Baseload, Bioenergy, Solar, Wind Power

The Lesson in Renewable Energy Development from Spain

The most recent energy sector reforms passed in Spain represent the fourth time that a sweeping set of retroactive changes has rocked the country’s renewable energy (RE) industry. This new Royal Decree Law modifies billions of Euros worth of renewable energy contracts in a move that, when added to previous retroactive measures, will almost undoubtedly trigger insolvencies across the sector.

Instead of looking at the new Law in detail, this article takes a step back, and looks at the key lessons that policymakers around the world should draw from the Spanish experience. 

As highlighted in previous analyses, the underlying problem that legislators in Spain are trying to address is the rapid growth of the electricity system deficit, which now stands at €26 billion.

This deficit has been created over the last fifteen years as the costs of generating electricity have risen faster than what utilities can lawfully recover from rates. The root cause of this is ultimately that Spain limits the amount by which electricity prices can increase.

While most commentators have attributed the deficit to the growth of renewable energy, the origins of the tariff deficit pre-date the rise of renewable energy in Spain. In the early 2000s, and again between 2005 and 2008, rising natural gas costs also contributed significantly to its growth, as utilities were not allowed to fully pass on the rising cost of fuel.

Second, despite countless articles and commentaries to the contrary, the problems in Spain’s electricity system are not caused solely by its feed-in tariff (FIT) policy.

To understand why, an analogy is instructive: to attribute Spain’s electricity system deficit to its FIT is similar to blaming an airline’s bankruptcy on its latest purchase of airplanes. A firm’s bankruptcy is always and everywhere driven by the failure to keep revenues ahead of costs. Buying planes is fine, as long as you have customers to fill them.

In Spain’s case, it is not the investment in wind turbines and solar power that represent the root of the problem: like many of its European partners, Spain encouraged private investment in wind and solar power partly to meet binding EU climate and energy targets, partly to improve its energy security, and partly to encourage the development of new economic sectors.

Moreover, numerous studies from major research institutes and think tanks around the world continue to find that FITs are the most cost-effective means of accelerating investment in renewable energy.

The problem is therefore not with wind and solar per se, nor with the policy that encouraged investment in them (though Spain’s FIT policy had a number of important design flaws): it is that the government, through regulations dating back decades, prevented utilities from recovering the true costs of the electricity system through rates.

In other words, Spain tried to have it both ways: it set out to transform its electricity system, but failed to establish a credible mechanism to pay for it. 

Which brings us to the core lesson for policymakers:

FITs are a powerful mechanism to attract investment in renewable energy, and to accelerate the transition to a cleaner and lower carbon power sector. They do this by providing long term, performance based contracts for electricity generated from renewable energy sources. This helps attract private investment, and engages citizens, farmers, businesses and investors directly in the transformation of the electricity system. They have been implemented in over 80 jurisdictions around the world, and despite all the criticism they have received over the years, they remain one of the most widely used renewable energy policies.

However, if one is going to launch a comprehensive policy to scale-up privately financed renewable energy investment, one needs to establish a credible, long-term mechanism to ensure that those costs will be recovered over time. This includes ensuring that the overall framework has the broad support of citizens and that it will be robust to changes in governments, and overall economic conditions.

A fundamental transition in the energy system can only be sustained if it is built on a sound financial footing, and if it has the broad support of the population. This consensus is now being tested even here in Germany, as parties fine-tune their positions ahead of national elections in September.

It is one of the tragedies of the Spanish situation that a policy mechanism that is premised on providing long-term investment certainty, and that has proven uniquely successful at scaling-up renewable energy investment worldwide has become associated with policy and regulatory uncertainty, and with imposing unsustainable costs on ratepayers.

As highlighted here, it is not the policy that is the problem, nor is it the desire to transition to a more sustainable and lower carbon energy system: it is attempting to accomplish this without introducing credible mechanisms to ensure that these investments will be paid for in time.

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