Reforming Renewable Energy Subsidies

Each year in October, Germany's grid operators publish the EEG surcharge for the coming year. This surcharge is assessed to electricity consumers in order to finance the subsidy system for renewable energy. For years, surcharge rates have been climbing, placing ever greater burdens on industry and households. Renewables currently account for more than 25% of electricity consumption in Germany. The subsidy system for renewables needs to be reformed in order to avoid onerous price increases, argues ZEW President Achim Wambach.

In 2015 alone the German government paid more than 22 billion euros in renewable energy subsidies. Electricity consumers finance this subsidy system with a surcharge that is assessed to their electricity bills. While surcharge exemptions are granted to energy-intensive industrial firms, the cost burdens of the system generally harm the competitiveness of German industry. Furthermore, households have been facing steeper electricity bills, with low-income households particularly impacted by the cost of the system.

As reaction to increasing surcharges, the German government has adopted a new competitive bidding procedure for the renewable energy sector. Instead of defining subsidy rates, the government will now dictate the green-energy capacity expansion that is to take place. When planning new projects, energy providers will competitively bid for the lowest subsidy rates they are willing to accept. While substituting the government's price control with a quantity control will not necessarily improve efficiency, the competitive bidding procedure does represent an important step in the right direction.

Renewable energy no longer a fledgling industry

Renewables accounted an insignificant share of electricity production in Germany in the early 2000s. Today, however, they are a core sector of the energy economy. Greater competition should be introduced to the market for renewable energy, as renewables are increasingly capable of standing up on their own two feet. Three steps should be taken in this regard.

First, the "tendering model", which foresees technology-specific tendering procedures, should be made more open. A key aspect of a competitive marketplace is "technological openness"; renewable energy systems should be constructed in locations that make the most sense based on geographic conditions. Currently, tenders are categorised by technology and made separately – wind farms for onshore use, wind farms for offshore use, as well as areas for photovoltaic systems and biomass at specific locations. Accordingly, blanket calls for tender should be made, without restriction to specific technologies.

Second, the way in which renewables are integrated into the electricity market should be reformed. Price signals are a crucial mechanism for aligning supply and demand. However, renewable energy has been insulated from this basic mechanism. Greater price awareness amongst renewable-energy producers could set incentives for the increased deployment of energy storage technologies. This would allow more electricity to be stored when prices are low and sold when prices are high, thus improving system efficiency.   

Third, the European emissions trading system (ETS), one of the most important tools for reducing greenhouse gas emissions, should be reformed. The current trading mechanisms ignore the heating sector as well as large segments of the transportation sector. ETS sets market prices for CO2 emissions, which in turn makes renewables more competitive compared to coal- and gas-generated energy.

In Germany we have made great progress in recent years. Renewable energy is no longer a fledgling industry, and, as such, does not need excessive shelter by the government. By promoting market-based mechanisms in the renewable energy sector while strengthening the emissions trading system, it should be possible over the mid-term to phase out renewable energy subsidies altogether. Only then will it be possible to speak of a sustainable energy policy.

A shorter version of this article appeared in the 13 October 2016 issue of the German business newspaper "Handelsblatt".