What Policies Work Best to Deploy Renewable Energy and Increase Energy Efficiency?

Investment in renewable energy worldwide rose to about $250 billion in 2010, up from $160 billion in 2009, to reach about 20% of new investment in the energy space. This is rapid growth, but most analysts agree that it must reach several trillions of dollars a year to propel the needed transition to a sustainable energy future. Most also cite “appropriate policy incentives” as essential to achieve that.

But what policy incentives for renewable energy and energy efficiency work best? How should they be tailored to fit different conditions? How can policy-makers make energy markets respond to deliver clean energy at affordable prices? These were some of the questions addressed at a recent World Bank workshop that produced guidance to policymakers, now captured online for a wider audience.

At the workshop, government and energy utility policymakers compared notes with private sector energy providers and analysts on experience with feed-in tariffs, renewable portfolio standards and energy auctions, among others.

Cost: the key factor for policymakers

“We are in a phase of developing higher-cost renewable energy, and this is a highly policy-dependent environment,” Tim Richards, Managing Director of Energy Policy for General Electric (GE), told workshop participants. The cost of electricity, he added, is the key factor on which policymakers should focus.

Cost is indeed the focus of feed-in tariffs (FiTs)—the most widespread policy incentive for renewable energy—which offer cost-based compensation to renewable energy producers.

But even if the cost of wind and solar power technologies is dropping, workshop participants agreed that they cannot yet compete with fossil fuels, absent policy incentives.

“FiTs are the policy driver in almost every PV (photo-voltaic solar) success story,” said Mark Fulton, Head of Climate Change Investment at Deutsche Bank.

Sean Whittaker, Senior Renewable Energy Specialist in IFC’s Climate Business Group, agreed that FiTs can be effective in driving a shift to renewable energy. But, he added, “electricity decisions are political…they may be motivated by a push for climate or environmental gains, but they could also be driven by demands for social development, to create jobs, reduce costs, or to develop a manufacturing base. So the procurement program must address these demands while also providing certainty for developers.”

Given these realities, the workshop addressed the challenge of balancing the need to assure a reasonable return to companies for their investments in producing, transmitting and distributing renewable energy, and the need to deliver electricity at rates consumers can afford.

One way to do this, the workshop was told, is to use energy auctions for price discovery, to establish price benchmarks before bringing in FiTs. But some warn that energy auctions can be “gamed” by bigger players if they are not well-designed.

Auctions cannot operate in a vacuum, said Luiz Barroso of PSR Consulting. With adequate regulatory frameworks effectively implemented, he said, auctions can be a powerful mechanism to scale up renewables. In Brazil, for example, prices for 2.9 giga-watts (GW) of wind energy were as low $60 per MWh after reverse auctions in 2011.

Overall, workshop presenters agreed that policy design and precision are essential to get the best deals for renewable energy. Among the key points that emerged from the workshop:

• a package of complementary policy instruments is most likely to deliver a gradual shift to a lower-carbon energy path
• governments need to set a clear policy purpose and vision for renewable energy and energy efficiency that is certain, long-term and transparent
• FiTs and auctions’ success depends on system and market conditions: legal and regulatory conditions, institutional and administrative efficiency, and the existence and use of risk-mitigating financial instruments
• RE policies must be coordinated with local energy market conditions
• Policies that have proven their value over time include: 
  • Reverse auctions
  • Adequate FiTs with long-term power purchase agreements
  • Mandatory access to the grids
  • Incremental cost pass-through

Energy efficiency: efforts needed on both supply and demand

Financial measures can change consumer behavior and mitigate rebound effects (in which gains in efficiency in one area simply prompt greater energy demand in another). || Xiaodong Wang, World Bank Senior Energy Specialist in East Asia

A mix of policy tools is also needed to scale up energy efficiency, the workshop was told. To promote supply-side energy efficiency, the most common incentives are competitive bidding to elicit proposals that offer the greatest kilowatt-hour (kWh) savings, or standard offers in which the government regulator sets the price. Several experts at the workshop lamented the fact that energy efficiency incentives lag behind those for renewable energy

South Africa is an exception. Tom Skinner, Energy Efficiency Manager at ESKOM, reported encouraging results from the introduction of Standard Offers (SO). This SO mechanism, analogous to a FiT, pays a pre-determined amount for energy saved, or for load curtailed. South Africa plans to scale up the SO model, and is considering introducing competitive procurement of energy efficiency in the future.

These must be complemented by efforts to reduce demand for energy, said Xiaodong Wang, World Bank Senior Energy Specialist in East Asia. “Financial measures can change consumer behavior and mitigate rebound effects (in which gains in efficiency in one area simply prompt greater energy demand in another),” she said. “But these require strong political will for energy pricing reform.”

There was consensus among practitioners that rapid progress is needed on both the supply and demand fronts. To do that, developing countries need support for policy design and financing of energy efficiency as well as renewable energy, on a level-playing-field, based on thorough assessments of their relative attractiveness.

The co-sponsors of the workshop, the World Bank’s Sustainable Energy Department, the Climate Business Group at the International Finance Corporation (IFC), and the Energy Sector Management Assistance Program (ESMAP), offer services and products in all of these areas.

Presentations during the workshop are available here. For more information on the workshop, as well as these services, please contact workshop organizers Gabriela Elizondo Azuela, Senior Energy Specialist in the Bank’s Sustainable Energy Department at gelizondo@worldbank.org or Luiz Maurer, Principal Industry Specialist in the IFC’s Climate Business Group at lmaurer@ifc.org.