.32 per kWh/US $ 0.075-0.118 per kWh) began to be prescribed from 2003

onwards. State/utility specific Quotas/RPO/RPS (1% to 14%) in 25 states. Recent (January 2010) introduction (operational from March 2011) of tradable renewable energy certificates (RECs); too

early to assess impact.

Federal Government Legal & Policy Support

Electricity Act, 2003: Contains enabling provisions (Sections 61 and 86) for fixing preferential feed-in tariffs, mandatory quotas, delicensing, and open access to the grid for RE power generators.

The National Electricity Policy (year 2005) and National Tariff Policy (year 2006) were framed as per provisions of the Electricity Act, 2003.

National target of 15% renewable power by 2020 under the National Action Plan on Climate Change (NAPCC).

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INDIA: SUPPORT INCENTIVES - 2

Fiscal/Financial Incentives by Federal Government

• Generation-based Incentive (GBI) from December 2009.• 80% accelerated depreciation in the first year of the project.• The 13th Finance Commission sanctioned statutory devolution of $1100 million (INR 5000 crore) as central

assistance to states doing well in grid-connected RE.• 10-year income tax holiday for income from wind power projects.• In 2010, the central government levied a cess of $1.10 (INR 50) on every tonne of coal consumed in the country to

create a National Clean Energy Fund (NCEF).• Assistance from NCEF available for transmission infrastructure development for wind power.• Concessions on import duty on certain wind turbine components.• 100% FDI allowed in RE generation projects.• Special incentives for setting up projects/manufacturing in special economic zones (SEZ).

Provincial/State-level Policy Support

• Wheeling, banking, third-party sale, and buy-back facility by states.• Leasing of government land at nominal lease rent.• Some states have created state-level clean energy funds by levying a green cess on conventional power. Support for

development of transmission infrastructure for wind available from these funds also.

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INDIA: DETAILS OF ACCELERATED DEPRECIATION & GBIAccelerated Depreciation (AD)

• It is a kind of Investment Tax Credit.

• 80% of the initial capital investment as income tax set-off, at the corporate tax rate of 33.22%. So effectively, the investor receives 26.5% of his capital investment in the first year as tax set-off.

• Investment in wind power in the initial years spurred by AD. Corporate investors with tax appetite invested in captive wind power projects – about 70% investment in wind (till recently) fall in this category.

• Besides the tax set-off on capital investment, they also benefited from captive consumption at the low generation cost of wind power, compared to high utility tariff for industrial electricity consumption.

• The main drawback of this incentive is that independent power producers/foreign investors with no tax liability cannot avail of this benefit .

• Also, the incentive is capital cost-based and not generation-based. Could be misused by over-invoicing of capital cost.

Generation Based Incentives

• Introduced in December 2009; INR 0.5/kWh (1.1 dollar cents) for non-depreciation availing investors – for 10 year period with a cap of $0.136 million (INR 62 lakhs).

• There was a cap on capacity upto 50 MW, which was subsequently increased to 4000 MW upto March 2012.

• As of now, only approx. 701 MW projects registered for GBI benefit.

• Investors found the GBI to be insufficient and stressed the need to raise it.

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States RES RPO Targets (%) RPO Performance (%)

2007-08 2008-09 2009-10 2007-08 2008-09 2009-10

Gujarat All 1 2 2 2.07 NA 2.55

Karnataka All 7-10 7-10 7-10 9.3 10.8 11.04

Maharashtra All 4 5 6 3.35 3.36 4.25

Rajasthan Wind 4 5 6 2.18 3.42 2.74

Tamil Nadu All 10 10 13 11.65 12.08 13.79

Reasons for non-compliance

• Slower growth in capacity addition due to state level issues of land and environment.

• Operational constraints due to grid problems, lower generation than projected.

• Unscientific RPO target fixation by regulator without proper potential assessment.

• Absence of an effective penalty mechanism.

• Only one of the states mentioned alongside (Rajasthan) has a segmented RPO for wind.

• Two states viz. Maharashtra and Rajasthan did not meet RPO targets.

• Some states like Tamil Nadu had historical advantage of high capacity addition and very good wind resource.

INDIA: STATUS OF RPO COMPLIANCE IN 5 STATES

(Source: India Infrastructure Report 2010)

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INDIA: FIT IN 5 STATES The methodology adopted for determining tariff is

called ‘Cost-Plus’ methodology. Under this, the FITs should cover the RE project

cost, plus an assured Return on Equity (19% for first 10 years and 24% thereafter).

MERC was the first to promulgate FIT order for wind in November 2003.

Since then, 13 state ERCs have declared FIT for wind power.

In September 2010, the CERC came out with RE tariff guidelines.

CERC has recommended zone-wise tariff depending on wind power density.

Maharashtra and Rajasthan have adopted zoning recommendations.

These two states have also allowed annual revision of tariff based on revision of capital cost.

Growth accelerated significantly after FITs. FIT, the most effective incentive mechanism.

State FIT (Rs/kWh)

Gujarat 3.56

Karnataka 3.70

Maharashtra Wind Zone I – 5.37(200-250 watt/m²)Wind Zone II – 4.67(250-300 watt/m²)Wind Zone III – 3.97(300-400 watt/m² )Wind Zone IV – 3.58(above 400 watt/m²)

Rajasthan 4.22 (3 Districts)4.44 (Other Districts)

Tamil Nadu 3.39

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POLICIES, INCENTIVES, AND WIND POWER DEVELOPMENT IN INDIA

First feed-in tariff order in

Maharashtra in 2003/04

Private Power Policy 1991

MNRE tariff guidelines

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CONCLUSION Major Asian markets will be China and India. Asian Countries need to design viable policies. Offshore development will take off soon in Asia. The sector will need separate policies, feed-in tariff and

other support mechanisms. Support mechanisms/incentives should be designed as a combination of instruments customized for

each country. No single mechanism will be effective enough. In fact, a critical issue in developing countries in Asia with high interest rates would be to provide soft

loans with longer loan tenures to the wind (and RE) sector. Other instruments can fail if low-cost debt is not available.

The most effective proven single instrument is feed-in-tariff followed by quota system (RPS/RPO). Issues to be resolved for providing level-playing field for wind power and for realistic feed-in tariff

determination: Phasing out subsidies for conventional/fossil-fuel-based generation or factoring this into their tariff

determination. Cost of social, environmental, health and economic externalities needs to be factored-in during tariff

determination of conventional power. Consider multiple cost-curves of cost escalation, cost reduction, and technology/efficiency improvement

curves while determining tariff.

THANK YOU!

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