Efficacy of Auctions Versus FiT as Policy Instruments
Over the last few years, we have seen that around the world, the governments or government-owned utilities and such bodies are keen to bring down the cost of renewable-based electricity generation to a bare minimum through an auction or a bidding mechanism. However, a few years back, a mechanism of Feed-in-Tariff (FiT) linked to an efficient and autonomous quasi-judiciary regulatory system prevailed in many of the developed and developing countries and was the preferred option. The FiT is now almost entirely replaced by a cost minimization strategy (CMS), which we see in the form of auctions and bidding process. It seems the assumption is that while earlier renewable energy projects needed support in the form of FiT, that is not the case now. However, many complex economic, societal and technological issues are being overlooked in the transition from FiT to CMS.
In this article, we not only compare the efficacy of CMS with that of FiT as policy instruments to achieve energy transition but also delve deeper into the very genesis of the CMS. We discuss how and why the cost should not be the only parameter in the generation of renewable energy electricity and that there are other equally or more important aspects that should be considered.
The reason for the drive towards low cost renewables electricity is of course economics?of cost and affordability. While this is important, ‘the extent to which ‘low cost procurement’ is being emphasized and practised through auctions and bidding is debatable.
When we talk about energy transition, it is basically about a shift in the primary source of energy at the point of generation. If this shift has to be achieved globally and nearly 100%, it means that the energy component in the production and delivery of everything from groceries, furniture, housing, clothing also shifts to renewable energy, in addition to electricity we consume in our homes and offices. Thus, there is bound to be an implication on the entire economic and financial system, which cannot be addressed in a simplistic manner by bringing down cost of renewable electricity. A relentless effort to bring down the cost to the ‘minimum possible’ means that the targets on the way to transition will not be achieved, pipeline of viable projects will diminish, quality of projects will tend to be sub-standard, and eventually, investors will shy away from renewable energy. There will also be an implication on research and development and academic work on renewable energy.
A deeper understanding of the cost issue requires that we delve deeper into the historical perspective. As far as energy and public and industrial infrastructure are concerned, we are conditioned to think in an environment that has evolved and prevailed, not since last few years or even decades, but over the last 200–300 years. This ‘conditioning-environment’ is an outcome of a combination of evolutionary processes that our society has experienced over the last few hundred years in the form of technological, political, economic, and industrial development working in tandem with the rise of the capital. This really is a well-entrenched and all-engulfing ‘conditioning-environment’ from which it is not easy to escape. The mindset is driven by strong financial and commercial considerations, so much so that the impact of our actions on nature and natural resources, such as global warming, plastic contamination of oceans, rapid pace of extinction, and the resultant climate change, gets completely disregarded (Book Excerpts-1).
It is the 18th century agents, i.e. technology (engines), industries, economics, colonialism, and geo-politics that worked in combination to deliver us with the climate-crisis of the current times. It is now obvious that by taking a plunge into the fossil-fuel mode back in the 18th century, the modern society has made a grave mistake and it must be corrected now (see Book Excerpts-2). Energy transition being talked about around the world, is the correction that we need now.
The cost of huge infrastructure built over the last 200 years, towards extraction, delivery and supply of fossil fuels, paid for by the consumers and tax payers, subsidises the cost of fossil fuels. It prevented the rise of the renewables due to the easy flow of oil and coal extracted at zero cost. It is surprising that there was no cost associated with the extraction of fossil fuels from reserves that took a billion years to be formed. All one had to do was pick it up (extract, pump, or mine), process, and sell.
The players involved in oil, gas and coal have had ample time to streamline their supply chain and the operations as well as the market dynamics. They have the ability to manipulate the prices (see Bandyopadhyay 2008[i]), lower it or increase it, and use it as an economic and political tool. The reason renewable energy costs are being hammered down through auctions and bidding process is because of the mindset that if electricity has to be supplied by solar and wind energy, it must be at a cost lower than that achieved through fossil fuels.
Between the provider of fuel, electricity, or equipment and the bulk procurer such as government or utility, the only element of negotiation is the ‘cost’ and it must be hammered down. ‘Least Cost Only’ is the product of this mindset and this environment. But should it be?
Now that there is a world-wide consensus to make a transition to renewable energy. Why should it match, or be lower in cost than fossil fuels ? This is the first question we must ask, because this condition is not fair to innumerable entrepreneurs, tech start-ups, and businesses working across the world in finding and implementing workable solutions with wind energy, solar power, and storage systems. The least cost approach is like a rock tied to the feet that sinks them before they rise.
Our primary purpose is to bring about a shift or transition from fossil fuel to renewable energy and this cannot be achieved by bringing down the costs. A shift in energy system will also cause a shift in the present economic and financial system. Economists, policymakers, and the managers of the monetary system have to find and device ways to cope with this shift.
The shift requires massive investments and, therefore, one of the objectives of any policy mechanism to enable energy transition should be to incentivize investments.
The need to bring down procurement costs, apart from the fact that it is generally considered desirable, also stems from the fact that any government setup is trained to minimize expenditure of public money, whether directly from the government or through the public at large. It is a philosophy, doctrine, policy, or procurement strategy pursued by a government body.
No doubt, under normal circumstances, a typical approach of a government body is to work with CMS but at the same time, it cannot be its main function. More important from a governmental point of view is the sustainability of its programme, economic development, energy security, and energy access. While reduction in GHG emissions is the overarching objective, there are many inter-linked sub-objectives that cannot be overlooked. Different dimensions, objectives, and success factors of such a policy framework are listed in Figure 1. A government is concerned with all these aspects and must ensure success of all the objectives.
Does the CMS really serve all the dimensions associated with the renewable energy programme and the energy transition? It is a question worth examining.
As a policy measure, a CMS does not seem to address the many-faceted objectives and desirable outcomes in a government programme and policy thrust. The question is then why this approach has become the preferred choice of the policymakers
The countries that still have a rudimentary, monolithic, and government-controlled and owned electricity sector need time to set in place a sophisticated regulatory framework with regulators who have independence. Such countries that need to quickly scale up renewable energy, may find the CMS an easy and straightforward approach, albeit with limitations. The reasons otherwise are entirely monetary and intended to protect the financial interests of the utilities or distribution companies. Since these entities occupy a strategic position and are monopolies or licensees, often protected by law, it becomes difficult to argue with them a somewhat different strategy for renewable energy offtake.
However, countries that have an established and functional regulatory setup such as US, Germany, India and many other developed and developing countries, a CMS is a retrograde step. It erodes the functionality of a painstakingly developed regulatory framework and institutional infrastructure. Evolution of a fully functional regulatory framework does not happen just with a government order but requires 5–10 years to take shape. Therefore, given the fact that a CMS has a limited monetary function, it is not desirable to carry on with it in countries with mature policy-regulatory-institutional framework.
It is instead worthwhile and desirable to work with a Feed-in-Tariff strategy, where the Feed-in-Tariff is determined by an independent regulator, who takes into consideration interests of a wider societal group including SME, small businesses, renewable energy-based captive units, employment, and economic development.
It seems, no analysis has been done of the benefits of CMS versus FiT approaches to the society. An efficient autonomous quasi-judiciary regulatory system can deliver the following:
1) Attract investments in renewable energy, which is must for the energy transition to take place
2) Achieve targets, which otherwise cannot be achieved through a CMS approach as the project pipelines for viable projects under CMS diminish rapidly
3) Ensure wider stakeholder participation in the renewable energy market and hence the economic benefits accrue to a larger section of the society. On the other hand, in CMS approach, businesses function in a highly cost-constrained environment, which also means compromises in know-how, technology, manpower, and planning.
4) A regulatory system (FiT) is able to consider interests of diverse stakeholders including grid managers, utilities, manufacturers, investors, and consumers and at the same time have a perspective on future and climate change. However, in the case of CMS, all arguments collapse into an argument of cost minimization only.
In conclusion, we feel that FiT linked to an autonomous regulatory mechanism is a superior policy instrument as compared to CMS in effectively delivering the renewable energy programmes of the governments.
There are many arguments in favour of the FiT strategy including long-term economic development, employment, industrial development, local manufacturing, skill development, capacity building, etc.
[i] Kaushik Ranjan Bandyopadhyay, “Economic and Political Weekly Vol. 43, No. 46 (Nov. 15 - 21, 2008), pp. 18-21 (4 pages)