The starting point for the financing discussion was initially the sluggish expansion of renewables. Some did not want to believe that the obstacles to approval and construction of the plants would delay the ramp-up and called for additional financial incentives. Recently, there were even voices that suspected massive overfunding.
What’s behind it? The “market premium model”, i.e. the funding instrument that currently ensures the expansion and payment of renewables for a large part of the capacity (the large plants), combines support through a premium that is flexible over time with remuneration for the plants at market prices.
The premium secures the proceeds from below. It results from the difference between the fixed “compensation to be applied” determined in the competitive auction and the average proceeds from an investment on the market within a specific period of time.
Hedging through market premiums less and less necessary
The market premium therefore changes over time – this protects the investments against fluctuating market prices and prevents high additional payments (premiums) in times of high market prices. With a bid of zero in the auction, the operators can forego a market premium and fully rely on financing on the market. This has happened more and more frequently in past auctions.
This is good news: the increasing competitiveness of renewables means that there is less and less need for hedging through a market premium. If you want to skim off profits, for example when there is wind at sea, you could simply hold an auction for the relevant location among the bidders who submit a bid of zero. Then there would be competition for the right to build the plants, and the state would even have income.
The market premium model thus releases systems into the market that no longer require funding, and still ensures that the expansion targets set are achieved by offering market premiums where they are necessary.
In addition, and this should not be underestimated given the increasing share of renewables in the system, the project planners have a vested interest in system integration in order to use all revenue opportunities.
development in the right direction
The promotion of renewables has therefore gradually developed in the right direction in recent years. Nevertheless, as part of the reform of the Renewable Energy Sources Act, the introduction of contracts for difference (CfD) for renewables is being examined and has already been announced for offshore wind.
In the case of contracts for difference, the plant operator always receives the CfD price for his feed-in, which is determined in an auction. This is associated with opportunity costs for the plant operator: he enters the subsidy system and forgoes possible profits with high market prices.
Now one hears that this would prevent an alleged oversubsidy, since the operators of the systems – in contrast to the market premium model – “refund” the difference to the CfD price to the state when prices are high.
What is overlooked: The market premium resulting from the auctions is likely to be much lower than the CFD price, since the operator anticipates in the market premium model that he can benefit from high market prices himself. In CFD auctions, on the other hand, the outside option of market participation without funding establishes the lower limit for the resulting CFD payments. So the comparison is flawed, a systematic over-subsidy in the market premium model cannot be derived from the market revenues of the systems.
Another argument for CFDs is that the state should pay the operators fixed feed-in tariffs in order to reduce the risk premiums in financing and thus promote the rapid expansion of renewables more cost-effectively. That would reduce the subsidy costs incurred for the expansion.
A very valid argument – if the two subsidy systems would lead to the same expansion, both regionally and in terms of volume. But that is by no means to be expected – and this is where the main pitfalls of the proposal lie.
Market conditions must be taken into account in the remuneration
Because fixed remuneration reduces the need to deal with the demand side and system integration. A reduced risk premium is therefore offset by higher system costs.
Dealing with phases of negative prices is also crucial for the comparison. In the market premium model, compensation for curtailment was largely abolished. If this is also handled so restrictively in a CFD regime, the argument of lower risk premiums for financing would be less valid.
Because the curtailment will represent an important risk for the plant operators in the future. Even a CfD will not eliminate this risk, which means that an investment in renewables is not a risk-free investment even under a CfD.
So should the state go back to paying for investments regardless of market conditions? No – if you decouple the remuneration of the systems from what is happening in the market, important incentives and the need to think about system usefulness are lost.
In addition, the market players are faced with the irrevocable decision for or against funding. No – it is better to rely on more market integration so that the renewable systems can deal with changing framework conditions at an early stage and maximize the expected revenues. Or just conclude a contract for direct acceptance with an industrial supplier.
The authors:
Ottmar Edenhofer is Professor of Economics of Climate Change at the Technical University of Berlin, Director of the Potsdam Institute for Climate Impact Research (PIK) and the Mercator Research Institute on Global Commons and Climate Change (MCC).
Veronica Grimm is a professor of economic theory at the Friedrich-Alexander University in Erlangen-Nuremberg and a member of the Advisory Council for the Assessment of Macroeconomic Development.
Andreas Loechel is a professor for environmental/resource economics and sustainability at the Ruhr-Universität Bochum, senior fellow at the Krupp-Wissenschaftskolleg Greifswald and chairman of the expert commission for the monitoring process “Energy of the Future” of the federal government.
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