Policy implications

When evaluating the implications for policy makers from our analysis above, one must first bear in mind that there is no such thing as an optimal renewable energy policy instrument that may be used for all types of technology under all circumstances (Canton and Johannesson Lindén, 2010), and that policy instruments’ effects on different types of renewable energy vary (Johnstone, Hascic and Popp, 2010). Our analysis is therefore only applicable to floating offshore wind farms at their present pre-commercial stage.

From our analysis of the economic indexes, it would seem that the most effective funding regime to encourage investor support in floating offshore wind are tradable green certificates, as exemplified by the Scottish funding scheme. This is a surprising result, given the generous Japanese feed-in-tariff and the lower risk to investors inherent in such a funding mechanism. A fixed price for every MWh of output produced that is guaranteed by law as it is the case under a feed-in tariff scheme provides investors with more security than a green tradable certificate scheme whose certificate prices are subject to market fluctuations. In our study this is reflected by the lower risk beta in the Japanese model. The Scottish and Japanese schemes follow quite different economic philosophies. Yet, both funding regimes yield quite similar and rather high economic indexes, especially when compared to the other two support systems under consideration in this study. Interestingly, in their study about the most favourable type of funding mechanism from a social welfare and environmental externality abatement point of view, Canton and Johannesson Lindén (2010) also reach the conclusion that green tradable certificate schemes are to be preferred over feed-in premiums and tariffs because the certificate schemes keep market distortions to a minimum. It surprises therefore that the option that Canton and Johannesson Lindén (2010) identify as the most beneficial for society and for the market also turns out to be the most beneficial for investors.

The difference between the Scottish RO and the Japanese feed-in tariff scheme is, however, in our analysis arguably merely marginal. We therefore consider both the Scottish ROC scheme and the Japanese feed-in tariff scheme as similarly beneficial in

attracting investor support for floating offshore wind. Because the two regimes yield similar results, the authors suggest that policy makers choose between the feed-in tariff and a tradable green certificate scheme and select the support regime that best fits their country’s economic philosophy. Some governments prefer to give more power to the market while others believe in the power of regulation. Scotland, for instance, has traditionally favoured more market-based support schemes while Japan seems to accept feed-in tariffs although these do not encourage electricity generators to respond to market demand at all. The countries’ economic philosophies are so different that it would seem unreasonable to suggest that one scheme is superior to the other and, for instance, suggest that Japan should adopt a green tradable certificate scheme or that Scotland should adapt a feed-in tariff scheme. These suggestions would run contradictory to each country’s economic philosophy and are therefore both unrealistic and unreasonable.

Whatever option policymakers ultimately decide on, however, it is crucial for them to appreciate how sensitive the economic indexes are to particularly the level of funding and the risk associated with the funding. The sensitivity analyses of the economic indexes indicate how sensitive the profitability of an investment in a pre-commercial floating offshore wind farm such as the one under consideration is to variations in the input parameters. This sensitivity in turn impacts the willingness of investors to invest. The level of funding should therefore be well chosen and the risk associated with the chosen support scheme should be minimised. This risk minimisation can, for instance, be achieved through a ‘headroom’-type measure like the Scottish government has implemented for the ROS scheme or through long-term political commitment to renewable energies and their development that instils confidence in investors. If policymakers furthermore wish to decrease the risk incurred by investors, and thereby increase the attractiveness of investments in floating offshore wind farms, direct government funding in the form of grants (as was exemplified by the French support system above) can reduce the risk to private investors significantly. The tax rate, albeit considered part of the funding scheme, only has a minor impact on the economic indexes. The level of funding and the discount rate should therefore be of primary concern to policymakers when designing support scheme. The tax rate should, of course, nevertheless ideally be designed in a way that is as favourable to investors as possible. The tax rate would preferably be set at a level that balances the

interests of investors against the interest of society at large. Going into more detail on this though would be beyond the scope of this study.

As established above, a feed-in tariff, if designed similarly to the Japanese example, can be almost as beneficial to investors as a green-tradable certificate scheme, as exemplified by the Scottish scheme. A country may choose to opt for a feed-in tariff over a green tradable certificate scheme because the former can, by directly favouring renewable electricity generation, motivate pollution abatement innovation more strongly. Somewhat paradoxically, utilities tend to prefer feed-in tariff schemes because these indirectly allow utilities to cause a certain amount of pollution when using fossil fuel-generated electricity (Madlener, Gao and Neustadt, 2009). Empirical studies have proven that feed-in tariffs can be very successful in developing renewable energies. But while feed-in tariff schemes provide a certain income for all units of electricity produced and have been very effective in encouraging all kinds of renewable energies in the past, if employed over a long period of time and encouraging a large share of renewable electricity production, they can lead to market disturbances because they do not encourage electricity producers to participate in balancing the market (Madlener, Gao and Neustadt, 2009; Canton and Johannesson Lindén 2010). We therefore suggest that jurisdictions which initially create a feed-in tariff scheme should opt for more market-based support schemes over the long run.

This is because in the long run policy makers do not only have to take into account what funding regime would yield the greatest or most favourable return for investors but also consider the market realities of a scheme. Renewables have two main effects on electricity markets: The merit order effect and increased price volatility (J.

Winkler, W. Gaio, et al., 2016). The merit order effect denotes the phenomenon of electricity price decrease that occurs when renewables are introduced to an electricity system. Renewable sources of energy take precedence over conventionally sourced energy, thereby receiving higher merit when fed into the grid. Renewable energy systems tend to have lower marginal costs than conventional electricity generation and are supported without market integration, which means that conventional energy sources with higher marginal costs are replaced by renewables in all hours in which renewable electricity is available. This in turn leads to an overall electricity price decrease. While this price development may be welcomed by consumers, it is unfavourable for investors of conventional power plants, flexibility options and

renewables without support (Winkler, et al., 2016). This can lead to concerns about security of supply. Winkler, et al. (2016) point out that literature so far has not yet reached a conclusion as to whether the merit order effect will truly lead to longer-term price reductions. They do acknowledge, however, that at least in the short run, renewable sources of electricity have an effect on the electricity price and that this effect is determined by the choice of support schemes in place. Under a feed-in tariff scheme, electricity generation is maximised at all times, independently of the prevailing demand at a given time and independently of costs. A feed-in tariff thus can easily lead to over- or under compensation of generators. Under a quota or premium scheme, by contrast, the merit order effect is slightly reduced compared to the feed-in tariff scheme because generators are encouraged to respond, at least to some extent, to market conditions. At very low electricity prices, variable costs of generation are relevant for electricity generation and might become more economical to reduce generation.

An increased level of renewable energies on the grid also leads to increased price volatility (Winkler, et al., 2016). Small shares of renewable energy generation such as solar PV have no significant impact, because their generation pattern fits the demand curve well, with photovoltaics mainly producing electricity during peak demand times, for example around noon. By contrast, offshore wind power generates electricity relatively independent from day and night time and is less predictable. In order to account for this problem, some markets permit negative electricity prices, which are meant to encourage market agents to restructure the electricity system (Winkler, et al., 2016). Given these merit order effect and price volatility considerations, we can establish that if a feed-in tariff scheme encourages too much renewable energy deployment with generators producing electricity regardless of supply and demand, the electricity market as a whole will be disturbed.

The floating wind farms that are currently in the planning phase, however, are still small in size, which is the reason why their effect on the electricity price overall will be rather minimal. This assumption is confirmed by Winkler, et al. (2016) who argue that differences among support schemes are only truly pronounced in times of low demand and high supply of renewable energies. Wissen and Nicolosi (2007) complement Winkler, et al.’s (2016) point by arguing that a merit order model is only valuable to assess short-term effects of volatile source of energy on the electricity

renewable energies in a given market. For this type of evaluation, they recommend using a long-term electricity market model that factors in the use of existing capacity.

Not accounting for long-term versus short-term effects of renewable energy sources can lead to a significant overestimation of the effect renewable energies may have on the electricity market. We can therefore conclude that in the short run, feed-in tariffs are the most effective option to encourage investment in floating offshore wind while keeping market disturbances to a minimum.

Despite its benefits, however, a price-based scheme like feed-in tariff requires a lot of money to fund, and tends to be mostly financed by tax revenue. In places where the economic or political cost of raising taxes is high – as it is in the United States and Scandinavia, for example – a quantity control policy like a GTC scheme may prove more economically viable (Madlener, Gao and Neustadt, 2009).

Whatever scheme is ultimately chosen by policymakers, we expect more renewables in general and more floating offshore wind in particular to enter the market in the future. An increasing amount of renewable energies on the grid then may lead to the aforementioned increased price volatility on the market, which should be taken into account by policymakers. Keeping a feed-in tariff for floating offshore wind at a time when large-scale deployment of the technology is underway could then destabilise the electricity market. We therefore argue for the sequencing of a variety of support schemes. Once the technology becomes more mature and a greater number of floating wind farms are deployed, the feed-in tariff should be changed to a feed-in premium scheme. The feed-in premium scheme provides generators of floating offshore wind with a guaranteed payment for every unit of electricity fed into the grid, on top of their normal electricity sale. The mechanism combines the advantages of a feed-in tariff with those of a market-based scheme: one the one hand, the feed-in premium provides a secure income and a secure demand for generators. On the other hand, the total price that electricity producers will obtain for every unit of electricity generated fluctuates according to the market price at any given time. Thus generators are enticed to adjust production to demand, which reduces the pressure on the electricity price.

Our suggestion is supported by Winkler, et al. (2016) who argue that a feed-in premium constitutes a good compromise between the advantages of a tradable certificate scheme, market participation on part of the generators, and the advantages of a feed-in tariff scheme, a comparably low risk for plant operators. However, by a

similar token, the risks inherent in a feed-in premium are an amalgam between those of a feed-in tariff and a green tradable certificate scheme, exposing generators, and by extension investors, to the electricity price risk (Canton and Johannesson Lindén, 2010). In part, our recommendations are in line with those by by Canton and Johannesson Lindén (2010) whose one policy conclusion is that a sequencing approach to funding mechanisms is suitable to best develop renewable energies further.

However, in part, our recommendation to policymakers to choose between a tradable green certificate scheme and a feed-in tariff scheme but to phase out the feed-in tariff at some point and replace it with a feed-in premium scheme also runs somewhat contradictory to another conclusion reached by Canton and Johannesson Lindén (2010). They argue that feed-in premiums should be preferred over feed-in tariffs at all times and that even the premium schemes should be limited in time, regularly reviewed, and ultimately replaced by a green tradable certificate scheme once the technology has become competitive. The discrepancy between their and our findings arises because our study evaluates funding schemes from an investor’s point of view while Canton and Johannesson Lindén (2010) argue from a social welfare point of view.