Adequacy

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New renewable markets require a strong injection of resources to get them running, after which they can be optimized for smooth performance. There are many types of drivers. The adequacy test must be applied to ensure that whatever its type, the driver is providing enough fuel for renewable development. To reiterate, the driver is what starts the engine, and it must initially be a fuel-rich mix which can be made leaner in the longer term.

Since manufacturing and job creation is often the jewel in the crown of a renewable energy policy, it is very important to achieve the correct financing, duration and intensity thresholds. These sometimes run counter to short-term economic efficiency which can create arguments for minimizing the cost impact of renewables or waiting until the technology undergoes further price reductions.

Table 3.3 Estimate of the future cost reduction of wind-generated electricity

Source

Relative share (%)

Design improvements - weight ratios

Improved conversion efficiency4 - aerodynamic and electric efficiency

Economy of scale - steady serial production and optimization of logistics

Other contributions - foundations, grid connection, O&M 5 Total

Note: Percentages refer to a total reduction of 15 per cent from 2000 to 2004. O&M: operation and maintenance.

Source: Mallon and Reardon (2004)

However, Table 3.3 shows how more than 50 per cent of cost reductions are achieved through economies of scale production and learning by doing — illustrating that the rationale to sit and wait holds little water. The empirical evidence clearly shows that firm and decisive policy brings manufacturing, jobs and exports. This begs the question of whether it is better to spend less money, only to have more money leave the country, or to spend more money up front in order to achieve greater domestic retention and manufacturing activity. I leave it to the economists to argue this point.

When we examine adequacy, there are at least three important questions to answer, and these will now be discussed in the following subsections.

Are the policies leveraging private sector investment?

Simply throwing money at renewables does not work6 — governments do not have deep enough pockets. The way to mobilize renewables is to mobilize private sector finance. And the key to that is ensuring investors can get a return on their money equivalent to or better than that available elsewhere. Good policy design will need to consider the investment profile of renewable projects and determine what is required to make the industry attractive to private investment.

An excellent example is the early investment by the US government in wind energy in the wake of the 1970s oil shocks. The result was a series of massive experimental wind turbines produced by companies like Boeing and Westing-house in the mid-1980s. However, it was primarily Danish and German companies (including Vestas, an agricultural machinery manufacturer) that eventually prevailed, building up a business in a stable policy environment that allowed the steady development of a wind industry.

Are the returns on investment comparable with other alternatives?

Renewable energy forms are cost competitive with conventional sources in an increasing number of jurisdictions. Intervention may not be required in such cases but, for bulk energy in large economies, some level of pollution internalization or positive intervention is necessary. We can think of positive intervention as compensatory, recognizing that it is easier to compensate 10 per cent of the energy sector for market distortions than to charge 90 per cent of the sector for pollution.

By way of example, I recently undertook a renewable energy scoping exercise on the Pacific island nation of Niue. There the cost of electricity to consumers is very high at about 30 New Zealand (NZ) cents (approximately 22 US cents) per kWh, a price which includes a 50 per cent state subsidy! By comparison, estimates show wind energy on the island could be produced at 20 NZ (15 US) cents. In Niue's case, the economics of electricity prices will clearly not be the limiting factor for the implementation of wind power. At the opposite end of the spectrum lie countries such as Australia where electricity is generated at a mere 1.5 US cents per kWh. There, policy intervention is needed to make up the renewable energy cost gap.

Interventions which create some sort of direct or indirect price support must be implemented at levels that allow independent, commercially viable projects to proceed. At first glance, this level would appear to be the difference between the price of conventional generation in the national systems and the price of new renewables. However, the price of either may not be what they first appear. The word 'independent' is very important here. It refers to projects which can be externally financed through normal corporate lending based on their own merits (project financed) — at financing costs which may be significantly higher than those which state-owned entities or large corporations may be able to achieve.

To explain this point, we need to understand that many large or state-owned companies are able to finance projects internally or off a balance sheet. That is, they can guarantee to make the repayments based on company cash flows as a whole, not the project itself. This may allow for better financial rates which permit projects to become viable. For example, a satisfactory internal rate of return for a state-owned company might be 6 per cent. However, institutional lenders might demand a return of 12 per cent (depending on the value placed on a green project), while for private financiers the rate might be up to 17 per cent, and for venture capital companies it could be 35 per cent. So the smaller renewable energy players must bank the project on the merits of the project alone and pay substantially more for their equity.

A support level which enables only state companies and large corporations to develop renewable energy is false economy. It excludes the wider private development sector and thus reduces the incubation of a highly competitive private development industry.

Are the investment periods long enough for project investors to get a return on equity?

Equity participants are very sensitive to the duration of projects. Almost all renewable energy projects are capital intensive and have low fuel costs. The projects are often financed through a mixture of equity and debt. Over the project's operational lifetime, its revenues are often first used to pay off the debt and thereafter the owners obtain a return on their equity. Projects with a lifetime of 20 years require a very long-term commitment by investors.

Table 3.4 Industry development rates and manufacturing as a function of the size of the Mandatory Renewable Energy Target (MRET) in Australia

Current MRET

5 per cent MRETby 2010

10 per cent MRETby 2010

Total renewable energy target (GWh)

9500

19,000

30,150

Total wind in target (GWh)

2470

7220

12,795

Total installed wind capacity at 2010 (MW)

940

2842

5037

Annual turbine installations to 2010 (based on an average wind turbine size of 1.5MW)

90

270

480

Blade manufacturing facilities at threshold demand (based on a threshold of 100 wind turbines per year per blade manufacturer)

<1

2-3

4-5

Maximum number of facilities (accounting for market share)

<1

2

4

Source: Maddox (2004); produced for the Australian Wind Energy Association

Source: Maddox (2004); produced for the Australian Wind Energy Association

If a project is to be viable, a balance must therefore be struck between the duration of a project and the cost of energy. Ideally a project would receive support for its full lifetime. If the support falls below this ideal, the project must charge higher prices for the energy in order to recover the debt and equity.

The use of excessively short periods of support can lead to prices which do not represent the real cost of the renewable energy and therefore reduce its competitiveness. This means that unnecessary costs are passed onto consumers or the taxpayer.

Are the installation intensity and scheme duration adequate to enable manufacturing?

The manufacturing life cycle is much more long-term than that of installed projects. It depends on a sustained stream of projects purchasing hardware at a sufficient rate over long enough periods for a factory to pay for itself and deliver decent profits. If this sustained installation period is absent or if the throughput is too small, then it may be cheaper and less risky for suppliers to import technology and domestic manufacturing will not occur.

Table 3.4 shows how different industry development rates are used to determine the number of manufacturing plants likely to be established under a given scheme. It is important to remember that the market volume must be divided between the likely number of manufacturers, and in a competitive market this will be at least two and preferably three. Therefore the optimum market size needs to be three times the volume required for a single manufacturing plant.

Note: Kenetech machines dominated the global wind market in the early 1990s, but failed to cope with the severe US and then Indian boom-bust cycles. Source: Paul Gipe

Figure 3.3 Kenetech wind turbines

Stability

The final, but most important driver-based measure is the need for stability. As seen in the previous chapter, an unstable policy is worse than no policy at all. Why? Because an unstable policy leads business to make investments that may collapse as future support wanes. A sector of formerly enthusiastic industry participants may be deterred from engaging in a further round. They may prefer not to engage until the government indicates it is ready for a sustained commitment.

Policy stability is a fundamental requirement of market certainty, which in turn is strongly related to both the production price of renewable energy and the development of manufacturing capacity.

Stability may be considered the key ingredient in the success of the German feed-in law, which remained largely unchanged for 10 years. Conversely, Swisher and Porter describe in Chapter 7 on the US how policy instability characterized the early US approach to renewables and continues to define the ongoing football game developers there must play with production tax credits. The Swisher and Porter comparison of US and German policies later in the book provides valuable insights.

The stability of support in Germany allowed project developers to be sure of prices and also to develop projects in a steady stream. Furthermore, the increasing experience and concomitant industry sophistication — in projects, financing and technology — has led to lower costs. These are benefits that can allow future revisions to bring down costs and ensure economic efficiency.

Installed capacity in India

450

400

350

300

*

250

2

200

150

100

50

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Installed capacity in India

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2250 2000 1750 1500 1250 1000 750 500 250 0

I Installed MW

■ Cumulative

Installed capacity in the US

1800

1600

1400

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800

600

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200

0

Installed capacity in the US

Pi

i

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1 1 ill PI Tl n=, ® n n _ilSli

6300 5600 4900 4200 3500 2800 2100 1400 700

» Cumulative

Note: Data for 2003 are forecast Source: BTM (2004)

Figure 3.4 Illustration of the boom—bust cycle in India and the US

So what does stability mean in practice? The following discussion attempts to cover some of the most important considerations.

Does the policy framework avoid boom-bust cycles?

The boom—bust phenomenon constitutes what is probably one of the most common failures in renewable energy frameworks.

Only a very small number of countries have successfully avoided this pitfall. They have done so with frameworks that avoid excessive time pressures or excessive competition for funds. We could describe their policy frameworks as having a more 'open' architecture as they tend to attract rather than deter.

Many treasury economists are worried by targets and spending volumes or periods which are not fully pre-defined, and so caps are usually put in place. These caps are often couched as aspirational targets such as 'one hundred thousand roofs', 'a thousand megawatts', or 'a billion litres'. This approach has its merits, but what happens in successful cases, when the target is reached or the money spent? The target of course becomes a cap and the boom becomes a bust.

As I write this chapter, I have just returned from several days of lobbying the Australian parliament about the current status ofwind power. I alerted them to the problem that wind in Australia is a victim of its own success. The Australian federal MRET policy has, in principle, a duration of 20 years. However, all of the project installations required to meet the target will have been completed within the first five years of the policy period. Projects have been found, factories built, people employed, farmers' land leased and so on. Yet once those five years have passed, the industry is poised to fall off the investment cliff into a market and policy void.

Boom—bust cycles can result from several factors, four of which I will describe here:

1 There may be a time restriction in which schemes are limited in terms of time or eligibility period. This leads to rushes of development and then stalls, as has been evidenced under the system of US tax credits.

2 There may be limited pools of resources that are unpredictable in amount or spent on an irregular basis. This leads to floods of development when there is incentive and droughts when there is not, typified by the pattern witnessed under the UK NFFO policy.

3 Targets or caps may result in development rushes to meet the said targets followed by a rather abrupt halt, as we have discussed is underway in Australia.

4 Excessive competition may create an environment in which developers must race one another to be included in a scheme.

Does the policy plan for the whole cycle of an industry's development?

Long-term and stable policies must entail some sense of where these industries are headed. Such policies must also profile the support that will be required for the industry's build-up and complete the process with an exit/integration strategy.

Note: The mean technology diffusion rate for the sample was 41 years. Source: Grubler et al (1999)

Figure 3.5: Technology diffusion rates for over 265 different technologies all following the same path

It is no minor task to manage sustained and steady development for industries which possess spectacular growth rates. Getting it right results in a success like Nokia; getting it wrong results in the renewable equivalent of a dot-com bubble. Thankfully renewables are not the first to tread this path. We can therefore identify the standard growth path expected for these industries and plan their trajectories.

Sources: Nuclear capacity: McDonald (2004);

Oil barrels produced per year: Meling

Sources: Nuclear capacity: McDonald (2004);

Oil barrels produced per year: Meling

Figure 3.6 Growth curves of two energy industries (non-dimensional)

In so doing, we can identify three fairly distinct areas of the growth phase. The slow, flat start is witnessed as new industries materialize from nothing and attempt to make sense of the world. Then we see the J-curve, as the industries get progressively better and bigger, leading to exponential growth. Finally we see a plateau as resource or other constraints gradually confront the industry.

Often we see policy measures that keep industries limping along in the first part of that curve (the engine that will not start). Or we may get the industry onto the exponential growth phase of the curve but without an idea of how long growth is to be sustained or financed, leading to the painful booms and busts.

Understanding the expected future role of a technology or resource base permits scenarios of the long-term trajectory to be established. With this understood, the plan to actively manage that trajectory and the resources required can be deduced and integrated into the policy framework

Does the policy provide an ongoing steady pull on development?

The opposite of a boom—bust cycle might best be referred to as a 'steady pull', with growth following most closely the S-curve of industry development. However, a 'steady pull' in this instance in fact produces dynamic growth. At some stages, linear growth may be considered steady, at others growth should be exponential and, as the industry reaches full maturity, a gradual levelling off is appropriate.

Installed capacity in Spain

1600.

1400 1200 1000 800 600 400 200 0

Installed capacity in Spain

1600.

1400 1200 1000 800 600 400 200 0

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 I I Installed MW -Cumulative

Note: Data for 2003 are forecast Source: BTM

Figure 3.7 7000MWof wind capacity were installed in Spain over 10years, without any market contractions

This is why the best measure of steady pull is the S-curve as a whole. The fewer wobbles and deviations from the curve, the more steady the pull.

Thankfully, this path is not as hard to achieve as it may at first appear. If the price behaviour of renewables did not change, it might be impossible to manage or coordinate such dynamic market behaviour, but in fact it is the price decline of any product that can itself result in this S-curve. Thus, the natural industry growth will be a steady pull along the S-curve, provided the policy framework does not artificially introduce perturbations (and barring unexpected disruptions from other sources).

The example in Box 3.3 shows how the exponential behaviour spontaneously emerges provided the resources made available for the incentive are maintained at the same level. This phenomenon occurs not because of the price decline per se but rather because of price convergence. In theory, if price convergence is achieved or is surpassed, the new technology will take up 100 per cent of market share. In practice, other constraints come to prevail and the full costs of renewable energy will not continue to decline forever. Market-size external obstacles and the costs of applying solutions ultimately curb the growth.

Box 3.3 The S-curve by numbers

Initially, as the market for a new technology expands, money spent does not go very far as the technology is expensive. However, the more that is produced, the cheaper the product becomes, allowing the same amount of money to go much farther. Figure 3.8 shows the price of a renewable technology declining with time. The price support goes towards making up the cost difference between normal technology costs and the new renewable technology. As the figure shows, this cost difference gradually declines towards zero.

Figure 3.8 The decline of price and price difference, and the resulting effect of a fixed level of financial support on volume of commodity
Figure 3.9 Typical curves comparing the number of new units sold and total installed capacity

The above assumes that price convergence can be achieved for one or all renewable energy technologies. If it is achieved for a given technology, the incentives ultimately become unnecessary. On the other hand, there may be some technologies that reach a price plateau preventing them from directly competing with fossil fuels. In this case, the price of carbon or other externalities play a role in determining their ongoing viability.

As the cost declines, the number of units that can be subsidized by a given volume of support rises exponentially. A new technology dominates the market not when its price is extremely low, but rather when its price is simply lower that its competitor. It is similar to the tale of two explorers in the African jungle who find themselves stalked by a leopard. As one dons running shoes his fellow says, 'That's a waste of time; you can't run faster than a leopard.' The first replies, 'I don't have to run faster than the leopard. I only have to run faster than you.'

There will be limits, however: limits on resource availability, for example, fuel or site cost increases, secondary costs such as managing peak load, and the cost of storage and distribution. As these constraints are felt, the level of new installation tails off and the activity required to maintain and replace that installed capacity sustains the industry thereafter (see Figure 3.9).

Is the resource base for the incentive sustainable?

In the real world no financial incentive is open-ended because no resource is inexhaustible. The additional cost of renewables is usually passed onto the consumer but sometimes it comes out of the tax pool. However, time after time, schemes intended to be open-ended are suddenly halted by intervention if they are running too fast for the supporting resource base to cope.

Working in favour of renewable industry expansion is the typical coupling of steady growth with steady price declines — the so-called learning curve. Steadi

Installed Capacity (MW)

Figure 3.10 Standard graph of price decline versus capacity increase for a learning rate of15 per cent per doubling in installed capacity

Installed Capacity (MW)

Figure 3.10 Standard graph of price decline versus capacity increase for a learning rate of15 per cent per doubling in installed capacity ness is important here since short-lived spikes tend to push up prices because they result in high demand combined with supply shortages.

So whatever the policy driver used to provide the incentive, the aim must be to achieve the right balance to provide a steady draw on renewable industry development. This steady pull should be matched by a balanced and sustainable pull on the resources made available by the government and by the wider economy.

One important factor that must also be considered concerns the resource base. A renewable industry contributes to the economy itself — investment is made, factories are built, people are employed and taxes are paid. So the flow of investment is not simply one way, but rather two way. This reality must be reflected in the equation of resource demand from the wider economy. Quantifying this effect is too wide a topic to consider here but it can be performed by independent economists (see Figure 3.11).

Are there long-term energy policies that provide guidance and surety for evolving policies and measures?

Because policy frameworks evolve, we must ensure that the revision of renewable and general energy-sector policies will not destabilize the industry.

In the words of the wise, All things change and nothing is permanent.' Therefore the policy framework must have some faculty to handle change. The more we try to wrap a policy in iron to shield it from change, the more we limit its ability to evolve to a changing world. We must reasonably expect that the policies we make today will be changed by others in the future.

180

160

140

a

120

100

Ë

80

¡3

<

60

40

20

Machinery and equipment manufacturing

Construction

Other

Total business investment

Source: CRA (2003)

Figure 3.11 Modelling of change in business investment from increases to the renewable energy targets in Australia

This said, people often resist change just as they fear the unknown, hence the old maxim: 'If it isn't broken, don't fix it.' Although a time may come when a particular policy requires fixing, we must hope that reform reflects the original policy objectives. This is why it is wise to reflect the objectives themselves within the policy.

The types of policies most applicable for the long term are non-legislated statements of objective. The most pertinent current example is the UK government policy for 60 per cent CO2 emissions reductions by 2050:

Our ambition is for the world's developed economies to cut emissions of greenhouse gases by 60per cent by around 2050. We therefore accept the Royal Commission on Environmental Pollutions (RCEP's) recommendation that the UK should put itself on a path towards a reduction in carbon dioxide emissions of some 60 per cent from current levels by about 2050. Until now the UK's energy policy has not paid enough attention to environmental problems. Our new energy policy will ensure that energy, the environment and economic growth are properly and sustainably integrated. In this White Paper, we set out the first steps to achieving this goal. (DTI, 2003)

Although this goal cannot be set as a single piece of legislation in any meaningful way, it does demand that whatever legislation is enacted be consistent with this objective. Unless climate change is solved by some great, yet-to-be-discovered innovation, the objective is likely to be just as pertinent 20 years from today — perhaps more so.

Consequently as the UK reviews and evolves its renewable energy policies they will all (one hopes) be in keeping with this overarching climate policy objective.

More robust still for renewables would be to have the stated objectives of long-term renewable targets enshrined in government policy. Given the slow turnover time of energy production facilities, such targets will preferably extend for several decades or even half a century.

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Renewable Energy Eco Friendly

Renewable Energy Eco Friendly

Renewable energy is energy that is generated from sunlight, rain, tides, geothermal heat and wind. These sources are naturally and constantly replenished, which is why they are deemed as renewable.

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