Experiment of the Century

I’ve been following the handful of clean energy policy experiments underway in Europe and the US with great interest. From Germany to California, governments are testing various incentive programs and, by historical standards, backing them up with sizeable funding commitments. Most recently, the CPUC has proposed $2.5 billion in funding for the California Solar Initiative covering 2007-2015 and authorized stop-gap funding of $300MM for 2006.

Before going on, I think it’s important to put these programs in the proper perspective—even the combined impact of these programs will do little to turn the tide of climate change. However, what is important is that the results of the current incentive programs, or more accurately how the results are interpreted, will form many of the precedents upon which future clean energy policy will be based. In that sense, I see these programs as experiments whose outcome will have a huge impact on the future of clean energy policy well into the next few decades and perhaps for the coming century.

It’s seems fairly obvious that entrepreneurs and investors in clean energy should have a good understanding of the types of incentives being implemented, how they shape market development, and the degree of support they get from industry stakeholders. This understanding is critical to both short-term market entry planning and to the development of mid- and long-term market scenarios for strategic planning. It’s also critical because entrepreneurs and investors are often in a position to lobby or offer insights to policy makers. Yet, I’m frequently surprised by the number of hi-tech-to-clean-energy converts I meet who treat policy as a given or as a minor marketing detail.

While every program is unique in terms of how it is implemented, they can generally be grouped into four incentive categories:

• Capacity Based Incentives – Reward project developers with incentives based on the capacity or peak power put into service usually in the form of a buy-down or rebate applied to project capital costs. Examples include the current SGIP, CEC ERP, and NJCEP. Capacity incentives can be very effective in stimulating market activity but critics often point out that they effectively amount to government price setting, reduce cost-reduction pressures on manufacturers, don’t ensure system performance over time, and lack an appropriate market mechanism for regulating incentive levels.
• Performance Based Incentives (PBI) – Pay project owners based on the actual energy generated by a project over time often in the form of a contract or feed-in tariff. Examples include the CEC’s pilot PBI, Germany’s feed-in law, and Spain’s feed-in law. PBIs can be very effective at generating demand and they provide the owner with an incentive to keep the system operational. However, critics assert that PBIs are not market-based, don’t encourage price reduction, can create huge stranded costs, and can result in excessive overpayment to developers.
• Renewable Portfolio Standards (RPS) – Set target for renewable generation as a part overall generation portfolio supplying a regional grid and identify a timeframe for achieving it. RPS programs are usually market-based and require generators to bid into a competitive. Proponents typically applaud RPS’s for being technology “agnostic” mechanisms that reward the most cost-effective resources via true market mechanisms. Critics often point out that RPS impose a strict economic regimen on what should be viewed as emerging markets, rewarding mature technologies rather than directing investment of public resources into the technologies that will provide the greatest long time reward.
• Renewable Energy Certificates (RECs) – Also known as “green tags”, RECs are not a true incentive but rather a funding mechanism for renewable energy projects.They’re worth a mention here because they’re integrally tied to RPS implementation and a lot is happening with unregulated commercial trade of RECs. A REC represents the “renewable attributes” of a unit of renewable electricity as separate and distinct from the commodity electricity. Bundled purchases of RECs (RECs plus electricity) are used by utilities to meet RPS requirements in many states. Unbundled RECs (the separate sale of RECs to a third party and electricity to the regional utility at wholesale prices) is growing rapidly as a way to unlock the value of the renewable attributes of a project for a developer. By unbundling the REC from the electricity, the REC can be marketed to a broader range of potential buyers rather than just to the regional utility who may or may not be willing to pay good price for it. Much of the unbundled market is unregulated and growing rapidly due to an increasing appetite on the part of business for easy ways to “get clean.” More on this later…
• Tax Incentives – Federal and state tax incentives in the US have proven to be a very effective way to encourage development of clean energy projects. Critics contend that using the tax code as an incentive mechanism results in market distortions and is effectively equivalent to spending government money on precisely the entities who least need it rather than redistributing it.

Policy experiments are tricky business—unintended outcomes and political dynamics can result in real or perceived policy failures. You don’t have to look any further than the 1970’s for an example of how a policy failure can have a long term chilling effect on an industry. In response to well-meaning but poorly structured incentives, a US renewable energy industry rapidly sprang into being that pushed immature technologies on consumers and abused public trust. Stories abound from the Carter era of technologies that didn’t work as promised and policy loopholes that allowed people to claim tax credits on renewable energy equipment that was never put into service. These stories tainted public perception of renewable energy, rightly or wrongly, as an industry of naïve dreamers and cynical scam artists. That perception made it politically challenging to enact renewable energy incentives in the US for a period 25 years.

The lesson here is that it’s not enough to plan a strategy or product design around today’s incentive programs. It’s imperative that clean energy entrepreneurs have a long term perspective on the political viability of various types of programs and anticipate which programs, though  successful now may result in ratepayer or taxpayer backlash. In subsequent posts I plan to explore each approach in more detail using current examples and assess how the results so far with an eye on the next century of opportunity.