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How (Best) to Subsidize Decarbonized Energy?
Write by Alexis Gléron november 2024
As discussions around the Budget Bill (PLF) and the Multiannual Energy Program (PPE) intensify, subsidies for renewable energy are back in the spotlight. The decline in electricity prices and the market value of renewable energy (capture price) has significantly increased the public service charges required to finance support mechanisms. Combine this with record public deficits, and the atmosphere becomes, to say the least... electric (pun intended).
This challenge is not unique to France; many European countries face a similar situation. They aim to develop renewable energy to reduce dependence on fossil fuels but are constrained by tight budgets and the need to manage financial resources allocated to this development.
How can governments achieve this? What changes to support mechanisms are needed in light of the growing share of renewables in the electricity mix? And what about nuclear energy?
Is the State "Long"... Too "Long"?
Feed-in tariffs and premium contracts, although operationally distinct, have similar impacts on public finances. In both cases, the State guarantees a fixed price (pay-as-produced) to renewable energy producers for a long period (15–20 years), enabling them to amortize their investments. The market value of renewable electricity is assessed through benchmarks such as the weighted spot price (the famous M0) for premiums or a basket of forward prices for feed-in tariffs.
If the market value exceeds the guaranteed price, the State makes a profit—like in 2021–2022 during the price surge. But more often, the reverse happens: the State covers the difference between the guaranteed price and the market price. However, electricity prices are highly volatile: after peaking in 2022, 2024 saw record numbers of negative prices. When reference prices plummet, the cost of support mechanisms skyrockets.
Financially, the State adopts a speculative “long” position in the electricity market. Unlike serious market players like electricity providers, the State remains exposed to price fluctuations. While the Energy Regulatory Commission (CRE) is exploring solutions to adjust reference price calculations, the State’s "long" position persists because no standard forward contract covers the timeframes of these support mechanisms.
A Structural Issue: Renewable Energy Cannibalization
When renewable energy development outpaces demand growth, the capture rate (market value captured relative to the average) decreases due to cannibalization: the more production during sunny or windy hours, the lower the prices. This loss of value increases costs for the State.
Although premium contracts encourage producers to halt generation during negative prices (limiting State losses), their reliance on spot prices heightens financial risk. While suitable for immature technologies like solar and wind in their early stages, these mechanisms have now become highly speculative bets.
Alignment of Goals and Demand
An often-overlooked point: no mechanism ensures that renewable energy deployment matches electricity demand during peak renewable production hours. PPE targets are based on politically influenced scenarios without adjustment for significant discrepancies.
If renewable capacity outpaces demand growth, cannibalization transforms the State’s financial wager into exponential losses. Should public service charges become unsustainable, the State might abruptly curb deployment or renegotiate existing contracts, creating regulatory uncertainty for producers.
Recommendations for Support Mechanisms
A robust support mechanism for an electricity system with high renewable penetration should meet two criteria:
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A predictable and known cost per MWh, enabling accurate budgeting.
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Alignment between renewable capacity development and electricity demand trends.
Upfront Grants or Tax Credits
Providing an upfront investment grant (or a tax credit, as in the United States) based on installed capacity is straightforward and fulfills the first criterion. However, this approach can cause boom-and-bust cycles: excessive grants lead to a construction frenzy, while insufficient grants stall projects.
A Premium Based on Secured Contracts
An alternative is to pay a premium per MWh based on the selling price secured by developers (through a PPA or a supplier contract). This mechanism stabilizes support costs for each installation while encouraging developers to secure long-term contracts with end consumers. Premiums would be allocated through tenders with defined budget envelopes, ensuring better cost control.
This approach would guarantee affordable renewable electricity for consumers over the long term, stimulate electrification, and align capacity development with demand trends.
The State could act as a guarantor of PPA payments and establish a last-resort buyer (like BPI in France). For small installations (residential or small territories), an investment grant remains preferable. However, feed-in tariffs should be avoided for installations of all sizes.
