The Pitfalls of Feed-In Tariffs

I recently ran across a story indicating that regulators in Arizona are considering implementing a feed-in tariff (FIT) for solar power in that state. This is somewhat ironic, coming as it does amidst a wave of hotly-debated reductions in European solar FITs, in response to the burden they've imposed on electricity customers and the unintended consequences they've created. With Germany, Spain, and now apparently France all slashing their FITs, it's worth taking a look at how these policies differ from the US federal and typical state incentives for solar power, and why they might not be the best choice for promoting solar power here, particularly in places with solar resources as inherently attractive as Arizona's.

As I've noted before, an FIT is effectively a tax, although imposed by utilities on ratepayers rather than by governments on taxpayers. It guarantees developers of renewable energy projects--usually for solar power--a predictable price for their output and thus a predetermined potential return on their projects, barring other project risks. Because these rates are normally fixed for long intervals, and only adjusted after much consultation and debate, they don't make allowance for the kind of significant cost reductions they're often intended to stimulate in the technologies to which they apply.

The price of solar photovoltaic (PV) modules has fallen sharply in the last two years, partly due to the classic experience-curve effects that the industry likes to tout, but also because of events such as the recession and alleviation of a global bottleneck in the production of polysilicon, the basic feedstock for most silicon-based solar cells. But module costs have also come down for another reason more directly related to the generous FITs that have been in place in Germany, Spain, France and elsewhere. They were so generous, in fact, that they attracted new entrants from low-cost manufacturing centers like China that were able to undercut local suppliers significantly and gain market share. In other words, instead of just helping to grow local solar industries--a clear example of industrial policy--high FITs can also spur new imports from foreign competitors with potentially sustainable cost advantages over domestic manufacturers.

In this regard, at least, the prevailing US federal policy of providing a substantial investment tax credit, or more recently the option of taking that ITC as an up-front cash grant, has important advantages. Because it is calculated based on the cost of each project, it automatically adjusts downward as technology and project prices fall--as we are frequently told they will continue to do for PV. Most of the state solar incentives I've seen take a similar form, providing consumers and businesses tax relief based on the cost of the solar systems they install, or cash rebates that decline rapidly based on cumulative capacity. Again, these are self-correcting, compared to Europe's FITs. That's beneficial for taxpayers, but also for the domestic solar industry, by forcing it to remain competitive.

Because the global solar industry has grown to a level of scale and sophistication such that it can quickly shift a large number of projects to the countries with the most attractive policies--as for example when developers decamped from Spain to France once the former's solar capacity threshold was reached in 2008--the cost of a FIT policy can mount quickly and unexpectedly. According to the Financial Times, solar incentives last year accounted for half the €6 billion annual tab for Spanish renewable energy subsidies, even though total solar capacity in Spain at year-end was just 18% that of wind, according to the Renewables 2010 Global Status Report of REN21. That's a lot to pay for installations that collectively displace the equivalent of just one medium-sized coal-fired power plant. States such as Arizona that are considering feed-in tariffs should think carefully, not just about the laudable goal of promoting solar power, but about the accompanying financial burden they're imposing on ratepayers, as well as the potential for unintended consequences.