Why subsidise renewable energy?

by Ajay Gambhir, Grantham Institute

This blog forms part of a series addressing some of the criticisms often levelled against efforts to mitigate climate change.

It is often claimed that intermittent renewable sources of electricity (mainly wind and solar photovoltaics), are too expensive, inefficient and unreliable and that we shouldn’t subsidise them.

Wind turbines at a burning sunsetWhat are the facts?

Last year, governments spent about $550 billion of public money on subsidies for fossil fuels, almost twice as much as in 2009 and about five times as much as they spent subsidising renewables (IEA, World Energy Outlook 2014). This despite a G20 pledge in 2009 to “phase out and rationalize over the medium term inefficient fossil fuel subsidies” that “encourage wasteful consumption, reduce our energy security, impede investment in clean energy sources and undermine efforts to deal with the threat of climate change”.

Reducing the cost of renewables

There is a key reason why it makes sense to subsidise the deployment of renewable energy technologies instead of fossil fuels. They are currently more expensive than established fossil fuel sources of power generation such as coal- and gas-fired power stations, because the scale of the industries that produce them is smaller and because further innovations in their manufacture and deployment are in the pipeline. As such there needs to be a period of translating laboratory-stage innovations to the field, as well as learning and scaling-up in their manufacture, all of which should bring significant cost reductions. This is only likely to be possible with either:

  • a) a long-term, credible carbon price at a sufficient level to make the business case for developing and deploying renewable energy technologies instead of CO2-emitting technologies; or
  • b) some form of subsidy in the short to medium term, which creates a market for these technologies and provides businesses operating in a less-than-certain policy environment with the incentive to build industrial scale manufacturing plants to produce them (ever more economically as scale and learning effects take hold).

Unfortunately, there is unlikely to be a long-term, credible and significant (“long, loud and legal”) carbon price anytime soon, given the immense political lobbying against action to tackle climate change, and the lack of global coordinated emissions reduction actions, which means any region with a higher carbon price than others puts itself at risk of higher energy prices and lost competitiveness. Whilst subsidies are also likely to raise energy prices, their targeting at specific technologies (often under some fiscal control such as the UK’s levy control framework) means they should have less overall impact on prices. In addition, subsidies have helped to put some technologies on the energy map faster than a weak carbon price would have done and have given a voice to new energy industries to counter that of the CO2-intensive incumbents.

Nevertheless, subsidies should not remain in place for long periods of time, or at fiscally unsustainable levels. Unfortunately some countries, such as Spain, have fallen into that trap, with an unexpectedly high deployment of solar in particular leading to a backlash as fiscal costs escalated, rapid subsidy reductions and the stranding of many businesses engaged in developing these technologies. Germany’s subsidy framework for solar, with its longer term rules on “dynamic degression” levels (which reduce over time depending on deployed capacity in previous years) has proven a better example of balancing the incentive to produce and deploy new technologies with the need to manage fiscal resources carefully (Grantham Institute, 2014).

Reaching grid parity

Fortunately, the price of solar and onshore wind has fallen so much (through manufacturing and deployment scale-up and learning that the subsidies were aimed at in the first place) that they are now approaching or have achieved “grid parity” in several regions – i.e. the same cost of generated electricity as from existing fossil fuel electricity sources. Analysis by Germany’s Fraunhofer Institute shows that solar PV, even in its more expensive form on houses’ rooftops, will approach the same level of electricity generation cost as (hard) coal and gas power stations in Germany within the next decade or so, with onshore wind already in the same cost range as these fossil fuel sources.  Subsidies should be phased out as the economics of renewables becomes favourable with just a carbon price (which should be set at a level appropriate to reducing emissions in line with internationally agreed action to avoid dangerous levels of climate change).

It’s important to note that grid parity of electricity generation costs does not account for the very different nature of intermittent renewables compared to fossil fuel power stations, which can very quickly respond to electricity demand peaks and troughs and help ensure that electricity is available as required. For example one common contention is that for every unit of solar capacity in northern latitudes, significant back-up of fossil fuel generation (most often gas turbines, which are quick to ramp up) is required to meet dark winter peak demand in the evenings. Indeed, analysis by the US Brookings Institute based on this principle (as given much publicity in The Economist in July 2014) suggested this would make solar PV and wind much more expensive than nuclear, gas and hydro power.

Unfortunately, and as reflected in the published responses to the Economist article, this analysis has proven to be too simplistic: not accounting for the fact that wind and solar provide complementarities since the wind often blows when the sun’s not shining; that electricity grids can span vast distances (with high voltage direct current lines) which effectively utilise wind and sunlight in different regions at different times; that there is a great deal of R&D into making electricity storage much cheaper; that electricity networks are going to become “smarter” which means they can more effectively balance demand and supply variations automatically; and that the costs of these renewable technologies are coming down so fast that (particularly in the case of solar) its economics might soon be favourable even with significant back-up from gas generation.

In summary, the world is changing, electricity systems are not what they once were, and there is a very sound economic case for meeting the challenge of climate change by deploying low-carbon renewable electricity sources. It is encouraging to see that there has been a rapid rise in the deployment of these technologies over the past decade, but more needs to be done to ensure that the low-carbon world is as low-cost as possible. This means supporting and therefore continuing to subsidise these critical technologies to at least some extent.


References

International Energy Agency (2014) World Energy Outlook 2014

Statement from the G20 in Pittsburgh, 2009, available at: https://www.g20.org/sites/default/files/g20_resources/library/Pittsburgh_Declaration.pdf

Grantham Institute, Imperial College London (2014) Solar power for CO2 mitigation, Briefing Paper 11, available at: https://workspace.imperial.ac.uk/climatechange/Public/pdfs/Briefing%20Papers/Solar%20power%20for%20CO2%20mitigation%20-%20Grantham%20BP%2011.pdf

Fraunhofer Institute (2013) Levelized cost of Electricity: Renewable Energy Technologies, available at: http://www.ise.fraunhofer.de/en/publications/veroeffentlichungen-pdf-dateien-en/studien-und-konzeptpapiere/study-levelized-cost-of-electricity-renewable-energies.pdf

The Economist (2014a) Sun, Wind and Drain, Jul 26th 2014, available at: http://www.economist.com/news/finance-and-economics/21608646-wind-and-solar-power-are-even-more-expensive-commonly-thought-sun-wind-and

The Economist (2014b) Letters to the editor, Aug 16th 2014, available at: http://www.economist.com/news/letters/21612125-letters-editor

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