Yoel Hanegbi, CEO of Eshone Energy, invites guest writer Christian Paulus to provide an assessment of the U.S. Renewable Energy Policy; where it falls short and what solutions he offers to close the gap.
Policy decisions are necessary to accelerate adoption of renewable energy. We have been fortunate that in the U.S., major bills providing significant subsidies have recently been signed into law. However, do we put those funds to work in the most efficient way? In this article, we will review the U.S. policies for PV Solar systems and evaluate the behavior these policies promote. Finally, we will contrast the U.S. policy direction with Germany's, as the leader in PV solar.
. A) Government policies and subsidies to promote renewable PV Solar energy projects
Government policies provide the legal basis for grid-connected distributed energy generation. They also provide incentives and subsidies to offset some of the costs of Solar Photovoltaic (PV solar) installations. We will provide an overview of the most important policies applicable for PV solar systems in the State of California.
1) Federal tax incentives
Federal tax incentives significantly lower the costs of PV solar projects for
taxpaying entities such as residential consumers or businesses.
- Investment Tax Credit (ITC) - The “Energy Improvement and Extension Act of 2008”1, signed into law on October 3, 2008, includes an 8-year extension of the 30% residential and business Investment Tax Credit for solar systems.
- Modified Accelerated Cost Recovery System (MACRS) and Bonus Depreciation2 - The IRS allows businesses a five-year accelerated depreciation of eligible assets such as PV solar systems, reducing the taxable income.
If certain criteria are met, the Energy Improvement and Extension Act of 2008 also provides a bonus depreciation: 50% of the installed costs of a PV solar system can be depreciated in the first year, while the remaining 50% can be depreciated over the original schedule.
2) Federal incentives for the public sector
Next to federal incentives for residential consumers or businesses, there are also federal incentives for the public sector such as Clean Renewable Energy Bonds and Renewable Energy Production Incentives.
- Clean Renewable Energy Bonds (CREBs)3 - For any investment, interest rates are used to describe the cost of capital. For PV solar projects, the initial investment costs are the biggest cost factor so that the interest rate plays an important role in the overall costs of the project.
Drawbacks include high transaction costs, an overall difficult process and the requirement to make the first bond principal payment in the same year the CREB was issued, even though the system may not be in service yet. Furthermore, CREBs claim to providing interest-free financing is often not true.
- Renewable Energy Production Incentives (REPI) - REPIs provide a production-based incentive program for renewable electricity generation. There are two significant challenges: Incentive commitments are made long term, but its funding is dependent on annual federal appropriations. In fact, “funding has been insufficient to meet 100% of the qualified REPI payments”.5 As a result, lenders don’t count on REPIs.
3) State and local incentives
In addition to the federal government, state and local governments can also provide incentives to promote renewable energy projects. Those programs are financed through System Benefit Charge Programs (SBCs) or through state and local government bonds. SBCs have been implemented in many states to fund various renewable energy related programs such as the California Solar Initiative, which can significantly lower the costs of a PV Solar project.
California Solar Initiative (CSI) - The goal of the CSI is to create 1,750 MW through PV Solar. The incentives decline with increasing electricity generation in ten steps. There are two incentive types:
- Expected Performance – Based Buy – Down (EPBB): EPBB applies for systems smaller than 50KW. Incentives are paid one-time, up-front, based on the expected performance of the system rather than merely based on the installed capacity.
- Performance Based Incentive (PBI): PBI applies for systems over 50KW. Subsidies are paid for five years based on the actual KWh generated.
The current residential EPBB payment is $1.90/KWh.
State and local government bonds6 - Next to SBCs, State or local governments can issue municipal bonds (General obligation bonds or revenue bonds) to raise capital for PV projects. However, there are many examples where the issuing government was not able to get the bonds to market, despite authorization to issue them.
Net Metering -Many states provide net metering policies which provide the framework for distributed energy generation: It regulates, and thus simplifies, how consumers can feed in electricity, which was generated in a distributed fashion, into the utility power grid.
“Net metering allows consumers to offset the cost of electricity they buy from a utility by selling renewable electric power generated at their homes or businesses back to the utility. In essence, a customer's electric meter can run both forward and backward in the same metering period and the customer is charged only for the net amount of power used.” 7 If a customer generates a net excess, he will receive a retail credit from the utility, which will be carried forward to his bill for up to 12 months8.
Solar Renewable Energy Credits (SRECs) - Many states define Renewable Portfolio Standards (RPS), specifying targets for renewable energy as a percentage of the overall energy the utilities provide to their consumers.
The dominant mechanisms to help utilities meet the RPS compliance goals are Renewable Energy Credits (REC’s) or Solar Renewable Energy Credits (SRECs): SRECs represent the attributes of green energy from PV Solar systems, which can be sold separately from the generated electricity. They can also be traded in voluntary green power markets.
SRECs can provide a significant revenue stream: 3 Phases Energy Services report that SRECs can contribute 42% to the NPV of a solar project in Colorado.9 10 The retail price of a REC typically ranges from 1c/KWh to 2.5c/KWh for residential and small commercial customers.11
However, RPS policies differ greatly on state, region, utility or green power market level. While in California SRECs do not trade for compliance yet, the California Public Utility Commission is proposing to change that12.
B) The behavior the renewable energy policy promotes – a residential PV solar use case.
We will now evaluate what impact the policy decisions could have on a residential PV Solar system owner. 13 We consider two residential consumer examples: A fairly moderate 3KW system and a larger 10KW system. The Federal Investment Tax Credit and the California Solar Initiative’s EPBB apply, which together, significantly reduce the initial investment costs nearly 50% However, in both cases the initial investment costs ($12,810 or $42,700 respectively) can still be considered to be significant. Financing can play an important role in overcoming this barrier by spreading the high initial investment costs over the life time of the system. The financing payments replace, at least partly, the payments to the utility company for an electricity bill. There are multiple financing approaches such as simply using a consumer credit or using a commercial entity such as a solar solution provider.
When using a financing approach, an interest rate needs to be applied to depict the cost of capital as well as the investment risk. No matter how low the interest rate, the ITC and CSI EPBB subsidies are not sufficient for PV Solar systems to reach grid parity. Unless investors are willing to pay a premium for “green” electricity, wide spread adoption of PV solar systems will not occur.
In an attempt to further adapt to reality, we can consider that during the past five years the average residential electricity prices increased 4.78% per year. Assuming that this trend continues, revenues from generating electricity through PV solar will also increase: The 10KW PV Solar Power System can reach or surpass grid parity (for all interest rates of 6.78% or smaller) while the smaller 3KW PV Solar system can only reach grid parity with a positive monetary value set at an unrealistic interest rate of 0%.
1) Break even scenarios
This calculation reveals two significant drawbacks of the current subsidy
- Investors need to be willing to make long term assumptions about electricity price increases to justify a PV Solar investment. If electricity prices increase less than expected, investors are stuck with too high payments over time periods of 20 – 25 years. Of course, on the other hand, if electricity prices increase more than expected, investors not only have predictable prices over a long time period, they also have locked in a price which is below the market rate. While there is risk and opportunity, many investors will simply not be willing to make assumptions for time periods of 20 to 25 years.
- Energy conservation is not incentivized. Instead, the larger the PV system, covering potentially more wasteful energy consumption habits, the higher the monetary returns14. Furthermore, environmentally conscientious persons who conserve energy and who may be most interested in installing a PV Solar system, receive less monetary value from a PV Solar investment and thus may not invest at all.
Smart PV system owners take tiered15 utility pricing models into consideration to further maximize their monetary return. The rates increase in steps as consumption increases. In addition, we can calculate the break even electricity price within this tiered model, where a PV Solar investment would turn into profitability.
The graphic below demonstrates that there is a threshold, mostly depending on the applied interest rate16: For an interest rate of 6% (reflecting a hypothetical electricity price of 0.214$/KWh) or even 7%, it would make economic sense to replace the electricity consumption for Tiers III, IV and V with electricity generated from a PV solar installation. It would not be profitable to substitute the entire electricity consumption, i.e. Tiers I and II. If an interest rate of 8% is applicable, it would only make sense to replace Tier IV and Tier V, but not Tier I, II and III any more.
2) Break even points in a tiered utility pricing model
As a result, the existing incentive structure promotes substitution of only
parts of the electricity consumption: The installed capacities will be limited.
On top of all the challenges mentioned above, the existing benefits structure is complex:
- There are too many, fragmented programs.17
- Programs often differ widely on local, state, utility or green power market level.
- Programs often differ widely on the recipients of the benefits such as residential consumer, businesses, public entities.
It is time consuming to research the various programs and potential recipients of benefits may not be aware of them.
Lastly, some programs are short term in nature: They do not provide sufficient financial predictability and continuity. As a result of the complex and/or short term nature of the policy decisions, the value of incentive programs may not be maximized.
3) To summarize: The existing policy decisions can promote undesirable or unfavorable behavior. The current subsidy levels and structures:
- Do not support the goal of widespread adoption. Unless many consumers are willing to pay a premium for “green” electricity, wide spread adoption of PV solar systems is not encouraged.
- Do not reward energy conservation. Instead, consumer segments with high electricity consumptions are rewarded, who are less likely to be environmental conscience and thus less likely buyers of PV systems.
- Do not maximize installed capacities. Instead, only partial substitution of the electricity consumption by PV Solar generated electricity is promoted, further limiting adoption.
- Require consumers to make long term assumptions and thus, does not provide sufficient long term predictability (e.g. electricity price increases).
- Can be unstable over the long term so they are not utilized (i.e. REPIs).
- Are complex and thus, the value of incentive programs may not be accessible to all potential recipients.
C) The behavior the German renewable energy policy promotes
Let’s now contrast the U.S. Policy approach and the behavior it promotes with Germany's Renewable Energy Law (EEG), which is discussed in “Policy decisions are necessary for a transformation of our energy systems”. At the heart of the EEG are Feed-in tariffs, which specify the payments for renewable energy generation.
The simplicity of this policy structure is immediately obvious: For example, a typical residential consumer operating a PV Solar Power System on his roof will receive 43.01 Euro cents for every KWh fed into the electricity grid.
To provide an accurate financial comparison between the U.S. and the German policy benefits, we need to consider that the average solar radiation in Germany is significantly lower than in the U.S. and that the residential electricity prices in Germany are higher (16.5 Euro cent / KWh) than in the U.S. The graphic below depicts the financials for a 3 KW Solar Power System with a solar incident of 1,000 KWh/m2/year.
Economic benefits when applying the German EEG law
Even without making any long term assumptions about electricity price increases, a moderate 3KW system almost reaches profitability at a 0% interest rate.
Once long term assumptions about electricity price increases are taken into consideration, the EEG policy drives widespread adoption of PV solar for all consumer segments, even with a high financing interest rate of up to 7.1%: The Net Present Value is positive (i.e. consumers earn income on their PV Solar Power System).
Since the Net Present Value is positive below the break even interest rate of 7.1% interest (i.e. the Internal Rate of Return), this policy encourages installing the maximum capacities or even installing over-capacities.
The German EEG law has been introduced in 2001, providing long term stability for all PV solar operators.
We conclude that the German EEG policy does not promote many of the undesirable behaviors, which can occur as a result of the U.S. Policy directions. We recommend introducing feed-in tariffs into the U.S. energy legislation to further increase adoption of renewable energies.
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