**Policies that support renewable energy use either price or quantity setting instruments. Of the different**

**options to support renewable energy, feed-in tariffs are increasingly seen as the “policy of choice” to attract private investment in renewable energy** (Menanteau et al.; 2003, Mitchell _et al._ ; 2006; Lipp, 2007; Lesser, 2008, Burer et al., 2009; REN 21, 2010, DB Climate Change Advisors, 2010). Under a feed-in tariff scheme, electric utilities are obliged to purchase renewable energy through long term contracts that guarantee access to the grid, at an enhanced price (the so called feed-in tariff).  Feed-in tariffs, where renewable energy delivered to the grid receives a pre-set tariff, have a clear track record of delivering significant volume increases in its deployment. The stable revenue stream across a pre-established timeframe reduces risk around cash-flow. IEA analysis indicates that cost of capital will be higher in support schemes with traded obligations given the lack of certainty over the revenue stream.<sup>1</sup> Feed-in tariffs can be applied consistently and transparently and can be readily adapted to different specific power market structures. For instance, the incentive can also be offered as a premium in addition to the spot-market electricity price (Cory et al. 2009, Couture et al. 2010).

# **_Box 1 Challenges for setting feed-in tariffs_**

Renewable energy support and incentive mechanisms are the most important factors that drive the growth of a market in renewable-based energy. Feed-in tariff (FIT), a price-based support, is in favor in majority of the European countries such as Germany and Spain. This system sets a guaranteed price for renewable energy generation or an addition to the prevailing market price. The feed-in tariff system is widely used in as well, and only few developing countries have implemented alternative solutions (see Box 2).

It is difficult to strike the right level of feed-in tariff. Low feed-in tariff may not trigger enough investment in renewable-based energy. High feed-in tariffs, though, also have a negative effect on cost reductions as they induce generators to choose high-cost sites and provide fewer incentives for cost cuts. This illustrates the importance of designing an efficient energy support system, which not only promotes diffusion but also provides continuous incentives for costreducing innovations. The rapid expansion of the Spanish solar PV and subsequent intervention to contract the market in 2008 (capping overall market size, alongside a 30% cut in the tariff) has been attributed as much to tariff design as to setting the tariffs at unsustainably high levels. In contrast, Germany prescribed stepped tariff reductions (degressions) and has produced steadier growth.

**The effectiveness of the feed-in tariff policy has been well documented in Europe.** A study comparing the effect of these policies to other policy mechanisms designed to support the spread of wind energy found that they resulted in 7-8 times as much installed wind capacity (European Commission, as reported by Thomas B. Johansson, Chair, Global Energy Assessment). The overall success of the German, Spanish, Danish and other national level feed-in programs has inspired similar initiatives in developing countries including China and, more recently, South Africa and India, as well as by regional and state governments in the UK, US, and Australia.

**The feed-in tariff policy has already been implemented in about 80 states and countries around the world, more than half of which are developing economies (see Fig. 5 below).** The most important element of these schemes is that they fully or partially remove the market risks of a project during a fixed period of time. The longer this period of guaranteed prices, the lower the cost of capital. Because of this, they are generally financed with a relatively large proportion of debt. In feed-in premium schemes, the risk of variations in electricity market prices is reflected by the tariff premium in the purchase power agreement (PPA). But private investors may struggle to acquire a PPA with a 15 to 20 year tenor at reasonable risk premium levels to cover this debt.   A strong government commitment towards the scheme is essential in this respect. Changes in the

> 1 IEA analysis indicates that a 2 to 30% cut in the cost of renewable energy can result from improved design of incentive or support schemes, with the higher end of this range linked to projects with higher project risk, such as offshore wind.

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