What’s up with record low renewable energy prices? Policy innovation is key to harnessing renewable energy potential.

There’s a revolution happening in the world of renewable energy policy. At last count, 48 countries had adopted auction-based approaches to subsidizing renewables, with an additional 27 countries seriously considering the idea.

The idea is simple (in theory). Set a target level of investment in renewable energy capacity, and then allocate these contracts to the lowest bidders. This idea is also somewhat polarizing because it marks a move away from “feed-in tariffs” which have been used in many countries, for many years, to subsidize renewable energy projects.

Feed-in tariffs (FiTs) have traditionally been set well above the prevailing electricity price. The concern among some renewable energy advocates is that determining tariffs via competitive auction will drive renewable energy subsidies down…or eliminate them entirely.

The potential to get more bang for each renewable energy buck is precisely what appeals to the governments on the supply-side of these subsidies. As renewable energy markets mature and penetration increases, a growing number of countries are looking to reduce subsidy costs by spurring competition.

The rise of auctions and the fall of subsidies

Some notable countries have recently turned green on the map above. Germany is one. Germany’s feed-in tariff system produced the “solar miracle” (truly miraculous to see 38 GW of solar PV capacity in a country that has the same solar potential as Alaska). But this came at a cost that was ultimately too high for consumers to bear. Last year, Germany ended feed-in tariffs in favor of competitive auctions for power purchase agreements.

India is another important example. For years the Indian government has guaranteed long term payments at above-market tariffs to renewable energy producers. These FiTs are rapidly being replaced by auctions in the hopes that competitive pressures will drive down procurement costs and increase transparency.

With all this auction adoption action, you might be wondering what’s happening to renewable energy procurement prices. The graph below shows auction prices for solar PV:

The general trend that jumps out is the decline in prices through 2016. In 2017, this downward trend has continued.

In June, we saw large-scale solar PV procured at an average price of $70/MWh in Germany’s most recent solar auction. Last month. France announced results of its second large-scale PV auction which contracted with 507 MW at an average price of $64.9. Since February, India has held four major solar power auctions with tariffs falling by as much as 26% between the first and the latest auction. In May, winning bids were as low as $38/MWh for utility-scale solar projects.

Recent wind auction results have also been making headlines. Germany held its first offshore wind auction in April. Winning bids were below the market price for power in Germany. This “subsidy-free offshore wind” is being celebrated as a “moon-landing moment”. India held its first-ever wind power auction in February. Last year, wind projects in India were contracting at FITs in the range of $62-$93/MWh. This year, the winning auction bid price was INR 3.46/kWh ($54/MWh).

Good news for a change?

Looking at how procurement costs are falling among countries that had previously relied on other mechanisms, it seems possible – even likely – that auction-based procurement is accelerating price discovery and reducing procurement costs relative to what we would have seen otherwise.

This sounds like good news (unless you are a project developer seeing revenues melt away). But is it really?

It’s good news if falling procurement costs reflect the market’s ability to seek out the most cost-effective projects, and if this competitive pressure will fuel efficient innovation going forward. But there are legitimate concerns that the cost reductions we are seeing today are short-lived and/or illusory.

Some critics argue that small/medium sized companies can be at a disadvantage in these auctions. If smaller outfits start exiting, a more concentrated wind and solar industry could mean less competition in the long run.

It’s also possible that auction-based procurement is forcing bidders to be too aggressive. If the winning bids are based on overly favorable assumptions about future equipment costs or debt financing, the winner’s curse could come back to bite us. Uber-aggressive bids could also reflect developers’ willingness to take a hit in order to enter a new market, or strategic hopes to renegotiate additional remuneration after winning the auction.

This kind of under-bidding could amount to a risk worth taking, particularly in emerging economies with ambitious renewable energy investment targets. As one Indian analyst observes: “If the first 20 gigawatts goes to scrap, but as a result, it brings competitive and widely scalable solar, they (the government) are happy to have that.” Moreover, there are things countries can do to mitigate under-bidding (e.g. impose pre-qualification requirements, such as bid bonds, to screen participants).

Learning by doing

The long-run political viability of ambitious global emissions reduction targets depends critically on finding lower cost paths. Early evidence from renewable energy auctions suggests that market-based procurement could be driving down procurement costs. Will this reduce the long-run social cost of a global energy transition? I think it’s too early to tell.

The ultimate success of this policy shift will depend to a significant extent on the gritty auction design details (which I have glossed over entirely in an attempt to keep this blog quasi-compelling). We’re seeing lots of variation in auction design. With 48 real-world experiments in progress (and more on the way), there’s a lot we can learn about how auctions can be designed to deliver sustainable cost reductions. Careful analysis of this large-scale experiment will be critical. We need technology innovation and policy innovation to fully realize renewable energy potential.