Feed-in Tariffs Are A Very Good Thing

Renewable energy FITs are in the news a lot these days here in Japan. “FIT” is the acronym for Feed-In Tariffs – a mechanism for paying for production of renewable energy at a guaranteed price. FITs are designed to encourage both investment in renewable energy production by allowing an energy producers to have a sure fire way to make money off their investment.  FITs have proven extremely successful in developing the renewable energy market in a large number of countries.

A silly man commented to me online that FITs are somehow very bad. Initially I thought that this silly person must be misinformed, but upon looking up his name online, I discovered he works in the nuclear industry. FITs are not so good for people with vested interests in nuclear as FITs enable countries to get by without nuclear plants.

Despite what some vested interests want us to believe, FITs are not an alien concept in the power industry. FITs are an extension of the ‘Cost Plus’ method of pricing electricity that have been in effect for decades.

Electric utilities around the world set their rates with more complex versions of the following formula:

Costs + Profits = Electric Rates

Costs are all the costs that the utility incurs in supplying power to consumers. For example, a nuclear plant, salaries, coal, natural gas, generators, emergency equipment, etc. are all examples of costs.

Profits are typically decided on by the regulatory agency. For example, the regulator (or government in many countries) decides on a ‘fair’ profit margin that the utility can make on top of its costs. For example, the regulator might decide it’s ‘fair’ that the utility make a 5% or 10% profit.

Electric Rates are the prices you and I pay for electricity. These prices are, in many cases around the world, the result of adding the Costs plus the ‘fair’ Profit decided. Hence, this system is sometimes referred to as the ‘Cost Plus’ system.

FITs are identical to this Cost Plus system. Regulators (or govt) study the costs of various renewable energy sources, decide on a fair profit margin, and set a price to be paid for electricity generated by people who own these systems.

The big difference between FITs and traditional systems is the beneficiary. Traditional power generation is often a monopolistic business dominated by huge investment in plant and equipment. The rates being set are for the benefit of these large centralized energy companies who mainly invest only in large centralized power generation facilities.

FITs, on the other hand can encourage small, medium, and large companies, and individuals to  create decentralized power plants. Every thing from giant wind farms, geothermal plants, to small residential rooftop solar installations can be incentivized by FITs.

In effect, properly designed FITs open the door to anyone to become an electric power generation company.  This scares the bejeezus out of traditional large monopolies or oligopolies for obvious and less obvious reasons.

FITs come in many sizes and flavors, but successful FIT programs have a number of common features according to the nice people at the World Future Council (PDF warning!):

  1. Long-term contracts with pre-determined prices.
  2. Rates (or tariffs) based on the cost of generation plus a reasonable profit, not based on avoided cost – in other words, the targeted resources receive a payment rate that reflects what they need to be profitable, rather than a rate tied to fossil fuel generation or average wholesale prices.
  3. Tariff rates that are adjusted periodically, for example every two to four years, or automatically according to a pre-set schedule, in order to respond to changing market conditions and place downward pressure on prices.
  4. Technology-specific rates (e. g. wind receives a different tariff than solar).
  5. Policy costs that are incorporated into electricity rates, rather than recovered from taxpayers.
  6. A streamlined application process that is open to all potential participants.

There are a number of myths that are being propagated by certain vested interests about FITs outlined by World Future Council that I recommend everyone interested read about.

I’d like to talk about a main one here.

Myth: FITs are expensive, inefficient, and against the free market!

Reality: FITs are cheap, efficient, and identical to the ‘Cost Plus’ pricing system already in use by the ‘market’ which is not ‘free’.

Well designed FIT policies have consistently shown themselves to be cheaper than the alternatives. For example, wholesale energy prices in Germany have already declined significantly due to the effectiveness of its well designed FIT policy. FITs are extremely effective at rapidly driving costs down for renewable energy technologies by driving broad adoption. As prices come down so do the FIT tariffs themselves. Interestingly, nuclear and fossil prices continue to rise, as FIT driven renewable prices are driven down.

The efficiency of FITs is also well known. For example, with alternative policies such as ‘net metering’, Japan has not increased penetration of renewable energy into its market since 2000. During the same time, Germany has been able to more than double penetration to over 20%. FIT’s have proven their efficiency in large numbers of countries.

Regarding the ‘free market’ red herring often thrown up by big energy lobbyists and misinformed pundits, the electric power market is highly regulated, typically a monopoly or oligopoly and uses the Cost Plus system for pricing electricity. Germany has one of the best FIT systems, and one of the most fiercely competitive electric power markets in the world.

Further, FITs are so much more transparent than traditional big energy Cost Plus treatments. For example, TEPCO and other power companies here in Japan, have been charging massive advertising costs and ethically questionable ‘donations’ to nuclear host towns as costs to be marked up and paid for by rate payers. This was only doable via the opaque system in place. It would be very difficult to do in a properly designed FIT system.

Anyhow, it’s getting late here in Tokyo and I’ve got to get some sleep. I hope you’ve learned something about FITs. If anyone out there please add comments or point out glaring mistakes (or even typos!), I would greatly appreciate it 🙂

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6 thoughts on “Feed-in Tariffs Are A Very Good Thing

  1. While it is correct that the pricing model for electricity historically has been cost plus profit and that still is the model in Japan, that actually is only true in some markets now. In an energy market open to competition that model is not any more adopted. Instead, wholesale electricity prices are set at an exchange, and the utility can charge costumers whatever it can get away with in the market competition.
    But I think your parallel between the feed-in tariff system and the traditional cost plus profit model is quite interesting. I had not heard of it before.
    By the way, in the old cost plus profit model, utilities don’t have an incentive to lower costs. On the contrary, lowering them might lower their profits as well, if these are set as a percentage of costs. That explains why historically big utility companies would not mind paying billions of dollars for nuclear plants.

    • Thanks for the comments and kind words!

      I agree that some markets, especially in the EU, are very competitive. However, as you stated, some markets are still like Japan using the cost plus method. For example, the newly approved nuclear plants in the US are a cost plus variant where ratepayers are even being forced to pay for plants even before their built!

      There are too many markets out there that use this outdated model.

      Regarding your take on the lack of incentive to reduce costs, I agree wholeheartedly. If a utility has a fixed profit margin (percentage of costs), the only way for them to increase the amount of profits is to create higher costs!! Idiocy which lead to Japan (and many other countries) to purchase extremely expensive nuclear plants. I was thinking about writing a post about his big problem separately 🙂

  2. Really enjoyed your blog Kevin. As you may be aware, the UK has employed FITs for 2 years now and the sheer amount of myth and misinformation that has flowed from some corners is staggering.

    It’s very interesting to hear a bit about it from a Japanese perspective and to see that the same points are raised in opposition. The more people that can write about the realities of what FITs offer us with such clarity and rationality the better. I hadn’t heard the cost-plus comparison before either – I’ll certainly be using it!

    • Thanks much for your kind words. Actually, I can’t take full credit for cost plus comparison – I read something similar on the web the other day, but not sure where! If I find the source, I’ll post it. It makes too much sense.

      I hope that the FITs in the UK work well. What I’ve learned so far is that its critical that governments implement them in stable fashion, rather than random start-stops.

      Regarding the myths and misinformation, so many people are vested in the less transparent and less inclusive old model. They’ll do anything, whether ethical or not, to prevent their gravy train from going before they retire. It’s a sad thing.

      Have a great weekend! I know I will! Japan is shutting off its last reactor tomorrow!

  3. Pingback: Why “Cost Plus” Is A Very Bad Thing™ | KMB48

  4. Pingback: Nuclear Charges 10X More Than Renewable Fees In Japan | KMB48

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