Setting the agenda for the long term

Like so many of life's disciplines, the best legislation for meeting policy aims is often fraught with complexity in the making, but a model of shining simplicity for long term implementation. So it is with legislation for the introduction of tradeable renewable energy credits. For increasing the use of clean, safe and sustainable energy sources--to meet world goals on green house gas reduction--there is no better option available right now.

The EU's Directive on Common Rules for the Internal Market in Electricity -- more popularly known as the Liberalisation Directive -- entered force in January after more than eight years in the making. It is, as one observer noted, "limited in scope, weighted down with provisos and escape clauses and stretched out over nine tortuous years." The nature and pace of its implementation, in terms of injecting competition into national electricity systems, will vary radically between countries. But the Directive nevertheless marks an important staging post in a process that has now become inexorable -- and that will change the face of wind energy in Europe.

The prospect of liberalisation has generally struck fear into the hearts of supporters of renewable electricity. Liberalisation is seen as a threat to the systems of support payments that have underpinned the development of wind energy on the European continent, particularly in Germany and Denmark. Indeed it is. But liberalisation is also an opportunity, if the wind energy industry manages to seize it in the right way at the right time.

To see why electricity liberalisation in some form is inevitable, one need do no more than compare industrial electricity prices in different European countries against each other, and against those of major competitors; and then look at the founding principles of the European Union. Prices vary enormously, and in much of Europe are considerably higher than at least some of Europe's leading competitors.

Each national system has been an isolated fiefdom. The industries that consume electricity -- and in some places, smaller consumers too -- have noticed. They have been banging on the doors of the European Commission, pointing to the central role of free competition in the founding Treaties of the Common Market and saying they want the freedom to buy electricity from whoever will supply it most cheaply. Some governments -- above all France -- have fought a rearguard action, with considerable success. But the characteristic of rearguar action is that it may delay, but rarely halts, the advance. Such is the situation in Europe.

Against fixed payments

Liberalisation inherently threatens systems of government mandated fixed payments for wind energy, which place a legal obligation on electric utilities to pay a fixed fee or fixed percentage of the sale price of electricity. Major examples of such systems include Germany's Electricity Feed Law (EFL), based on the concept of a Renewable Energy Feed in Tariff (REFIT), and the Danish Windmill Law (table). The government sets the price; the utilities are forced to pay it; and the wind energy companies profit. The government claims credit for supporting renewable energy; the utilities squeal; and the wind energy companies applaud.

With liberalisation, the utilities will not just squeal. They will howl, fight even harder -- and ultimately win the battle against government price mandates. As long as utilities are allowed to maintain monopolistic control over captive consumers, they can always cross-subsidise to support their wind energy payments. In the face of ongoing liberalisation, though, that will become harder.

If utilities carry the costs of supporting wind energy and other renewables, their industrial consumers will slowly migrate to independent electricity suppliers that do not face these costs. Even if the utilities do not win early claims about unfair competition, the costs of support will become more and more focused on captive domestic customers. They, in turn, will become more and more restless and rebellious. Eventually the political and financial basis of support for fixed payments will be eroded to the point where it collapses.

The problems are exacerbated by the fact that such fixed payment systems put little downward pressure on wind energy costs. With these systems, anyone who can make money at the proffered price is a winner. Unless politicians change the rules, it is a relatively safe business and so the dominant incentive is to make sure that politicians do not change the rules. A lot of effort goes into price protection rather than cost reduction. Perhaps, as the capacity and hence cost of the support systems expand, they may collapse under their own weight; but with liberalisation apace, the industry risks standing like Canute, putting its big effort into holding back the tide of liberalisation, and reinforcing the image of wind energy as a costly source into the bargain.

THE threat and the promise

So how can liberalisation be an opportunity? Let us first acknowledge clearly and loudly that unfettered liberalisation is a threat, not only because it undermines the present fixed payment systems, but also because electricity from natural gas has become so cheap that nothing can easily compete with it. With the remarkable advances in combined cycle technology, with a massive gas surplus on Europe's borders, and with gas liberalisation set to follow that of electricity and give potential generators access to that gas, the outlook for any competing source is pretty grim if they have no protection.

Politicians may readily accept that an unfettered dash-for-gas in Europe is undesirable and that the renewable energy industries need support for environmental and strategic reasons. The challenge is to devise models of support which are effective, efficient enough to be maintained as the industry expands, and compatible with liberalisation. To meet the challenge requires switching from a system of price supports focused on utilities towards competitive volume supports focused upon all electricity suppliers. Specifically, this can be achieved through a system of renewable electricity credits, as proposed in the EC's Green Paper on renewables, soon to by published in final form as a White Paper for policy implementation. In the United States, such credits systems are known as "Renewable Portfolio Standards."

Through the door

Before introducing such credits, there has to be a market framework in which they can be traded. First, it will be necessary to establish a target contribution for wind energy in a given period, as a percentage of electricity supplied. This can be at either national or European level. Being ambitious, we can suppose that a target is established at European level to coincide with commitments on CO2 emissions established under the climate change protocol, due to be completed at the UN climate change conference in Kyoto in December.

Let us suppose that Kyoto stipulates the maximum allowable CO2 emissions from the EU for the period 2005-10. The European Council, as part of its strategy for implementing this commitment, then agrees a target that wind energy shall generate an average of, say, 2.0% of EU electricity over that period.

The target, probably, will be aggregated up from national targets of varying ambition. It will include some extra target capacity negotiated with countries that do not yet have a goal for wind energy. In this way each country will have undertaken an obligation with respect to wind energy generation, most probably derived from existing national plans.

Following the subsequent introduction of renewable electricity credits through regulation, electricity suppliers will face a legal obligation to obtain credits equivalent to a given percentage of the total electricity they supply in that period. Credits will be obtained by generating wind energy, by buying electricity from wind farms, or by buying the credits from those who obtained surplus credits by either route. Credits will thereby acquire a value reflecting the additional costs of ensuring that the target is met, a value which will ultimately accrue to those investing in wind farms.

Such a system will allow free trade in wind energy credits; generally, they will be bundled with electricity sales from wind farms and then traded amongst electricity suppliers in the increasingly competitive European electricity market. If the amount of wind energy generation was in danger of falling below the target, the price of credits will rise, rewarding existing wind generators and stimulating additional investment in wind energy. Compliance penalties will ensure that suppliers do obtain the required credits; and a modest futures market, or provision for banking of surplus credits for future periods, will help to maintain some price stability in the event of over-achievement. Brokers and all the usual attendant facilities to oil the wheels of trading will appear spontaneously; much of the trading will be traced and managed electronically.

Governments may choose initially to give all suppliers a percentage commitment equal to the national percentage commitment, or they may vary the initial commitment according to geographical location of suppliers, or other criteria. This will not matter, provided the national total reaches the target; and the ultimate location of wind farms need not be affected by the distribution of commitments, since the credits will be traded according to where wind farms can be most acceptably and economically developed. Credits, furthermore, can be traded internationally among countries that participate in the scheme -- Dutch electricity suppliers, for example, can meet part of their requirement by importing electricity, or credits, from Germany or Scotland.

Attractive too

Recognition of wind energy's value by granting it credits tradeable on an open market is an attractive approach. For a start, it fits with the likely Kyoto structure of emission targets specified over budget periods. More important, however, it creates a competitive structure for the wind energy industry within a guaranteed market.

Some of the advantages of this are suggested by the UK's Non-Fossil Fuel Obligation (NFFO) system. In the framework of NFFO, the government announces "Orders" for renewable energy, for which companies submit bids. On the basis of these bids, the government sets a contract price and selects the proposals offered below that price (subject to additional evaluations of project viability). Since only developers that bid below that price will get contracts, there is a strong downward pressure on price. The additional cost to the electricity suppliers that have to buy the electricity at the government contracted price is refunded through a flat-rate national electricity levy.

The success of the NFFO system in stimulating a viable industry and driving down prices is impressive, as readers of Windpower Monthly will know. Different contract periods and resource conditions make comparisons difficult, but it is, nevertheless, striking that the most recent NFFO round saw average contract prices for wind energy below ECU 0.05/kWh, compared with over ECU 0.10/kWh under the EFL in Germany. The falling cost makes the NFFO system more politically acceptable and the fact that the levy is spread across the national system minimises any competitive disparities between electricity suppliers.

But although the NFFO system is compatible with a liberalised electricity system and has proved its effectiveness on some criteria, it has important drawbacks. The need for government selection of projects makes the process highly bureaucratic. Applications are time consuming and costly and a low rate of selection means a lot of wasted -- and expensive -- effort by disappointed bidders. Furthermore, it gives no international flexibility. Scotland's fine wind resource is reflected in the country's low "strike price" for wind energy contracts under its own NFFO system, the Scottish Renewables Obligation. But there is no way for Scotland to profit by helping the rest of the UK -- or Europe for that matter -- meet wind energy targets. NFFO has been successful in steadily building installed wind power capacity, but it is not a model for the long term future.

A renewable credit system would have a number of the same advantages, but without the limitations of NFFO. And, as liberalisation proceeds, one additional advantage will emerge. Liberalisation could bring "cost reflective" pricing, with the price of electricity varying according to the location in the network and over time. Areas remote from centralised generation, for example, will attract higher than average electricity prices, as will electricity generated in winter. That should be an advantage for wind energy and for other renewables, reflecting their true value in supplying more dispersed or remote locations in upland, coastal or island locations -- with much of the energy generated in winter. The NFFO and the fixed tariff systems override such "cost reflective" electricity prices, impeding the structures required for wind energy to realise real and inherent economic advantages over more centralised sources. A credit system would complement and add to cost-reflective pricing systems.

Start campaigning

In the longer term, the most rational "support" mechanism would not consist of targeted supports at all, but would rather rely on full external cost pricing of all electricity generation. Wind energy would benefit by not facing emission taxes applied to fossil fuel generation.

In Denmark and the Netherlands, the first steps in this direction have been taken, although only in the crude form of a general tax on all energy consumption. In Denmark this tax is "refunded" to the owners of wind plant as part of the fixed payment for power they sell to the grid. In the Netherlands, wind energy has been exempted from a national "ecotax," introduced last year (see box). But while such taxes are a step in the right directionÐand a valuable one for wind energy -- the system has major drawbacks. It applies to electricity output rather than reflecting differentially the damage arising from emissions; and the level of the tax inevitably has as much to do with the politics of taxation as with the level of damages or the needs of renewables. Furthermore, in most countries such taxation is political dynamite -- witness the fate of the European carbon tax.

The difficulties of devising and introducing policies for the internalisation of external costs are such that they are not about to be introduced, rational as they may be. Right now the focus is on forming European energy policy for the greatest uptake of renewables. The major issue is building up new industries. As liberalisation sweeps the electricity markets of the European continent, wind industry support for the Green Paper's proposals on tradeable renewable energy credit systems will be well spent. No other proposal on the negotiating table in Brussels holds so much long term potential for creating the right market framework for renewable energy to thrive.

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