The Japanese Feed-in Tariff Scheme on Renewable Energy: Is it worth the money?
Program Director and Faculty Fellow, RIETI
Since the Tokyo Electric Power Company's (TEPCO) Fukushima Daiichi Nuclear Power Plant incident, renewable energy has generated high expectations. The current Basic Energy Plan formulated before the earthquake aims to increase the ratio of renewable energy sources within the total electric power source up to 20% by 2030. In the currently ongoing process of revising this plan, a further acceleration of the use of renewable energy sources is being discussed.
There should be little objection to this move, which is positive not only from the perspective of responding to global warming but also from those of energy security and diversifying electric power sources. However, the promotion and increase of the use of renewable energy require a certain policy support because it costs more than existing power sources. The trump card within such policy is the feed-in tariff (FIT) scheme scheduled to be introduced from July 1 of this year.
The FIT scheme expands the scope of the current one, which only focuses on residential solar power, to include other renewable energy sources such as wind and biomass; and to oblige electric utilities to purchase electricity at a fixed price for a fixed period of years. Purchase costs would be added as a surcharge to electricity bills and, in principle, be borne by electricity users including households and firms.
Terms of purchase, such as the price and period, are to be announced by the minister of Economy, Trade and Industry, honoring the opinions of other relevant ministers as well as that of the Procurement Price Calculation Committee, to which the Diet consented last March. Operators in and outside Japan are anxiously waiting for the purchase terms to be announced.
The FIT scheme has been introduced in Germany and Spain and has proven to be very effective in accelerating the use of renewable energy. On the other hand, serious problems have also been pointed out.
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In this article, I would like to discuss, from the perspective of economics, three important points in considering the design of the FIT scheme.
The first point is the method of calculating purchase prices. Reflecting discussions in the Diet in 2011, this method is to allow for appropriate profits for renewable energy power suppliers. In other words, a typical renewable energy power generation model is assumed, and the purchase price is determined to cover the cost of installing and operating such assumed model and earning appropriate profit.
What is interesting is that the concept behind this calculation method is similar to the idea of "cost-based pricing," which is determined by adding up the costs of electric utilities operators including labor and fuel. This is the very idea for which TEPCO has been criticized since the earthquake. The problem with this pricing approach is that it lacks incentive for the general electric utilities operators to improve their business efficiency because the price is set to ensure that costs are fully recovered. Institutionalization of a scheme to secure the appropriateness of purchase prices would be needed to avoid a similar problem with renewable energy power suppliers.
Specifically, it may be worth considering mandating renewable energy power suppliers to report business results annually and institutionalizing a process to review and revise purchase prices based on their respective performance. Securing the appropriateness of costs and business returns is important in maintaining incentive for renewable energy power suppliers to reduce costs and improve business efficiency. Establishing a review mechanism by the government in the area of renewable energy, an area with remarkable technological innovation, is a matter of high urgency.
The purpose of purchase price setting is to promote the use of renewable energy in the first place. Then, it makes more sense to set the price at a level adequate to achieve a certain target volume of renewable energy, rather than at a level that would generate adequate profits. In order to make the process of determining the purchase price transparent, it may be important to develop multiple purchase price scenarios and clarify the expected volume and cost of renewable energy for each.
Clarifying the relationship between the purchase price, volume, and costs of renewable energy will foster an informed national debate on the appropriateness of purchase prices. This is also desirable as a government policy as it enables the assessment of economic efficiency in terms of the cost-benefit ratio.
There have been also deliberations on suppressing the rise of electricity rates in the form of surcharges by allocating a portion of the petroleum and coal tax revenue to purchase renewable energy. There are limits to the extent to which the increasing purchase cost amounts can be added to electricity rates in the name of enhancing environment value. The ideal state should be to define the FIT scheme as part of national efforts to deal with global warming and turn it into a mechanism supported by the whole nation and not only by major electricity users.
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The second point is the utilization of the mechanism of competition. Obviously, the higher the purchase price and the longer the purchase period, the greater penetration of renewable energy will be achieved. A necessary policy consideration is how to set purchase terms that will minimize the burden of the people and, at the same time, promote the efficient penetration of renewable energy.
In order to enable the efficient penetration of renewable energy, it is desirable to apply uniform purchase terms, in principle, to all suppliers regardless of their size and the type of renewable energy used for power generation. The following two factors are important here: (1) responsiveness of the quantity of renewable energy power to changes in purchase prices (elasticity); and (2) degree to which the cost per unit of power generation in the future will be lowered in response to an increase in the penetration of renewable energy power (scale economies). In practice, the FIT scheme should allow for prompt and flexible adjustments to purchase prices in response to the current volume of renewable energy power used.
Another possible approach might be to break down purchase categories meticulously, for instance, based on the scale of power generation and the type of generation facilities. However, the more complicated the procedure for facility certification and purchase price calculation, the greater will be the likelihood of trouble and confusion in practical operations, which, as a result, could impair people's trust in the FIT scheme. Its design should be simple and easy to operate.
The third point is aiding the fostering of industries. In considering the cost effectiveness of the FIT scheme, an important policy perspective is to expand the markets related to renewable energy and aim to revitalize the nation's industries through it. Should Japan experience a situation similar to that of Germany—where, as a result of introducing the FIT scheme, a huge volume of panels made in China were imported, forcing many domestic solar battery manufacturers to go bankrupt—the significance of the scheme would be reduced from the perspective of fostering domestic industries and maintaining employment. On the other hand, however, any system excluding overseas manufacturers from the scheme would be criticized as an anachronism under the present trend of globalization.
To use the FIT scheme as a trigger for revitalizing Japan's industries, what is needed is not a perspective to "protect" the domestic industries but one to "enhance" their strengths. One possible idea is to consider creating facility certification standards designed to prioritize strategically the mission-critical renewable energy technologies that are likely to have significant ripple effects.
For example, by giving preferential treatment to facilities equipped with power system stabilizing technologies and/or power conditioning batteries, an area in which Japanese companies are strong, we can expect significant technological ripple effects on other industries such as electric automobiles and home appliances. Such facilities can be also utilized as emergency power supply sources in the event of disasters. Actually, having power facilities equipped with these mission-critical technologies facilitates the large-scale feeding of renewable electricity—such as solar and wind power—into utility networks. In consideration of this fact, taking a somewhat discriminatory approach in facility certification, such as the one discussed above, is fully justifiable in light of the objectives of the FIT scheme.
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The FIT scheme has the potential to change drastically Japan's renewable energy-related market environment. Starting this July, we must work with this system for at least 10 years. Learning well the lessons from overseas failures, we should calmly and carefully design the system so as to turn it into a foundation of Japan's new energy and energy-saving promotion efforts and thereby aid in the revitalization of the country's stagnant economy.
* Translated by RIETI.
April 17, 2012 Nihon Keizai Shimbun
May 21, 2012
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