The increasing concerns over climate change and the intense pollution associated with the fossil fuel industry have encouraged innovative techniques to increase the competitiveness of renewable energy sources worldwide. The increasing demand for renewable technologies promote the substitution from historically dominant and conventional energy sources. Hence, the associated change in consumer and producer behaviour away from inefficient energy has limited environmental damage and promoted countries to adopt renewable technologies. Specifically, to encourage the development and transition towards wind energy, mechanisms such as feed-in tariffs and the competitive bidding process have been encouraged.
The FiT scheme and the bidding process are the most common and successful support mechanisms that have been implemented to accelerate and increase the competitiveness of wind energy sources. FiTs operate a price-based approach for systems where the quantity of renewable energy (RE) is determined by market actors and the price is set or partially set by the appropriate regulatory body. Conversely, the auction process focuses on approaches where public authorities set a quantity target (Menanteau et al., 2003) of RE and the price is determined by competitive bidding from market actors. However, regardless of the mechanism chosen the relative merits remain similar, to stimulate a smooth transition towards renewable energy technologies.
A FiT can be structured as either a fixed price tariff or a premium tariff. The former guarantees producers to sell their electricity to the grid at a given price hence, these FiTs are market independent. Alternatively, the premium tariff adds a bonus to market price received by wind energy producers (Couture and Gagnon, 2010) and is therefore, market dependent. FiTs have led to sustained development of wind power across Europe, particularly in Germany, hence this mechanism is considered the most effective instrument at encouraging investment (Mitchell, 2006).
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The FiT provides subsidies directly to the sale of electricity from wind farms and internalizes the transition costs associated with renewable energy technologies so that the wind farm is competing on the same level as existing energy industries. Hence, the major benefit associated with FiTs is that this mechanism allows the energy producer to capture rent therefore providing an incentive for increased innovation (Bhattacharyya, 2011).
In the context of wind energy, producers are encouraged to exploit all available generating sites until the marginal cost of producing wind power equals the proposed FiT. FiTs remain flexible to adapt to market changes and ensure the accommodation of different policy objectives. Furthermore, the producer has tariff certainty thus limiting the financing risks that may be exposed in emerging markets. Hence, the relative merits of FiTs can be used as a powerful policy mechanism to encourage innovative renewable energy development and help achieve energy security and emission reduction objectives.
However, it’s not always possible to rely on prices as a policy mechanism as such the competitive bidding process is a quantity restriction mechanism whereby it’s useful for volume and budget control. Auction mechanisms promote high cost efficiency due to price competition amongst producers therefore, there exists potential to discover the real production costs of RE. A disadvantage associated with the auction mechanism is that the price paid to producers is limited to the bid price therefore removing the available rent in the case of the FiT mechanism.
The removal of rent subsequently discourages the incentive to innovate. As such, the technological learning is greater for manufacturers using FiTs because of the strong growth generating capacities and the ability to ensure the renewable sector reaches a commercial scale (Menanteau et al., 2003). Therefore, FiTs are generally considered to be the most effective instrument at encouraging investment which is essential to ensure a smooth transformation into renewable energy sources.
The high uncertainty associated with renewable electricity generation, the supply curve is not known in advance of these industrial policies. If the slope of the MC curve is gentle the quantity-based system works better in the presence of uncertainty, whereas the price-based system works better if the slope of the MC curve is steep.
In terms of installed capacity, price-based approaches have yielded better results than quantity-based approaches (Menanteau et al., 2003). In theory, there should be no difference, since bidding prices established at the same level as FiTs should logically give rise to comparable installed capacities. The difference can be explained by the merits of fixed prices, which project developers see as ensuring safe investments with better predictability and a stable incentives framework, as well as by the lower transaction costs for each project (Menanteau et al., 2003).
