Price-based versus quantity-based approaches for stimulating the development of renewable electricity: new insights in an old debate

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1 Prie-based versus -based approahes for stimulating the development of renewable eletriity: new insights in an old debate uthors: Dominique FINON, Philippe MENNTEU, Marie-Laure LMY, Institut d Eonomie et de politique de l Energie (IEPE), Grenoble, Frane. Lead uthor: Marie-Laure LMY (PhD student) Institut d Eonomie et de Politique de l Energie BP 47 F GRENOBLE Cedex 9 Phone: ; Fax: ; marie-laure.lamy@upmf-grenoble.fr 1. Introdution The general awareness that has been growing over the past 20 years of the threats to the environment, reently strengthened by the onfirmation of the risk of limate hange [1] has led to a signifiant reawakening of interest in renewable energy, owing to the environmental advantages that they represent in omparison to onventional energy soures. This interest motivated the appliation on 27 Otober 2001 of the European diretive on the promotion of eletriity from renewable soures (RES-E) [2]. In addition to introduing ertifiation for green energy and measures aimed at reating equitable onditions and failitating the penetration of renewable energy into the domesti energy market, the diretive speified that an aim of the European Union would be to double the share of renewable energy in gross energy onsumption, with the target being to reah 12% by t national level, this ambition means that eah of the member states will have signifiant prodution targets to reah by In this new ontext, the support that the publi authorities have been giving to renewable energy soures over the past 10 years or so assumes a new dimension. The various inentives offered in the past, whih flutuated with oil pries, now need to be reinfored in order for the above targets to be reahed within the timesale set. The ost of the publi poliies that this implies will no doubt inrease, and the effetiveness of the various types of inentive used will thus beome a question of ruial importane. Indeed, faed with the deployment of green energy prodution required by the European Commission (22% of gross eletriity onsumption by 2010 as against 13.9% in 1997), it will be a vital onern to ahieve these goals at the lowest possible ost. To help larify matters, this artile ontains a omparative analysis of the relative effiieny of the instruments used to promote renewable eletriity [3], first from a stati point of view and then using more dynami riteria. First, we examine the justifiation of poliies supporting renewable energies on the basis of both the internalisation of externalities in eletriity prodution and their role in stimulating the learning proess in relation to still immature renewable tehnologies. Next, the instruments are haraterised in relation to the lassi disussion of environmental poliy that onsiders prie-based approahes versus -based approahes. Third, we look at the ost of these poliies for the ommunity and more speifially at the sharing of surplus and the reperussions this has on the tendeny of produers to innovate. 2. Environmental justifiation and features of publi poliies supporting renewable energy The obstale faing renewable energies in the domesti eletriity market is twofold. First of all, the wholesale prie gives a very imperfet idea of the real ost of eletriity prodution. s it does not take into aount the ost of pollution ontrol inherent in the use of fossil fuels, it prevents the environmental benefits of renewable energies from being onsidered at their true value, and thus removes any omparative advantage they may have. Seond, as these tehnologies are still immature, they annot enter into diret ompetition on the market with onventional tehnologies. Now, without the stage of widespread dissemination needed for the tehnologial learning proess to our properly, these tehnologies annot aim to be ompetitive. Publi intervention may therefore be justified in theory in two ways: internalisation of the environmental externalities and stimulation of tehnologial hange. 2.1 bsene of internalisation of environmental externalities The main advantage of renewable over onventional energy is that they ontribute to the preservation of publi goods, namely lean air and limate stability. Beause of the non-exludable and non-rival harateristis of these publi goods, private ators are not prepared to invest in something whih everyone an aquire free of harge. In suh onditions, the diffusion of RES-E annot be assured spontaneously by the market. The liberalisation of the eletriity market, seen as the possibility offered to ustomers of expressing their preferenes and thus their willingness to pay for 1 Intergovernmental group of experts on limate hange, 2000: Speial report on emission senarios, summarised for deision-makers. 2 Diretive 2001/77/CE of the European Parliament and Counil dated 27 September The thermal use of renewable energies will not be dealt with here even though they offer potential for development that is at least as high as that for eletriity. Pending a European diretive similar to that for eletriity prodution, the issue of heat prodution from renewable energy soures is distintly different and would need to be disussed in a separate artile.

2 this environmental good, may appear to be a partial response to this problem of appropriation. But, as an be seen from experiene in Europe, the problem of free-riding remains [4][5]. Individual hoies do not fully reflet the real value that the publi may plae on preserving the environment by generating green energy and therefore annot replae publi assistane. Moreover, the advantages offered by RES-E annot be viewed simply in terms of reduing greenhouse-gas emissions. Indeed, as they are purely domesti, they may make a signifiant ontribution to improving the reliability and diversity of energy supplies. Today, the European Union relies on energy imports to over 50% of its onsumption; this figure ould reah 70% by 2020 [6]. With the international energy sene dominated by unertainty regarding the physial availability of raw materials and the geopolitial stability of the major produing regions, the development of green eletriity prodution would help to slow down the rate of growth of this dependene to a great extent. Lastly, the undeniably loal harater of green eletriity prodution would make it by definition a signifiant soure of job reation at loal level. Hene this is an important aspet of regional development when onsidering greater eonomi and soial ohesion among the regions. 2.2 Stimulating tehnologial hange real appreiation of these advantages by the market and the re-establishment of equitable onditions for ompetition between fossil fuels and renewable energy soures will still not guarantee the reation of a dynami proess of renewable energy diffusion that is onsistent with the olletive objetive of preserving the environment. Renewable energies, whih like any new tehnology have to ompete with established tehnologies, remain in an unfavourable position. They have not reahed their optimum performane in terms of ost and reliability. Optimum performane will be ahieved gradually as a result of the proess of learning by using or learning by doing [7][8]. In other words, it is not beause a partiular tehnology is effiient that it is adopted, but rather beause it is adopted that it will beome effiient [9]. Inentive systems are therefore required so that renewable energy tehnologies an be adopted beyond narrow market nihes and progress on their learning urves. Other barriers related to the tehnial and eonomi harateristis of renewable energies stand in the way of their diffusion: the new ators in the liberalised eletriity markets tend to favour the least apital-intensive generation tehnologies with non-random energy supply, while the tehnologial ulture of established eletri utilities tends to favour large systems. RES-E do not therefore present the same value for a market ator as does, for example, a gas turbine whih an generate power ontinuously. This type of ompetition between eletriity generating tehniques onstitutes suffiient justifiation for providing publi support for new energy tehnologies: it stimulates a dynami proess whih will reveal their ultimate performane [10] and at the same time helps expand the range of tehniques that an ontribute to environment preservation. 2.3 Fixing aims: a ost/effiieny approah The publi support for RES-E is therefore justified initially as a temporary ompensation for the negative externalities that they avoid. s long as energy taxes do not represent the marginal ost of the damage aused by using fossil fuels, this support aims to re-establish a balane in the onditions of ompetition between tehnologies to the benefit of the least polluting. State intervention is justified by the existene of shortomings in the market with the aim of "initing eonomi agents to adopt patterns of behaviour that are more in line with the publi interest than those whih they would adopt without suh ation" [11]. From the point of view of strit eonomi logi, ompensating for negative externalities appears to be justified as long as the sum of the benefits that it offers is higher than the sum of the osts that it imposes (this is the ost/benefit priniple). However, it is debatable whether a reliable, unquestionable value an be determined for externalities. The diffiulty lies in estimating the value of the publi good that is preserved by the development of RES. Given the problems that our in observing ertain parameters, it is impossible to refer to an optimum level of renewable energy prodution. Consequently, one is fored to adopt a strit ost/effiieny approah in whih the target is defined exogenously by politial deision-makers on the basis of available sientifi information, but without any eonomi rationalisation. 4 BTLEY, S.L, COLBOURNE, D., FLEMING, P.D, URWIN, P., 2001, Citizen versus onsumer : hallenges in the UK green power market, Energy Poliy, 29 (6), pp WISER, R., PICKLE, S., 1997, Green marketing, renewables, and free riders : inreasing ustomer demand for a publi good, Ernest Orlando Lawrene Berkeley National Laboratory. 6 European Commission, 2000, Vers une stratégie européenne de séurité d approvisionnement énergétique, Livre Vert, COM (2000) 769 final. 7 RROW, K., 1962, The eonomi impliations of learning by doing, Review of Eonomi Studies, DOSI, G., 1988, The nature of the innovative proess. In DOSI, G ; FREEMN, C. et al. (ed.), Tehnial hange and eonomi theory, London. 9 RTHUR, W.B., 1989, Competing tehnologies : inreasing returns and lok-in by historial events, Eonomi Journal, 99 (1). 10 FORY, D., Diversité, séletion et standardisation: les nouveaux modes de gestion du hangement tehnique, Revue d Eonomie Industrielle, (75), 1996, pp BONTEMPS, P ; ROTILLON, G., 1998, Eonomie de l environnement, La déouverte, Paris.

3 It is in this ost/effiieny approah that the aims fixed by the European Commission however indiative represent a onsiderable advane in the development of RES-E, as they define the level of effort to be provided by the member States. It is also in this perspetive that we shall ompare the effiieny of the instruments available to the publi authorities to throw some light on disussions onerning the amounts of money alloated to deploying renewable energies. 3. The prie- issue applied to inentive instruments for renewable energy n examination of the poliies implemented in Europe over the past 20 years to stimulate the development of RES shows that the instruments used all bear a strong resemblane to the instruments of environmental poliy to whih they an be assimilated. In partiular, they raise the same questions from the point of view of the lassial debate between prie-based and -based approahes [12]. 3.1 How instruments to promote green eletriity work Publi funding for researh and development and subsidies to enourage investment were initiated 25 year ago and have long been the main measures used within the European Union for promoting RES. They are still direted at the least mature areas of tehnology, but in the ase of those that are nearly ompetitive from the eonomi standpoint, more speifi instruments are now used with the aim of introduing RES into the eletriity market. Support shemes fall into three main ategories that are either prie-based or -based in their approah: fixed feed-in tariffs, used in partiular in Denmark, Germany, Spain, and Frane sine 2001, whih onstitute the oldest and most widely used inentive system; bidding proesses suh as those used in the United Kingdom and in Frane until This type of sheme is based on a fixed amount of renewable energy to be generated nationally; tradable green ertifiates shemes, where eletriity suppliers or final onsumers are obliged to produe or buy a ertain quota of renewable energy. This type of sheme is used in a few ountries (Netherlands, Denmark, Belgium) on an experimental basis, but ould eventually be extended to most member States (Italy, United Kingdom, ustria, Sweden). Fixed feed-in tariffs The guaranteed feed-in tariff sheme involves an obligation on the part of eletri utilities to purhase the eletriity produed by renewable energy produers in their servie area at a tariff determined by the publi authorities and guaranteed for a speified period of time (generally about 15 years). The feed-in tariff system operates as a subsidy alloated to produers of renewable eletriity. It thus works in the same way as a pollution tax does for firms that pollute. In pratie, produers are enouraged to exploit all available generating sites until the marginal ost of produing RES-E equals the proposed feed-in tariff p (f. graph below). The amount generated then orresponds to q. q may be estimated a priori if the marginal ost urve for RES-E is known, whih is not generally the ase (f below). prie ( /kwh) p p Graph 1: operating mode with fixed feed-in tariffs p produers' rent with inremental feed-in tariffs + produers' rent with uniform feed-in tariffs q (kwh) In the simplest ase of a uniform feed-in tariff, all produers whose marginal ost is lower than the fixed feed-in tariff benefit from the tariff p. The differential rent [13] thus granted to produers is therefore represented by the area (p) between the marginal ost urve () and the feed-in tariff p. 12 COURNEDE, B., GSTLDO, S., 2000, Combinaison des instruments prix et quantités dans le as de l effet de serre, Journées FSE, Marseille, Frane. 13 In energy eonomis, differential rent is used onventionally to designate inome derived from least-ost oil resoures in omparison with marginal resoures. Marginal resoures are defined as the most expensive ones exploited to satisfy demand at a given moment (CHEVLIER, J.M., BRBET, P., BENZONI, L., Eonomie de l Energie, Presses de la Fondation Nationale des Sienes Politiques &Dalloz).

4 To ensure a minimum rate of return to produers at generating sites of lower quality (hydrauli, solar and wind energy may be onerned) while at the same time ontrolling the rent allowed to produers who benefit from more favourable onditions, it is possible to define a feed-in tariff dereasing in stages with the level of prodution. Carefully defined instruments an thus ombine the aims of regional development (avoiding a onentration of installations at the most profitable sites) with eonomi effiieny (enouraging the most produtive investment). Introduing an inremental feed-in tariff p' an thus help to limit the differential rent to the area (p'p'') situated between marginal ost urve and the inrements resulting from the tariff [14]. Competitive bidding proesses In the ase of ompetitive bidding proesses, the regulating authority defines a reserved market for a given amount of RES-E. Eletri utilities are then obliged to purhase the eletriity from the seleted power produers. Competition-based bidding systems were used in the United Kingdom under the Non-Fossil Fuel Obligation (NFFO) in fore from 1991 to 2000, whih onerned different renewable energy tehnologies, and in Frane with the Eole 2005 programme set up in 1996 and abandoned in 2000, whih onerned only wind energy. Competition fouses on the prie per kwh proposed during the bidding proess. Proposals are lassified in inreasing order of ost until the amount to be ontrated is reahed. Eah of the renewable energy generators seleted is awarded a long term ontrat to supply eletriity at the pay-as-bid prie. prie ( /kwh) p 4 Graph 2: operating mode with ompetitive bidding p 3 p 2 p 1 q 1 q 2 q 3 q obj (kwh) Via suessive bidding proedures, the ompetitive bidding proess shows the shape of the marginal ost urve (f. graph 2). To reah the objetive set (q obj ), the quantities q 1, q 2, q 3, and then q obj are suessively put up for aution and offered at the maximum pries p 1, p 2, p 3 and p 4. In this situation, therefore, produers do not reeive any differential rent. Green ertifiates In this type of sheme, a fixed quota of eletriity sold by suppliers on the market (supplier-distributors, eletriity generators or onsumers) must be generated from RES [15]. Operators then have the possibility of generating the required amount of eletriity themselves, purhasing it in the long term from a speialised renewable energy generator, or purhasing ertifiates for speifi amounts of green eletriity from other operators [16]. Certifiates are issued by renewable eletriity generators who benefit from generating renewable eletriity in two different ways: by selling it on the network at the market prie, and by selling ertifiates on the green ertifiates market. The amount of green eletriity to be generated is deided for the whole ountry, as in the ase of bidding shemes, and is then divided among eah of the operators. Sine operators do not all benefit from the same opportunities to use renewable energy soures and thus have different marginal prodution ost urves [17], green ertifiates enable quotas to be alloated in an effiient way. Without suh a flexibility mehanism, operators with idential obligations would inur different marginal osts, whih would be a soure of ineffiieny. With a ertifiates system, the burden is shared effiiently: marginal prodution osts are equalised among operators and speialised produers are enouraged to enter the market. 14 For a detailed disussion of the mehanism of inremental guaranteed feed-in tariffs, f. ElGreen Projet, 2001, tion Plan for a Green European Eletriity Market, European Communities, pp This obligation onerns suppliers in the United Kingdom and produers in Italy. 16 VOOGT, M., BOOTS, M.G., SCHEFFER, G.J. and MRTENS, J.W., 2000, Renewable eletriity in a liberalised market: the onept of green ertifiates, Energy and Environment, 11 (1). 17 In the ase of wind energy, for example, it is obvious that a distributor situated near to a oastal area will have greater resoures, enabling him to ahieve lower prodution osts than a produer situated inland.

5 Graph 3: operating method with green ertifiates prie ( /kwh) p The equilibrium point in the green ertifiates market is situated at the intersetion between the demand urve, defined by the quota q obj, and supply, represented by the marginal ost urve (). The quota q obj is thus represented on the green ertifiates market by the equilibrium prie p [18]. The differential rent alloated to produers is thus equal to the area (p), as in the ase of uniform feed-in tariffs. 3.2 The onsequenes of unertainty on marginal ost urves In the ase of energy prodution, when all the neessary information is available, prie-based and -based shemes produe very similar results. It is therefore equivalent to introdue a feed-in tariff p resulting in an overall of prodution q, or to fix a quota q obj orresponding to the same q, the equilibrium prie (in the green ertifiates market) or marginal prie (in the ase of bidding proesses) then beoming established at the level of the fixed feed-in tariff p. The administrative authority an fix the "prie" in the ase of the fixed feed-in tariffs, or the "" in the ase of green ertifiates or ompetitive bidding, so as to reah the same green eletriity prodution target. However, prie-based and -based approahes are not equivalent in situations where information is inomplete and where there is unertainty [19]. When the ost urves are not known, neither of these approahes an give an idea a priori of the overall ost of green eletriity prodution sought. However, guaranteed feed-in tariffs offer a ertain way of ontrolling the ost of the measures to be implemented, as, by setting a eiling for the marginal ost, guaranteed pries eliminate options that are too ostly. Conversely, the -based approah by definition offers diret ontrol over the target level of prodution, whereas suessive adjustments to the feed-in tariffs (partiularly downwards, whih is rarely aeptable politially) would have to be made to ahieve the desired level of prodution. The symmetry between the prie-based and -based approahes is thus not total, and one or the other may be preferred depending on the respetive shape of the prodution ost urves [20]. If it is assumed that the RES urves are relatively flat in the present situation [21], it an be seen that a slight variation in the proposed feed-in prie will have major reperussions in terms of the quantities produed. s the overall ost of ahieving an objetive q is given by the produt p x q, an overestimated fixed feed-in prie will result in a signifiant inrease in RES-E prodution and a large of publi subsidies. In ontrast, the -based approah will help to limit this risk as fixing a quota or organising suessive ompetitive bids is a way of ensuring total ontrol over quantities and hene indiretly over the volume of publi subsidies. This apparently obvious result an, however, explain the paradox that fixed feed-in tariffs in the field of RES are ritiised as being too ostly. 3.3 Empirial analysis: the supremay of fixed feed-in tariffs (kwh) number of renewable energy tehnologies have benefited to varying degrees from the support of inentive programs introdued in the industrialised ountries over the last 20 years. The impat of these instruments has been partiularly felt in the ase of wind energy, whih is now nearly ompetitive with onventional tehnologies. The example of wind energy is therefore used here for referene purposes. Wind energy, and to a lesser extent biomass tehnologies at the present state of development, should be able to provide most of the extra renewable energy required to reah the objetives set by the European Commission. n examination of the results obtained by the various member states as a onsequene of the inentives they have offered appears to underline the fat that fixed feed-in tariffs are q obj 18 green eletriity produer an sell his prodution on the wholesale market and green ertifiates market. The prie of the green ertifiate itself is thus obtained by deduting the wholesale prie from the marginal ost of prodution. 19 CROPPER, M.L., OTES, W.E., 1992, Environmental Eonomis: a survey, Journal of Eonomi Literature, vol XXX, pp WEITZMN, M.L., 1974, Pries versus Quantities, The Review of Eonomi Studies, 41 (4), pp The shape of the ost urves is not preisely known. However, the latest studies onsider that they are flat and preditable with a high level of probability (ElGreen projet, 2001, tion Plan for a Green European Eletriity Market, European Communities).

6 better than ompetitive bidding proedures [22]. The effiieny of these instruments will now be examined in terms of stimulating RES-E, industrial impats and projet aeptability. Stimulation of RES-E The two systems exhibit radially different harateristis in terms of future profitability, risks and transation osts. The fixed feed-in tariffs in operation in Germany, Denmark and Spain have led to sustained development of wind power, both in terms of installed apaity and at the industrial level: these three ountries alone aounted for over 90% of additional installed apaity in Europe in Total installed wind apaity in Germany, Denmark and Spain reahed 7717 MW at the end of 1999, while it did not exeed 500 MW in UK and Frane. This result an be partly explained by the high prie level proposed in the fixed feed-in tariff systems (7-9 /kwh) while the ompetitive bidding systems led to signifiantly lower pries (4-5 /kwh): all else being equal, it is perfetly logial that higher feed-in tariffs should orrespond to greater quantities of RES-E. The differene between the proposed pries do not explain, however, the huge observed differenes between the installed apaity. The very nature of the bidding system means that profit margins are onsiderably redued and expeted profitability rates signifiantly lower than those assoiated with fixed tariffs. The balane between the risks involved and expeted profits is thus learly to the disadvantage of ompetitive bidding, making it a less attrative option for investors. The seond fator affeting the attration of bidding systems is the unertainty regarding the profitability of submitted projets. The fat that bidding proedures take plae at irregular and partiularly unsheduled intervals has also reated a limate of instability that works to the disadvantage of operators, in ontrast to fixed tariff systems. Lastly, the high transation osts inurred by the bidding proedures (for projet formulation and monitoring, obtaining building permits, et.) have undeniably been an obstale to the development of RES-E, as the size of the installations is neessarily limited, making it diffiult for them to be profitable during the ontrat period. Industrial impats t the industrial level, the impat also differs between ountries that have set up guaranteed tariffs and those that use ompetitive bidding shemes. In 2000, Germany, Denmark and Spain were home to eight of the ten biggest wind turbine manufaturers in the world. On the other hand, in the United Kingdom, the government has not reahed its goal of developing a ompetitive renewable energy industry. The premature opening up of the market to ompetition has had an evition effet on inexperiened British manufaturers to the advantage of Danish manufaturers who, better prepared by a muh larger national market, have supplied Britain with most of its wind energy generating equipment. Projet aeptability last fator affets projet feasibility in the ontext of ompetitive bidding systems. Certain aspets that are apparently less essential, suh as impat studies, informing and onsulting loal people, integrating the works into the site, et. are paid less attention during the projet formulation phase. s a result, strong opposition movements have grown up in ertain regions, partiularly in the north of England. In ontrast, projets are muh more aeptable in ountries that pratie guaranteed tariffs sine the better profitability rates that they offer mean that projets are not onentrated in the best sites, where the onstrution of extremely large numbers of wind turbines is diffiult to aept. Comparatively speaking, feed-in tariffs have an undeniable advantage in relation to these three riteria. However, it should be stressed that the objetives initially set by the governments that opted for ompetitive bidding systems were muh less ambitious at the outset than those of the German, Danish and Spanish governments. The differene between the results obtained with ompetitive bidding and fixed feed-in pries is thus due in part to the fat that the impliit aims in the two ases were extremely different. But it an also be explained by the more inentive nature of feed-in tariffs, whih are more preditable and provide produers with a higher rent. In this respet, in the absene of any tehnologial progress (f. table 1), green ertifiates are no different from uniform fixed feed-in tariffs, whih enable produers to benefit from the entire differential rent. Conversely, ompetitive bidding systems ompletely eliminate differential rents to the benefit of onsumers, but do not offer the same results in terms of installed apaity. Inremental feed-in tariffs may be onsidered as an intermediate option that keeps the inentive harater of the priebased approah while at the same time limiting the differential rent reeived by produers, thereby lightening the finanial burden borne by the ommunity. 4. Cost to the ommunity and stimulation of tehnologial progress: the question of surplus sharing The seond justifiation for publi RES-E inentive poliies is that they stimulate tehnologial hange, none of RES-E tehnologies being yet suffiiently mature to ompete on the eletriity market. By analysing the distribution of surplus (defined as the sum of all rents), the approah an be extended beyond simply its ability to stimulate lower osts over a short period, to inlude the possibility of reating lasting tehnologial progress. The introdution of suh a proess depends partly on the investment made by onstrutors in researh and development, whih leads to ertain 22 Experiene with green ertifiates is still limited, and therefore annot be inluded in this empirial analysis.

7 improvements, but also on the tehnologial learning proesses onneted with wider dissemination. Here again, different types of support will have different effets depending on whether inentives are offered for innovation (researh and development) or dissemination (widespread adoption of the innovation) [23]. 4.1 Graphi analysis Whatever system of inentives is adopted, tehnologial progress will produe a downward shift in the marginal ost of prodution urve. The marginal ost of ahieving a given goal is lower following innovation. ll else being equal, the effet will be to inrease the surplus obtained by produers but, depending on the type of inentive used, the surplus reated in this way will not be shared in the same manner. Uniform guaranteed feed-in tariffs The onsequene of prie-based inentives is that the of green eletriity produed inreases from q 0 * to q t *: for the same tariff level, produers an now exploit sites that were not eonomially profitable before the innovation (f. graph 4). This instrument gives produers the entire benefit of the rent derived from tehnologial progress (i.e. the area DBC) [24]. In this ase, therefore, tehnologial progress results in an unsheduled inrease in the quantities produed and in the produers' surplus. It is represented by the area (Dp 0 ). Graph 4: guaranteed feed-in tariffs and rent derived from tehnologial progress prie ( /kwh) p 0 B D differential rent rent derived from tehnologial progress p C Green ertifiates In the ase of green ertifiates, tehnologial progress is taken into aount automatially as the prie of the ertifiate is set at level p t without the regulator having to intervene (f. graph 5). The rent derived from tehnologial progress and granted to produers is thus equal to the area (CBF) and the mehanial lowering of pries under the effet of innovation allows the ommunity to save an amount equal to the area (p t Fap 0 ). The total produers' surplus is thus equal to the area between the new marginal ost urve t and the new prie p t, (Bp t ). With a -based instrument governed by market mehanisms, tehnologial progress will thus redue the rent alloated to produers and onsequently ost less for the ommunity. p 0 * prie ( /kwh) Graph 5: green ertifiate markets and rent derived from tehnologial progress 5.a in situation 0 5.b in situation t B 0 t q 0 * p 0 p t q t * prie ( /kwh) (kwh) F B 0 t C C q obj (kwh) q obj (kwh) differential rent; rent from tehnologial progress; redution in produer's surplus 23 MILLIMN, S.R., PRINCE, R., 1989, Firm inentives to promote tehnologial hange in pollution ontrol, Journal of Environmental Eonomis and Management, 17, pp The rent derived from tehnologial progress is defined as the inrease in the produer's surplus onneted with maintenane of the previous inentive framework whereas new and more effetive tehnologies are available.

8 Competitive bidding s in the stati situation (f. above), the proedure involving suessive alls for bids means that ompetitive bidding an also follow the marginal ost urve without any intervention by the regulator (f. graph 6). The maximum pries p 3 and p 4 automatially replae the maximum pries p 3 and p 4 in the bids reeived from produers replying to invitations q 3 and q obj, thus anelling the entire rent derived from tehnologial progress alloated to them [25]. Graph 6: ompetitive bidding and rent derived from tehnologial progress p 3 q 1 q 2 Introdution of Dereasing feed-in tariffs The fixed tariff versus ompetitive bidding debate has emphasised a number of imperfetions and in partiular obliged prie-based systems to evolve so that tehnologial progress is taken into aount more fully. The priniple of a dereasing feed-in tariff involves antiipating tehnologial progress (f. graph 7) and hene the shift in the marginal ost urve. On the new ost urve ( e t), the tariff needed to obtain the q 0 * is no longer p 0, but p t. However, the regulator does not know for ertain how tehnology will develop, and he must therefore fix a feed-in tariff on the basis of an antiipated tehnologial progress ( a t). If the observed ost urve ( e t) differs from the antiipated ost urve ( a t), the produed will be q t *. omparison between graphs 7a and 7b shows that the dereasing prie mehanism enables the area (p 0 DEp e t) to be saved by onsumers in ontrast to a uniform feed-in tariff that grants the surplus Dp 0 to produers. In this way it is possible to limit but not entirely eliminate the rent derived from tehnologial progress alloated to produers. Ultimately, the total surplus from whih produers benefit orresponds to the area (Ep e t). It is higher than the produers' surplus alloated in the ontext of a green ertifiate market (Bp t ) if the regulator responsible for sliding guaranteed feed-in tariffs has antiipated less tehnologial progress than is atually observed (the same is true for the of green eletriity prodution, whih reahes the level q t *.). Nevertheless, this system ensures a more equitable distribution of the rent derived from tehnologial progress, as it redues the overall ost for the ommunity while at the same time giving a surplus to innovative produers. Graph 7: the ontribution of sliding feed-in tariffs 7.a situation in t with uniform tariffs 7.b situation in t with sliding feed-in tariff prie ( /kwh) p 0 prie ( /kwh) p 4 p 4 p 3 p 2 p 1 C q 0 * 0 B e t q t * D q 3 q obj (kwh) prie ( /kwh) 0 Legend : 0 = marginal ost urve at 0; e t= effetive marginal ost urve at t; a t= antiipated marginal ost urve q 0 * (reps. t) = optimum prodution at 0 (resp. t); q t = prodution at t without sliding mehanism. p 0(resp. t) = optimal fixed feed-in tariff at 0 (resp. t); p e t= effetive feed-in tariff at t. differential rent; rent from tehnologial progress; gain (f. text), surplus alloated to produers owing to wrong estimate of real tehnologial progress. p 0 p e t p t C B q 0 * q t * E a t q t D e t 25 Depending on the shape of the marginal ost urves and the rate of tehnologial progress, the average bidding pries for suessive tenders may even fall (f. NFFO 3 to 5, OFGEM, 1998, Fifth renewables order for England and Wales).

9 Table 1: Summary of differential rents and total surpluses aording to support instrument Differential rent (stati) Total surplus (dynami) Competitive bidding None None Green ertifiates market Maximum (p) Low (Bp t ) Uniform guaranteed feed-in tariff Maximum (p) Maximum (Dp 0 ) Inremental guaranteed feed-in tariff Low (p p ) - Sliding guaranteed feed-in tariff - verage (Ep e t) Where promoting tehnologial progress is onerned, this analysis shows that a distintion an be made between stimulating innovation and enouraging its dissemination. Making produers ompete with one another through ompetitive bids fores them to adopt the most effiient tehnologies in order to be awarded ontrats. However, as this involves restriting their profit margins (by eliminating the differential rent derived from tehnologial progress), they have diffiulty in initiating the innovation proess by investing in R&D. With guaranteed feed-in rates, the maximum surplus is alloated to produers, so that they are better plaed to develop new tehnologies even though this will ost the ommunity more. None of these extreme solutions is really satisfatory. This is espeially true of onstant uniform or inremental feed-in tariffs, whih award the benefits of tehnologial progress only to produers. From this point of view, sliding rates and green ertifiates are the most attrative options as they do not entirely eliminate the surplus derived from tehnologial progress as bidding proesses do, while at the same time they enable onsumers to benefit from the improved performane levels due to tehnologial progress (table 1). 4.2 The question of surplus sharing: onsiderations for empirial analysis vailable empirial data are insuffiient for performing a detailed analysis of surplus-sharing between produers and onsumers and its onsequenes in terms of tehnologial progress [22]. However, an examination of the inentive systems implemented in various European ountries seems to onfirm the initial results obtained by a theoretial analysis. Competitive bidding proesses have enouraged produers to adopt available new tehnologies in order to remain ompetitive, but they have not enabled them to present well-strutured industrial supplies and invest major resoures in R&D. Conversely, industrial supplies have developed onsiderably through the enouragement of guaranteed feed-in tariffs, though this has ost the ommunity very muh more. Overall ost of supporting renewable energy soures The poliy of guaranteed feed-in tariffs has proved to be very ostly in terms of publi subsidies. This is the diret result of its positive effet on RES-E. Subsidies paid in 1998 by the Danish government represented more than 100 million euros and it seemed likely that this amount would ontinue to grow owing to the regular inrease in apaity, reating an inreasingly great burden on the State budget [26]. This poliy also requires ostly ross-subsidies that ould be estimated at around 200 million euros in Germany in In the ase of bidding systems, the possibility of ontrolling the publi subsidies alloated to RES-E is a major advantage. In this respet, a -based approah enables publi expenditure to be ontrolled more effiiently by organising inremental inreases, progressively revealing the shape of the ost urve. omparable result ould have been obtained with guaranteed feed-in tariffs but the system was rigid from the institutional standpoint, making it diffiult to ontrol its progress by adjusting guaranteed pries in aordane with tehnologial progress. Introduing sliding rates now means that prie hanges an be announed from the outset (f. below). Distribution of surplus and innovation stakes Fixed feed-in tariffs and pay-as-bid tendering shemes differ in terms of how the surplus resulting from tehnologial hange is shared out. In the first ase, it is produers-investors and manufaturers who benefit from lower osts, if pries are not adjusted in step with tehnologial hange, while in the seond ase, produers pass on ost savings to taxpayers or onsumers. But the very slight impat made by -based inentive mehanisms on renewable energy generation limits the learning effets of loal manufaturers in the ountries onerned. Remember that the three leading ountries in Europe, stimulated by fixed feed-in tariffs, installed 20 times more generating apaity in 2000 than the ountries operating ompetitive bidding shemes. In terms of R&D programs, the redued margins inherent in the bidding system limit the budgets of manufaturers and their suppliers. Consequently, in interdependent eonomies operating different support mehanisms, the redution in osts observed for wind generating systems with bidding systems is helped by the tehnial progress made by manufaturers in ountries where support poliies are more favourable. In these ountries, sine firms are 26 MORTHORST, P.E., 1999, Danish renewable energy and a green ertifiate market, Conferene paper Design of energy markets and environment, Copenhagen.

10 allowed to benefit from the differential rent, feed-in tariffs make it possible for manufaturers to invest more heavily in R&D and to onsolidate their industrial base. Lastly, while the poliy of fixed feed-in tariffs seems to offer better onditions for produers wishing to progress on the learning urve with regard to renewable tehnologies, it needs to be supported by the publi authorities and this is quite ostly for the ommunity. Conversely, bidding proesses have not triggered long-term improvements in tehnology in spite of their effiient ontrol of overall osts. 5 Conlusion In terms of installed apaity, muh better results have been obtained with prie-based approahes than with -based approahes. In theory, this differene should not exist, as bidding pries set at the same level as fixed pries should logially lead to omparable installed apaities. The differene an be explained by the strong inentive effet of fixed pries, whih make existing inentive systems more stable and more preditable in the eyes of investors. On the other hand, the system of fixed feed-in tariffs makes it diffiult to antiipate the level of RES-E prodution owing to unertainties relating to the ost urves, and thus limits the extent to whih the ost of inentive poliies an be ontrolled. From this point of view, -based approahes are more effiient as bidding for suessive quotas provides an indiret way of ontrolling overall osts. Fixed-prie and pay-as-bid systems lead to two situations that differ in the way the differential rent is distributed. In the ase of fixed feed-in tariffs or green ertifiates it is the produers who benefit entirely, whereas in pay-as-bid systems no rent is given to them. Similarly, the surplus resulting from tehnologial progress is distributed solely to the benefit of produers in the ase of fixed prie systems and solely to the benefit of onsumers in pay-as-bid systems. European experiene in supporting wind energy shows that, in the first ase, onditions are more favourable for the development of new tehnologies but at a high ost to the ommunity, whereas in the seond the lower margins for produers raise questions onerning ongoing tehnologial hanges. Between these two extremes, sliding fixed feed-in tariffs that make allowane for improved performane levels and green ertifiates are inentive systems that distribute surpluses more equitably between produers and onsumers and are thus of obvious interest in supporting the development of new energy tehnologies without the entire ost burden falling on the onsumer. The potential advantages offered by green ertifiate trading systems based on fixed quotas are enouraging a number of ountries to introdue them in order to ahieve high installation targets in an eonomially effiient way. Greater ontrol over quantities, ompetition among produers and the inentive to lower osts are among the main reasons for adopting green ertifiates. This system also has an advantage over the others in terms of effiieny of alloation. This advantage, whih is based on the exploitation of differenes in marginal osts, an be usefully applied at European level to reah the targets fixed by the European Diretive at the least ost for the ommunity [27]. However, as long as unertainties remain, espeially onerning the operation of the markets and the reation of a framework that investors onsider stable, its atual effiieny remains to be proven. Lastly, any omparison between the various instruments must take into aount the atual onditions of appliation of inentive poliies that apply not just to one tehnology but to multiple RES tehnologies. The ability of a single instrument to support tehnologies that have reahed different levels of maturity may be an attrative way of avoiding the need to define speifi inentive frameworks. In the ase of bidding proesses, speifi invitations to tender are essential to avoid ompetition that would marginalise emerging tehnologies. In ontrast, it would appear to be diffiult to reate several green ertifiate markets depending on the tehnology used. There ould be ompetition between tehnologies on the green ertifiates market provided that rules are introdued to make ertifiates equivalent, aording to the tehnology used, so as to leave room for the development of new tehnologies. In the ase of the European ertifiates market, this means oordinating the support poliies of the member States and defining ommon priorities in the field of tehnologial development. Without question, the simplest solution is that of fixed feed-in tariffs, whih enables them to be modified in aordane with eonomi performane and the rate of progress of eah tehnology. This theoretial disussion of the searh for a more equitable distribution of the surplus resulting from publi inentive poliies between produers and the ommunity reflets the publi authorities' onern to support the development of RES-E while at the same time improving publi welfare. Comparing the effiieny of prie-based and -based systems is thus a way of helping to improve the manner in whih they are supported rather than of baking the partisans of one system or the other. 27 REBUS (Renewable Energy Burden Sharing), 2001, Effets of burden sharing and ertifiate trade on the renewable eletriity market in Europe, Energy Researh Centre of the Netherlands, ECN