A feed-in electricity tariff is a policy mechanism used in many countries to support renewable energy technologies until they can compete with other methods of generating electricity. But, as experience in the Netherlands shows, it is a challenging policy task to support renewables without wasting government money or creating perverse incentives.

The Dutch government has implemented two feed-in tariff schemes since 2003, the first being the Environmental Quality of Electricity program (in Dutch, the Milieukwaliteit van de Elektriciteitsproductie), or ‘MEP'. This was followed in 2008 by the Promoting Renewable Energy scheme (Stimulering Duurzame Energie), better known as the SDE.

The general principle behind the Netherland's policies has been to guarantee generators of renewable-energy-based electricity a premium payment per kilowatt hour (kWh) of energy that takes into account production costs plus a 'fair' profit margin, which is differentiated by technology. This is different from the way feed-in tariffs are applied in most other countries, where electricity distributors are often obliged to buy renewable energy at a pre-determined price (which raises consumers' electricity bills).The Netherland's scheme is funded by taxpayers.

The economic justification for feed-in tariffs is under debate, but proponents argue that the subsidy is defensible given the ‘positive externality' of reduced CO2 emissions and the environmental and economic gains to be won by helping a young industry through its teething stages. As it is, renewable-energy producers find it difficult to obtain the investment and experience they need to start up and become cost-competitive. Opponents argue that renewable-energy-based electricity offers no additional CO2 reductions if it exists alongside a cap-and-trade permit market (although it does shift the burden of who must reduce their emissions), and that it would be more cost-effective for the government to invest in research and development.

The principle of a good scheme is that it should help technologies build a foothold in the market until they can compete without direct financial support. It should be regarded as stable if it is to be attractive to investors, but needs to be flexible too, to adapt to changing market conditions. Above all, it needs to be effective (achieving the desired results) and efficient (doing so cost-effectively). And it should be temporary.

Results of the Netherlands' first feed-in tariff, the MEP, were mixed. The scheme was designed to guarantee a fixed payment to reduce the cost of renewable-energy-based electricity for 10 years. The price was set to make up the difference between the expected long-term electricity price in the market and the cost of producing electricity from renewables.

The scheme's effectiveness was undisputed. The goal was for renewable energy to provide 9% of national consumption by 2010. By 2006 it was already apparent that that target would be met.

But the scheme performed more poorly on the criterion of efficiency. The payments for renewable-based electricity were based on an assumed market price for electricity of 2-3 euro cents per kWh in the long-term, whereas the actual price was much higher than expected, between 6 and 8 cents per kWh. This meant that the MEP offered a greater financial incentive - and cost a lot more money - than had been planned. Furthermore, it was open-ended: all applicants that met certain minimum criteria could benefit from the feed-in tariff. For these reasons, the public came to see the MEP as an uncontrollable policy instrument that created a windfall for operators of renewable-energy-based power plants. The current annual expenditure is around €600-700 million a year, although figures vary depending on the market price for electricity.

This combination of a faster-than-expected expansion of renewable energy and unpopularity due to its inefficiency led to the MEP's early retirement. It was closed to all new applicants as of 18 August 2006. It will, however, continue to make payments to all the companies that joined the scheme within its lifetime until they have received their 10 years-worth of support.

The SDE, introduced in April 2008 and still in force today, was designed to correct some of the MEP's short-comings. The payment to renewable-energy producers, called a flexible premium, is now calculated on a yearly basis taking into account electricity prices as realized on the spot market. Final subsidies are paid at the end of the year, corrected to take into account the average price of electricity on the spot market throughout that year. New applications are approved only if the budget ceiling has not been reached. And the duration of support has been extended from the previous 10 years to between 12 and 15 years, depending on the technology.

Renewables-based electricity is intended to generate 35% of the Netherlands's electricity by 2020. Most of the new capacity is made up of renewables registered under the MEP, which have been late coming online. Contributing factors to the pause in project development between 2006 and the beginning of 2008 include the economic crisis and the tight credit market in 2008-2009, as well as unfamiliarity of the market with the new support scheme.

The cost-effectiveness of the SDE remains an open question, as it is only one-and-a-half years old. Of concern among its supporters is the continued stability of the support. Fine-tuning the instrument from time to time can be good, but major changes can be disruptive. The SDE needs time to establish itself as reliable support mechanism for renewable electricity.

Clearly, if a government offers a big enough subsidy, just about any goal can be achieved. But at any given time there are many competing demands on public finances. Ideally, policies need to offer enough stability to be effective and enough flexibility to be efficient. The market for renewable energy is particularly challenging in this regard, where prices are volatile and new technologies can emerge quickly. It all comes back to a question of taking as much care as possible to ensure that policies are intelligently designed.
 
 Dr S.M Lensink works at the Energy research Centre of the Netherlands (ECN)